India is considered to be one of the largest markets for consumer finance in the world, behind only the US and China. It is also one of the most underpenetrated markets for lending, with close to 70 percent of the market being served by institutional lenders. Traditionally lending activity in India was either carried out by brick and mortar financial institutions like banks or by local money lenders, both catering to different borrower segments. Banks depend on their branch network for all of their lendings. They were restricted in the scale of operation because of high costs and the dependence on feet on the street to acquire borrowers.
A huge portion of lending is backed by a guarantor, collateral. So many borrowers diverted their borrowings from Banks/NBFSs to either microfinance or private lenders. Off late, Microfinance institutions have emerged to serve unnerved groups of people with no security and collateral but with high-interest rates. This covered and served Self Help Group, Joint Liability Group in the remote area where people require daily cash flow to run the business.
About lending models
The emergence and evolution of Fintech companies changed how the whole mechanism of lending and borrowing from banks/FIs and other lending institutions works. Financial technology transforms the process for lending and minimizes the cost, time, and process to disburse the amount to the borrower. Off late, many online lending companies started this activity with various lending models such as Business Loans, Students Loans, Purchase Lending, Personal Loans, Peer-to-Peer Lending, Pay Day Loans, and many more. Online Lending is a unique concept that emerged due to the lack of focus and ability by Banks/ FIs to serve the small businesses and individuals with various reasons like CIBIL score, stringent regulations and processes, unaffordable interest rates, need for collateral, and securities against credit, small tenures, etc.
Many start-ups jumped into this sector to tap the underserved credit market. Business loans through Online lending and peer-to-peer lending have gained a lot of traction in the market because of its ability to provide loans in less time with no security, affordable interest rates, and various other terms which are not offered by private sector Banks, PSU banks and NBFC’s.
The online lending Industry theme becomes favorable amongst PE/VC and other HNI categories of investors. Many investments have been made into this sector. Capital float raised US $ 45 Mn, Neogrowth raised US $ 43.62 Mn, Lendingkart raised US $ 42 Mn, etc. These investments have been mainly utilized in the development of infrastructure & Services and the advancement of technology to make the process more economical and quicker.
Pros & Cons of Online Lending Industry
Despite the commendable contribution to the nation’s economy, the SME (Small and Medium Enterprise) Sector had long been neglected by government departments, corporate, as well as banks, and other financial institutions. The biggest hurdle that small businesses face in their day-to-day operations is a shortage of funds and immediate requirements to keep the short-term working capital cycle running. Of late, the government has been proactive in injecting various types of financial aid into small businesses. Many of the government initiatives aided this sector from its grassroots such as Microfinance, license of Small Bank Finance, Payment Banks, the vision of Financial Inclusion by 2021, etc.
Although the government has put a lot of effort to channel funds to the small and vulnerable businesses in the country, there is still a vacuum left by traditional banks when it comes to extending easy credit. These loans are subject to cumbersome processes, unaffordable interest rates, need for collateral and securities against credit, small tenures, etc. making it anything but ‘easy’ for those in need of funds. Traditional banks have not been able to fully meet customer needs which has led to the rise of microfinancing start-ups in the country. Financial technology businesses have targeted the segments ignore by traditional banks so far. Considering facts of the online industry following are the benefits and risks involved for lenders in P2P lending.
Benefits:
1) High Risk-adjusted returns
2) Asset class with returns more stable compare to Stock Market
3) Steady Cash Flow
4) Hassle-Free Process
5) Paperless work
6) In Process regulatory framework
Risks:
1) High-Interest Rate for borrowers
2) Default risk and creditworthiness of the borrower over time
3) Concentration Risk
4) Risk of recovery
3) Credit Policy Risk
4) No Insurance Risk
5) Macro Risk
6) Liquidity Risk
7) Foreclosure early repayment risk
P2P lending is one of the most revolutionary and disruptive financial innovations of our times. Modern technology, lifestyle, and the way we earn, spend, and invest are the lifeline of P2P lending. Because it provides many left behind a chance towards financial inclusion. With borrowers well-rated and mostly paying on time, with the promise of decent returns and the simplicity of asset class. With a conducive regulatory framework, and greater data transparency in the system. P2P lending may become one of the most profitable investment classes in the coming years.
Traditional Bank Lending vs. Online Lending
|
Traditional Banks |
Online Lending | |
|
Pros: |
Costs less via better interest rates |
Simpler process |
| The industry is heavy-regulated, providing more peace of mind (Comparatively) |
Convenient-can be done anywhere with internet access | |
| Bigger the business, the better the rate |
More accessible if personal credit is flawed/imperfect | |
| The breadth of business lines means better terms on add-on services |
Funding cycles can be more | |
|
Cons: |
Tedious process | Higher interest rates (in some cases, much higher) |
|
Response time can take weeks or even months | The industry not as regulated – predatory brokers and lenders do exist | |
|
Requires good personal credit |
No physical branches to speak to someone in person | |
|
May require collateral | ||
|
Less innovative solutions |
Due to the absolute transparency provided by online loans, customers can compare the services of various banks easily. The market has evolved over the years, with metropolitan cities such as Delhi/NCR, Mumbai, Chennai, Pune, and Bangalore driving growth in the market. However, low awareness with respect to online loans continues to deter consumers from using online loans.
