Imagine that you are sitting on a cash pile, with no idea on where to invest it. Well, you have a range of options. You can
1.Open an FD Account with a bank.
2.Invest in securities
3.Invest in Real Estate
4.Invest in gold
These are the traditional avenues to which you can shift your money. Logically, going by the diversification rule, your portfolio will consist of a mix of these. Why? Every option has a level of risk and return attached to it. So, a mix of these options will ensure that the risk is rewarding.
Let’s draw a risk-returns matrix and see where each option sits
So, now where would you place your pile? On one option or many?
To most of the readers, this is elementary knowledge. You guys are probably wondering, “This is Financial Management 101! Where is she going with this?”
I agree with you guys. However, I am about to present to you a fifth option. And that is Peer-to-Peer lending. Yes, I am talking about “shadow banking”.
According to Wikipedia, “Peer-to-peer lending, commonly abbreviated as P2PL is the practice of lending money to unrelated individuals, or “peers”, without going through a traditional financial intermediary such as a bank or other traditional financial institution.”
I learnt of the existence of P2P when I received a spam mail from one of the P2P marketplace site, called Faircent.com. I decided to explore more and uncover this investment trend. Apart from Faircent, we have i-lend. There are other P2Ps in the market, but they focus on lending to companies and not retail investors/borrowers.
So, how does this model work and why will anybody choose P2P?
P2P portals help lenders meet borrowers. Lenders can choose from a list of verified borrowers on the website. They are also advised to spread their investment among borrowers to lessen the risk of default. The investment begins from INR 5k upwards and for this risk, the lenders get a return of 15%-24% on i-lend and upto 25% on Faircent. The borrowers can borrow from INR 25k to 100k at 12% upwards. The portals charge an upfront fee from both lenders and borrowers and get the borrower’s documents and employment details verified by a third party. A contract with terms and conditions is signed within a week, with a recovery process in place for those who default on payments.
What is the advantage of P2P?
Bank customers can sometimes struggle to secure bank loans because of employer credentials, salary requirements or credit history. Around INR 3.8 trillion ($61 billion) in personal loans, excluding home loans, were outstanding in March 2012, a Reserve Bank of India report shows. This includes education loans and credit card dues. Thus with bad loans mounting, banks in India have become wary of lending in certain sectors in the past few years.
Informal lending is common in India, with businessmen and family members often lending money in times of need. P2P is a progression of that, with the money flowing not from family/friends but from other like-minded people. According to a research article by Mr Ankit Shah, a Senior Associate Consultant for Finacle (Infosys), the advantage of P2P lending is the likelihood for the borrower to secure the loan at a lower rate of interest as compared to a bank loan and the likelihood for the lender to receive a better interest rate as compared to a bank deposit. P2P lending asset class is different from the traditional savings account or stock market linked investments. The only risks involved here are the counterparty risk and the concentration risk. Concentration risk can be greatly mitigated by spreading the loan amount across a large number of borrowers. As for the Credit risk, lenders can decide to lend only to borrowers having a specific credit profile, which is listed on the sites.
What is RBI’s take on P2P?
As per a Jun 2014 RBI report, “India’s ‘shadow banking’ sector essentially refers to the large number of ‘unregulated’ entities of varying sizes and activity profiles, raises concern partly because of the public perception that they are regulated. Technology-aided innovations in financial disintermediation such as peer-to-peer lending warrant a regulatory preparedness.” “While in certain regulatory jurisdictions this space is being looked at as more favorable, some other regulators have raised concerns mainly relating to distress for lenders in the event of a sudden closure of such platforms. While these platforms are still new to India and the scale of transactions is insignificant, this is a gap which requires regulatory attention. This is all the more important since in developed markets, mainstream financial market participants and products are making an entry into this space amidst concerns over regulatory arbitrage.”
What’s on the cards?
Mr Shah continues to say that, P2P lending is still in its nascent stage. With evolving models, better regulatory mechanisms and improved credit rating facility, we may see more and more lenders and borrowers participating in this new way of lending. In the coming years, it can have the depth to support a larger participation. Also, with internet users spending more time on social networks, it is likely to generate higher interest in people in the time to come.
So, if you are sitting on a cash pile, where would you place your bet? The traditional avenues or P2P?
This article was written by Vinita Jagannathan (PGDM, Batch 19, XIME-B)