Why do bank deposits fetch an average return in the range of 5% to 7% per annum? Banks have a massive infrastructure with a vast enough network to cover almost every village or town in India. Besides, they have a robust controlling authority in the Reserve Bank of India. Plus, there is a Government backing. So despite all the banking industry’s paraphernalia, why are the returns low? It can be an intriguing question to many. But those who know the rules of investment realize that “Lower the risk, lower the return.”
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A move toward better returns
People today realize that the higher the risk, the better the returns. So, they are moving towards alternatives like P2P lending, cryptocurrencies, etc., that promise higher returns. Why should anyone invest their hard-earned money in bank deposits and mutual funds that barely give decent returns to stave off inflation? Would it not be better to lend the money to P2P platforms that offer annual returns in the 9% to 12% bracket?
- Cred, a fintech startup, has launched a P2P lending platform partnering with LiquiLoans, an RBI-registered P2P non-banking finance company.
- BharatPe has its P2P lending platform through its 12% Club app.
- Money Club has an online registered chit fund platform that promises returns much higher than banks.
Compare the scenario with the banking industry.
- India’s leading bank, State Bank of India, offers 5.4% on its term deposit. Senior citizens get a better rate of 6.2%.
- SBI’s counterpart in the private sector, ICICI Bank Ltd, offers a maximum interest rate of 5.75%, with senior citizens getting 6.50%.
Why is there such a significant disparity in the interest rate?
The primary reason is that investment in a P2P lending platform is subject to higher risk than depositing the money in a bank. The bank is bound by an undertaking to pay the contracted interest rate on the deposit. However, it is not so in the case of P2P lending platforms. So, if things work out well, the investor can get excellent returns on their investment on the P2P lending platform. But, simultaneously, there are chances of negative returns if things do not work according to plan. Thus, the higher the return, the higher the risk involved.
How do P2P platforms mitigate this risk?
To understand how P2P platforms mitigate this risk, one should know how these platforms function. Now, the RBI prohibits P2P lending platforms from accepting deposits of money from the public. If they do so, there would be no difference between them and the banks. So, the P2P platforms solely depend on the investments made by their members. Since the investment is not a deposit, there is no question of a contracted interest rate. Everything depends on the returns the investment generates on the platform.
For example, CredMint spreads the investment you make among 200+ borrowers on the platform on average. If your investment is in the range of Rs 1 lakh through the Auto-Invest feature launched by LenDenClub, the amount gets distributed to nearly 400 to 500 borrowers using their unique algorithm. The purpose is to negate the chances of default and reduce them to the barest minimum. It works on the principle that not all borrowers default simultaneously. So, there is a cushioning layer to absorb the hit. Besides, these P2P platforms are online. Their overheads are minimum. Hence, they can offer better returns to investors.
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However, the risk remains.
Investors should know that the loans offered by these P2P lending platforms are unsecured. Generally, the borrowers on these platforms have low credit ratings or CIBIL scores. Hence, the chances of default are omnipresent.
CredMint states that its customers are those who have been using the Cred cash facility, having CIBIL scores of 750+. Therefore, they contend that the investments made on the platform are safe. Similarly, Money Club says that they verify every member’s credentials before admitting them into their Money Club programs. BharatPe offers 12% returns on investments and credits the interest amount daily to the investor’s accounts. Thus, these platforms appear secure. But, the same cannot be said of the hundreds of P2P lending platforms operating on the market.
Nevertheless, we conclude that P2P lending platforms offer better returns than banks, but one should never discount the risk factors.