What Is Peer-to-Peer (P2P) Lending and How It Works?

Nowadays, multiple channels are available for accessing credit. Besides banks and NBFCs, digital platforms have also become an integral part of the loan arrangement process.
In this regard, Peer-to-Peer (P2P) lending not only allows borrowers to access funds directly but also promotes the use of regulated internet platforms that connect them to other lenders, thereby doing away with the traditional lending route entirely.
This blog explores the concept of P2P lending, its implementation in practice, its pros and cons, and the legislation governing P2P platforms in India.
 

What Is Peer-to-Peer Lending? 

The peer-to-peer (P2P) lending defines a lending model where an online platform helps the borrowing process instead of involving traditional banks. 
The platform does not lend its own funds. Most P2P loans are not funded by a single lender. They are split into groups, which is why the model is commonly called social lending or crowd lending. 

For example, a ₹1 lakh requirement for education or medical needs may be covered through multiple lender contributions on the same listing. The borrower repays the loan in installments once the borrowing is done, and the lenders receive interest according to the agreed terms.

Also Read - What is the Difference Between a Bank and NBFC?

How Does Peer-to-Peer Lending Work?

The mechanism revolves around an online platform that brings together potential borrowers and lenders. The platform manages the surrounding processes, and escrow accounts are used for fund movement in line with regulatory requirements.

The overall process usually follows these stages:
● Lender and borrower registration and KYC on the platform
● Loan application or posting by the borrower, including the loan amount, duration, and purpose
● Credit assessment and risk grading carried out by the platform using its underwriting framework and borrower data. Credit information is also shared with recognised credit information companies
● Interest rate discovery and funding, in which lenders select loans based on risk grade and expected returns. Loans are often funded by multiple lenders in smaller portions
● Disbursal through escrow once the loan is fully funded, in line with RBI-mandated fund-flow rules
● Repayments, made by the borrower into the escrow account and distributed to lenders according to the agreed schedule

Steps for Borrowers

1. Platform onboarding involves setting up an account and completing identity checks.
2. Loan requests are submitted by specifying the amount, tenure, purpose, and required documents.
3. Go through credit checks and risk grading, after which the platform assigns a risk category and outlines possible interest terms.
4. Get listed for funding, allowing one or more lenders to contribute to the loan amount.
5. Receive funds through the escrow route once the loan is fully funded and begin repaying instalments as per the schedule.

Steps for Investors (Lenders)

1. Create an account and complete KYC, then transfer funds to the designated lender escrow account as per platform guidelines.
2. Browse borrower profiles containing risk grades, loan terms, and expected yield information.
3. Spread funds across more than one loan rather than funding a single borrower, which helps balance risk.
4. Allocate investments and keep track of activity through the platform dashboard showing repayment and disbursal details.
5. Get principal and interest payments through the escrow route, based on borrower repayment rather than platform assurances.

With the Hero FinCorp's personal loan app for Android and iOS, you can check eligibility, apply, and track your loan from one place!

Benefits of Peer-to-Peer Lending

The advantages of P2P lending vary depending on whether you are borrowing or investing.

For Borrowers

Access to Funds for Those With Imperfect Credit Scores

Some borrowers who don’t qualify easily with banks still manage to raise funds through P2P platforms. This is largely because lenders look at risk more flexibly across different borrower profiles.

Competitive Interest Rates

Since P2P platforms typically operate with lower costs, interest rates can be competitive and, in some cases, lower than bank rates. Pricing depends on the borrower’s risk grade and lender demand.

For Investors (Lenders)

Higher Returns Compared to Traditional Fixed-Income Investments

Peer-to-Peer lending for investors can deliver higher returns than fixed deposits or savings accounts. Returns vary based on borrower risk and loan duration.

Diversification of Investment Portfolio

Lenders can spread funds across multiple loans. This reduces reliance on one borrower and lowers the impact of individual defaults.

Transparency in Loan Selection and Tracking

Platforms share borrower details, risk levels, and repayment updates. This helps lenders make informed choices and follow performance easily.

P2P lending offers flexibility. That does not make it the only option. Traditional personal loans are still worth comparing. Fixed rates and defined EMIs matter to many borrowers. Hero FinCorp provides personal loans through a fully digital process.

Risks Associated With P2P Lending
 

There are risks involved in P2P lending. These should not be ignored.

Default Risk (Borrower Non-Payment)

Borrowers may default. When that happens, lenders lose money. Platforms do not cover this loss.

Liquidity Risk (Difficulty Withdrawing Funds Quickly)

P2P lending is not designed for quick exits. Once funds are committed to a loan, they are usually locked in until the borrower repays over the agreed tenure. Some platforms may offer limited exit options, but these are not assured. 

Regulatory Risk (Changes in RBI Norms)

P2P platforms are regulated by the RBI. The RBI may introduce new rules that will impact how online platforms operate. This can gradually affect the limits, features, or user experience of the platforms.

Platform Risk (Operational Failure Of The P2P Platform)

Platforms do not hold funds, but they run loan systems. If the platforms go offline or encounter a problem, then the repayments and documentation will also be affected.

RBI Regulations for Peer-To-Peer Lending in India

The RBI has issued rules for P2P lending in India. These rules control how platforms operate and protect users.
P2P platforms must register as Non-Banking Financial Company – Peer-to-Peer (NBFC-P2P) entities before offering services. This keeps them under RBI supervision.

Key P2P lending regulations in India include:

Registration With the RBI is Mandatory

Every P2P platform must obtain a Certificate of Registration from the RBI. Platforms that are not registered are not permitted to onboard users or facilitate lending activities.

Limits on Borrower and Lender Exposure

Both the overall amount a borrower can raise across all P2P platforms and the amount a lender can invest are capped by RBI regulation. These limits are intended to reduce concentration risk and promote responsible participation.

Mandatory Use of Escrow Accounts

Escrow accounts run by licensed banks or trustees are required for all money transfers between borrowers and lenders. The prohibition on platforms holding or directly accessing user funds enhances transparency and lowers the possibility of misuse.

Detailed Data Reporting Requirements

NBFC-P2P platforms are required to report loan and repayment data to credit information companies. They must also adhere to the RBI's reporting guidelines, keep correct records, and reveal pertinent performance data.

P2P Lending vs. Traditional Bank Loans

Here's a breakdown of the major differences:

A personal loan from a reputable NBFC can be a better option if you want consistent payments, a single lender, and well-defined loan terms.

With Hero FinCorp, you can determine your eligibility online and complete your application in minutes without going through the hassle of needless platforms or funding cycles.

Choosing the Right Lending Option for Your Needs

P2P lending has conditions around limits, risk, and tax treatment that borrowers need to be aware of. Many people, therefore, continue to choose traditional loans for their simpler structure.

Hero FinCorp offers personal loans through a clear and transparent process, with defined eligibility criteria and fast approvals. With our loan options, you can plan repayments confidently and access funds without the uncertainty of multiple lenders or variable funding cycles. Get in touch with us for more info!

Frequently Asked Questions

What Is the Entry Point for Investing via P2P?

It depends on the platform’s rules. Many allow lenders to start with small amounts and build a diversified portfolio gradually.

How Do Platforms Decide a Borrower’s Risk Level?

Borrower information is assessed, and a risk category is assigned. Lenders can use that grading to spread investments across multiple loans.

Are P2P Platforms Allowed to Hold User Funds?

No. Money is routed through escrow arrangements as per RBI rules, not held directly by the platform.

Does a P2P Loan Show Up in Credit Reports?

For borrowers, repayment behaviour may be reflected in credit records. For lenders, credit scores are typically unaffected.