Global Investors And Governments Shun P2P Lending, But BharatPe And Cred Look To Enter The Segment

Last week, Cred launched Mint, its peer-to-peer lending platform. The objective was to enable its users to earn interest on idle funds, while enabling other users to borrow money. BharatPe soon followed with its own peer-to-peer lending product, named the “12% Club”.

Like the name says, BharatPe’s product would allow users to earn up to 12 per cent interest on their money. Cred’s product would pay around 9 per cent interest rate. These platforms are offering two to three times the interest rates offered by savings account in banks.

High interest rates have been a hallmark of most P2P lending platforms, and have helped attract billions of dollars from investors so far. But high returns imply high risk. And high risk (combined with bad economics) is the reason behind USA’s largest P2P lending platform ceasing its operations, and the Chinese government banning P2P lending. China and the USA make up around 95 per cent of the world’s P2P lending markets.

The Beginning:

In the early days, P2P platforms were established as a way to circumvent the intermediaries between lenders and borrowers – the banks. P2P platforms sought to connect individual lenders to individual borrowers. Rather than lending to banks, individual lenders could also lend to sub-prime borrowers and earn a much higher rate of return. Banks usually do not lend to sub-prime borrowers, making it difficult for such borrowers to avail credit.

Soon, P2P platforms began attracting borrowers with low credit scores and investors looking for high returns. The procedure is quite simple, the borrower signs up with the platform and is assessed for creditworthiness. He is assigned a risk category and matched with a lender ready to bear the risk and lend. Often a few lenders come together to make a loan, lowering the overall portfolio risk for each investor through diversification.

Zopa, established in the United Kingdom, was the first P2P lending platform in the world. Prosper and LendingClub led the P2P-lending ecosystem in the USA. Given the nature of the business, the loans are mostly unsecured, making it easier for borrowers to borrow without having any collateral. With these tailwinds, LendingClub’s investors had funded $11 billion dollars in loans by 2015, within a span of nine years.

Lack of Investor Enthusiasm:

But, India has seen a much lower rate of growth in P2P lending so far. The P2P lending space is dominated by small players. Most fundraise have taken place in the Rs 5-15 crore range. This is a far cry from the other fundraises in the digital lending/ fin-tech space. Besides, most of the deals appear to have taken place between 2015 and 2019, with almost no new deals in 2020 and 2021, implying that venture capitalists might not be very enthusiastic about the P2P lending space in India.

The lack of VC enthusiasm quite possibly stems from the problems plaguing the P2P lending sector world over. For instance, despite the blistering growth of its loan portfolio, LendingClub shut its P2P lending platform. The high rate of defaults by borrowers, combined with poor crowd-funding economics, hastened its exit from the P2P lending business. Instead, the company now lends by borrowing from institutions, just like a bank would.

China’s experience with P2P lending was even worse. At its peak, China had more than 5,000 P2P-lending companies, but now, only three dozen remain. The Chinese government was forced to crackdown on the sector because of the high rates of fraud and default. Despite having introduced regulations in 2015, frauds and defaults continued unabated. Ultimately, the government virtually outlawed P2P lending and asked companies to wind down their P2P lending businesses by 2021.

Bringing in the Money:

All marketplace businesses are dependent on the side with the money – retail investors, in the case of P2P platforms. If P2P platforms are unable to attract investors, their businesses will fail.

But from an investor’s perspective, the high rate of default makes P2P lending a risky speculation, not an investment. Even the safest customers on these platforms have a high probability of defaulting, given the fact that they have been unable to receive financing from conventional sources. Since lenders lend to sub-prime category borrowers, the interest rates are quite high, resulting in a debt trap for borrowers with an already weak credit. The difficulty in recovering unsecured debts further adds to investors’ woes.

Indian investor aversion to P2P lending is quite evident from the fact that FairCent’s (India’s first registered P2P lending company) site displays that borrowers require funds worth Rs 250 crore, but currently, there are lenders with only Rs 165 crore worth of funds on the platform.

A Contrarian Bet by Indian Fintechs?

P2P lending companies in the USA and China are exiting the P2P lending space and focusing on direct lending. But large Indian fin-tech companies are entering the P2P-lending space. Indian fin-techs like BharatPe and Cred are hoping to monetise on the financial data they have collected over the years.

So far, Indian fin-techs have been struggling with monetising their businesses. With the rise of Unified Payments Interface (UPI), e-wallets lost their relevance, and the payments space has become highly competitive.

Some of these companies have been distributing direct mutual funds, implying that they do not receive commissions.

Given the pressure to generate revenues, and at some point, profits, most fin-tech have begun lending, with a special focus on “buy now pay later” schemes.

Lending usually takes place through partner banks and non-banking financial companies (NBFCs), with the fin-techs focusing on borrower onboarding, providing data and payment collections.

The entry into the P2P lending space might not just be aimed at increasing lending assets. The move is quite possibly aimed at onboarding more users with the lure of higher returns. So far, P2P lending has remained relatively obscure, but with the entry of larger (and more popular) players who offer high returns on idle funds, P2P lending could see renewed interest in India.

So far, the P2P lending story has not really played out the way it was supposed to. The use of data analytics, artificial intelligence, and machine learning to identify inefficiencies in the sub-prime lending market hasn’t improved investing results for investors.

Further, the unsecured nature of the loans would mean a huge downside for investors. It remains to be seen whether the new entrants in the space can revitalise the space and attract investor interest.