The Reserve Bank has recently made life difficult for the Peer-to-Peer lending ecosystem. In a recent update to P2P lending platform directions on August 16, 2024, the Reserve Bank clarified and expanded upon its previous directions.
Before we discuss the tightening by the RBI, let’s take a step back and see how this space has evolved over the years.
How Does Peer-to-Peer Lending Work?
Lending and borrowing among individuals must be one of the first monetary transactions in the history of mankind. Hence, this arrangement has always existed. But earlier, you could only borrow from someone (or lend to someone) you knew or through a reference.
In the mid-2010s, many websites popped up that brought together borrowers and lenders who didn’t know one another. RBI finally decided to regulate this sector by introducing the regulations for such facilitators in 2017. A new term NBFC-P2P was coined and all such websites/facilitators had to register with RBI as NBFC-P2P. The regulations set out what such platforms could do or could not do and also imposed certain restrictions on P2P lenders and borrowers.
However, NBFC-P2P platforms did not become very popular by themselves. Hence, such NBFCs tie up with popular fintech platforms such as Mobikwik or CRED and started offering P2P lending/borrowing services to the platform users.
Here is an example. LiquiLoans (A P2P NBFC) has tied up with CRED (a fintech). And when you invested in any P2P offering by a fintech, your money is divided/lent to multiple matching P2P borrowers. This diversifies your investment and reduces your risk too.
Sounds good, but the Reserve Bank is not happy and rightly so. Even without reading any further, you can expect that the NBFC-P2P companies and fintech platforms would have tried to push the boundaries of the regulatory envelope, something the banking regulator is unlikely to be happy with.
Why Is RBI Unhappy and What Has It Done?
When P2P regulations were introduced in 2017, RBI would have thought NBFC-P2P companies will do just what RBI prescribed. Bringing P2P lenders and borrowers together and facilitating transactions.
However, the industry grew sharply through a very different structure. NBFC-P2P platforms tied up with popular fintech platforms and launched P2P lending products that lacked transparency and implied high returns and liquidity. I highlight a few areas RBI has found problems with.
#1 Closed-Loop Arrangements
Sometimes, this arrangement between a NBFC-P2P company and a fintech platform can be a closed loop arrangement too.
For instance, both P2P lenders and borrowers are exclusively from CRED.
Such closed loop arrangements proliferated since P2P lending regulations didn’t prohibit such arrangements. However, RBI has now explicitly disallowed such arrangements.
#2 Inadequate Disclosure about Charges/Commissions
Let’s consider an example.
P2P Borrower gets the loan at say 14-18% p.a. P2P lender gets the interest (return) at 9% p.a. from the same loan. Where is the rest of the money? Of course, the other two participants (NBFC-P2P and the fintech platform) must make money too on this transaction.
However, the compensation structure must be transparent. If the lender does not know the cost at which his money is being lent, it goes against the spirit of P2P lending regulations. Similarly, the lender must know the exact costs and commissions involved.
While the fintech platform is giving you the comfort of a wrap product, you must still get proper disclosures.
RBI has clearly stated that the pricing policy (compensation structure) must be objective and must be disclosed upfront. The fee shall not depend on repayment by borrowers.
#3 Promise of Liquidity
Now, when you lend money to someone, you get the exit only when the loan is repaid. However, various fintech platforms (in tie-up with NBFC-P2P) allowed you to exit your investment whenever you wanted. In other words, you could take out money even when the underlying loan/loans were not repaid.
Remember, they were not doing this for just 1 lending transaction. Your invested money could have been lent to multiple borrowers. Hence, by promising you exit on your terms, they are allowing you to exit from multiple lending transactions.
How could they do it?
They can do this by either buying your investment off. NBFC-P2P are not allowed to do that. But fintech platforms may do that. Or they will just find someone else to take your place. I do not know how it works under the current arrangements.
In any case, the Reserve Bank has disallowed this artificial liquidity. Copying an extract from the revised regulations.
An NBFC-P2P shall not utilize funds of a lender for replacement of any other lender(s).
This effectively kills the liquidity option offered on fintech platforms.
#4 Promise of Returns
Cred Mint advertises “Earn up to 9% p.a.”
You can always add caveats in the fine print and say that you are not really guaranteeing returns. However, the investors (P2P lenders) get the impression that they are investing in bank FD like product. Or that P2P lending is an investment product.
Well, every lending is an investment. For banks too, your loans are an investment/asset. However, RBI has problems with position P2P lending as an investment product. And rightly so.
When you try to position something as an investment product, risk is underplayed and returns are overplayed.
RBI does not like that.Reproducing an extract from revised regulations.
The P2P platform shall not provide any assurance or guarantee for the recovery of loans. Further, the P2P platform shall not promote peer to peer lending as an investment product with features like tenure linked assured minimum returns, liquidity options, etc.
Further, the Reserve Bank has explicitly stated that the entire loss of principal or interest shall be borne by the lender (P2P investors). NBFC-P2P shall not provide any credit enhancement or credit guarantee to eventual lenders. NBFC-P2P also cannot cross-sell any insurance product, which is in the nature of credit enhancement or credit guarantee.
#5 Lenders Taking Too Much Risk
The nature of P2P lending is such that you expect higher returns than bank fixed deposits. And the lure of high returns sometimes makes investors take disproportionate risks.
That’s why the Reserve Bank had placed restrictions on how much you can invest/borrow via the P2P ecosystem.
The maximum aggregate exposure by a lender (P2P investor) across the P2P system is capped at Rs 50 lacs. And the maximum aggregate borrowing by a P2P borrower across the P2P system is capped at Rs 10 lacs. Further, the exposure of a P2P investor to a specific P2P borrower cannot exceed Rs 50,000.
RBI has further tightened and added an additional restriction now. While the upper aggregate investment cap is Rs 50 lacs, if you want to invest more than Rs 10 lacs across the P2P system, you must submit a net worth certificate certifying minimum net worth of Rs 50 lacs.
Submit a net worth certificate if you want to invest more than 10 lacs. We will have to see how many investors will be willing to take this pain.
These fresh regulations will clearly impact the way P2P lending happens in India.
What do you think? We will have to wait and see how these regulatory changes will affect the P2P ecosystem.