Freefall: Can P2P lending grow out of RBI's iron fist regulations?

What's next for P2P lending in India?

In 2018, China witnessed a crash in its P2P lending market.  It was the result of much-needed-but-long-overdue regulations, imposed due to widely reported malpractices prevalent in the once-booming industry. Five years later and south-west of China’s border, is Indian P2P lending going down the same road? 

Can the industry brave this regulatory rough patch? Or has RBI all but sounded a death knell to the modern P2P lending model as we know it today?  

Unlike China (which saw a mainstream boom P2P lending), India’s P2P lending has been a wallflower in the backdrop of a booming Indian fintech landscape. While digital financial services (lending, payments, and investments) grew at breakneck speed the past decade, P2P lending grew on the sidelines at a slower pace, under the watchful eye of the RBI.  

The first P2P lending platform in India was launched in 2014. Three years later, the model was inducted to the NBFC club, with RBI’s master directions for NBFC-P2Ps. And throughout the decade, space has had perception problem: Should it market itself as an investment or a lending platform?  

It’s a valid question, after all. The business model is a marketplace that connects lenders to borrowers. However, simply calling it a “money-lending marketplace” implies high risk, reducing the business model that’s a mere money-lending transaction with a tech layer. Calling it an investment avenue, however, insures the business from this assumption.  

This isn't to say that platforms didn’t try go the “lender-borrower marketplace” route. The Ken points out that when the product was sold as such, it barely saw growth. That was until COVID when players (seeing opportunity in the high demand for credit) collaborated with major fintech/payment platforms, pivoted their marketing, and rebranded P2P lending as an investment tool. So much so that P2P lending options featured in the investments category in several third-party platforms. Lenders were christened investors, and the products promised quick and high returns. Add to this the perceived lack of transparency in the distribution of received funds, details of borrowers, and more, and the RBI was expected to intervene. And intervene it did.  

RBI’s hard pill 

The RBI’s crackdown came in the form of revised directives for NBFC-P2Ps, leaving players scrambling for a way forward. It touches upon on several points that ensure more transparency to lenders and enforcement of fair lending-marketplace practices: 

• Prohibition of investment marketing and insurance cross-selling: This means that P2P lending can no longer masquerade as an investment tool with guaranteed returns or liquidity alternatives. It also deters platforms from cross-selling insurance products that act as credit enhancements or guarantees. 

• Escrow account requirement and funds transfer: The RBI mandates all financial transactions between lenders and borrowers through escrow accounts. Platforms are prohibited from using funds from one lender to substitute for another.  

• T+1 Day settlement from escrow accounts: Funds in the Lenders' and Borrowers' Escrow Accounts must be transferred within one business day (T+1) of receipt.  

The aftermath 

With RBI’s latest intervention, I see P2P lending platforms facing three major problems challenges: 

The operations angle: Teething problems are inevitable in events of disruptive regulations. Platforms have frozen new transactions to accommodate them. A noteworthy challenge for the industry stems from the T+1 escrow-account settlement. Operations-wise, it’s bound to pose logistical challenges. Quick reconciliation requires overhauls in back-end systems to accommodate high-volume transactions.  

The marketing angle: The larger impact of the T+1 settlement in P2P lending is the marketability of the new model. Quick settlement means that the lender receives the funds repaid by the borrower immediately, disallowing platforms to reinvest the lender’s money. This takes away from the allure of looking at P2P lending as an investment avenue altogether (even if the product has been marketed as a lending marketplace). Will lenders then think of P2P lending as a good place to park their money? I think not.  

Moreover, the revised regulations allow no wiggle room to provide extra-frill benefits like cross-selling of products or even credit enhancement. So what does the “investor-lender” gain from P2P lending? It will be interesting to see how players – especially those without an MSME/social-betterment angle – will position themselves.  

The goodwill angle: Having RBI on their radar has earned P2P lending enough bad press. While we’ve seen several brands that leveraged regulatory loopholes bounce back, reviving trust in the P2P lending business will surely be a tough nut to crack. An online platform that connects lenders to borrowers is quite a hard-sell, but I see some respite in its RBI-backing. Are watertight regulations reason enough to trust a business model? Is it strong enough an angle for players to piggyback on? The people will decide.  

Conclusion 

Despite the regulatory challenges posed by the RBI's new guidelines, P2P lending remains crucial to India's economy, particularly for Micro, Small, and Medium Enterprises (MSMEs). P2P platforms bridge this gap by providing access to much-needed credit, fueling growth and innovation within the MSME sector. 

While the revised regulations may limit the appeal of P2P lending as an investment vehicle, they enhance transparency and fair practices, positioning P2P lending as a reliable alternative for financing MSMEs, which are key drivers of the Indian economy.  

As for the players in the business, I’m confident they’ll brave the storm. The question is, will they be back with a bang? Or continue to remain on the fringes of India’s fintech story? Time will tell.

What do you think will happen next? Write back. I’d love to know.  

Cheers,  

Rajat