Lending on P2P platforms: A risky proposition; not an investment

In December 2019, the Reserve Bank of India (RBI) allowed lending on peer-to-peer (P2P) platforms to the tune of Rs 50 lakh, up from the previous limit of Rs 10 lakh. That’s good news for those who borrow from P2P platforms, but should lenders jump to lend more? Mumbai-based Surendra Mistry, 31, would disagree, in all likelihood.

Having heard some positive reviews of how one can “earn” some extra bucks by lending online at higher rates, Surendra decided to try his hand at lending money on a P2P platform. That was in November 2018. Tempted, he withdrew Rs 1 lakh from his fixed deposits that had just matured and used the money to lend to borrowers who came with a low-credit rating of between ‘D’ and ‘F.’ P2P platforms, typically, profile and then rate borrowers depending on their repayment and borrowing history, bank balance, income levels and so on. A borrower with an ‘A’ rating  is considered to be the best of the lot; amounts lent to such borrowers fetch the lenders around 10 to 12 per cent. A person with an ‘F’ grade (known to be of the weakest credit profile) gets to borrow at a rate of around 25 per cent. Says Surendra, “With the greed to earn higher returns from lending on P2P platforms, I decided to lend to lower-risk-grade borrowers.”

The lending amount Rs 1 lakh was divided among 20 borrowers. “In the initial two months I received the monthly instalments on a specific date assigned by the platform. However, afterwards, some of the borrowers started postponing instalments and others defaulted for a couple of months,” says Surendra. Within a span of one year, he could recover a meagre Rs 20,000. This amount included principal and interest. He couldn’t recover remaining amount.

Surendra made his first mistake of looking at lending on P2P platforms as an ‘investment’ that earns ‘returns.’ His second was he that he deployed his FD proceeds – a conservative investment – and deployed them into a high-risk gamble called P2P lending. His third mistake was that he did not do proper due diligence of his borrowers. His move had ‘risk’ written all over it.

What P2P lending entails

Experts point out that the default rate is 2-7 per cent on P2P platforms. Rajat Gandhi, Co-Founder & CEO of P2P lending firm, Faircent.com says, “A lender needs to take default rates into consideration before lending and know the credit profile of the borrowers.”

P2P platforms offer unsecured loans, and interest rates are higher for borrowers compared to those offered by banks and NBFCs. Faircent, Lendenclub, i2ifunding, Cashkumar, RupeeCircle and Lendbox are some prominent P2P platforms. A lender should not go beyond two to three platforms for lending. All P2P platforms insist on a certificate from a chartered accountant certifying the lender’s networth because it's mandatory as per regulations. Typically, a lender who is ready to lend in excess of Rs 10 lakh on a P2P platform is required to have a minimum net worth of Rs 50 lakh.

Borrowers can request for loan amounts of as low as Rs 500. The minimum loan tenure is six months and the maximum is 36 months.  Harshvardhan Roongta, Principal Financial Planner at Roongta Securities says, “Do not earmark more than 10 per cent of your investible surplus to P2P lending.”

Risky borrowers

Typically, people who borrow on P2P platforms are those who don’t get loans from banks because of a weak credit profile or very low income. Salaried people with a monthly income of between Rs 10,000 and Rs 25,000 look for short-term loans (for medical emergency, business, to repay credit card dues, etc.). Some self-employed, those running small boutiques and professionals such as doctors and lawyers too look to borrow money for short-term requirements.

A CEO of P2P lending firm, requesting anonymity says, “Around 20-30 per cent borrowers enrolling on P2P platforms have no credit history. Generally, they don’t get loans from banks or non-banking finance companies (NBFCs).”

P2P platforms rely on income proof, bank statements and other data points, which include social, educational, financial history, etc. to come up with a credit score / credit profile. A credit evaluation report of the borrowers is shared on P2P platforms to know the income level, stability at work/business, default on loans (if any in the past), credit score (if available), etc.

Gandhi of Faircent says, “A lender must take an informed decision on the borrower before lending and evaluate the borrowers’ fixed obligations to income ratio (FOIR), average quarterly balance maintained with bank mentioned in credit report, bureau data  (which includes number of loans borrower is servicing, loans settled, credit card dues, etc.) from credit report.”

However, as per regulations, a lender cannot give more than Rs 50,000 to the same borrower across all P2P platforms, at any point of time.

Safeguarding your interest

P2P platforms are mandated to be registered with the RBI. In case a P2P lending platform is still in process of applying for a NBFC-P2P license from the RBI, but decides to shut the operations, there is a substantial risk that you will not get all of your money back. Also, there are some P2P platforms not registered with the RBI and claim guaranteed returns on lending, through advertisements or via their websites.

Abhishek Gandhi, Co-Founder at P2P lending firm, RupeeCircle recommends, “Diversify your P2P lending across multiple borrowers with different risk grades and tenures and lend small amounts to a single borrower to reduce default risks.”

Some P2P platforms help lenders in recovering loans; this provides some comfort. But carrying out the due diligence of borrowers remains extremely critical, if you must lend on P2P platforms. If a borrower is present on three P2P platforms, his credit report on all these three platforms will reflect his/her entire credit history.

Moneycontrol’s take

First things first: Lending on P2P platform is not an investment; one that fetches returns. It is merely deployment of funds that are meant to help others borrow temporarily, and one that earns the lender some interest. Any P2P platform that advertises this as an investment (from a lender’s point of view) must be avoided.

If you must lend, it’s always safer to restrict to borrowers with the highest credit rating. Ensure that you have surplus funds. Be prepared for defaults and, worse, to pursue defaulters.