In today’s Finshots, we discuss the issues facing peer-to-peer lending in India and the RBI's regulations to keep them in check.

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The Story

We don’t need to tell you that lending has always been a messy business, especially in India.

For years, borrowers had just two choices…

One was to rely on moneylenders charging exorbitant interest rates. And the other was to go through banks or other financial institutions, which although offered lower rates but drowned borrowers in paperwork and demanded upfront collateral.

So, against this backdrop, online peer-to-peer (P2P) platforms emerged like a breath of fresh air.

They promised to cut out the middlemen and directly connect lenders—folks with spare cash looking for better returns – with borrowers who urgently needed funds. No collateral. No waiting around for months like traditional bank loans. Just quick, paperless loans.

The platforms took a cut of the action. About 2–3% from lenders and 6–8% from borrowers, to service the loan. This was how the ecosystem worked and everyone seemed happy.

Even the Reserve Bank of India (RBI) recognised the potential. In 2017, it started regulating these platforms and classified them as non-banking financial companies (NBFC-P2Ps). For a while, it seemed like P2P lending was a match made in fintech heaven.

But not everything looks rosy as of now.

How, you ask?

Well, just last week, Capitalmind received a response from RBI showing that the non-performing assets (NPAs) in the P2P sector have skyrocketed to ₹1,163 crore. That’s a jaw-dropping leap from just about ₹14 crore in FY19. So, a staggering 8,200% increase in about five years!!!

And the obvious first question you’d have is, what caused these massive defaults?

A lot of things to answer generously.

You see, the problem began when some P2P platforms rushed to grow at a breakneck speed. They started taking on risks like banks and NBFCs. They also began promising assured returns and loss guarantees on money. And even instant withdrawals.

Now, it won’t take a genius to know that when borrowers are in the market to get loans, and when they see these assurances, they would see P2P lending as a low hanging fruit, and a risk-free game.

It wasn’t.

Worse, this blurred the lines between P2P platforms and deposit-taking NBFCs, which also triggered alarms at the RBI.

What followed was even worse. Lenders, particularly those with a higher risk appetite, were drawn to potential returns far exceeding traditional banking products. Normally, these platforms are supposed to match lenders with borrowers, but some P2P companies started bundling up these loans into big pools and selling them to lenders. This mimicked what banks do when they issue loans—but without collateral safeguards. The platforms made money by charging borrowers higher interest rates than what they paid to lenders. And they kept the difference as a profit margin.

But it all worked just until borrowers started defaulting in droves. Margins evaporated. And losses piled up.

The cracks ran deeper. Some platforms used funds from new lenders to cover withdrawals for old ones, creating a system riddled with accountability issues. To top it off, platforms began onboarding riskier borrowers who agreed to pay higher interest rates as there was no upper limit on the interest charged from borrowers. While this boosted their short-term profits, it also led to a spike in defaults.

So, in August 2024, the RBI decided enough was enough and introduced new regulations to rein in the chaos.

For starters, loan pooling was banned. Platforms must follow a ‘one lender to one borrower’ model or ‘many lenders to one borrower’ at most. This effectively ends the practice of bundling loans into large pools.

Then, it said that P2P platforms can no longer earn from the spread between lending and borrowing rates. Instead, they’ll need to switch to a fixed-fee model.

Then, caps were introduced on how much lenders and borrowers could transact across platforms. Lenders can’t lend more than ₹50 lakh across platforms, and those lending over ₹10 lakh must prove a net worth of ₹50 lakh. Borrowers face limits, too, and could borrow ₹10 lakh across platforms, with a ₹50,000 cap per lender.

While these measures aim to curb reckless practices, P2P platforms feel these are overly restrictive. If lenders understand the risks, why limit how much they can lend? And if a borrower with a strong credit score can secure more backing, why hold them back?

Another rule that these platforms are worried about is that all transactions settle within a T+1 timeframe. Simply put, any transfer from the lender’s account must reach the borrower’s account within a single day and vice versa. Here, too, the platforms feel this is extremely difficult to achieve and involves high costs for the borrower as well as the lender. This makes the P2P system less competitive and ultimately reduces business for them.

So yeah, the RBI’s rules, though well-intentioned, might complicate the matching process and hinder the industry’s growth potential.

But here’s the thing—the RBI’s job is to safeguard lenders and borrowers first. If they’re in trouble, the P2P industry itself will falter, right? And when trust collapses, it ripples across the entire financing ecosystem. Most people using these platforms don’t fully grasp how their money is handled or the risks involved. Imagine a lender putting up a large chunk of money only for the P2P platform to hand it to high-risk borrowers. The likelihood of default skyrockets; even if risks are disclosed, lenders are left holding the bag. Borrowers, too, often pile on debt without fully understanding the math. The RBI is stepping in to stop this kind of fallout and restore some order.

Our only question is, where does the P2P lending industry go from here?

Will they return to their roots—simple matchmaking between lenders and borrowers? Or has the damage already been done?

Until then…

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