By Dr K Srinivasa Rao
Innovations in financial intermediation led by fintechs and virtual banks have changed the landscape of lending to retailers and small and medium entrepreneurs. Hyperactive digital lending by new-age tech entities has begun to pose a challenge to banks and regulators. Falling in line with the competitors, banks have also partially adopted the digital mode and started business process reengineering of low-ticket loans (LTLs) – in the range close to Rs 10 lakh.
Time-tested lending by banks using ‘meet and greet method’ is fast losing sheen for LTLs. More and more lenders are driving growth through mobile apps and online lending and offsite contact-less processing using automation modes. KYC, due diligence, credential checks are conducted electronically and TLTs are disbursed directly into the account of borrowers based on data collected from aggregators.
Such digital lenders are increasingly engaged in point-of-sale lending, invoice-based lending, crowdfunding, supply chain financing and lending to SMEs in a big way. They are roping in customers not usually covered by banks. It is estimated that the demand for digital lending could be close to $820 billion.
Digital lending startups have attracted around $2.4 billion in new funding. According to a 2019 report by ICICI and CRISIL, consumer loans in India may hit nearly $1.3 trillion in size by FY24. Over 120 million working-class Indians are the potential consumers of credit card companies whereas there are only 6.5 million credit cards in India. Some innovative methods are to cross-sell LTLs using debit card base. That is the reason ‘buy now, pay later’ loans and conversion of purchases into interest-free instalments are getting popular, mostly offered by fintechs/banks.
Speed, outreach, cost and efficiency are the harbingers of digital lending mode where the turnaround time (TAT) could be in hours instead of days by accessing potential borrowers through data aggregators. It is very costly to lend using the past procedures of pre-inspection, spot visits, interactions with borrowers and post verification of end use of loans. Digital lenders are increasingly using AI and ML-based algorithms and built-in predictive tools for credit underwriting that reduces the cost of acquisition and servicing borrowers.
Credit bureaus like Experian, CIBIL and Equifax are mainstream data aggregators. In addition, platforms such as Perfios and CreditVidya help FIs like banks and NBFCs through their alternative scoring models. These aggressive non-bank entities are providing LTLs seeking assistance using AI and ML to generate credit profiles and assess creditworthiness.
In view of this fast changing digital lending space, the Reserve Bank of India constituted a Working Group on digital lending, including lending through online platforms and mobile apps in January 2021, to look into the mechanics of how the digital lending ecosystem is evolving, its safety, sustainability and how to ensure customer protection and data privacy while continuing to encourage innovation.
The committee made some interesting recommendations in the larger interest of mainstreaming digital lending as an integral part of lending operations. The mushrooming of digital lending apps is making it difficult to identify genuine players. It is estimated that out of close to 1,100 digital lending apps in use, 600 are fake and malicious. Hence, it recommended formation of a nodal agency to be set up in consultation with stakeholders to verify the authenticity and certification of these apps; self-regulatory organisation in the digital lending space to create a collaborative safe digital lending ecosystem covering all participants; separate legislation to prevent illegal digital lending activities. Besides, digital lending solutions will have to follow certain standards and pre-conditions to bring about standardisation and uniformity in operations. Disbursement, servicing of loans, enforcing recovery are to be done only through borrower accounts.
Also, data collection from borrowers with prior consent should be supported by verifiable audit trails and the data should be stored only in India for maintaining data privacy; algorithm metrics, features and architecture in digital lending should be well documented, among others.
Once the digital lenders are well regulated implementing the relevant recommendations of the committee, they will be able to play a critical role in reaching out to the hitherto untouched informal borrower community. Timely availability of microcredit through digital mode can spread employment-intensive entrepreneurial culture and bring about economic transformation.
The RBI data of March 2020 on size-wise distribution of credit indicates that out of 272.5 million bank borrowers, 95.7% borrow only up to a million rupees. If this segment is moved to digital mode, banks will find enough time to concentrate on credit risk management. Even the quality of overall credit and asset quality management can improve if lending automation can take care of the major chunk of borrower load.
It will be pertinent to mention that staff accountability in non-performing loans up to a million rupees has been almost waived except in fraudulent loans keeping in view the insignificant role of staff in credit decision making in such small size loans. They are now increasingly driven by prebuilt algorithms that drive credit risk underwriting. Manual intervention is very nominal in small loans that can influence credit decisions.
Such lending reforms can mainstream digital lending and provide enough latitude to financial intermediaries to use it as a gateway to add better rigour to credit risk management practices at unit levels. Regulating digital lending with well-regimented firewalls of systemic controls and self-regulatory lens can be the right move to accelerate the flow of credit.
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