Expert Speak India Matters
Published on May 04, 2022 Updated 23 Days ago
To ensure responsible borrowing, FinTechs should build a credit assessment framework that the microfinance industry can adopt to help keep low-income households out of debt traps.
Microfinance, low-income borrowers, and digital loans: Good intent, mixed signals The Indian microfinance industry has been shaped around unsecured, micro-ticket-sized (around INR 30k-50k), medium-tenured (one to two years), group-liability, livelihood-related lending to women and their households who are self/family employed and entrenched in the informal cash-based economy in rural/semi-urban areas. Strong policy and regulatory support and supervision (and self-regulation) and business model stress-tested over time have made microfinance a socio-economic tool, reaching over 15 crore households over the last decade. Considering the social-economic milieu of the microfinance customer segment and the constraints that women borrowers face, the microfinance model has two distinct flavours—physical door-step access for sourcing underwriting-servicing of loans and consideration of household income, not just individual income, for the credit assessment to decide the loan amount and monthly debt serviceability. Over time, the decades-old regulation on microfinance framed around this model was confronted with two challenges.
  • Regulations including customer leverage norms and pricing caps applied to just one class of entities, i.e. NBFC-MFIs, leaving out two-thirds of lending by other regulated entities—banks, SFBs, NBFCs, most with NBFC-MFI past—offering microfinance. While the microfinance lending model factored in a borrower’s household income in deciding the lending amount/debt serviceability, it only considered the indebtedness at the individual borrower level and not the household indebtedness.

The new regulation is a watershed for microfinance to shape the market conduct by entrusting lenders with household income assessment, pricing, and repayment thresholds within an overarching customer-protection framework.

The recent RBI regulatory update on microfinance regulation addresses these gaps. It applies to all regulated lenders and unsecured lending to low-income (defined as INR 3 lakhs per year) households (husband, wife, and unmarried children). It mandates lenders to factor both income and indebtedness of the household with a tight definition of the household to avoid any arbitrage/misinterpretation in the market. Removal of cap on interest rates allows a risk-based premium pricing. The new regulation is a watershed for microfinance to shape the market conduct by entrusting lenders with household income assessment, pricing, and repayment thresholds within an overarching customer-protection framework.

The genesis of Indian digital credit

In the past few years, the government’s pioneering stewardship of digital/cash-less economy and to direct them for financial inclusion and socio-economic impact, progressive regulatory and policy framework and public infrastructure (India stack) alongside thriving internet and data-ecosystem and young mobile aspirational demographics, have created a perfect mix for digital lending. While digital lending is still searching for a perfect definition (including regulatory outlook), broadly speaking, a checklist will include lending digitally (paperless, person-less, friction-less, without physical touch-points) and the use of alternate data/approaches for a credit assessment to address current and emerging consumer needs. Equally important aspects of digital lending are convenience, choice, dignity, and privacy in accessing credit. With younger demographics, and the distribution of low-cost internet data access beginning to increase consumer adoption of digital finance across India, the future could see us move from Phygital (a portmanteau of physical and digital) to digital-first to digital-only. For the naysayers, look back 15 years in time to understand how far we have come along in the financial services space, especially in accessing credit and payments.

The government’s pioneering stewardship of digital/cash-less economy and to direct them for financial inclusion and socio-economic impact, progressive regulatory and policy framework and public infrastructure (India stack) alongside thriving internet and data-ecosystem and young mobile aspirational demographics, have created a perfect mix for digital lending.

Like everyone, millions of young and not so young, salaried and self-employed, need sachet-sized short-term personal credit for personal use, business, cash flows, and purchases for goods/services they value. However, for various reasons, including the non-availability of suitable and convenient short-term credit products, and the hassle of seeking traditional credit products (collateral, credit history, paperwork, and low income), many of them found it hard to access formal credit that suited their needs. It is hard to imagine a logical mind putting themselves through the gruelling process of a ‘formal loan’ to fund a need which may be as small as INR 5,000 (‘small’ from the institutional point of view) and for as short as a month.

