The Backdrop
India as a consumer market is fairly complex in terms of geography, cultural preferences and consumer behaviour. For any given product or service, there are multiple consumer segments, each with its own unique set of buying preferences. But a common unifying factor is the ubiquity of mobile connectivity and the rapid adoption of the internet as a data source influencing the buying decision. India is currently the world’s second largest telecommunications market with over 1.17 bn mobile telephony subscribers (penetration ~ 90%) of these about 300 mn smartphones are in use today. There are about 500 mn internet users (penetration ~ 40%). This ubiquity of telecom, smartphones and access to internet is a potent enabler for the adoption of digital channels in terms of accessing financial services.
Banks in India have been providing digital channel access to their customers for over two decades. On the liabilities side banks have leveraged technology in terms of ATM networks, mobile and internet banking for queue busting and to provide convenience to their depositors. On the assets side banks provide online access to loan accounts for informational transactions and repayment options like direct debit and internet banking payments. For providing service to existing customers, banks and other traditional financial institutions have effectively adopted technology and digital channels. In spite of this the underlying business model remains the same.
The primary mode of accessing potential borrowers in need of credit, of credit underwriting and entering into loan agreements is offline through brick and mortar outlets supported by call centres. Banks and NBFCs rely heavily on hardcopy documents, on traditional data sources like income statements and credit scores, on face to face meetings and on wet signatures. This makes technology just another support system for the brick and mortar world of doing business. The full leveraging of technology and true digitisation in the lending business started with Fintech companies in India. The two segments that have been the focus of Fintech lenders are urban individual consumers and the MSME segment.
The Fintech lenders disrupting the unregulated financing market
Traditionally the major block of unsecured lending in India is held by community finance – comprising family, community members and unregulated private lenders. Some experts feel that community finance is as big as the traditional bank consumer lending. The hallmark of this business is a very high annual interest rate averaging about 36% and in some cases going up to 200%! This space is characterized by a lack of standardization – in price, processes of credit underwriting, repayment terms. It suffers from a lack of transparency and coercive collection practices. Borrowers accessing funds through community finance do not have a credit history and thus lack an acceptable credit score. Often these borrowers do not have the kind of documentation that banks and other traditional lenders demand in order to assess income and the ability to repay. This segment was ripe for disruption through technology and remains the segment of focus for Fintech lending start-ups in India.
In urban India, individual borrowers avail the services of a Fintech lender in order to avoid the heavy documentation requirements and wait times that are typical of the traditional lending industry. Looking at trends of demand for retail credit we see that disbursements have grown at a steady CAGR of ~ 16% over the last 5 years. Further demand is expected to be driven by consumption growth in housing, automobiles and white goods. This increasing consumption will lead to the aggregate retail credit demand reaching INR 53 tn by 2023 as compared to INR 33 tn today. A significant portion of this demand will comprise the demand from underserved borrower segments overlooked by traditional lending institutions.
MSMEs in India are heavily cash starved in spite of being willing to submit to onerous processes and wait times. There are about 63 mn MSMEs in India. Between these MSMEs the total debt demand is INR 26 tn. Traditional lenders serve only about 20 mn MSMEs and meet a cumulative debt demand of INR 11 tn. Thus there is an estimated INR 15 tn unmet debt demand amongst Indian MSMEs! This credit gap is the target of many Fintech lenders in India. Today receivables financing, Working Capital financing and equipment finance are the solutions that Fintech lenders provide to this borrower segment.
