Growth of Alternative Lending in India

Reshma, a cheerful lady of 48, works as a cook at multiple households in Mumbai (India). Her character is commendable and she is often recommended to other households for her work and integrity. Apart from her work, Reshma is devoted to her daughter and wishes to give her the opportunities she never had, including a college education for a successful future. However, in order to raise finances, she doesn’t have a formal credit history and is forced to borrow from a loan shark at a staggering interest rate of 35%.

Image: PYMNTS

Similarly, there are many hard working merchants out there in India who, due to their lack of credit history, struggle to keep their businesses afloat. In context to India’s demographic landscape, digital footprints are limited to a small size of the overall population. Taking a segment based example, the MSME segment in India contributes 37% of GDP. Within this there is an unmet credit demand of $200 billion. In these situations, lending institutions have shown a growing interest in alternative forms of lending which is reliant on non-financial sources of data. The key questions to get an overview of this emerging method are:

  1. What are the factors contributing to the growth of alternative modes of lending? What is the underlying methodology behind this model?
  2. What are the benefits received by the lender and borrower?
  3. How will the collections be processed for credit offtake through digital means?
  4. Is there an operational model for the Indian industry to benchmark itself to?
  5. What is the secondary impact of alternative finance methods on other financial trends (eg. saving habits)?
  6. What are the security concerns behind such alternative forms of lending?

Factors conducive to the growth of alternative lending (India):

In the last 15 months, internet penetration (measured against population) has increased from 20% to 30% and usage of digital transactions has increased by 55%. From the lender’s side, these two factors have supported in gathering more information about potential customers, thereby supplementing the process. From the customer’s side, it has allowed credit worthy but financially excluded members of the society gain access to credit.

The underlying methodology is to develop an alternative credit score computed on the basis of:

  • Geographical attributes
  • Utility payments trend
  • Assets ownership
  • Social media (identification purposes)
  • Conventional sources such as bureau reports (if available)

It is imperative to take cognizance of the fact that if you have never taken a loan or haven’t had any record of EMI payments, you may not hold a favorable credit score. In the Indian context, 75% of the population has never taken a loan. Hence the inclusion of the above 5 factors is of paramount importance in predicting credit worthiness.

 Benefits to the borrower:

  • Access to credit despite limited or no formal credit history.
  • Transparency on terms and conditions compared to borrowing from informal sources
  • Lower turn around time to receive a loan

Benefits to the lender:

  • Expansion of customer base (~40%) – Opportunity to lend to the financially excluded section of the society.
  • Expansion of product range – Create customized products for SME businessmen thereby creating a niche for oneself.
  • Customer Retention (~60%) – Use analytics to determine potential products which can be cross sold and suitable time periods when the customer might require refinance for the existent product.
  • Reduction in IT costs (~12%) – To operationalize scorecard/analytics based lending, Banks/NBFC’s are leveraging the support of Fintech initiatives (eg. Credit Vidya). Cloud based computing, migration of data to single platforms (for credit and operations) digitalizing the entire process of loan application to loan disbursal will significantly reduce the overall outlay on IT.

Cashless Collections

With regards to the collection of repayments (EMI’s), lending institutions (banks, NBFC’s and MFI’s) are looking to rely on cashless modes of collections. This is primarily on account of 2 reasons: (a) lower cost of operations by 12%-15% (b) reduction in turnaround time. From a safety standpoint, cashless collections has helped proportionately reduce fraud, pilferage and snatching (usually occurring in cash modes of collections) as reported by lending institutions using this method in rural and urban areas. Large scale lenders such as Bajaj Finance and HDFC Bank and MFI’s such as Village Financial Services (West Bengal based) are focusing on an operating model where either (a) the customer uses e-wallets to make the repayments or (b) pays at a designated outlet run by a third party service provider or a telecom service provider against which the principal outstanding for the customer gets adjusted. Interestingly, another option being explored is by Sonata Finance (Lucknow based MFI), running a pilot project to enable collections using the Aadhaar enabled biometric payment mode.

For loans disbursed through alternative methods, cashless collections is still at a nascent stage. Out of every 100 transactions, 55 repayments are collected through cheques, 33 repayments through the Electronic Clearing System (ECS) route and 12 through digital cashless means. Hence there is ample scope for cashless collections to pick scalability and further enhance the operating capabilities of lending institutions.

