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New P2P Amendments by RBI - Giving the Industry Cold Sweats

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Written by Keerthi Gorthy, the author is a law student currently pursuing BBA.LLB from Symbiosis Law School Pune.


Introduction

Peer-to-peer (P2P) lending industry in India is a fintech innovation, acting as an alternative to traditional banking, that allows to lend and borrow money directly between individuals with an online intermediary in between. With a demand for alternative financial solutions and increasing digital penetration, the P2P lending model is flourishing. The Indian market valuation of the industry is 9.60 billion USD and is anticipated to grow with a CAGR of 21.66 billion USD by 2029.[1] Unlike traditional bank depositing and lending mechanism, P2P platforms, act as NBFC typically playing the role of online intermediaries, connecting lenders to borrowers. The Reserve Bank of India regulates the P2P sector by way of prudential norms and P2P Master Directions.

 

Why is Peer-to-Peer Lending Important for India?

India has 160 million Credit Underserved Population. The P2P lending market steps in this gap, for supporting the underbanked and underserved individuals.[2] Individuals, often unable to obtain loans from traditional banks due to insufficient income documentation or lack of credit history, are drawn to P2P platforms because they offer faster credit access and more flexible loan conditions. These consumers include small business owners such as shopkeepers, repair shops, micro-scale factories, MSME’s[3], wherein, only 14% of MSMEs have access to formal bank credit, need quick and accessible financing to sustain or expand their operations. P2P platforms mainly assist customers who require emergency funds, small business loans, or personal financing and who may be ineligible for traditional bank loans.[4] This form of lending is an effective way to address the financial needs of disadvantaged communities, offering accessibility, lower interest rates compared to informal lenders, and customized loan options.

 

RBI'S New Guidelines on P2P Lending Platforms

On August 16, 2024, the Reserve Bank of India (RBI) amended the Master Directions - Non-Banking Financial Company – Peer to Peer Lending Platform (Reserve Bank) Directions, 2017[5]. The amendment directed operational changes to the P2P platforms compelling them to significantly adapt their business course.[6] 

 

Key Amendments

Prohibition of Credit Risk Assumption

Old Guidelines: P2P platforms operated with the understanding that they had no risk bearing. However, the guidelines did not explicitly prohibit from indirect risk assumption.

Amendment: Explicit prohibition of any credit risk by the NBFC either directly or indirectly. Placing the entire risk upon the lender, thus for this reason the disclosures to the lenders are directed to be adequately made.

 

Ban on Cross-Selling Insurance

Old Guidelines: Since 2017 there was a ban on cross selling, except for insurance product.

Amendment: Withstanding that, now cross selling of any insurance product that is in the nature of credit enhancement or guarantee is also now prohibited. This will prevent platforms from giving a false sense of security to the lenders, reinforcing that the lenders must bear all the risks.

 

Strict Use of Lenders' Funds

Old Guidelines: Previously some level of flexibility was granted in the deployment of the funds by the intermediaries.

Amendment: The updated rules strictly prohibit usage of the funds for any other manner other than the way specified in the Guidelines. This means the lender’s funds will be used for the direct purpose of lending and so there is no scope for repurposing enhancing financial discipline of the intermediaries.

 

Exposure Limits

Old Guidelines: The exposure of lender to borrower was subject to limitations and disclosures, however not as explicit or stringent.

Amendment: The new guidelines cap the aggregate exposure limit of the lender to Rs 50,00,000, and this needs to be in proportion to their net worth. In case the amount lent by the lender is above Rs 10,00,000 they need to submit a Chartered Account certification confirming their net worth is above Rs 50,00,000. This is to prevent overexposure of the lender and to ensure that these lenders have sufficient financial standings to lend huge amounts, preventing systematic risks.


Matching of lenders to borrowers

Old Guidelines: The usage of algorithms to automatically match lenders with borrowers was in practice in the P2P companies.

Amendment: No loan be disbursed unless lenders and borrowers have been matched and approved by the individual lender with all participants signing the loan agreements. Closed user group matching is prohibited.

 

Escrow Account Mechanism and T+1 Settlement Requirement

Old Guidelines: Escrow accounts were mandated but no specific instructions on how long the funds could remain in these accounts.

