RBI’s P2P proposals: crossing the river by feeling the stones

The Reserve Bank of India’s (RBI) proposals to regulate the peer-to-peer (P2P) lending segment have been broadly seen as positive for the nascent industry, which, if anything, will gain greater credibility once it is regulated. Regulation will give these platforms greater legitimacy, which in turn will attract more investors and customers to such entities. The experience of the microfinance sector in the aftermath of the Andhra Pradesh crisis, which led to the sector being regulated by the RBI, is a case in point. Still, there are some issues that executives in the P2P business have raised and will provide feedback on to the RBI. Read more here

Capital requirement

The first issue raised is that the Rs.2 crore capital requirement is too high and will make entry into the business onerous. It is understandable that industry would want to limit capital requirements to a bare minimum, but the RBI’s objective in doing this is to ensure that those entering the business are serious participants and have skin in the game. Today, it is not difficult to set up a technology platform and at a relatively low cost. As such the barrier for entry is low. But in a financial services business (and yes even a platform connecting lenders and borrowers should be seen as a financial services business) very low entry barriers can spell trouble.

The RBI also says that the platforms may be asked to adhere to a “leverage ratio”. This is not as easy to understand as the initial capital requirement. Since most of the P2P lenders are not loaning their own money, imposing a leverage ratio doesn’t make much sense.

Brick and mortar presence

The RBI’s suggestion that P2P platforms have a brick and mortar business presence is another condition that could be seen as an unnecessary imposition. It’s easy to see where the regulator is coming from. They want someplace to go to catch the culprit if things go wrong. This, however, appears to be a futile exercise. Having a physical office hasn’t prevented people from getting away with a scam n the past and it won’t do so now. In an increasingly digital world, where even banks are choosing online channels over once-treasured branches, insisting that online platforms have a brick-and-mortar business presence seems pointless.

Prudential limits on lending?

The RBI, in its discussion paper, has said that it may consider imposing prudential limits on the amount that can be lent to a borrower or a segment of activity. The regulator seems undecided on this and said such limits “could be specified”. Those in the business would like the RBI to stay away from this. However, it is important to find some way to ensure that the amount borrowed is in sync with the ability of the borrower to repay. That is a basic principle of any lending business. Currently, the amounts lent out through these platforms are small. So, as a start, the RBI can perhaps allow the platforms to self-regulate this by limiting the amount that can be borrowed by a person based on their assessment of the borrower’s credit profile. However, if these amounts start to rise, the RBI may need to step in. Strong supervision will be needed to compensate for ‘Light Tough’ regulation in this regard.

Funds moving directly from lender to borrower

In saying that funds should move directly from a lenders account to a borrowers account, the RBI is trying to prevent the risk of a platform collecting the lender’s money and vanishing. It is a risk, yes. But the industry’s suggestion that an escrow mechanism could be followed through a banking entity seems like a reasonable suggestion as long as enough checks and balances are put in place.

Cautious advertising

Finally, like in the case of many other financial products, the RBI asks P2P lenders to stay away from “suggesting a promise of extraordinary returns, which implies some form of guarantee of returns to lenders.” No one can argue with that. The lure of get-rich-quick schemes can be tough to resist and India has seen many such schemes. A favourite example of this is a potato purchase scheme in Kolkata that the capital market regulator busted in 2013. The sponsors of that scheme were offering a 100% return in 15 months in exchange for investments in potatoes. This is not to compare P2P lending with anything similar to that, but just to say that platforms and regulators will have be very careful in how P2P lending is marketed to both borrowers and lenders.