Digital Lending Thesis: $400 Bn Market

Credit Gap in India: $1Tn of credit gap among businesses and individuals is anticipated. Digital lending solely will grow to $400 Billion by 2024, contributing 55% of FinTech. 500 Million Indians who have not yet achieved complete financial inclusion.?

Solution across three segments -?

• B2B: $400 billion, 10% of India’s GDP is untapped in the MSMEs market which hampers the growth of the sector and the economy even though they account for 30% of India’s GDP.?

• B2C: There are over 500 million new-to-credit (NTC) individuals in the country.?

• Infrastructure: The evolution of infrastructure from monolithic, on-premise solutions to micro-service-driven, cloud-based ones will promote flexibility to customise products.?

Lending Market

The traditional lending market is worth $1,910 Bn in FY22 & the digital lending market is worth $270 Bn. Expected to reach $2,838 Bn & $593 Bn respectively by FY 26.?

Portfolio outstanding of Commercial loans are $1078 Bn and Retail loans are $99 Bn in FY 22. 90% of the commercial loans are disbursed by the private and public sector banks. 51% of loans are disbursed by NBFCs. Fintech contributes to 83% of personal loan & 16% consumer loan. Indian banks’ weak loans (non-performing assets or NPAs) are projected to drop to 4.5% at the end of FY 2023-24, and to 3.5% at the end of FY 2024-25.?

Rise of NTC (New to Credit) Customers: 35 million new credit histories began in 2021; an additional 31 million within the following nine months. Millennials constitute 42% and Gen Z - 29% of new credit users, with 67% from rural and semi-urban areas.

However, there are a lot of challenges with the NTC customers - lack of formal credit history, may not have assets for collateral, struggle with documentation and regulatory requirements.?

Supply Challenges faced by lenders - Prolonged turnaround time for formal credit acquisition, data complexity in credit underwriting, collections and recovery.?

Drivers of Digital Lending:?

• Improved banking access with 77.3% bank account penetration (2021).
• A tech-savvy younger generation with ~52% Gen-Z and millennials
• Significant untapped MSME market with a credit gap of ~$400 billion
• Government support with IndiaStack by leveraging Digital Public Infrastructure (DPI) for efficient lending platform operations.?
• In FY24, the credit-to-nominal GDP ratio is expected to increase from 1.2x to 1.7x.?
• 510 Mn Pradhan Mantri Jan Dhan Yojana accounts, 100 Bn UPI transactions, 6.65 Mn+ Aadhar enabled payments, 55% of people and 39% of businesses have availed credit facilities.?

India’s credit eligible 814 Mn adult population demographic:?

• 179 Mn - Credit served
• 63 Mn - Newly Acquired
• 164 Mn - Credit Undeserved?
• 408 Mn - Credit unserved?

Credit approval rates have declined across segments due to increasing new-to-credit (NTC) applicants and decreasing risk appetite.

Rural Connectivity: India's expansive rural areas, with 720 districts and 5 lakh villages are served by only 154,725 post offices. 150K+ branches, 1.8M bank correspondents 2021. The no. of business correspondents and digital users has seen remarkable expansion, growing by 7x and 2x respectively, while physical branches have only grown 1.3x.

Digital Public Infrastructure - India Stack has empowered lending platforms to utilise digital public infrastructure and data, enabling them to reach and underwrite a previously unreachable large population.

• Identification & Onboarding Layer: Adhar, E-KYC, Digilocker
• Enabler & Data layer - Account Aggregator, ONDC, OCEN
• Payment Layer - UPI, e-Nach +Auto UPI

Evolving Regulatory Framework?

• RBI regulations:? promote ethical practices, with mandatory cooling-off periods, loan transaction limits, and customer consent for credit limit increases.
• Co-Lending regulations:? includes direct loan disbursement into borrowers' accounts, upfront disclosure of loan costs as APR, and mandatory reporting to CICs.?
• Strengthen data security: ?guidelines for digital lending issued in September 2022 has consumer data restrictions, third-party restrictions and all data needs to stored.?

FinTech and traditional lenders have shifted from competition to cooperation, fostering innovation and expanding financial access in India.

Investment Trends?

VC/PE investments decline from $2 Bn across 129 deals to $596M across 32 deals in 2023. Lending tech comprises two-thirds of all fintech startups in India, making it the largest segment.? The sector has attracted $5.8 billion of capital raised in the last six years to target a market size of $400 billion by 2024.?

Big M&As in 2023: Trillion Loans acquired by BharatPe for $36M (38.7x multiple), Upwards acquired by Lendingkart for $12M (12.6x multiple), Ezetap acquired by Razorpay for $200M (9.3x multiple).?

Unicorns in Lending (2022-23): Incred raised $318M at 9.5x multiple, Vivriti Capital raised $205M at 19.3x multiple, Oxyzo raised $201M at 13.5x multiple, Yubi raised $239M at 30x multiple.?

Components of successful operating models?

• Competitive Interest Rates - NBFCs typically have higher cost of funds compared to banks, and fintechs have higher rates than NBFCs. Therefore, effectively managing the cost of funds to provide competitive rates is essential.?
• Fast Turnaround Time (TAT) - Implementing digital data collection and processing systems for efficient online verification to maintain accuracy and reliability.
• Wider Reach and Accessibility - Need to explore innovative customer acquisition channels to tap into new markets.?
• Effective Risk Management and Collections - ?Optimised collections strategy, combining digital communication with selective physical engagement for improved recovery rates.?

