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P2P lending may solve India’s problem of financial inclusion but success depends on these key areas

Credit and Finance for MSMEs: When it comes to lending, a solution is required to address minimal collateral, lack of credit history and absence of point of sales.

  • By Bharat Dureja

Credit and Finance for MSMEs: The World Bank defines financial inclusion as making financial services and products such as banking services, insurance, investment and debt products, payments services etc. available to every individual of society at affordable costs. Financial inclusion deeply focuses on providing reliable solutions to economically underprivileged sections of society using fair and transparent means. Today global financial system supports billions of people around the world. Yet around billion people are deprived of this global financial system which indicates that there is a long way to go.

The Unbanked and Roadblocks

Imagine a poor farmer Babulal in India, his income is cyclical as he gets paid only during harvests which he must ensure lasts an entire year, but he lacks a secure place to save. In case of natural calamities like flood or drought, he loses his yield and there’s no one willing to sell insurance. If he wants to buy new equipment, there is no one willing to lend. Thus, there is no trail and therefore no history, which makes it harder to find a financial solution for him. This is the reality of those 1.7 billion people and sadly India holds the major share.

In summary, for India to achieve financial inclusion, roadblocks that lay ahead are low financial literacy, cyclical income, minimal collateral, lack of credit history, absence of formal identity, illiteracy, poor distribution network, long processing times, and cumbersome procedures. Government and regulators have taken initiatives like Basic savings bank deposit account (BSBDA), Lead banking scheme (LBS), Pradhan Mantri Jan Dhan Yojana (PMJDY) and set up payments’ infrastructure like BHIM, UPI, DBT to jumpstart the process of financial inclusion.

P2P Potential

When it comes to lending, a solution is required to address minimal collateral, lack of credit history and absence of point of sales. This is where Peer to Peer (P2P) lending comes to rescue. P2P lending is the practice of lending money to individuals or business specifically through online platforms that match borrowers with lenders with minimal hassle. In theory, P2P has the potential to solve India’s problem of financial inclusion.

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Taking the case of our poor farmer again. Since low annual rainfall was forecasted, Babulal wanted to set up a groundwater pump. He gets to know through the radio about a P2P lending firm. He seeks help from his neighbour who owns a smartphone and registers himself on platform using his Aadhar card. Platform’s credit risk prediction system classifies him as a high-risk borrower but matches him with a lender with appropriate risk appetite. Thus, despite being classified as a high-risk borrower, Babulal manages to get a loan from portal at an attractive interest rate. Finally, the pump is installed and Babulal saves himself from that year’s low rainfall, consequently enabling him to repay the loan, which increased his credit rating and the cycle continues and his situation improves.

The success of P2P lending depends upon smartphone penetration, the attraction of risk-taking lenders, robustness of the platform’s credit risk analytics, the authenticity of identity, and the detection of fraudulent activities. P2P lending is not new to the world. Opened in 2005, Zopa, a UK-based P2P company was first one of its kind. After initial global success, P2P lending picked up in China, where platforms number grew from 50 to 3,500 between 2011 to 2015 with outstanding loans of $192 billion and 50 million users, which was largest in world. In 2015, it seemed P2P lending is the panacea to Chinese financial inclusion, but the cowl does not make the monk. In 2016, the Chinese Banking Regulatory Commission showed that around 40 per cent of platforms were elaborate ponzi schemes, consequently leading to tightened regulations. Due to stifling regulations, platforms started closing and around 4,500 platforms have shut shop since 2013.

P2P lending is relatively nascent in India and has been in business only since 2014. In September 2017, RBI notified that these platforms will be registered as NBFCs and came up with guidelines such as declaring default rates which seems to be the first step in the right direction. Nonetheless, there is less likelihood that Chinese fiasco will repeat in India. First, regulations in India are more stringent than those in China, for example, RBI has capped total borrowings per user to Rs 10 lakh across platforms and additionally lenders cannot lend over Rs 50,000 to a single user across platforms.

Second, the business model itself is different. In China, when the lender lends through the platform, the lender would disburse money to the platform which then will distribute to borrowers, thus platform was taking the onus of returning the money. In the case of India, the platform does not take money, it flows directly from lender to borrower thereby shielding platform from risks of the sector. Nonetheless, the big question is how the loan recovery process will evolve which would be relevant not only to India but to all developed and under-developed countries.

Bharat Dureja is the Engagement Lead – Management Consulting at Kearney. Views expressed are the author’s own.

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