Open Networks for Credit: The Potential and The Pitfalls

We explore the biggest new development in Digital Public Infrastructure: Open Networks for Financial Services. Are we about to see the UPI moment for Credit? Or is the ecosystem ill-prepared for such a development?

The success of UPI and its rapid scale-up can in no small way be attributed to the simplicity of the design of the early architecture as well as the unique and intelligent Governance framework surrounding it. Many countries had attempted Real-Time Payments (“RTP”) networks but had not seen scale or adoption in the way India did - proving that good protocol, architecture and governance design from the get-go are the keys to success.?

Buoyed by this success - the new buzz in the Indian market seems to be “Can we have a UPI moment for Credit?" and like UPI, the success will be predicated on the design of the protocols, the architecture and governance. Or is it? Is credit just a far more complex beast that cannot be slipped into a simple architecture? Let's look under the hood.?

OPEN NETWORKS IN FINANCIAL SERVICES?

The concept of an Open Network in financial services is not new - and in India, we have been discussing this for many years now - first thanks to the iSPIRT’s tireless work on OCEN (Open Credit Enablement Network). ONDC FS (Financial Services on Open Network for Digital Commerce) has now also entered the fray and both promise to drive a new era of inclusivity, innovation, and access in the financial landscape.

An open network is NOT a marketplace. A marketplace usually has a price setter and a price taker (and normally some middlemen in between) that manage customer discovery and pricing. On the other hand, an Open Network is designed to offer universal accessibility (i.e. all market participants can and should join) as well as complete transparency and openness to all. An Open Network should be self-governing, once the rules of the game have been outlined. Each participant should follow the protocol designed by the network. The main benefit of this is that the end user (in the case of Credit - the borrower) - gets a? better, fairer and more innovative set of products to choose between. At the same time, the financial participants (lenders in this case) get low-cost and easy access to borrowers at scale, reducing acquisition costs and increasing credit supply.?

Both OCEN and ONDC promise to provide the most innovative product experiences (to the borrower) but at the same time, standardise the offerings that lenders can develop - and this has led to some criticism in certain corners.?

OCEN: BRIDGING CREDIT GAP FOR MSMEs

There is no doubt that improved credit supply is needed in the Indian market - Small businesses are still woefully excluded when it comes to access to credit. As per government data, micro, small & and medium enterprises (MSMEs) contribute over 30% of India’s GDP and employ more than 120 Mn people. Yet less than 20% have access to formal credit. Banks and NBFCs are not able to service small-ticket loans due to the complexity of acquisition, underwriting and servicing costs involved.?

OCEN, built on India Stack, is able to bridge the gap by connecting lenders, loan service providers (LSPs) and other marketplaces via a common platform and protocol that makes small ticket credit not only cheaper but much easier to service. OCEN has seen some success and currently has a focus on what's called “flow-based lending” to SMEs - i.e. using existing cash flow data as a basis for underwriting. Lenders who have used OCEN to enrol on the Government e-Marketplace (GeM) Sahay platform are successfully lending against Purchase Orders today and solving a significant pain point for the supplier as well as the government. Whether OCEN can scale from here will depend on things like its ability to integrate alternative underwriting methods (i.e. to function in the absence of the flow data) and to embed collections and servicing modules to the protocol. These are coming soon.?

ONDC - FINANCIAL SERVICES?

The Open Network for Digital Commerce (ONDC) was launched this year to great fanfare - initially to solve the pain point of connecting SMEs to buyers and assisting in fulfilment and distribution (reducing over-dependence on expensive marketplaces such as e-comm platforms). The network has been a success and is expected to clock 2 lakh daily orders by early next year.?

Interestingly - the same Open Network concept is now being re-purposed for the distribution and fulfilment of financial services, starting with small-ticket consumer products such as personal loans, mutual funds and general insurance products. The network makes integration between product manufacturers and product distributors easier with standard open APIs that bring overall costs down.

Again, the promise is that the cost to source and service a customer will be dramatically reduced by the Network, leading to a better outcome for the end consumer and easier growth for the financial institution.?

CONCLUSION

The promise of both OCEN and ONDC is obvious and exciting -?

• Reduced costs: With a common digital infrastructure in place, lenders and loan service providers (LSPs) will see reduced operational, servicing and acquisition costs - these should be passed on to customers plus open up new unserserved segments
• Financial Inclusion: Built on the India stack, the digital public infrastructure allows financial institutions and service providers to reach customers across the country, especially the underserved population. Small businesses, for example, can now avail themselves of credit at competitive rates, thereby increasing financial inclusion

• Enhanced Innovation: With the guardrails laid, there is immense scope to create financial products for multiple segments and launch experiments as the Network scales?
• Collaboration: Open Networks offer a faster, easier opportunity for digital partners and lenders to collaborate backed by a clear protocol and regulatory framework. ?

But of course, there are some challenges too. For any new platform, the classic challenge of adoption hurdles does exist, or the “chicken and egg” phenomenon. For the end value to come through, all financial institutions are needed to participate but many will not join the Network until they see critical mass.?

Certain financial institutions seem sceptical about these Networks - in particular some fintechs who may have spent significant resources building their own “middle-ware” to link lenders and borrowers. Many of them are not excited about being simply LSPs in this new world.?

Similarly, some traditional lenders have shown reluctance to integrate because of a lack of technological capabilities - for example - even if they can implement the Open Network protocol - do they have the back-end systems to handle servicing and retention of completely digital customers??

End-consumer love for these Networks will only happen when the challenges above are solved - i.e. consumers need to see all participants on the Network and true benefits in terms of better pricing, higher approval rates and improved customer service. This will take time to come through.?

Finally, some are accusing the concept of Open Networks of stifling innovation - ie by creating standard protocols, financial institutions who spend money on deep product innovation, will not get rewarded.?

Whilst this may be true, it's important to understand the bigger picture at play here. Open Networks solve a very pertinent problem which is ultimately access and financial inclusion.? Access to credit for customers and businesses, access to the network for players thereby growing the entire ecosystem.?

The potential of OCEN and ONDC to reshape the digital landscape is immense. These initiatives signify a paradigm shift, empowering individuals and businesses and steering us toward a more inclusive and connected digital future - but as ever the devil is in the details and we may have some delays as the participants of these Networks make peace with uniform protocols.?

What do you think - will open networks be a game changer for financial services or are the odds stacked against? ?

And what would you like to understand more about this topic? Please comment and we will research for a future edition!?

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