India looks lucrative for consumer lending startups. It is the most densely populated country in the world (more than 1.4 billion people) with still very low financial services penetration, e.g. unsecured loans account for only 5% of GDP.
In India, it is possible to start lending without obtaining a banking licence, all you need is to get a non-banking finance company licence. The number of NBFC lenders is much larger than that of banks, viz. about 10,000 vs. 100 traditional banks. Mobile applications and remote channels of interaction with the client are not that well developed in traditional banks, so partnerships between banks and fintech companies are gaining more and more popularity.
Digital lending platform Viva Money has launched a pilot for lending via mobile application in December 2023.
We are a so called lending services provider, we have a Financial partner (NBFC) that gives us a competitive edge – we can connect an unlimited number of partners and thus increase the client’s chances of obtaining a loan.
While the Indian market is highly tempting and there are no high barriers to entry, it seems to be challenging to survive and gain a firm foothold in it. Before entering the Indian market, we thoroughly studied the experience of various companies with a similar business profile.
We saw that in the last 2 years several lending platforms in India have gone bankrupt or changed ownership to save themselves from bankruptcy. These include companies like Zest Money and Bold Finance.
We have scrutinised the reasons why this happened so that we won’t make the same mistakes. Here are the risks I would advise to pay attention to:
Risk No. 1 – Miscalculation in Scoring
Such lending platforms as Viva Money can partner with banks and non-bank lenders, in this case loan applications are filed to different lenders.
Any fintech company has its own lending strategy that it offers to a partner, and it usually tends to involve more risk. This entails a higher level of overdue debt in the segment that the fintech player offers to lend to. Most likely, this delinquency will be compensated for by a higher interest rate and high fees. So usually Financial NBFC partner has its own Personal loan product and a set of loan products that they offer to fintech partners.
Here are a few conditions under which fintech players can go under. The first problem is that they have not tuned their scoring well enough together with NBFC partner, made a calculation error, and generally overestimated their ability to manage credit risk.
That was the mistake made by the Zest Money platform, which was sold cheaply about six months ago, at a price much lower than it had valued itself at in its investment rounds. It was a pure fire sale. The company operated in the BNPL segment. It issued many loans, the risk turned out to be worse than expected, and they could not cross-sell other companies’ products.
Risk No. 2 – Circumventing Regulatory Procedures
Fintech companies have a great temptation to bypass regulation. The Indian regulator RBI allows several lending schemes, the main one being the First Loan Default Guarantee which covers only 5% risk. If the risk is higher, say 10% or 15%, such loans will have to be bought back from Financial partner’s book using some other the lender’s balance sheet. There are no exhaustive or proper regulations of repurchase activities, hence RBI may see it as a circumvention of the FLDG rule.
RBI is trying to prevent fintechs from working with the high-risk segment. But fintechs operate mainly in the collateral-free segment, so there is a conflict of interest. Operating under the FLDG rule is risky in itself because it does not allow fintechs to work with the segments that they are primarily targeting.
As a result, companies use schemes to circumvent the 5% threshold, which the regulator considers a violation of the law and orders them to change the model. The regulator thinks that if the risk is lowered below 10%, rates will be low, but in fact many people in India are losing access to borrowing opportunities.
Some companies go further and are not only into grey schemes but also into predatory lending, which is in direct violation of RBI norms.
Any company without an NBFC licence can lend up to 50% of its assets. Once it reaches this limit, it has to get a license to lend. So what does the company do? It can take 5-6 legal entities that have other businesses and start lending using their balance sheets. This directly leads to blocking accounts and can entail other sanctions by the regulator, but some companies play this game and lose it as it is a direct circumvention of the requirements for the companies regulated.
Another option is issuing loans at the rates of 200%+ per annum. A recent example is Acemoney which lost its licence for not meeting RBI’s requirements for verification of new customers and for not complying with the regulator’s expectations for justification of its interest rate policy for customers.
Risk No. 3 – Higher Cost of Funding
Capital market conditions have changed over the last two years and we see increasing pressure on funding costs. There are two reasons for this. The first is global. Inflation is rising and central banks have been raising rates, as a result, the cost of borrowing has increased. The second reason is local.
RBI from its end has forcibly started tweaking unsecured lending by raising risk weights. For unsecured loans, the risk weights are now 125%, whereas earlier it used to be 100%. Additionally, loans from banks to NBFC players, who have more than half of their assets in unsecured loans, now also require risk weights of 125%. Fintech players have had to raise the interest rate to compensate for the increased cost of bank loans. Pushing sales of unsecured loans eats up capital but yields higher returns.
Risk No. 4 – Wrong \ Wasteful Business Model
If the founders of a startup don’t know how to manage their costs, they risk not reaching the break-even point or even closing down. There are several examples of fintech players who were forced to cut costs and layoff large numbers of from their teams because revenue growth rates did not cover the growing expenses – Simple, Coinswitch, Wint Wealth.
Takeaways
Despite all the hidden pitfalls of operating in the Indian market, it is possible and worthwhile to work in it providing you keep a close eye on the changing external conditions and the regulator’s policy.
We scrutinise the cases of fintechs leaving the market – what they have been banned for. And we do not repeat their mistakes.
It is also very important to keep an eye on the compliance side – the revocation of Paytm Payments Bank’s licence in early 2024 was definitely caused by such violations. Failure to disclose the name of the financial product issuer to clients before they sign a contract is a mistake of almost all digital players in the sector who work not with one financial partner but with several, as was the case with Paytm Payments Bank.
