Proposed norms for P2P lending: A setback for cash-poor but promising startups? Article by Archana Khosla of Vertices Partners

“The world as we have created it is a process of our thinking. It cannot be changed without changing our thinking.” -Albert Einstein

True to what Einstein said, comes the moment when financial services as a sector in this country sees a new regimen. Peer to peer (P2P) lending can be stated to be a form of crowd-funding that brings individual borrowers and lenders together to raise or lend unsecured loans without a middleman. The P2P lending marketplace is an alliance between technology and finance. It functions through an online platform, which matches the borrowers with the relevant lenders, thereby reducing the traditional banking formalities to a great extent. The P2P platforms do not lend themselves but act as pure facilitators to both the loan-seeker and the loan-giver.

The P2P industry is steadily becoming a viable alternative to traditional bank loans and is slowly but surely going to emerge as a competitor to the traditional banking system. Although nascent in India and not significant in value yet, P2P lending has gained immense popularity as an alternate form of lending in the past few years. 

The salient features of P2P lending are:

• It works through online platform
• It connects lenders and borrower
• It allows easier approval of loans
• Borrower can be individuals as well as legal persons
• It acts as a facilitator between the loan-seeker and the loan-giver.

It would be erroneous to construe this concept as new in India since it has been practiced for ages. Even in this day and age, most individuals depend on their friends and families for short-term loans. The P2P platform has just elucidated and formalised this age-old practice of taking loans from friends and family and facilitated the addition of unknown individuals within its ambit; and the integration of technology has made it effortless and seamless in getting quick desired results. 

Reserve Bank of India to regulate P2P:

The Reserve Bank of India (RBI), on April 28, 2016, has released a consultation paper on P2P lending and proposed to bring such platforms under its purview by defining them as non-banking finance companies (NBFCs). Before issuing its consultation paper, the RBI had conducted a study on the different models and regulations applicable to P2P lending sector in different countries globally. It is treated as a banking activity by some countries and as an intermediary activity in some others, while some countries have prohibited it altogether. After interpreting and analysing each of the business models adopted by various countries, the RBI espoused the “intermediary” model as best suited to India’s financial and economic environment. 

According to the RBI, it is judicious to regulate the P2P business because of the impact it can have on traditional banking channels and NBFCs and its potential to disrupt the financial sector. The proposed regulations are expected to strike a balance between over regulation and under regulation. Over regulation may slow down the business of P2P industry. Under regulation may carry the risk of bad practices being embraced by segment players, which may be detrimental to the entire sector. 

Proposed regulations:

• P2P companies can be registered only as an intermediary and their role is limited to bringing the borrower and lender together.
• The companies must have a minimum capital of Rs 2 crore.
• The platforms may have to adhere to a leverage ratio so that they do not expand with indiscriminate leverage.
• P2P lenders cannot take on the functions of a bank and can neither seek nor keep deposits.
• Prevent/ eliminate the threat of money laundering funds moving directly from the lender’s bank account to the borrower’s bank account.
• P2P platforms cannot assure returns.
• P2P companies will need to adhere to the requisite regulations on advertisement.
• Prohibition on transactions between residents and non-residents.
• Prudential limits on maximum contribution by a lender to a borrower/segment of activity.
• P2P platforms may be required to have a “brick-and-mortar” presence in India.
• Platforms will need to submit regular reports on their financial position, loans arranged each quarter, complaints, along with other details to RBI.
• Since RBI can only regulate companies and co-operative societies (and not individuals, proprietorships, partnerships or limited liability partnerships), all P2P platforms may have to be structured as companies.
• The platforms will have to guarantee confidentiality of customer data.
• Loan recovery practices of the P2P platforms will need to adhere to existing guidelines on NBFC’s recovery practices.

Although the consultation paper has received a reasonably warm welcome from the P2P segment players, a few edicts there may prove to be a major setback for cash-poor but promising startups. 

P2P companies are principally matchmakers for borrowers and lenders without the lending and borrowing getting reflected on their balance sheets. Therefore, the proposal to mandate capital requirement of Rs 2 crore does not appear desirable. Such excessive capital requirements will merely act as a blockade for new startups. It will also adversely affect a startup's ability to bring in innovation in areas of matching algorithms and ascertainment of credit risk profile. It would be desirable if minimum capital requirement is linked to the quantity of loans outstanding by the platform. Further, if the lending and borrowing are not reflected in the P2P company’s balance sheet, adherence to a leverage ratio to that extent is a measure that needs more contemplation from an applicability perspective. 

Secondly, most P2P startups are more of e-finance platforms, therefore the requirement of “brick-and-mortar” presence in India may prove to be inconvenient for such startups.

Additionally, the following issues also need the attention of the concerned regulator.

• Ceiling on the rate of interest that a lender can charge and on the commission that a platform can collect not prescribed.
• Money to move directly from lender’s account to borrower’s account without an “escrow account” or “nodal account”.

RBI has invited feedback from various stakeholders on its discussion paper till May 31, 2016. The feedback and comments of stakeholders will aid RBI finalise the regulations to track and systematise P2P lending in India. Once P2P lending is streamlined and the risk cover for such alternate lending is rationalised for the lender and borrower, the P2P lending sector would unleash its full potential as a sought-after alternate lending system, which will be beneficial for the common man who wishes to seek quick finance without undergoing the hardships of the traditional rigmarole. 

Archana Khosla is founder partner, Vertices Partners. The article includes inputs from Nirav Punjani, associate, Vertices Partners.