What is Peer-to-Peer (P2P) Lending?
Between the financial year 2021 to 2026, India’s peer-to-peer (P2P) lending market is expected to grow at a CAGR of 21.6%.
This growth is driven by the inherent advantages of P2P lending, such as low operating costs and reduced market risk. It is the direct lending of money to individuals with a specialized RBI approved financial institution (NBFCs-P2P) acting as a facilitator.
Conducted through online platforms, P2P lending eliminates the need for physical branches and staff. Technological advancements further enhance these benefits.
However, the market also faces challenges. While usually this type of asset leads to higher returns than other asset classes, during economic downturns, it could also have a higher risk of defaults. Also, evolving regulatory oversight can significantly alter the offerings available to customers.
This article will explain what peer-to-peer lending is, its benefits, and its challenges.
What is Peer-to-Peer Lending?
Peer-to-peer lending, also known as crowd lending and social lending, is a financial technology that enables individuals to borrow money directly from investors without the involvement of financial institutions like banks as intermediaries. In India RBI has created a special financial institutions (NBFC – P2P) to act as facilitators between the lenders and borrowers.
This process is usually done through a P2P lending website that matches potential borrowers with lenders. While most P2P lending loans are unsecured personal loans, some may be secured by underlying assets.
P2P loans offer an alternative to traditional bank loans for borrowers who find securing funding through conventional loans challenging. Additionally, borrowers with good credit scores can benefit from lower interest rates.
One of India’s leading providers of P2P lending is PowerUp P2P, offering lenders a return of up to 12%. PowerUp has partnered with Liquiloans (NDX P2P Pvt. Ltd.), an RBI-regulated NBFC P2P, to meet the RBI’s regulatory requirements. PowerUp uses smart algorithms to minimise investment risks and identify creditworthy borrowers.
How Does Peer-to-Peer Lending Work?
Keep reading to understand the operational mechanics behind peer-to-peer lending. This detailed guide below discusses how individuals borrow funds directly from investors through online platforms, bypassing traditional financial institutions.
Step 1: Plan Selection and Investment
To start with select a plan and the amount you want to invest. For e.g. in PowerUp’s P2P lending you can begin with as little as ₹10,000.
Note: Daily interest accrual starts immediately. Opting for a plan with a lock-in period can provide additional cashback alongside the earned interest.
Step 2: Borrower Verification
Before disbursing funds, the platform checks borrowers’ CIBIL scores (which must be 700+), conducts thorough verification, and completes KYC processes to ensure creditworthiness.
Step 3: Investment Allocation
The P2P platform allocates the invested amount among multiple borrowers, diversifying your investment and minimizing individual risk.
Step 4: Risk Management
Platforms like PowerUp use advanced risk management and borrower sourcing mechanisms to ensure a balanced and secure investment portfolio.
Step 5: Earning Interest
P2P platforms like PowerUp provide lenders with lower interest rates than those charged to borrowers. This gap creates a buffer to cover potential defaults. Lenders can expect a net pre-tax yield ranging from 7.50% to 12% XIRR on the net invested amount.
Step 6: Wealth Compounding
Lenders benefit from the compounding effect. While initial interest rates may seem comparable to other asset classes like fixed deposits, the compounded growth over time can significantly increase returns.
For instance, at a 7% interest rate, an investment can grow by 1.9 times in 10 years and by 3.8 times in 20 years. Comparatively, at a 12% interest rate, the same investment can grow by 3.1 times in 10 years and by 9.6 times in 20 years. This demonstrates the significant long-term gains achievable through peer-to-peer lending.
Step 7: Monitoring and Withdrawals
Platforms provide dashboards for tracking returns. Lenders earn daily interest, which compounds over time. Withdrawals are processed within 2 days, crediting the amount directly to the lender’s account. Despite the risks, PowerUp has maintained a 0% Non-Performing Asset (NPA) rate.
Top Applications of Peer-to-Peer Lending
In this section, we will explore the primary ways in which P2P lending is utilised, highlighting how it efficiently and effectively caters to diverse financial requirements.
1. Personal Loans
Utilise P2P lending to cover expenses like car repairs or purchases, home improvement projects, and debt consolidation.
2. Business Loans
With P2P lending, secure funding to launch a startup, expand existing operations, or manage cash flow requirements.
3. Home Loans
Refinance an existing mortgage or obtain a new one with fewer requirements, such as no mortgage insurance and around 10% less down payment.
4. Student Loan Refinancing
Use peer-to-peer lending to consolidate multiple student loans into one, often at a lower interest rate, making payments more manageable and reducing overall costs.
5. Medical Loans
Finance elective medical expenses such as dental work, fertility treatments, weight-loss surgery, hair treatments, or other specialised healthcare needs with peer-to-peer lending.
Key Benefits of Peer-to-Peer Lending
In this section, we highlight the advantages of P2P lending for both borrowers and lenders, demonstrating how this innovative financial model offers practical solutions and significant benefits.
