In the digital age, financial institutions such as banks and non-banking financial companies (NBFCs) are adopting new business plans in line with the evolving credit ecosystem in India. These include the increasing use of digital models to create a differentiated value proposition for customers. Innovative partnership models such as peer-to-peer (P2P) lending, pay-later loans, invoice financing, point-of-sale transaction-based lending, marketplace lending, bank-led digital lending and captive models are emerging as strong spheres of growth.
The shift
The shift towards the digital lending domain will help leverage its tremendous untapped potential. The digital lending market in India is expected to grow at a CAGR of 30 per cent per annum from $110 billion in 2019 to $300 billion in 2023. During this period, the market is set to add nearly 300 million consumers due to changes in the underlying demographics in the economy.
The Digital India initiative has been facilitated by platforms like unified payments interface (UPI), the Goods and Services Tax Network and Aadhaar. Through Aadhaar-based know your customer (KYC) and account aggregators, lenders can now easily access customer data with consent, and ensure better due diligence and early disbursal of loans. Other important factors driving India’s shift to digital are increasing consumer preference for mobile payments and the emergence of a digital ecosystem across sectors such as e-commerce and B2B commerce.
Some recent initiatives in the digital lending domain are Indifi’s partnership with various NBFCs to provide unsecured loans to small and medium enterprises, Yes Bank’s launch of digital loans against securities solutions and HDFC Bank’s plan to launch a dedicated digital platform for vehicle loans.
Customer satisfaction is key
Today, customers demand a variety of benefits from their digital lending platform. These include ease of application, ease of KYC/on-boarding, ease of document submission and verification, easy and trustworthy query resolution, transparency in the interest rate or the financing structure, and fast disbursement and flexibility of repayment. To meet such demands, lenders are increasingly leveraging various traditional and alternative data sets to enrich the customer data universe. These practices are being used to improve the loan orientation process by making it easy for the customers to upload their personal data through e-KYC, and verifying any tax deductions or collections using an application programming interface linked to the customer’s account number or PAN.
The use of data sets has also streamlined the loan agreement process, resulting in quick appraisals and procurement. Further, it has improved the security of transactions, and facilitated faster collection through direct disbursement, online servicing and automated repayment set-ups.
Challenges to overcome
The digital lending space is fraught with challenges. First, the process of loan disbursal to small and medium enterprises is not fully digital as credit checks need to be made physically. Second, there are gaps in the digital process as it cannot determine the eligibility of a customer and thus, there is a need for physical checks. Third, poor collection efficiency remains the biggest impediment in the digital lending process, which often escalates cost. Fourth, there is a need to rationalise costs for regular monitoring of customer payments and document processing. Fifth, clear regulations on data privacy must be enacted in India. Currently, the General Data Protection Regulation (GDPR) guidelines are being followed in the country due to the lack of any guidelines on the subject by the Reserve Bank of India. As per the GDPR guidelines, most financial institutions do not provide third-party access to their customer data. That said, government regulations are important for regulating third-party data sharing.
At present, the regulatory landscape in the country is proactive in managing and regulating the digital lending space. The regulator needs to have a future-ready vision in order to combat any future challenges. Some key challenges can be addressed by improving the digital on-boarding process through e-KYC to ensure timely execution, streamline the physical document processing procedure and create a digital platform to handle mortgages.
Role of fintech
The role of fintech is critical in the successful implementation of the digital lending model. Globally, fintech companies provide infrastructure to banks to carry out digital transactions. They also provide services like advanced credit scoring, credit automation, non-performing loan management and regulatory monitoring/reporting. In India, the primary role of fintech service providers is lead generation. The quality of leads generated determines the earnings. The incentive structure in such a scenario is either a predetermined fee or a commission that is equivalent to 2 per cent of the loan sanctioned.
A few fintech companies in India venture into digital lending by creating their own platform. They use a host of models to disburse a variety of loans like individual, personal, educational, vehicle, salary and gold loans.. These models include the captive model, the e-commerce model, the P2P model and the buy now, pay later model.
Fintech companies also face risks and challenges. The most pertinent problem is their ability to collect money. Any hindrance in the collection process increases the cost of lending for the fintech company. Second, there is difficulty accessing a secure line of credit to lend. Fintech companies engage in a lot of planning to acquire credit at a reasonable cost. These companies need to have a considerable amount of equity capital/bank guarantees to avail of credit even under the first loan default guarantee (FLDG) cover (FLDG guarantee varies from 3 per cent to 10 per cent of the loan sanctioned). Third, if the in-house credit scoring algorithm has not been tested at scale, there could be risks for the fintech company. Fourth, there is a need to put in place a process to ensure continuous and ongoing engagement with the customers even after lending.
The success of fintech is essential for transforming India’s lending landscape. This requires assistance from the government in providing credit guarantees up to a certain extent for lending to NBFCs, which could help in mitigating the risk averseness of banks and providing funds to smaller companies. In other countries, fintech is being utilised for the distribution of financial benefits and relief and this could be beneficial in India as well.
Role of account aggregators
Account aggregators facilitate consented sharing of financial information in real time. This helps lenders de-risk their loan books and reduce the proportion of non-performing assets. Thus, lenders can offer their customers more personalised loan products and monitor loan accounts post disbursement for early intervention and lower loan cost provisions. Banks and NBFCs are using account aggregators for safe lending. They enable real-time data access, allowing the financial institutions to process the loan applications faster. It also helps institutions access underserved segments like micro, small and medium enterprises (MSMEs), which are highly under-funded with only 8 per cent of MSMEs having access to formal credit.
An account aggregator can also be used to aid individuals in making better financial decisions based on their own data, as it stores all the personal finance data of an individual in one place. Personal finance management tools can help people make better financial decisions at scale by keeping track of their finances, creating financial plans and achieving financial goals. Account aggregators can also make wealth management affordable by enabling tech-based tools, which make it simpler to engage with ultra-wealthy clients. One example of a successful account aggregator is the DBS “iwealth” platform.
Conclusion
India is set to become a digital powerhouse. The most critical element of any successful economy is the strength of its underlying financial system. By leveraging digital lending, India can simplify the process of lending/borrowing and thus benefit a large section of its population.
Based on presentations at a recent India Infrastructure conference on Digital Lending in Indian Banking