P2P lending –a “financial intermediary in social democracy” – indian scenario

P2P Lending –A “Financial Intermediary in Social Democracy” – Indian Scenario Page 1
MICRO Research paper presentation
On
P2P Lending
A “Financial Intermediary in Social Democracy”-Indian Scenario
By:
Prashanth Ravada
January - 2017

Financial Institutions with higher credit flow to Micro-Sector; A Scheme for Promotion of Innovation and
Rural Entrepreneurship and Agro Industry (ASPIRE); Scheme of Fund for Regeneration of Traditional
Industries (SFURTI), Performance & Credit Rating Scheme (PCR) to create an ecosystem of SMEs for
easier/ cheaper access to credit for the rated enterprises, and initiative of “Startup India campaign,” backed
by positive business sentiments, Improved Customer confidence to earn and expense, and more over enact
of corrective measure under phase of “DEMONETIZATION” through regulatory are a few Means, to
correct and boost Economic Growth.
.
Significant development could be sighted in financial markets, its instruments and associated intermediaries
driven largely by deregulation, technological advancement and rapid globalization resulting financial
intermediation has also undergone remarkable changes, more so in developed countries but also in emerging
economies like India, where Market participants who historically sought finance / investments through
private equity & traditional banks, are now obtaining capital from Peer-To-Peer model (P2P lending.)
The P2P lending model uses online technology platforms to connect investors with individuals and
businesses in search of capital. The model is attractive to borrowers as it allows them to access money at
lower interest rates when compared to traditional credit providers. As has evolved into a distinct asset class,
this model also provides a new investment opportunity for Retail Investors. P2P service providers typically
earn money by charging a service fee on each facilitated loan and with the use of technology application
process decreases transaction costs, making it more efficient and user-friendly than conventional lending.
Indian Economy is in the phase of correction posing robust growth trend, with
sound economic policy & regulatory initiatives comprising “Make-in-India”
appealing and attracting Investments from both Domestic and International Markets.
With allocation of Rs 10K crore through the Micro Units Development Refinance
Agency (MUDRA Bank), start of “JanDhan” a Central initiative targeting every
Indian with provide of Savings bank a/c on its successful grass roots and a step
forward for Financial Inclusion., introduction of the Goods and Service Tax (GST)
Bill, Prime Minister’s Employment Generation Programme (PMEGP) to facilitate
Latest RBI’s initiative by extend of 11 new licenses in the Payments and
Small Bank category, which indeed pose to be of ‘Challenger banks’, as they
take on traditional banks with core objective to sustain Financial Inclusion, by
expand of access to financial services in Emerging Markets comprising of
Rural and Semi-Urban areas with traditional banking activities by accept
deposits and lend to underserved sections of customers, including Small
business units, Small & Marginal Farmers, Micro & Small Industries, and
entities in Unorganized sector through Technology platform.

Fig. P2P Loan Origination and Process flow
Fig. General Purpose of Loan across the Industry Segment along with Borrower Risk Categorization and IRR along with
Principal Protection (Service provider specific)
 Individuals register themselves on P2P service provider platform as
Borrower or Lender by pay of registration fee. Registration includes
providing information such as personal, professional, financial
details which service provider verifies along with the relevant KYC
duly submitted online at par with RBI’s guidelines.
 All approved borrowers and lenders listing are then published on the
site. Lenders can view borrower loan listing which includes
information such as loan purpose, demand and need for lenders make
offers to them, personal, professional and financial information that
allows lenders to make an informed decision before lending to a
borrower.
 Borrowers can receive offers from multiple lenders and similarly,
lenders can lend to multiple borrowers thereby diversify their risk
along with the interest rates are determined by the borrowers and
lenders and not service provider.
 Once a borrower loan is 100% funded by investors the loan is
disbursed.
 Loan disbursals involve loan agreement between borrower and
lender, money transfer from lender to borrower for the loan amount
and EMI transfer from borrower to lender.

