P2P Platforms: What you need to know as a lender as well as a borrower

I have a friend whose family lends money to local stores at interest rates ranging from 24% to 40% per annum. While this return may seem like a great return on investment, the reality is quite different. The risk of shop owners defaulting or delaying payments is high, which can significantly reduce the actual returns. Recovering the money is also a huge challenge, and not everyone is cut out for it.

Compare this to putting money in a fixed deposit at a bank. The bank pays you interest and lends your money to others at a higher rate, keeping the difference. Regardless of whether the borrower repays, the bank is obligated to return your money when you need it. Since the risk is low, the return you earn from such an investment is also on the lower end.

Now, there’s something in between— online-based Peer-to-Peer (P2P) lending platforms, which connect lenders and borrowers for a fee. This is a loan product from borrowers’ perspective and an investment product from lenders’. 

These platforms do the basic assessment of the borrower, giving a score based on their repaying ability. In case of default, they may also help in recovering from the borrower. The interest rates on these platforms typically start from 8%-12%, higher than what fixed deposits from banks offer, and can go higher as the risk of the borrower goes up.

Since these platforms are in the business of lending and borrowing, they operate under the surveillance of the RBI and must be registered as NBFCs (non-banking financial institutions). As this space grows, RBI amends the regulations as and when required. 

Recent RBI rules make it clear that P2P platforms cannot sell this as an investment product to lenders. The regulator insists on highlighting only the loan aspects of the product. The rules also state that there shouldn’t be any assurance of a guaranteed/minimum return, nor can they offer instant liquidity options. After all, these platforms merely connect lenders and borrowers —so how could they promise features similar to those offered by a bank?

In this article, we’ll focus on the entire P2P ecosystem from both a lender’s and borrower’s perspective, including what the new RBI rules mean for you.

How it works:

P2P platforms act as intermediaries between lenders and borrowers. While the fee for the former is about 2-3% of the loan amount or any fixed amount, the processing fee for the borrower could be higher at 6-8%, which will be adjusted against the loan amount. Borrowers are listed based on their repaying ability, and the lender can choose whom they want to lend to.

These loans are unsecured, meaning they are not backed by assets. If the borrower defaults, the loss falls entirely on the lender. While P2P platforms assist in recovery efforts, they do not absorb the loss. Recovery costs, including expenses for legal notices, have to be taken care of by the lender.

Though the platform does the borrower’s basic checks, it is left to the lender to do a thorough assessment before lending.

As a lender, you’ll receive details about the borrower, including their personal identity (with their consent), the amount they need, the interest rate they’re asking for, and their credit score.

On the other hand, the borrower won’t get the lender’s personal identity or contact details. But, they will receive details such as the amount a lender is offering and the interest rate.

Once matched, the platform lets the lender and the borrower enter into an agreement. A key fact statement will be issued with details of the Annual Percentage Rate (indicates the total cost of funding for a borrower, including the interest rate and fees), the recovery mechanism, details of the grievance redressal officer etc.

Similar to bank loans, the borrowers on this platform also repay the loan in equated monthly installments (EMIs), which include both principal and interest. The maximum tenure for these loans is 36 months or three years.

To ensure that these loans don’t go overboard, the RBI has set specific limits. The total amount one can lend across all P2P platforms combined cannot exceed ₹50 lakh. If your lending crosses ₹10 lakh, you need to obtain a certificate from a Chartered Accountant verifying that your net worth is at least ₹50 lakh.

For borrowers, the total amount borrowed across all P2P platforms cannot exceed ₹10 lakh. Additionally, the exposure of a single lender to the same borrower, across all P2Ps, is capped at ₹50,000.

Note for a lender:

The following are some important points that a lender on a P2P platform needs to be aware of –

Risk of capital: As a lender, the first and foremost point that you need to understand is that there could be a permanent loss of your money in case of a default by the borrower. Borrowers on these platforms are often those who might not have gotten loans from other sources due to low-income levels or poor/lack of credit track record. This is a high-risk category, and in the event of a default, the entire loss will be yours. Even if the platform claims it will cover your loss in case of default, remember that this is not permitted under RBI guidelines. And the fee you pay to the platform does not depend on whether the borrower repaid. 

