Peer-to-peer lending: Increase accessibility and regulate, for RBI, a domain full of dilemma

With peer-to-peer (P2P) lending gaining ground, the Reserve Bank of India (RBI) has a unique dichotomy to address — on one hand, enhancing accessibility to financial services using this new-age form of lending and on the other ensuring robust regulatory systems to address issues that are unique to P2P; indeed a tall order given the heady pace with which technology is making inroads into the financial sector.

Background

Unprecedented growth in digital banking has resulted in the RBI grappling with the question of how best to regulate these developments. One school of thought favours adopting a ‘laissez-faire’ approach based on the argument that regulation of financial services comes at a very high price i.e. stifling innovation in a technology driven sector. In his paper, “The Economic Rationale for Financial Regulation”, David Llewellyn observed that regulations often impose costs that exceed the costs of the original problem and also impose a wide range of costs that ultimately are borne by consumers. The other school of thought supports the regulator continuing to hold the reigns on the direction and manner of growth in this sector (as has been the case for the banking sector over the years), a proposal that the proponents of free market would challenge as stifling growth and innovation.

These schools of thought have been explored by the RBI while deciding to regulate P2P lending. RBI’s approach appears to favor a certain amount of regulation of P2P platforms.

Know your customer checks

‘Know Your Customer’ (KYC) , a mandatory requirement by the RBI for lending by financial institutions, necessitates a borrower to furnish identity documents with the objective of identifying the customer and with a view to mitigate risks of benami transactions and money laundering.

The first challenge in this area will be coming to terms with the concept non-face to face customers which is inherent to P2P lending, a concept that RBI thus far has been fairly skeptical of and has refrained from providing any comprehensive guidelines on. The second aspect is that of the use of paperless KYC, which could be achieved by leveraging technological innovations in the KYC space to facilitate a faster and effective process such as e-Aadhar, reliance on electronic copies of documents, conducting KYC through phone, video, online means which is supported through secure platforms.

Parity of credit scoring and reliability

Credit scoring is one of the key value propositions offered by P2P platforms and the lenders will be relying on the credit scores assigned by the platform.

The robustness of the credit score will depend vastly on the quality of information that will form the basis of such scoring. Presently, banks and financial institutions have access to credit information stored by credit information companies (CIC). It may be worthwhile to bring P2P platforms within the fold of entities which can use and contribute to the information stored and developed by CICs. This would broaden the ambit of accessibility to credit information by lenders in two critical ways – firstly, new lenders who did not have access to credit information held by CICs will now have the benefit of this data for the purposes of lending on the platform; secondly, existing financial lenders will have the benefit of the data sourced from bank lending and also from P2P lending.

Settlements and nodal accounts

The concept of “nodal accounts”, which is a single bank account which can be operated by an intermediary for routing payments from and to different participants has been successful with merchant/trade transactions and is a concept that may be applied in the P2P lending sector as well. Disbursement of the loan from P2P platforms to borrowers could occur by way of disbursement into a nodal account established by the P2P platform with a bank. The regulations pertaining to the nodal account should ideally specify permitted debits and credits, thereby ensuring that the P2P lending platform has oversight of the disbursal and repayment mechanism without actually handling any cash itself.

Conclusion

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The key drivers for the P2P regulations should factor in the financial literacy of the participants and the potential abuse of the simplified levels of regulation by sophisticated participants. The regulations will also have to work towards providing a robust framework to guard against abuse of first-time lenders and small investors, in order to make P2P lending a palatable and sustainable investment option for the public at large. Keeping this in mind, it may be worthwhile for the RBI to consider streamlining its regulations to cater to different categories of participants, depending on their level of financial literacy, particularly in areas such as assessment of creditworthiness of potential borrowers (and promoting information symmetry by collaborating with CICs), KYC checks, calculating realistic returns, and for payment and settlement of transactions.