P2P Service provider is a facilitator between
the lender and borrower for a loan
transaction and they tend to ensure that all
borrowers are verified for the information
provided i.e. identity, employment, income,
contact information as well as
creditworthiness.
Helps in the loan disbursement and
monitoring process upon loan acceptance
by a borrower i.e. ensures that agreements
are signed between borrowers and lenders,
EMI cheques collected from borrower
before loan disbursal and monitor the
repayment.
Sends regular alerts / notification to both
lenders and borrowers on various activities
in their account including status of
registration, verification, loan offers
received, loan accepted, disbursed, EMI due
date alerts, EMI payment updates.
They does’t recommend borrowers to
lenders. All loans are made at the discretion
of the lender with understanding of
possible risks associated with such
transactions.
Role Play
P2P is only an online marketplace connecting borrowers and lenders to facilitate an
unsecured loan transaction between them and does not guarantee borrower loans nor
does it guarantee repayments to lenders. However, endeavors to keep full track of the
loan repayment schedule and report any delay or default at the earliest with a suggest
corrective action plan and assist in loan recovery and collection etc., if required.

Retail Lending - Indian Mkt. Dynamics
 India is a mixed market economic system scattered between Urban, Semi Urban and Rural. Rural
Mkt. is significantly predominant by informal/Unorganized finance sector comprising of Money
Lenders, Traders & Land Lords to that of the formal segment comprising Institutional
financers(Large scale Public/Pvt./NBFCs’/Foreign Banks) etc..
 Informal sector which is legal, but officially unrecorded and unregulated... having its identity in the
grass roots based on few characteristics comprising of Caste, Religion, Social, Political and
Geographical features, Financial illiteracy, low cost value transactions, large distance, poor transport,
etc...Similarities among the groups, with more identity.
 Backward (Deeper geo limits) having less access to Formal Finance Segment / Institutional Credit
and hence, they are more dependent on Informal Finance Sector.
 The extent of transaction cost, rate of interest incurred etc under formal finance being low compared
to that of Informal segment. How-ever, these haven't given much importance to differentiate between
and expose by bring to the notice of end customer.
 Increase use of Technology, Centralized processing and decision procedures, KYC regulations
etc.,measures adopted by formal segment are of higher standards in the current mkt. dynamics. On
contrary, Informal finance segments having been further aggressive in funding on SPOT and by
penetrate to deeper geo by understand of local flavor with flexible policy procedures and decision
making empoweredness, posing a cut throat competition.
 In-adequate access to business loans has emerged as an obstacle for growth of Micro Small and
Medium Enterprises (MSMEs). Inefficacy of measures in credit flows (such as credit scoring for
SMEs) to information asymmetry faced by banks and financial institutions; there are plentiful
challenges that have impacted the contribution and performance of SMEs in the Indian economy.
More than 70% of these entrepreneurs are resorting to other avenues of alternative financing, much
influenced by Un-Organized sector. In most cases, transaction lending and access to credit pose
strong challenges basis
1. Availability of low credit facilities because of the Origin and Size of banks
2. Long-drawn decisions on credit financing and delays in fund disbursement
3. A specific bias against smaller-sized loan portfolios
4. Cumbersome processes and non-task oriented structures of Indian banks
5. The requirement of complex collaterals for obtaining term loans- even at very high rates
6. Difficulty in obtaining Private Equity Funding
7. Non-standardized project appraisal systems for term loans, etc.
 Potential opportunity exists for consumption loans in rural
market through formal finance mechanism. How-ever, the
segment is marked by seasonal based employment (specific
to agriculture), the risk of exposure funding in this nature is
high and discouraging, unless a mechanism for sustaining
regular means of lively hood is in place.
 NBFCs’ having their significant identity in particular to Hire
purchase, leasing operations, finance to traders of agricultural
pre and post related activities. In general, out-look of formal
finance segment being profitability / viability marked by
regulatory requirements to be met by maintaining high
reserve ratios, Interest rate ceilings, branch licensing, directed
credit etc..Constraints indirectly proving to be a boon to
Informal mkt. segment.

Emerging P2P Financial Intermediaries, their role in Indian Mkt. Dynamics Scenario
Influenced by the West and post global financial crisis era backed by the impact of Basel III capital
adequacy regime on the banking sector and the appetite of its members for lending to smaller businesses has
been a key driver for the P2P markets’ penetration and growth in India. With around 30 odd companies with
loans disbursed approx Rs.51 Crores as of March’16, operating on ‘e’-technology platforms which are yet to
be regulated by RBI, are getting accepted as a viable, return generating asset class from lenders (Individuals
& Institutions) who deliver credit to Small Farmers, Micro Small & Medium Industries, its allied sectors of
the economy that do not have access to formal finance / largely influenced by the Un-Organized sector, by
pay of similar attention as practiced under formal finance sector ref. to Risk & Underwriting, Credit
verification & Appraisal, Collection processes, KYC, Default Management etc., by Technology means,
Machine Learning Algorithms, Tech intervention in traditional offline processes.
According to Morgan Stanley research, P2P lending is estimated to increase to $290 billion globally,
growing at an expected compound annual growth rate (CAGR) of 53.06% during the period 2016-2020
Source: Company Data, Morgan Stanley Research estimates

