The Reset: India’s Digital Lenders On Rewriting Credit Models To Beat Slowdown

“There is a virtual standstill in lending in the consumer, personal loans, home loans and unsecured SME loans segments due to the pandemic. Only select corporate lending is active with grim visibility on demand and resumption of business.” — Manish Lunia, cofounder, FlexiLoans.

India’s banks, digital lenders and non-banking financial companies (NBFC) have braved events like demonetisation (2016) and GST (2017) and the ILF&S crisis (2018) with resilience. But a pandemic is unprecedented and the market is all gloom and doom at the moment.

In the lending and credit market, the fear of non-performing assets and loan defaults are an all-time high. Even leading organisations are facing a liquidity crunch after the Reserve Bank Of India announced a three-month moratorium on secured term loans.

Banks that work with NBFCs in times have also reeled in their credit lines, putting NBFCs in a bind once again. Digital lenders are being forced to reevaluate models, revisit customer profiles to change their approach. Online lending platforms have had to default to giving loans to only those with good credit history, something they have actively tried to move away from for so long. Plus, individual borrowers have seen their borrowing limit shrink with loss of jobs and pay cuts.

“S&P Global expects the NPA ratio in India is likely to be around 2.0%, but the credit costs ratios should be worse, increasing by about 130 basis points,” added Charlie Lee, founder and CEO, True Balance.

Overall, the situation is bleak. But this is also the time when the market will see the rise of most sustainable and stable players in the lending ecosystem, particularly the digital lenders. In comparison to the traditional lending institutions, digital lenders have so far been operating on wide-reach, high-risk models. These are testing times for digital lenders as they reassess their loan books and see how efficient they have been so far.

“When something like Covid-19 hits, the fundamentals of business do not change. It’s just you identify where the focus needs to get a shift,” said Instamojo cofounder and COO Akash Gehani.

Credit Models Flip In Real-Time 

With businesses across industries taking a deep hit, assessing an average Indian creditor on existing parameters will not be possible any more. Each creditor, whether new and existing, will be assessed again from a new focal point, which will keep rapidly evolving. This will further compel companies to opt for automation, data analytics, data science, and AI/ML-driven credit scoring algorithms rather than using bureau credit scores, especially for subprime and unsecured loans.

While SME lending companies were already taking into account the macroeconomic factors, now it is expected that such factors will play a prominent role on the consumer lending side as well.

Key factors to consider in consumer lending

Before Covid-19 — Primarily Historical Data

Credit Bureau Scores → Other Loans → Savings & Investments → Current Income

Post Covid-19 — Focus On Real-Time Macroeconomic Indicators

Historical Data → Current Income → Job/Business Sector Stability → Environmental Issues → Government Regulations → Changes In Technology→ Future Opportunity

Gaurav Hinduja, CEO and MD, Capital Float believes that the majority of the credit models are designed based on past data, whereas the Covid-19 situation has disrupted these models completely.

Credit Chain Goes Digital

KYC verification, underwriting, and collection are primary events which the lending industry will strive to digitise in the near future. In particular, digital lenders will have to plan for a significant drop in borrower ability to repay due to potential job losses and loss of business. In such scenarios, restructuring of dues and settlement strategies will play an important role.

“The use of a hybrid approach where digital tools, as well as one on one communication, is used for collection will be a good option,” believes CRED founder Kunal Shah.

Underwriting: Greater scrutiny in the disbursement of credit and also reduction of credit limit offered to customers unless companies have access to high-trust individuals. Although small-ticket loans are already offered on the basis of new-age credit criteria, larger ticket loans might also come under this purview in the near future.

Collection: Loan collections have largely involved face to face interactions with agents so turning this process completely digital would be challenging at first. Also, collection metrics such as right party connect rate, dialer optimisation and ensuring calls go at the right time will need to be tracked extensively.

Fraud Management: Digitisation of processes will further lead to increased fraudulent activities. This will push lenders to focus on risk analysis and collaborate with fraud management startups.

Tech-first & Paperless Processes: An increasing number of loans might evolve into this format, wherein the physical presence of the borrower or the lender might not be required.

KYC Verification: At present, eKYC verification is not deployed by all subsectors of digital lending. Many digital lenders are still dependent on physical KYC verification. It’s time that the government will look to boost the usage of India Stack at deeper levels in the lending sector.

