Instead of being guided only by returns, investors should also factor in the risks of lending on these platforms.
According to news reports, the Reserve Bank of India recently sent a list of questions to registered peer-to-peer (P2P) lending platforms enquiring about several aspects of their business.
While some industry insiders dismissed these queries as routine, others believe they are a precursor to the regulator undertaking further tightening of norms within the industry.
In the meanwhile, investors using these platforms to earn higher returns should exercise a lot of caution.
Modus operandi
P2P platforms essentially match lenders with borrowers. Different platforms focus on different segments of borrowers.
India P2P, for instance, focuses on women who own small businesses.
LenDenClub, on the other hand, lends to individuals in need of a small sum of money for a short period, and to merchants.
Attractive returns
Lenders can earn an attractive rate of return on these platforms.
"You can earn a consistent 15-16 per cent return, which is usually not possible in other debt instruments," says Neha Juneja, CEO, IndiaP2P.
Investors can use these platforms to diversify their fixed-income portfolios.
"A person who invests in debt mutual funds and other fixed-income instruments could invest a part of his money in a P2P platform. Besides diversifying his investments, this will also boost his portfolio return," says Bhavin Patel, co-founder and CEO, LenDenClub.
Default risk
The foremost risk of lending via these platforms is that of the borrower failing to repay the loan.
"Borrower default is a key challenge in the P2P space," says Avisha Gupta, partner, Luthra and Luthra Law Offices India.
Liquidity could be another issue.
"If you have lent for a certain tenure and require the money before the end of that period, pulling it out may not be so easy," says Vishal Dhawan, chief financial planner, Plan Ahead Wealth Advisors.
Lenders could also face concentration risk.
"If a large number of borrowers on a platform are from a particular geography or industry, which faces a downturn, the lender could be impacted in a big way," says Dhawan.
New regulations could affect this upcoming industry and hence the investors participating in it.
Dhawan also warns that many of these platforms do not have a long track record.
Check performance data
Instead of being guided only by returns, investors should also factor in the risks of lending on these platforms.
Look closely at the borrower segment the platform caters to.
"We cater to women borrowers running small businesses, after checking their CIBIL scores. Some platforms cater to younger borrowers making BNPL (buy now pay later) purchases. The risk profile of borrowers can vary considerably from one platform to another," says Juneja.
Look up the performance of loan portfolios on a platform (especially non-performing assets).
"It is mandatory for platforms to provide this information," says Patel. He suggests going with a platform that presents this information in a manner that is easily comprehensible to potential lenders.
P2P platforms are mandated to undertake credit assessment and borrower risk profiling, and disclose this information to lenders.
"Lenders should also undertake independent credit risk assessment before making investments," says Gupta.
Juneja suggests that investors diversify their loans across multiple borrowers from different geographies, income segments, etc.
Investors should also limit their lending on these platforms to 5 per cent of their fixed-income portfolios.
"Lend on these platforms with the clear awareness that the higher returns they offer come with higher risks," says Dhawan.
Since riskier borrowers offer higher returns, Dhawan suggests that borrowers try to strike a balance between the returns offered and borrowers' risk profile.
Go with a P2P platform that is registered with the RBI and adheres to prudential norms, in terms of the amount lent and borrowed from individual borrowers and lenders, respectively.
Finally, understand the rules governing premature exit.
Disclaimer: This article is meant for information purposes only. This article and information do not constitute a distribution, an endorsement, an investment advice, an offer to buy or sell or the solicitation of an offer to buy or sell any securities/schemes or any other financial products/investment products mentioned in this article to influence the opinion or behaviour of the investors/recipients.
Any use of the information/any investment and investment related decisions of the investors/recipients are at their sole discretion and risk. Any advice herein is made on a general basis and does not take into account the specific investment objectives of the specific person or group of persons. Opinions expressed herein are subject to change without notice.
Feature Presentation: Ashish Narsale/Rediff.com
