Are low-interest rates making you jittery? Consider P2P lending

Falling interest rate amid coronavirus crisis has impacted income of many investors who depended on debt instruments; those with surplus cash can consider peer-to-peer lending, which is attracting increasing interest from people willing to lend to those in need of short-term financing -- whether individuals or small businesses

KEY HIGHLIGHTS

• P2P lending helps earn decent returns and bridge the credit gap in the economy
• P2P platforms connect lenders with borrowers; former earns interest and latter receives loans
• It faces a high level of risk due to unsecured lending and is suitable mostly for investors with a high-risk appetite
• Coronavirus lockdown has reduced demand for loans, but willingness to lend stays
• Risk of defaults has increased post-COVID-19, but a well-managed portfolio may still earn 12-14%
• Minimum Rs 25,000 and maximum Rs 50 lakh can be invested across P2P platforms
• Exposure to single borrower can't exceed Rs 50,000
• A few P2P players have their lending limits within RBI's prescribed limits

The falling interest rate has impacted the income of many investors who depended on debt instruments such as fixed deposits, bonds, debentures, government securities and debt mutual funds. At a time when the interest rate has fallen significantly, gold prices are trading near record highs with the limited scope of similar performance in near future, stocks markets are volatile and the sentiment is negative towards debt funds due to defaults and liquidity issues, investors with surplus cash are looking for new investment avenues to deploy their savings. One such investment is peer-to-peer lending, which is attracting increasing interest from people willing to lend to those in need of short-term financing - whether individuals or small businesses.

There are around 30 P2P players in the country, of which 21 have the NBFC-P2P licences as on February 2020. 5Paisa Loans is the latest to have received the licence by the RBI. While the loan demand on P2P platforms has decreased post coronavirus, the willingness to lend has stayed the same.

Faircent, the country's first P2P player to receive the RBI licence, saw a 25 per cent drop in April volumes. However, it expects May to close better with disbursements reaching around Rs 90-100 crore. Another P2P player Lendenclub says it is processing 40 per cent fewer users compared to previous months.

"Majority of people are at home under countrywide lockdown. This has suppressed the demand for consumption leading to less demand for loans. Once economic activities resume, consumption will go up and so will the demand for loans. A similar situation has happened with investors as well. Once the monetary circulation is back in the economy, more investors will come back with even more money. At this moment, we are experiencing sluggish loan demands, not the lack of investment interest," says Bhavin Patel, Founder, LenDenClub.

Faircent sees the demand to boost post the lockdown, but borrowers belonging to risky segments may see lack of funding interest. "As normalcy is restored and economic activity recovers, most businesses will need credit support to get back on their feet. With this, the loan demand will increase sharply. It will have to be structured in a manner that ensures efficient funding by lenders. Credit evaluation will be influenced by how COVID-19 has impacted the borrower. For example, lenders may start lending based on COVID zones, rather than PIN codes, while employees of stress sectors such as airlines and hotels could be affected when seeking loans," says Rajat Gandhi, Founder and CEO, Faircent.

Meanwhile, most players, including Faircent and Lendenclub, have offered a moratorium on loans for borrowers to cope with the ongoing challenge. To boost the borrowing demand, Faircent has launched loan products such as the 'anti-lockdown loan' to help borrowers access to credit along with easy repayment options. It is also helping borrowers in green zones access quick and easy loans by tagging their listings as 'low impact COVID zone' on the platform.

Is P2P lending worth the risk?

Also read: What to do if you find something fishy about a financial offer?

The coronavirus pandemic has indeed raised the risk of defaults by borrowers, the algorithms that P2P players use to rank them on their platforms as per their risk profile can help you build a portfolio as per your return expectation and risk appetite. If you do not want to take much risk, you can lend only to high-rated borrowers. If you are comfortable with more risk, you may diversify your lending across all types of borrowers. Since the interest rate that you earn on your lending depends on the repaying ability of the borrower, diversification helps you reduce risk and average your returns. Most experts advise the thumb rule of 80:20, that is, lending 80 per cent to high-rated clients with reasonable returns and 20 per cent to low-rated clients. It is advisable to diversify maximum when lending to lower-rated clients.

"P2P lending gives you an option to look beyond equities and debt to earn high yields. Returns anywhere between 19-21 per cent are expected through this medium. Even if some loans turn bad, investors can still earn 12-14 per cent on their capital," says Prakarsh Gagdani, CEO, 5paisa.com.

Going by the RBI guidelines, one can invest up to Rs 50 lakh across P2P platforms. The minimum amount is Rs 25,000. The central bank has specified that the tenure of a single loan cannot be more than three years and exposure to a single borrower cannot go above Rs 50,000. For example, if you have Rs 50 lakh to invest, you need 100 borrowers across platforms. Besides, different P2P players may fix their lending limits within the RBI prescribed limits.

Saumya Shah, Founder of Tarrakki, a wealth management platform, says the demand from high net-worth individuals to explore P2P lending as an investment has increased post the lockdown since we are in a declining interest rate environment. "Although returns may decline over the next few months for lenders, P2P lending will see more demand and P2P players will gain market share."

Thus, if managed well, P2P lending could be a decent option to shift your funds stuck in low-yield investments to earn higher yields.

Also read: How to become a crorepati with PPF investment