Survival at Stake? The impact of RBI’s Norms on P2P Lending Platforms
Dayita Kanodia and Manisha Ghosh l finserv@vinodkothari.com
Introduction
RBI on August 16, 2024 has issued a notification for the review and modification of Master Direction – Non-Banking Financial Company – Peer to Peer Lending Platform (Reserve Bank) Directions, 2017 (‘Directions’) for platforms acting as intermediaries and providing an online marketplace for lending between peers.
The review has been carried out pursuant to observations that some of these platforms have adopted certain practices which are violative of the said Directions. These practices include, among others, violation of the prescribed funds transfer mechanism, promoting peer to peer lending as an investment product with features like tenure linked assured minimum returns, providing liquidity options and at times acting like deposit takers and lenders instead of being a platform.
In the past as well Mr. Tamal Bandyopadhya, an Indian business journalist, known for his weekly column on banking and finance, had highlighted concerns about the pseudo-FD schemes run by P2P NBFCs coloring marketplace lending into another assured-return scheme with P2P absorbing the risks and returns. It was argued that while this is a supervisory issue, it’s essential to recognize two key points:
- Potential of marketplace lending:
The inherent economic argument presents itself, where a borrower can get the best deal by posting his requirement on a marketplace and let potential lenders compete, why do we expect the old-fashioned way of a borrower borrowing money the negotiated way. After all, if there are marketplaces for everything – from debt securities to renting a house to domestic services, why can’t there be marketplaces for loans, thereby using technological abilities to eliminate one of the basic reasons for the emergence of intermediaries.
- Temptation of assured returns
The allure of assured returns has been a breeding ground for financial scams in the past. This issue isn’t confined to retail investors; even professional financial entities, like banks involved in co-lending or loan purchases, often operate in a manner that mimics assured return schemes. This is where the supervisor shall step in and scrutinize the practices to prevent them from becoming an assured return scheme.
Vide the notification, RBI has issued certain clarifications putting emphasis on existing norms, and new insertions have also been made. This article discusses key amendments introduced along and their impact.
Effective Date
The changes made through the review shall be effective immediately. However the timeline (T+1) for transferring funds from the escrow accounts (both lender and borrower) shall come into effect ninety days from the circular i.e from November 14, 2024.
Not an Investment Platform
RBI through the review has instructed P2P platforms to not promote peer to peer lending as an investment product with features like tenure linked assured minimum returns, liquidity options, etc. This would be a big blow to several large P2Ps who have been marketing their offering as investment opportunities for retail lenders. The existing practice of P2P platforms was to manage the funds for the lender while utilising the proceeds for making disbursement to the borrowers and providing a return to the lender- this was showcased as being akin to a deposit of funds by the lender for extending loans which were entirely managed by platforms.
No Credit Enhancements
Clarification has been provided to para 6(1)(iv) of the Directions, stating that any credit risk arising out of the transactions on the platform shall not be undertaken (directly or indirectly) by the P2P platforms. Meaning that on default of repayment by borrower, the loss of (principal or interest or both) shall directly be borne by the lender.
Further clarification with respect to credit enhancement is provided through extending para 6(1)(vii) stating any insurance product permitted to be cross sold by the platform shall not be in the nature of credit enhancement or guarantee.
This would mean that the P2P platform shall not be permitted to absorb any losses of the lender under any circumstances.
Matching and Mapping of Participants
P2P platforms were earlier directed to form a Board approved policy, setting out the rules for matching lenders with borrowers in an equitable and non-discriminatory manner. The same shall now be updated to include mapping lenders with borrowers.
Difference between matching and mapping?
In the P2P business, matching refers to the lenders manually selecting the borrower depending upon the credit score and other parameters set by them. Similarly, the borrower also selects the lender based on rate of interest and other factors. Therefore, there is matching of lenders with the respective borrowers whose expectations from the loan transaction coincide.
On the other hand, mapping is an algorithmic mechanism where, lender has provided the platform with criterias desired by the lender for extending the facility. Based on these parameters, the platform shall cruise through the data, picking the borrowers that best fit the specified criteria.
The practice of matching/ mapping participants within a closed user group i.e lenders/ borrowers sourced through an affiliate/service provider to the NBFC-P2P has also been prohibited by insertion of para 8(5) in the Directions.