Levers of Operating Models?

Digital Lending Infrastructure

Lending infrastructure includes SaaS/Tech platforms for end-to-end loan underwriting and collections management. Core systems manage workflows, while data providers supply data to these workflows.?

Infrastructure -?

• Loan Origination System (LOS): helps lenders in managing the entire process of loan application, approval, and disbursal. Cos - Lentra, LendingPad, VEFIN.?
• Loan Management System (LMS): cover processes including loan servicing, reporting, customer care, syndication and customer monitoring. Cos - Yubi, CredFlow.
• Credit Card Management Systems (CCMS): software designed to oversee and manage the entire lifecycle of a card. It typically includes automated business rules to streamline card management processes. Cos - Vegapay, Finserv,?
• FRM/ Collections: Systems for Financial Risk Management and delinquency recovery, automating risk assessment, monitoring, and debt collection workflows. Cos- DPD Zero, Credgenics.?

Data Providers -?

• Alternate data platforms: Companies that offer non-traditional or unconventional sources of data for assessing creditworthiness and making lending decisions. Cos - Creditvidya, Creditmantri.
• Embedded finance platforms: Integrate banking services within non-financial apps and websites for seamless financial transactions and services directly within user experiences. Cos - Rupifi, Finbox, Finstack.
• Banking Data: Banking data providers and account aggregators drive lending decisions through advanced analytics, open banking, and API integration for seamless financial insights. Cos- Fego, Perfios, CAMS Finserv.
• Credit Bureau: AI and Big Data enhance credit scoring and report analysis for precise, efficient lender decisions. Cos - Equifax, TransUnion.?
• KYC/ AML/ Risk Management: KYC and AML compliance through API solutions, including Video-KYC, meeting evolving regulatory standards. Cos - Karza, Bio Catch.?

80% banking data is unstructured. Global Market for AI in banking is $19Bn in 2023 & will reach $236 Bn by 2032.

Open Banking

Open Banking unlocks financial data with the user’s permission to allow secure sharing with regulated third-party providers. Account aggregators (AA) act as an intermediary by collecting data that hold the customers’ financial data and share that with lenders. In India, the number of successful open banking payments increased by 130% between 2022-2023. Further, 14 AAs operate with a NBFC-AA license.?

Rise of Co-Lending: Collaboration where NBFCs team up with banks to offer loans, enabling NBFCs to grow rapidly using the bank's larger balance sheets, boosting their ROE.

• Financial Inclusion - Targets underserved regions, enabling credit flow to EWS, LIG, and MIG through NBFCs' local reach and banks' capital.
• Affordable Credit - Leverages bank-NBFC partnerships to offer lower interest rates, reducing financial barriers for borrowers.
• Risk Distribution: Adopts an 80:20 funding model, balancing risk and incentivising quality loan origination.?

65% of the Gold Loan Market is unorganised, and 35% is organised which is worth $6 trillion, out of which there is an 80:20 ratio between Bank & NBFC.?

Different form factors of lending

• Market Aggregators: Serve as a one-stop-shop platform for comparing various loan products from different lenders. Eg. PaisaBazaar, BankBazaar, and PolicyBazaar.
• Embedded Finance: Integrates multiple lending functions within non-financial websites or apps for a seamless user experience. Eg - Rupifi, Finbox.?
• Co-branded cards: Credit cards issued jointly by a bank and a retail brand, offering brand-specific benefits. Eg - Amazon ICICI Bank credit card.?
• Vertical SaaS Lending: Specialized software solutions for specific industries that also offer lending as part of their product suite.?
• BNPL: Allows consumers to purchase immediately and pay over time, often interest-free. Eg - Simpl, PaytmPostpaid.?
• Credit on UPI: Offers short-term credit facilities over the UPI platform for instant transactions for both B2B and B2C. Eg: Aspire.?
• CBDC Lending: Digital form of fiat money, issued and regulated by RBI and can enable precise tracking, facilitating purpose-driven loan.

Challenges

• Technology mismatch between traditional FIs and fintech players.?
• Increasing data security and privacy risks.?
• Higher cost of funds and poor credit quality is eroding profit margins. Struggle to achieve scale while managing customer acquisition costs.?

RBI Guidelines

• No third party collection is allowed. Funds must move directly between the borrower and the Regulated Entity (RE), avoiding any third-party accounts.?
• Fintech companies are prohibited from collecting any fees from borrowers.
• Borrowers are allowed a period during which they can opt out of a digital loan by repaying the principal and a proportionate APR without penalties.?
• REs must appoint nodal officers for effective grievance handling.?
• Digital Lending Applications (DLAs) must collect data based on necessity, maintain clear audit trails, and operate with explicit consent.?

Co-Lending guidelines

• Banks and NBFCs share risk in a ratio of 80:20; 80% of loan is borne by the bank and a minimum of 20% remains with nonbanks like NBFCs, HFCs, Fintech, etc.?
• Co-lending requires thorough initial diligence, including Know Your Customer (KYC) checks and a minimum holding period for loans.
• Banks cannot co-lend with NBFCs that are part of their promoter group.?
• All bank and NBFC transactions must go through an escrow account to prevent the mixing of funds.?

Note: Above article is the summary of report published by Eximius Ventures