Conventional banking carry an element of risk / mismatches between short term liabilities (Deposits) and
long term assets (Asset Loans), which can make a bank vulnerable expose to large withdrawal of deposits /
loan defaults to anticipate. On contrary, in P2P platforms as lenders are directly matched to borrowers and
while a cluster of defaults would certainly hurt lenders, it would not necessarily bring down the lending
company and trigger a wider financial crisis.
Evident and experienced, demand and use of mobile phone had a greater penetration in India in-line with the
population growth by 80%, as its usage had tailor-made to the needs of a country with a large semi-literate
population that is living on the borders of the poverty line though aren’t capable to handle a computer…but
were capable enough to use & operate a mobile phone, and this being a key driving factor for the P2P
platforms to sustain its objectives in a more tailored fashioned manner.
Use of alternative credit scoring methods (Non Traditional data sources) comprising assessment of large
data streams from online social networks, mobile phone records, community domicile based information,
utility service bills and psychometrics etc., forming part of alternative means of evaluation to identity
potential borrowers in cases where traditional credit information is scarce, enabling new lending and control
over risk by these emerging intermediaries, where traditional finance sectors are lagging behind and serving
the potential credit-worthy yet financially excluded population, and simultaneously contributing for financial
inclusion.
P2P lending intermediary, a unique and new asset class on the Indian investment
scene, is being considered by investors because of its higher returns at predictable
risks. These platforms intended to create new investment opportunities for income-
seeking investors, especially those who are ready to go an extra mile of earnings.
Currently it is providing an opportunity to investors to earn a gross return of up to 18-
26% p.a. by diversified portfolio as per their risk appetite as compared to the interest
rates of 4%-7% on Savings and fixed deposits offered by traditional financial
institutions, who inter alia charge 10-22/24% lending interest rates on various loans
and basis risk lending matrix, take the advantage of spread between borrowing &
lending rates.
Impact of Demonetization strategy tends to put an effort in
formalizing the unorganized / informal finance sector
which accounts for 45% of the India’s GDP to be
streamlined/exit and by pose of opportunities for the
Organized Finance sector to serve the increase demand in
Short (or) Medium Term for business funding significantly
from SMEs comprising Small Time Entrepreneurs’ and
Business Owners. Given the context, P2P financial
intermediaries tend to take lead role, basis their expertise
in minimizing the risk spread by bringing borrowers and
investors on same platform.

Risk Description Drivers
Risk Category Investors Borrowers Driver description
Credit Risk
Is tempted to invest by the promise of
an unrealistically high rate of return on
investment.
Insufficient financial literacy of
Investors and high complexity risk
analysis is necessary to evaluate
projects
Loses the capital invested in the event
the borrower is unable to meet its
repayment obligation.
Insufficient assessment of the
creditworthiness service provider
Does not receive the funds back
Borrower does not receive the funds
collected from lenders
Incomplete information ref. money
remittance provider authorization
Suffers loss because platform defaults
Borrower could be held liable by the investor
in the event of failure of the service provider
platform
Lack of financial safeguards against
platform default
Risk of Fraud
suffers loss when a borrower acts
fraudulently
Insufficient background check on a
borrower, by the platform
Uncertain about the reputation and
the security of a P2P Lending
platform
Borrower is uncertain about the reputation
and the security of a P2P funding platform
Non disclosure requirements of
platforms / Nil Regulatory control.
Investors personal data may be
stolen or misused
Borrowers face the risk that personal data
may be stolen or misused
Lack of document handling
processes of platform provider
Unable to identify conflicts of interests
of the platform, its shareholders,
managers and key employees
Insufficient information disclosure
requirements of platforms on
potential conflicts of interests
Misled pricing structure or information
about other terms and conditions
applicable to the parties
Insufficient contract information
disclosure requirements
Not been provided the information
necessary to assess a certain project
[and/or the reputation of the borrower]
Lack of Customer due diligence
process on borrower by a platform;
Insufficient information regarding
the ability or willingness of lenders
to pay the committed amounts
Uncertain about his rights to withdraw
or to cancel an investment prior to its
maturity
Insufficient termination rights for
the lender/Misleading explanations
on applicable termination rights
Not in a position to assess a certain
platform’s reputation and probity
Lack of information disclosure
requirements of platforms on
potential conflicts of interests
-
Borrowers may not receive committed funds
because lenders are not able or willing to
pay as agreed
Insufficient assessment of the
creditworthiness/risks by the
platform
Legal Risk
Investor is uncertain about his rights
and obligations vis-a-vis the parties
involved
Borrower is uncertain about his rights and
obligations vis-à-vis the parties involved
Inappropriate or misleading
information about the contractual
rights and obligations of the
contracting parties
Lender faces an inappropriate
complaints handling mechanism on a
platform
Borrowers can be affected by inappropriate
complaints handling mechanism on a
platform too
Unclear complaints handling rights
and regulations of market
participants
Lender's funds might not be
transferred to the Borrower
-
Missing requirement for platforms
to follow money remittance provider
authorization
-
Borrowers’ project ideas could potentially be
copied
Lack or insufficient project ideas’
safeguard clauses

