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RBI Views on P2P Lending in India: A Work in Progress

Founder and CEO, Transfin.
Jun 30, 2016 2:30 PM 4 min read
Editorial

RBI Views on P2P Lending in India: A Work in Progress

RBI’s recent discussion paper on peer to peer (P2P) lending is its first attempt in setting a framework around this new, fast growing and likely disruptive sector. Considering India’s weak performance in financial inclusion, P2P’s potential as an alternative source of credit cannot be understated. The paper in its current shape is relatively high-level – nevertheless, the nascent industry and its backers are closely watching.  

 

P2P platforms are essentially websites, where borrowers can solicit unsecured loans from lenders. Though the exact business model differs from company to company, these platforms essentially act as a broker intermediating the transaction. They make money by charging various transaction fees at origination.

 

RBI’s main recommendations include reiterating P2P platforms’ intermediary nature, enforcing a minimum capital requirement of INR2cr, leverage ratio thresholds, prudential limits on ticket size, periodic reporting and demanding promoters and senior management to qualify as “fit & proper”.

 

Being an “intermediary” restricts these platforms from taking any balance sheet risk. They cannot assure guaranteed returns to the lenders. Their income should purely be fee-based and not driven by the spread between lending and deposit rates, as in case of a bank. Furthermore, they are to be registered as NBFCs to legally prohibit them from collecting deposits.

 

It is clear that our regulator is aligning itself with the UK model. On the positive side, this increased scrutiny adds a sense of formalisation to the sector. However, the proposals have its share of detractors. Firstly, RBI insists that all funds should transfer directly between lenders and borrowers. The industry argues that this is difficult to implement – an escrow/nodal account is key to execute proper management and allocation of funds, especially in cases where a single borrower is dealing with multiple lenders. They further insist that borrowers often pay EMIs via post-dated cheques, making direct transfers not feasible (as security for potential defaults – a bounced post-dated cheque can lead to trial under the Negotiable Instrument Act).

 

This is a fair point as it is based on an operational reality which the regulator has ignored. No matter how technology-heavy these platforms claim to be, most of the collection and payment processes are still manual due to structural issues within the Indian context e.g. use of cheques, lack of electronic signature verification etc. The RBI should tailor its guidelines accordingly, updating them over time as the sector evolves. It should further be understood that the industry has produced two different models – pure-bred P2P platforms which links individual borrowers to individual lenders, as well as a hybrid model where individual borrowers are linked to institutional lenders. The regulator should clearly differentiate between them especially with regard to its operational recommendations, such as the one above. The evolution of a Unified Payment Interface (UPI) currently underway will obviously be an additional driving factor.  

 

Second point of contention concerns RBI’s insistence of platforms to satisfy a minimum leverage ratio. Though the ratio hasn’t been precisely defined, there is already significant noise on how such a metric may deter growth. The usual argument is that since the P2P platform doesn’t face any credit risk, there is no sense in adding capital controls. This view is fundamentally flawed. Yes, the platforms directly do not undertake any credit risk. They do however originate the transactions and hence have the prudential responsibility to see that the underlying credit is properly approved and priced. A leverage ratio would align them to be risk aware in their search for growth. In fact, a minimum leverage ratio for such platforms is not a new concept and is already practiced in the UK, a pioneer in this industry. The Financial Conduct Authority (FCA) has defined it as minimum capital required as a percentage of the outstanding loan exposure. The requirements are broken by loan slabs (volume-based) and are naturally much lower than banks, but they essentially work on the same principal.   

 

P2P lending is a relatively new sector in India with close to 30 operating start-ups. It is currently insignificant vs. traditional banking but with rapid penetration of the internet, increase in customer data and a large unbanked population, it is only about time that this sector gains scale and importance. The RBI is fair is in its view of commencing early regulation, unlike in China where P2P is an unregulated behemoth with over 2,000 players. But it is essential to strike a balance of promoting solid business models without supressing their growth. India-specific operational practices as well as precedent International standards should be considered before providing a more detailed framework – hopefully soon. The digital footprint of customers via social media and mobile activity is on the rise, leading to platforms using sophisticated in-house algorithms to assess credit risk. The regulator should however make sure that P2P platforms also have access to traditional credit bureau data (e.g. CIBIL) as well as allows them to report defaults. CIBIL scores would definitely give them more teeth, make the market more competitive and also help in capturing credit data of new customers.

 

It is important that only firms with strong fundamentals can survive and thrive, especially at a time when there is no lack of turmoil in the banking system in India. RBI’s proposal to setup a panel involving all stakeholders to study issues facing the Fintech industry is a move in the right direction. We should remember that a robust alternative financial system will in the long-run contribute immensely towards de-stressing the banking sector.