In the last article- The ‘Investment Product’ that earns 12% & more when FD offers below 7% – P2P Lending (Part 1) of this series we had seen the broad architecture of P2P lending. In this article let’s explore more details of P2P lending.
We at Bonvista are associated with Monexo (P2P Lending Platform). We have experienced their processes closely. Hence explanation of the processes and mechanism in this article has the impression of Monexo’s actual working.
P2P lending is a simple investment product. It tries to unit borrowers with lenders (investors). In India there are many people who need small loans but they can not access the loans from banks. These borrowers do not want to keep visiting banks as they are looking forward to some quick access solutions to their loan requirement. Many among these loan seeking individuals have good credit ratings and all the intentions to pay back their loans. P2P lending tries to serve this class. Lenders get ready access to these people with their filtered list. The list has complete details like the family background of the borrower, their income, credit rating , job profile, employment duration, employer, whether he stays in his own house or rented etc.
The P2P lending model makes the maximum benefit available to both the ends, that is to the lenders ( investors) and to the borrowers. Borrowers get loans after easy processing, mostly online but after due verification. Borrowers have these (P2P) loans available at a cheaper cost than the credit card loans. It’s like a personal loan, but with much flexibility. The loan can be of a smaller amount, easy access, rewarding to genuine borrowers.
On the other hand lenders get good returns on their investment. In the current investment scenario there is a good gap between Debt investment (like investment in Fixed Deposit, PPF and Debt Mutual Funds) and Equity Investment (like shares and Equity Mutual Funds). On one hand these debt investments offer (mostly) assured returns around 7%. On the other Equity offers around 14-15% but without any assurance. Equity comes with a lot of volatility. This gap between 7% and say 15% can be filled up by P2P investment. In P2P investment lenders get more than 12% returns. These returns are assured as well.
P2P lending is completely transparent. The statement gives accounting of each penny. It lets the end users know how the cash flows from one end to another.
Every product was new at some point in time. When Mutual Funds were launched in India in the 90’s very few investors believed in it. However, those who invested and consistently held their investments in Mutual Funds have benefited. Yes, there is a risk of ‘unknown’. We may not know certain things about the product. These unknowns can be- there is no history, no one around me has invested in the product. However, one needs to understand when you are among the earliest investors you get benefited the most. Those who have invested in Shares, say HDFC Bank shares, have enormously benefited out of their investment.
So, to sum up, basically the risk is there. But the risk needs to be managed. In my opinion most P2P platforms have managed the risk well. (We shall see in this article in the later part how the risk can be managed) If the risk is well managed it no longer remains as risk.
The borrowers are selected by the risk management team of P2P lending company based on their internal risk management process. In case of Monexo, they chose the borrowers based on their credit rating, salary, job profile (loan is given only to salaried individuals). Each individual is categorised as per his credit rating. To be a little more specific, these borrowers are mostly private employees, with white collar jobs, having monthly salaries between 15000 to 50000 and having decent credit history.
Yes. Based on credit rating you can choose the borrowers. The credit rating in case of Monexo is divided between M1 to M8. Here M1 means highest rated individual and M8 means individual with lowest rating. Investors with the help of their advisor can choose whom to lend among these borrowers.
If the lenders choose borrowers among M1 to M3, it can be termed as a ‘Conservative’ loan portfolio. This loan portfolio can be considered pretty safe. If M4 to M5 is chosen by the investor it can be considered as a ‘Moderate’ portfolio. Borrowers between M6 to M8 are comparatively lower credits. Hence this portfolio is considered as ‘Aggressive’. Finally, if the investors wish, he/she can distribute the loans among all credit ratings between M1 to M8. This portfolio can be termed as Diversified portfolio.
In a Conservative portfolio the risk is lowest and the returns are also lowest. In the current scenario one can expect returns around 12% in Conservative loan Portfolio. As you move from Conservative to Aggressive the risk increase and so the returns are also high. In the Aggressive portfolio, in the current scenario, you can expect returns to be around 20%, but with highest risk.
Most P2P lending platforms have their Risk Management system in place. As we understand, there will always be some amount of default in any loan. In P2P lending too we can expect to have some default rate.
But before getting into default of P2P, we need to understand what is the default rate in case of loans distributed by banks and also the loans on credit cards. The default rate of Credit Cards is about 1.7%. The default rate of Personal Loans is about 0.52%. And the same for ‘Loan Against Property’ is about 2.62%. With these NPA rates most banks and credit cards are generating good surpluses and are profitable.
In case of P2P lending the default rate will be different for different credit ratings of borrowers. With the current available study the default % of Conservative loan portfolios (M1 to M3) is 0.04%. For Moderate, Diversified and Aggressive portfolio the default rates are respectively 1.59%, 1.87% and 4.08%. So you can see that the default rates currently are comparable to that of the bank loans. Ofcourse, we as an investor need to keep a tab on the default rate and other factors on an ongoing basis.
An article in Economic Times throws light on the default rate of each type of loan. According to the article the default rate is lowest in Personal Loans. As P2P is a kind of personal loan we can compare the same. Here is the link to that article.
Let me take a pause here. We have some more to know on this topic. In the next article on P2P lending I will write on how much should one invest in P2P lending, how P2P lending portfolio is diversified, the actual returns calculations etc.
You can ask any questions in the comment box below, we shall be more than glad to answer them.