Peer-to-peer (P2P) lending is an advanced financial platform that bypasses conventional financial institutions and links borrowers and lenders directly. Under this concept, people can lend money to other people or companies, frequently at interest rates greater than those of conventional savings accounts.
To put it simply, in a P2P transaction, there are three parties involved.
- The borrower (who needs money)
- The investor/lender (who has money to lend)
- The P2P platform (where this transaction takes place)
The registration of the borrower and investor is important on the P2P platform.
Every P2P platform needs to have an RBI (Reserve Bank of India) license. So, this P2P investment is regulated by RBI.
Individuals, HUFs, Organizations & even NRIs can be registered as lenders (Investors).
How Does P2P Lending Work?
- Borrower Application: People or companies use P2P platforms to apply for loans, giving information about their creditworthiness, financial status, and loan requirements. For that application of borrower must have approved by the platform. After approval, the borrower receives different loan options from investors on the platform. It depends on their credit rating and the assigned interest rates.
- Credit Assessment: Frequently utilizing a credit score (CIBIL/CRIF etc.) methodology, the platform evaluates the borrower’s creditworthiness.
- Loan Listing: The platform lists approved loan requests together with the borrower’s information, interest rate, and loan duration.
- Investor Investment: After looking over the loans on the list, investors have the option to avail of one or more loans.
- Repayment: The borrower makes consistent installment payments to repay the debt, including interest. After then, the investors receive their payouts.
Advantages of Peer-to-peer Loans (as an Investor)
- Greater Returns: When compared to conventional savings accounts, peer-to-peer lending frequently offers greater interest rates. On average p2p investor can earn 8% to 15% returns on the investment i.e. by lending money. Remember, it is on a case-to-case basis. Lower returns, if the borrower’s creditworthiness is higher and vice versa.
- Diversification: You may lower risk and diversify your portfolio by investing in many loans. If you have Rs. 1 Lakh, you are allowed to choose different borrowers as per your risk appetite. You can give Rs. 0.20 Lakhs each to 5 borrowers or Rs. 0.50 Lakhs each to 2 borrowers. The choice is yours.
- Accessibility: P2P platforms make it simpler to begin investing by being available to a broad spectrum of investors.
- Impact Investing: You may invest in loans that promote environmental or social issues through certain P2P networks.
The Risks of P2P Lending (as in Investor)
- Credit Risk: Just like banks have NPA (non-performing assets) percentage, this risk also lies in P2P lending. There’s a risk that borrowers may default on their loans, which will be a potential loss for investors. Hence, it is advisable to diversify the portfolio (distribute money amongst different borrowers).
- Risk on P2P Platform: The platform itself can have legal troubles or financial challenges, which would affect how secure your assets are.
- Liquidity Risk: Selling your P2P assets fast might be challenging, particularly if the market is volatile.
- Regulatory Risk: A few things are beyond our control such as changes in regulations, and changes in RBI Policy. These can impact the P2P lending industry and its operations.
Pros & Cons in P2P Investing:
| Feature | Pros | Cons |
| Returns | Possibility of earning higher interest rates than conventional investment products | There are no guaranteed returns. Risk of defaults |
| Diversification | Distribution of investments across borrowers and loan categories as per the risk appetite | Low liquidity as compared to some options like Mutual Funds |
| Direct Impact | You can invest in businesses and individuals directly | You need to rely on the platform’s credit assessment and risk management |
| Convenience | Convenient investment through user-friendly platforms | More requirements for research and efforts |
How to Mitigate Risk while Investing?
- Distribute Money as an Investor: To minimize the impact of any defaults, distribute your investment among several loans to different borrowers. There are very less chances that all the borrowers will default at the same time.
- Research: Before investing, thoroughly examine the platform, the borrower’s profile and creditworthiness, and the loan terms.
- Expected Returns: Recognize that peer-to-peer lending carries some risk. Be ready to lose. Keep an eye on your assets and be informed on how well your loans are performing.
- Terms & Conditions: Often, P2P loans have predetermined terms. Verify that the terms of the loan repayment align with your investing time horizon. Understand the platform’s price structure, which covers platform and processing fees as well as any other costs that could be involved.
Conclusion
P2P lending is a fascinating chance to diversify your investment portfolio and increase earnings. But it’s crucial to proceed cautiously and be aware of the threats involved. You may make wise choices and perhaps profit from P2P investing by properly evaluating your risk tolerance and carrying out an in-depth study.
List of Few P2P Platforms in India:
Also Read: What is Portfolio Management and How Does it Work?