Smart Ways To Reduce Risks In P2P Investments
Peer to Peer (P2P) lending is a relatively new concept in India. They have been around since 2014, but RBI came out with guidelines for P2P lending platforms in 2017. RBI also announced they will be registered as non-banking financial companies (NBFC). While any financial transaction or arrangement has an inherent element of risk, lending money on an online platform to virtual strangers raises its own set of concerns and questions.
As a borrower or lender on a P2P lending platform, you are right to have questions and potential risk concerns. Here’s what you must do to reduce the risks involved in P2P investments.
Study the platform
P2P lending has the potential for building a secondary income and offering good interest returns on your capital. But you need to understand how the system works. As a novice investor, focus on how the loan matching algorithm works on P2P marketplaces. Learn the technical jargon, the risks and return ratio, disbursal cycles, collection percentages etc. At this point, it is also worth enquiring if the platform is RBI registered NBFC.
Check with the P2P lender about their overall volumes, recovery processes, returns, and defaults.
Research and review
A P2P lending platform follows due process and carries out an elaborate check of an individual’s creditworthiness, following sundry parameters. Only after they are satisfied, will they register you as a borrower on the website. For lenders too, there are certain criteria to get registered.
You too must carry out your own research online and check the platform’s reviews and ratings. There are many websites and forums that rate P2P marketplaces along with member feedback. This will give you an overall idea of the prevailing opinion about a P2P platform. But do exercise your own discretion and take this information with a pinch of salt.
Read the fine print
Visit the FAQs section of their website and you will find most of your queries answered. If not, don’t hesitate to reach out via email or phone to ask some of the important questions.
The Reserve Bank of India (RBI) has recently mandated certain guidelines for the newly instituted NBFC- P2P companies and licensing them with the intent of safeguarding borrowers and lenders from potential frauds and threats. Make sure that the platform that you choose is registered with the RBI.
You can read about RupeeCircle’s RBI registration on the blog post here.
Focus on the long game
It is a mistake to compare P2P investments with short-term equity investments. This is at the very least a 2-3 year investment for you to reap good returns. If you compare the results over a long term, the returns are similar to equity investments. Often the returns may even be higher than equity, but it is important to understand the math behind these calculations. Many lenders are tempted to withdraw their monthly returns too soon. Avoid focusing on the short-term gains and allow the returns to create a compounding effect to view great returns.
Study the borrower’s profile
As a lender, you are justified in doing a profile check of the borrower to ensure that your capital amount will be repaid with interest. Most P2P platforms have assigned a rating or a score to each borrower with other significant details that help you gauge the trustworthiness of the candidate.
The borrower’s score is assigned after analyzing a number of parameters that include his/her credit history, employment tenure, CIBIL score etc. This will generally give you a fair estimate of the borrower’s ability to repay the loan.
Don’t put all your eggs in one basket
It is a smart idea to diversify your investment. Don’t lend all your funds to one borrower. Better still, split up your principal amount and register on one or more P2P platforms as a lender to mitigate the risks.
Spread the risks by dividing your capital among several borrowers. There is a great sense in fractionalization of loans and also opting for a spectrum of return rates as opposed to only high-interest returns. Some P2P platforms offer auto-invest options to help you invest in a great number of borrowers. With reporting and analytics features, you can monitor and track your portfolio performance.
Be aware of delays
Often lenders aren’t aware of default rates and delays. This comes as a shock when there is a delay in the repayment cycle. As a lender, you must understand that there can be delays. As the returns are on a reducing balance and are paid in EMIs, lenders have to be aware of delays. Per RBI guidelines, all P2P platforms are mandated to disclose the delay and default rates. As a lender, you are advised to study this information.
If you research the default rates, you have a better grasp of each platform’s risks. When studying multiple platforms, make the correlation between the marketplace’s advertised average ROI and default rates.
If you play your cards well, P2P platforms can be an alternative investment option that can generate a secondary income and compound your capital in the short term. Like any other financial instrument, you must understand the risks involved and do your research well to mitigate the risks before you decide to lend or borrow.