MoneyTalk #2 - RBI Cracks Down on P2P Lending, Where Should Investors Allocate Funds?
- kkgala
- Aug 22, 2024
- 6 min read
Question: RBI has introduced new directions for P2P platforms. I have invested money through few P2P platforms. What should I do with my investments? Are my investments safe? Where should I re-allocate my funds?
What if we told you that your P2P investments might be on the verge of a major shakeup? With the Reserve Bank of India’s latest crackdown on P2P lending platforms, the way you’ve been investing through these platforms and the returns you’ve been counting on, could change overnight. If you’ve been relying on these platforms to grow your wealth or fixed monthly income, you need to know how these new directions could impact your portfolio and where to move your money next. This is more than just a regulatory update - it’s a wake-up call for every savvy investor.
The Peer-to-Peer (P2P) lending landscape in India has grown significantly over the past few years, offering investors an alternative asset class with potentially higher returns. However, as this sector has matured, the Reserve Bank of India (RBI) has recognized the need to introduce better directions to safeguard investors and maintain financial stability. Recently, the RBI announced a series of new changes to the existing master directions aimed at bringing more transparency and reducing risks in the P2P lending ecosystem.
In this blog, we’ll break down why RBI introduced new directions, what they mean, how they affect P2P platforms, and what investors need to know moving forward.
Why did RBI introduce new directions? Understanding the RBI’s concerns -
The primary concern for the RBI is that these practices blur the lines between what a P2P platform is meant to do versus what banks do. Here’s how the key issues play out:
1. Pooling of Funds:
Banks: Legally pool deposits from customers, use these funds to lend, and manage risks with reserves and regulatory oversight.
P2P Platforms: Some were pooling money from multiple investors, then assigning these funds to borrowers in a way that resembled banking operations. This essentially created a fund-like structure rather than a direct lender-to-borrower connection.
Change - Platforms are now prohibited from pooling investor money and then assigning it to borrowers. Each loan must have a clear, direct link between the investor and the borrower.
2. Management of NPAs:
Banks: Banks provision for non-performing assets (NPAs) based on regulations and absorb these losses using their reserves.
P2P Platforms: By covering NPAs and not passing on the losses to lenders, some P2P platforms were mimicking banks and misleading investors about the true risk profile of their investments.
Change - If a borrower defaults, the loss will now be directly borne by the investor, not the platform. This change increases transparency and aligns the risks and rewards of P2P lending with those who invest.
3. Loan Assignments & Auto-Investments:
Banks: Can freely manage their loan books and reassign funds as needed within the regulatory framework.
P2P Platforms: By automatically assigning borrowers to lenders or allowing secondary transfers to provide liquidity, P2P platforms were acting more like financial intermediaries rather than mere facilitators of direct lending between peers.
Change - Investors must now manually select which loans to fund. Auto-assignment or automated investment options are no longer permitted, ensuring that investors make deliberate and informed decisions.
4. Fixed Tenure and Returns:
Banks: Offer fixed deposit products with guaranteed returns and tenure, backed by regulatory protections.
P2P Platforms: By offering similar fixed-tenure products, these platforms were encroaching on banking territory, which is not allowed without a banking license.
Change - Platforms cannot transfer loans between investors to manage liquidity or meet withdrawal requests. This ensures that each loan remains a direct agreement between the original lender and borrower.
The RBI’s new directions aim to restore the original intent of P2P platforms: to be facilitators of direct lending between peers, without acting as financial intermediaries. This helps protect investors and ensures that P2P platforms do not take on risks and activities that require a banking license.
Implications on P2P Platforms & how these changes affect Platforms?
The new directions by RBI require P2P platforms to shift their business models significantly:
Redefined Business Models: No More Bank-Like Operations. Platforms must now operate purely as intermediaries, matching borrowers and lenders without managing funds or risks Platforms must shift to purely facilitating direct lending, with clear disclosures and no financial intermediation.
