India: Regulation Of Peer-To-Peer Lending: Recent Developments

The last few years have seen increasing volumes of business for start-up ventures, proprietorships and small business concerns with entrepreneurs looking to infuse more capital into their businesses and expand the scale of operations. In order to meet these increasing business requirements, individuals and entities are looking towards new and innovate means of raising money, instead of relying on traditional banking channels. One such avenue to raise money that has increased in significance in recent times is over the Internet in the form of peer-to-peer (P2P) lending. P2P lending has been favoured due to its ability to provide easier access to micro-credit at lower interest rates to borrowers and higher returns to lenders.

P2P lending is a business model that matches lenders and borrowers over an online platform to provide unsecured loans, repayable with interest. As a prerequisite to avail/ offer loans, the borrowers and lenders are required to be registered on the P2P platform. Based on a preliminary assessment of creditworthiness carried out by the platform, participants are shortlisted. The interest rate may either be fixed by the platform or mutually agreed upon by the borrower and lender. Market practice indicates that most platforms follow a reverse auction model wherein the lenders bid for a borrower's loan proposal.

The underlying documentation for the transaction, including post-dated cheques issued by the borrower in the lender's name as security, are facilitated by the P2P platform, along with collecting loan repayments for the lender. For this service of financial intermediation offered by the online platform, it charges an origination fee from the borrowers, which may be a fixed flat rate fee or a variable fee, calculated as a percentage of the amount of loan obtained, depending on the risk involved, and an administration fee from the lenders. If the lenders opt to avail additional facilities offered by the platform, such as legal advice, additional fees may be charged.

Even though such P2P platforms are engaged in the business of financial intermediation, they are unlike other financial institutions in the sense that their profits are derived from the fees charged and not from the difference in lending and depositing rates. As a result, they remained unregulated by the Reserve Bank of India (RBI) thus far. However, recognizing the importance of P2P lending in shaping the future of the financial sector in India, RBI issued a Consultation Paper on Peer-to-Peer Lending in April 2016 (Consultation Paper) evaluating the prospects of regulating P2P lending and proposing appropriate regulatory changes.

Since P2P lending is still an emerging business model, there is massive variation in the manner in which they are regulated in different jurisdictions. While some countries exempt P2P lending from regulation, other countries regulate it either as an intermediary, such as in the United Kingdom, Canada and Australia or as full-fledged banks, such as in France, Germany and Italy. Based on an assessment of the various regulatory models, the Consultation Paper proposed to regulate P2P lending platforms as intermediaries.

In keeping with this view, the RBI, almost a year and half since the Consultation Paper, has through its notification of 24th August 2017 (Notification), specified non-banking institutions carrying on the business of P2P lending as Non-Banking Financial Companies (NBFCs) under §45I(f)(iii) of the RBI Act 1934, thereby bringing P2P platforms under the purview of RBI's supervision. In exercise of its resultant regulatory authority, the RBI has now issued Master Directions - Non-Banking Financial Company – Peer to Peer Lending Platform (Reserve Bank) Directions 2017 (Master Directions) under §45JA, §45IA, §45L and §45M of the RBI Act 1934 laying down registration requirements and other prudential norms for P2P lending platforms, including the following:

• Registration: No P2P lending platform may commence business before obtaining a Certificate of Registration (CoR) from the RBI. For the purpose of obtaining the CoR, the P2P platform must fulfil certain conditions, such as maintaining adequate capital structure, necessary technological, entrepreneurial and managerial resources, robust information technology system and business continuity plan.

Upon receipt of the in-principle approval from the RBI the entity is required to put in place their technology platform and complete all legal formalities. If the RBI is satisfied that the P2P lending platform is ready to commence operations, it shall grant the CoR.

