How and in which proportion should you invest money on peer to peer lending?

Peer to peer lending or P2P loans is a new concept which has taken off in various countries across the world and is poised to make an entry in India. Pending RBI guidelines, you will soon be able to participate in this financial apparatus as a borrower or a lender. The concept is simple- just as you lend money to friends/siblings/colleagues in times of need, you can now lend to strangers through the help of a validated online underwriting platform at a specific rate of interest.

As an investor, you can hedge your risks by lending smaller amounts to different borrowers. You can do this to disperse your risks and lend amounts to safer profiles at a lower interest rate and to riskier profiles at a higher interest rate. So to give an example, if there are borrowers A, B, C and D with varying risk profiles and you have Rs. 50,000 to invest, you can choose to lend Rs. 10,000 to each at interest rates ranging from 13% to 25%. This keeps part of your investment safe while taking a small risk with the rest to earn more.

The concept is no different from an equity based insurance schemes where a part of the premium you pay is guaranteed with a much lower returns while the rest is linked to investments that are riskier. The idea thus is no alien to us in India with the only difference being that now you have the power to decide the risk you want to take and rewards you want to earn on your own. While this might be the case, studies in countries where peer to peer lending is already popular indicate that investors always end up with gains much higher than some other financial instruments even with defaults. The studies indicate that the delinquency rate itself is not very high and investors can safely lend to all sorts of profiles. For instance Lending Club, the largest P2P platform player in the US states that 99.9% of investors who have atleast 100 investments have seen positive returns.

This is great news for everybody who wants to invest through Peer to Peer lending in India and also an indicator that you need to diversify your investment and not keep all eggs in one basket. Infact the least interest rate charged on a P2P platform in itself is higher than the rate for a fixed deposit while being in the same vicinity of safety. The following table indicates the risk vs reward matrix for peer to peer loans and the ultimate average payout.

	Fund	₹ 1,00,000
	Utilization of funds	85%
	Funds in rotation	85000
	Rate of Interest	14%	16%	18%	20%	24%
	Default rate	0.5%	1.0%	1.5%	2.0%	2.5%
	Percentage of Fund parked	10%	15%	20%	25%	30%
	Absolute amount	₹ 8,500	₹ 12,750	₹ 17,000	₹ 21,250	₹ 25,500
	Average Ticket Size	₹ 2,500	₹ 2,500	₹ 2,500	₹ 2,500	₹ 2,500
	Number of investments	3.4	5.1	6.8	8.5	10.2
	Bad Debt	₹ 43	₹ 128	₹ 255	₹ 425	₹ 638
	Interest earned	₹ 1,190	₹ 2,040	₹ 3,060	₹ 4,250	₹ 6,120
	Interest(Less Bad Debt)	₹ 1,148	₹ 1,913	₹ 2,805	₹ 3,825	₹ 5,483
	Net interest rate	17.85%

As the calculation shows, you can have a percentage of your capital deposited in loans with different interest rates from high to low. The lower rates indicate safer profiles indicating an ability, history and proof of good credit while this decreases as the interest rate rises. Even with a delinquency rate as high as 4% for the most risky profile, which in reality is lower, you can still end up with a net interest rate of nearly 17% on your investment which is much higher than even what some MFs provide.

Average Return on Investment     

      

Since it is established that peer to peer lending is actually safe and lucrative tool for investing money if you hedge your risks, let us look at how you should be investing your money. As a private investor, you might not have the time, inclination or expertise to go through every profile and then decide whether to invest or not. To take this a little further even if you look at interest rate buckets it might be difficult for a new investor to take a call on what percentage and how many profiles to invest in as part of each bucket.

The popular method which has come up to deal with this dilemma is the Average RoI calculator developed by most P2P platforms. This convenient tool leaves you with only one decision to make which is the average RoI you want from your investment. As soon as you decide on this, the tool decides on how much to park in each interest bucket as well as the number of profiles. Upon approval, the tool goes ahead and makes the investment on your behalf and you can track investments periodically to ensure that things are going according to plan. Again Lending Club states that a majority of private investors opt for this option when making their loan investments

Risk Receptiveness

Risk receptiveness is a technical as well as psychometric concept that estimates your aptitude to take chances and bet on rewards. There are obviously a lot of psychometric tests which estimate this based on a number of criteria. In terms of a peer to peer lending environment, the onus rests on you to estimate the kind of risk you want to take. The RoI calculator does most of the work for you to advice on the investment pattern based on the returns you expect but it is expected of you as a lender to also look at investments in riskier profiles. The calculator might suggest about 30% investment in about 25 profiles in the medium to high risk categories. It is dependent on you as an investor to estimate whether you are satisfied both in the percentage of investment as well as the number of investments. There will be calculators in the future which will help with estimating your risk receptiveness.

So having money parked in your account doesn’t make much sense now. While it is good to have safer investments like FDs, it doesn’t harm to have another investment avenue in P2P loans.