What is Peer-to-Peer (P2P) Lending?
Lending is one of the oldest and most important financial and trade services provided by banks and financial institutions, playing a crucial role in the economy. Keeping a balance between lending and a well-sustained, smooth-running economy is critical to the functioning of the economy. The financial crisis of 2008 got severely aggravated by the disbalance between home loans and cash withdrawals. Therefore lending, more importantly, balanced lending, plays a critical role in the economy.
What is P2P?
Peer-to-peer lending, also known as social lending or crowdlending, is the practice of borrowing and lending money between individuals without the involvement of banks or financial institutions. P2P platforms involve three parties, the borrowers, the lenders, and the intermediaries that provide the services. The intermediaries involved in P2P channels are not formal financial institutions but businesses that create a platform to keep money flowing between potential borrowers and lenders.
The P2P market share has grown exponentially in recent years. The P2P market is expected to grow at a CAGR of almost 30% by 2027 and is expected to exceed $700 billion by 2030.
The increased adoption of fintech globally is responsible for the astronomical increase in P2P lending.
How P2P Works
In P2P, all three parties need not interact simultaneously. The platform provided by the intermediary allows both borrowers and lenders to register by providing their personal information. Then the personal information provided by both parties is verified against their official documents by the service provider. Once the personal details are verified, the platform automatically connects lenders and borrowers according to its preset algorithms.
Before proceeding with the transaction, the lender and borrower individually are required to accept the interest rates and fees involved in the process. The lender and borrower are required to pay a certain percentage of the loan amount to the service provider as fees, and the borrower is additionally required to accept the interest rate pre-fixed for the loan amount.
The transaction is finally complete after the borrower has repaid the loan, along with the fixed interest rate, and both the borrower and lender have paid their fees to the service provider. In P2P, because there is no involvement of official parties like banks and financial institutions, the interest rates and fees are considerably lower than otherwise. The low fees and interest rates incentivize borrowers and lenders to participate in P2P lending.
Benefits of P2P Lending
There are several benefits associated with P2P lending, because of which its popularity has increased so enormously. All three parties benefit from the platform. The service provider earns through the fees paid by the borrowers and lenders, and the remaining two parties individually benefit from the simple services.
- In P2P lending, borrowers get the opportunity to get lower interest rates on their loan amount, which can help them save and repay much faster.
- P2P loans are alternative options for borrowers, where they can get easier access and more flexible options, compared to traditional loans.
- P2P loans offer better flexibility concerning interest rates, moratorium periods, unsecured loans, etc.
- Unlike traditional loans, borrowers are less bothered about their credit scores in P2P platforms because of their non-involvement with formal channels like banks and financial institutions.
- The process involved in P2P loans is much simpler and quicker compared to traditional channels.
- Investors lending through P2P platforms can get higher returns on the loan amount compared to other investment options.
- The platforms are easy to navigate through and register. They also provide opportunities for lenders to choose if they want to proceed with the transaction based on the borrower’s profile.
- P2P lending also allows lenders to diversify their risk potential across different loans, as the capital amount of the lender can be divided into separate loans availed by more than one borrower.
Drawbacks of P2P Platforms
Although P2P services have gained immense popularity, a few risks and disadvantages are involved in this type of lending.
- P2P lending platforms require mandatory credit checks on borrowers and lenders to make the platform more secure. Credit checks can filter out people with low credit scores and poor credit history.
- To avail of P2P services, both lenders and borrowers must pay fees to the service provider.
- P2P platforms are a very recent novelty in the lending industry. Their applicability depends on the availability of these services and the legislation surrounding them in different countries.
- P2P lending does not guarantee returns, which implies higher credit risk for potential lenders, as the people availing alternative lending channels are likely to have low credit scores.
What Does the Future Hold for P2P?
P2P lending is a disruptive augmentation of the fintech world, gradually overtaking a considerable share of the traditional lending channels. The technological developments emerging in the fintech world, are rapidly changing how financial services are provided and availed. Alternative lending options, such as P2P and BNPL (Buy Now, Pay Later), are aggressively advancing toward mainstream lending channels. The P2P lending market is steadily gaining more credibility with established and popular companies joining the battalion. P2P lending is only a scratch on the surface, implying an enormous potential for disruption and growth.