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How to choose the right P2P lending investment product?

Apr-21-2022


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How to choose the right P2P lending investment product?

Peer to Peer (P2P) lending means direct lending between two peers. A peer could be a business or an individual.

Let us first understand lending or credit.

Lending is giving a loan/debt/credit to another party that this party promises to repay at a future date. Interest is the extra the borrower pays to the lender for the time and risk they contribute.

The word 'credit' comes from Latin and means 'they/she/he believes in the borrowing party's promise to repay.

While lending may have originated with one individual giving a loan to another, it has evolved with the advent of modern banking. Formal banks are in fact traced to the early 15th century.

Typically, depositors like us put money in a bank and the bank gives us some interest earnings. The bank further lends this money to those seeking loans at a higher interest rate and keeps the difference (usually a fat one) as its income.

In lieu of this income, the bank provides services such as underwriting (risk assessment), transaction security, collecting repayments, sharing borrower repayment performance with other lenders/credit bureaus, etc.
 
Banks also lose some of their earnings when the borrowers they lend to default i.e. do not repay.

With technology and evolving regulation, these services can be implemented between 2 peers without a bank in between.

In late 2017, the Reserve Bank of India (RBI) came up with a regulatory framework to enable peer-to-peer (P2P) lending with retail investors on one side as lenders and individual borrowers on the other side.

This regulatory framework allows a select set of organizations to operate P2P platforms and undertake services such as underwriting, transaction management, collections, etc. 

These platforms are technology-first and charge low margins. Thereby enabling investors or lenders to earn direct and thus high income as interest earnings from borrowers. It is important to note that in this case, the risk of the borrower defaulting is also on the investor.

Across RBI permitted P2P platforms you can choose from a variety of borrower types and products. Here are 5 important things to assess:

How does the P2P platform manage and reduce risk :
 
Risk is reduced via a combination of-
a) choosing creditworthy borrowers
b) spreading your investment across many borrowers
c) getting diverse borrowers i.e. from different locations, income sources, etc.
 
Underwriting credentials of the management:
Check if the management team comes with lending and risk experience and the parameters of their credit scoring algorithm.
 
Borrower types onboarded:
Does the platform onboard borrowers with prior credit histories or new to credit borrowers. It is important to understand who you are lending to and feel comfortable with their risk-return profiles. Also, check if the platform gives you information about the borrowers your investment has funded.
 
Fees & policies:
Fees can eat into your earnings. Check before investing if there are any onboarding fees to be paid and if the projected returns are net of platform fees.
 
Returns & Timing:
You are making this investment to earn a suitable return. Compare the returns projected and offered by various platforms and how often they are paid out - monthly, yearly, after 3 years and so.

 

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