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Lending to peers may be worth the detour

Peer-to-peer loans can yield higher returns at relatively lower risk in a declining interest rate scenario

IInterest rates have dropped considerably. Bank deposit rates have eased and current returns on fixed income mutual funds (portfolio YTM) are much lower than they were before. In this situation, investors looking for relatively higher returns may consider an avenue known as peer-to-peer (P2P) lending. Let’s first understand the concept.

P2P is a quasi-formal system where you give loans to people you don’t know until now, for relatively smaller amounts, at high interest rates, without any collateral of securities.

P2P platforms

The function of bringing together previously unknown lenders and borrowers is performed by service providers called P2P platforms. In today’s digital age, this is done online through websites operated by these platforms.

Similar loans and borrowing in the unorganized sector have a long history in India; the P2P system gives it a structure and it operates according to the guidelines of the Reserve Bank.

What is the appeal of P2P as an investment avenue? The returns are high, double digits. This is much higher than bank deposits or debt mutual funds. What are the risks ? If a loan goes badly, the P2P service provider assumes no responsibility; they can help you by giving you advice on legal remedies. This complies with RBI regulations; the guidelines state that the platform “will not provide or arrange for credit enhancement or credit guarantees.” The borrower’s profile is someone who has likely not been able to benefit from bank financing, possibly due to a relatively lower CIBIL score, but who is unwilling to opt for even higher rates charged by informal money lenders.

If there are risks, what are the guarantees? There is global risk management in terms of diversification, i.e. limit of exposure to borrowers. If we look at the data on bank NPAs, industry, i.e. large corporations, has the highest NPA component (around 70% of total bank NPAs), followed by services, agriculture, MSMA, etc. Retail trade has the lowest NPA component (4% to 5%). Even if a borrower were to default, your exposure is limited.

The gist of the RBI’s risk exposure guidelines is that between a lender and a borrower the cap is 50,000, a lender’s exposure to the P2P mechanism is 50 lakh, and a borrower can benefit. of a maximum of 10 lakh on all P2P.

The RBI also mandates these entities to obtain membership in all credit reporting companies and submit data. Although borrowers who access the P2P system may not have a high CIBIL score, any digression would have an additional impact on the CIBIL rating.

An important security aspect of the P2P system is the NPA level. The NPA data of this platform is supposed to be disclosed on the websites. For your due diligence, you need to analyze data across all platforms to decide which one you want to work with.

Savings on expenses

Note, in this mode of investment, you do not get the services of a professional fund manager as in mutual funds. But then you save on expenses as well as you do it yourself. To do your due diligence, start with a Google search for P2P platforms. Check the RBI website for a list of approved P2P platforms (https://www.rbi.org.in/Scripts/BS_NBFCList.aspx) to make sure the entity you are dealing with is trusted.

The website will tell you what they can do for you as a lender and what they cannot do. Your choice of P2P platform also depends on the quality of the information disclosed, the quality of due diligence they exercise on borrowers, etc.

According to regulations, P2P service providers must perform due diligence on participants, assess credit and profile borrowers’ risk and disclose to lenders, document loan agreements and provide services for debt collection. ready.

Some of the other services you can expect are borrower segmentation based on CIBIL score, income bracket, etc. The borrower may be required to purchase insurance (including personal life, permanent disability, or loss of livelihood / employment) for the loan. P2P service providers can assist a panel of lawyers to initiate legal action for non-payment of IMEs. User experience shows that despite the risks i.e. unsecured loans to people with relatively lower CIBIL score, the returns are decent. The interest rate you lend is higher, which is the offsetting factor. Even if one or two borrowers defaulted, they are not large companies, therefore, they would not have the bandwidth of a legal device or other backing. The more diversified the loans, the few potential defaults are usually offset by repayments and a higher interest rate.

(Joydeep Sen is a Debt Markets Corporate Trainer and Author)