India is one of the world’s fastest-growing economies, boasting the sixth-largest GDP and a vibrant business landscape. At the centre of this landscape are small businesses and MSMEs – between 55 million and 60 million micro, small, and medium-sized enterprises operating in India today. Collectively, these smaller businesses employ more Indians than any other sector (except for agriculture). The MSME sector has contributed roughly one-third of India’s GDP in the last ten years.
While India is poised for further growth through small businesses and MSMEs, they face a common problem – a widespread inability to gain sufficient access to formal credit.
In India, the credit demand by the MSMEs is at $490 billion according to The Reserve Bank of India (RBI). But, the overall supply from the formal sources stands at a scanty $192 billion. Moreover, the demand for retail borrowing is over and above the MSME borrowing. The huge credit gap of about $330 Billion suggests banks and traditional financial institutions are not able to serve this segment of borrowers due to reasons such as:
- Lack of formal financial data for credit assessment
- Lack of typical business loans that suit a small business or retail borrowers not having credit access
- Lengthy process and a long turn-around-time for loan disbursement
- The requirement of collaterals/guarantees by traditional lenders
- High-interest rates
- Complex documentation and loan application procedures
- Balance-sheet based lending rather than lending on future potential cashflows
These limitations in the traditional lending industry bolstered digital lending. Along with the limitations of traditional lending, factors promoting digital lending were as follows:
Formalization of MSME economy
MSMEs in India are rapidly formalizing (becoming government-licensed or government-registered businesses) and digitizing (adopting digital processes and practices). In 2017 alone, there was a significant increase in MSMEs with some form of registration, driven by GST. Smaller businesses also started rapidly digitizing across various dimensions, including business processes, payments, and online sales.
The launch of UPI succeeded by demonetization stimulated a digital wave across the country. It forced many smaller businesses to adopt digital as a mode of transaction. GST initiative further compelled businesses to work on their digital capabilities.
India Stack maturing
India Stack and additional APIs now serve as a rich source of public and private data. These data sources will enable granular verification of MSMEs and assessment of their future credit behaviour. A rapidly maturing India Stack combined with this growing API-based data availability is transforming every step of the credit value chain — which could allow nearly end-to-end digital MSME lending to become a reality.
Plummeting data costs
In India, the cost of data has fallen by 95 per cent in the last three years, making it the cheapest globally. These low costs have driven an eight-fold increase in data consumption across the country—including among previously non-digital small businesses. Cost reductions have also led to a doubling of smartphone penetration in the last three years, to roughly 300 million users. Currently, 85 per cent of MSMEs have smartphones. This increased access to and consumption of digital data is poised to have a significant impact on overall levels of digitization and business productivity among MSMEs.
Receptivity to Digital Lending
Let us look at the key distinguishers of traditional lending and digital lending and why receptivity towards digital lending has increased.
- Ease –
Our world is moving towards simplicity and ease. For traditionally getting a loan, you would have to find a suitable bank, visit the branch, spend hours waiting in queues, complete a plethora of paperwork and submit numerous documents to the bank. And even going through all these hectic procedures, chances are you won’t get the credit you desire.
With digital lending, the process is straightforward. Most of your personal and professional details are filled in by powerful auto-fill technologies that fetch data from various directories. A few eligibility checks, verifications, and you are good to go. The complete process can be done from the comfort of your home. How good an option digital lending is during the times we are living in today with the pandemic still affecting lives.
- Turnaround time –
Getting a loan sanctioned traditionally is a time-consuming process. Gathering all the documents, doing multiple branch visits, and even after the process is completed, the manual verifications take time. It can take weeks or even months to get money transferred to your account.
With digital lending, it typically takes only 2-5 days to get money transferred to your account. The process is swift given the use of advanced technologies for eligibility checks, verifications, and other processes. Such a fast turnaround time for getting a loan sanctioned is a boon for startups and small businesses.
- Paperwork –
A traditional lending procedure requires you to submit a variety of proofs that can include your identity proofs, address proofs, employment documents, property documents, and whatnot. Carrying around so many important documents all the time is a hassle. Then there are other concerns about these documents going missing, which would be unwanted trouble.
