Sometime ago, payday loans were availed by blue collar employees who receive their wages on a weekly basis. Recently, many start-ups have entered this business targeting the young, highly mobile and aspiring population. Let us discuss the merits and limitations of availing such a loan.
Understanding payday loan
The concept of payday loan was quite popular in developed countries wherein the lender provided loans which were given in advance of the next pay cheque to blue collar workers who lead their life from pay cheque to pay cheque. Interest charged on these loans were generally on the higher side as they are unsecured.
The same concept is packaged in a new form and sold to a different set of customers now. In India, many start-ups today offer payday loans to the young, aspiring population.
According to some market research agencies, the payday loan market in India is estimated at R70,000 crore which is expected to growth at the rate of 14% per year. Around 100 start-ups have already forayed into this market in the last 18 months. Banks never lend money for 7-15 days and it is not cost-effective for them to offer small value loans of R10,000-30,000. The option of credit cards comes with higher interest rate especially if one withdraw cash from the card.
How it works?
The targeted customers are generally youngsters who are looking for funds to buy the latest mobile phone or fund a short holiday, education fees or some unforeseen expenses towards the end of the month. The typical loan size is R10,000-30,000. Loans have to be applied online and are approved and sanctioned in five to ten days.
Start-ups use technology to assess loan eligibility, amount, interest rate, etc. They even check your social media profile, comments, status, timeline, number of followers, etc., to cross check the data provided in your online application. The typical interest rate is one percent per day. The primary security is the next month’s salary and the loan needs to be paid back out of the next pay cheque.
Is it a possible trap?
A major concern in this model is the flat rate of interest which might possibly impact the borrower if he is not careful. Majority of the payday loan providers don’t have a non-banking licence but have tie-ups with other non-banking finance companies for loan disbursal. As of now, there are not too many legal regulations for lending through electronic platforms. To conclude, disruptive technological innovations should not lead to irrational enthusiasm in lending.
The writer is associate professor of finance & accounting, IIM Shillong