Lending – how to trust the borrower?
A lender trusts the borrower by having some due-diligence and checks/balances.
This is what the banks and financial institutions have been doing since their inception. So, the critical piece boils down to how to do the due-diligence because that will determine the fraud and credit model for any intermediary which is lending.
These things have not changed much since the last few decades. The banks are still determining the trust by checking the collaterals, assets, etc of the borrower, which led to serving only the mid-high income and high-income individuals, which in turn created a huge access gap to credit for anyone below that income strata.
Hence, disruption started happening outside the traditional financial institutions to develop new due diligence processes (or credit model) by leveraging the alternate data and behavioral economics.
And this has led to the birth of micro-finance institutions – which start doing lending at a very small scale to people who don’t satisfy banks criteria, basically unsecured loans. They did something beautiful to create trust among the borrowers by lending at a group level – SHGs or Self Help Groups, so as to de-risk it by leveraging social and behavioral psychology.
We are seeing some red flags in micro-lending specifically.
“A reversal was observed in the trend with rise in ticket size outpacing the growth in client base. While MFIs continue to expand their reach and add new clients, in the post-demonetisation period, greater focus has been on client retention (by offering higher ticket sizes) and eliminating delinquent clients, which has slowed down the pace of client growth for the sector. ” ~ Supreeta Nijjar, Sector Head – Financial Sector Ratings, ICRA
“In South Asia figures are similar, with 11 percent saving in a financial institution in the last 12 months and 9 percent receiving a loan from a financial institution. And yet the massively popular Self-Help Group movement in India counted 97 million households affected by March 31, 2010. But even this indication of participation is weak when compared to the potential market of the 900 million households in India that live on less than US$2 a day” ~ [5]
The next phase in this innovation cycle is to design, develop and customize financial services for next billion users by leveraging smartphone and internet penetration to get various forms of alternative data to build new forms of credit as well as fraud models. In this phase, fin-tech can play a very important role as a disruptor and hence a replacement to existing ways of doing lending business.
“The concept of fintech is very exciting, particularly with respect to credit scoring and figuring out what products are needed by different people. “ ~ Robert Dunn
What fin-tech companies needs to figure out to disrupt (not just an incremental improvement from the previous ways)?
- Know the ability to pay vs willingness to pay of your customer.
- To be able to determine the fraud and credit model
- Use positive screening over negative screening while creating credit or fraud model.
I like to end this post with the quote by Nandan, which I used in my last post as well – fin-tech or tech enabled banks.
“Financial services in India is going from low volume, high value, high cost to high volume, low value, low cost” ~ Nandan Nilekani
References:
- https://knowledge.wharton.upenn.edu/article/how-is-fintech-transforming-microfinance/
- https://home.kpmg/in/en/home/insights/2018/12/microfinance-digital-fintech-collaboration.html
- https://triplejump.eu/wp-content/uploads/2018/05/How-Microfinance-is-Navigating-the-Fintech-Revolution-in-Africa-1.pdf
- https://www.bloombergquint.com/business/microfinance-disbursements-hold-up-despite-tight-liquidity-icra
- https://openknowledge.worldbank.org/bitstream/handle/10986/12272/9780821389270.pdf?sequence
PS: I would love to hear from your journey being a fin-tech entrepreneur, investor or an enthusiast like me. Shoot me an email at sagar@humane.network or WhatsApp at +91-8095786001 for a cup of coffee.
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