P2P lending under RBI lens.

Move is to protect traditional banking and prohibit lending by unincorporated entities

Peer-to-peer (P2P) lending is the newest disruptor on the financial scene, going by the RBI discussion paper on regulating it.

The timing is surprising, considering that the business is nascent, with hardly 30 players and no significant volumes. It is not that the RBI sees any serious systemic threat, the move is apparently driven by the perceived threat to traditional banking and also to ensure no violation of Section 45 of the RBI Act (prohibits lending activity by individuals and unincorporated entities).

While the RBI recognises the potential of the model, it is also clear that it wants the platform to remain a pure market place, much like a Flipkart for loans and not participate in lending or borrowing.

Operating like an NBFC

The paper proposes a few regulatory changes. Some of them, such as the requirement of platforms (currently, tech firms own the platforms) to convert themselves into non-banking financial companies (NBFCs) and the minimum capital requirement of ₹2 crore merit discussion.

First, though conversion into an NBFC brings them under RBI control and allows an indirect way of controlling lending activity by individuals (the crux of Section 45), how this would work in effect is unclear, considering that the NBFC itself would not be participating. The paper merely states “the platform will be required to ensure that Section 45S of the RBI Act is not attracted by its activities.” Would it be left to individual platforms to sort out with participants? Restrictions would need to be sensitive to the fact that P2P loans are largely small sized (akin to microfinance), involving individuals rather than entities.

Another impact could be on finances of the platforms — currently these are tech companies and enjoy venture capital funding. The valuation-based funding models could give way to the more staid financing rules of NBFCs; how the platforms respond remains to be seen.

Secondly, specifying a minimum capital of ₹2 crore or leverage norms serves little purpose because the platforms are not exposing their balance sheets. But on the flip side, by giving it legitimacy and recognition, the regulation could well give a boost to P2P business, which augurs well, especially for small borrowers.

Unaddressed issues

With this almost singular focus on the NBFC model, the paper makes only cursory references to other regulatory aspects. It believes that banks should address money-laundering and KYC concerns, since they will be the payments conduit. On loan recoveries, beyond expressing concern on “soft recovery practices, while not ruling out coercive methods”, the paper says little else.

Not-so-easy a transition

P2P lending may appear to be a logical transition from goods to money, but the differences are significant. In e-commerce for goods, ‘caveat emptor’ has been the guiding principle and platforms take refuge in an omnibus “Buyer and Seller shall comply with all the applicable laws” clause. In fact, sellers were reported to be unhappy when the e-commerce industry chose the marketplace over the inventory model, as it led to the removal of the implicit warranties that model had offered. While market economics reasonably addresses quality and governance issues in goods, money is different, which is why there is a plethora of State laws on moneylending and moneylenders covering a wide range of areas from licensing, rates of interest to penalties. A question to be asked is whether the onus of compliance will be on individual lenders and borrowers, or on platforms.

How conversion into an NBFC and RBI regulation would address this needs to be seen. In fact, the issue is not whether P2P lending should be regulated or not (the answer is a clear yes), but the mode of regulation, specifically its extent and comprehensiveness. While the business of moneylending itself is not new, it is the technology edge that is driving this variant; regulation, therefore, needs to make the fine balance between providing adequate safeguards and promoting innovation, lest this advantage dissipates.

The writer is an independent consultant

(This article was published on May 1, 2016)