P2P Lending in India Faces a Reckoning

India has a credit problem. EY says retail credit penetration is just 11%. Compare that to the U.S at 75% and China at 55%. That’s a huge gap. And where formal lending doesn’t reach, informal lenders step in at a hefty price. For rural households and farmers, this means borrowing at interest rates over 40%. That’s even worse than the penalty rate on your credit card when you default. Formal credit needs to expand, and fast.

One potential fix for this gap is P2P lending, or peer-to-peer lending. It connects borrowers and lenders directly, cutting out traditional banks and reducing costs for both sides. Borrowers get loans at relatively lower rates—typically around 16-18%— a world apart from the usurious rates of moneylenders. Lenders, on the other hand, earn decent returns, usually about 9-12%, which beats your average FD or debt fund. The difference, or the “spread”, is earned by a P2P platform that helps connect the two together.

Back in 2017, the RBI tried to bring some structure to this budding industry. It allowed P2P lending to happen through a special Non-Banking Financial Company (NBFC) license, with a regulatory circular outlining how P2P lending should work. The idea was straightforward: P2P platforms would act as matchmakers, connecting borrowers with lenders. No loans would sit on the platform's balance sheet. Everything would remain direct—one lender to one borrower, or maybe a group of lenders to a single borrower.

Remember, when a lender gives money to a borrower, and the borrower defaults, it’s the lender that gets impacted, not the P2P NBFC platform. It is important because the risk of default cannot lie, even partly, on the platform - it’s entirely peer-to-peer.

But it was also obvious that a Suhruth lending money from Bangalore to a Divyansh from Jaipur would simply not work because there is no security against the loan and there’s no way to recover the money easily from a distance. Someone had to “guarantee” the loan in some way, either through a solid recovery mechanism, or an insurance of sorts by a guarantor offering to pay if the borrower did not. RBI wanted only the recovery mechanism, not the “guarantee”. Risk, in RBI's opinion, should only be for the lender - not any other entity that appeared to guarantee the loan, otherwise such entities would be akin to banks that take deposits and lend.

In essence, it was that platforms started bending the rules. Instead of just connecting people, they began pooling money from lenders. Once pooled, it wasn’t really P2P anymore, with many lenders in a pool lending to many borrowers. If someone defaulted, it could be spread across the entire pool. If one lender wanted to get out, you could have their stake bought out by someone else in the pool, or it could be subsidized by a higher spread earned by the platform. But both these concepts are not legal in P2P; RBI wanted the platform to take no risk, so using higher spreads to cover defaults was illegal. Replacing lenders in a pool is effectively playing the role of a bank rather than a P2P solution.

To make matters worse, some platforms began offering loss guarantees to lenders, standing “guarantee” for any losses. This fundamentally changed how these platforms operated.

Here’s what happened next:

Lenders Were Blind: Instead of knowing who their money was going to, lenders were now dealing with an opaque system. The platforms essentially said, “Don’t worry, we’ve got this,” without offering any visibility into who the borrowers of their money were, and whether they were creditworthy.

Illusion of Safety: Loss guarantees gave lenders the false impression that their investments were risk-free. It’s like putting your money in a high-risk investment but being told, “Don’t worry, you can’t lose.” That’s not how risk works.

Loss guarantees were a clever marketing move on the surface, they made P2P lending seem like a risk-free alternative to traditional fixed-income instruments. Platforms effectively told lenders, “Don’t worry about defaults; we’ll cover the losses.” This illusion of safety worked well when Non-Performing Assets (NPAs)—or defaults—were low. As long as most borrowers repaid on time, platforms could absorb the occasional default without breaking a sweat.

But here’s the problem: this only works until it doesn’t. When NPAs start climbing, the entire house of cards begins to collapse. Why? Because platforms, unlike banks, don’t have the capital buffers or regulatory safeguards to absorb sustained losses. They’re essentially promising something they cannot guarantee if the numbers go south. They were never supposed to take the risk in the first place, so RBI didn’t place any lending capital requirements on them.

And then it happened.

According to an RTI response received by us from the Reserve Bank of India, NPAs, defined as loans in default for over 90 days, in the P2P lending sector have skyrocketed. At the end of FY19, NPAs stood at a relatively modest ₹19 crore. By the end of FY24, this figure had exploded to ₹1,163 crore.

