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We don’t need no banking system

This week, the Reserve Bank of India is expected to come out with concept guidelines for peer-to-peer lending, which is one of the fastest growing borrowing systems in the world. An idiot’s guide to P-to-P

business Updated: Apr 27, 2016 12:15 IST
B Sundaresan

This week, the RBI is expected to come out with concept guidelines for peer-to-peer lending, which is one of the fastest growing borrowing systems in the world. HT gives you a lowdown:

What is peer-to-peer (P2P) lending? Where did it start?

P2P lending is the concept that links borrowers to many individual lenders over online platforms circumventing the need for a bank. It is called marketplace lending as it brings borrowers and lenders on one platform.

This concept originated in the United Kingdom in 2005, with the founding of Zopa, now one of the biggest P2P lenders in the world. P2P lending gained prominence after the global financial crisis as banks became reluctant to give out loans to individuals.

How is P2P lending different from crowd-funding?

P2P lending is a type of crowd-funding, which relies on many small individual lenders, who choose projects they want to invest in. In addition, P2P lending carries interest rates and repayment clauses. P2P lending is thus categorised as “lending-based crowd-funding” or “debt-based crowdfunding”.

How does it work?

Suppose you want to start a new business and cannot convince the banks to give you a loan of Rs 5 lakh. You log on to a P2P lending website such as Lendbox or Faircent in India. You submit your proposal with the amount of funds required, your expected rate of interest and the time in which you will want to repay the loan.

Lenders registered on the website will be able to see your proposal and will be able to chip in with amounts such as Rs 10,000. Your probability of getting investors is higher if you offer to pay a higher interest rate. On Tuesday, the average interest rate on Faircent was 23.32%.

P2P lenders net a commission on every transaction that take place on their portal.

Why is it suddenly in the news?

Because P2P lending is unregulated in India and the recent case of Chinese P2P lender Ezubao being charged with operating a “ponzi scheme” to dupe 1 million investors has raised questions over how the sector can be monitored.

After the recent monetary policy review Raghuram Rajan said “there is a regulatory gap here (in P2P lending)”. He added that though volumes were small they can expand quickly – similar to China where at least one scheme has gone off track. “This impells us to move faster on this. Before they get big, let us understand what needs to be done,” Rajan has said.

Is P2P lending unregulated across the world?

No. The US was the first country to start regulating the sector in 2008. By 2015 many developed countries including UK, Germany, Spain and Lithuania had regulations in place. P2P lending is banned in countries such as Japan and Israel, while it is unregulated in Brazil, South Korea and Egypt.

Regulations involve mandating reserve requirements for P2P lenders to cover for default and capping of maximum size of loans.

After the Ezubao scam, China released draft regulations for P2P lending (Research: B Sundaresan)

After the Ezubao scam, China also released draft regulations for P2P lending that required lenders to register with the government and disclose all financials. The rules also sought banned the use of foreign funds by P2P companies.

What are the issues with P2P lending?

Securities and Exchange Board of India (Sebi) noted in its 2014 consultation paper on crowdfunding noted that “in P2P lending, there is no investor protection to cover defaults” and “retail investors, who do not have the capacity to absorb defaults, may lose significant proportions of their investments”.

The issue of who will regulate P2P lending also persists. The paper noted that since P2P lending does not generally involve direct issuance of securities, its regulation may fall under the purview of RBI. The central bank has meanwhile said that either it or Sebi will have to be the regulator. This will become clear once the RBI issues its draft guideline on Saturday.