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Peer-to-peer lending
Sep 22, 2017

[GS Paper III: (Indian economy and issues relating to planning, mobilisation of resources, growth, development and employment)]

Why in News?

The government has recently finalised norms that peer-to-peer lending (P2P) platforms would be treated as non-banking financial companies (NBFCs) and regulated by the Reserve Bank of India (RBI).

What is peer to peer (P2P) lending?

  • P2P lending is a crowd-funding model (largely online) where people, looking to invest their money with people who want to borrow, can do so. 
  • The concept is centered around savers getting higher interest by lending their money instead of saving and borrowers get comparatively lower interest rates.
  • Borrowers are either individuals or small businesses. But unlike a traditional savings account, one can lose money if the borrower defaults.

Regulation in India

  • P2P lending platforms are largely tech companies registered under the Companies Act. 
  • According to RBI, the potential benefits that P2P lending promises to various stakeholders (to the borrowers, lenders, agencies etc.) and its associated risks to the financial system are too important to be ignored.
  • If the sector is left unregulated altogether, there is the risk of unhealthy practices being adopted by one or more players, which may have deleterious consequences.

What are NBFCs?

  • Non-Banking Financial Companies or NBFCs, are financial institutions that provide certain types of banking services, but do not hold a banking license.
  • As per the RBI, NBFC is a company registered under the Companies Act, 1956 engaged in the business of loans and advances, acquisition of shares/stocks/bonds/debentures/securities issued by Government or local authority or other marketable securities.
  • Some of the features marking them different from banks are  

i. NBFC cannot accept demand deposits;
ii. NBFCs do not form part of the payment and settlement system and cannot issue cheques drawn on itself;
iii. deposit insurance facility of Deposit Insurance and Credit Guarantee Corporation  (DICGC) is not available to depositors of NBFCs, unlike in case of banks.

NOTE: 

DICGC is a subsidiary of Reserve Bank of India. It was established on 15 July 1978 under Deposit Insurance and Credit Guarantee Corporation Act, 1961 for the purpose of providing insurance of deposits and guaranteeing of credit facilities. DICGC insures all bank deposits, such as saving, fixed, current, recurring deposits for up to the limit of Rs. 100,000 of each deposits in a bank.

What are the risks and opportunities in P2P lending?

  • Financial inclusion: The long-term application of P2P lending is in enabling financial inclusion. The information technology can help assess creditworthiness at a much lower cost and therefore make it easier to give loans to marginal customers which the conventional banks may find difficult. 
  • Timely access to affordable credit: P2P lending platforms can begin to displace informal lending by delivering value to end-borrowers on two fronts: 

1. By extending access to formal credit to segments that have traditionally been underserved by banks.
2. By delivering this credit in a timely manner that matches or even exceeds the speed of borrowing from an informal lending channel, i.e., moneylender.

  • The P2P model is in some ways safer than conventional bank lending which creates mismatches between short-term liabilities (such as deposits) and long-term assets (such as mortgage loans) making banks vulnerable to loan defaults or a sudden withdrawal of deposits. 
  • By contrast, lenders under the P2P model are directly matched to borrowers and while a cluster of defaults would certainly hurt lenders, it would not necessarily bring down the lending company and trigger a wider financial crisis.
  • However, while a bank guarantees the credit risk, a P2P firm passes on the entire credit risk to the individual only promising to help with the recovery process.
  • Further, credit ratings provided on borrowers help by allowing investors to choose a particular risk level, it is dangerous to rely on them too heavily. Default rates implied by ratings represent an average over similar loans in a particular year and not the probability of default on individual loans.

Way Forward

Globally, Peer-to-Peer (P2P or Marketplace) lending has emerged as a viable alternative to traditional banking channels. In India, whilst marketplace lending is at a nascent stage, the model can be a powerful tool to match capital providers (e.g. regional banks/pension planners) with unserved or underserved demand (e.g. SME borrowers/ rural poor).


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