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NAVIGATING THE FUTURE: How P2P Lending works

By Fundbezzie
Published on 2024-03-22 08:03:32

Peer to Peer Lending : Invest Smart, Grow Wisely

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What Is Peer-To-Peer (P2P) Lending?

Peer-to-peer (P2P) lending is a financial model that revolutionizes the traditional borrowing and lending process, offering an alternative to conventional banking channels. In a P2P lending system, individuals seeking loans are directly connected with potential lenders through online platforms, eliminating the need for traditional financial intermediaries like banks. Key Features of P2P Lending: 1. Decentralized Transactions P2P lending facilitates direct transactions between borrowers and lenders, cutting out the need for intermediaries. This decentralization streamlines the lending process and reduces associated costs. 2. Accessibility for Borrowers: Individuals who may face challenges in obtaining loans from traditional financial institutions, such as those with low credit scores or limited income, find P2P lending highly accessible. It broadens the scope of financial inclusion. 3. Direct Connectivity: P2P lending platforms act as matchmaking services, connecting individuals looking for loans with those willing to lend. This direct connection creates a transparent and efficient lending environment. 4. Mutually Beneficial: Borrowers benefit by gaining access to funds that might be challenging to secure through traditional means. Lenders, on the other hand, stand to earn interest on their investments, potentially achieving higher returns than traditional savings or investment vehicles. 5. Elimination of Middlemen: Traditional financial institutions often act as intermediaries in lending processes, imposing additional costs. P2P lending eliminates these middlemen, reducing the overall cost of borrowing for individuals and increasing potential returns for lenders. 6.Global Financial Inclusion: P2P lending has the potential to extend financial inclusion globally. By connecting lenders and borrowers directly, irrespective of geographical locations, it opens up opportunities for individuals who may be excluded from traditional banking systems. 7. Application in Various Financial Needs: P2P lending caters to a diverse range of financial needs, including education financing, debt refinancing, business expansion, and more. Borrowers can access funds for specific purposes with flexibility. 8. Convenience Through Technology: P2P lending operates through online platforms or applications, making the entire process convenient and accessible. Borrowers can apply for loans and investors can manage their investments from the comfort of their homes.

History of P2P Lending:

The concept of P2P lending began to surface in the early 2000s. Platforms like Zopa (2005) in the United Kingdom and Prosper (2006) in the United States emerged with the idea of connecting individual borrowers directly with lenders through online marketplaces. Despite initial challenges, P2P lending gained traction globally. New platforms emerged, and existing ones expanded their operations. LendingClub, a prominent P2P platform, was founded in 2006 and officially launched in 2007. The global financial crisis in 2008 played a pivotal role in the growth of P2P lending. As traditional financial institutions tightened lending criteria, P2P platforms became appealing alternatives for borrowers and attractive investment opportunities for lenders. In the early 2010s, the concept of P2P lending gained traction in India. Platforms like i-Lend and Faircent started exploring the potential of connecting borrowers directly with lenders through online marketplaces. In October 2016, the RBI released comprehensive guidelines to regulate P2P lending platforms in India. These guidelines aimed at ensuring the legitimacy of operations, consumer protection, and risk management. With Regulatory Clarity, many new platforms like Monexo, LendBox, LenDen, RupeeCircle, i2ifunding and many more entered the space As the industry matured, P2P lending platforms in India diversified their offerings beyond personal loans. Some platforms began facilitating loans for small businesses, education, healthcare, and more. P2P lending platforms leveraged technology to streamline processes, enhance risk assessment, and improve user experience. The use of data analytics and artificial intelligence became common in assessing the creditworthiness of borrowers. P2P lending gained popularity as an alternative investment option for lenders seeking better returns and for borrowers looking for accessible financing outside traditional banking channels. The regulatory landscape for P2P lending in India continues to evolve. The RBI periodically reviews and updates regulations to address emerging challenges and ensure the stability and sustainability of the industry.

How Does P2P Lending Work?

P2P lending is done through an online platform that connects borrowers and lenders directly. Those who want to lend money, open an account with a P2P platform as a lender. And those who require a loan register themselves as a borrower. These platforms then evaluate borrowers on various aspects. They don’t limit their evaluation to just credit scores. They perform their checks, including the borrower’s employment, income, credit history, etc. Not just that, using technology extensively, these platforms also capture borrowers’ habits through social media activities, app usage, etc. Based on this assessment, the creditworthiness of borrowers is decided, and they are assigned to different risk buckets. Lenders can check this assessment done by the platform for various borrowers and pick whom they want to lend their money as per the risk they want to take and the return they want to earn. Similarly, borrowers can also see the profile of lenders and reach out to them. The P2P platforms do not keep a margin from the monthly instalments or transactions between the lender and the borrower. To make sure that the platforms don’t do anything fishy or fraudulent, like holding on to money invested by the lenders or money paid back by borrowers, RBI regulates these platforms. How Is P2P Lending Regulated in India? Since P2P lending is a form of well, lending, it comes under the Reserve Bank of India (RBI). RBI has set guidelines around how P2P lending platforms need to work. For instance, any company which wants to offer P2P lending services need to register for an NBFC-P2P license from the RBI. As the regulator, RBI also ensures that there is no significant systemic risk in these platforms. As per RBI regulations, if a P2P platform decides to shut down, then the company’s board will act according to a pre-decided Business Continuity Plan. The plan has all the details to keep the information of all lenders and borrowers safe. The plan also has nuances about servicing loans for the entire tenure in case of closure of the platform. So these are among the several regulatory measures that RBI has put in place to reduce the risks in P2P lending. That said, P2P lending investment is not entirely risk-free. Let’s understand more about the risks in P2P lending.