Amendment: Effective from 15th November 2024, the funds transferred to lender’s escrow account and borrower’s escrow account should not be present for more than one business day, T being the day funds are collected in the escrow account. This seemingly for faster transfers will inherently reduce risks of funds being mishandled and delayed.

 

Enhanced Transparency and Disclosure Requirements

Old Guidelines: Transparency and disclosure though enforced; its emphasis was lighter.

Amendment: P2P now mandated to provide detailed information to lenders, on the identity of the borrower (consent), amount of loan required, interest rate and credit score. It should also disclose financial performance, including non-performing assets (NPAs) and losses incurred by lenders. These clarifications are to provide lenders with additional information to help them make informed decisions and better assess credit risks.

 

Risk Disclosure

Old Guidelines: Fair practices code was in existence but the risk disclosures were not as explicit.

Amendment: Prohibits P2P platforms from offering guarantees of credit recovery. In addition, platforms cannot promote P2Ps as investment products with features such as returns and currency options. Despite being registered with the RBI, it is necessary to display a prominent notice that guarantees the accuracy of loan details and repayment. This change is important to prevent fraudulent transactions and ensure that lenders are fully aware of the risks involved.


Ombudsman Scheme Compliance

Old Guidelines: P2P platforms were mandated to hold a grievance redress mechanism.

Amendment: P2Ps to comply with the Reserve Bank- Integrated Ombudsman Scheme, 2021. This will stand as a formal avenue to dispute resolution, enhancing consumer confidence.

 

Outsourcing Restrictions

Old Guidelines: P2P platforms were allowed to outsource certain function with general guidance in place.

Amendment: Brought a new section which specifically stipulates certain functions that must not be outsourced like core management functions, including internal audit, strategic, pricing and compliance. This comes due to a speculative risk that is assumed with outsourcing.

 

Comparative Analysis Across Global Jurisdictions

A study suggested that P2P encourages risky borrowings[7] hinting towards charging of hefty commissions from small borrowers; a practice of exploitation seen globally, from China to Indonesia, presenting a need for regulating the P2P market. But the idea is to regulate and not overregulate which was in the case of China which had its once flourishing P2P market with 50 million customers and 6,887 platforms, most destroyed in 2018 when the country introduced stringent and abrupt regulations that practically destroyed the industry in China with 5,825 out of 6,887 platforms collapsing by 2019[8] with government announcing by 2021 that all P2P lending platforms have been closed.[9]


In Indonesia, recently the government via POJK 10/2022[10] aimed to protect the lenders by strict requirements for lock-periods in terms of ownership, certification and a fit-and-proper tests for key executives.[11] While the US has taken an approach of slowly integrating the industry under regulatory framework while allowing them to function and their constant application of securities and banking regulations in P2P market has made them a healthier centre[12] for growth of the sector. But due to higher standards in US, opening a P2P platform is not as lucrative despite being less risky. In UK, the FCA[13] works on the feedback system wherein it provides feedback to the P2P lenders and in turn requests feedback from them in order to develop new rules. FCA is always ready to tighten rules on P2P lenders if it views that the borrowers are at risk.[14]  While China is a cautionary tale for India, and Indonesia is still something one would need to wait and observe, the US and especially UK shows us a way on how we should move ahead with regulations.

 

Conclusion

The Reserve Bank of India’s 2024 amendments to the Peer-to-Peer (P2P) Master Directions will bring a new level of transparency, reminding the complex nature of P2P finance and the risks involved. These new rules reinforce the role of P2P platforms being mere intermediaries by preventing them from accepting credit risk, along with prohibiting the acceptance of insurance to improve credit. As a result of this, lenders bear the sole responsibility for all the associated risks. Although this strategy is aimed at preventing misleading practices and ensure that the lenders are well-informed, it may also discourage low-capital investors, hence reducing the amount of capital available. powerful controls, may have an impact on compliance and high fees, hence leading to high risks for lenders.[15]


Strong controls such as lender’s direct control of creditor compliance, such as the lender's direct control over creditor compliance, timing of the escrow account financing procedures, and restrictions on outsourcing key management functions that might limit the flexibility for small platforms may affect compliance and high fees, ultimately high risks to the lenders. While these rules protect participants and financial system, they may inadvertently damage the aggregation capabilities of P2P platforms, losing competitive edge against other financial solutions.