• Prudential Norms: Once it commences operations, every P2P lending platform is required to maintain a net owned fund of not less than Rs.2,00,00,000/- and leverage ratio not exceeding 2. Whereas the maturity of the loans facilitated by the P2P lending platform may not exceed 36 months, caps have been imposed on the quantum of borrowings across all P2P lending platforms as well, in the following manner:

• Permitted Activities: No P2P lending platform is permitted to raise deposits or lend on its own. P2P lending platforms are also not allowed to provide any credit enhancement or guarantee. P2P lending platforms may only act as an intermediary online that facilitate unsecured borrowings domestically inter se residents.

• Operation: Every P2P lending platform is required to have in place a Board approved policy setting out the eligibility criteria for participants, determination of pricing for services, and the rules applied for matching lenders and borrowers. Once the individual lender and borrower have approved each other and the loan agreement is executed, the fund transfer is to be carried out through escrow accounts operated by a trustee. Cash transactions are strictly prohibited. In the recovery of loans, P2P lending platforms are strictly prohibited from resorting to any harassment of borrowers.

The P2P lending platforms are required to obtain the consent of the participants for accessing their credit information, and must ensure that all credit data is up to date, accurate and complete. In this regard, the P2P lending platform must store and process all data on hardware located within India. It is the responsibility of the P2P lending platform to ensure that any information received by it from the lenders or borrowers is not disclosed to any third party without the consent of the participants.

• Grievance Redressal: P2P lending platforms are required to put in place a grievance redressal mechanism to address the complaints of the lenders/ borrowers within a period of one month and in accordance with its Board approved policy. The P2P lending platform must also disclose on its website that if the complaint is not satisfactorily resolved within the specified time, the participant may appeal to the Customer Education and Protection Department of the RBI.

The Notification and the Master Directions have both created a fair amount of interest and debates amongst investors, borrowers and the financial sector experts. However, considering that P2P lending platforms often attract high risk borrowers who are denied loans by traditional banking channels, most stakeholders have welcomed the regulatory changes due to their ability to foster better decision-making on the part of (often) uninformed lenders, and to facilitate timely repayment on the part of borrowers, by virtue of access to credit scores from CICs.

Whereas the lender may choose not to advance money to a borrower with a low credit score, the borrowers would be motivated to adhere to repayment schedules due to the fear of a default negatively impacting its credit score. Regulating P2P lending also protects the borrower by serving as a shield against the use of coercive/ unlawful means in recovering the loan amounts. Further, considering the potential competition that P2P lending platforms could pose for traditional financial institutions, it was only a matter of time before regulations governing their operations were put in place. In fact, the regulation of the P2P lending platforms, by way of capping the maximum permissible borrowing, strengthens its very objective of facilitating access to micro-credit, by keeping away bigger players.

Having said so, while the Master Directions render credibility to the business of P2P lending platforms by way of regulating and legitimising the same press reports indicate that there may still be some regulatory gaps. For instance, it appears that an association of P2P lending platforms is planning to seek clarifications from the RBI regarding whether institutions will be included within the definition of 'participants' and hence be allowed to lend through P2P platforms.

Further, the Master Directions do not specify the maximum rate of interest which may be charged on the loans facilitated by the P2P lending platforms. This may not be a pressing issue at the moment considering the market practice of following the reverse auction model in the lending process. However, if not addressed going forward, it may result in higher interest rates on P2P lending platforms.

While the prudential norms set by the RBI ensure that only serious players enter into the business of P2P lending, some experts argue that that the net owned fund and leverage ratio may be too onerous for some P2P lending platforms. Further, the stakeholders view the caps on maximum borrowing as being too restrictive, thereby potentially driving the borrowers to the unorganized sector.

However, based on the press reports, it appears that most P2P lending platforms have welcomed the Master Directions. The RBI has granted three months' time to all existing P2P lending platforms to obtain CoR and comply with the Master Directions. The existing P2P lending platforms may carry on their business unhindered till the RBI finally rejects their application for registration. Further, the RBI has also reserved the right to exempt certain P2P lending platforms from the purview of the Master Directions, as it deems appropriate. However, it is yet to be seen how this may pan out for the stakeholders. The true impact of the Master Directions on the existing and future business of P2P lending platforms in India will be determined once the registration and oversight process commences.

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