*This is the second part of a multi-part series demystifying the recent developments and trends in the banking and financial services sector. Read the first part here.*
The main functions of a bank are aggregating deposits and issuing loans. With recent developments in FinTech, these activities are slowly being taken over by consumers. Developments such as P2P lending enable people with surplus capital to directly lend to the end borrower at a significantly higher return as compared to that of banks. Similar is the case with Crowdfunding. In this section, we explore the evolution of these products in the financial landscape, which is disintermediating the landscape and commoditizing some of the traditional models.
Peer-to-peer (P2P) lending is a method of borrowing and lending that takes place at an individual (peer) level without an intermediary or an aggregator of sorts. Peer-to-peer is able to reduce transaction costs as it removes middlemen/intermediaries (traditionally played by the bank or broker) from the process, while reducing transaction time given its digital nature. A person sitting in one part of the world, can lend to anyone through these platforms.
P2P platforms, like their brick and mortar counterparts, have their own methods of calculating risk and assessing creditworthiness. This enables the lender to make informed decisions about the loans. Lenders have a good estimate of what the risk involved is, their exposure in the entire loan, the interest rate on loans, and repayment schedule. This business model is largely fee-based. The platform takes fees during registration as well as per transaction.
In September 2017, the RBI issued a notification that all P2P lending sites are to be treated as NBFCs, bringing them under the RBI’s purview. The biggest benefit of such an arrangement is the quick access to loans at relatively short notice with limited transaction cost and procedures. The risk of default still exists, but that is the case with all loans. However, what makes this arrangement lucrative is its investor protection options wherein upto 100% of the principle amount is secured. The lender is able to get better returns as compared to traditional avenues because the intermediary doesn’t take a cut or load its margin onto the interest rate. As a result, this business model has caught on in India, with over a dozen sites coming up in the past few years– i2ifunding, Faircent, Lendbox, i-lend, LenDenClub, to name a few.
Crowdfunding as a means of raising money has grown in popularity in recent times. Regulators have been watching this sphere closely, with many recognizing its potential. SEBI released a consultation paper in 2014 where it defined crowdfunding as “solicitation of funds (small amount) from multiple investors through a web-based platform or social networking site for a specific project, business venture or social cause”.
In simpler terms, crowdfunding combines the concept of P-2-P lending (and transacting) and crowdsourcing to bring together individuals from across the world as investors, as a way of raising money for ventures. People are able to pitch their ideas directly to investors and donors, thereby connecting with them directly. People who are interested in the venture or the project can use this as a medium to directly be a part of the cause.
Crowdfunding may be used to raise money for a wide variety of causes, ranging from finance for a company to raising money for upgrading infrastructure in schools. Many Indian companies have used this method to raise money– Aisle, Printajoy, and Spin Academy, to name a few.
There are three types of ‘crowdfunding’: Donation, reward, and equity.
Donation crowdfunding is the raising of money with no return being provided. This is very common and widely used. This is used in cases such as raising money for education, healthcare, etc. Reward crowdfunding is where there is a promise of reward. These could be loans being given with interest being paid at the end and such. Equity crowdfunding is where equity is issued for the money being invested. letsventure, grex, ketto are some of the most popular sites in this sphere.
In India, strictly speaking, equity crowd funding is not allowed due to provisions in the companies act, SEBI act, and securities contract act. Currently, SEBI is working with the corporate affairs ministry towards finalizing the regulatory framework for crowd-funding in India. It floated an idea to categorize crowdfunding platforms as venture capital funds. However, this move faced a lot of opposition. Thus, equity crowd funding remains a tricky subject in India.
– Contributed by Bhargav
Picture Credits: eletsonline.com