P2P Lending in India: A Broken Promise ?
Is it a Lucrative, High-Yielding Debt Investment Opportunity?
Let’s start with an old Banking joke.
A bank is a place where they lend you an umbrella in fair weather and ask for it back again when it begins to rain. — Robert Frost (American poet, 1874–1963)
Human to Human lending system
How was the lending landscape before Medici family created the first banks in the 14th Century? Florence, the Italian city state, then the home of Medici family, also was home of banking.
Banking came from the word banca, meaning "table". The table where lenders sat in the marketplace to conduct their business.
These obligations were to be settled at a future date, and the system that geared up around these debts formed the first rudimentary forms of money and debt in earlier civilizations.
But wait, why history?
To highlight the fact that person-2-person is not a new or radical idea. Before the origin of modern banking – the oldest lending frameworks for centuries were in fact P-2-P (Person-2-Person).
Something based entirely on trust between an individual borrower and individual lender, with some additional guarantor/co-signer comfort, usually as a mutual acquaintance.
So, what does a bank do today? How is it different from before?
Complexity is the enemy of execution. — Tony Robbins
The core concept of banking was and still is simple : A bank receives deposits and makes loans.
But then, do we really need a bank? Or do we merely need trust? Why can people not lend directly to each other?
Technology, which has disrupted old business models from e-commerce to payments, attempt another time to bring down the ivory towers of “High Finance” crashing..
Internet, P2P lending and Platforms: P2P’s second coming
The rise of internet brought with itself the promise of doing away with intermediaries. And banks were the biggest intermediaries of all.
P2P lending platforms rose from this and immediately captured the attention of socialist groupies, Silicon Valley CEO bros and yield seeking savers (GFC brought with itself floor low interest rates).
The Undeniable Appeal of P2P lending
Lets admit one thing. P2P business model at least - on paper - a sexy model. Banks offer a typical saver 2-6% interest on his deposits but lend at an eye-gouging 10-24% interest rate.
And there is spread. And the spread is where the juice is. P2P was projected as the best of both worlds. Creative projects get funded and savers get attractive yields. After all, banks were sitting ducks, making their credit decisions on static information (CIBIL, KYCs etc.).
So why not turn it into an algorithm?
The initial pitch looked very much like this. Some of us, at The Grey Swan, have been part of those conversations, and the seductive simplification with which the startups pitched their VCs was stunning and ludicrous.
The Many Lives of Indian P2Ps
Indian P2Ps came back in different avatars over the
centuries years. Copying the success of the first P2P player from Silicon Valley - ZOPA, (started in 2005, 3 years before the global financial crisis, when liquidity was awash), Rang De , an Indian P2P took shape in 2008.
The business model of Rang De was simple. Raise money at nominal interest rates, pass the capital to their ‘partner micro-finance companies’ for them to lend.
Not surprisingly, the idea was a still born.
The second coming of Indian P2Ps was in the back of the Great Chinese P2P boom. Lufax - a Chinese P2P platform was growing like weeds - 2100% annually from 2012 to 2013, if anyone is interested. CreditEase, another Chinese platform was originating over $9bn in loans with an RoI of 8-26%.
Parallely, in UK, Proper, with 2.2MM member and Lending Club with its $8.5bn valuation was scorching 2014 cap tables.
Can’t quite blame, Indian entrepreneurs for getting FOMO’d, can we?
But then, what’s a story without its trials and tribulations.
And just as it surged, P2P platforms came under a pincer attack. In 2017-18, Chinese regulators cracked down on the P2P players that were proliferating.
In 2017, there were ~7000 P2P platforms, opting for all kinds of shady practices in their bid to collect. P2P platforms were suddenly out of vogue from VC discussions.
RBI swung back and brought in their regulatory framework. The winter came hard. And the P2P ecosystem in India shriveled.
But why were P2P platforms so vulnerable?
