By Amol Agrawal
In its August 2023 Monetary Policy, the Reserve Bank of India (RBI) announced a pilot project to develop a public tech platform for frictionless credit, to be developed by the Reserve Bank Innovation Hub (RBIH).
Providing frictionless credit has been a longstanding goal of banking policy around the world. While the definition of frictionless credit is not as clear, economic and finance literature is rife with ideas on credit frictions. In a financial market, there is usually high information asymmetry between the borrower and lender. The credit-worthiness of the borrower is not known fully to the lender, leading to uncertainty in the mind of the latter.
For overcoming information asymmetry, the lender imposes credit frictions. There are two broad credit frictions. The first is price-related, where the lender charges higher interest rates to cover for the perceived higher financial risk. The second is non-price-related, where lender asks for minimum collateral, minimum documentation, etc. Most lenders impose both price and non-price credit frictions.
The credit frictions lead to lower flow of credit to the economy, which, in turn leads to lower investment and lower growth. Further, the credit frictions amplify the business cycle as the frictions ease during growth years and tighten during slowdown. Monetary policy also impacts credit frictions. When central banks increase interest rates, it impacts asset values and cash flows reducing creditworthiness of both households and firms. Credit frictions also lead to financial exclusion, which is seen as a major impediment for the well-being of people.
Much of economic research in finance studies the impact of the credit frictions on the economy and discusses policies to ease frictions. The financial sector has specific entities such as credit rating agencies and credit information bureaus, which help in lessening information asymmetry. The banks themselves monitor borrowers. The government’s Aadhaar provides identification and address proof of the borrower. However, all these are separate systems which add to the frictions. The government has come up with many policies to foster financial inclusion.
Given the discussion on credit frictions, how can the Public Tech Platform help in providing frictionless credit? RBI specifies that the tech platform would provide seamless flow of required digital information to lenders leading to frictionless delivery of credit. The platform will be based on open digital architecture in which financial sector players can connect seamlessly in a ‘plug and play’ model. The platform will bring all the financial sector players on the common platform, reducing the credit frictions.
The central bank had instituted RBIH in 2020 for leveraging technology to promote innovations in the financial sector. Even before the recent RBI announcement, the RBIH had adopted the objective of enabling “access to suitable, sustainable financial products to a billion Indians in a secure friction-less manner”. RBIH’s Annual Report 2021-22 mentions that under the Agri Credit project it is trying to make the loan application process frictionless under Kisan Credit Card (KCC). The scheme will reduce the turnaround time of credit from four weeks to a few minutes and aims to help around 100 million farmers across India. The RBIH also hosted discussions with multiple stakeholders to streamline and remove frictions from the current KYC process.
The central bank announced that apart from KCC, the pilot project will cover dairy, MSME (without collateral), personal, and home loans through participating banks. The project shall also connect the various records needed to avail loans such as Aadhaar e-KYC, PAN Validation, Transliteration, Aadhaar e-signing, account aggregation etc. Five state governments have boarded the project—Madhya Pradesh, Tamil Nadu, Karnataka, Uttar Pradesh, and Maharashtra. The land records from these states will also be available to the platform. Then, data such as satellite data, milk pouring data from select dairy co-operatives, house/property search data etc. will also be linked to the platform. Based on the lessons from the platform, the scope and coverage of the platform will be expanded.
RBIH’s PTP is an interesting initiative to work towards a longstanding goal of frictionless credit. Ideally, the objective should be to make credit markets have less friction, especially doing away with friction related to duplication of documents and procedures.
This also joins India’s public digital infrastructure programme. Under the programme, the government and its agencies are creating public digital goods and services for easing living and business in the digital world. The program has enabled identities (Aadhaar) and payments (UPI, Rupay) which have been successful. The government is currently working on e-commerce in form of ONDC (Open Network for Digital Commerce). RBI’s new platform aims to provide frictionless credit or a less friction credit market. The central bank should share results of the pilot project with the public to build understanding on the workings of these new markets and new ways of doing finance.
The author teaches at Ahmedabad University