Is demonetisation a boon or bane for P2P lending sector?

In the wake of demonetisation, peer to peer (P2P) lending is likely to gain ground as the share of informal lending channels has always remained significant in India

By Raghavendra Pratap Singh

It wouldn’t be any exaggeration to say that India is going through a phase of a financial emergency. Rs 500 and Rs 1,000 notes which make up 24% of the notes in circulation have lost their value permanently. They may only have some vintage value in future. Astonishingly, 98% of consumer transactions by volume and 68% by value are executed in cash. (Data Source: PricewaterhouseCoopers, Bloomberg Quint). This may give you an idea about how cash-strapped Indians have become overnight. RBI now has a herculean task of taking 2,300 crore currency notes of Rs 500 and Rs 1,000 off the shelf and infusing new notes of various denominations of an equivalent amount. It might take a while before situation at the grassroots level comes to normalcy. (Data Source: Indian Express dated November 09, 2016)

End of the parallel economy?

The country has been fighting with the demon of black money. The estimated size of the parallel economy is around 26% of India’s GDP. In other words, the informal sector is more than 1/4th of the formal economy and goes untracked by the Government. (Data Source: McKinsey & Company, Bloomberg Quint). The move of demonetization has been the Joker in the pack. Likely, it’s going to change the dynamics of the Indian economy, almost permanently. Indian Government has come down heavily on the hoarders of cash. The scrapping of currency will automatically destroy a large chunk of black money and the counterfeit currency.

Here’s how

Those with a large stock of black money held in Rs 500 and Rs 1,000 notes may not swap the old currency with the new ones, fearing the legal action. The Government has provided immunity to genuine taxpayers and honest citizens. However, any account receiving cash deposits over Rs 2.5 lakh between November 10, 2016, and December 30, 2016, will be reported to the tax authorities. In such cases, if the tax returns filed by the depositor fail to justify the possession of a big chunk of cash, the Government will take intense actions that include slamming of 200% penalty on the tax amount.

And that will result into…

Back in 1978, When Morarji Desai Government had launched a demonetization drive, nearly 25% of hard currency didn’t return to the system. This indicates that citizens had earned the same by dodging taxes or maybe through illegal activities. If we were to see a replica of that in 2016, the finances of the Government would receive a nitro boost.

Let’s understand the nitty-gritty…

The currency in circulation is shown on the liability side of the balance sheet of RBI while the asset side is comprised of investments, viz. treasuries. When the currency doesn’t return to the system post-demonetization, RBI’s liability reduces proportionately, but there wouldn’t be any simultaneous write-offs on the asset side. This will result in huge revaluation gains depending on the quantum of fall in liability. Higher the windfall, higher would be the amount available with RBI for announcing dividend to the Government.

Significant improvement in the fiscal position of the Government helps it borrow at a cheaper rate. Falling yields on sovereign bonds denote that the lenders are ready to accept lower rates for parking their monies in Government treasuries.

The intent of the Government behind scrapping the high denomination notes is very clear—it wants Indians to prefer more formal payment channels and shift away from the cash economy.

The process is already underway

Within first few days of India abolishing Rs 500 and Rs1,000 notes, Indian banks were hit by a tsunami of money as they collected over Rs 3 lakh crore. The number will swell up by the time the deadline of December 30, 2016, gets over.

India has witnessed demonetisation twice before—in 1946 and 1978. However, as compared to then, the scale of demonetisation this time has been unmatched. In 1946 close to 12% cash was sucked out of the system. The proportion fell to 2% in 1978. In the on-going cleaning act, India has planned to scrap over 86% of the money in circulation—mammoth by any standard.

Impact on the banking sector…

It’s quite evident that banks which faced a liquidity crunch until recently and depended on RBI’s liquidity infusion, have all of a sudden witnessed unprecedented inflows. Please don’t be surprised if interest rates on deposits go down. In the absence of strong credit demand, banks are likely to slash deposit rates. Since they follow Marginal Cost of Funds based Lending Rate (MCLR) regime, loans will also get cheaper along with deposits. Plus, falling inflation may provide RBI more elbow room to reduce policy rates, if it feels appropriate. These factors, together, may reduce the interest rates on loans substantially.