Year	FY 19	FY 20	FY 21	FY 22	FY 23	FY 24
Total NPAs (In Crore Rs.)	14.7	25.9	107.9	191.7	472.1	1,163

So, there’s no consensus on how big the industry actually is. Strangely, the RBI did not reveal any AUM numbers, saying that they did not have the data. Though that may be because of the fact that P2P lenders were not supposed to have loans on their books (this is what was flouted thought). The Hindu Businessline cites a figure of ₹6,500 crore. With NPAs at ₹1,163 crore, that’s over 17% of the total lending in the sector. That’s not just bad, it’s potentially catastrophic.

Naturally, the RBI has stepped in with tighter regulations. The first thing they’ve done is to axe the pooling of loans. Going forward, lending has to be purely peer-to-peer—one lender to one borrower, or many lenders to one borrower. No more pooling funds into a single pot. All losses will now be passed directly to the lender. In return, lenders get more transparency: details about the borrower, including credit scores. This transparency will align risk and reward, giving lenders a clear view of exactly what they’re signing up for.

This change also shifts how P2P platforms make money. Gone are the days of earning through the spread between borrowing and lending rates. Platforms will now have to pivot to a fixed-fee model. On paper, this makes the business more sustainable in the long term. But here’s the catch: with no “skin in the game,” platforms might be less incentivized to help recover funds in case of a default. Lenders could end up carrying the full burden of chasing down borrowers, which isn’t ideal.

Loss guarantees have also been banned outright. At first glance, this might seem harsh, why not let platforms absorb the losses if they want to? But this change makes sense when you think about the bigger picture. Loss guarantees on inherently risky lending products distorting risk and creating moral hazards. When platforms promise to cover losses, lenders treat P2P lending as if it’s risk-free, which it absolutely isn’t. Worse, a loss guarantee makes a P2P platform equivalent to a deposit taking NBFC, a concept which RBI is very wary of and does not give new licences for.

And then there’s the systemic risk. As the industry scales, offering loss guarantees becomes dangerous. A wave of defaults could easily topple a platform, threatening its solvency and shaking the entire sector. By banning guarantees, the RBI forces both lenders and borrowers to acknowledge the true risks, making the system healthier in the long run.

Not all of the RBI’s new measures are equally balanced, though. Some of them might stifle the industry before it has a chance to mature.

The RBI now mandates that all transactions settle within a T+1 timeframe (one day after the transaction is authorised). P2P platforms have to use two escrow accounts—one for the lender and one for the borrower—and this process works fine. But under the new rules, any transfer from the lender’s escrow account has to reach the borrower’s escrow account within a single day, and vice versa.

For context, India’s stock markets only recently moved to a T+1 settlement cycle from T+2, and that’s for a highly liquid, well-established ecosystem. Forcing a budding industry like P2P lending to adopt T+1 settlements feels unreasonable. It’s an expensive operational burden on platforms already struggling with high NPAs and massive regulatory changes

The RBI has also introduced caps that are overly conservative. Lenders can’t lend more than ₹50 lakh across all P2P platforms, and anyone lending above ₹10 lakh must prove a net worth of at least ₹50 lakh. On the borrower side, the cap is ₹10 lakh across platforms, with a further limit of ₹50,000 per lender to a single borrower.

This seems like regulatory overreach. If a lender understands the risks (thanks to better borrower transparency, introduced by the RBI) and is willing to take them, why impose such tight limits? Similarly, if a borrower with a strong credit score can convince lenders to fund more than ₹10 lakh, why should the RBI stop them? These limits only complicate the matching process for platforms and prevent the industry from scaling to meet India’s credit gap.

Here’s another issue: platforms have no way of knowing a borrower’s or lender’s exposure across other P2P platforms. The RBI now requires borrowers and lenders to provide certificates declaring compliance with these caps. But what’s the enforcement mechanism? There’s no mention of penalties for borrowers or lenders who fudge the numbers, and platforms are left relying on a trust-based system.

A better solution might be a centralised repository for P2P credit data. Platforms could access this database after receiving an application, ensuring compliance with limits. Such a system would also give the RBI real-time visibility into the total outstanding credit in the sector.

This is a pivotal moment for the P2P lending industry. While some of the RBI’s measures are well-intentioned, others risk strangling growth. The industry itself needs to step up. An industry-specific body for P2P players—separate from general digital lending associations like the DLAI—could establish common standards, encourage collaboration, and engage constructively with regulators. This could pave the way for a more sustainable and scalable P2P ecosystem. At what seems to be 17% NPAs, the system looks ready to implode.

And then there’s the RBI. I don’t envy their position. They’re tasked with finding the sweet spot between encouraging innovation and ensuring the sector doesn’t implode. Striking that balance will be no small effort, but with the right focus and decisive action, there’s every chance for the sector to be shepherded toward a more stable and innovative future.