The best way to understand the role of Fintech in the business of lending is to study a successful real life case study. Happy Loans a business of ArthImpact Finserve Pvt. Ltd. is a representative example and clear case study of how Fintech lenders address the needs of the MSME segment. Happy Loans in its current business model provides loans against receivables to retail merchants. Happy Loans focuses on retail merchants who have been acquired by merchant aggregators. Aggregators have a record of electronic transactions of their merchants done through open loop payment systems, mobile wallets, remittance mechanisms etc. Aggregators are also the channel through which merchants receive their dues through daily settlement. A tie-up with such aggregators gives Happy Loans access to electronic transaction data used for credit underwriting. The aggregator also enables the repayment of loans disbursed through daily split settlement of electronic transactions at a merchant outlet. The entire value chain of prospect acquisition, credit underwriting, loan disbursement and repayment is completely digital thus bypassing the need for brick and mortar stores, physical documents and lengthy wait times. Happy Loan’s business model is supported by an AI engine which performs credit underwriting based on transaction data thus making redundant data points like income statements, credit history and credit score. Happy Loans and other similar companies are providing access to credit to the underserved segments of Indian borrowers, providing much needed capital and more importantly an entry into the world of organized financing. Borrowers get loans at competitive interest rates and an opportunity to build credit history. These companies are building profitable businesses by serving the underserved and thus creating immense social and economic impact.
Established business models
Today the Fintech lending business in India has evolved into multiple different models:
Point of Sale transactions based lending
This is the model that Happy Loans works on today. Credit is extended using data of electronic transactions at POS and against future receivables at POS
Bank Fintech partnership model
In specific segments (travel, food and hospitality for eg.) banks have tied up with Fintech companies that source and underwrite potential borrowers for banks. Indifi is an example of the same.
Invoice discounting exchanges
Some Fintech companies like KredX operate exchanges where unpaid invoices can be discounted by SMEs to a network of financiers (Banks, NBFCs), wealth managers and retail investors
Marketplaces
Marketplaces like PaisaBazaar connect borrowers with financial institutions. They provide the value add of digitizing the entire supply chain to provide borrowers with a seamless digital experience
Bank led digital models
Banks like Kotak Mahindra Bank are using their digital platforms to sell loan products and acquire new to banking credit card customers
Captive models
Companies that exist in entirely different businesses are entering the lending space in order to lend to their captive customer base either directly by setting up NBFCs (like Flipkart) or by partnering with financial institutions (like Ola)
P2P model
Companies like Faircent have set up P2P lending platforms in order to connect borrowers to affluent individuals with excessive liquidity. The Individual nature of lenders as opposed to institutions separates this model from marketplaces.
Future evolution
Today digital lending has reached an estimated annual disbursement value of USD 75 bn (INR 5.4 tn). Spread over a 5 year period, from 2019 to 2023, BCG estimates the total market size for Fintech lending to be USD 1 tn (INR 72 tn). The size of the pie today drives a lot of start-up and investor activity. The space is segmented and with maturity there will be consolidation. For winning business models and successful companies the payoff is huge. The underlying product that is sold – credit, is essentially a commodity. In that sense the companies that will succeed are companies who innovate in terms of accessing customers and servicing their needs while building mechanisms and relationships that enable them to keep their own cost of funds low and their pricing competitive.
Some likely future developments within this industry:
Traditional lenders will form exclusive or near exclusive tie-ups with Fintech companies
For traditional lenders this business model is new and it involves fundamental changes in processes. It is possible that these large banks and corporations may develop nimble teams that target this opportunity. A much likelier scenario is the creation of contractual tie-ups between traditional lenders and Fintech companies that grant access to low cost funds to Fintech lenders while providing secured access to this borrower segment for traditional lenders
The use of alternative data for credit underwriting will increase
The very lack of credit scores and credit history amongst a huge section of potential Indian borrowers dictates the demand for alternative data. The success of alternative data at current scale validates its usability at much larger scales. As Fintech lenders grow, alternative data and AI based learning algorithms will become increasingly important and necessary
Trusted third party data platforms will emerge
CIBIL and other credit rating agencies play an important role in the lending business today. Similarly a host of third party data platforms integrating and processing data from multiple alternate sources and providing the platform as a service to lenders are likely to emerge as an adjunct business to Fintech lending
The future for this industry is one of growth and profitability while at the same time closing the crippling credit gap in India thus boosting economic growth and creating social impact. Fintech lending will gain market share initially in segments underserved, and progressively in adequately served segments transforming the traditional lending business model completely.
Disclaimer: The opinions expressed within this article are the personal opinions of the author. The facts and opinions appearing in the article do not reflect the views of DLAI and DLAI does not assume any responsibility or liability for the same.