Benefits for Lenders:
1. High Returns for the Investors
Peer-to-peer lending often yields higher returns for investors compared to other investment types. Lenders can earn directly from their loans, bypassing financial institutions as intermediaries.
2. An Opportunity to Diversify Investments
With P2P loans, the lenders can diversify their investments, thus reducing the risks associated with the default of any single investment.
Benefits for Borrowers:
1. Accessible Source of Funding
P2P lending is a more accessible, flexible, and easy funding source than traditional institutions. It is particularly beneficial for borrowers with low credit scores or those needing loans for unconventional purposes.
2. Low Interest Rates
Considering the high competition between lenders and low origination fees, P2P loans tend to have lower interest rates than conventional loans
Challenges of Peer-to-Peer Lending
This section outlines the primary difficulties lenders and borrowers face in the P2P lending market.
Challenges for Lenders:
1. High Risks
Many P2P loan applicants have low credit scores, making them ineligible for traditional loans. This elevates lenders’ default risk, potentially leading to significant financial losses. However, good P2P NBFCs usually have enough buffers to absorb these defaults and still pay the consumers the indicative returns. That’s why it is important for lenders to evaluate the lending policies of the NBFC P2P platform that they have choosen to invest.
Since inception, 100% of PowerUp P2P customers have achieved the indicative returns mentioned to them during investment.
2. Limited Regulatory Protection
Lenders lack insurance in case of borrower default which is applicable, for example, for FDs in India. However, for customer’s protection, therr are strict compliance requirements mandated by the RBI for organisations conducting peer-to-peer lending in India. Some of the them are as follows:
- Registering as an NBFC-P2P startup
- Demonstrating ownership of at least ₹2 crores
- Limiting individual lending to ₹50,000 per borrower
- Borrowers can borrow up to ₹10 lakh across multiple P2P platforms
- Lenders can lend a maximum of ₹50 lakh across various P2P platforms
This makes P2P lending market in India relatively safer, given the central bank has strict guidelines for the NBFCs to follow.
3. Vulnerable Technology
Peer-to-peer lending relies heavily on technology, making it susceptible to technical glitches and cybersecurity threats. Such vulnerabilities can disrupt or complicate the lending process.
Therefore, it’s always better to invest with platforms like PowerUp P2P that are technologically stable and have partnered with large P2P NBFCs that have enough processes in place to minimise these threats.
Challenges for Borrowers:
1. Legislation Constraints
In some regions, peer-to-peer lending is prohibited. Companies must adhere to strict investment regulations where permitted, making it difficult for borrowers to access P2P loans.
2. Limited Loan Amounts
Regulatory limits on borrowing amounts can restrict borrowers from obtaining the full funding they need, especially if they require substantial loans.
Conclusion
Peer-to-peer lending, projected to reach $10.5 billion by 2026, connects borrowers and lenders directly, offering benefits like accessible funding, lower interest rates, and high returns and diversification for lenders.
However, it also presents challenges like high default risks, limited regulatory protection, legislative constraints, and technological vulnerabilities. That’s why it’s important for lenders to choose their P2P platform carefully.
PowerUp P2P is one of the safest P2P platforms that has demonstrated great results in mitigating these risks. PowerUp P2P also offers up to 12% returns and uses smart algorithms to minimize risks while complying with RBI regulations.
FAQs
1. What is peer-to-peer meaning and definition?
P2P means a financial model where individuals or businesses borrow and lend money directly through online platforms. This model has no intermediaries, such as traditional financial institutions like banks.
2. What fees are involved in peer-to-peer lending?
Typically, P2P lending platforms charge fees from borrowers for loan origination and servicing, while in the case of lenders, they charge fees for loan management and administration. These fees are indicative, vary by platform, and tend to be disclosed upfront.
3. How are interest rates determined in peer-to-peer lending?
In P2P lending, interest rates are determined based on the borrower’s credit score, loan term, and prevailing market conditions. Investors tend to set their preferred interest rates, and then the peer-to-peer platforms facilitate competitive bidding to match borrowers with lenders.
4. What are the typical loan terms in peer-to-peer lending?
While loan terms in peer-to-peer lending tend to vary, they generally range from six months to five years. The terms depend on the borrower’s creditworthiness, loan amount, lender’s readiness, and platform’s policies.
5. What happens if a borrower defaults on a peer-to-peer loan?
If a borrower defaults, the platform typically initiates collection efforts. However, lenders bear the risk of financial losses, as usually there is no insurance or protection against defaults.
6. What measures do P2P platforms take to ensure data security?
P2P platforms implement various security measures, such as encryption, secure login protocols, and regular security audits, to protect users’ personal and financial information. Choosing a platform with robust security practices is important to safeguard against data breaches.
Disclaimer: The data and information presented on this blog are currently undergoing revisions. Please do not rely on this content for making any decisions and refer to the latest RBI guidelines.