Also, just because these platforms are RBI-registered doesn’t mean that your risk of lending goes away. RBI makes sure that the platforms are running as they should be but doesn’t provide any assurance for repayment of the loans lent on it.

No instant liquidity: Keep an eye out for platforms that claim that you can withdraw your money anytime. They may also promise tenure-linked assured minimum returns. For example, if you hold an investment for 3 years, they guarantee at least 6% interest per year, regardless of repayment by the borrower.

However, according to the recent RBI guidelines issued on August 16, 2024, platforms cannot make such promises. Offering these features would only be possible if the platform shuffled loans or used its own funds to compensate for the loss —both of which are not allowed by the RBI, effective immediately.

If you’ve already lent money on these platforms before August 16th, you might need to wait until the loan tenure ends to recover your funds. And if defaults occur, you may not receive any minimum returns from the platform.

There are reports that fintech platforms are seeking a relaxation of these rules for existing customers, but as of now, no updates have been provided.

No cash transactions: Cash transactions are a no-no.

Here’s how your money flows on a P2P lending platform: All transfers happen through escrow accounts. Escrow account is held by a third party, where the platform has no control over your funds.

Funds from your account go to the lender’s escrow account and then to the borrower’s bank account after checks. Similarly, when the borrower repays, the money passes from the borrower’s escrow account to your bank account. Platforms can’t use your funds for anything other than lending, and cash transactions are not allowed.

New rules require that funds in these escrow accounts must be moved out within one day (‘T+1’ day). Some platforms find this time frame tight, claiming that it is difficult to map a lender and a borrower in one day, so further developments may occur.

No cross-selling: The platform is not allowed to cross-sell any products to the lender or the borrower. Cross-selling means trying to sell you additional products or services that are not directly related to the main service you’re using. For example, if you’re using the platform to lend money, they shouldn’t try to sell you unrelated products like credit cards or investment advisory that have nothing to do with the loan.

RBI says that selling loan-specific insurance is okay, but it shouldn’t cover credit enhancement or credit guarantee. In other words, insurance that helps with loan repayment due to unforeseen events like a borrower’s death is allowed. But, an insurance that guarantees to fund the loss in case of a default by the borrower is not allowed. 

Note for a borrower

Impact on credit score: A loan is a double-edged sword. While it provides access to funds when needed most, any delay or default in repayment can lead to hefty penalty charges that could be 18% per annum. This is in addition to EMI overdue charges. This could create a lot of financial burden on the borrower.

Further, since P2P platforms share your repayment details with credit bureaus, such issues can negatively impact your credit score.

Legal proceedings: In the worst-case scenario, the P2P platform may send a legal notice to the borrower for the default. Before resorting to legal action, the platform typically attempts to recover the money through agents trained to act appropriately. These agents are prohibited from harassing borrowers, contacting them at odd hours, or using coercion to recover loans. If such misconduct occurs, borrowers can file a complaint through the platform’s grievance redressal mechanism or, if necessary, escalate the issue to the RBI Ombudsman.

Conclusion

In conclusion, while P2P lending platforms offer a flexible alternative to other fixed-income options for lenders, one must understand how it functions and the risks that come along with it before committing the money. The RBI guidelines reiterate the fact that the platform cannot participate in the losses of the lender in case of default by the borrower. Neither does the RBI assure repayment.

In fact, RBI doesn’t want this platform to be marketed as an investment product. These fintech platforms are mandated to show how their loans performed including share of non-performing assets (loans that are overdue) on a monthly basis and segregation by age.

Since these platforms are still new in India and haven’t worked out well in some other countries, the rules could evolve over time. Both lenders and borrowers must understand the regulations, penalties, recovery processes and grievance mechanism before signing up for the services.