Imagine you are sitting on a cash pile, with no idea on where to invest it. Well, you have a range of options. You can
1.Open an FD Account with a bank.
2.Invest in securities
3.Invest in Real Estate
4.Invest in gold
These are the traditional avenues to which you can shift your money. Logically, going by the diversification rule, your portfolio will consist of a mix of these. Why? Every option has a level of risk and return attached to it. So, a mix of these options will ensure that the risk is rewarding.
Let’s draw a risk-returns matrix and see where each option sits
So, now where would
you place your pile? On one option or many?
To most of the
readers, this is elementary knowledge. You guys are probably wondering, “This
is Financial Management 101! Where is she going with this?”
I agree with you
guys. However, I am about to present to you a fifth option. And that is
Peer-to-Peer lending. Yes, I am talking about “shadow banking”.
According to
Wikipedia, “Peer-to-peer lending, commonly abbreviated as P2PL is the practice
of lending money to unrelated individuals, or "peers", without going
through a traditional financial intermediary such as a bank or other
traditional financial institution.”
I learnt of the
existence of P2P when I received a spam mail from one of the P2P marketplace
site, called Faircent.com. I decided to explore more and uncover this investment
trend. Apart from Faircent, we have i-lend. There are other P2Ps in the
market, but they focus on lending to companies and not retail
investors/borrowers.
So, how does
this model work and why will anybody choose P2P?
P2P portals help
lenders meet borrowers. Lenders can choose from a list of verified borrowers on
the website. They are also advised to spread their investment among borrowers
to lessen the risk of default. The investment begins from INR 5k upwards and
for this risk, the lenders get a return of 15%-24% on i-lend and upto 25% on
Faircent. The borrowers can borrow from INR 25k to 100k at 12% upwards. The
portals charge an upfront fee from both lenders and borrowers and get the
borrower’s documents and employment details verified by a third party. A
contract with terms and conditions is signed within a week, with a recovery
process in place for those who default on payments.
What is the
advantage of P2P?
Bank customers
can sometimes struggle to secure bank loans because of employer credentials,
salary requirements or credit history. Around INR 3.8 trillion ($61 billion) in
personal loans, excluding home loans, were outstanding in March 2012, a Reserve
Bank of India report shows. This includes education loans and credit card dues.
Thus with bad loans mounting, banks in India have become wary of lending in
certain sectors in the past few years.
Informal lending
is common in India, with businessmen and family members often lending money in
times of need. P2P is a progression of that, with the money flowing not from
family/friends but from other like-minded people. According to a research
article by Mr Ankit Shah, a Senior Associate Consultant for Finacle (Infosys),
the advantage of P2P lending is the likelihood for the borrower to secure the
loan at a lower rate of interest as compared to a bank loan and the likelihood
for the lender to receive a better interest rate as compared to a bank deposit.
P2P lending asset class is different from the traditional savings account or
stock market linked investments. The only risks involved here are the
counterparty risk and the concentration risk. Concentration risk can be greatly
mitigated by spreading the loan amount across a large number of borrowers. As
for the Credit risk, lenders can decide to lend only to borrowers having a
specific credit profile, which is listed on the sites.
What is RBI’s
take on P2P?
As per a Jun
2014 RBI report, “India’s ‘shadow banking’ sector essentially refers to the
large number of ‘unregulated’ entities of varying sizes and activity profiles,
raises concern partly because of the public perception that they are regulated.
Technology-aided innovations in financial disintermediation such as
peer-to-peer lending warrant a regulatory preparedness.” “While in certain
regulatory jurisdictions this space is being looked at as more favorable, some
other regulators have raised concerns mainly relating to distress for lenders
in the event of a sudden closure of such platforms. While these platforms are
still new to India and the scale of transactions is insignificant, this is a
gap which requires regulatory attention. This is all the more important since
in developed markets, mainstream financial market participants and products are
making an entry into this space amidst concerns over regulatory arbitrage.”
What’s on the
cards?
Mr Shah
continues to say that, P2P lending is still in its nascent stage. With evolving
models, better regulatory mechanisms and improved credit rating facility, we
may see more and more lenders and borrowers participating in this new way of
lending. In the coming years, it can have the depth to support a larger participation.
Also, with internet users spending more time on social networks, it is likely
to generate higher interest in people in the time to come.
So, if you are
sitting on a cash pile, where would you place your bet? The traditional avenues
or P2P?
This Article is written by Vinita Jagannathan (PGDM 2013-15)