How high is the default rate on peer-to-peer lending?

peer to peer Rate

Many people consider P2P lending platforms an alternative to banks and financial institutions. They are wrong because P2P lending cannot equate with bank lending. Banks and other lending institutions have the massive infrastructure to lend thousands of crores of rupees. You can check out the balance sheet of the Adani Group or the Ambani Group to know the extent of bank financing they have.

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P2P Risk Classification

Generally, who approaches a P2P lender for financing facilities? The answer is a no-brainer. The following category of borrowers look to P2P lending.
  1. Individuals who have a low CIBIL score and do not stand a chance of getting a credit facility from a bank.
  2. Individuals with no credit history and thus no CIBIL score also approach the P2P platforms for credit facilities.
  3. Individuals who are in urgent need of money and cannot wait to complete bank formalities.
  4. Individuals who do not have any collateral to offer.
Thus, you can see that the risk category of each person (especially categories a and d) applying for P2P loans could be in the high to very high range. So, the interest rates would also be high, somewhere more than 18% to 25% per annum. What can you expect the recovery rate to be? It would not be 100% because these persons would have easily gotten loans from the banks if it had been.      However, these platforms perform due diligence and assist in the recovery process, as well as follow up on repayments and, if necessary, employ recovery agents.

Loan Default Rates of P2P lending platforms

All P2P lending platforms are not bad. You have excellently performing P2P venues like The Money Club, Faircent, LenDenClub and RupeeCircle, that exercise extreme caution when lending money. They do not lend money to anyone who applies on their platform. Faircent has gone on record saying that their loan conversion rate is 5%. So, for every 100 people who apply for loans on Faircent, five people get the loan. So, one can trust, if a company like Faircent says that its recovery percentage is good.

Generally, the top P2P lending platforms have a default rate between 2% and 7%. LenDenClub has shown a default rate of 4.45% for the first quarter of FY22. On the other hand, shows a gross NPA ratio of 11.5%.

Safeguarding Measures

Today, P2P lending is in its early stages in India and has limitations. Therefore, the Reserve Bank of India understands them and has stipulated strict restrictions on the financing. For example, a particular lender cannot have exposure to a single borrower for more than Rs 50,000 across all P2P platforms.

At the same time, no borrower can borrow more than Rs 10 lakhs at a time from all P2P platforms

The purpose behind these restrictions is to limit the loan size and exposure by a single lender. It safeguards the lender’s funds and does not expose them to high risks.

Similarly, P2P platforms cannot lend for tenures of more than 36 months,      which makes monitoring easy.

These measures aim to ensure that the loan tickets remain small. Secondly, smaller loan tickets display better recovery percentages. As a result, you’ll notice that P2P platforms have low default rates.

peer-to-peer lending

Are chit funds better alternatives than P2P lending?

Chit funds are promising avenues of lending and borrowing money. For this, you need to  understand the mechanism behind the chit fund. This example should make it easy for you to understand. A chit fund constitutes a group of people committed to depositing a fixed amount of money every month for a specified period. For example, let us assume 20 people come together to contribute Rs 5000 every month for 20 months.
  1. Bidding takes place every month where the members declare the sacrifice they can afford to make and receive the money pooled together. For example, A has the lowest bid of Rs 85000. Therefore, the month’s pool goes to A.
  2. The chit fund company collects its charges from the contribution.
  3. The 19 members share the remaining amount (Rs 15000 minus charges) as their profit on the investment.
  4. This cycle continues every month, with each member getting a chance to receive the pool amount.
The default rate on chit funds is practically zero.

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Final Words

We have seen how chit funds work as P2P lending platforms and show low default rates. The Money Club is an Indian registered chit fund platform which helps you join peer-to-peer chit fund clubs. 

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