The economic downturn of 2007-08 served as a wake-up call to the long-standing monopoly of traditional lenders. Since the catastrophic collapse of Lehman Brothers in 2008, plausible alternatives to conventional credit intermediaries have emerged, and one such digital lending method is Peer-to-Peer (P2P) lending.
Efforts have been undertaken to raise the standard of living of those who are at the bottom of the pyramid, most of who are without basic bank accounts, credit or other financial services. Concurrently, the digital revolution and faster internet access has enabled people worldwide to trade virtually. Individuals can now swap money worldwide without financial intermediaries like banks or other financial entities.
Financial sustainability is an indispensable item of economic development and financial inclusion. Financial inclusion is a vital part of making the nation's economy and markets sturdy and durable.
The P2P lending industry has witnessed a dramatic change in technology, consumer behaviour and business offerings. The segment has seen a rise in technology adoption from both lenders and borrowers in the age group of 25-40 years. Additionally, as restrictions are relaxed, demand for credit to aid economic recovery will rise rapidly. The world of P2P lending is all geared up to provide quick, easy and flexible lending solutions in the days to come.
The Fintech Revolution
Sir Edmund Hillary once said, "If you only do what others have done, you will only feel what others have already felt. However, if you choose to do something that no one else has ever done, you will have a satisfaction that no one else has ever had." It couldn't be more fitting for the blossoming P2P lending arena.
The universal P2P lending market has expanded rapidly in the past seven years. The category is expected to grow at more than 31 per cent compounded annual growth rate (CAGR) through 2021-2026.
We have all heard about cryptocurrencies and how episodes of extraordinary volatility temper their exceptional performance. But P2P lending is an altogether unique modern-day investing tool.
Here are some of the reasons why lenders are considering investing in P2P lending models:
Low Entry Cost: You don't need much money to start establishing your P2P lending portfolio. The admission cost is low, and a new investor can begin with as little as Rs 50,000 to Rs 1 lakh and slowly expand the size of their portfolio. Returns are heavily dependent on the portfolio established by a lender.
Investment Simplicity: P2P lending is a technique. It indicates that the entire process is carried out digitally, from identifying borrowers who fit your standards to executing legal agreements with borrowers to receiving repayments. All transactions are conducted through an escrow account managed by a bank-promoted trustee—the platform tracks and updates the performance of your portfolio in real-time.
Higher Returns: This happens in two ways.
Passive Income Via Reinvestment: Lenders generate passive income through equated monthly investments, including interest and principal earnings. The lender is reimbursed monthly by borrowers through EMIs. The P2P lending platform acts as a catalyst, collecting EMIs from borrowers and depositing them in the lender's escrow account, wherein the lender can withdraw or reinvest as desired. This leads to consistent returns from diversified investments.
Auto Invest: P2P lending institutions offer auto-investing options, providing a diverse portfolio to save time and effort. The algorithm gives the lender an edge in choosing the best investment plan.
A Word Of Caution
The Reserve Bank of India (RBI)-regulated P2P lending industry is booming in India and has evolved as a robust and versatile asset class competing with traditional investing platforms. However, like every investment option, P2P lending also comes with some risks.
Risk Of Default: One of the risks is that the borrower can default on your loan. Another concern is that no compensation scheme protects your contributions, which means that in case of a default, one won't get his/her money back quickly.
Less Liquidity: Another downside to P2P lending is the liquidity of investment. The repayments from the borrowers come to the lenders as per the EMI and the loan tenure. Therefore, encashing an investment before the repayment date is a challenge.
Tax On Returns Earned From P2P Lending: In P2P lending, investors essentially earn interest from the amount they lend. Thus, just like interest earned from other instruments like fixed deposits, interest income from P2P lending is taxable. The interest amount earned from P2P lending is classified as ‘Income from Other Sources’ It is added to the lender's income and taxed as per the tax bracket the lender falls in.
Bhavin Patel is co-founder & CEO of LenDenClub.