The people’s bank that LiquiLoans has built

The non-banking finance company founded in 2018 had stitched some early high-profile partnerships with fintech platforms Cred and BharatPe. It is now leaning more towards mutual fund distributors, targeting clients looking to diversify beyond fixed deposits. But where does the 10% rate come from?

The answer is quite surprising: zero-cost EMIs, or equated monthly payments, for consumer loans. These loans are given through merchants such as Dr Batra’s, VLCC, and Upgrad, and the merchant absorbs the interest rate on the loan.

LiquiLoans passes on this interest (net of fees) to the lenders on its platform. The loan is disbursed to the merchant rather than the end-consumer, which cuts the risk of the customer using the money for some other purpose. Since the loans are small (below ₹1 lakh, on average) and low tenor (under 12 months, on average), chances of default are low, Adukia explained.

Spreading the risk

The default, or non-repayment, rate for LiquiLoans is less than 1%, which has a bearing on the fee earned by the platform. The platform earns a spread (as fees) between the lending rate (10%) that investors get and the borrowing rate (charged to the borrowers) at 18-20%.

The math has worked out well for the company, with no consumer complaints of default the past 5 years.

The market is also large. Adukia estimates it at around ₹50,000 crore, mostly with NBFCs such as Bajaj Finance. LiquiLoans says it offers better terms to dealers and is able to nibble at a small share of the industry. But there is still room for it to grow.

LiquiLoans also has an algorithm that automatically assigns a customer’s investment to hundreds of small loans, spreading out the risk. Exposure to each borrower is limited to 0.5%.

This takes away the headache of manual selection, an issue that stymied the growth of the peer-to-peer lending industry. But critics say this may be against the spirit of the Reserve Bank of India’s regulations for the P2P industry, where lenders must select the borrowers.

Adukia, however, says a manual option is also available, although few seem to want it. According to him, LiquiLoan’s model is similar to that of overseas P2P lenders such as Lending Club and Zopa.

Kosher? Maybe not. But effective

LiquiLoans, which earlier had instant liquidity, now has a 3-month lock-in. This was a step that it and the rest of industry took after a series of RBI inspections.

If you withdraw your money after this 3-month period, Adukia says your loans would be sold in the secondary market. In effect, they are assigned to other lenders by the platform’s algorithm.

According to critics, this too isn’t kosher, but industry experts feel this feature is almost a pre-condition for retail participation.

A lender who approached Mint on condition of anonymity said that despite being a fresh investor his portfolio had been assigned some delayed loans (30 days past due). However, he was still getting an interest rate of 9-10% due to the power of diversification.

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According to Adukia, such loans constitute a small proportion of any portfolio and lenders get a choice to opt out of purchasing secondary loans. In the past, LiquiLoans also got some of its loans rated by rating agency Icra, something which a P2P lender cannot technically do because the platform doesn’t own the loans.

However, according to Adukia, this was just a notional rating to get the quality of the loans independently assessed. There was never any intention to actually sell the loans in question.

Icra subsequently withdrew due to the non-sale.

According to one critic who declined to be named, Liquiloans’ marketing material still contains statements of the rating. This, at the end of the day, is all that some LiquiLoans users care about. What happens at the backend is immaterial.

“I don’t understand it all. But I trust my distributor," said a senior citizen who was at LiquiLoan’s Pune conference.

According to Adukia, this is not the norm and most investors are aware of the risk and guided by financial intermediaries.

The convenience code

On the tax front, the interest is taxed at slab rate. However, tax isn’t deducted at source, which allows a cash-flow advantage to lenders and investors.

LiquiLoans supplies a statement to investors each year, enabling them to calculate and pay the tax. Many investors max out their exposure through multiple family members or the Hindu Undivided Family (HUF) model. This can also spread out the taxable income.

Much about the P2P lending business model resembles an actual bank. It takes money from retail investors and disburses it to small-ticket borrowers, keeping a part of the spread (as fees).

Through the use of its algorithm, LiquiLoan seems to have cracked the customer convenience code–few small investors want to themselves look through loan listings and give out small-ticket loans.

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LiquiLoans also makes no guarantees of interest or safety. But that really is the key question. Do investors understand the risk involved?

RBI rules impose a ₹50-lakh limit per investor on P2P loans. This means the product has to be pitched to middle-class and retail investors. For a wealthy investor with a ₹10-crore portfolio, ₹50 lakh may not move the needle.

This seems to be counterproductive. Institutional capital is more savvy. Retail investors entering through a mutual fund or NBFC might actually be safer than coming directly.

It will also be interesting to watch the path the regulator adopts as platforms scale–grant them a more formal banking license (global examples: LendingClub and Zopa) or continue to regulate them as P2P platforms.