Protecting borrowers in the digital era

Imagine borrowing a small loan and having your name splashed all over social media for not being able to pay it back on time. Or imagine borrowing a multitude of tiny loans you thought you could pay back, only to realize you’re stuck in an endless cycle of debt. These are real stories from countries where the new-age “digital lending” industry has evolved. As India takes its first steps in digital lending, which promises to unleash credit for hitherto underserved segments, it must ensure such lending is done responsibly.

Digital lending consists of lending through Web platforms or mobile apps, by leveraging technology for authentication and credit assessment. Digital lending promises to be a respite for the “ordinary Indian” who is starved of institutional credit. In our recent work on financial health in India, we found that three out of five Indians continue to remain primarily dependent on informal credit. There is a huge unmet credit need (approximately $400 billion plus per year), particularly in the microenterprise and low-income consumer segment. Indians continue to borrow from family and friends, and moneylenders, sometimes at usurious rates, primarily because these loans are more flexible and convenient. Institutional lenders are unable to lend without appropriate collateral, and the high costs of lending limit the flexibility of lending products.

This is where digitization can be instrumental in enabling inclusive lending. India is the only country in the world with a billion unique digital IDs and more than 600 million mobile-phone users. The emergence of digital data trails—the histories of an individual’s past digital activity, such as phone call and SMS records, remittance data, social media footprint—that can be tracked, archived and used for credit assessments, opens up the potential of inclusive digital lending. Emerging business models are already leveraging these digital data trails—digital data credit-scored lending, peer-to-peer platforms and invoice discounting—to lend to lower-income Indians. At least 40 lenders (mostly start-ups) are already active in this space in India.

We had the opportunity to study some early experiments in inclusive digital lending in India that use the “India Stack”—a set of digital application programming interfaces (APIs), which can transition consumer lending to cashless, presence-less and paperless transactions by leveraging their digital data trails. It builds on the Aadhaar platform and has the potential to unleash digital lending by reducing the cost of lending, and channelizing access of data trails for credit assessments. Our study of these experiments suggests that digital lending has the potential to be a remarkably positive force for inclusion. However, we do worry about the risks and believe it is imperative to put in place measures that can protect consumers, prevent overlending, and ensure the responsible growth of the digital lending industry.

There are three major risks in the digital lending space that the Indian borrowers may face. First, overlending: Because there is no centralized tracking of lenders and borrowers in the digital lending space, it is possible that people will end up borrowing “too much” from multiple lenders that they cannot pay back. Second, unsuitable lending: Indians—especially the marginalized, less literate consumers—may choose the wrong loan because of unclear disclosure of terms around, for example, interest, repayment time, and qualifying terms and conditions. Third, misuse of personal data: Sensitive data can be shared or sold without proper consent, as data is controlled by under-regulated non-state actors. These risks loom large on the digital lending space—and if they continue unaddressed, may very well lead to another lending bubble, with unintended consequences, like the one that India witnessed with the microfinance institutions crisis in 2010.

We recommend four measures that regulators should consider to address the risks involved in digital lending. First, institute strong data-sharing protocols. Because several players will have access to sensitive consumer data, there must be clear guidelines around, for example, the type of data that can be held, the length of time data can be held for, and restrictions on the use of data. Second, put in place a code of conduct for lenders. Like the Microfinance Institutions Network code of conduct, digital lenders should proactively develop and commit to a code of conduct that outlines the principles of integrity, transparency and consumer protection, with clear standards of disclosure and grievance redress. Third, explore the possibility of creating a “super credit bureau” that tracks all digital loans and consumer/lender credit history. Fourth, strengthen and scale the DigiLocker initiative, which has the potential to be a safe repository of individual data, with access rights controlled by the individual.

In addition, we believe it is incumbent upon providers to invest in more user-friendly products: developing intuitive products that will help consumers better understand loans and consent protocols so they can make truly informed choices.

India stands on the cusp of a digital lending revolution. Ensuring that this lending is done responsibly can ensure the fruits of this revolution are realized.

Varad Pande and Niloufer Memon are, respectively, partner and senior consultant at Dalberg, a global strategic advisory firm focused on social impact and inclusion.