P2P Lending - How does it work

P2P lending involves direct lending between individuals, bypassing traditional banks. It attracts investors seeking higher returns compared to fixed deposits, yet wanting to avoid the risks of the stock market or diversify their investment portfolios. On the borrower side, P2P platforms provide loans to individuals willing to pay higher interest rates, often those who do not qualify for traditional bank loans. This model benefits both parties by providing investors with attractive returns and borrowers with access to funding otherwise unavailable through conventional financial systems.

For example, if a borrower takes a loan from a P2P lending platform at an interest rate of 21%. Out of this 21%, the platform takes 2% as a service fee and allocates 4% to cover the risk of NPAs (Non-Performing Assets), which are potential loan defaults. The remaining 15% is the interest margin passed on to the lender, providing them with their return on investment. Illustration for the same is given below.

Key players in the P2P lending space include Lendenclub, Liquiloans, and Lendbox. Recently, these firms have formed partnerships with fintech companies like BharatPe and Cred to launch products such as 12% Club by BharatPe and Cred Mint, offering investors returns of 12% and 9% respectively. These collaborations say the intention is to create accessible, high-yield investment opportunities for individuals seeking better alternatives to traditional savings options.

Continuing with the earlier example, suppose a borrower is charged 21% interest, and the 15% margin is meant for the lender. Out of this 15%, a portion—say 3%—is allocated to fintech companies like BharatPe or Cred for facilitating the onboarding process. The remaining 12% is passed on to the lenders who invest through these fintech platforms, providing them with their return on investment.

P2P lending is not a new concept in India; it has been around for quite some time. However, early players in this space faced challenges because they tried to directly match borrowers and lenders on a 1-to-1 basis, which significantly increased the risk for lenders if they were paired with high-risk borrowers. This issue has since been mitigated by diversifying each lender's money into multiple small portions spread across hundreds of borrowers, thereby reducing the individual risk exposure for lenders.

Although these platforms are technically P2P, some companies also leverage the funds to offer loans to their customers as no-cost EMIs, thereby expanding their customer base. This is a debatable topic as this is not really a p2p anymore.

Key metric tracked

Assets under management (AUM)
Non performing asset (NPA)
Fund diversification %
Interest p.a. earned by lenders
Average ticket size (ATS)
Average Tenure of loans

Risks associated with P2P lending

The reports submitted by many P2P lending platforms are often unaudited, which raises concerns, especially regarding NPAs (Non-Performing Assets). While things may seem fine when NPAs stay within expected limits, they can surge drastically during unfavorable market conditions. For instance, if the NPA rate climbs to 15% instead of the projected 4%, the margin left for the lender can drop to just 1%, especially if users are onboarded via platforms like BharatPe. This is highly likely as these are No Collateral loans. This highlights the importance of managing and mitigating risk in P2P lending.
This is a highly regulated industry where a change in regulations can significantly disrupt or even overturn the entire business model.
Liquidity risk, Expected risk reward mismatch are some of the other risks associated

Concerns & Regulations

The enticing advertisements lure customers by presenting these offerings as attractive investment opportunities. However, these platforms officially label themselves as tech platforms, distancing themselves from the role of investment managers or entities accountable for managing investments. This approach can mislead customers into investing without fully understanding the high risks involved. In response, the RBI has set a ceiling of 50L per lender and also announced that these platforms are prohibited from promoting themselves as investment products with features such as tenure-linked benefits, assured minimum returns, or liquidity options.
Earlier, the p2p platforms can get authorization from lender once though their money will be split into multiple small portions spread across hundreds of borrowers. Now RBI has regulated this saying they need this to autorised individually for how many ever split is done from the lender’s money. This could mean hunderds of authorisation. RBI had given 3 month time to be compliant with the regulation. It would be interesting to see how these platforms overcome such regulation which fundamentally challenges their business model.
Previously, P2P platforms could obtain a one-time authorization from lenders, even though their money would be split into multiple small portions spread across hundreds of borrowers. However, the RBI has now regulated that each split from the lender’s money must be individually authorized, potentially requiring hundreds of authorizations. The RBI has provided a three-month period for compliance with this regulation. It will be interesting to see how these platforms navigate such a change, which fundamentally challenges their business model.
RBI is concerned in general about reducing bank deposits and RBI has introduced additional regulations, such as
- Prohibiting platforms from committing to cover defaults, as they may not be able to fulfill this promise in all circumstances.
- Mandating that lenders must receive immediate credit (T+1) as soon as the EMI is received from the borrower.

These changes impose further challenges on P2P platforms, pushing them to adjust their operational models and practices accordingly.