By Mayank Agarwal & Anita Baid (firstname.lastname@example.org)
Peer to Peer lending (P2P Lending) is a virtual marketplace which connects borrowers and lenders online by providing quick funds to borrowers and high returns to lenders. The borrower can raise fund by borrowing from a single lender or a group of lenders. The accelerated growth in P2P Lending platforms was recognized for the first time by the Reserve Bank of India (RBI) in its First Bi-monthly Monetary Policy Statement, 2016-17. The RBI realized that it cannot be oblivious to the risks posed by such institutions to the monetary and banking system of the country. It further also mentioned to come out with a concept note on P2P Lending platforms for public comments by April 30, 2016. The consultation paper that came on April 28, 2016 was to seek comments/views from all interested parties and general public and based on the feedback, the contours of regulating P2P Lending was to be decided in consultation with the SEBI.
Based on the nature and extent of services provided, there has been a lot of innovation and variants of P2P Lending platforms. The RBI consultation paper outlines the pros and cons of regulating the sector and proposes a suitable framework for regulating this activity, which includes minimum capital requirement, permitted activity, governance requirements, fair practices code for customer dealing and data security. The RBI consultation paper, inter alia, proposes the following:-
- Currently the platforms functioning in this industry are required to get registered as intermediaries; provided that they only one act as a platform where borrowers and lenders come in contact with one and another and do not lend their money through the platform. The platform will also have to ensure that section 45S of the RBI Act is not attracted i.e. it does not accept deposit from the purpose of lending the money;
- These platforms are also barred from guaranteeing any return to the lenders;
- These platforms will require to have a minimum capital of Rs.2 crores;
- Risk management systems need to be put in place.
- It has also mandated that all platforms in this sector will have to be registered as a company under the prevailing laws.
Subsequent to its issue, there has been a debate on the discussion paper, addressd by Shri R. Gandhi, Deputy Governor at Mumbai on May 17, 2016. Following arguments against the regulatory approach to P2P Lending were pointed out:
- Unrestricted or laissez-faire competitive equilibrium is the most efficient economic arrangement;
- Doubts on the benefits of regulation of financial services- regulation may not in practice solve market failures or imperfections; and even if it does a cost is involved that exceed the costs of the original problem; serious moral hazards arises when regulation is imposed; and regulation imposes a wide range of costs which are paid ultimately by consumers;
- Due to the reduction in competition, financial regulations serves the interests of the financial service providers and are mostly detrimental to consumer.
The arguments in favour of regulating the P2P Lending platform were as follows:
- Neo-classical assumptions, when applied to the financial sector, do not hold good as there are in reality imperfections, information asymmetry, incompleteness, and failures in perfectly competitive or laissez-faire financial markets;
- Financial systems, markets and participants need regulation and there is also need to avoid consequences that may arise in case of absence of regulations;
- There are three main reasons for financial regulation: i) To protect the customer against monopolistic exploitation ii) To provide smaller, retail (less informed) clients with protection, and iii) To ensure systemic stability;
- One critical argument in favour of financial regulation relates to what happens in the absence of regulation;
- Interposing regulation and supervision into an otherwise free-market context weakens the incentives for the owners and managers to monitor and control themselves, and for their clients to exercise due diligence.
The other important aspect that was discussed and debated upon was whether financial innovations should be regulated. Whether the innovators and entrepreneurs should be largely left alone, or whether public policy authorities should be actively involved in regulating those. The several approaches employed by RBI for regulating financial innovation include to ignore, to watch out, to regulate passively, to regulate actively and to ban. For example, the prize chits and money circulation schemes have been banned, whereas with regard to the virtual currencies like Bitcoins, the RBI cautioned the public about the risks involved in dealing with them. Towards the end of the discussion it was concluded that P2P Lending platforms need to be regulated, even though they have not yet really taken serious magnitude.
In this regard, the areas of concern that RBI will be considering before formulating the regulations inter-alia includes the type of regulation- whether prudential or conduct of business or both, the structure of the platform, capital requirement, corporate governance, risk management structure and the technology and customer grievance redressal mechanisms.
Thereafter, the RBI had not taken any steps since the release of the consultation paper and was exploring various options as to how the P2P sector should be governed. Section 45-I (f) of the RBI Act, 1934, specifies that RBI would require an approval from the Central Government and notification in the Official Gazette in order to classify any financial institution as a Non-Banking Financial Institution and bring it under its purview.
The dilemma ended on 18th September, 2017 when RBI by way of an official gazette notification classified “a non-banking institution that carries on ‘the business of a peer to peer lending platform’ to be a Non-Banking Financial Company”. Hence, having finally been notified by the Official Gazette, the RBI put an end to the mystery surrounding the P2P lending industry in India. Furthermore, the notification defines P2P lending platforms as companies providing under a specific contract the service of loan facilitation via online medium or otherwise to participants who have entered into an agreement with that platform to lend on it or to avail of loan facilitation services provided by it. However, the RBI still has to propose the reporting requirements that need to be made by these platforms.
The intention of RBI is to bring clarity to the fact that P2Ps are prohibited from acting as anything more than mere intermediary in the financial transactions facilitated by it. That is to say, these platforms are NOT allowed to undertake any other activity other than connecting the borrower(s) and lender(s) with one another. Conclusively, the decision to classify P2Ps as NBFCs will major implications on the operations of these companies and the P2P market as a whole. Considering the fact that NBFCs are to be regarded as companies, P2P firms that are presently constituted as LLPs or partnership will be required to undergo a change. Also, P2P platforms will have to disclose all data and credit rating mechanisms related to its operations to Credit Information Companies. RBI has also been considering allowing the P2P companies to operate offline as well, a decision which is sure to fuel the growth of P2P ecosystem, especially in the under-covered rural and semi-urban regions. 
The future of this promising industry hinges on the specific laws or regulations that RBI comes out with for P2P Lending companies. The decision to classify them as NBFCs will have its downsides as well, because unlike a regular NBFC, P2Ps are prohibited from participating in lending activities or participating in financial transactions in any way other than just acting like intermediaries, which puts a question mark over their ability to be able to bear the additional costs in the form of regulatory and social compliances, one of the major ones being that a NBFC should, at all times, maintain a balance of at least Rs. 2 crores as net owned funds.
The ideal solution seems to be to treat P2P companies as a separate classification of NBFCs and create laws that suit both the P2P Lending entities as well as its beneficiaries, which will in turn benefit the financial ecosystem of the country as a whole.
 Summarized by David Llewellyn in his paper ‘The Economic Rationale for Financial Regulation’
 Views of Prof Charles Goodhart, in his book ‘Financial Regulation: Why, How and Where Now?’
 Caution statement made by Prof Goodhart