Alternate lenders including P2P lenders, marketplace platforms, digital lending platforms are targeting specific credit needs of retail consumers and micro and small businesses that remained underserved by banks and NBFCs or specified market segments including e-merchants and other internet-enabled business.
The alternative lending business model is built around technology that enables highly efficient customer acquisition, approval and servicing activities within a relatively light-touch regulatory environment, most Indian banks and NBFC’s operating models, in contract, include physical branches operating expenses, significant regulatory overheads, collections and recoveries functions that are needed to service an aged loan book. Despite the low cost of funds enjoyed by banks, these factors add to the average cost of a loan. The alternative lending model enjoys significant operating cost advantage as compared to the traditional banking and NBFC business model.
Till now, most of the borrowers' services by alternative lenders tend to fall outside the bank’s risk appetite and segments that value speed and convenience enough to pay a premium (for example, SMEs particularly in term loans or high-risk retail borrowers applying for personal loans). In the medium to long term, the emergence of alternative lenders is likely to have an impact on the NBFCs business in India. Unlike banks, most of the NBFCs do not have access to the low cost of funds and with higher acquisition and servicing costs. NBFCs may be outcompeted as alternative lenders gain traction in the Indian market. The robustness of the credit algorithm of fintech players in this space is yet to be tested as the industry is yet to complete a full credit cycle.
As the industry matures, appropriate controls need to be put in place to avert NPAs. Alternate lenders will have to focus on keeping NPA percentages lower than conventional banks. They must not prioritize quantity over quality of loans. This will ensure the success of this model.
Within alternative lenders, peer-to-peer lenders and market place lending platforms are likely to break out faster as these lenders target profitable niches of Indian borrower segments, pioneer new business models by having an only digital presence, target underserved market segments, and shape user behaviour by gaining trust.
Peer-to-peer lending is an innovative model for transferring credit risk from banks and financial institutions, dispersing it among individual lenders. These lenders are typically individuals and households with surplus funds and savings who are seeking a better return. In India, P2P lending through informal ways such as borrowing from family, friends and unorganized money lenders have traditionally been the primary source of capital for micro and small businesses as well as individual borrowers meeting their exigent financial requirements. Online P2P platforms institutionalize and scale up this age-old financing mode and act as a matching platform between borrower and lender groups.
Expectedly, financial returns (from lending) remain the topmost reason why individual lenders use P2P platform along with seeking diversification investment avenues.
Easy/ quick application process, fast decision making, the convenience of the online platform, competitive rates, repayment flexibility, little documentation required.
Better return on investment, easy and simple to convenience, ability to specify risk aversion/ return, ability to chose who to lend to.
The Indian P2P lending segment is evolving rapidly as new entrants play the role of market makers and industry champions. Most of the P2P platforms currently focus on unsecured loans (Personal loans and microfinance) and the MSME segment by targeting borrowers that remain undeserved by banks and NBFCs.
Two different business models have emerged in the P2P lending segment. Currently, players have adopted either the direct disbursal model or assisted disbursal model.
Direct Disbursal model – The P2P platform directly matches the requirements of borrowers and lenders and is similar to global P2P platforms. Its current focus is on the personal loans segment for urban, educated and middle-class customers who understand the marketplace model and transact online. A few of the large P2P platforms have started to maintain nodal/ escrow accounts for better monitoring and control. This allows both borrowers and lenders to deposit funds in an escrow account held by the P2P platform and both disbursement and repayments are routed through these escrow accounts.
Partner assisted disbursal model – In this mode, P2P platforms tie-up with a field partner (local NGO or Micro financer) to manage customer acquisition, disbursement and collection for a fee. The P2P Platforms tie-up with a field partner (local NGO or micro financer) to manage customer acquisition, disbursement and collections for a fee. The P2P platform is primarily responsible for onboarding lenders and offering matching services. This model is focused on unsecured loans (micro-finance) to low households ranging from 100 to 500$.
As observed, in most of the borrowing cases, P2P platforms are increasingly offering competitive interest rates to borrowers along with extending significant premium to lenders, owing to a very low platform operating costs (1-2% of the loan value administered). Considering that P2P platforms offer new investment avenues and prospects of significantly higher financial returns, the supply side factors could exponentially drive the growth of this segment, as it attracts return conscious lenders, and as these platforms gain trust amongst investors as well as build strong underwriting, credit risk management and fraud management capabilities. Developing very rigorous risk management procedures will lay a strong foundation required not only to gain the trust of lenders but also to meet regulatory scrutiny.
RBI already put in place regulatory framework for P2P platforms (necessarily to be incorporated as a Company and registered with the RBI as NBFC). By enabling borrowing and lending without the intermediation of a bank, P2P lending reduces the cost of originating and funding loans, thereby providing more competitive rates to borrowers. Being unaffected by branch infrastructure, overheads and capital reserve requirements to drive up operating costs for traditional banks there are significantly lower barriers to entry in the P2P lending space. The online process on a small scale also allows for a faster loan approval process. However, as the system is completely online, this also increases the risk of online fraud and de-personalises the banker-customer experience.
At a basic level, P2P lending platforms provide a facility creating a marketplace where investors who wish to lend funds can find potential borrowers and provide credit through P2P agreements. These marketplaces are made possible by online technologies, which provide investors with high-quality direct lending opportunities that would otherwise not be possible. Platforms may provide additional value-adding services to their users – the investor and the borrower to ensure that the loan or investment characteristics best meet their needs.
From borrower perspective, P2P lending offers a completing source of finance to the banks. From the investor perspective, it is a new investment opportunity, similar in nature to corporate bonds but with a focus on the small and medium-sized company (SME), consumer and property loans. P2P lending provides a new, effective form of financial intermediation.
How to P2P platforms manage risk for their investors? Credit risk assessments, management of liquidity risk, and the policies for minimizing platform risk. This includes an assessment of both the approaches adopted by platforms and the outcomes that they have achieved so far. The evidence considered in this report indicates that:
P2P platforms are incentivized to conduct effective credit risk assessments, employ industry best practice and deliver outcomes consistent with those of traditional lenders;
Underlying risk characteristics of P2P lending are comparable to those of other retail investment asset classes, which does not suggest that this investment should be considered to be ‘non-mainstream’ and thereby not readily available to retail investors.