News Analysis | India may rightly be going the China way on P2P lending

Reserve Bank of India

In 2014, the peer-to-peer lending (P2P) model was booming in China. Touted to be a market worth upwards of a few hundred billion dollars, it triggered an aspiration among many entrepreneurs in India. From FairCent to Lendbox to Liquiloans, there was a lot of private equity interest flowing into this space.

Nearly three years later, the Reserve Bank of India (RBI) came out with regulations for P2P lending. NBFC-P2P was created as separate category of non-banks that would function within the ambit of regulations. Cut to 2024, when there is existential crisis around the model, exactly the way it played out in China. Only this time around, if players shut shop, the ones to take the blame would be the companies themselves.

Where the model failed

By definition, P2P is a pooled lending business. Investors come together to fund small businesses on an online platform. The returns  the businesses earn are shared with the investors; very similar to the chit fund way of working prevalent until about two–three decades ago.

Thankfully, unlike chit funds, P2P players were not targeting all and sundry. High net-worth individuals, and those with a propensity for risk and  an appetite for investment products beyond the plain-vanilla options were the potential investors. This is where the model failed.

P2P lending platforms were masquerading as a high-return investment option, often delivering mouthwatering gains in a span of just a few months.

All this is set to end with four major clauses introduced by the RBI on how NBFC-P2P players can operate.

Among the notable ones are  diktats on not assuming credit risk, mapping lenders and borrowers, restrictions on the utilisation of lenders’ escrow accounts, and transfer of funds within a day from when it hits the escrow accounts.

What is expected to hurt the players the most are the  norms pertaining to the escrow accounts.

The industry is hopeful that when it makes a representation to the central bank on this point, which is expected to happen later this week, the regulator may undo some of the restrictive clauses. But if that doesn’t happen, the fate of India's P2P players may well go the China way. Who’s to take the blame for this?

What went wrong with the model?
By 2017, when rules around P2P lending were formalised, India was a well-developed financial services market. Loans were available for every category of borrower, albeit at different costs and different degrees of credit penetration. For P2Ps, positioning as merely a pooled lending model wasn’t quite cutting it.

It was around the pandemic when interest rates touched a rock bottom that P2Ps started making waves. Assured returns of 11–12 percent initially, which went over 16 percent later, the ability to earn this in a short span, and the flexibility that lenders enjoyed in structuring these products made P2Ps a hit, especially among the rich.

The success of this model was compelling enough for fintech majors such as Cred and BharatPe to show interest in P2P businesses. It gave them indirect access to the lending model. However, a few players who stuck with the rulebook, not positioning their products as exotic investment options, lost out. Will the RBI acknowledge the presence of a few good men, or will the industry pay the price for the sins of the biggies?

If one is to go by what happened in China, the latter seems more likely and rightly so, given that the industry has already been given a second chance. In December 2023, the RBI came out with dos and don'ts for the sector with guidelines on lending and borrowing. While the industry started showing signs of change, it was far from satisfactory.

Should we give it a third chance then?

There are over 2,000 P2P players including many unlicensed entities. They proliferate in smaller cities and towns where financial literacy may not be at its best. Even if the P2P industry comprises less than five percent of India’s total lending,  it's best to nip the problem in the bud.