Liquidity Risk
Lenders can face liquidity problems
if, after the the loan is given out, the
repayments do not follow the agreed
plan
Borrowers can face liquidity problems if,
after the project’s financial approval, the
provision of funds is delayed, thus
undermining the success of the project
Lack of timeline of fund availability
requirements on platforms
Operational
Risk
Lender suffers loss when a the
platform experiences technical issues
Borrowers might face liquidity problems if
platforms have technical difficulties
Insufficient corporate governance
arrangements; A particular platform
is technologically faulty
Risk Category P2P Financial Intermediary Drivers
Reputation Risk
Platforms face Reputational Risk, that loans will
not be paid intentionally
Lack or insufficient disclosure requirements of platforms; no
obligation for the P2P platform to obtain a permit from Financial
Supervisory Authorities; lack or insufficient background check
on a borrower by the platform
Cyber Risk
Threat with Cyber security Hackers to
Information systems
Lack or insufficient requirements on safeguards against hackers'
attacks
Service provider platforms might be misused for
fraudulent or money laundering activities
Lack or insufficient customer due diligence; Anti-money
laundering regulations are not applicable to P2P platforms
Platforms may be shutdown due to fraudulent or
money laundering activities of borrowers/lenders
Platforms are not subject to comply with KYC/AML/TF
regulations

The website of the platform should contain information of borrowers and Investors. Information
about the risks for lenders – including risk of total / partial loss of capital invested; lack of liquidity –
must also be provided on the platform’s website. All information to be clear, understandable and not
misleading. Moreover, Lenders should only be permitted to invest after confirming acknowledgment
of this information.
Disclosures
In case of lending contributors comprising of Institutional Investors (White-Label Partnership)
comprising Banks, Hedge Funds or other business entities that lend money through P2P platform,
such means to be handled in accordance with the guide lines set by the RBI.
Set investment limits for lenders by permit invest to maximum amount, within a certain period of
time or depending on his income or wealth. To ensure adherence to these investment limits, the
platform to seek lenders confirmation to comply with the statutory limit.
P2P platforms to disclose detailed information to extent a risk assessment has been performed. Any
information gained is made available to lenders, so as to strengthen the ability of lenders for informed
decisions.
KYC
Platforms to conduct an effective, proper and clearly defined due diligence procedure on any
investment opportunity, possibly above a certain threshold, before posting on platform’s website.
Furthermore, any results of due diligence procedures performed in relation to a project to be
disclosed.
On anticipate of risk that individuals acting under false identity through use of P2P platforms to
collect money for fake offerings, would require background checks. Platforms should therefore be
obliged to request identification & addresses, information about financial status/creditworthiness and
potential criminal records from borrowers/lenders. Furthermore, platform to restrict access to its
website on reason to believe that a borrower/ lender might potentially act fraudulently
Platforms to establish lender protection services. For this, platforms to obtain data regarding
creditworthiness of borrowers & lenders. Furthermore, platforms would in any event be obliged to
provide disclaimers regarding the credit/counterparty risk on the platform. This risk driver could also
be mitigated if P2P lending platforms were required to cooperate with a bank/credit bureau/rating
agencies, either in the way that the bank processes the assessments on a professional basis.
Platforms, their shareholders, managers or key employees to be prohibited from having or acquiring
financial interests in a borrower’s business. In any case, platforms should be obliged to implement
measures to identify and manage potential conflicts of interest. Furthermore, these measures should
be unambiguously disclosed on their websites.
Platforms to clearly describe the rights and obligations of the parties, the financing process and all
costs and other features applicable to contracting parties. In addition, a draft contract should be made
available on the website to both borrowers and lenders, and customers should confirm their
acknowledgment of the terms and conditions prior to the conclusion of any contracts.

