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On 16th August 2024, the Reserve Bank Of India (RBI) released draconian guidelines for the P2P industry, making the regulations crystal clear to stop all the creative interpretation that various P2P platforms were doing. In the introduction to the 16th August guidelines, RBI chosen it words very carefully, it said:
It has been observed that some of the NBFC-P2P platforms have adopted certain practices which are in violation of the 2017 Directives. Such practices include, among others, violation of the prescribed funds transfer mechanism, promoting peer to peer lending as an investment product with features like tenure linked assured minimum returns, providing liquidity options and at times acting like deposit takers and lenders instead of being a platform.
Many investors in the industry thought, the violation word has been used loosely as there have been no fines imposed on any P2P players. But then came the fines, on 23rd August 2024, RBI fined Lendenclub INR 1.99 Crores and Liquiloans INR 1.92 Crores for all the above violations.
Source: Economic Times, RBI
These fines dispelled all conspiracy theories from P2P product distributors, industry supporters, and others who claimed that the RBI was being overly strict and didn't want the P2P industry to grow because it was hurting bank deposits.
But let's be realistic. According to some industry sources, the P2P industry is worth around INR 7000 Crores. In comparison, the Bank Deposit industry is approximately INR 200 Lakh Crores, which is INR 200,00,000 Crores. The P2P industry is just 0.035% of that amount.
Would stopping this product really impact bank deposits in any meaningful way? No, not at all!
The RBI did not clarify the P2P guidelines because of competition with bank deposits. Instead, it aimed to stop the misinterpretations by several P2P platforms that could have posed various risks to investors, which the RBI was not prepared for. In this article, we will discuss each new guideline released by the RBI and provide context on why these changes or clarifications were made. By the way, if anyone wants to read the 16th August 2024 circular, you can download it here.
#1 Credit Enhancement Or Guarantee
In the previous model, P2P platforms offered fixed returns of 9% - 12% while lending at interest rates of 20% or higher. For simplicity, let's assume they paid 12% to lenders and received 20% from borrowers, with around 1000 such loans. The 8% difference is their commission (that's how they make money).
Now, if 100 out of 1000 loans default, the P2P platform still has to pay you 12% interest because that's what they promised. So, the P2P platform would use their 8% commission to cover all the losses on the 100 loans and still honor the 12% payment to the investor.
This, in the RBI's eyes, is seen as credit enhancement or credit guarantee, which P2P platforms were never allowed to do according to the original regulations. Indirectly, the platform is using its own money (profits) to cover losses. This works well for investors as long as it continues, but what if losses start to grow and P2P platforms can't cover them anymore? Investors who were promised fixed returns and fixed tenures will be unhappy.
So, in the new model, the RBI has asked platforms to pass on the principal and interest directly to the lender without adjusting the commissions in between. If there are losses, they have to be borne by the lender.
#2 Cross Selling Of Products
Certain P2P platforms began selling unrelated products through their platforms, such as unlisted shares and unlisted bonds. This was not permitted under the existing NBFC-P2P provisions, and the RBI has reiterated this rule. P2P platforms also cannot sell any insurance products that act as credit enhancement or credit guarantees. Only loan-specific insurance products can be sold, though it's unclear what those exactly are.
#3 Matching / Mapping Lender - Borrowers
All P2P platforms need to have a board-approved policy on how they will match a lender with a borrower. Additionally, the lender must approve the individual borrower to whom their money will go, and all participants must sign a loan contract.
However, it is unclear at this stage whether lenders have to choose borrowers one by one on the P2P platform or if the platform can still get a waiver form signed from the lender and choose loans on their behalf. If anyone knows, please let me know.
#4 Fund Transfer Within T+1 Time Period
This is a new provision within the guidelines. Previously, an investor could give funds to the platform, and the platform had no specific time period to deploy the funds. Now, once the platform receives the funds in their escrow account, they need to transfer it to the borrowers or return it to the lender.
The flip side is also true, as soon as interest or principal repayments are received from the borrowers, that money needs to be transferred back to the lender's escrow and then to their bank account within a T+1 timeline. According to the platforms, this is too restrictive because it becomes very difficult to find borrowers within the T+1 timeline. See the video below from Bhavin Patel (CEO @ Lendenclub) explaining the issue (4:15 onwards).
#5 Accurate Disclosures On Website
All NBFC-P2P platforms must publicly disclose the overall portfolio performance. This should include monthly NPAs and categorize loans by age (i.e., how old they are).
You might be surprised to learn that some of the largest platforms in this industry have never done this, violating both the previous and new guidelines.
If you want to see such reports, simply go to Google and search "XXXXXX NPA report," where X is the platform name.
#6 Incorrect Promotion of Products
As per the new guidelines, the NBFC-P2P platform is not supposed to market P2P as an investment product with features like tenure linked assured minimum returns, instant liquidity, etc.
All the options which made P2P very lucrative to retail investors have been taken away in the new regulations. This was done to remove the Asset Liability Mismatch (ALM) risk which was growing in the industry. ALT Investor first wrote about ALM in November 2023. You can check that article here.
#7 Disclosing The Fees Upfront
The NBFC-P2P platform must clearly disclose the fees they will charge the lender at the time of lending. The fees should be a fixed amount or a fixed percentage of the principal. The fees cannot depend on the borrower's repayment. This is related to point 1 above, where platforms were adjusting their fees based on the number of defaults.
#8 No More Closed Loop Transactions
As most of you know, many P2P platforms had fintech partnerships with companies like Cred and Mobikwik. Some of these platforms were handling both sides of the business.
For example, Cred, as a super-app, would attract investors through the Cred Mint framework. This money would then be lent to borrowers coming to Cred for loans. This meant that the money never left Cred's system, effectively operating a closed loop or acting like a pseudo-P2P platform without having a license.
The RBI has effectively stopped this practice. If fintech companies want to continue this kind of activity, they need to have a license. This change will impact many existing partnerships in the industry, and I expect the AUM of some P2P platforms to be reduced by half as a result.
Conclusion
My personal recommendation is to avoid all P2P platforms for the foreseeable future. The sustainability of these platforms under the new regulations is highly uncertain, and their ability to conduct business feasibly remains in question. If you are invested in a fixed maturity product, there is no need to panic; your funds are hopefully secure. However, you may face delays in withdrawals, especially after the lock-in period. It is advisable to check with the respective platforms for more details.
For distributors of these products, it is crucial to reassess your approach. While fixed tenure and instant liquidity products may have been lucrative, the potential risk to client relationships for a 1-2% commission is not justifiable. It is essential to prioritize long-term trust over short-term gains.
To conclude, the latest RBI guidelines for the P2P industry mark a significant shift towards stricter regulation and transparency. By addressing issues such as credit enhancement, cross-selling of unrelated products, and ensuring accurate disclosures, the RBI aims to protect investors and maintain the integrity of the financial system. These measures, while restrictive, are designed to prevent potential risks and misinterpretations that could harm investors. As the P2P industry adapts to these new regulations, it will be crucial for platforms to comply and do business within the framework to continue offering valuable services to their users.
All these regulatory changes are objectively discussed in the ALT Investor community, if you want to be a part of it, apply here.
Please note that this is an opinion blog and not official research advice. I am not a registered RIA in India, and none of these views reflect those of my current employer. This blog aims to promote informed decision-making and does not discourage you from investing in any deals.
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