Impact on P2P lending platforms

In the wake of this, P2P lending is likely to gain ground. The share of informal lending channels has always remained significant in India. As per the data published by Ministry of Statistics & Programme Implementation (MOSPI) based on the 70th round of National Sample Survey, about 32% urban and 22% households reported outstanding cash loans. Further, non-institutional credit accounted for 19% of families in rural areas and 10% in urban areas.

Another interesting trend that emerged from the survey was institutional players mainly distributed loans at a moderate interest rate ranging from 6% to 15%. Approximately 92% of the urban loans and 89% of the rural loans provided by the institutional investors were priced below 15%. This indicates that institutional lenders are cautious to the creditworthiness of the borrower and are reluctant to cater to the needs of a large section of the economy.

The average household debt-asset ratio in rural India hovers at 3.23% while that in the urban area stands at 3.70%.

This statistic makes it clear as to why so many Indians depend heavily on informal lending sources. Non-institutional players lend at 20% plus the interest rate. As a percentage of total loans disbursed by non-institutional players, 69% sanctioned in the rural areas and 58% in urban areas quote a rate of 20% or higher. Transparency has always been an issue with non-institutional lenders, in particular with those dealing in cash.

More about non-institutional lending

Traditional moneylenders, chit funds, nidhis and hundis among others have huge sums of hard currency generated through legitimate or illegal business activities. Since amounts are undisclosed, they usually don’t make bank transfers instead issue cash loans—no compliance is an added advantage to them.

Now with a big chunk of black money getting wiped out, non-institutional and cash lending activities are likely to get whacked. In such a scenario P2P lending would vanquish.

Changing times…

After receiving the shock therapy on November 08, 2016; businesses in India, small and big both, will shy away from dealing in cash. As the more money would stay within the system, chronic cash deficits with banks may fade away, resulting in a further drop in the deposit rates. P2P lending would provide an excellent alternative to those who are willing to retain the risk associated with lending. In layman’s language P2P lending platforms allow you to be a bank of the borrower. Whether or not to lend to a person is completely your choice. Lenders share risks among themselves. P2P platforms such as ours provide you with an in-depth assessment of the credit profile of the potential borrower.

Although out of complete necessity, individuals and businesses would increasingly turn to digital payment solutions. More folks would use formal channels to borrow money. P2P lending platforms would be the frontrunners in reaping the benefits of this emerging trend.

Depending on the risk grade of the debtor, you may earn interest which may range from 12% to 30%.

A compelling case for people with surplus money especially builders and jewellers…

The primary market for the real estate which is dominated by the cash-rich investors may get more illiquid with demonetisation. Moreover, the premium for being honest will go up with Government clamping down on black money. This will leave lesser cash in the hands of real estate developers, and property deals might increasingly happen in a more transparent way. For the efficient utilisation of surplus, developers may consider P2P lending as a useful option. The same holds true in the case of Jewellers and bullion market participants. Even if a small population from these two classes engages into lending activities on P2P platforms, the market might grow by leaps and bounds.

Benefits to the borrowers

The high debt-asset ratio indicates that most of the potential borrowers would still remain out of favour for institutional lenders. Those who are ready to pay the right price for securing loans would turn to P2P platforms as the local money lenders might be planning to shut their shops. Cash is no longer king

Borrowers that depended on informal lending sector so far may initially find it difficult to secure a loan from formal sources, in the absence of dependable credit history and credit score. If you go to a bank asking for a personal loan, it may just deny you any credit. India has a large under-banked population. P2P lending platforms would be the perfect place for such borrowers.

Securing a loan through unscrupulous private money lenders often involves paying unreasonable interest, keeping disproportionately high collaterals. If that’s not enough, you also have to face mental harassment at times.

P2P lending is free of all such faults. It’s one of the most transparent platforms available for securing private loans without many hassles. Likeminded lenders team up to finance the needy. P2P platforms are impartial—for them, all lenders and borrowers are at par. This serves as a proof of the real intent and legitimacy.

Are you ready to make your first appearance on a P2P platform?

The article is contributed by Raghavendra Pratap Singh, Co-Founder of i2ifunding, a leading peer-to-peer lending firm.