Regulating P2P lending startups: Missing the woods for the trees  

4th May 2016
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Twenty-first century businesses need twenty-first century regulations. However, despite being the occasional cheerleader of disruptive startups and entrepreneurs, RBI Governor Raghuram Rajan seems to have chosen the easier path – copy-paste regulations for an existing category to another, albeit with a few tweaks. With the recent ambiguous FDI policy (courtesy DIPP) for India’s hyper-funded e-tailing space still fresh in our memories, the proposed peer-to-peer (P2P) lending guidelines do not come as a surprise.

P2P lending in India is not yet significant enough (there are around 30 P2P lenders) to pose systemic risks to the economy in the near future, but has the potential to disrupt the small-ticket lending space. That’s why I had argued in my March column that  India’s P2P fintech startups should voluntarily seek regulation, as scale will eventually invite scrutiny. The startup ecosystem, therefore, should not be wary of new appropriate regulations, but be prepared to deal with hurriedly-compiled, inappropriate regulations.

rbi-peer-to-peer-lending

Unfortunately, the RBI governor seems to be a man in a hurry – perhaps with valid reasons. The recent collapse of leading Chinese P2P lender, Ezubao, in which investors lost around USD 7.6 billion should be enough to send the alarms ringing. But that’s still not a strong enough reason to come up with logic-defying ideas, even though they are up for discussion. The need of the hour is to amend the RBI Act to create a separate category of financial intermediaries and bring the P2P lenders under its ambit.

The irony, therefore, is that the fine print of an apparently sensible move doesn't make much sense. Although P2P lenders compete directly with banks, non-banking finance companies (NBFCs) and micro-finance institutions, they are not engaged in “banking” per se. They are just technology platforms operating a marketplace that brings together a prospective customer seeking loans and an investor willing to risk money based on a payoff matrix. They are definitely competitors of banks, NBFCs and microfinance institutions, but they aren’t peers.

In this context, the two absurd ideas floated in the discussion paper by the RBI are: 1) proposal to cap the leverage ratio, and 2) minimum capital requirement of INR 20 million. First, let’s understand, what’s leverage? To quote Investopedia, leverage is the amount of debt used to finance a firm’s assets. A leverage ratio is simply a firm’s debt-to-equity ratio. However, P2P lending platforms do not extend “loans” to their users by borrowing from the market. The loans extended never sit on their books. And that’s why the proposal to cap the leverage ratio doesn’t make any sense.

As LendBox CEO Ekmeet Singh told me, "It would have made sense if our balance sheet were exposed. Instead, our business model rests on building a transparent system to connect retail investors with an alternate asset class – people." The proposed minimum capital requirements seem too high and unnecessary given the business model. Whether the business model itself is viable and sustainable or not is a different question altogether, and requires a detailed analysis. But that’s for another day.

Last but not least. The proposal to allow direct transfer of funds between the borrower and the investor without ceding any control over the flow of funds to the platform will prove to be damaging, not only for the platforms, but also for its users. Monitoring fund flow is critical to overall cash management as the industry evolves to be more efficient, effective and reliable. P2P lending startups would also need to seek clarity on the proposal to have “brick and mortar” locations – is one central location enough or do they need to have presence in all regions of operations? If the latter is true, it would hit hard at the very idea of disruption that could change banking as we know today, forever.

Instead of focusing on trifles and be mired in short-termism, Indian policymakers and regulators need to realise that the world around us is changing fast, leaving behind the relics of archaic polices and guidelines. The idea is to keep pace with change and not make monumental blunders in order to play catch up. The desire to have ‘skin in the game’ is so passé. Now it’s all about having the whole body in it. The faster our policymakers realise this, the better.

(Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the views of YourStory.)

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