P2P Lenders Tried To Outsmart RBI, Then Paid The Price

On Feb. 9, as audience at the CII event were paying attention to Reserve Bank of India Deputy Governor M. Rajeshwar Rao’s speech, a flag on the NBFC-P2P business practices surprised everyone. Of late, some business practices of these lenders do not appear to be in-line with regulatory guidelines, he said.

Rao re-asserted that any breach of regulatory guidelines was non-acceptable. The players were underplaying risks in lending activities—all this by promising assured returns, structuring transactions and so on, he said.

“Instead of educating the lenders about the inherent risks in the lending activity, NBFC-P2Ps have been observed to underplay the risks through various means such as promising high/assured returns, structuring the transactions, providing anytime fund recall facilities etc.,” Rao said.

As extracts of the speech started spreading, a consensus was formed—the next clampdown may be on P2P lenders.

“Beware, this is a sign,” wrote Deepak Shenoy of Capital Mind in his dated post on X, formerly Twitter.

“The NBFC-P2P lending is gaining in scale and there is increased acceptance between segments. So, supervisory action is natural,” according to Rohan Lakhaiyar, partner, financial services risk at Grant Thornton Bharat.

The Start Of All Problems

P2P lending came as a decentralised financial model that connected individual borrowers directly with lenders. A peer-driven system, it omits the hassle of going to traditional lenders like banks for funds.

Over the years, as this alternative source of funds became popular, the portfolios now stand at around Rs 6,000-10,000 crore, according to market participants NDTV Profit spoke to.

As per an Industry ARC report titled 'India P2P Lending Market - Forecast (2024 - 2030)', the market size is expected to touch $10.5 billion by 2026, after growing at a CAGR of 21.6% during 2021-26.

While RBI’s master directions on NBFC-P2P lending highlight 10 scope of activities, four of them capture the essence of what these entities can and can’t do:

Act as an intermediary providing an online marketplace or platform to the participants involved in peer-to-peer lending.
Not raise deposits as defined by or under RBI Act, 1934 or the Companies Act, 2013.
Not lend on its own.
Not provide or arrange any credit enhancement or credit guarantee.

Over the last one year, RBI started a review of the P2P lending system and raised multiple questions, according to two people associated with NBFC-P2Ps. It then started sending out letters to certain entities, seeking clarifications on their business models and asking them to shut down certain practices.

These practices had to do with offerings like instant liquidity, pooling of funds, and flow of repayments via P2P lenders, the first of the two people quoted above said on the condition of anonymity.

Following this, a 12-member association of P2P platforms also engaged with the RBI on this issue.

The association discussed three "critical" issues with the regulator—agreement signing between lender and borrower, reinvestment of funds and functioning of a secondary marketplace, according to Ekmmeet Singh, co-founder and chief executive officer of Lendbox.

While the first two required tweaks in how the operations are managed by NBFC-P2Ps, a secondary marketplace can’t function as per RBI’s guidelines. According to Singh, the association flagged this as critical and the RBI may put guardrails, if necessary, in the coming days.

Till now, the RBI has only asked these players to fix respective issues and not taken any penal action, according to Mukesh Bubna, founder and chief executive officer of Monexo.

“The communication from RBI is clear and targeted…In its capacity, the RBI can impose fines on entities and can also cancel the license,” he said.

Also Read: RBI Fines SBI, Canara Bank For Regulatory Violations

Messy Structures And Operations

The nucleus of the problem lies in the way NBFC-P2Ps structure products and manage their operations, especially the marketing of them, according to market participants.

NBFC-P2Ps started acting like deposit-taking entities as traditional P2P business didn’t take off, said two more people with knowledge of the matter. And this is where the problems lay.

The platform would accept money from multiple people and assure them of stable returns, while signing an agreement. This way, it would pool money at one place and extend loans to multiple borrowers, which is against RBI’s guidelines.

In case a lender wanted to withdraw funds before the loan tenure ended, the platform would provide instant liquidity by giving them money accepted from another lender. This would create a loop of funds moving between multiple lenders and borrowers.

In this entire transaction, the NBFC-P2P would give returns of 12-13% to the lenders as it gave loans at around 20%. Since the pool had an average default rate of 3-4%, the NBFC-P2P easily managed to make 3-5% returns on the pool.

In the industry’s parlance, these entities also created a margin of safety, which is essentially the difference between cost of raising a deposit and lending rate. The collected money then, goes towards absorbing any losses or non-performing assets, according to the second person quoted above, who works with an NBFC-P2P.

However, none of this is permitted as per the RBI’s master directions. Yet, the industry has thrived and grown almost 10 times since inception.

According to an official at a P2P lending firm, instant liquidity and stable returns make the business very attractive for lenders. Hence, they even come on the platform.

Lakhaiyar of Grant Thornton Bharat agrees.

“If a platform wants to grow, they promise returns to investors and access to funds to borrowers—all at a cost-effective manner. But marrying both is a challenge and that’s exactly what these NBFC-P2Ps do.”

The Way Forward

While several rounds of discussions have already happened between association of P2P platforms and RBI, a clarity from the regulator is still awaited.

The association has decided that NBFC-P2Ps would stop offering anytime liquidity products as a step towards the change, according to Singh of Lendbox.

The association has also proposed certain amendments to operations of NBFC-P2P but is again awaiting a response from the RBI.

However, it is likely that the regulator may stop offerings like instant liquidity, P2P escrow account and some ultra short-term products by this March, according to a person with knowledge of NBFC-P2Ps.

While Bubna affirms the likelihood of an action, he asserts that regulatory compliance is paramount. “When you’re dealing with public money, you must be cautious as it is about retail customers’ money. And regulation is the only way to build this trust,” he said.