Fund Transfer Mechanism
The amendment has mandated all P2Ps to follow the compulsory fund transfer mechanism as provided for under Annex I. Further, it has imposed very strict timelines of T+1 days for the deployment from the lender’s and borrower’s escrow account. Accordingly, the funds deployed by lenders for lending through the P2P can stay in the lender’s escrow account for a maximum period of one day from the day the funds are received in such an escrow account. This may pose significant challenges for the P2Ps which will have to put in requisition for the funds as and when needed for lending to the borrowers.
Therefore, if a particular lender has been mapped with 50 different borrowers, the P2P platform will have to request for funds everytime it needs to make disbursements. A lender shall only deposit the funds in the escrow once requested by the P2P.
Further, the amendment has also provided that any repayment made by borrowers will have to flow back to the lender immediately and cannot remain in the borrower’s escrow account for a maximum of one day from the date of repayment.
Pricing of Loans
The amendment has also inserted a new section mandating the formulation of a pricing policy which will provide for the fees to be charged by the platform and basis for computing such fees. Further, the fees charged has to either be a fixed amount or a fixed proportion of the principal amount involved in the lending transaction and can in no circumstances be dependent upon the repayment by the borrowers.
Thus, this puts an end to the practice of charging a variable performance based fee by the Platform depending upon the performance of the loans.
Further, such pricing of fees to be charged by the P2Ps cannot be outsourced and should be decided by the P2P itself based upon its pricing policy.
Disclosure requirements
The following disclosure requirements have been made mandated by the amendment:
- To the Lender details about the borrowers including
- personal identity with borrower’s consent (which should be kept on record),
- required amount,
- interest rate sought and
- credit score as arrived by the NBFC-P2P.
- Publicly disclose on its website
- portfolio performance including share of NPAs on a monthly basis and
- segregation by age
- all losses borne by the lenders on principal or interest or both
It is important to note that the P2P has to publicly disclose the total loss sustained by the lenders from the loans lent through the P2P Platform. The intent behind such a disclosure could be to provide an idea on the risk and vulnerabilities associated with the loan transaction, to the lenders before they lend through the Platform.
No Exit or liquidity to existing lenders
The insertion of the restriction on not utilizing funds of a lender for replacement of any other lender(s) completely washes the idea of creating a secondary market. RBI also clarifies that, funds from ‘Lenders’ Escrow Account’ shall not be used for repayment of loans and funds from ‘Borrowers’ Escrow Account’ shall not be used for disbursement of loans.
While the secondary market in the P2P market is the need of the hour, the absence of necessary machinery and regulatory provisions would curb this.
P2P lending is essentially a retail savings product. One of the reasons an investor invests in a savings product is for ease of exit, either by redemption or secondary market. The only exit available to the lender is once all loans deployed by the lender are fully repaid, which could be months. It is necessary to understand that the reason a retail investor would exit is because either he needs to use his savings, or to redeploy his money. Therefore, the idea of the lender waiting for months, and then keep receiving trickling sums of money does not serve his exit needs at all. As the platform itself cannot use its own resources to buy out the lenders or assure an exit, a secondary market is necessary.
One question arises – Would the lender’s discretion to exit the loan or acquire a different loan on the platform be disallowed by this change as well? In our view this should not be the case, the inserted para reads as follows – “NBFC-P2P shall not utilize funds of a lender for replacement of any other lender(s)” , meaning P2P shall not on its own discretion replace the lender in transaction. However if the original lender wishes to exit the loan and if there is a willing acquirer, should not pose any issue.
Conclusion
Through the recent amendments, the RBI has made efforts to address and curb certain practices within the P2P lending industry. These practices include violations of the prescribed funds transfer mechanisms, the promotion of P2P lending as an investment product with features such as tenure-linked assured minimum returns, and P2P platforms offering liquidity options, which at times led them to operate more like deposit-takers and lenders rather than functioning purely as intermediary platforms.
While these regulatory changes aim to enhance transparency and protect consumers, they may also be viewed by some as overly restrictive. This raises a critical question: have these amendments inadvertently created an existential crisis for P2P platforms? The stringent regulations might limit the flexibility and innovation that these platforms traditionally offered, potentially threatening their viability in the market.
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