The stringent amendments objected to enhance transparency and security could unavoidably lead to market consolidation affecting smaller competitors particularly. Due to higher borrowing costs, the sector could lose its appeal and inclusivity, attracting more high-end P2P platforms while alienating smaller players. It is possible that a more flexible regulatory enforcement could balance the demands for industry growth and innovation with the objectives of transparency and accountability. Gradual rolling out of laws is better than a sudden crackdown on P2P lending. On the lines of allowing the escrow account rules that have been implemented from November 15 2024, it would have been easier to adjust had that been the case for all the other parts of the new amendments.[16] It can still be speculated that the relaxation of certain restrictions, in further amendments, considering the importance of P2P system in India, could allow smaller businesses to work in a dynamic and diverse lending market, while still adhering to reasonable financial security and regulatory standards.


References

[2] Cibil, T. (2022, April 25). More than 160 million Indians are Credit Underserved. More Than 160 million Indians Are Credit Underserved. Available at https://newsroom.transunioncibil.com/more-than-160-million-indians-are-credit-underserved/

[4] Dias, Stanny & Nigalye, Anukool & Mahajan, Jayant. (2022). Adoption Factors of P2P Lending in India. Available at https://www.researchgate.net/publication/366658173_Adoption_Factors_of_P2P_Lending_in_India

[5] Master Directions - Non-Banking Financial Company – Peer to Peer Lending Platform (Reserve Bank) Directions, 2017 (Updated as on August 16, 2024) RBI/DNBR/2017-18/57

[6] Rastogi, E. (2024, August 23). RBI strengthens guidelines for NBFC Peer-to-Peer lending Platforms. Metalegal Advocates. Available at https://www.metalegal.in/post/rbi-strengthens-guidelines-for-nbfc-peer-to-peer-lending-platforms


[7] Klein, G., Shtudiner, Z. and Zwilling, M. (2021) 'Why do peer-to-peer (P2P) lending platforms fail? The gap between P2P lenders’ preferences and the platforms’ intentions,' Electronic Commerce Research, 23(2), pp. 709–738. Available at https://doi.org/10.1007/s10660-021-09489-6.

[8] Chen, Xiao and Hu, Maggie and Zhang, Bohui, Monitoring Fintech Firms: Evidence from the Collapse of Peer-to-Peer Lending Platforms (September 9, 2023). Available at SSRN: https://ssrn.com/abstract=4566595 or http://dx.doi.org/10.2139/ssrn.4566595

[9]Liu, Yidi & Li, Xin & Zheng, Zhiqiang. (2023). Consequences of China’s 2018 Online Lending Regulation and the Promise of PolicyTech. Information Systems Research. 10.1287/isre.2021.0580. Available at https://www.researchgate.net/publication/374314265_Consequences_of_China's_2018_Online_Lending_Regulation_and_the_Promise_of_PolicyTech

[10] AKSET Law. (n.d.). POJK 10/2022 Archives - AKSET Law. Available at

[12] Fordham International Law Journal 2024, (April 2) Promise or Peril: Comparing P2P Lending Regulations in the United States and China. Available at

[13] FCA brings in P2P investment and marketing restrictions - Intelligent Partnership. (2019, July 3). Intelligent Partnership. Available at https://intelligent-partnership.com/fca-brings-in-p2p-investment-and-marketing-restrictions/#:~:text=Retail%20investors%20will%20be%20allowed,new%20rules%20for%20the%20secto.

[14] Nemoto, N., Storey, D., Huang, B., & Asian Development Bank Institute. (2019). Optimal regulation of P2P lending for Small and Medium-Sized Enterprises. ADBI Working Paper Series, 912. Available at https://www.adb.org/sites/default/files/publication/478611/adbi-wp912.pdf

[15] Kaushal, T. J. (2024, August 23). Why RBI’s new guidelines have halted the P2P lending industry? Business Today. https://www.businesstoday.in/personal-finance/story/why-rbis-new-guidelines-have-halted-the-p2p-lending-industry-442715-2024-08-23

[16] Anshul. (2024, August 19). India P2P pauses withdrawals and new investments following RBI guidelines. CNBCTV18. https://www.cnbctv18.com/personal-finance/rbi-new-rules-p2p-lending-nbfc-india-pauses-withdrawal-new-investments-19461764.htm

 

 
 
 

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