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Peer to Peer lending (“P2P lending”) is a transformative success story in consumer finance made possible by this era of digitization we find ourselves in. The growth of the P2P lending concept globally has fueled it’s rise as a popular alternative asset class for both retail and institutional investors. Though it’s a fairly new concept in India, P2P lending being completely online and fully transparent has enormous potential to transform the idea of ‘lending’ as a way to invest.
So, what is P2P lending :
P2P lending marks a dramatic shift from traditional banking by enabling individual investors and borrowers to directly transact through an online platform – completely cutting out the bank. Peer to Peer lending platforms like Monexo function through a simple, online marketplace where loans which meet credit standards of the platform are listed on a daily basis for the investors to log in and invest. For eg, in Monexo, with a small INR 1 lakh of investment, an investor can lend across 100 different loans of salaried borrowers – each with an investment as low as INR 1000.
The investor gets a high yielding, short term asset class by lending directly to borrowers screened by the online platform while borrowers get access to timely, transparent personal loans which can be used to meet a wide array of financing requirements.
Growth of Peer to Peer lending – globally :
The global growth of P2P lending industry has resulted in it emerging as the dark horse which could take over the mantle of consumer lending from banks in the near future. What began in 2006 as a nascent industry in UK has today transformed into a $30 billion industry. Platforms like Zopa (UK), Lending Club (USA) have benefitted from the internet boom, issued more than $20 billion in loans and are today publicly listed companies.
There is mounting evidence to demonstrate that investors globally are shying away from low yielding bank deposits and putting their capital to work in P2P platforms instead where they are compensated with attractive loan yield and interest income.
What makes P2P lending an asset class for investors ?
Regular cashflows / yield : In P2P lending, through the platform, investors are ultimately investing in the simplest of debt instruments - a personal loan. Loans have reliable monthly cash flows with definitive yields which are earned by the investor over the period of the loan. Investors are compensated for investing in higher risk loans with commensurately better yields.
Definite time horizon : P2P lending constitutes a short term debt investment opportunity. Typically, the tenor of underlying loans vary from 6 – 36 months allowing the investor the opportunity to diversify his existing investment portfolio with a high yield, short term debt product.
Graded and priced loan assets : Just like stocks are classified into small, mid and large caps as per associated risk - reward parameters, P2P loans are also graded in terms of the credit risk associated with each loan.
Ability to diversify : In P2P lending, investors are able to pool their funds and take exposure across several loans. This helps them diversify their investment – thereby limiting the possibility of any significant loss due to default. It also results in curation of a lending portfolio with an optimum mix of loans.
-- Ability to match returns with risk appetite : In P2P lending, platforms list loans on the P2P marketplace and let the lenders decide on (i) the loans they want to lend to, (ii) the amount of lending exposure (iii) interest rate mix and (iv) the time period of investment. As a result, lenders with divergent risk appetites are able to invest in the loans which closely mirror their outlook towards risk and return.
Is P2P lending a risk free investment ?
No. P2P lending, like other forms of investment (MFs, bonds, real estate etc.), involves risk.. Default risk – i.e non payment from borrower constitutes the major risk element but diversifying lending portfolios with a mix of loans across risk buckets is a great way to ensure that risk adjusted returns continue to remain very attractive.
A detailed overview of associated risks with P2P lending and simple steps for investors to manage these risks independently with ease will be shared in subsequent articles.
Why should investors consider adding P2P loans to their portfolio ?
Simply because ‘risk adjusted’ returns in P2P lending are still nearly twice as high as what is earned in a bank fixed deposit. Across the debt products spectrum, P2P lending offers a new, short term asset class which is not meant to replace the investor’s existing portfolio – but rather blend in and add more value to it.
- P2P lending is an alternative investment option – P2P loans offer a great way to normalise the investors existing portfolio and enhance overall portfolio returns
- It is delinked from market volatility being - investing in P2P loans will help balance out the volatility from the investor’s equity portfolio during times of market correction.
- P2P lending has the ability to beat inflation in the short term horizon with returns upwards of 13% p.a
- P2P lending is a debt investment opportunity with monthly cashflows which provide for reinvestment and subsequent compounding of return.
- Above all, P2P lending is one of the simplest investments to execute – it is easy to understand and investors can start lending with a small corpus – unlike other alternative asset classes like Hedge funds, angel investments etc.
In P2P lending, since the entire process of sourcing loans, borrower due-diligence, documentation and repayment collection from borrowers is taken care of by the P2P platform – lending is made hassle free. Driven by the simplicity, ease of use and high yields – savvy investors in India are waking up to the potential which P2P lending has as an asset class for regular income and portfolio diversification.
With final RBI guidelines for P2P lending just around the corner, financial advisors / distributors now have an opportunity to understand this asset class better, increase their product portfolio for clients and create investor awareness to make P2P lending a mainstream debt investment.