Sachet Loans To Go Digital

According to CRED’s Shah, the decline in business revenue and individual income are likely going to drive up the need for short term credit very quickly. This need may be further exacerbated by the fact that many small businesses and families have little savings to tide them through these times.

This again presents an opportunity for lenders to offer consumers credit when they need them the most. Also, short term loans can be paid on a much faster basis and can help create credibility for the merchant in a shorter tenure and on a real-time basis. Also, it gives better visibility into the risk of NPAs in the near future.

“While digital lenders have always been a fan of byte-sized loans, traditional NBFCs will have to revive their strategies in a broader manner. However, reducing the average ticket size for loans is not as simple as it sounds,” said Instamojo’s Gehani.

Experts believe small tenure loans will lead to much faster iteration and require an overall upgrade to the business model, where all existing processes need to be systematically aligned with each other.

Reducing the loan ticket size by 40%-50% impacts the earning and cost of operations involving disbursement, collections and more.

Thus, this uncertainty will force businesses to expect a bigger risk appetite from banks and larger NBFCs for long tenure loans. Particularly for the SME sector, which requires minimum working capital for at least two quarters to revive until the consumption boost comes in.

“It will also push them to open up their credit lines to digital lenders in order to diversify their risk among short term creditors,” said Alekh Sanghera, co-founder of an agri-financing startup Farmart.

Reining In The NPAs

The way credit lines have been dried up and repayments have been delayed will be one key learning from Covid-19 for every lender. In the aftermaths of Covid-19, it is expected that NBFCs and digital lending companies will look to tap the post loan disbursement journey as well right from day one.

As Aye Finance cofounder and managing director Sanjay Sharma told us, those who were able to connect with their customers at this point of time will be able to forge long term relationship. This will further require eradicating the middlemen and engaging directly with the merchants in their day to day business processes. This will also help identify the NPA triggers at an early stage, infusing more data and visibility into the impact merchants are bound to take during any kind of crisis.

“In the post-Covid-19 consumer lending sector, demand will come down and supply will come down much faster. At the same time the scenario will be more complicated in the SME lending domain,” said Early Salary cofounder and CFO Ashish Goyal. 

According to Chiratae Ventures’ founder and managing director TCM Sundaram, at the moment investors will be very cautious about investing in any lending company. The bar will be very high right. Only if there’s somebody doing it uniquely or somebody with a tremendous track record can be seen raising more capital. Thus, new funding models like venture debt, revenue sharing agreements, bonds, securitisation, etc will definitely make their way into the lending ecosystem.

Co-origination or marketplace model of partnership between financial institutions and digital lenders will gain higher significance going forward. The industry is likely to move towards a hybrid model of lending to navigate through the liquidity crunch in the market.

“Thus, the next 3-6 months will be crucial for lending startups to avoid fallout, ensure effective collection, maintain a good book, and demonstrate that they can recover,” Aye Finance’s Sharma added.

Will Lending Ecosystem In India Shrink?

While stakeholders may have differing views on how the lending ecosystem will bounce back, they agree that the post-Covid-19 era will see massive consolidation in the market. Apart from significant shutdowns and distress buying for loss-making entities, the consolidation will primarily be seen through larger NBFCs acquiring smaller players in the same segment or loss-making digital lending companies, or through deep-pocketed digital lending companies acquiring smaller startups and lending tech platforms.

“This might not happen in the traditional sense where the whales swallow the minnows but instead lead to fruitful partnerships between fintech players, banks, and other stakeholders in the ecosystem who are looking to create and offer more curated and specialized digital services to its patrons,” said CRED’s Shah.

However, the consolidation does not mean the balance is tilted towards bigger banks and lending institutions. India has a huge gap in credit access wherein there is a large segment that cannot go to traditional lenders. As risk appetite or credit capacity for banks and traditional financial institutions goes down, we will see new entrants bridging this credit gap, but with evolved, more NPA-proof models.

The biggest challenge in the lending business is about the quality of the debt or the amount of liability they [lending company] will end up having to pay in case the loan book does not realise correctly. This will make the deep-pocketed non-fintech players take a cautious approach while expanding into the lending vertical.

“In essence, Covid-19 pandemic has put Indian lending sector in reaction mode. Slowly, the market will move to the growth stage and then scale up to the reemergence stage. But until then, current risk models will become obsolete and create a new lending landscape in every manner.” — Tanul Mishra, CEO, Afthonia Lab.