P2P lending is broken in India. What can we do to fix it before it’s too late?

Photo credit: Jon Collirt.

If you want a loan without having to deal with the hassle of a bank, your best bet is to use a P2P (peer-to-peer) lending startup. There, you can connect with individuals who want to lend you money so they can earn off the interest you pay.

It’s a business model that’s been gaining interest in India. According to the Reserve Bank of India (RBI), twenty P2P lenders entered the scene last year, bringing the country’s grand total to thirty.

The excitement is with reason: this is the first time that millions of Indians without financial histories have the opportunity to take out loans.

And yet, it’s important to take the excitement with a grain of salt.

In China, where P2P lending companies are mostly unregulated by the government, a major industry player was indicted for cheating over 900,000 investors out of US$7.6 billion. It promised high interest rates to attract investors to the platform. When it couldn’t deliver, it made up investment products so it could take money from new investors to repay old ones.

In the United States, where P2P lending startups are banned in some states and have to go through two levels of regulations in others, the US$392 million-funded Lending Club is facing its own issues. It lost its CEO and P2P lending kingpin Renaud Laplanche and was accused of major inconsistencies soon after. Those included a US$22 million irregularity toward a single borrower and an employee working on a portfolio that would personally benefit them.

The question is: how can India tap into the full potential of P2P lending while avoiding the dangers that come with it?

Too many details

My friend had a bit of extra cash lying around, so he decided to try out Faircent, an Indian P2P lending site backed by ex-Infosys CEO Mohandas Pai and JM Financial.

When he signed up with the site, he was met with a list of borrowers, ranked by how risky it would be to lend to them. “These numbers were calculated by things like their account balance, or their credit scores, or loan histories,” he recounts. “The lower the risk, the lower the interest rates – something like 16 to 18 for really low, and 24 to 25 for mid-tier.”

It’s not that we don’t have the technology… we’re just waiting for regulators to catch up.

He was also prompted to place the amount of money that he would want to transfer into a virtual currency wallet as a placeholder. The money would not be taken from his bank account until after the procedure was over, he explained to me.

He decided to choose a medium-risk borrower who resided in Pune. The borrower had the option to choose multiple lenders for the same loan, so my friend had to bid on how much money he wanted to put in.

That’s when my friend began to feel a little uncomfortable.

An OK future

Murky waters