THE CHEAT SHEET. There’s a new lending boom

No, but in the US. And surprisingly, really really big in China.

Not yet, but it seems to be definitely headed in that direction.

It’s called peer-to-peer lending, that is, people like you and me lending money to others like ourselves (overwhelmingly online) without the stuffy banking system getting involved. It’s supposed to build a perfect but informal financial situation that’s a win-win for both lender and borrower. The lender gets higher than savings-bank returns while the borrower gets funds at, again, lower than bank interest rates.

In a true peer-to-peer platform, potential borrowers can explain their funding requirements which potential lenders can view and fund, if they like. Much like how crowdfunding happens online, but here, with the clause that the borrower does eventually pay back the money.

Quite obviously. For one, much of the credit profiling happens via browsing through the borrower’s social networking activity. And two, given the lack of regulation, there’s the risk of adverse selection, implying that the borrowers who choose this system are highly likely to those rejected by the formal banking system.

These are usually unsecured loans with no requirement of an upfront collateral. Also, the financial crisis left several people unable to borrow from banks — so peer-to-peer was an alternative route. In China, for instance, the banking system has always preferred lending to corporates over individual borrowers and small-time entrepreneurs, explaining why the peer-to-peer market there is much larger than in the US.

Some estimates put it at around $16 billion in China, to the US’ $10 billion, by adding up the loan value of online peer-to-peer platforms. The reason it’s getting bigger and gaining a lot of attention is the entry of institutional money by way of venture capitalists investing in these online platforms.

For instance, Yooli, a peer-to-peer lending site in China, has already received tens of millions of dollars in funding from prominent Asian investors.

But the signs are definitely there. One cause for worry is the entry of derivative products with peer-to-peer loans as the underlying asset. Banks are reportedly using these loans to create mortgage-backed securities, much like they did with home loans through the 2000s. These derivatives do have a genuine reason to exist — loan securitisation increases liquidity in the market. But the risks are the same as those that haunted the earlier wave of mortgage-backed securities — that lenders may become competitive and start bypassing checks and balances to just keep lending more and more, ultimately welcoming into the system borrowers who will be unable to pay back.

Not yet. Financial regulators in both the US and China are trying to rein online peer-to-peer lending in. China, the largest such market right now, might soon introduce bans on extremely high-risk financial products or strict capital adequacy requirements for these portals.

India does have a few, most of which are primarily crowdfunding or microfinancing platforms but don’t do the sort of big business that exists abroad. Which explains why they’re still out of the Indian regulatory purview.

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