Considering P2P lending as a finance alternative

With the Indian economy not growing as expected, widespread economic disparity, and financial institutions reeling under pressure from stressed and non-performing assets, there is a strong need for small and medium-sized enterprises, and individuals, to have an alternative access to funds. To bridge this gap, there are more than 30 platforms in India providing alternative sources of funding known as peer-to-peer (P2P) lending.

P2P lending is where the relevant platforms act as loan facilitators to allow the lender/investor to provide loans to borrowers. Both parties have to register on the platform and pay certain fees to the platform. The platform will conduct a diligence on the borrower and make the credit appraisal available to registered lenders. The lender is able to bid for/select the borrower to whom he or she wants to provide the loan.

The terms and conditions, including tenure and rate of interest, are finalized between borrowers and lenders. The lender directly credits the borrower’s account, the platform assists in recovery of equated monthly instalments and the same is directly credited into the lender’s account. The lender gets to choose their level of risk and receives returns better than normal investments in some other financial products. The borrower gets the loan at rates cheaper than some financial institutions.

With the advent of players in the “fintech” space, the online P2P lending landscape adds convenience for all parties and thus increases the ease of doing business. However, with the increase in importance of any field/business there are several issues raised, giving rise to a requirement for consistency and regulation. India has seen several alternate sources of lending through chit funds, cooperative societies and associations extending credit, and each have had their own perils.

P2P lending is unregulated in India and is still in a nascent stage compared to countries like the US, UK and China. Regulators in India have been discussing P2P lending as a sub-set of crowdfunding. However, considering most of the platforms are not aggregators of funds and merely bring together the parties, they are considered more as a “loan marketplace”. Accordingly, the Securities and Exchange Board of India mentioned in its consultation paper on crowdfunding in India that it would not have jurisdiction over such platforms.

With the sharp rise of the P2P lending space in India and the potential that the sector has, it is clear that such platforms will increasingly tie up public money. Most of the platforms don’t guarantee any returns (not even the principal) for the lenders. The issue of taking on the liability of providing returns is something that may cause the regulators to re-examine the structure.

Lending through such platforms doesn’t have any restrictions on exposure, whether dealing with an industry, geography, age group or otherwise. Therefore, it is always possible to overleverage and have increased exposure to only a particular sector. The lenders have to take a decision based on the credit analysis of the platform for which the platform is not liable. There are no clear parameters that the platforms need to provide for such an analysis and accordingly it increases the risks, including fraud risk.

There is no monitoring on the end-use of the funds. Unlike for financial institutions, where there are credit information companies and other databases, including defaulter lists, there is no repository of information for credit availed by borrowers as P2P lending. The platforms are also unclear about the validity and the binding nature of the document being entered into by the borrower and the lender. It is unclear whether adequate stamp duty is being paid in the relevant jurisdictions.

Considering the enforcement issues that the financial institutions are facing despite their relevant expertise, adequate documentation should be a primary concern. Additionally, since there is no restriction on the eligibility of lenders, the platforms can also be seen to be possible business options for money lenders who may otherwise be required to be registered under state legislation.

In light of the above, the Reserve Bank of India has decided to intervene in the space of P2P lending, and released a consultation paper in April 2016 for public comment. It suggested that the platforms should be considered as intermediaries, without pooling money for on-lending. However, such intermediary platforms have to be registered as non-banking financial companies, and have to satisfy minimum capital requirements and maintain a leverage ratio.

Though there are definitely areas which require clear parameters, it is important to ensure that introducing regulation doesn’t stifle a market that has huge potential and is also a requisite.

Babu Sivaprakasam is a partner, Deep Roy is an associate partner and Sharmila Ratnam is an associate at Economic Laws Practice. This article is intended for informational purposes and does not constitute a legal opinion or advice.