RBI guidelines to act as a growth catalyst for P2P business

A rapid growth phase is in the offing for P2P lending platforms as the RBI gears up to issue guidelines to regulate various aspects of the P2P lending business.

The law of the jungle is that there is no law — only the cleverest or the strongest survives. Contrary to that, any civilised society has certain rules and regulations applicable to ALL. You can’t do anything arbitrarily. For example, it’s immaterial whether you own a sports car or a small utility vehicle — if you are driving on a road that has a speed limit, you have to rein in your speed, or else it becomes a punishable offence. Can we afford not to have driving rules at low-traffic volume roads?

Lack of regulations sometimes poses systemic risks.

So why should the same logic not be applied to Peer-to-Peer (P2P) lending platforms? For many individuals, P2P lending is an alternate source of securing finance. However, at present, it is an unregulated sector. There are lines of reasoning in favour of as well as against regulating P2P lending. The jury is still out on whether and how the RBI should oversee this sector.

Those who don’t favour the RBI issuing guidelines often ask a question — why do we need a regulatory framework for P2P lending marketplaces? Arguably, the sector is in a nascent stage of development and poses no systemic risks. P2P lending is not perceived to have any significant impact on monetary policy transmission mechanism either. Further, it is often said that regulations may limit the progress of this innovative, efficient, and accessible avenue of alternate finance.

At present, there are about 30 P2P lending entities, out of which many are standing at a tipping point. Industry experts believe clear guidelines and a well-defined regulatory framework will help the sector grow by leaps and bounds. Moreover, they will also contribute to curbing malpractices. Putting a sunrise industry on the regulatory scanner will assist in avoiding a fallout at a later stage. Therefore, resisting the issuance of guidelines is a futile exercise.

On a similar line, the RBI also articulated the rationale of regulating P2P business. “Considering the significance of the online industry and the impact which it can have on the traditional banking channels/NBFC sector, it would be prudent to regulate this emerging industry. In its nascent stage, this industry has the potential to disrupt the financial sector and throw surprises,” noted the Central Bank in its consultation paper on the subject.

More to the story…

Global practices on regulating the P2P lending sector have been mixed. Countries such as China, South Korea, and Egypt have unregulated P2P lending markets. On the other hand, in countries such as the UK, Australia, New Zealand, and Canada, P2P platforms are regulated like intermediaries. In some developed European nations — France, Italy, and Germany — P2P platforms have to follow banking regulations. The world’s largest economy — the US — has its own unique model for regulating P2P businesses. In the US, P2P businesses are monitored on two levels — regulated by the Securities and Exchange Commission (SEC), they are subject to state laws as well.

The RBI had released a consultation paper on P2P lending in April 2016 and had also welcomed feedback and suggestions. Going by the developments since then, it appears that the RBI may create a separate category for P2P lending businesses within the category of NBFCs (non-banking finance companies). The RBI had followed a similar approach for regulating microfinance companies.

Once the RBI issues guidelines and lays down a regulatory framework, there will be a level playing field available to all players. At present, there are no set rules.

The scope of regulations…

• Permitted activity
• Prudential regulations on capital
• Governance
• Business continuity plan (BCP) and customer interface
• Regulatory reporting

For those who have entered the business just to have a presence in a promising industry, complying with rules and regulations will become an onerous task. They will either have to pull up their socks to survive the competition or be ready to perish. When the money of a promoter is not at stake or the promoter group is not being held responsible for business operations, less serious players linger around, spoiling the party for serious players.

Committing say Rs 2 crore as prescribed capital for a business wherein you are not allowed to accept deposits or grant loans is not a small amount. While big players can easily afford to invest and forget such a sum, no promoter would like to hold a bad investment in its arsenal as it drags down the reputation of the group. Currently, the trend of many large business houses across the industries is to exit non-core businesses and focus on core operations. Regulations also make it simpler for those who want to exit.

Serious buyers always prefer to enter a sector that is regulated.

Strict regulations = greater accountability = higher transparency = big growth opportunities for serious players 

At present, there’s no one to run a check on loans disbursed through P2P lending platforms and ascertain the quality of credit. Once the RBI starts overseeing the sector, P2P lending platforms will become more diligent in reporting numbers. So be it gross disbursals made through the platform or number of accounts that dishonoured EMIs, P2P lending enterprises will have to maintain complete records.

And that’s not all. The RBI will prescribe mandatory disclosures along with the reporting format. This will not only standardise the process under review but also make crucial data available to the public as a whole.

A hawk-eyed regulator such as the RBI will deter industry players from cooking the books or making unfounded claims about their effectiveness — a positive from the investors’ protection point of view. Any discrepancy in regulatory reporting may attract huge penalties and might even cost a business licence in extreme cases.

The benefits of the RBI regulating the sector don’t end here.

In the current scenario, defaulting borrowers are getting camouflaged due to lack of reporting norms. The credit score of a person missing an EMI on a P2P platform doesn’t suffer as credit rating bureaus are not collating data from the unorganised lending sector. In the absence of any data-sharing programme, P2P platforms are forced to depend largely on their in-house assessment. This is providing an unwarranted refuge to wilful defaulters.

Once P2P lending activities come in the mainstream, credit rating agencies will start accounting for the credit history of a person even on a P2P lending platform while providing him/her a credit score. Tracking borrowers’ credit behaviour will become easy.

Nonetheless, this shouldn’t be considered a dead-end in the regulating the sector.

The RBI is most likely to place a restriction that all the borrowing-lending transactions should happen among lenders and borrowers directly via bank-to-bank transfers. Although there are some real merits of this, which include transparency and seamless flow of funds, there are some notable drawbacks as well. Account-to-account transfers among lenders and borrowers create a hurdle.

Consider this case…

Suppose a borrower secured a loan funded by 10 different lenders. Now, he will have to wait for all of them to transfer money to his account. What’s more, he will have to pay EMI in their accounts separately. This creates inconvenience to all when there are multiple parties involved. To overcome this difficulty, the RBI, at some stage, will have to think about allowing P2P lending platforms to maintain nodal/escrow accounts. This will allow both borrowers and lenders to deposit funds in a bank account held by the platform. The platform will be responsible for disbursing the right amounts to the right people.

All closed and semi-closed e-wallets maintain their customers’ funds in an escrow account. On similar lines, even P2P platforms should be allowed to route all transactions through a nodal account.

There’s one more benefit of doing so. P2P platforms can sharpen their risk management processes based on unique traits observed in borrowers’ payment habits.

The global experience suggests that rigorous risk management procedures lay the foundation of any P2P lending organisation. While it takes roots in India, clear and accommodative guidelines will ensure that the P2P lending business is on firm footing.

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