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The good and bad sides of digital lending, in 5 charts

Digital lending refers to the online disbursal of loans where all processes, even loan approval and recovery, take place remotely, typically through mobile appsPremium
Digital lending refers to the online disbursal of loans where all processes, even loan approval and recovery, take place remotely, typically through mobile apps

  • Digital lending is on the rise in India, and could revolutionize credit disbursal by reducing costs for banks. However, there is also a rising trend of illegal and unsecured lending apps, whose risks need regulators’ attention

India’s lending space is witnessing a tech-tonic shift with loans increasingly being disbursed through digital means in recent years. Over 6% of all loans given by commercial banks in April-December 2020 were digital, a marked jump from less than 1.5% in 2016-17, said a report by a Reserve Bank of India (RBI) working group last month.

The trend is still in a nascent stage, but there are concerns, too. Data privacy issues and unethical or illegitimate lending operations pose risks to financial stability given the pace at which digital loans are picking up, the report said.

If regulated well, innovative and cost-efficient models can help digital lending leapfrog traditional lending modes in the future. Here’s more on the phenomenon:

1. Rising proclivity

Digital lending refers to the online disbursal of loans where all processes, even loan approval and recovery, take place remotely, typically through mobile apps. The shift is part of the digital transformation pushed by the pandemic. Loan apps comprised just 4.9% of all apps installed in India in October 2020, but this rose to 11% in October 2021, said analytics firm AppsFlyer.

“While the pandemic’s economic implications may have played a part in the demand, a borrower-friendly approach, reduced paperwork, and high availability were also key for the increased usage," said Aditya Maheshwari, head of customer success at AppsFlyer India.

This was also pointed out by the RBI panel, which recorded a 12-fold jump in the credit disbursed digitally ( 1.4 trillion) by a sample of commercial banks and non-banking financial companies (NBFCs) between 2017 and 2020. Low overhead costs and the use of technology helps digital lenders operate efficiently to satisfy the aggressive post-covid economic needs, said the report.

2. Strictly personal

Private banks and NBFCs dominate the digital lending space, with a 55% and 30% share, respectively, as of 2019-20. Public sector banks’ share increased from 0.3% to 13% between 2016-17 and 2019-20, the RBI data showed.

Personal loans made up a lion’s share—just over half by value—of all digital loans given by banks. This was followed by loans to small and medium enterprises (16%). “Buy now pay later" loans had less than 1% share by value but commanded a 37% share by number of loans.

This is in large part a symptom of a growing demand for small-ticket retail loans in general. NBFCs in particular now give more than half their loans digitally, but by value, digital loans still have 11% share. This has been shaped by increasing demand for housing, vehicles, and education loans during the pandemic. So much so that the trend has taken the spotlight away from industrial loans, making retail the largest segment in India’s credit market for the first time ever in 2021.

3. Impressive jump

As a sizable chunk of loan portfolios for private lenders comes from this fast-growing retail segment, the conventional lending landscape is set to transform dramatically. This will in turn drive up the share of digital lending itself in overall credit.

Digital sourcing is already making great inroads into retail products. ICICI Bank, India’s second-largest private lender, processed 94% of its personal loans by volumes digitally in April-September 2021, compared to 62% in 2019-20. Kotak Mahindra Bank reported a 120% quarter-on-quarter growth in July-September in personal loans sourced digitally, and a sequential growth of 105% in home loans sourced digitally.

Not all banks provide comparable data every quarter, but the larger trend is similar. Banks have responded well to this digitalization during the pandemic, with public sector banks and leading private lenders coming up with their own apps for credit disbursal. However, the RBI report also flagged the use of unsecured third-party apps for lending used by some private banks and NBFCs.

Pace of growth in digital credit
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Pace of growth in digital credit

4. Legal tangle

This creates the risk of unsafe transactions. The RBI panel found that more than 50% of loan apps in the market may be illegal, and the trend could only rise as more apps come in. Around 2,562 complaints were filed against digital lending apps on the RBI’s Sachet portal between January 2020 to March 2021. This included 919 in a single month in December 2020, when the central bank urged consumers to report such apps. Complaints typically pertain to apps promoted by unregulated entities.

Taking cognizance of this patchy and still-evolving lending ecosystem, the report proposed norms aimed at “orderly growth" of the sector. The panel recommended safeguard legislation, and creation of self-regulatory organizations that can verify and regulate the conduct of lending apps.

Anand Dama, banking analyst at Emkay Global, said the proposals appeared to be largely constructive for the digital lending space and were on expected lines, but believed that regulations could tone down the rapid growth rate of digi-loans.

5. Repayment challenge

Rising bad loans in the retail segment could be a big worry as the trend gathers steam. Sample this: scheduled commercial banks’ gross non-performing assets for two major sectors—agriculture and industry—declined during 2020-21, but rose for retail loans from 1.7% in September 2020 to 2.1% by March 2021.

Although technology in lending could be a boon to the banking sector, aggressive growth at the cost of quality of lending can result in deterioration of asset quality in the future for banks below the tier-1 category, said Vinod Nair, head of research at Geojit Financial Services.

This will increasingly throw the spotlight on how banks can stay cautious while adopting new technology. Responsible lending will remain a “distant goal" without customer awareness and watchful enforcement, the RBI panel said.

All said, digital lending is a positive technological disruption that is inevitable in the modern business environment and banking sector

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