How Will Recession Affect P2P Lending? Are We Prepared?
P2P lending is one of the fastest growing alternative investment platforms in India but will it survive an economic downturn? How prepared are P2P lending companies in the event of a recession?
One of the cruel facts of a flourishing economy is the impending threat of recession looming large in the horizons. As per a report by the International Monetary Fund (IMF), recession affects the global economy every eight to 10 years. And all it takes is as little as a GDP that declines for two consecutive quarters. The underlying causes of recession may be more complicated – it may range from high interest rates to inflation to Brexit to US policy changes. Even an unknown leader from an unknown country having a sneeze can affect the global economy. Basically, factors beyond one’s control and even understanding.
Over the years we have seen how investor mindset changes during a recession. Investors may either start buying low hanging fruits in the stock market or switch to gold. But have you ever wondered how recession impacts P2P lending? Being a nascent industry in India investors may not be aware how bad times may (or may not) affect this fast growing sector.
How recession affects loans
Loan, as an asset to institutions, deteriorate in value due to recession. The default ratio of loans begins to increase due to loss of credit and jobs. The loans which erstwhile looked promising may falter. And in case recession prolongs then the number of defaults may increase alarmingly.
P2P loans may also meet the same fate as they are unsecured personal loans and subject to issues such as loss of job.
How recession affects P2P lending
No one can know for sure how recession will hit P2P lending and P2P loans because there is no first-hand account. Two of the most popular contemporary P2P lending companies in US were fledglings when recession hit in 2007.
We can merely speculate while comparing P2P loans with bank loans.
- Unsecured P2P loans: Unlike housing loans or auto loans, P2P loans are unsecured. In a booming economy this is the USP of P2P lending companies, but in a recession the lack of collaterals may pose a grave problem as the defaults rise.
- Debt consolidation (vicious) cycle: One of the most popular reasons why people approach P2P lending is to get debt consolidation loans. It is a personal loan used to pay off or consolidate all other loans or payments, for example credit card payments. In a debt consolidation loan a person pays off high interest credit card loans by taking low interest P2P loans. The problem arises when the person, after paying off credit card bill, starts using the credit card again. This puts a burden on his repayment capacity. This situation will be aggravated during a recession.
- Liquidity of funds: Most P2P lenders face the issue of early exit or liquidation of their investment. Investors usually need to wait for the borrower to repay the entire loan amount and interest before they can liquidate their whole invested amount.
How Can RupeeCircle Offset Losses from Recession
Standard and Stringent Underwriting Processes
P2P loans disbursed by us will always be unsecured. But the stringent credit underwriting process refines the borrower credibility on the platform. Furthermore, a balance is maintained between the lenders and borrowers on the platform. The reason for this is as explained below:
- When the number of lenders is more than the number of borrowers it would be compelling to disburse loans to risky borrowers which will result in more defaults.
- When the number of borrowers is more than the number of lenders then the borrower loan requirement will not be met in a timely manner which will hamper the credibility of the service.
Emphasis on Diversification
The loan applicants on the RupeeCircle marketplace are categorized from A to F (A being the least risky applicant). Investors are urged to diversify their funding to a good mix of applicants for good returns and risk mitigation. In the event of a recession an investor with a diversified portfolio will incur lesser losses.
Tie-up with Tata AIG
One of the factors that set RupeeCircle apart from its peers is its tie-up with general insurer, Tata AIG. Borrowers are insured against job losses. What this means for the investor is that if a borrower is unable to repay due to loss of job then the insurer with pay the loan amount for up to 3 months.
The secondary marketplace at RupeeCircle is an excellent avenue for investor to liquidate their funds. Those who opt for an early exit can list their portfolio here; alternately investors can also buy loan portfolios from the secondary marketplace. How a secondary marketplace performs during an economic downturn is yet to be seen but the shrewd investor does have the option for an early exit.
The fear of recession will always loom large over investors, but investments in P2P lending RupeeCircle is safeguarded against multiple scenarios.