In this age of digital disruption, where technology has made a lasting impact across a number of service sectors — e.g. retail (Amazon and Flipkart), transportation (Uber and Ola Cabs), travel and hospitality (AirBnB and Oyo Rooms) – financial services is no exception. Technology has enabled the finance world to bounce back from the crisis of 2008 by responding strongly to increased capital requirements from borrowers. Apart from the erosion of public confidence and higher regulatory costs, which are global financial concerns, the Indian finance institutions have also had to battle with keeping NPAs low.
Globally, Peer-to-Peer (P2P or Marketplace) lending has emerged as a viable alternative to traditional banking channels, wherein a group of lenders or investors – using an online platform – directly lend to various classes of borrowers (MSMEs, individuals etc.). Marketplace lending attempts to leverage technology to reduce the delivery time and operational costs of lending, particularly for small-ticket loans; the cost savings through such disintermediation are then shared between lenders and the borrowers on the platform. Simultaneously, marketplace lenders are pushing the frontiers of new credit markets, using technology to reach previously underserved populations through innovations in product design, sourcing, and underwriting.
There are a very compelling set of drivers today that can enable marketplace lending models to scale rapidly in India and unlock significant economic and social value.
Financial inclusion through digital lending: In India today, traditional financial institutions cater to less than a quarter of the total MSME debt financing need. The situation with regard to personal lending, especially in the rural areas, is also dismal – health related expenses alone being a major cause of indebtedness. Banks have traditionally struggled to cater to such segments, due to a combination of access issues, outmoded underwriting, and high costs of delivery. A fundamental principle of marketplace lending is that anyone with an internet connection can apply for a loan. Data surrogates (for instance, digital exhaust from electronic subsidy transfers) can be used to underwrite alongside, or replace, traditional inputs to build a credit history. Technology-driven workflows can significantly reduce origination costs, making lending viable at scale.
Displacing informal lending – timely access to affordable credit: Informal lending has always been a key source of credit to a large portion of the Indian population. In fact, many informal lending models look like offline lending marketplaces, where groups of moneylenders come together to provide loans. Despite the high rates of interest charged, quick processing times and ease of securing funds, have been the main reasons for them to remain relevant. Marketplace lending platforms can begin to displace informal sources of financing by delivering value to end-borrowers on two fronts: first, by extending access to formal credit to segments that have traditionally been underserved by banks (due to lack of availability of credit data or high origination and servicing costs); and second, by delivering this credit in a timely manner that matches or even exceeds the speed of borrowing from an informal lending channel, i.e., moneylender.
Inflation beating savings option: In India, the choices today are extremely limited for people trying to invest in fixed return products. Typically, people close to retirement would invest in fixed deposits and bonds with a view to obtaining predictable returns. FD rates provided by banks, though relatively risk-free, have lagged considerably below inflation for most of the recent past. Investor returns from marketplace lending in India would likely be considerably higher than bank deposit rates or even corporate issuances. Furthermore, they can benefit from diversifying their portfolio. A key principle of marketplace lending is that an investor can invest in a fraction of a loan; e.g., instead of investing INR 1 lac in a single loan, the same principal can be split across a basket of a hundred loans (INR 1000 each) – not risk free, but diversified.
Channel for institutions to lend: Marketplace lending models may also serve as efficient delivery platforms for financial institutions, which often differentiate their business models through niche-based lending (for instance, specializing in MSME finance). Such platforms could serve as efficient alternate channels for banks to lend, e.g., to meet priority sector lending requirements. Developed jurisdictions such as US and UK are already seeing a paradigm shift, where marketplace operators are ‘partnering’ with big banks instead of ‘disrupting’ them. There is considerable synergy in India for such partnerships where banks, which typically have legacy software and high operating costs, ‘plug into’ marketplace platforms to lend. Borrowers would benefit from speed of delivery, lower pricing and the chance to build a credit history.
Broadly, whilst marketplace lending is at a nascent stage in India, the model can be a powerful tool to match capital providers (e.g. regional banks/pension planners) with unserved or underserved demand (e.g. SME borrowers/ rural poor). The infrastructure to enable this model is already being put in place by the authorities (Digital India/ Aadhar/ UPI etc.). What will be key to success is a balanced regulatory environment which supports these new platforms of financial services delivery, whilst maintaining the high standards required of any organisation dealing with public monies.
The author are: Akshay Sarma, Senior Manager, Capital Markets- Capital Float, and Aman Bhargava, Senior Vice President- Capital Float