India is a huge economy. Its population is so large that even our exceptions run in millions. Our population has not only been rising but has also been becoming more aspirational and entrepreneurial, especially the younger demographic groups. The requirement for credit has increased significantly in recent years. There has been a rise in the variety of credit needs too.
According to the MSME Ministry of India, as of March 2022, the country has more than 7.9 million micro, small, and medium enterprises (MSMEs). According to the report by the UK Sinha Committee commissioned by the Reserve Bank of India (RBI) in this June 2019 report, the MSME sector’s total credit gap was to be ₹20–25 trillion. As of December 2021, MSMEs cornered a share of only 13% of the total gross bank credit. The sector accounted for only 16% of the total outstanding credit flow from scheduled commercial banks in 2020–2021. To meet their credit needs, these MSMEs seek money from local money lenders, family, or friends.
There are several reasons for India’s huge MSME credit gap. Information asymmetry, lack of sufficient collateral, banks’ increasing risk aversion with an aim to maintain their asset quality, and lack of proper documentation of business activities are some of the key reasons. The pandemic, which disrupted many businesses across the country, was extra hard on MSMEs with their limited capital. Now, after the pandemic, these MSMEs are in greater need of easy and affordable capital.
According to the International Finance Corporation, the credit gap for MSMEs led by women stands at a staggering $158 billion in India. The majority of these enterprises rely on informal sources. Female entrepreneurs’ rejection rate by lending institutions is much higher than that of male entrepreneurs in India. Women-led enterprises are considered riskier by traditional financial institutions. Less access to formal higher education and restricted access to property and assets that limits their collateral keeps them away from credit. A large part of them depends on their inherited assets and savings for their credit needs. But what about those women who are equally aspirational and capable, but without any financial support? Peer-to-peer lending comes to their rescue.
As discussed earlier, Young Indians are increasingly aspirational and consumerist in their approach to life. They are not hesitating before applying for a personal loan for those needs, which were considered luxuries by their previous generations. The younger generations have been taking credit to even fund their travel goals and purchasing consumer durables. Many of these loans are small ticket loans, which are usually not serviced by banks. Even if they do, imagine going to a bank and applying for a loan for your next trip to the Himalayas! Again, Peer to Peer lending, backed up by cutting-edge technology, is the solution.
Why are Traditional Lenders Struggling to Plug This Gap? – How P2P Lending is the Solution
When you invest in a traditional fixed-income asset class, the money is used by the respective institution as a source of funding. Cumulatively, these sources of funding are furthered by the institution as finance. Now, in some cases, you earn pretty low single digit returns which are close to nothing when adjusted for the inflation rate.
On the other hand, P2P lending marketplaces offer direct access to a pool of creditworthy borrowers. Of course there are risk-mitigation strategies in place to secure your investments. The role of P2P lending marketplaces is more of a market-maker unlike banks. This gives you the opportunity to earn higher returns with some players, for instance LenDenClub, providing returns as high as up to 10 to 12% p.a.*
Some industries are more likely to receive funding than others from banks, because of banks’ lending guidelines. Lenders display reluctance to lend money to businesses due to such internal policies. Enterprises in the services industry suffer due to this. However, P2P lending removes this bias by creating large lending pools, with each lender contributing some amounts to lend to a borrower. LenDenClub’s AI mechanism takes a small piece from each lender, bundles them, and disburses the amount to individuals or businesses in need. Here, the lender is not a single entity but a large pool of lenders, with the risk spread across all of them. Little risk means less reluctance in lending money.
Another growing issue with the current banking system is that deposits are not growing as rapidly as loans.
With the rising inflation, individuals are growing more reluctant to deposit money with banks. They are instead focusing on investment options with higher returns such as mutual funds and stocks. If banks don’t have enough deposits with them, their loan-to-deposit ratio (LDR) increases. High LDR means that they don’t have enough liquidity for unforeseen fund requirements.
As a result, they would be forced to be tighter with their loan disbursements. P2P lending is one of the most attractive investment opportunities for such investors. LenDenClub’s flexible maturity peer-to-peer investment plan (FMPP) offers returns of up to 10 to 12% p.a.* To bridge the credit gap in the country and service the growing requirement for credit in our growing economy, money lenders who are willing to deposit/invest in the system are crucial. By offering a viable investment option for investors, P2P lending attracts more investors and plugs this gap.
LenDenClub enables money lenders to access the credit market directly. The credit-gap in India left a huge untapped market. This gave the opportunity to P2P lending entities to create a business model that capitalises on this gap and allows its investors to earn better returns. This brings India’s large population of small- and medium-income individuals into the money lending landscape.
The marketplace itself is responsible to ensure that the invested funds go in the hands of creditworthy borrowers ensuring safe-lending practices.
Hyper-diversification of Risk
We have seen that small ticket personal loans form a significant proportion of the credit demand. But, we cannot deny the fact that there is risk involved in these loans. P2P lending solves this conundrum by hyper-diversification of risk. LenDenClub hyper-diversifies money lenders’ risk by dividing their money into small amounts, some as small as ₹1.
One of the key features of LenDenClub’s Peer to Peer lending product – FMPP is that your funds stay invested for a pre-selected tenure that can range from 1-5 years. You can select the time-frame for which you want to stay invested. Or you can create multiple FMPPs if you’re looking at different time horizons. This in turn allows LenDenClub to reinvest your funds + accumulated interest over and over again till maturity. The higher the time-frame, the higher will be your yield due to the compounding effect.
P2P lending is one of the effective solutions for plugging the growing credit gap in India. It also offers a high-return, low-risk investment opportunity for investors. These investors can be of varying incomes and risk appetites. LenDenClub is the place to go if you, as an investor, are looking for P2P help.
*P2P investment is subject to risks. And investment decisions taken by a lender on the basis of this information are at the discretion of the lender, and LenDenClub does not guarantee that the loan amount will be recovered from the borrower.