P2P lending can help diversify investments
The economic downturn of 2007-2008 served as a reminder of the long-standing monopoly of traditional lenders. Since the catastrophic collapse of Lehman Brothers in 2008, plausible alternatives to conventional credit intermediaries have emerged, and one such digital lending method is Peer-to-Peer (P2P) lending.
Efforts have been made to raise the living standards of those at the bottom of the pyramid, most of whom lack basic bank accounts, credit or other financial services. At the same time, the digital revolution and faster internet access have enabled people around the world to trade virtually. Individuals can now exchange money around the world without financial intermediaries such as banks or other financial entities.
Financial sustainability is an indispensable element of economic development and financial inclusion. Financial inclusion is an essential element in making the country’s economy and markets strong and sustainable.
The P2P lending industry has seen a sea change in technology, consumer behavior and business offerings. The segment has seen an increase in technology adoption by lenders and borrowers in the 25-40 age group. Also, as restrictions are eased, the demand for credit to help with the economic recovery will grow rapidly. The P2P lending world is poised to deliver fast, easy and flexible lending solutions in the days ahead.
The fintech revolution
Sir Edmund Hillary once said, “If you only do what others have done, you will only feel what others have already felt. However, if you choose to do something no one else has ever done, you will have a satisfaction that no one else has ever had.” It couldn’t be more appropriate for the thriving P2P lending arena.
The universal P2P lending market has grown rapidly over the past seven years. The category is expected to grow at over 31% compound annual growth rate (CAGR) through 2021-2026.
We’ve all heard of cryptocurrencies and how bouts of extraordinary volatility temper their exceptional performance. But P2P lending is a very unique modern investment tool.
Here are some of the reasons lenders are considering investing in P2P lending models:
Low entry cost: You don’t need a lot of money to start building your P2P loan portfolio. The cost of admission is low and a new investor can start with as little as Rs 50,000 to Rs 1 lakh and slowly increase their portfolio size. Returns are highly dependent on the portfolio established by a lender.
Investment simplicity: P2P lending is a technique. This indicates that the entire process is done digitally, from identifying borrowers who match your standards, to executing legal agreements with borrowers, to receiving repayments. All transactions are conducted through an escrow account managed by a bank-promoted fiduciary – the platform tracks and updates your portfolio performance in real time.
Higher yields: This happens in two ways.
Passive income through reinvestment: Lenders generate passive income through equivalent monthly investments, including interest and principal income. The lender is repaid monthly by the borrowers through the EMIs. The P2P lending platform acts as a catalyst, collecting EMIs from borrowers and depositing them into the lender’s escrow account, into which the lender can withdraw or reinvest as desired. This leads to consistent returns from diversified investments.
Invest automatically: P2P lending institutions offer self-investment options, offering a diversified portfolio to save time and effort. The algorithm gives the lender an advantage in choosing the best investment plan.
A word of warning
The Reserve Bank of India (RBI) regulated P2P lending industry is booming in India and has evolved as a robust and versatile asset class competing with traditional investment platforms. However, like any investment option, P2P loans also come with some risk.
Default risk: One of the risks is that the borrower could default on your loan. Another concern is that no compensation scheme protects your dues, which means that if you default, you won’t get your money back quickly.
Less liquidity: Another disadvantage of P2P loans is the liquidity of the investment. Borrower repayments are made to lenders in accordance with the EMI and term of the loan. Therefore, cashing out an investment before the redemption date is a challenge.
Tax on returns generated by P2P loans: In P2P lending, investors basically earn interest on the amount they lend. So, just like interest earned from other instruments such as fixed deposits, interest income from P2P lending is taxable. The amount of interest earned on P2P loans is categorized as “Income from other sources”. It is added to the lender’s income and taxed according to the tax bracket in which the lender is located.
Bhavin Patel is co-founder and CEO of LenDenClub.