P2P Lending

Peer-to-peer (P2P) lending has been gaining popularity in recent years. Many fintech companies are offering this new service where people can lend as well as borrow money. Here’s how P2P lending works and the risks involved.

What Is P2P Lending?

• A form of credit service that enables an individual to borrow money directly from other individuals.  
• P2P websites are like aggregator marketplaces that bring together lenders and borrowers.  
• Any resident of India who has a PAN card and a bank account can become a lender or investor. RBI-listed NBFCs or companies formed under the Indian Companies Act can also be lenders.
• Starting steps for lenders include KYC verification, linking bank account and setting a preference for the type of loans they want to invest in.  
• Any salaried individual can borrow. Some websites have an age criterion, typically 21-55 years. Some checks determine the borrower’s creditworthiness.

How Does It Work?

• Each P2P platform sets interest rates and loan terms. Interest rates are based on the borrower’s credit score, and are typically higher than in banks. The range is from 8 per cent to as high as 28 per cent a year.
• The investor opens an account with the website and deposits the money which is to be disbursed in loans.  
• The borrower also creates an account. The P2P platform does credit verification. Based on the applicant’s financial profile and risk category, the interest rates apply.
• The loan applicant can accept the most suitable offer. The platform handles disbursements, monthly payments and repayment. But in case of default, the lender bears the loss, and the platform acts only as the facilitator.

Risks Involved

• The first major risk for lenders is default or late payment. Since P2P lending is a form of unsecured loan, there is no guarantee put up by the borrower to redeem in case of a default. However, the unsecured nature of the loan is also the reason behind the high returns.
• Another risk is the loss of privacy and data security. These tools are heavily dependent on technology, which makes them vulnerable to the risk of technology failure.
• In case of a default, borrowers risk negative impact on credit score. So, their ability to take loans from the formal sector would further reduce in case of default. With a low credit score, they may be charged higher interest rates in future.