Benchmark Model

To gauge the performance of alternative methods of lending in India, it is critical to look at other economies wherein this model has successfully been established. Turning our attention to the European markets would be one way. The European alternative finance market is estimated to have provided $4 billion worth of credit, out of which $300 million has been shelled out to provide working capital to over 10,000 start-ups. The 3 biggest lenders of credit through alternative means are UK, Germany and France. Out of these, the French market is an example of a government backed initiative towards growth of alternative finance.

The French government has been strongly supportive of crowd funding (raising funds for one project through multiple lenders online). It created a dedicated website for this industry, where major French crowd funding projects are listed. In January 2013, it set up the Public Investment Bank (PIB) to support the development of alternative finance platforms. To consolidate on a robust regime of regulations, it put forward the Financial Markets Authority (AMF) and Prudential Control Authority and Resolution (ACPR) – set of tried and tested regulations. A review of these regulations and its relation to maintenance of asset quality will be worthwhile to ascertain if they can be incorporated in India. However, this needs to factor in some structural differences such as credit growth %, nature of borrowers, infrastructure readiness (physical as well as digital) etc. between the Indian and French economy.

Impact on Propensity to Save

The methods behind the growth of alternative finance has paved way for greater savings amongst the Indian population. In terms of a strict correlation to the Marginal Propensity to Save or increase in deposits, it is challenging to place a validated figure. However, it is interesting to note the growth of savings channeled through P2P platforms and the insurance industry (cross selling a policy along with a loan). A low risk lender can fetch over 8% (2x times the return from a traditional savings bank account) by investing in P2P platforms. This has led to an estimated $280 million worth of savings placed on P2P platforms in India. Undoubtedly, there are inherent risks for the lenders in case the borrower defaults. Besides the regular legal recourse provided by P2P platforms, as data analytics and the quantum of data point availability advances, one can expect the deterioration in asset quality to be under control.  Moreover, the amount lent gets divided amongst a number of borrowers. Essentially, one is contributing to multiple loans and hence the risk gets diversified.

On the insurance front, 4 insurers (ICICI Lombard, Birla Sun Life, PNB Metlife and HDFC Life) are already using data repositories to support customer relationship management and sales. The online insurance market (using data points to trace potential customers, offer customized products and price the risks better) is estimated to be valued at $108 million (FY 15-16) and is forecasted to grow at 27% per annum up to 2020 (BCG Report : “Digital@Insurance-20x by 2020”).

Security Concerns

While using alternative sources of data to determine the creditworthiness of a loan applicant has many advantages, it also leaves behind a traceable digital footprint with multiple layers of information. An increase in such data sharing has to be balanced with privacy concerns. Establishing data ownership, ensuring that customers subscribe to lenders gaining information about them and prevention of malware contamination are critical causes of concern. Thus a key factor going forward would be to maintain a transparent system of utilizing information and to prevent the misuse of data against the consumer’s interests.

Future Outlook

With regards to the Indian government’s goal of financial inclusion and the growth of entrepreneurial ventures which are value accretive, alternative lending will definitely lend support to extending the credit availability space. A PWC paper titled “Fintech Trends Report” (2017) suggests that in FY 16-17, 4 out of 11 start-ups have successfully raised capital via the alternative lending mode. If there isn’t a significant deterioration of asset quality in these cases, there may be merit in relaying more focus in this method.  Moreover, with public sector banks currently facing constraints on expanding their lending activities, private banks and NBFC’s may use alternative lending to ramp up credit growth and meet the aforementioned desired objectives of the government.

Ayush Banerjee

Ayush Banerjee

Policy Intern at InPRA
Ayush Banerjee has completed his bachelor's in economics from Narsee Monjee Institute of Management Studies. He has been associated with several NGO's (Round Table India, Make a Difference, Save the Children etc.) in the past and is committed to making a positive difference. An avid follower of activist investing and Buffetology, he aspires to become a successful value investor in the Indian equity markets.
Participating in debates and MUN's has motivated him to research on international law and change the public perception about the prevalent laws by conducting a deep dive analysis of policies and it's ramifications. He hopes to do the same by writing for InPRA.
Ayush Banerjee