All you wanted to know about peer-to-peer lending

Many of us, at some point or the other, have borrowed money from friends or family instead of going to a bank. That’s because it’s quick, requires no collateral and many a time, the ‘loan’ comes at zero interest rate. Peer-to-peer (P2P) lending is something similar, but happens on a larger scale. Though the loans aren’t interest-free, the rate can be lower than that charged by other lenders. While P2P lending is still small in India, the RBI recently came out with proposals on regulating it.

It refers to unsecured lending that happens on online platforms, without the involvement of a bank or a finance company. While a bank takes deposits and then lends money to individuals and businesses, a P2P lender simply brings lenders and borrowers together on a common online platform so that they can transact with each other.

Sounds like crowd funding? Not exactly. In P2P lending, loans carry an interest, but in the case of crowd funding, money is either provided as equity capital for a business or as a donation. In P2P lending, lenders and borrower have to register themselves on the platform and undergo a verification process. The P2P lender relies on information from credit bureaus and its own research for scrutinising borrowers.

Every lender and borrower can deal with multiple members. In fact, many P2P lending platforms do not allow an individual to fund more than a certain percentage of a single borrower’s requirement to limit exposure risk.

Once a borrower and a lender have agreed upon an offer, they enter a loan contract. Globally, the money from each lender goes into an escrow account held by the platform. The loan is disbursed after a minimum amount has been collected and post-dated cheques towards EMI payments have been given by the borrower.

If the EMIs are delayed or not paid, the borrower is charged a penal interest rate. And in case of a default, the P2P lender assists with loan recovery. For the services they provide, P2P platforms charge borrowers (and in some cases, lenders too) a fee.

Globally, P2P lending is emerging as an important source of cheaper fund-raising for people or businesses (particularly small ones), that may not be able to borrow from banks. According to the Peer-to-Peer Finance Association, global P2P lending has grown from £2.2 million in 2012 to £4.4 billion in 2015. While India too has many P2P lenders, the size of the industry is believed to be fairly small. Since P2P lenders do not have a large physical presence and big workforce, they are able to operate at a lower cost. From the lenders’ perspective, the attraction lies in the opportunity to earn high interest rates.

If you want to raise some money quickly for a business or for some personal need, but have no collateral, you can consider a P2P lending platform. But, while doing this may make sense, if you are a small creditworthy borrower, don’t expect to get a loan if you have a poor credit record.

As a lender, you may be tempted by the returns that P2P lending platforms offer, but do remember that it is a risky investment. Even in countries where P2P lending is regulated, there is no monetary protection provided to investors in case of default.

Neither a borrower nor a lender be, warned Shakespeare. But if you’re on a peer-to-peer platform, be a borrower and not a lender.

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