Much Ado About P2P
If the number of mentions in the news reports in the last two months are to go by, you will believe that peer to peer lending (or marketplace lending as I am going to call it ) plays a major role in financial services in India. When we first thought ofLoans4SME as a marketplace for business loans about a year back, there were no more than a handful of startups in the space. One year later, I count at least 30 companies in various stages of setting up, and I encounter someone new working on a similar idea practically every week. Not to be left behind, RBI jumped into the fray with a consultation paper proposing to regulate the fledgling sector. So is marketplace lending that big a deal? The short answer is…not yet. But it presents a unique $400 billion opportunity.
Why Marketplace Lending
All over the world, marketplace lending started and evolved to answer one or both of the two market gaps:
- Access to Capital: There are more people who need debt than banks are currently able to fund. Marketplace lenders bring non-traditional lenders (individuals, family investment offices) to the fold, typically to lend at much higher rates to people who will not otherwise get bank credit because of low credit scores or lack of collateral security.
- Cost of Capital: Successful marketplace models have proven to be more efficient and cost effective in both originating and assessing credit risk of loans. They do it by using technology more effectively and by streamlining processes. Over a longer timeframe, marketplaces make loans cheaper in another important way. By using expanded, alternative sources of data and innovative assessment tools like psychometric tests, marketplace lenders have found effective ways to assess credit, potentially leading to lower default rates over time.
But that’s not all. Banks spend a lot of their origination time and cost on rejecting applicants who don’t meet their average credit quality requirements. Because marketplace lenders bring on board a wide range of lenders with varied risk appetites, they spend a lot more time matching deals with the right lenders and much less cost and effort rejecting loans.
India is different
Like in most hot sectors for startups, if you were to ask a P2P lender what prompted them to set up shop, they will quote you the billions of dollars in disbursements generated by the likes of Lending Club in US and CreditEase in China. So why, you wonder, did the phenomenon not spread to India any sooner. The reasons are both regulatory and environmental.
Most of the marketplace lenders in India today are focusing on what they think of the tried and tested US formula — individuals lending to other individuals for everything from medical crises to holidays. But remember that US lenders were trading high yields for a genuine market demand — high risk borrowers who did not meet the credit score thresholds set by banks in the aftermath of the financial crisis. In India, NBFCs and to some extent, microfinance companies, are already quite effective at originating and managing personal loan books.
The regulatory hurdles to get individuals to lend on a marketplace aren’t small either. If you were to lend any meaningful sums of money, there are onerous moneylending guidelines to deal with. And our Companies Act puts pretty much a blanket ban on individuals lending to businesses. With all these restrictions, the opportunity in marketplace lending is unlikely to be in the copycat model of individuals doling out high risk personal loans.
The Indian Opportunity is Huge, but Unique
Marketplace lenders, with their technology driven focus on efficient origination and credit assessment, have a clear role to play in the big gap that exists in the funding of small businesses. For small businesses to get access to credit, collateral free and at rates that make sense, there needs to be an element of trust that is completely lacking in the current high NPA and subjective credit assessment environment. With their data driven, research backed credit assessment models, trust is exactly what marketplace lenders can create.
This is also a much smaller leap of faith than getting pensioners to invest in marketplaces. If we can only get the existing lenders — both banks and NBFCs — to lend more to small businesses, it will go a long way in addressing the estimated $400 billion gap in small business funding. By providing lenders with a lot more information to base their decisions on, making the processes both efficient and cheaper and creating cashflow based structures, marketplace lenders are just at the right place to lead this change.
Simmi Sareen is the founder of Loans4SME, a curated marketplace that’s building an ecosystem to effectively assess the credit risk for small businesses to help them connect with and access capital from debt providers.