Lending on peer-to-peer platforms is fraught with higher risks

Investors can earn as much as 12-36 per cent, but limiting the amount to each borrower will help contain losses

Peer-to-peer or P2P lending has emerged as an alternative option for investors who wish to earn higher rates of return than what traditional fixed-income instruments can offer. However, lending on these platforms also entails higher risk, which investors need to be aware of before venturing into this relatively new investment avenue.

Though P2P lending has been around for four-five years, it gained impetus after the Reserve Bank of India (RBI) came out with guidelines on P2P lending last year. The government recognised P2P players as Non-Banking Financial Company-Peer to Peer Lending Platform (NBFC-P2P). They are to act as facilitators or intermediaries and cannot lend money, take deposits, or provide credit guarantees by themselves. P2P works under the crowd funding model where people wanting to invest deal with borrowers directly on these P2P online platforms.

Opportunity to earn more: The foremost reason why investors should consider lending on P2P platforms is that they offer an opportunity to earn higher returns. The rate of interest for loans given on P2P platforms can range from 12-36 per cent. They also offer a chance to diversify your investment portfolio beyond the traditional options like equities, fixed income and gold. According to Rajat Gandhi, founder and CEO, Faircent.com, “These returns are not susceptible to market fluctuations, unlike stocks, mutual funds, or real estate.”

Lenders on P2P platforms need to first check the profiles of the borrowers listed on them and then decide whom they want to lend to. You can lend at different rates of interest and for varying tenures. These platforms provide complete analysis of borrowers' credit profiles to help lenders understand the risks involved.

To reduce risk, some P2P players allow lenders to fund only up to 20 per cent of a borrower's loan requirement. This ensures that each loan is funded by at least five lenders, and the risk is well spread out. “P2P lending platforms achieve risk diversification by slicing every investment into multiple opportunities,” says Rajiv M Ranjan, founder, PaisaDukan, a P2P market place.

Like borrowers, lenders too have to register online on P2P platforms. You have to first fill up a form available on the platform, provide know-your-customer (KYC) documents and a bank account statement. The eligibility criteria vary from one platform to another. You can begin by lending a minimum amount of Rs 1,000 on  Faircent, Rs 5,000 on i2ifunding, and Rs 25,000 on Lendbox. Each lending platform has its own minimum annual income criterion too: Rs 144,000 on LenDenClub and Rs 300,000 on i21Funding. 

Fees and charges: Lenders have to pay a variety of charges on lending platforms. Faircent charges a non-refundable Rs 1,000 for registration. Lendbox charges Rs 500 for registration and an additional fee of Rs 500 for every investment of Rs 100,000. Some platforms do not have any registration fee. The transaction fee is around 1-2 per cent of the loan amount. Before any money is transferred, a loan agreement is signed between each borrower and lender. Every P2P platform opens two escrow accounts, one for fund transfers from lenders and pending disbursals, and another for collections from borrowers.

Attractive interest rates: The interest rate that a lender earns depends on the borrower's risk profile. Every P2P platform has its own range of interest rates. Generally, an investor choosing a borrower with a higher risk profile will earn a higher rate of interest, and vice-versa. Interest rates range from 12-24 per cent on PaisaDukan.com; 18-26 per cent on Faircent; and 12-36 per cent on Lendbox. No P2P platform guarantees any return on the capital, nor does it assume any credit risk on lenders' behalf. But in case of default, P2P lending platforms do provide legal assistance, the costs for which have to be borne by lenders. 

The interest income earned by a lender is added to his income and is taxed based on the income tax slab. 

Reduce risk: Borrowers who find it difficult to get a loan from banks or NBFCs turn to P2P lending platforms. Suresh Sadagopan, founder, Ladder7, a financial advisory firm, cautions about the risks lenders run. “Most borrowers on these platforms are those that have been rejected by banks, or have limited access due to poor credit history, so lenders run higher credit risk when lending to them. Investors also have to rely on P2P players' credit underwriting process.” These risk assessment methods may or may not be accurate. 

Investors can reduce their risks by diversifying their lending, and by limiting the amount they lend (as a percentage of their total investment portfolio) on these platforms. Also, those who lack  proper knowledge should seek their financial adviser's help before lending. “Even if you plan to diversify your portfolio by investing on P2P platforms, have a low exposure to these kinds of products,” says Santosh Joseph, founder, Germinate Wealth Solutions.