Digital lending to low-income customers needs careful review

UPI is a payments system that facilitates instant fund transfer between two bank accounts on a mobile platform, without requiring any detail of the beneficiary’s bank account.
UPI is a payments system that facilitates instant fund transfer between two bank accounts on a mobile platform, without requiring any detail of the beneficiary’s bank account.


  • Lending to new-to-credit low-income borrowers has to operate as a ‘seller beware’ model.

The small-ticket lending space has seen a flurry of regulatory activity lately. The Reserve Bank of India (RBI) released regulations for microfinance. To address customer protection issues attributed to digital lending practices, RBI took multiple steps in quick succession. It barred the loading of prepaid instruments issued by non-banks through credit lines, notified recommendations of its working group on digital lending, and issued guidelines for it. These regulations define digital lending as “a remote and automated lending process, majorly by use of seamless digital technologies". At the same time, industry reports have pointed out that more than 60% of digital lending through platforms and mobile apps is to low-income, new-to-credit (NTC) borrowers. Lending to such customers using a remote and automated process is a potent mix. In our quest for innovation, we must pause to reflect on the why, what and how of such lending and its impact from a customer’s perspective. The well-established microfinance model (MF) has adopted digitalization in a calibrated way while maintaining a customer focus.

The MF model of group lending was an innovation that catalysed the delivery of micro-credit to low-income NTC borrowers in the early 90s. Lending to such borrowers had been a challenge due to the inability of banks to deliver small value loans without collateral. Microfinance institutions (MFIs) overcame the information asymmetry inherent in such lending due to a lack of documents and data by accessing the information embedded in their social networks through the joint-liability group lending model. This required innovations in product design, process and customer engagement based on consumer behaviour. The MF model focused on doorstep delivery of services, an understanding of client’s livelihood and cash flows, and low operational costs. Supported by an enabling regulatory environment, lenders using this model cater to around 60 million urban and rural clients.

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Over the last decade, the MF sector has digitalized while keeping in mind levels of financial literacy and evolving consumer behaviour. It now deploys an optimum mix of technology and human touch. A separate credit bureau for MF loans was set up in 2011 and now all loans and repayments are reported to credit bureaus. Non-banking financial company MFIs and banks have invested in a technology framework to enable data upload to credit bureaus at a daily or weekly frequency. Faster turnaround of loan applications and customer complaints is achieved by the use of tab-based solutions. A field force of nearly 200,000 provides an assisted digital interface to borrowers. Know-your-customer documents are read using optical character recognition and verified using API integration with the central KYC registry. Underwriting models use data on credit experience with different customer segments and compulsorily use credit bureau reports. Nearly 100% of microfinance loans are being digitally disbursed. At the same time, efforts to make borrowers comfortable with digital repayments have shown good results. All these initiatives are in addition to the weekly or fortnightly group meetings attended by field officers of the lender to impart the human touch required in last- mile delivery of financial services.

Lending to NTC low-income borrowers has to operate as a ‘seller beware’ model, keeping in mind their level of financial literacy. For an NTC borrower, this literacy is acquired over a period of time through experience with financial products, peer-group discussions and regular interactions with the lender. We should ponder if digital interactions can replace this organic process.

Microfinance regulations require the lender to ensure that annual loan repayment obligations are capped at 50% of the debt-taking household’s annual income. Lack of documents, multiple streams of income and seasonality in cash flows make estimation of income and expenses an intensive exercise. The use of surrogate indicators is a poor replacement for in-person interactions and runs the risk of nudging borrowers inadvertently into over-indebtedness. With the use of credit reports becoming central to underwriting, delays in repayment by such borrowers might in effect lead to their ‘financial exclusion’. Coupled with a remote grievance redressal system, such issues might become widespread: a study by FINCA International showed that only 30% of the customer complaints are lodged through a formal system; the rest are addressed by the on ground staff during regular interactions.

A customer-centric approach to the digitalization of the lending process has the potential to deliver widespread benefits. The regulations issued by RBI have several positives, such as a compulsory free-look period during which a borrower can cancel a loan, the issuance of a Key Fact Statement with details of interest rates and other terms, and the requirement of customer consent before increasing a loan amount.

At the same time, there are other features of remote and automated lending that would benefit from a closer review. These pertain to the assessment of income and repayment capacity, ensuring against over-indebtedness, promoting financial literacy and also grievance redressal.

These are the authors’ personal views.

Alok Misra & Vinay Kumar Singh are, respectively, CEO and director, and Self-regulatory Organization head, Microfinance Institutions Network (MFIN)

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