Spotlight on RBI: Why & how it needs to build P2P lending business in India
Peer-to-peer lending or P2P lending has become an established model of funding consumers and businesses in the US, UK and China and growing adoption in India.
The benefits around reducing the cost of capital and increasing access to capital are well established. Such has been its impact that even governments have backed the system, with the UK government being active participants in sites like Funding Circle and Zopa. This week it has gone a step ahead as it announced a £2 million fund created to back social organizations via peer to peer lending and crowdfunding platforms. On the other hand, regulators and government in the US have staunchly supported P2P systems and have come up with various measures to regulate and safeguard the industry.
India is capital starved country and needs new alternative vehicles to increase access of capital. While some early inroads have been made in the P2P lending segment in the country, individual efforts have not translated into a policy from the government. The lack of clarity of rules and regulations has meant the industry is shooting in the dark.
Where regulations stand:
In June last year Securities and Exchange Board of India (SEBI) came out with the draft guidelines for the crowdfunding industry. The paper efficiently laid out the prevailing international rules and regulations and the challenges in implanting the guidelines. However, the main aim of the paper was to enable Indian startups and SMEs a new source of finance, while ensuring investor protection. However, there has been little movement on the draft guidelines since then, but the move by SEBI has been widely acclaimed by all as forward thinking and a welcome step. The Reserve Bank of India (RBI) now needs to come up with similar guidelines to regulate the P2P industry.
We have to remember that alternative sources of funding like P2P sites have emerged after the collapse of the financial system and central banks had to rescue banks with never seen instruments like quantitative easing. At a time when public trust was at an all time low and the anger on the mismanagement at Wall Street was at an all time high, alternative sources of funding were able to fill the vacuum.
While P2P and crowdfunding is well entrenched in countries like the US and much of Europe, it is still extremely early days for the sector in India. Few have the understanding or even the confidence to question the norms of alternative sources of finance prevailing in the country. In the absence of dictated policy or scriptures, it is quite plausible that misguided individuals may fall prey to unscrupulous operators that may look to make a quick buck.
Till now the central bank’s policies for the markets and financial institutions have worked, but we have to remember P2P and crowdfunding is unconventional.
With the segment gaining popularity the central bank may also have to look at the quasi-fiscal element. The question is if the segment continues with the momentum and popularity, would the central bank not want any oversight or have some degree of control so that its fiscal and monetary stance is maintained? Many interventions to infuse or mop up liquidity have an inherent fiscal element to them and a day may not be far when P2P is no exception.
Given the low entry barriers, there are a number of players entering the P2P market in the country. While many of these institutions look good on paper, but are untested. The fear is a repeat of what happened in the micro-finance, chit fund, and the para-banking segment. Lack of oversight, regulations and law meant it was free for all and financial instruments that may have real potential to make a difference were nipped in the bud. The current mess in these financial segments is a terrible betrayal for the current and future generations that could have benefitted tremendously. We need a new approach to the economics and governance of P2P in the country.
Serious players in the India like Faircent, Rang De and Milaap would want RBI to come up with some guidelines. The RBI would do well to conduct impact assessments and come up with laws and mandates that include the overall. What the RBI clearly needs to do now is appoint monitors that are trusted by users, have clear laws about what’s acceptable and what’s not and lay down procedures to resolve conflicts. This, however, has to be done keeping in mind how P2P sites work and what makes them unique. Any regulations that look to stifle the industry and contain market forces from driving down interest rates will be counterproductive.
What can be done?
One provision the RBI needs to take care of is to mandate electronic contracting for P2P transactions. Given the nature of the industry, it is almost given that there will be no formal loan documents to be signed and electronic contracting is the way forward. Electronic contracting is also more efficient, saves the hassles of filing and record keeping and straightforward. RBI should clearly look at electronic signatures as an admissible agreement between two parties and make it a legal under guidelines that may be laid down.
This would then pave the way for borrowers to honor their loan commitments legally like taking a loan from any other financial institutes like banks, a provision which is gray at the moment for P2P operators. In 2009, the RBI had come out with directives for the opening and operation of accounts and settlement of payments for electronic payment transactions involving intermediaries. In the current system settlement of e-commerce/m-commerce/bill payment transactions, are credited to the accounts of these intermediaries, before the funds are transferred to the accounts of the merchants in final settlement of the obligations of the paying customers. Under this system a Nodal Account is created for the purpose of pooling the monies collected from buyers and subsequently paying out to the seller. This nodal account is not operated by the intermediary and this reduces the chances of fraud. RBI can allow a system where P2P lending platforms are allowed to pool money into Nodal account, just like pre-paid card companies are made to do.
Subsequently, every default in payment should be reported to credit bureaus. This would strengthen the financial systems and provide a holistic picture of an individual’s credit worthiness. Currently an individual can maintain a very good credit record but can be a defaulter on a P2P platform. At the same time, like it did for banks, the RBI should lay down proper process for recovery and management of delinquencies. This will safeguard both lender and borrower interests.
In the overall scheme of things RBI should be proactive and not be passive and reactive regulator. Indian authorities have been caught napping when it comes to adapting to changing times. The financial services industry has seen its fair share of controversies with the government looking the other way till the time a crisis blows on their face. Individual rogue users can have a harmful effect on the nascent industry, especially since the financial sector is known for tragedies where the onus of damage is not often fully borne by the ones causing it.