The distance between imagination and reality is shrinking at a pace we have never witnessed before. With better access to data and affordable technology, every industry has been disrupted. Financial services has been under disruption for a long time but the real turn of events started after the 2008 meltdown, when everyone began looking towards technology to prevent a recurrence of the crisis.
Financial technology, or fin-tech, spans across applications such as payments, lending, personal finance management, and digital banking. Let’s look at how lending has been disrupted by fin-tech companies across the globe.
In the US, LendingClub did consumer-lending transactions worth $8.4 billion in 2015 while OnDeck did $1.9-billion worth of transactions for small business lending. The market grew about three times from the previous year.
In the UK, market leaders like Zopa and FundingCircle did $800-million worth of transactions in 2015. The largest alternate finance market was China, where Internet finance market leader CreditEase alone clocked $15 billion in transactions, and the top five players did $56.4 billion.
In India, this number is small but growing rapidly. Recent reports have said that India has emerged as the third-largest alternate lending sector in the world, followed by the US and China. There are close to 100 fin-tech startups in India, and they attracted close to $180 million funding in over 20 deals.
Why is fin-tech attracting attention now?
Five key factors are driving fin-tech adoption across the globe.
Technology: With cloud-based IaaS (information-as-a-service) models and API (application programming interface) banking gaining rapid adoption, it is now possible to have the stack ready with minimal capital expenditure. In fact, technology has been a great asset for companies across the globe to gain speed to market and grow as fast as the more established counterparts in other countries. In many countries, disbursing and collecting instalments has been made possible through seamless banking integration but India is yet to see a mature solution around it. UPI is a step in the right direction but still needs a lot of work before lenders can use it.
Data: Alternative finance hinges on the availability of newer data sources to make risk decisions. More data allow informed decision making and lending to segments which were otherwise underserved. On this metric, countries like the US, UK and China have been far ahead because of connected data sources like bank accounts, companies database, tax data, etc. while India lags behind as many data sources are still inaccessible (e.g., litigation database), insufficient (e.g., bureau penetration) or inaccurate (e.g., business ratings). However, the government has put huge focus on this and programmes like UIDAI and IndiaStack are enabling this at a good pace.
Capital: Money is raw material in finance and fin-tech flourishes where there is availability of capital. Globally, investors are opening up and willing to put their money into this industry. India is already witnessing investor interest and the right teams and businesses are able to easily raise money.
Regulation and policy: Certainty in this area is critical to the success of any industry, especially finance. Banking institutions have gone through many cycles of regulatory evolution but new-age fin-tech is fairly new to this pressure. In fact, many believe that the absence of clear regulation allows fin-tech companies to fly under the radar and pose risk to the industry itself. India is far less mature from a regulatory standpoint compared to other countries and immediate action is needed from the apex body.
Data security: Lending inherently means handling very sensitive and personal information of customers and, thus, securing this data is important. Across the globe, hacking incidents have caused businesses to collapse and eroded value and privacy. While strict data security and privacy laws have been successfully enforced in many countries, India lags far behind in drafting and implementing such policies. As a result, customer privacy and data handling is somewhat ignored until repetitive risk poses a threat to the enterprise.
Across these metrics, technology is the biggest leveller, while data is the biggest differentiator in how various fin-tech companies across the globe operate and innovate.
What challenges does India face?
Accessing the customer: Small Indian businesses are unique in many ways. They are separated by borders, languages, needs, digital readiness, etc. Also, in the absence of a government-led growth agenda and solid governance, they have learned to survive and grow with the help of the social ecosystem, commonly referred to as the ‘informal economy’. Any fin-tech that is trying to provide finance to this underserved small business segment in India has to innovate on the acquisition model. There are a number of new-age lenders like FlexiLoans, LendingKart, NeoGrowth and CapitalFloat, who are doing it effectively by targeting the digitally savvy e-commerce segment through a partnership model with e-commerce platforms, or targeting offline retailers through partnerships with point-of-sale providers. However, the deep end of the retailers is still waiting to be accessed.
Assessing the borrower: After the acquisition, the next big problem is to assess the borrower for risk of default. This is where the ‘alternate lending’ methodology kicks in. Because of a thin credit file or sparse financials in this segment, new-age lenders have developed innovative data science-led approaches to solve this problem. Various sources like social sites, device data, digital footprint, seller reviews, etc. are being used to develop surrogate yet highly correlated indexes that can potentially replace or enrich traditional models.
Unit economics: This is where banks find it difficult to cater to the small business segment. The needs of this segment are to get quick, unsecured, small-value loans but because of the cost-heavy branch-based operating model, it is sometimes unviable for banks to lend small-value loans. New-age lenders have solved this very efficiently by using cutting-edge technology to bring the acquiring, processing and servicing cost down such that they are profitable for small value loans as well. This is really the birth of ‘digital lending’.
India is still enjoying the honeymoon phase as most companies still remain at the early stage and investments are starting to open up. While we wait for unicorns to emerge in the alternate lending space in India, the honeymoon of fin-tech is over in the west and the focus has now shifted to profitability, scale and controlling non-performing assets.
An alumnus of IIT Bombay and ISB Hyderabad, Abhishek Kothari is co-founder of Mumbai-based digital lending platform FlexiLoans.
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