By Raghav Madhukar
“We have the Internet of everything, but not the inclusion of everyone,” said Ajay Banga (CEO, MasterCard). But what does it really mean to include everyone? For starters, it means providing everyone the opportunity to improve their economic circumstances – a key facet of that being access to formal finance.
In developing nations around the world, millions of individuals are unable to tap into credit from formal financial institutions due to a lack of credit history, adequate documentation, or sufficient collateral. The lack of access to credit is exacerbated by the fact that most micro and small enterprises are informal, unregistered, transact predominantly via cash, don’t pay taxes, and possess little or no assets. As a result, they are simply unable to access finance from banks, and instead resort to usurious money lenders who often charge exorbitant interest rates.
To put things in perspective, India is a country with 63 million small businesses, and over 300 million lives are dependent on their success. Unlocking the economic potential of this vastly underpenetrated segment can have an enormous positive impact. Unfortunately, the numerous attempts by the Indian government to facilitate easy access to credit through banks have not yet had their desired effect as conventional ‘asset-as-collateral’ models are simply inapplicable to most small businesses.
However, with the ubiquity of mobile phones and data trails, fin-tech companies are beginning to experiment with a variety of disruptive models for assessing credit worthiness and deploying loans. In addition, smart policy changes are beginning to stimulate and support innovative lending models. Two such initiatives by the Indian government stand out: Aadhaar and the Unified Payments Interface (UPI).
Improving Technology Infrastructure
One of the major hurdles in the race to achieve financial inclusion is the absence of identification, necessary to meet know-your-customer (KYC) requirements). Identification is any document that can prove you are who you claim to be, whether that be a driver’s license, birth certificate, or other similar documents. While this widespread lack of identification may be hard to initially understand, it is the harsh reality of life in the developing world – millions of people (mostly the poor, illiterate and rural populations) don’t have any acceptable means of verifying their identity. In 2009, the Indian government rolled out what is today the largest ID program anywhere in the world: Aadhaar.
With Aadhaar, the Indian government provided every citizen with a unique 12-digit number (like the Social Security Number but without any associated functions such as taxes/ benefits) that could be officially used to identify them. Today, over 1.2 billion people have Aadhaar numbers, covering more than 90% of India’s population. This ID program laid the foundation for India’s financial inclusion, enabling more than 300 million people to open bank accounts for the first time in a span of three years.
In 2016, National Payments Corporation of India developed the Unified Payments Interface (UPI). The National Payments Corporation of India describes UPI as follows:
“Unified Payments Interface (UPI) is a system that powers multiple bank accounts
into a single mobile application (of any participating bank), merging several banking features, seamless fund routing & merchant payments into one hood.”
Today, UPI has enabled a number of banks and technology companies (such as Google and WhatsApp) to facilitate payments at a very low cost, capping transaction fees at 60 basis points, compared to the ~ 3 % that credit card companies charge. UPI now facilitates over 1.2 billion transactions a month, well exceeding the number of credit card and debit card payments in India.
The low costs of payments, and the ability of merchants and vendors to use their payment history to demonstrate credit worthiness, has further propelled the fin-tech revolution in India. FinTech Lending Models
Scores of lending startups have opened their doors during the past few years, largely owing to the presence of a strong underlying inclusion infrastructure outlined above.
Capital Float, a FinTech company based out of Bangalore, has grown into one of India’s leading digital financing companies. They lend working capital to small and medium-sized enterprises (SMEs) through their proprietary digital-only platform.
Another interesting business model is that of NeoGrowth. This Mumbai-based company collects a percentage of the daily credit card sales of their beneficiary vendors in order to recover the loan. This approach allows for adjustable repayment depending on daily sales, thereby hedging the likelihood of non-performing assets (NPAs) and defaults in the instance of collateral-free financing.
The core attributable elements to the success of Fintech lending are fivefold:
Leveraging technology to determine credit-worthiness using non-traditional parameters
Requiring minimal documentation to apply for financing
No collateral requirements for availing loans
End-to-end simplified online loan application procedure
Quick processing of requests (in the span of hours)
Marketplace financing, also commonly referred to as peer-to-peer (P2P) lending is another emerging field. These marketplace platforms play the role of an intermediary by connecting borrowers with prospective investors who selectively finance loans. P2P platforms typically display individual loan data as opposed to bundled securitized products. That way, investors are aware of the specifications of the loans they finance. These platforms also offer a system of fractional loans by which loans are divided into smaller notes which retain the credit risk of the underlying asset. This allows retail investors with small portfolios to diversify their risk. However, in the P2P approach, the platforms do not bear any balance sheet exposure to the loans deployed, on either the asset or liability fronts. This allows these companies to direct their efforts towards acquiring new customers, enhancing their platform, and expanding their footprint.
The State of FinTech
An objective indicator of the performance and scale of any sector is the investment it attracts. In 2019, startups in India cumulatively raised $ 14.9 billion, of which FinTech received the highest funding of any sector, with $ 3.7 billion (~ 25 %) directed towards startups in the space. The lending vertical, however, received only 10.8 % of that pie – amounting roughly to $ 400 million. Clearly, there’s a lot more room for progress and expansion!
When projecting the growth of the nascent Fintech sector in India, it is perhaps useful to look back at the evolution of the sector in a mature country like the US. In 2018, personal loans outstanding in the US reached $138 Billion. In 2013, Banks held a 40% share of this market, credit unions 31%, and FinTechs just 5%. However, by 2018 the tables had turned - FinTechs had risen to a whopping 38%, and banks and credit unions held 28% and 21% respectively!
This rapid institutional rebalancing of the lending industry in the US over the span of just five years exemplifies the hope and potential of the burgeoning industry over the coming decade in countries like India. As the forces of FinTech and government policy converge to address the penetration-gap of financial services, it will be interesting to follow how the inclusion story plays out in the years to come.