Differences and more

Unlike microfinance, where lenders physically check the household’s annual/monthly income to assess income, risk, and repayment capacity, digital lending looks at the individual differently—only e-meeting the consumers through the digital medium, verifying her/his credentials digitally and digitally lending and collecting, using data other than income such as payment/purchase history. However, there is overhanging industry anxiety that the regulatory definition of microfinance loans now extends to unsecured digital loans to an individual from a low-income household. And therefore, the argument extends that the digital lenders have to necessarily check an individual borrower’s household income to check if the loan is a ‘microfinance loan’. Expectation from the digital lending model to do a ‘microfinance’ litmus test, i.e. capturing/verifying an individual’s household as per definition and capturing household assessment (KYC income, underwriting for indebtedness, and credit behaviour) in a digital environment is an anti-thesis to the fundamental business existence. Imagine the complexities and frustration of a digital loan customer, needing, and expecting an immediate check-out loan on an e-commerce portal, taking consent of her/his family (not all willing or staying away or simply not being able to transact digitally), providing evidence of relationships, marital status, identity, income, and credit bureau reports for a digital loan of INR 10,000 for three months and then knowing that she is not eligible as her brother (who has a separate source of earning from hers) has utilised family debt limit (50 percent of monthly income) as per micro-finance.  This also presumes that all individuals have shared-common financial lives in a family setting.

Entangling the digital-borrowing segment and their lenders to the microfinance model could slow down and possibly even undermine the potential of digital lending for financial inclusion.

Technical and business model arguments aside, such a mandate raises questions of individual choice, consent, and constraints in accessing credit involving members of the household. After all, it is an individual’s choice to take a loan and not be encumbered by one’s family members’ consent, constraints, income, and credit profile. Some could argue that it could border on infringement of consumer privacy or even that of their family members. For pure-play digital lenders, it could be a double whammy–of process and paperwork for which their model is not built, as well as their domestic liabilities pool treating exposure to their loans as microfinance loans, and therefore, the debt-funding access could slow or even dry. As it is, the Indian domestic debt market is shallow, and the non-banks (NBFCs, HFCs, MFI, digital lenders) all end up borrowing a large(r) proportion of their liabilities pool from the very banks, who could also operate a competing business with the same set of consumer segments. Entangling the digital-borrowing segment and their lenders to the microfinance model could slow down and possibly even undermine the potential of digital lending for financial inclusion. Or conversely, FinTechs could build a credit assessment framework for low-income consumers’ indebtedness and borrowing capability that the microfinance sector could emulate. In short, the intent of the lending sector and the regulator is to ensure that vulnerable borrowers don’t fall into a debt trap. The industry has to take the lead in engaging with potential borrowers for responsible borrowing habits. At the Inaugural Address of the Sa-Dhan National Conference on “Revitalizing Financial Inclusion”, Shri M. Rajeshwar Rao, Deputy Governor, Reserve Bank of India said, “The roots and origin of microfinance should not be forgotten and sacrificed at the altar of the bottom-line growth. There is no denying the fact that self-sufficiency and financial sustainability are the objectives that lenders need to pursue. However, prioritisation of profitability at the expense of social and welfare goals of the microfinance may not be an optimal outcome.”

Along with customer education, stronger governance and product focus on suitability and affordable credit, real-time reporting to credit bureaus can address the over-indebtedness and multiple borrowing in a better way.

At the same time, further safeguards can be built into the digital lending ecosystem to make it safer for consumers. Along with customer education, stronger governance and product focus on suitability and affordable credit, real-time reporting to credit bureaus can address the over-indebtedness and multiple borrowing in a better way. The implementation of customer protection principles (fairness, suitability, transparency, and grievance redressal) needs an open outlook and new approaches to recognise the peculiarities of the digital lending business model and customer segment as they are. The construct of the microfinance industry, as well as that of the digital lending industry, is for-profit with a positive social impact. With time, the Indian market will see more data collation possibilities, for the low-income groups, catalysed by digital capabilities. This could be a game-changer in making microfinance a digitally-enabled community-banking solution. The regulatory framework should drive the industry to deliver purpose, prudence, and profit. After all, it has to be a win-win for all. True financial inclusion is to give choices to the consumer, including the right to say no to all.
(Opinions expressed by the author are personal, and not attributable to any of the organisations / platforms he is associated with).
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