03 May, 2016

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Peer to Peer Lending - A Unique way of Funding

Peer to Peer Lending - A Unique way of Funding

Planning for luxurious holiday ? Dreaming of extravagant marriage ? Want to learn some expensive courses ?

 

Yes and why not.Everyone has right to dream big.But do these dreams come true even if you don’t have a genie ?

 

Yes of course. This genie is known as P2P lending – Peer to Peer lending. C’mon, let’s understand more about P2P lending , its benefits , regulations and how it will fare in India.

What is P2P lending?

 

P2P Lending or Peer to Peer Lendng refers to newest concept in the market , where a group of lenders are ready to lend multiple borrowers depending on there credit ratings.This financing arrangement is carried out by online platforms like , who connect and match the borrowers to the probable lenders.These online platforms charge fees for this service which consists of credit analysis of the borrower’s profile , recovery or collection services etc.

 

Reasons behind rise of P2P Lending

 

- Banks and other financial institutions have stringent requirements towards repayment and security.

- Costs of securing the formal loan from such banks or financial institutions are high.

- Lengthy and time consuming process of approving the loan defeats the purpose of borrowing.

- The online platform or the P2P lenders do not have the external cost of capital as banks or financial institutions.this brings down the hurdle rate or break even rate , which is quoted as interest.

- Interest rates vary for each P2P Lending platform and based on the demand of the lenders.

 

How does Peer to Peer lending work?

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- There is online platform who will carry out P2P lending , by matching the needs of the borrowers to those lenders who are ready to shell out money for lending these borrowers.

 

- This online platform is responsible for collecting details as below

 

1) Basic details such as purpose of the loan , amount of loan required , name and address of the borrower, educational qualifications , employment or self employment details etc.

 

2) Financial details such as financial status , credit rating analysis based on CIBIL (Credit Information Beurau Limited )score etc.

 

- After fulfillment of these formalities , verification procedure is carried out by the online platform.

- So whenever the borrower’s profile is ready , it is hosted on the website for letting the lenders know the details of the borrower.

- If any lender/s is/are interested to lend money to the borrower , then he/they will approach the borrower with their offer.

- Certain platforms allow the risk to be segmented by allowing the lenders to lend only a part of loan requirements.

- Also, these portals allow lending to multiple borrowers which implies diversion of credit risk and default risk attached to the single borrower model.

 

Benefits of P2P Lending

- Quicker way of obtaining the loan.

- Cost wise beneficial to borrower.

- Lower interest rates for loan.

- Lesser formalities as compared to banks or financial institutions.

- One time processing fee for the loan proposal.

- Collection activity carried out by the online portal hence no stressing over recovery.

 

Disadvantages of P2P lending

- No regulations by any standard authority ,hence not safe.

- Reasonability of interest and processing fees not ascertainable.

- No surety with respect to returns or/and principal of the amount lent to the borrower.

- A borrower may choose to borrow from various portals in the absence of any regulations. This will defeat the very purpose behind P2P lending.

 

P2P Lending in India

 

Recently RBI has introduced a proposal for regulating the Peer to Peer Lending, which will ensure its optimal growth in a holistic way. This regulation is expected to bring about a rise in clientele .This proposed regulation will with distribution and disbursement of credit to micro and small size business entities.

 

However , this regulation has its own hacks.It proposes to set minimum capital requirement , thereby regulating online portals facilitating P2P Lending.However actual funds flow will be from lender to borrower.This funds flow should be a main concern for regulation.

 

This is because the online portals nowhere record the amount lent by lender/s to the borrowers/s.Hence, even if the regulation is amended to recognize P2P lending separately, the amount actually lent will escape out of scope.

 

If not regulated , P2P lending can turn into a troublesome activity rather than an expansion of funding arrangements.This is what happened in China , where the P2P Lending actually turned into a scam.

 

CONCLUSION

 

India is seen as the most progressive country with well developed financial market .However , financial literacy and financial freedom concepts are still valid in books here, given the large population.

If RBI is successful in devising and implementing the appropriate legislation for P2P Lending regulation, then this sector will surely help a lot of small and micro companies who are unable to obtain credit from banks and other financial institutions.

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