Cause for Vulnerability: Scale is the issue
The vulnerability of P2Ps is not particular to only India. Even those in western countries were finding it difficult. P2P platforms needed to balance the funnel on both sides, lenders as well as borrowers. Without ‘seeding’ the platform, the growth was difficult to come by.
Its not that ‘seeding’ is not possible, but collection as always is ‘bitch’!
So, P2P lenders relabeled themselves to marketplaces (i-2-i = institutional-2-individuals) as firms broadened their funding sources. In this new avatar, no-one was spared from the marketing blitz - hedge fund to banks, and asset managers alike…
…But then, wind was long lost from the P2P sail.
A New Lease of Life: P2P’s new found growth
Do cats have nine lives, or seven, or six? If the symptoms are right, P2P looks like the proverbial cat with nine lives. Or at least, one more life.
The recent surge of the global equity markets awash with liquidity has changed many things. It has also put a new ramp for the P2P platforms into the sky.
Today, not to be left behind in the orgy of irrational exuberance, the P2P players are offering their platform as an alternative investment opportunity.
And man, has their growth been impressive!
Today’s pitch decks of these P2P platforms look like this (By the way, if you want to take a look at the pitch deck in its entirety, there is a button down below)
Riding the Wave: Cred and BharatPe
The new lease of life that P2P has received, has given ‘wings’ to Cred. For Cred, the game plan is easy to execute. Given its aim to build a ‘gated’ digital community of high-trust individuals (average credit score of 750 or higher), it is very organic for Cred to move to P2P.
CRED Mint partnered with LiquiLoans, an RBI-registered P2P NBFC, as they needed someone to do the actual work! (after all, Lending is just a feature), and started offering, nope assuring 9 percent, if one goes by their marketing print.
Not to be left behind, BharatPe offers a 12% assurance. The race to the bottom inevitably has begun.
So, what’s the conclusion?
All borrowing or lending in the world - from medieval Florence to dabba to hawala to banks to P2P - is founded on one thing : Trust
Trust that — if the need arises — there will be someone to pay back the debt. When you peel the onion the banking business is really about “translating” money between people, places, over time, and from the short to the long term.
This ‘trust’ is backed by the promise that banks will come knocking if a borrower defaults. That is, banks will come home to collect.
This is where P2P platforms are failing.
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And this our key point : Without collection, P2P platforms are designed to Fail.
Lending is easy. Everyone does it. But collection is HARD. This is not the first time you have heard this. Nor this is the last time. But in between now and the next, lies the tomb of countless companies who underestimate importance and difficulty of collections.
But it just so happens in their bid to turn into a two-sided platform between borrowers and lenders, no-one is handling the ugly work of collections.
Collections are definitely not their core business. Economics of low-ticket loans is preventing a third-party to come up and fill the gap. Investors are reluctant. After all, putting
boots sandals on the ground costs money. And it eats into the juicy spreads for their investors.
Given this lack of focus on collections, the platform has to do either of two things:
Lose money but build a collection efficiency like Bajaj Finance or HDFC, or alternatively,
Increase ticket size.
However, not all P2P can be treated the same way. Some have identified the risk. Here is what Neeket Agarwal from Liqiloan has to say about it:
The defaulter is called every alternate day, house/office visited by the collection agents and notices are sent to the defaulter. In addition their credit score is impacted severely making it difficult for them to get any loans in future. Last but not the least, the lender funds are distributed in such small portions that a few defaults doesn't affect the return of the lender. There is enough and more margin to absorb even the highest expected default rates.
In the short run, there is a gap between the companies’ incentives and the lenders’ preferences to reduce the risks of the loans.
Oh yes, we almost forgot. The pioneer of this P2P business model, Zopa (remember them?) has turned into a bank.
A few weeks back, Zopa announced it would be winding up the peer-to-peer side of its business, including buying back the existing loans of investors.
So it remains.
Paraphrasing, Leo Tolstoy, all ‘happy’ fintechs harbor different plans, every ‘unhappy’ fintech holds the same dream - to be a bank.
P2P just has a habit of creating so many of them.