India is not China in P2P lending; it has robust model to manage risks for investors that world can learn from

I came across an article that raised concerns about the risk management practices in the peer-to-peer (P2P) lending space in India. This is why I am compelled to remove all doubts about the robustness of the P2P lending space in India.

Here are the reasons that makes the Indian P2P lending space unique and relatively safe for investors.

Well-regulated by RBI

P2P or lending has grown dramatically since the Reserve Bank of India laid down a regulatory framework for the sector in 2017. At the time of introducing regulation, the sector barely had Rs 100 crore in assets under management and now it has more than Rs 7,000 crore in assets - a growth of almost 100% last year, thanks to robust regulations.

P2P lending, as the name suggests, is lending between the lender and the borrower. In India, RBI regulations require such lending to be facilitated by an NBFC-P2P platform which has taken necessary RBI approvals. Both the lender, or investor, and the borrower are retail users where the lender can at most lend a total of Rs 50 lakh on such platforms.

Middleman replaced by technology which expands its outreach and reduces cost

P2P lending bypasses conventional middlemen in the credit (lending) value chain and thus, reducing capital distribution inefficiencies. This leads to unlocking higher returns for the investor as well as lower costs for the borrower by virtue of systemic efficiency. The model therefore, carries immense potential to not just deliver good returns to investors but also enable bridging the economy's credit gap.

No guarantee of return but efficient risk management through diversification

While a P2P platform cannot guarantee returns to a user, it can help an investor effectively manage its risk by enabling the investor to have a large and diversified portfolio of borrowers. To enable a diversified portfolio, any borrowing amount that a borrower needs is broken down into small fractions, where each of these fractions then comes from a different investor. With technology, this fractionalisation can be both intelligent and extremely cost-efficient, even for very small investment tickets.

Popularity and relative predictability of returns have led to sometimes incorrect comparison with fixed deposits and savings accounts. It must be expressly stated that no platform can realistically promise or even predict fixed returns. Investors must note that returns stated by most platforms are the maximum possible earnings, and that these are not assured. Marketing and investor education campaigns run by platforms need to be guarded and prudent about any comparison with fixed deposits or savings products as these are fundamentally distinct.

Liquidity offered as innovation and as per standard practice of MF and others

The concerned article stated that platforms are offering P2P lending products as liquid products. It must be noted here that like most investment products, including mutual funds etc., liquidity or premature withdrawals are subject to best effort basis only and like returns, are not guaranteed. Platforms today facilitate withdrawals by enabling lenders to sell their loans to other willing lenders. The willingness and availability of the latter are outside the scope of the platform.

The concerned article also states that platforms tend to sit on un-invested lender capital as a negative. Here, it must be clarified that no platform controls the participating lenders' capital as these are managed via escrow accounts. Norms of prudence require platforms to enable every lender's capital to be invested across a diverse set of loans which cannot always be achieved instantaneously.

Exposure limit in place to reduce the risk investors

The RBI has in fact built in this diversification within the guidelines by setting a higher limit on this fraction to be Rs 50,000. So, no single lender can lend more than Rs 50,000 to a single borrower while the borrower can borrow a total of up to Rs 10 lakh cumulatively, across all P2P platforms.

Cutting-edge technology in place for credit risk management

Leading P2P players in the country have built robust technology platforms, unrivaled in the world and made in India for India, which help lenders to get access to verified borrowers. These platforms also help them to understand the risk profile of borrowers, easily choose the type of borrowers they want to lend to and seamlessly disburse the loan to the borrower in a timely and hassle-free manner.

Investors, however, must remain cognizant of the fact that borrowers can default on their repayments. Consistent returns delivered bears testament to the sturdiness of the credit assessment process and prudence in lending, thereby ensuring the safety of investors' funds. Those are very much comparable with any other lending institutions in the country even though these platforms do not book loans on their balance sheet and they earn flat fees from the transaction.

RBI's cautious approach strengthens safety net

It was farsighted of the RBI to have put in place a regulatory regime for P2P lending platforms when the industry was barely in its infancy. The idea was to prevent any moral hazard through aggressive behaviour on the part of lenders, borrowers or the P2P platforms. Unlike China, where anyone and everyone could start P2P lending which led to the influx of ill-intentioned players and the eventual shutdown in China, in India, the NBFC-P2P approvals have been given only to entities found to be fit and proper by the RBI. Globally, P2P lending exists under various regulatory regimes in the US, UK, Indonesia and many other markets.

One might argue that the guidelines are extensive and thus a little restrictive, however, guardrails like maximum borrower-to-lender limit, designated escrow accounts clearly ring-fencing the lender funds from the company's balance sheet, prudential norms, requirements of robust technology infrastructure, no wholesale lending, escrow accounts operated by bank promoted trustee etc. have been designed to ensure that interests of the lenders is protected at all points in time.

As the industry matures regulations are likely to evolve further

The rapid uptake of P2P lending, a completely new asset class, is likely to impact how investors plan their portfolios. This shift has also led to the investment products' community taking notice as competitors.

Unlike banks and traditional NBFCs which have well-laid down rules and regulations, NBFC-P2Ps in India are still nascent when compared to the overall financial sector. Therefore, regulations are likely to further evolve for this sector as it grows. Robust guidelines focused on retail investors combined with innovations through technology sounds like a good recipe for the future growth of P2P lending in India.

(The author is CEO, India P2P.)