Investment Banking

Digital lending – the next frontier for growth

November 2018

Read Time: 7 minutes

The Indian lending market is changing. 


In the financial year 2017-18, for the first time in history, personal loans constituted the highest share of bank loans. In fact, personal loans comprised about 96% of all new bank loans during FY18, with INR 2.34 trillion (USD 34.23 billion) worth of disbursements in just the first 10 ½ months. During the same period, the share of personal loans reached 25% of the total non-food bank credit - effectively doubling the personal loan share since 2016. 


There is little doubt that India’s credit economy is well on its way.


Personal loans and the Indian consumer

The growth in the personal loan segment can be attributed to a variety of factors, the most important of which is the changing preferences of the people. Consumers are now more enthusiastic than ever when availing personal loans for various expenditures, such as purchase of white goods, vacations, consumer electronics, and celebration expenses. It is no surprise then that by 2025, India is expected to be the third largest consumer market in the world with over USD 4 trillion in consumption expenditure. 


Although this surge in consumer spending is driven by rising trends in average salaries, it is also highly dependent on the consumer’s access to credit. This is where banks and other financial institutions have had a significant role to play. Unfortunately, very few of them have been able to keep up with the changing times. We find that most traditional banks, in both the public and private sector alike, have found it difficult to connect with the most important generation of contemporary consumers – millennials. It is quite possible that traditional banks today are still wary of credit card losses like the ones they suffered just before the 2008 financial crisis, especially while grappling with higher stress in their own corporate books.


In fact, millennials are the ones driving consumer spending as they comprise 47% of the working age population, and constitute the largest segment of wage earners - nearly 350 million. However due to their youth, they possess a limited credit history, a thin file borrower, as they call it, and are not easily accepted by traditional lenders. Without an established credit history or substantial collateral, millennials suffer at the hands of outmoded cost-benefit analysis and risk assessment models followed by most banks. 


Millennials, technology and digital lending

However, these traditional obstacles are quickly falling away in the digital-first economy. Millennials, as a demographic, expect and rely heavily on technological innovations to offer solutions, and lending is no different. In order to serve the needs of these “digital natives”, a few innovative and modern NBFCs (Non-Banking Financial Company) have emerged. These NBFCs have done an impressive job of servicing customers that traditional banks have left behind. With their numerous retailer partnerships across multiple digital and non-digital channels, they have been able to offer millennials an omnichannel lending experience like no one else – from EMI cards to single-click purchase on e-commerce platforms. 


In the last 10 years, the consumer finance segment alone has grown manifold, resulting in a double-digit year-on-year (YoY) growth in net profits of these NBFCs. In the wake of their success, other banks and financial services institutions have begun to take notice and are attempting to catch up with new products and offerings tailored on digital solutions.


Digital lending revolution

The digital medium has already proven itself capable of offering new value propositions in every industry, including finance with, improved customer acquisition, faster underwriting, efficient funds disbursement and collections. However, the most valuable contribution that the digital medium provides is access to vast quantities of customer data and business intelligence. Combined with advanced analytics and machine learning algorithms, this data can pay massive dividends across the entire lending business. Contrary to popular beliefs regarding social media intelligence and underwriting models, digital lending professionals swear by the data which is openly available from a borrower’s phone. 


By accumulating vast quantities of customer data and leveraging analytic tools, digital lenders can derive insights that can help them significantly improve their business processes and drive innovations in the industry. From precisely calculated credit ratings to refined customer segmentation, from automated collections systems to proactive customer engagement - companies can use these insights to enact fundamental change in how they assess and disburse loans, which can in turn transform their balance sheets radically for the better. 


Insights such as data driven user profiles can help lenders discover high quality customers in larger numbers without worrying about large pools of loans going bad in the future. Not only does this help them offer attractive rates but also build long lasting partnerships with customers for mutual benefit. Digital solutions are also versatile as they can be leveraged differently by companies based on their specific structures. For companies like Paytm, OLA, PhonePe, Mobikwik and Amazon, that have access to a large set of customers for wider horizontal usage, the advantages of lower customer acquisition cost are immense. On the other hand, personal lending players like Kissht, Paysense, ETMoney, Moneyview, Moneytap, Walnut, and EarlySalary, are able to utilize digital solutions like Search Engine Optimization (SEO), Search Engine Marketing (SEM), expense management tools, wealth management platforms and a network of existing users to acquire customers more efficiently.


With the benefit of data-based insights, these digital players offer new products with unique hooks such as buy-now-pay-later, pay-day loans, purchase financing, and instant line of credit. Even an electronics giant like Xiaomi is now branching into the Indian lending market with “Mi Credit” - their recently launched instant lending platform built in partnership with KreditBee, focused on pay-day loans. All these products are targeted towards specific customer segments that lenders have been able to discover thanks to digital tools. While some of these players lend out of their own balance sheets, some of them partner with banks or NBFCs who are willing to experiment with new ways of assessing the underwriting. Some of these digital lenders even offer first loss default guarantee (FLDG) provisions to sweeten the deal for partner banks. 


With over 500 million Indians online today, and many more to come, the potential consumer base is too big to be ignored by any consumer lending business. While some traditional players might view this as a threat, the digital revolution brings with it immense opportunities for lenders to grow their businesses and leap-frog into the future. 


An eye on the future

We are already witnessing partnerships between banks and financial technology services that will help traditional players take bold steps into these unexplored arenas. But even as newer products and process innovations emerge, the key priority will always be to keep a close eye on core indicators such as yields, net margins, and origination and collection costs, to establish the long-term viability of these solutions and gauge healthy return metrics for the business. 


It is important to note that cycles play an important role in assessing the veracity of new products, processes and systems over a longer duration. So far, we have seen only a handful of players operating in the digital lending space, for a short period of time. This leaves us with very limited cycles from which we can draw conclusive data that assures long-term success. As a result, the effectiveness of digitally enhanced credit scoring systems, customer acquisition/retention, and collections is yet to be fully proven. 


However, given the emergence of multiple players, it won’t be long until we discover what techniques work and what mistakes are to be avoided. One thing is for certain, hundreds of millions of Indian consumers are yearning for easy, quick, and digitally empowered financial solutions. The lenders who fulfil this need effectively, will grow their business rapidly. However, the truly successful lenders will be those who understand that in the credit business, giving is always easy but getting it back is what makes all the difference. These are the players who will go a long way and truly emerge victorious!

Author: Pankaj Naik – Executive Director and Co-Head, Digital & Technology, Avendus Capital

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