P2P Lending: Understanding The Risks

The price of market-linked products like stocks, bonds, gold, or mutual funds fluctuates daily. However, there is no market-related risk in P2P lending. So the value of your investments in P2P lending will not fluctuate daily. The risk involved with peer-to-peer lending is the risk of default by the borrower, i.e., the borrower doesn’t pay the interest and the principal amount. If a borrower defaults, a P2P platform can assist the lenders in recovery and file legal notice against the defaulter. Since the default risk is the primary risk you are taking as a lender, the assessment of potential risk a borrower brings to the table becomes the key. One argument given to counter the credit risk is that investors can diversify their investments across various high-creditworthy borrowers. While this strategy can help you minimize the risk to some extent, it doesn’t make the investments completely risk-free. P2P Lending Returns: How Much Can You Earn? Like any investment, the return in P2P lending depends on the risk you are willing to take. You can measure the risk in P2P lending on two parameters: one, the borrower’s creditworthiness. And two, the tenure for which you lend. The longer the lending period, the higher the returns. You need to consider two things while looking at the returns from P2P lending are the default rate and the platform fees. That’s because your actual return will get reduced due to these. For instance, if you earn a 20% return from your investment and the non-performing assets account for 5%, your net returns will come to 15%. Say there is a 2% platform fee, then your net return will come to 13%. Taxation On Returns - P2P Lending In P2P lending, investors essentially earn interest from the amount they lend. Thus, just like interest earned from other instruments like FDs, interest income from P2P lending is taxable. The interest amount earned from P2P lending is classified as ‘Income from Other Sources.’ It is added to the lender’s income and taxed as per the tax bracket lender falls in. So if someone is in the 30% tax bracket, he will pay 30% tax on the interest earned. For instance, say, you invested Rs. 1 lakh in P2P lending, and the interest you earned from the principal amount is 15% or Rs. 15,000. If you are in the 30% slab, you will pay Rs. 4,500 (30% of Rs. 15,000) in taxes.

Should You Invest in P2P Lending ?

At a time when banks are giving around 7% interest on 1-year FDs, the prospect of earning a 10% – 12% interest per annum through P2P lending looks attractive. But there are some risks involved, which is true for any investment that gives higher returns. In P2P pending, the risk is that some borrowers may not be able to repay the loan. However, RBI has set guidelines for P2P NBFCs to minimise such risks. P2P lending is riskier than FD (the reason for higher returns). But it’s not as scary as equities, where investors can see a 20% – 30% correction in a few weeks and vice versa. Investors also need to understand that even though the returns are high in P2P lending, they are not guaranteed. Therefore, understand these risks before you invest. Conclusion: In the dynamic realm of investment, the choice between traditional products like Fixed Deposits (FD) and new-age investment avenues such as Peer-to-Peer (P2P) lending is a decision influenced by individual goals, risk appetite, and preferences. As investors seek opportunities to grow their wealth, platforms like FundBezzie emerge as crucial facilitators, bridging the gap between traditional stability and innovative potential. In the realm of new-age investments, informed decisions hinge on a deep understanding of lender profiling, credit underwriting processes, collection strategies, current Assets Under Management (AUM), Non-Performing Asset (NPA) ratios, and platform backgrounds. FundBezzie takes centre stage by curating investment products through a meticulous due diligence process. Investors benefit from a scientific approach that evaluates and selects opportunities with a focus on risk mitigation and potential returns. Recognizing the strengths of both traditional and new-age investments, FundBezzie provides a platform that harmoniously integrates stability and innovation. Investors can leverage the reliability of traditional products and the dynamic potential of P2P lending. The investment landscape can be intricate, especially when balancing conventional fixed deposits with emerging alternatives. FundBezzie simplifies this process, offering a user-friendly interface that empowers investors to navigate complexities with confidence. Armed with comprehensive information about each curated product, investors on FundBezzie can make informed decisions aligned with their financial objectives. The platform acts as a guide, helping investors strike the right balance between risk and reward. The scientific approach to due diligence involves a thorough examination of potential investment opportunities. This data-driven strategy ensures that investors have access to a curated selection of products with a strong risk-management foundation. FundBezzie adapts to the evolving investment landscape, acknowledging the changing preferences and needs of investors. The platform evolves in tandem with market dynamics to provide contemporary solutions.