Why is so much of India’s population excluded from access to formal credit and what can be done to address this issue? Rohit Sen argues that advances in data science, technology and the government’s new financial infrastructure will encourage the development of financial inclusion.
A couple of weeks ago, my maid asked me for a loan. “What do you need the loan for?” I asked. “Sir, I took a loan last year, but the interest is very high. Each month my balance keeps going up and up. It is too much”.
It turns out she went to a local money lender and is paying 5% per month, which is about 80% annualised. It’s easy to see how things can get out of hand. Sensibly, she wanted to borrow from me to pay off this high interest loan. It was the only way she could get her head back above water. She’s someone I trust, so I gave the loan. But let’s suppose I didn’t. What would she do then? I doubt she really had anyone else to turn to. Would she have to sell something precious to her? Would it just spiral out of control?
In India today, a substantial amount of people are facing this situation. The security guard in my building has no access to formal credit. Nor do many working in the service sectors. Call centre staff? Workers in small and medium sized enterprises? No chance. Even most graduates can’t get a loan from a bank.
In fact, access to credit in India is so restricted, that rather than ask who can’t get a loan, the more pertinent question is who can get a loan. The answer is that less than 10% of Indians have access to formal credit. That means there are at least 1 billion to people who can’t access formal credit in India. To be clear, I am not saying that all of them should be able to get credit, it’s merely an indication of the size of the problem. And in the same way water fills available space, in India there is a large informal lending economy to fill the gap.
People queuing outside a bank in Kerala. Picture credit: Arunvrparavur CC4.0
Why don’t Indian banks lend to such a large demographic of the population? Why are all the aforementioned people, who have jobs, denied credit? Are they all really that unsuitable as potential borrowers? The problem actually arises from two factors: first, most of the population has no formal borrowing history and thus no bureau (CIBIL) score and are consequently invisible to banks. Since banks don’t have enough information on the borrower, they ask for collateral, and that’s why most lending is secured. The trouble is, many people don’t have the luxury of having security they can pledge.
Second, banks, due to their large branch network and employee base, have a heavy cost structure. Any loan disbursed needs to be of a certain size for it to be economical for them. There’s a reason why you can’t apply for a Rs 10,000 ($150) personal loan. Again, most people are not in a position where they can borrow and afford to repay a loan of Rs.1 lakh ($1,500) or more which further encourages the practice of informal money lending at high rates.
The good news is that we are living in a time where three trends are coming together; their confluence creates a solution to this long-lasting problem of access to credit. Advances in data science, technology and the Indian government’s ‘India Stack’ infrastructure allow us to create products that the underbanked need and want, and a business that can have enough scale to address this challenge in a meaningful way. No longer do individuals need to be in invisible; by capturing some of their data from their digital and analogue footprint we can make an assessment of an applicant’s creditworthiness. By having an operationally light, fully digital infrastructure, not only can we provide the underbanked with products that are relevant to them, we can also provide a better experience as well. Incrementally, it is possible that hundreds of millions more Indians will be able to have access to credit through a formal system. Credit will be cheaper and easier to access and manage than the informal channels available to them today.
Does it matter that people have or don’t have access to credit? Why can’t people just save up enough money before they buy whatever good or service they are seeking? Yes it does matter. A lot. Millions of Indians are constrained from pursuing their wants, needs or aspirations simply because they lack the capital to do so. They could do these things if they were able to spread payments over time, it’s not as if they don’t have income, but in a credit scarce world they are stuck. Think of the budding photographer that can’t pursue their passion, the millennial that is unable to take an educational course and better their prospects, or the family that can’t afford to pay the hospital fees for medical treatment in an emergency. Credit is not the answer to everything. It can lead to trouble. If managed responsibly however, it can help level the playing field in the good times, and provide a safety net in the event of a financial shock. It can give people the choice and economic freedom to do with their lives what they choose, or at the very least, fulfil important lifecycle events.
This new form of digital underwriting is still in its nascent stage. Fintech players have barely scratched the surface into figuring out what sorts of alternative data have significance in explaining credit worthiness of a borrower. They haven’t faced a full credit cycle through which their models have really been put through their paces. There is a long way to go. Nevertheless, we do now have a roadmap towards financial inclusion. This will help people to save, invest, and improve their circumstances. An economically empowered population will of course be good for the bottom line of the national accounts, but it will also have a profound impact on a societal level too. A freer society is a richer society. Let’s hope that this can be realised.
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About the Author
Rohit Sen is CEO and Co-founder of NIRA, a consumer credit fintech startup based in India. Previously, he worked as a structured credit trader in London for 12 years. Rohit completed his Bachelor’s at Oxford (2002) and his Masters degree at LSE (2003). He tweets @solar_corona