Asset classes that beat inflation are an ongoing subject of discussion, and P2P lending has emerged as one of the options.
WHAT ARE P2P LENDING PLATFORMS?
Ola and Uber started a trend of bringing the seller and buyer of services on a common platform. Swiggy and Zomato followed to become a feature of your life.
P2P lending platforms bring lenders and borrowers in the same space. It was initially meant to enable borrowers rejected by banks to raise money at higher interest rates. It soon became an online investing avenue for people with surplus funds, who wish to get higher returns than what other asset classes offer.
WHERE DOES THE CATCH LIE?
Investors lend money at their own risk.
Banks are financial intermediaries that accept money from depositors and lend it to borrowers. However, the depositors earn a fixed rate of interest, and the lending risk is entirely that of the bank.
P2P lending platforms provide the technology to shortlist borrower profiles based on their credit rating and other financial data. They assist the lender in recovery by making collection and debt recovery calls.
Beyond this point, the risk is entirely borne by the lender.
Higher the risk, higher the returns. Lesser the risk, lower is the rate of interest earned by the lender.
FUNCTIONS OF P2P LENDING PLATFORMS?
- Verification of information provided by borrowers
- Getting their credit scores and other financial information
- Profiling borrowers with algorithms
- Onboarding lenders
- Classifying lenders based on their risk appetite
- Helping diversification of risk with certain rules
- Enabling online deals between the lender and borrower with all documentation
- Devising products for borrowers to get money based on their needs and risk profile.
- Designing products for lenders to spread risk
- Sharing information based on research and analysis
WHO CAN BE A P2P INVESTOR?
- Individuals with valid KYC documents
- RBI-listed finance companies
- Registered Companies
HOW DOES P2P LENDING WORK?
P2P investors can sign up on a reliable platform certified by RBI as a P2P-NBFC.
A list of certified institutions is available here.
They park funds to be invested in an Escrow account in their name.
A single investor can take a maximum exposure across all P2P lending platforms in India of Rs. 50 lakhs. However, an investor needs to submit a net worth certificate of at least Rs.50 lakhs, to move beyond the amount of Rs.10 lakhs. Some platforms facilitate obtention of net worth certificate from a chartered accountant.
The ticket size of a single loan is maximum Rs.10 lakhs. Investors are discouraged from catering to more than 10%-20% of a borrower’s needs, in the interest of risk diversification.
Check the default rate in various categories published by the platform.
Scan borrower profiles and choose one or more, going by your risk appetite, expected rate of return and credit ratings of borrowers.
Sign agreements online as per procedures on the platform.
Transfer money from your escrow account to the borrower.
Inform the platform about defaults, but be aware that risk and loss are entirely yours.
Spread your money across different borrowers, to diversify risk.
MORE OPTIONS FOR RISK DIVERSIFICATION
1. Double Loans
The platform collects money from different investors, and lends it to eligible borrowers as per their algorithms.
The rate of return can vary depending on performance of the loans.
P2P LENDING FOR BUSINESS
2. Pool Loans
The loans are given to small traders and businesses to cover their working capital requirements – like money stuck in micro-ATM transactions for a couple of days, or funding the wallet of forex traders in the morning.
3. Line of Credit
Here, one can lend to small businesses by way of a predetermined limit. The borrower draws as much as needed.
EXPECTED RATE OF RETURN ON YOUR INVESTMENTS
Generally, the rate of return is in the range of 10%-12%.
One can charge a higher rate of interest on high-risk loans.
The platform charges transaction fee and other kinds of fees. Read terms and conditions carefully to understand how much will you actually earn, after the platform has taken its cut.
IS P2P LENDING A GOOD INVESTMENT?
This is one of the emerging new asset classes in India. The cons are not fully evident as yet, so a good asset class strategy is to block only a small percentage of your net worth.
The growing popularity of P2P lending as an investment, stems from the fact that bank deposits and mutual funds are unable to deliver returns that beat inflation in the short term.
You need to have clarity on your risk-bearing capacity and risk appetite, depending on the stage of life you are in.