Imagine standing at the door of a moneylender because you have a medical emergency to pay for or just a big credit card debt that’s due at the end of the month. The moneylender is likely to offer you money but at a high interest rate and possibly ask you for a collateral in the form of jewellery or property. As it turns out, 43% of all loans in the country are actually disbursed this way.
This is the some startups are trying to fill, by allowing individuals to directly lend to other individuals. Called peer-to-peer lending, the concept is fairly new to India but it has managed to entice more than two dozen entrepreneurs who have already entered the space with their startups to have the first-mover advantage.
These startups essentially help people crowd-fund money through their platforms, using the reach of social media and internet. The differentiating factor, however, is that these are not donations made by individuals but loans extended at a fixed rate of interest and strict repayment terms.
Take, for instance, Lendbox, which started out less than a year ago as a three-person company. Its co-founders come from a startup accelerator programme and have investment banking backgrounds. Now, it has grown to 20 people working full time for it as the company claims to have disbursed loans worth Rs 8 crores already.
The repayment period in companies like Lendbox ranges from six to 36 months, with interest charged at upwards of 20% per annum in almost all cases. The maximum loan amount for most companies is about Rs 5 lakh.
“I quit my job in June last year to come back to Delhi and start this because we assessed our model for a month and there was strong potential,” said Bhuvan Rustagi, one of the co-founders and the Chief Operating Officer of Lendbox. “We have had tremendous response as we have lent to more than 300 people in the short duration of our existence.”
The company claims to be growing 20% every month with an average loan size of Rs 2 lakh to Rs 2.5 lakh. The reason it has been able to give out so many loans so quickly, it says, is because of its proprietary software that helps it assess creditworthiness of borrowers.
While conventional lending involves credit scores, bank histories, credit card debt and similar financial data, firms like Lendbox are willing to lend to even new entrants in the financial service industry – people without a salary or those with no prior bank accounts or credit cards.
These people, like everyone else, are made to go through a wide array of tests and evaluations that analyse everything from bank accounts to the number of apps on a person’s phone, his emails as well as social media accounts. Moreover, the form for applying for a loan is built for psychometric testing as well as analysts eventually judge whether a potential borrower erased things too many times, for instance, or filled the form in a hurry – or took it seriously.
“We have a group of bankers who are given this job of assessing a person before he is allowed to list on the platform as a borrower, there’s also physical verification of his address,” Rustagi said.
While the company boasts that it hasn’t faced any defaults yet, it isn't taking any risks. There is a long list of options available for it to recover the money ranging from post-dated cheques to a legal agreement that binds the borrower and lender in a contract that can be held up in a court of law.
However, this does not mean a client will never default on their repayments or the action is foolproof. Most players in the industry are less than two years old so they are making plans as they go.
Consider i2i funding which was launched in October 2015 by five co-founders who wanted to do something that had market potential and also had a social welfare aspect to it.
i2i funding has already disbursed more than Rs 1 one crore in loans and has more than 2,500 registered users on the platform. While it works like other companies in the domain, it claims to be safer than many others because it doesn’t allow borrowers and lenders to negotiate an interest rate for the loans.
“We know that other platforms let borrowers haggle for interest rate but that’s a bad practice,” said Vaibhav Pandey, a co-founder of i2i funding. “This means that the same person could get a loan from one person at 20% and from another person on 30% while his creditworthiness remains the same.”
Pandey’s solution to the problem was simple: underwrite loans from start to finish and dictate interest rates. Borrowers have to go by the rates suggested by the company which removes the arbitrariness of market discovery.
This is not all. i2i funding also has what can be called tranches of funds for both borrowers and lenders. The high risk category comes with higher returns but lower protection of funds and vice versa. For instance, a person can choose to lend to only category A borrowers who will pay him 10%-14% in interest rate but 100% of the principal amount will be protected by the company in case of a default.
Pandey explained that these categories go from A to F and those lending to the F category will generate an interest of 24%-30% per annum on the amount they “invest” but only 50% of their principal is protected.
“The defaults are bound to occur, if not today, it will happen tomorrow but we encourage our lenders to not invest in only one project and spread their basket of investments,” Pandey said adding that his firm too carries out an analysis of Facebook and LinkedIn profiles of people applying for loans. “Category F is obviously risky so people should not invest wildly. There is a 2%-4% chance of default at all times.”
While the currently unregulated industry is trying to make the most of the situation when regulators are away, the reality is that the day of reckoning is not far. In late April, the Reserve Bank of India issued a consultation paper on peer-to-peer lending which seeks to form rules and guidelines for the sector.
Love for regulation
These rules are expected to limit borrowers from borrowing on multiple platforms for the same purpose, and lenders from indulging in questionable practices such as offering financial incentives or enhancing credit without due process.
But the consultation has just begun and final rules could take upto a year to come into effect – and p2p players aren’t exactly ducking the regulatory eye.
Bhavin Patel, Chief Executive of Mumbai-based LenDenClub, said that RBI regulations on the sector will help the industry a lot as it will sort out the kinks such as overlap of rules.
“Every state has its own money lending act and there’s a central money lending act,” Patel said. “We don’t know which applies when things get to the judicial process so some clarity is needed on the sector and we need to have best practices in place.”
Patel’s firm has disbursed more than 200 loans so far at an average interest rate of more than 20% but the danger and possibility of a default is imminent at an unregulated sector trying to guess creditworthiness of borrowers through their social media activity – something that Patel believes is bunkum.
Bridging the gap
“Even we collect social media information from people but we don’t use it to a large extent,” Patel said. “Unless you find correlation between two events, you cannot determine a person’s repayment behaviour by just looking at their Facebook. Banks have started doing it but the industry doesn’t have enough data to make these assumptions yet.”
Economist Radhika Pandey, who works with the National Institute of Public Finance and Policy, said that p2p lending has a huge potential to improve financial inclusion in the country but the sector needs to be efficiently regulated.
“Households still rely on moneylenders, family and friends for borrowing. The p2p lending channel would act as an alternative source of finance. Global experience shows that the market has the potential to grow,” Pandey said.”It is a great move towards financial inclusion.”
These companies shouldn’t, however, start functioning like banks and regulations should be formed in such a manner that helps the industry grow, Pandey added.
“The scope for regulation should be limited to ensure that any collection of money should not turn into 'deposits'," Pande said. "So long as the participating entities do not function as 'banks' without the appropriate regulatory burden of being a bank, the regulatory framework should allow this business model to grow,” she added.