Why is India a front-runner in the field of digital lending?

By Puja Sharma

In the absence of a universally acceptable definition of the term ‘digital lending’, the (Financial stability board) FSB definition of the term ‘FinTech credit’ as all credit activity facilitated by electronic platforms whereby borrowers are matched directly with lenders comes close, according to a report by the RBI.

In India, the digital lending ecosystem is still evolving and presents a patchy picture. While banks have been increasingly adopting innovative approaches to digital processes, NBFCs have been at the forefront of partnered digital lending. From the digital lending perspective, such lending takes two forms, viz. balance sheet lending (BSL) and marketplace lending (MPL), aka platform lending. The difference between BSL and MPL lies where the lending capital comes from and where the credit risks of such loans reside.

The IBS Intelligence proprietary data shows, In 2019, lending startups in India generated revenues of over $350 million. However only seven out of those had a positive EBIDTA. The digital lending market is expected to reach $350 billion by 2023. This industry is mainly covered by FinTechs and NBFCs.

In the post-global financial crisis, financial markets around the world have undergone a significant transformation driven by technological innovation. In the credit segment, P2P lending platforms have emerged as a new category of intermediaries, which are either providing direct access to credit or facilitating access to credit through online platforms.

Balance Sheet Lenders are in the business of lending who carry the credit risk in their balance sheet and provide capital for such assets and associated credit risk, generated organically or non-organically. Market Place Lenders (MPLs) or Market Place Aggregators (MPAs) are those who essentially perform the role of matching the needs of a lender and borrower without any intention to carry the loans in their balance sheet.

Evolution of P2P lending space

Peer-to-peer lending or P2P lending has been defined by FSB to include marketplace lending i.e., lending financed mostly from wholesale sources and non-loan obligations, such as invoice trading. FSB has also classified ‘peer-to-peer lending’ and ‘loan-based crowdfunding’ as the main components of FinTech credit. Taking cognizance of the lack of a universally acceptable comprehensive definition of ‘FinTech credit’ or ‘digital lending’, this report has not attempted to define this term, as new models and approaches are still evolving.

While P2P lending in India is a clear example of MPL, many other players who are in the business of originating digital loans, (e.g., MPAs, FinTech platforms, or the so-called ‘neo banks’ or BNPL players) transfer such digital loans to BSLs, can also be bracketed with MPLs/ MPAs. These categories of market players form part of the broader class of Lending Service Providers (LSPs).

Besides, there are companies primarily engaged in the technology business which have also ventured into lending either directly or in partnership with financial institutions. Such companies include ‘BigTechs’, e-commerce platforms, telecommunication service providers, etc. In the digital lending space, we have global examples of Person-to-Person (P2P), Person-to-Business (P2B), Business-to-Person (B2P), and Business-to-Business (B2B) lending models.

Way ahead

Digital lending is driven by a combination of supply-side and demand-side factors. In India, unmet credit demand of younger cohorts, low financial inclusion, technological advancements, and increasing internet penetration are going to be the strong drivers.

However, trust in technology, data security, and customer protection considerations will play a critical role in determining the extent of FinTech adoption. India accounts for the most number of DLAs in the world. India’s vision towards becoming a cash-light economy combined with the growth of public digital infrastructure and the demand for financial inclusiveness makes it a front runner in the digital lending technology arena.

To regulate digital lending entities, RBI established a working group in January 2021. Lending business can only be conducted by entities regulated by the central bank or authorized to do so by any other law, according to the new guidelines. Lenders are prohibited from automatically increasing credit limits without borrowers’ consent under these rules, applicable only to RBI-regulated entities and lending service providers.