Why online lending should not be regulated

Online lending marketplace is the latest innovation to hit the consumer finance world. It goes by its more popular name "peer-to-peer lending".

It directly connects an individual lender and borrower using a simple online platform. It links one who has a capacity to invest and the other a need for finance.

There is no need to go to a bank or a friend, family member or moneylender. And you can avoid many formalities and onerous conditions to get a small loan and tide over a sudden or short-lived financial exigency. Think of it as the Uber or Airbnb of on-demand lending - for small businesses, for the self-employed, students, families, and financially excluded.

One can see the popularity and demand for such an instant credit service in China, where in 2016, there were 2,349 such P2P platforms operating with $100 billion loans outstanding. In India there are 30-odd lending marketplaces with sub-$20-30 million portfolio.

It is early days still in India.

Whether the lending marketplace system in India would want to emulate the Chinese diffusion model or carve out its own unique model of growth and viability is anyone's guess. But regulation will play a big part on how this pans out in India.

Generally, one finds that in markets that are in early stages of their development, regulation is a burden for both the emerging sector and the regulator alike.

While regulators are quick to scan and spot new innovations, whether it is marketplace lending, crowdfunding, blockchain, robo advisors, virtual stock games, algorithmic trading, drones, driverless cars or anything else. They then inadvertently end up slowing down these innovative processes through poorly thought out, though well-intentioned, oversight.

It seems regulation works best in hindsight.

Mobile banking/ payments and digital wallets did not exactly benefit until a few years back (100 per cent growth being the norm now).

The axis has shifted to the customer, who is being served by a variety of competing business models, not all coming under the purview of various Acts and supporting legislations. The explosion of mobile banking (expected to be $100 billion in value terms by March 2017) is a proof of how private banks (and later PSU ones) got their act together and worked with start-up fintech companies to rejig their apps, sites and in-house wallets to keep up with customer expectations, rather than trying and do everything by themselves, or waiting for the regulator to dictate or goad them. My point is that the days of supply-side/industry-based regulation is now obsolete.

Markets, if left alone, are self-correcting in nature.

What are the benefits of this type of uberisation in the lending and borrowing space?

a) Cab aggregation platforms in India have overnight transformed and formalised the hitherto disorganised retail transportation market into a lucrative $20 billion market with significant employment and second order economic benefits.

b) It has the potential to end the usurious nature of the Indian informal credit market. Thus for instance, kali peeli taxis, Merus, hire cars, radio cabs, AC cabs haven't got "killed", but their ability to extract unfair surplus has been.

c) As P2P does not carry liabilities on its books and no conventional balance sheet risks as such (P2P platforms source their income predominantly from arrangement fees from both sides), these platforms, asset-light in essence, become "non-banking, non-financial companies". Therefore,

1. The proper regulatory authority for "non-banking, non-financial companies' is the ministry of corporate affairs. However, these companies should register with the Reserve Bank of India (RBI) so that at any point the central bank can track the growth of this sector and make mid-course corrections for systemic risks.

2. Whilst they register with the relevant regulator, they must remain a self-regulating mechanism, which is a self-regulating organisation (SRO), as in microfinance and pre-paid wallet sectors. This mechanism supports and supplements regulatory bodies and reduces their burden of supervision.

3. Business rules should be not attempted to be granularly defined or cast in stone in early stages.

Here are a few ways in which to go about it:

a) Among proposed guidelines, P2P lenders are required to put investors' money in nodal/escrow accounts in banks. Under such an arrangement, banks would have to disclose an array of data including the platform's number of borrowers and lenders and its volume of bad loans. These can be done equally by an SRO and backstopped by credit ratings agencies.

b) Subsequently, the SRO from day one (working closely with the relevant regulating body, and across) can also work out detailed guidelines on various industry safeguards like leverage, interest rate caps, lending/borrowing caps, borrowing processes, KYC, underwriting norms and soft and hard credit check.

c) Since the tech platform has no financial liabilities, exposures or provisioning requirements (it just connects lenders with borrowers), the equity of Rs 2 crore is high. Most companies are happily capitalised at tens of lakhs (pre-funding) with modest debt:equity ratio. Therefore, a proportional capital base dependent on size of portfolio may be better.

In conclusion, while regulatory oversight is unavoidable its nature (light versus definitive), timing (now, or after a year) and mechanism are debatable.

A direction-setting approach at early stages and thereafter, based on data and operational experience, a light approach should hold the industry in good stead in years to come.

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