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P2P Lending Growth Potential

August 27, 2020

In 2015, the first peer-to-peer lending platform, Zopa, was launched in the UK. The P2P lending market has grown substantially since then. From a theoretical perspective, this growth has, according to Serrano-Cinca, Gutierrez-Nieto & López-Palacios (2015), been explained through the market equilibrium theory and the financial intermediation hypothesis.

The market equilibrium theory states that efficient markets are characterized by a state of equilibrium between supply and demand. Thus, advocates of the market equilibrium theory claim that peer-to-peer lending platforms bring the credit market towards equilibrium by solving a credit rationing problem that exists because there are borrowers, especially in economic downturns, who do not receive loans even if they are willing to pay higher interest rates. On the other hand, the financial intermediation hypothesis focuses on the fact that peer-to-peer lending platforms are more cost-efficient and have lower intermediation cost than banks, which makes them more attractive to both borrowers and lenders as competition forces platforms to share these lower cost with both sides.

From a more practical perspective, a research report on financial technologies from the International Organizations of Securities Commissions (IOSCO) pinpoints four supply and demand factors that have supported the growth of P2P lending:

1 Reduced Technology Costs

The operating costs of P2P platforms are minimised because of the online nature of the business models, which reduces the cost of attracting both borrowers and lenders. At the same time, algorithms can be utilised to automate processes like credit scoring and diversification of investments by lenders. Also, because P2P platforms normally do not participate in lending decisions or collect deposits as in traditional bank lending, their intermediation and transaction costs are kept low.

2 Underserved Market Segments

In many countries, the demand for capital is lower than the available supply of capital because startups and SMEs (small and medium-sized enterprises) are underserved by traditional banks. This is especially true in China where the large public banks have mostly played the role of serving large corporations. At the same time, P2P lending has been a place for small scale investors to invest even small sums.     

3 Low Interest Rates

Low interest rates (in periods even negative) have been the norm since the global financial crisis of 2007-2008. The same is true for yields on sovereign bonds, which has forced investors to look elsewhere in the search for higher yields. Here, P2P lending represents an alternative investment that offers potentially higher returns. However, as is always true with investments offering high returns, investors must also be willing to accept a higher risk.  

4 Risk Diversification

Following the above, P2P lending offers individual investors the possibility to invest in loans, something that was previously only possible for mainly institutional investors.  

Let's Indianize things. There was(The word 'was' has been used to pay respect to Modi JI) a whole Parallel Economy before Demonitization and the most common practice was to give the black money as loans to business houses who would pay a premium to bank interest rates just like the old Zamindars because of the nature of Loan being unsecured and no requirement of Collateral. Now, since those roads are closed and all the black money has magically converted to white money where do we invest this money to earn a higher rate of interest?

P2P Lending is just a formalized way of doing the same thing with a slight difference of increasing security by placing limits on maximum lending to 1 indiviudal person to Rs. 50,000/- as well as doing background checks and NACH Mandates from the borrowers. We suggest a portion of your risky portfolio be allocated to this asset class. Risky portion because Bad Debts are always going to be a risk and High Returns come with Higher Risk, however if one is not greedy it should make a decent 10-12% IRR.

-Rishabh Kankaria

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