Understanding new P2P lending norms and their impact

Earlier this month, the Reserve Bank of India (RBI) issued a notification regarding the peer-to-peer (P2P) lending industry. This sector, which has rapidly grown to include about 25 active players, is still coming to terms with the tighter regulations.

The RBI's latest directive has imposed new regulations on the P2P lending landscape, which has raised concerns among both industry players and investors. The new guidelines aim to curb some of the prevalent practices in the industry, focusing on how P2P platforms operate and market themselves. The RBI has introduced four major clauses that directly impact how non-banking financial companies (NBFC)-P2P platforms function.

The notification emphasizes that P2P platforms must cease presenting themselves as investment products with assured returns or liquidity options. This move is aimed at ensuring that these platforms do not take on any credit risk, offer credit enhancements, or guarantee returns to lenders. Essentially, lenders must now bear the full burden of any defaults, which significantly alters the risk profile of P2P lending.

Moreover, the RBI has prohibited the practice of matching lenders with borrowers within a closed user group, a common practice in the industry that allowed for a more controlled and less risky lending environment. This prohibition further tightens the operational framework for P2P platforms, compelling them to rethink their business models.

What is P2P Lending?

Over the past few years, peer-to-peer (P2P) lending has emerged as an alternative to traditional banking systems. In the conventional banking model, banks lend money to borrowers and accept deposits from individuals and businesses. P2P lending, on the other hand, allows individuals to lend money directly to other retail borrowers through online platforms.

The journey of P2P lending in India has been marked by significant growth, though it wasn’t without its early challenges. Inspired by the booming P2P market in China around 2014, a handful of startups emerged in India, eager to capitalize on this new financial frontier. However, the initial progress was slow. The sector struggled to gain momentum due to limited public awareness and questions about its credibility.

The turning point came in 2017 when the RBI introduced master directions for the P2P lending sector, providing much-needed credibility and a regulatory framework. This brought some structure to the industry, weeding out startups with unsustainable business models while allowing others to thrive. By 2016, there were around 30 P2P lending startups in India, but not all survived the regulatory scrutiny.

The NBFC-P2Ps, entities regulated by the RBI, connect borrowers and lenders, facilitating loan transactions without the need for a bank or other traditional financial intermediaries. These platforms cater to various financial needs, including personal and business loans, as well as specialized financing options for education and medical expenses.

What Led to the Growth of P2P in India?

The growth of the P2P lending industry was driven by the promise of assured returns and the flexibility of withdrawal that these platforms offer. Investors, particularly high-net-worth individuals (HNIs) and those with a higher risk appetite, were attracted to the potential returns that far exceeded those offered by traditional banking products. According to industry estimates, the P2P lending industry has grown significantly, with an estimated Rs 10,000 crore in loans and around 10-15 lakh lenders/investors participating through these platforms.

However, this rapid growth was not without its challenges, as the industry often relied on interpretations and workarounds of existing regulations to achieve these returns.

For example, some P2P platforms introduced a secondary market where loans could be transferred between lenders, providing an exit option for investors who wanted to withdraw their money instantly. Additionally, P2P platforms often absorbed losses by offering loans at high-interest rates of 18-24% while providing investors with returns of up to 8-10%. The difference (or spread) was the NBFC-P2P’s margin, which these platforms also used to cover any defaults.

The sudden rise of the P2P model in India can also be linked to the fact that these platforms gave fintech giants indirect access to lending.

The Impact of the New RBI Diktat on HNIs

The RBI's new guidelines are set to have a profound impact on both high-net-worth individuals (HNIs) and retail investors who have been active participants in the P2P lending market. HNIs, who have traditionally been drawn to the higher returns offered by P2P platforms, should study the impact of the new rules on the risk-reward equation, including the removal of credit enhancements and guarantees.

The Future of P2P Lending

While the regulator's intention to protect consumers and ensure transparency is clear, the industry will have to come to terms with the new rules. P2P platforms will need to study and implement the new regulatory environment.

As the industry grapples with these changes, the next few months will be critical as all players navigate this new regulatory landscape.