What is FMPP?
“FMPP is an investment offering in this era of low FD rates and volatile stock-market conditions. It has a completely new algorithm for capital allocation. It is under development and testing since last 18 months and it is finally live. The FMPP investment plan is an ‘alternative investment avenue’ for all categories of investors, be it retail or HNI,” says Bhavin Patel, Co-Founder and CEO, LendenClub.
Despite RBI raising rates several times, the 10-year G-Sec rate as on July 28 stands at 7.33% and bank FD rates are still yet to reach the level of 8% annualized return. So, is there more risk involved in a loan product that offers very high returns? Are there hidden risks that investors should understand, and should you go for such debt investment product? Read on to find out.
How does ffmp work?
P2P is a platform that allows individual investors to lend small sized amounts to retail borrowers. The new product, launched on a P2P platform, mandates a minimum number of borrowers, which requires diversification of the lender’s money to be invested. So, if you have Rs 20,000 to invest, it will go to at least 100 borrowers. Therefore, the maximum amount of exposure you can have per borrower will be Rs 200. They have built the algorithm in such a way that as the borrowed amount increases, it increases the number of borrowers. Theoretically it is possible to go for hyper-diversification by increasing the number of borrowers under this product so that the borrowing amount per borrower comes down to less than Re 1 per borrower.
How much can you invest?
The minimum investment amount that you need to lend in the new product is Rs 10,000 while the maximum investment amount is Rs 50 lakh.
what are its dangers?
Here’s a look at the potential risks of FMPP.
Effect of Default of Borrowers: The most common risk that a lender faces is non-payment of the borrower amount by the borrower. Like any other lending institution, p2p lending Companies have huge amount of NPAs which cannot be completely cleared. According to Patel NPA Levels at LendenClub have generally been around 2-6%. Any increase in NPAs can significantly impact the return and safety of capital. Hence, investors should keep this in mind before finalizing their investment.
Apart from proprietary credit profiling tools, diversification of lending amount to a higher number of borrowers and smaller ticket size per borrower are broad strategies used by the lending company to reduce NPA risk. According to Patel, they have designed the FMPP such that an investment amount is highly diversified across a vast pool of borrowers, thereby reducing the default rate significantly, thus offering risk-less returns to investors. .
Earlier a lender had to give a minimum loan of Rs 500 to a borrower, however, now with the new product it is possible to give a loan of Re 1 to a borrower as well. The P2P lender has kept the maximum borrowing amount less than Rs 25,000 for salaried lending. Whereas for a business borrower the maximum loan amount goes up to Rs 1.5 lakh. Since the FMPP will ensure that each lender will have very little exposure to a borrower, the company expects it to safeguard the overall investment.
fmp Defaults also faced by mutual fundsFixed Maturity Plans (FMPs) offered by mutual fund houses also provide a way to invest in debt products by holding securities till maturity and locking in the returns. These were considered secured debt investments until they faced defaults four years ago, when several schemes failed to pay back investors on time. However, these defaults were mainly due to some corporate clients with high debt who could not repay their loans on time. The FMPP offered by LendenClub differs in terms of the nature of the borrowers, the number of which is diverse and the ticket size is small. The small ticket size ensures that default by some does not affect the rest of the portfolio.
Risky Borrower Segment: The interest rate that is being charged to the borrower is at a higher level than what is usually done by financial institutions when there is more risk involved in lending. Like other NBFCs, the interest rate charged to borrowers under P2P lending is generally between 18% to 28%. Customers who have a good repayment history and a good credit score often get easy loans from banks at much cheaper rates. So, which type of borrowers are willing to pay higher interest on their loans?
Most of the people who borrow from P2P platforms are those who are either new to credit and without any credit history or accessing bank loans due to reasons like paperwork, time taken to process the loan, small ticket requirement gets difficult. Many such borrowers usually get their lending needs met by unorganized local moneylenders, who typically charge an interest rate of 3-5% per month which translates into an annual rate of 36%-60%. Ease of process and faster disbursement are also reasons why some borrowers in need of smaller loans may prefer P2P loans.
How reliable is the recovery system?
Patel explains that a major part of collection and recovery is IT driven such as reminder alerts and follow up by call bots which also keeps the recovery cost down. He reiterates that so far, their recovery has been strong and they were able to recover Rs 97.5 out of an NPA of Rs 100.
Yet to prove resilience to systemic risks: It survived the coronavirus pandemic, when LendenClub suffered its highest quarterly default of 6%, during which retail borrowers had a higher default rate. However, it is difficult to predict what the future systemic risks may be and how borrowers will behave in case of an economic crisis.
Should you invest?
FMPP provides an attractive return, but it is not a replacement for FMPs offered by MFs, bank FDs, small savings products and government securities mainly due to the high risk factor. If you fully understand the risks involved in P2P lending and are comfortable with the risk-return dynamics, you can consider investing in this product. However, it is better to keep your exposure low which can help you boost the return of your overall loan portfolio and give yourself some time to understand the product. If you want to tread more cautiously you can start with a short term FMPP of 1-2 years. Once you spend time and develop a better understanding then you can think of long maturity investments.