Affordable Credit for India’s next billion

We have come a long way, but have we done enough?

73 years ago began our tryst with destiny. We were then a country of 350 million with a GDP of $20 billion (PPP terms). Fast forward seven decades, our population has grown 400% and our GDP has grown 8700%. Which means the average Indian is 25X better off than when we started. And it is very evident. Our cities are bustling, we have the largest working population in the world and the India story couldn’t get any better!

Or could it?

Much of the growth that we have seen over the last several decades has been segmented. Some have done better than others. From 1977 to 2011, the percentage of population that earns less than $5.5 a day has decreased from 97% to 86.8 %. A positive progress - but not nearly enough. Especially when put in the context of our GDP growth it becomes obvious that the upper quartiles of our population and businesses have done far better than the rest of the country has.

None of this is a surprise, this is the lurking underbelly of incredible India.

Beneath the surface, problems galore

For those of us that choose to look deeper, it’s not hard to find the major factors behind inequitable growth. Fair and affordable access to financial services is one of them, close on the heels of education and healthcare.

The problem is acute. For a majority of India, both consumers and small businesses, access to affordable credit is a still pipe dream. In fact by world-bank’s estimates, the credit gap for just the MSME segment in India is over $200 billion. For next billion consumers, only about 25% of the credit requirement comes from formal institutions.

Part of the challenge is legacy. Financial services are steeped in legacy – and legacy stifles inclusion.

First and foremost is the problem of affordable credit. When a formal financial institution takes the traditional path to offering credit – they must at a minimum take certain costs into consideration. These include the cost of processing the credit application, cost of checking application credit history with credit bureaus, cost of underwriting the application, for a securitized loan there is the cost of appraisal of collateral and finally the costs associated with customer acquisition. Add to that the cost of funds and provision for defaults. It quickly becomes apparent that almost all of these costs are fixed in nature – meaning they add to the same value whether you borrow ?5000 or ?50,000. This makes smaller transactions unaffordable and is the genesis of financial exclusion. Financial services have structural barriers to creating products that fits all sections of the society or businesses.

Second, cost aside, there are methodological barriers as well. As long as credit bureau scores remain the single lens for consumer or business evaluation, more than 40% of the population and businesses will remain outside the formal credit support net.

Third is the data problem. Much of consumer and business data is fragmented and distributed with multiple government bodies and some large consumer platform players. Not all financial institutions have access to this data while taking a lending decision. In the absence of data most will shy away from giving credit even to potentially credit worthy customers.

Finally, the last mile divide. India’s next billion across tier-3 and beyond cities and rural India not only face legacy financial practices but also access to financial institutions within reasonable distance. Compounded with their limited financial literacy, banking has largely remained an out of bound experience.

Where there is a will, there is a way

We may not have all the solutions today, but we know enough to take the right steps.

First and foremost, we need risk based pricing as compared to product based pricing. That means, credit products will be priced to give ‘good credit behaviour’ the reward of cheaper credit. By using a range of consumer data points including purchase behaviour, payments, cash flows and social behaviour Fintech’s have the opportunity to create unique and affordable credit products for all sections of society and businesses.

Second, we need a much broader credit guarantee scheme from the government that gives lending institutions the coverage to take more customers under their fold. The recent CGTMSE initiative is in the right direction, but needs to be more inclusive and bring in a larger partner network within its fold who can bring their customer reach to the program and multiply its impact manifold.

Third, the public credit registry must come into effect. The need of the hour is a public institution that is the custodian of all credit data covering all of our 1.381 billion citizens and 68 million MSMEs. This would dramatically reduce the dependence on credit bureaus and reduce the cost of credit.

And finally, the last mile divide can only be solved through financial access that combines technology with low touch human presence helping educate the underserved on financial literacy and ensuring they get the right product at the right time. Fintech’s that can successfully create such extensive networks through variable cost models would have solved one of the most pertinent and persistent problems in Indian banking.

Together for a better tomorrow

The public and the private sector must come together and take an ecosystem view of financial services. With the scale that government and its regulatory bodies bring and innovation and agility from private players we have an opportunity to unlock a new future for India’s next billion.