The digital lending balancing act

The digital lending balancing act

By Rohit Taneja

The Indian digital lending landscape witnessed a flurry of cascading developments in the past two weeks. With falling household savings and an unprecedented rise in retail loan disbursement, the Reserve Bank of India increased the risk weightage on unsecured retail loans. This was soon followed by banks and large NBFCs asking their on-lending partners to go slow on new retail lending while, at the same time, a prominent fintech player announced they were cutting down their retail loan portfolio. Amidst this, the news of the closure of a big BNPL player has created some caution in the industry. However, there continues to be a demand for digital loans, with more than 53% of all loans disbursed by NBFCs being done through digital means, making it a primary instrument for financial inclusion. However, a sustainable framework for regulating the industry, which balances stability with innovation, is needed. Integrating Digilocker KYC, traditional credit scores, and fintech underwriting models with RBI’s recent fintech repository to create a unified underwriting process might be the best path.

The RBI’s decision to increase the risk weightage on unsecured retail loans was prudent. Regulations such as these are known as macroprudential regulations. These are policy instruments aimed at controlling the market’s liquidity and lie outside monetary policy’s toolkit. A recent International Monetary Fund (IMF) meta-analysis has shown that macroprudential regulations are effective, mainly to tackle specific macro-financial vulnerabilities.

However, the unprecedented rise in unsecured lending is not the main vulnerability but the lax lending patterns. Usually, when a particular loan category sees tremendous growth for a sustained period of time as compared to overall loan growth, it usually means that financial institutions are giving out loans by reducing the underwriting standards. Between April and June 2023, TransUnion CIBIL stated that 51% of small-ticket personal loan borrowers already had more than four credit products.

With this regulation decreasing the margins of digital lenders, the unintended consequence is a faster pace of lending to increase scale to make up for the margin loss, which might erode borrower quality further. A complementing framework is needed to help digital lenders scale sustainably.

The answer lies in a robust digital public infrastructure. The fintech repository RBI plans to create is an excellent first step towards this complementing framework. One of the significant challenges fintech lenders face is conducting full KYC of their customers, with more than 49% of fintech companies identifying it as their top challenge. It is a conundrum. On the one hand, it is the most critical element of lending but also the most time-consuming, which goes against the primary unique selling proposition of speed for these lenders. The government’s decision to allow Digilocker KYC was an incredible move to solve this problem, but unless credit scores are integrated into this infrastructure, problems like the ones TransUnion CIBIL observed will persist. Hence, the first step is to integrate Digilocker Credit Score into the infrastructure to create a more sustainable underwriting model and disincentivise siloed underwriting, eventually leading to greater scrutiny.

However, this will only solve the problem of borrowers incorporated into the formal financial system. Most fintech borrowers are new to credit customers, and credit score underwriting does not work for them as effectively. To counter this, multiple fintech lenders use their own underwriting models. However, these underwriting models, though effective, are not uniform; hence, they are seen with suspicion by the regulators. This can be solved if these underwriting models are integrated with traditional credit scores on the FinTech repository that the regulator launched. This will not only bring all these underwriting models under one regulatory umbrella platform but also bring in a level of standardisation. Once this is done, Digilocker can also be integrated into this infrastructure over a period of time. This would solve the main vulnerability of the current lax lending patterns in the system.

Such a platform and macroprudential regulations will stabilise the economy and help fintech lenders grow sustainably.

The author is founder and CEO, Decentro

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