The decline of P2P lending in India: What went wrong?

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The Decline of P2P Lending in India: What Went Wrong?

Peer-to-peer (P2P) lending in India, once seen as a promising innovation in the financial sector, is now facing a crisis that threatens its survival. The concept of P2P lending is straightforward: it connects borrowers and lenders directly without the need for banks or traditional financial intermediaries. Platforms like Faircent, Finzy, Credmint, and LenDenClub facilitated these transactions, offering an alternative route for individuals and small businesses to access credit while providing investors with returns on their capital.

At its core, P2P lending seemed like the ideal solution to expand financial inclusion in India. With just 26 recognized players in the sector, some of which were inactive, the industry managed to accumulate ₹10,000 crore in assets under management (AUM). However, a combination of regulatory tightening, liquidity risks, and rising defaults has led to the industry's sharp decline. The RBI’s recent actions have placed the sector under tremendous strain, making the future of P2P lending uncertain.

P2P lending platforms serve as intermediaries between borrowers and lenders. The process begins when a borrower fills out an online application, which is then assessed by the platform based on the individual’s creditworthiness and risk rating. Once approved, the borrower is presented with loan options from various investors, each offering different interest rates. The borrower receives the loan, and repayments begin according to a predetermined schedule. Meanwhile, the investor earns interest, and the platform charges a fee for its services.

On paper, this process offers a streamlined alternative to traditional banking, especially for those who may not have access to formal financial channels. It also provides investors with an attractive opportunity to earn higher returns than those typically offered by conventional savings or investment products.

The Rise of P2P Lending: A Promise of Financial Inclusion

P2P lending platforms gained traction in India during the 2010s, particularly with the rise of fintech solutions that aimed to disrupt the financial sector. For borrowers, P2P lending provided easy access to loans, particularly for small businesses, freelancers, and individuals with limited credit histories. For lenders, it promised better returns compared to traditional savings products. The platforms’ ability to offer quick, low-cost loans and the promise of democratizing credit drew the attention of investors and consumers alike.

The industry’s growth was bolstered by India’s burgeoning digital economy and the widespread adoption of online financial services. With the backing of tech-savvy investors and entrepreneurs, P2P lending seemed poised for exponential growth. In 2017, the Reserve Bank of India (RBI) introduced its first set of regulations for the sector, signaling a formal recognition of P2P lending as a legitimate financial service.

Regulatory Crackdowns and Industry Missteps

However, the rapid growth of P2P lending platforms came with significant risks. The RBI’s light-touch regulation in 2017 was intended to allow the sector to innovate while ensuring consumer protection. Yet, some companies in the industry interpreted these guidelines too loosely, engaging in practices that raised red flags for the regulator.

Some platforms started offering guaranteed returns to investors—something that contradicted the very essence of a risk-based lending model. Others entered into secondary market transactions, where they repackaged bad loans and sold them to new investors, masking the true risk of these products. These actions were clear violations of the original regulatory guidelines, but they went largely unchecked until the RBI began conducting audits and investigating these business practices.

RBI’s patience eventually ran thin. Despite the industry's efforts to correct its course, the damage had been done. On August 16, 20243, the RBI released a stringent set of guidelines that severely restricted how P2P platforms could operate. These new rules effectively disrupted the business models that many of these companies had built, pushing the industry into a state of crisis.

The New RBI Regulations: A Death Knell for P2P Lending?

The August 16 RBI directive shook the very foundations of the P2P lending industry. The most impactful change was the restriction on escrow accounts—an essential component of the P2P model. Previously, platforms had some flexibility over how funds moved in and out of these accounts. However, under the new guidelines, any funds entering the escrow account must be returned to the borrower or lender within a day if not immediately disbursed. This put immense pressure on platforms to manage transactions in real-time, creating logistical and financial burdens.

Additionally, platforms were barred from touching escrow accounts, effectively limiting their ability to hold and manage funds for future disbursements. These changes disrupted the basic functionality of P2P startups, making it increasingly difficult for them to operate efficiently.

These regulations have essentially "broken the entire customer experience" as investors now face the arduous task of individually selecting thousands of loans to diversify their portfolios, something that few have the time or inclination to do. For borrowers, the delays in receiving funds make P2P lending less attractive compared to traditional banks or NBFCs (non-banking financial companies).

The Industry’s Response: Too Little, Too Late?

Before the RBI’s crackdown, many P2P companies had attempted to course-correct. Partnerships with large consumer-facing apps like CRED and BharatPe were scaled back, and some companies abandoned risky products like instant-withdrawal loans. However, these efforts may have been too little, too late. The RBI had already identified systemic risks in the industry and was no longer willing to take a light-touch approach.

The RBI’s harsh stance is understandable in light of the violations that occurred. But for those in the industry, it has felt like a premature death sentence for a sector that still held significant promise. Better collaboration between the industry and the regulator could have led to a more balanced approach—one that protected consumers without stifling innovation.

What Lies Ahead for P2P Lending in India?

The future of P2P lending in India looks grim. The new regulations make it difficult for platforms to scale, and the business model itself seems increasingly unviable under such tight restrictions. The costs of compliance, fund transfers, and borrower acquisition are likely to rise, making it hard for startups to remain profitable.

However, all is not lost. The P2P lending model has evolved in other countries, such as the U.S. and U.K., where larger financial institutions and even governments have begun participating in these platforms. In India, the sector may need to shift its focus towards specific niches, such as small and medium enterprises (SMEs), where traditional financial institutions are less willing to lend.

For now, the industry is in a holding pattern, awaiting further dialogue with the RBI. Whether or not P2P lending in India can survive will depend on the willingness of regulators and industry leaders to collaborate on a sustainable path forward.

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A Broken Model or a Second Chance?

The rise and fall of P2P lending in India is a cautionary tale of regulatory oversight and industry missteps. While the model promised to democratize access to credit and offer investors new avenues for returns, its execution was marred by risky practices and a failure to adhere to regulatory guidelines. As the sector grapples with the latest round of regulations, the question remains: Can P2P lending in India be revived, or is this the end of the road?

For now, the industry’s fate hangs in the balance. But one thing is clear: the road ahead will not be easy. The next few months will determine whether P2P lending can reinvent itself in India or become another cautionary tale in the history of fintech innovation.

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