Why liquid schemes of P2P lenders are set to hibernate

Decision to temporarily freeze these schemes comes in the wake of increased scrutiny by RBI

Peer-to-peer (P2P) lenders have decided on a temporary freeze of their liquid schemes that allow instant withdrawals of investments from 1 April. A decision to this effect was taken by the newly formed P2P Association, according to a recent press release issued by association member and leading P2P lender Liquiloans.

Some industry insiders told Mint that the decision to temporarily halt subscriptions of new liquid schemes comes in the wake of increased scrutiny by the Reserve Bank of India’s (RBI) of the practices of the nascent peer lending industry. A few others said it was done to promote a longer lock-in period, of at least three months, for P2P financial products. None of them wanted to be quoted for the story.

Liquiloans, whose co-founder Achal Mittal is the president of the P2P Association, said the move will have no impact on existing liquid P2P investments. The association is responsible for nurturing the peer lending industry, on the lines of The Association of Mutual Funds in India, or Amfi. Besides Liquiloans, its other members include Faircent, Uni P2P, Lendenclub, India P2P, Finzy, I2I Funding, Financepeer, Lendbox, and Rupeecircle. However, not all P2P players are part of this association. An earlier association of these lenders, formed in 2018, was dissolved in 2021.

The temporary halt of schemes is a reflection of the ambiguity on how a P2P firm should be run, say some industry experts. Mukesh Bubna, co-founder of Chennai-based P2P company Monexo, said P2P lending firms only have the role of matchmakers between a borrower and investor as per RBI guidelines and can only charge a fee for transactions.

The difference in the spread between what is charged to the borrower and what the lender gets is the margin of safety on which these P2P firms operate. The problem, however, begins when many of these firms behave like a bank or an non-banking financial company (NBFC) and take credit, interest rate, and duration risks on their portfolios. This is the reason why RBI is becoming uncomfortable with P2P businesses, added Bubna.

Some P2P firms are bundling loans into a pool and selling it to investors. This is akin to taking a credit risk. If, and when, the margin of safety is breached, the P2P firm would have to absorb the losses.

A spokesperson of the P2P Association, however, said that certain filters on the platforms allow lenders to select borrowers based on their preferred tenure and risk categories at the time of lending.

Bubna’s Monexo, who is not a member of the P2P Association, did not reveal the names of firms that are violating the P2P norms. Asset liability mismatch

A mismatch in asset and liability can prove to be catastrophic to lenders, a case in point being the collapse of US-based Silicon Valley Bank (SVB). The bank had taken a massive chunk of deposits from startups. It invested a bulk of the depositor’s money in long-term bonds. However, startups can require cash at frequent intervals and can demand their money back anytime. SVB’s troubles began when borrowers wanted to withdraw money at the same time as bond prices were falling. The bank was forced to sell its bond investments at a steep discount to repay its startup investors. This led to its collapse.

P2P platforms do not face such risks as long as they stick to the RBI guidelines of being a pass-through between the borrower and lender. Nevertheless, some venture capital-funded P2P players went ahead and launched instant liquidity products. This meant the investors and lenders on their platforms were promised instant liquidity at any time.

RBI mandates P2P firms to maintain a capital of ₹2 crore but this amount can easily be breached when many people want to withdraw funds during a downturn. Some platforms have more than ₹500 crore in assets under management (AUM).

Yash Roongta, founder of Alt investor, said P2P platforms opting for liquid schemes need to get fresh inflows regularly but the equation might change in a situation when liquidity dries up. He also said that P2P firms are not supposed to get into such complicated structures in the first place.

Additionally, many P2P firms bundle borrowers and package them for a single investor. For instance, if someone wants to invest ₹1,000, then this amount is split among 200 borrowers. There is no way the lenders can know who they are lending it to or if the loan was sold through the secondary market.

“This is contradictory to RBI’s mandate of P2P NBFCs to simply match lenders and borrowers,” said Bubna.

On 9 February 2023, RBI deputy governor M. Rajeshwar Rao sounded an alarm. He said, “Of late, some of the business practices of NBFC-P2Ps do not appear to be in line with the regulatory guidelines. A large proportion of lenders on NBFC-P2Ps are individuals and they are not expected to be wellequipped to understand the risks involved in providing credit. Instead of educating the lenders about the inherent risks in the lending activity, NBFC-P2Ps have been observed to underplay the risks through various means such as promising high/ assured returns, structuring the transactions, providing anytime fund recall facilities, etc.” Damage control

The news of P2P players stopping liquid facilities is not good news for its investors. Naturally, some investors want to pull out money from the P2P platform. This can potentially create an asset liability mismatch scenario where investors want to pull out money but the underlying loans are illiquid in nature. To counter this, P2P firms have started offering discounts and incentives for investments in their platform. For instance, Lendbox’s P2P platform ‘Per Annum’ is offering 1% cashback for a 12-month plan, 0.50% for 6 months and 0.25% cashback for 3 months.

An email sent to Lendbox did not elicit any response.

Industry and financial experts say the RBI needs to look closely into the P2P ecosystem, particularly in view of reports suggesting that the industry has surpassed ₹10,000 crore in AUM and is now susceptible to systemic financial shocks.

The P2P Association said that P2P firms operate on a non-balance sheet model and there is no room for asset-liability mismatch . P2P platforms communicate and educate lenders that any liquidity on the platform is facilitated through the reassignment of loans. This process operates on a best-effort basis and is dependent on the availability of willing lenders on the platform.

The newly formed P2P Association is responsible for nurturing the peer lending industry, on the lines of Amfi