Platform to ensure that lenders are aware of their rights to cancel a contract prior to its maturity.
Platforms should offer a true, clear and complete explanation of the termination rights applicable
under statutory law and, where necessary, pursuant to their contractual terms. A platform would
accordingly be required to disclose on its website the exact point in time at which it would no longer
be possible to terminate an investment prior to maturity.
Furthermore, platforms are required to offer lender the right to withdraw commitment, provided that
the funding goal/target amount hasn’t been reached and the borrower hasn’t yet received the money.
To set up an appropriate complaints handling mechanism (Grievance Redress Mechanism). A clear
and flexible open policy on complaints handling should also be explicitly described in the terms and
conditions of the platform.
On un eve scenario of Platforms handling money from lenders or borrowers,Sec.45(I) of RBI, same
to be required to be segregate and reported in books of accounts and disclose to Regulatory, as in the
current scenario, same being prohibited considering the platforms being likely to be assigned NBFC –
Intermediary status.
Platforms are required to be authorized by an affiliate authority (RBI). These further to include check
of natural persons who manage platform meet appropriate standards for competence, capability,
integrity and financial soundness. Relevant disclosures with ref. to be updated on Web portal.
Business Continuity Plan/Committee (BCP) to be set up for measure of performance, risk assessment
and arrangements to be envisaged by setting up a compensation scheme, insurance coverage for
default, or similar provisions and by ensure that loans would continue to be administered even if
platform goes out of business.
Platforms to take reasonable care in establish and maintain systems and controls that are appropriate
to business, including timely transfer of agreed funds. Must also disclose all risks, including risk that
pledged money may not be paid when it is due, in a way that is fair, clear and not misleading.
Provide of “Principal Protection Fund” (PPF) to all investors who lend through P2P lending platform
with no extra charges. For which service providers to set aside X% of the disbursed loans towards
PPF, which allows its Investors to enjoy up to 100% protection against loan defaults, so as to further
build and develop a Financial Healthy Economic System to sustain.
IT risks for lenders and borrowers may arise in particular from the unavailability of systems,
networks, or data, or from a loss of data integrity. Mitigating these risks requires a sound IT
Organization frame work.
Platforms to be complied and include in the scope of the Anti-Money Laundering Directive as set by
the regulatory (RBI). Plat forms to take reasonable care to establish and maintain appropriate controls
in that sense (including when using a payment service provider)

P2P lending financial intermediaries though not a significant player in terms of overall market share and
willn’t fundamentally disrupt/displace banks' core function as lenders in mass market., but tend to play an
active role in the financial system of our economy, as they complement the role of service provider and are
aimed to serve Customers under facilitator mode, while pose little Systemic Risk, their importance to some
key sectors and other areas of the Economy Warrant RBI’s interest and oversight. With their low operating
cost backed by technology, minimal regulatory, data-driven models, and specializing in channelize low cost
borrowings and higher earning interest attracting Individual investors / Institutional investments helping to
meet funding needs of larger population including under-served, these tend to extend their share in the
Nation’s Economic growth by promote of Financial Inclusion through technology enabled platforms and by
spread of Financial Literacy, Service, by extend opportunities of growth, days coming by in both Retail and
MSME business segment offerings, as currently forming part of ‘Traditional Lenders,’ share.
 PricewaterhouseCoopers, Peer Pressure: How Peer-to-Peer Lending
Platforms are Transforming the Consumer Lending Industry,
PWC.COM (February 2015)
 Peter Man beck and Marc Franson, The Regulation of Marketplace
Lending: A Summary of the Principal Issues
 Morgan Stanley Research “Global Marketplace Lending: Disruptive
Innovation in Financials" (May 19, 2015).
 Opinion of the European Banking Authority (EBA) on lending based
Crowd funding.
 Practice Pointers on: P2P Lending Basics: How It Works, Current
Regulations and Considerations
 R Gandhi: “Regulating financial innovation - P2P lending platforms
design Challenges” at the Mint Marketplace Lending Summit,
Mumbai, 17 May 2016.
 Status of Micro Finance in India 2015-16 – NABARD
 MSME at a Glance 2016 – Govt. of India.
 General Web search.

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