Increased Transparency: Platforms will need to be more transparent about the risks involved and cannot hide defaults by absorbing losses themselves. Platforms need to provide more detailed information to investors and adhere strictly to RBI’s guidelines.
Regulatory Compliance: Stricter adherence to compliance will be necessary, with platforms focusing on building robust systems for matching lenders with borrowers without crossing into banking functions.
Focus on Fees: Platforms will generate revenue through platform fees and management fees instead of spreads or managing pooled funds.
What these changes mean for Investors?
As an investor, these changes have several implications:
Reduced Liquidity: The absence of a secondary market and the prohibition of loan transfers mean that investments may be less liquid.
Direct Risk Exposure: Investor will directly bear the risk of any defaults, making it crucial to assess each investment carefully.
Greater Transparency: Investors will have a clearer understanding of the risks involved, as platforms can no longer absorb losses or manipulate returns.
Informed Decision-Making: With auto-assignment gone, Investor will have more control over your investment choices, ensuring your portfolio aligns with their risk tolerance.
How to navigate the new P2P Lending landscape?
Understand the Risks: Recognize that P2P lending involves higher risk, especially now that defaults will directly affect your returns. Pay close attention to the creditworthiness of borrowers. Look for detailed information on their income, employment, and past borrowing history.
Diversify Investments: Spread your investments across multiple loans and borrowers to mitigate the impact of any single default. Look for alternative investment options such as:
Debt Mutual Funds – Liquid Funds, Low Duration Funds, GILT funds, etc. offer liquidity to investors with easy redemption options. They are less risky than P2P lending but do come with interest rate risk and credit risk. Ideal for investors looking for moderate returns with relatively lower risk.
Corporate Bonds – They could be more liquid than P2P lending, with some bonds trading on secondary markets. Risk profile of these bonds varies based on issuers credit ratings. High rated bonds will offer low interest but are safer. Ideal for investors with higher investment amount (for diversification across multiple bonds), looking for returns higher than government bonds.
Fixed Deposits – Risk with FD is minimal, especially with Bank FDs which are insured up to Rs. 5 Lakhs. Investors with slightly higher risk profile can also look at Corporate FDs (however, they are not insurance protected). Ideal for investors prioritizing capital protection over higher returns and lower liquidity (since, pre-mature withdrawals are subject to charges).
High Yield Savings Accounts – Small Finance Banks (SFB) are offering higher yields on savings account over certain minimum balance. This offers investors liquidity with higher interest and insurance protection (Yes, SFB are also covered under insurance). It is ideal for investors prioritizing safety of capital and liquidity. (Though protected under insurance, due to their nature of operations, SFB are more susceptible to risks. Investors should keep close watch on Bank NPAs and prefer listed SFB)
As these regulatory changes unfold, it’s crucial to understand that this is an ongoing situation, and our insights are based on the current interpretation of the RBI’s new guidelines. Investors should consult their financial advisors to assess the impact on their specific portfolios. In a worst-case scenario, akin to a bank run on P2P platforms, it may be prudent to consider withdrawing your funds early and reinvesting funds at a later date, upon receiving further clarity. Platforms may approach RBI to seek further clarity and probably few relaxations from the new directions. It is likely that Platforms will communicate updates with the investors in coming weeks. We encourage investors to stay informed, avoid making hasty decisions, and wait for official commentary from the P2P platforms.
Disclaimer: Content of this post is for information purpose only. Financial products mentioned in this post are for illustration purpose only. It is not a buy/sell recommendation. Purpose of this post was to share our perspective on new directions issued by RBI for P2P platforms. Our view is subject to change as this is an ongoing development. Our interpretation of the amendments may be subject to unintentional misunderstanding/errors. Reader discretion is advised. Consult your financial advisor before making any investment decision.
Disclosure: Thursday Ventures LLP is empaneled with NDX P2P Pvt. Limited (LiquiLoans) and receives commission from the company on investments placed through their platform.
Link to RBI Master Directions and Amendment Notification:
Master Directions: https://www.rbi.org.in/Scripts/BS_ViewMasDirections.aspx?id=11137#
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