In the traditional loan structure, financial institutions like banks act as the mediator. For the borrower, this generally means loans with high interest rates and a delay in loan disbursement.  

However, P2P lending single handedly solves both these pain points. In peer to peer lending, the transaction directly takes place between the borrower and the lender. 

As no mediator is involved, no additional costs are associated with procuring the loan. Further, the request to loan disbursement turnaround time is significantly reduced.

History of P2P Lending Marketplace

The concept of P2P lending is not new. An earlier account of peer-to-peer lending schemes in 18th century France states that local non-notarized credit markets existed way before the banks came around. 

These markets typically functioned in closed circles–people living in close neighborhoods exchanged money both in cash and goods (barter system) in the form of deferred payments. 

In fact, David Nicholson–the mastermind and co-founder of Zopa–reveals that inspiration for Zopa came from understanding the pre-banking past & the basic principles of lender-borrower relationship.

P2P lending made a comeback with the launch of Zopa in 2005.

Source: Precedence Research

Why is P2P lending the future of loans?

The numbers speak for themselves: the peer-to-peer lending market is estimated to advance at a CAGR of 28.3% during 2021–2031.

Other factors:

• People with low credit scores or those that lie in the low-income category find P2P lending highly accessible.
• As a source of financing, peer to peer lending has the potential to extend financial inclusion globally.
• P2P lending allows borrowers to get a loan for various purposes–for financing their education, debt refinancing, expanding their business, etc. 
• P2P lending is convenient as it can be done through websites or apps, also known as P2P lending platforms.

How does P2P lending work?

Peer to peer lending is fairly straightforward. All transactions are carried out through a specialized online platform. 

Here are the steps:

1. A potential borrower wanting a loan fills an online application on the peer-to-peer lending platform.
2. The platform assesses the application for risk determination and credit rating. Accordingly, the applicant is assigned with an appropriate interest rate.
3. On the application’s approval, the applicant receives the available options from the investors based on their credit rating and assigned interest rates.
4. The applicant can evaluate and choose from the suggested options.

Take note:

The applicant needs to pay interest payments periodically. Further, they need to repay the principal amount at maturity.

Further, the company maintaining the online platform charges a fee from both borrowers and investors for the provided services.

Who can lend or borrow in a P2P lending marketplace?

Lenders 

They can be both private individuals and institutional investors. Besides, traditional credit institutions like banks are increasingly allowed by platforms to participate in the funding. 

The reward received by investors in peer-to-peer lending is interest payments. These depend on the borrower’s default risk and the loan term.

Borrowers 

They can be both businesses and private individuals. Generally, everyone who fulfills objective criteria like nationality, legal age, etc. can normally invest in P2P loans. 

However, borrowers must pass a credit rating system that defines whether it is possible to borrow and on what terms. 

Borrowers achieve financing through an open call. So, it is easy for everyone interested to participate. 

What are the various P2P lending marketplace business models?

Globally, the first two models are majorly prevalent. But we will substantiate on the other ones too. 

1. Client-Segregated Account Model

It is the simplest form of P2P lending model where the lenders directly interact with the borrowers and themselves fix their counter parties. 

The process is as follows: 

• The borrower first puts in their loan request on the P2P lending site.
• These loan requests are then listed on the P2P lending website for the lenders to identify and act on the loan requests.
• After the borrower’s successful identification & credit worthiness assessment, the lender releases the funds in favor of the borrower.
• These funds are deposited into a specific account–the investor sub-account–maintained with the P2P lending company. There is a separate investor sub-account for every client (lender and borrower). 
• Funds are then transferred into the borrower’s investor sub-account for them to withdraw the same when convenient.
• Once the funds reach the borrower, the P2P lending company charges their administration fee from both the clients.
• At time of repayment (principle and interest), the borrower deposits the amount in the same investor sub-account.
• Then, these funds are transferred to the lender’s accounts. The lender can withdraw or use them to fund further transactions at the P2P lending portal. 

Benefits of the Client-Segregated Account Model

• This form of P2P model is very transparent as both the parties have complete knowledge of where their money is going. 
• Here, the lenders have no risk of losing their money in case the P2P company goes bankrupt. This is because there is a direct agreement between the lender and the borrower.

2. Notary Model

This is a comparatively complex form of P2P lending model. It involves a commercial bank besides the lender or the borrower. 

Here’s how the process takes place:

• The borrower puts in their loan request on the P2P lending site.
• The P2P company forwards the loan request to a commercial bank associated with it. The bank sanctions a loan and issues the loan promissory note to the company.
• The company forwards the promissory note to the borrower & charges an admonition fees. 
• The borrower submits the promissory note to the issuing bank and in return, gets the amount. 
• Meanwhile the company lists the loan request on its website. Lenders view them and advance funds to finance the request. 
• Once the company gets sufficient funds, it immediately buys the loan receivables from the commercial bank. At the same time, it issues pass-through certificates (PTC) to lenders while charging an administration fee from the lenders. 
• At the time of loan repayment, the borrowers pay the company to pay off their debts. 
• The amount is transferred to the lenders’ accounts. 

Benefits of the Notary Model:

• This form of P2P lending model saves the borrowers’ time in getting a loan. Borrowers do not need to wait for a lender to identify him/her and advance them loans.
• Instead, the company helps the borrowers by making the loans originate from the bank as soon as possible and later converting the loan into a P2P loan. 
• This is the model used by the industry leaders like Lending Club and Zopa.

3. Guaranteed Return Model

Here, the platform collects funds & applies an interest rate. It is calculated considering the borrower’s risk and the loan’s features. 

This can be done using two different methods:

• Method 1: 

A research and pre-screening of financers outside the platform is done. Then, the loan request is displayed on the platform website for the lenders to make their offers.

This is a popular method in China where there is an excess of supply compared to the demand. 

• Method 2:

Here, an algorithm automatically invests the funds collected. The remuneration is calculated based on the rates & loan duration.

4. Balance Sheet Model

The platform retains loans in their balance sheet for it to sell them to institutional investors, or other retail investors financing loans.

In this case, the platform obtains the money from these investors and provides it to borrowers.

The borrowers, in turn, pay interests to the lending platform. In case the platform fails, investors will have difficulties obtaining their money back.

Final Note:

There are many reasons to expect the continued rapid growth of P2P lending. The fact that the internet can facilitate disintermediation by allowing parties to communicate directly with one another is a fundamental reason.

Further, P2P lending platforms have several competitive advantages over the incumbent suppliers, i.e. the banks. These are:

• Better return rates than those on bank deposits 
• Relatively low fees for borrowers
• Credit provision to some types of borrowers unable to access bank lending
• Technical innovation, that is improving the quality and speed of service to borrowers and lenders.

Want to build a premium P2P lending marketplace? Talk to us for a free demo.