As opposed to conventional lending, digital lending only requires a couple of fundamental proofs for granting the desired credit. And these documents can be scanned and uploaded, easy and hassle-free. Again, this is a big factor why digital lending can be much more convenient.
- Flexibility –
Another major difference between traditional lending and digital lending is the flexibility of credit offered to the borrowers. For Traditional lending, a loan of less than 1 lakh might be a risk factor. The eligibility criteria for conventional lending is quite narrow, which has young business owners, university students at a disadvantage.
When it comes to digital lending, many companies are willing to offer unsecured loans in the range of Rs 25,000 to Rs 5 lakh and even more, as per the creditworthiness of the borrower. This flexibility on the credit range is immensely beneficial for borrowers.
It is no puzzler that digital lending is a much better option to go for. With the rapid shift of banking operations to digital means, getting a loan is becoming easier. With emerging new-age technologies, the future of digital lending is bright. It is the perfect time for traditional lenders to upgrade their offerings to digital means and offer their customers an easy yet effective way to get loans using digital lending.
Emerging Landscape for Digital Lending in India
The Emerging Digital Lending Landscape Digital credit is poised to transform lending in India, bringing millions of more MSMEs into the formal market in the next several years. But how the market will evolve is not yet fully evident. Digital lending models have evolved differently around the world, based largely on the uniqueness of their home market. In the United States, incumbent banks, with their captive customer base, now dominate digital lending. In China, large technology platforms have leveraged the advantages of their closed ecosystem to capture that country’s digital lending market. Across Africa, mobile operators working in partnership with banks are gaining the top advantage. India—with its unique open infrastructure, significant unmet customer demand, and strong digital uptake—is likely to be far more friendly to a broad range of players. This can be seen from India’s open digital infrastructure.
India’s open digital infrastructure will prevent any single player from establishing a monopolistic advantage over customers and customer data. It will also minimize data asymmetry, allowing for democratized data access with consent. The current dominance of informal credit among MSMEs means that most of these potential customers are new to formal credit—in other words, no player holds an incumbent advantage. The benefits of India’s leapfrogging in digital behaviour (e.g., going directly from cash to digital payments by skipping cards altogether) will be available across all players in the digital lending space.
Further, initiatives like the Account Aggregation framework and the OCEN will democratise credit for retail borrowers and MSMEs through the channel of digital lending.
Impact of OCEN and AA
OCEN has the potential of transforming digital lending in India. OCEN reimagines the lending ecosystem in a manner wherein any service provider that interfaces with customers can now also play the role of the credit provider.
Think of Ola providing loans to drivers on its platform with the help of Bajaj Finance. Ola would help Bajaj Finance determine the cash flows of the driver; Bajaj Finance would pay Ola for customer acquisition.
Now imagine, not just Ola, but all aggregators providing loans to platform participants, would evolve the entire digital lending landscape in the country. Access to credit would be available to almost everyone in the ambit of these aggregators.
Add to this the account aggregation framework, which accumulates siloed data from various financial service providers. With the introduction of account aggregation, financial institutions could start lending based on the cash flow generating ability of MSMEs and retail borrowers (who do not have access to formal credit) rather than asset-based lending. Other than the assessment of creditworthiness, banks and NBFCs will be able to increase the velocity of secured lending in the following manner:
- Reducing risk by de-risking their loan books and reduce their NPAs.
- Reducing of time taken to process a loan and reduce loan processing costs.
- Offering personalized and customized loans to the customers.
- Monitoring loan post disbursement to intervene in case of any red flags.
With the open digital infrastructure, especially initiatives like AA and OCEN, the entire value chain of lending has been fundamentally transformed to provide loans digitally.
The aggregators closer to the customers will be more empowered. OCEN will positively impact the unit economics of cash-burning startups in India as this would lead to the monetization of a large customer base.
Digital lending would also facilitate quicker financial inclusion in India as hitherto unused data points like GST, spending patterns, etc. – thereby generating a trail of alternate data to provide loans – would now be analyzed.
There are clear signs of an impending lending revolution in India.
White Revolution disrupted the diary capabilities of India. This revolution may prove to be the same for lending in India.
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This is a guest post by Yash Surana, who is a CA and an MBA (Finance) from SPJIMR, Mumbai, and loves writing about finance, strategy, startups & Personal Finance.