Peer to Peer Lending

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The financial services industry has been the object of many innovations over the years with a significant impact on consumers. Today the sector is once again confronted with the turbulent forces of digital disruptions and technical & social transformations. A new generation of customers has emerged that are more tech-savvy. The use of algorithms, big data, blockchain, peer-to-peer lending and crowdsourcing, means that the role of the intermediary is changing-banks now face competition from other intermediaries. Digital disruption is not only changing the provision of services in the sector but may also be solving problems in financial markets, such as high switching costs, or high transaction costs.

So, what is Peer to Peer Lending?

Peer-to-Peer Lending enables individuals or businesses to obtain loans directly from other individuals through online platforms that matches lenders with borrowers cutting out the financial institution as the middleman. Peer-to-Peer companies offer online services to operate with lower overhead costs and provide loan services more economically than traditional financial institutions. It provides investors with the opportunity to build up a diverse portfolio of assets by spreading investments across loans thereby reducing the risk of the borrower.

How it is different from Bank Lending?

Bank Lending
P2P Lending

Growth of Peer-to-Peer Lending

Earlier Peer-to-Peer Lending system was viewed as providing loans to those who would be turned down by traditional institutions or as a method to consolidate student loan debt at a lower interest rate. Now it acts as a method of online debt financing which allows creditors to lend varying amounts to small businesses and individual borrowers. Growth drivers of Peer-to-Peer Lending are — 1) Low operating cost as it neither requires infrastructure/ buildings nor a large workforce, unlike traditional banks. P2P lending platforms function via internet-based services. The data is available to the public through their sites which gives a clear idea to consumers about loans and their types available. 2) P2P Lending platforms are widely using different technologies like AI, ML and Big Data market which helps them in accessing complex and large datasets to improve their core processing capabilities and offer enhanced consumer services and insights. P2P lending platforms have an innovative edge over traditional banking systems since it offers higher transparency in businesses. 3) The Rise in the number of MSMEs provides lucrative opportunities for the growth of the market. The global peer-to-peer lending market size was valued at $67.93 billion in 2019 and is projected to reach $558.91 billion by 2027 growing at a CAGR of 29.7% from 2020 to 2027.

How does Peer-to-Peer Lending work?

P2P Lending platforms are largely technical companies acting as an aggregator for lenders and borrowers thereby, helping create a match between them. Once the borrowers and lenders register themselves on the website, due diligence is carried out by the platform and those found acceptable are allowed to participate in lending/borrowing activity. The companies often follow a reverse auction model in which lenders bid for a borrower’s loan proposal and the borrower has the freedom to either accept or reject the offer. The documentation for the lending and borrowing arrangement is facilitated by the P2P platform. Interest rates and the methodology for calculating those rates vary among P2P lending platforms. They range from flat interest rate fixed by the platform to the dynamic interest rates as agreed upon by the borrowers and the lenders to the cost- plus model (operational costs plus margin for platform and returns for lender).

Key Market Segments

Peer-to-Peer Lending provides significant advantages to both borrowers and lenders:

1)Higher returns to the investors: P2P Lending provides higher returns to the investors relative to other types of investments. Different risk portfolios are available on the platform for investors — Zero Risk (ROI: 12–13% p.a), Low Risk (ROI: 16–18% p.a ) , Medium Risk (ROI: 20–24% p.a ) and investors can access the portfolio as per their choice.

2) Lower interest rate: P2P platforms usually come with lower interest rates because of the greater competition between lenders and lower origination fees.

3)More accessible source of funding: P2P lending is a more accessible source of funding than conventional loans from financial institutions- due to the low credit rating for the borrower, the process is smooth with less paperwork and documentation required, and the loan is disbursed within 24–48 hrs.

Challenges to the development and adoption of P2P Lending

To enable the development of P2P Lending there are several important barriers that need to be resolved. The highlights being regulation, infrastructure problems, customer acquisition, funding and Credit and risk modelling.

Uncertainty in regulations is the biggest hindrance in securing funds to scale operations. Thus, the long-term success of the industry would depend on the support from regulatory agencies and the investor community. The P2P industry’s competitive advantage depends on lean operations and low transactional cost, establishing a suitable technology infrastructure that helps in achieving these advantages will be a challenge. P2P Lending success depends on the identification of the right borrower to lend to. Devising appropriate risk and credit models will be a challenge to the firms.

Future Of P2P Lending

P2P lending would be a major factor driving the change that includes changing business models, disruptive technologies, etc. It has forced traditional institutions to restructure the way they conduct business. It is steadily growing and will soon probably achieve mainstream status. Peer to Peer Lending development, which is based on new-age technology, has opened various avenues for transparency and openness of transactions. Both investors and borrowers will find P2P lending to be an appealing alternative to traditional institutions. The market’s rapid growth in such a short period of time demonstrates this. P2P companies, for all intents and purposes, act as creditors, even up to the point of collecting arrears, and the larger organizations are taking precautions to protect their investors from bad debtors. With the RBI’s approval of P2P lending, more lenders and borrowers will turn to it for loans, thus expanding the sector. Small lenders will have a way to lend their excess cash in a transparent manner, yielding a greater rate of return than bank deposits. Although NBFC status puts a lot of credit data into the system, compliance for these platforms would increase modestly, as with any regulation.

Sources

  1. Investopedia Article : P2P
  2. PWC Article : Lending
  3. Lendenclub Article: Future of P2P
  4. Faircent Article : P2P
  5. Report by AMR : Global P2P Outlook
  6. Lendbox Article: Risk Investment