Technology has been the crux of the Indian banking system and the advent of Covid-19 has fuelled the shift of business models from ‘physical’ to ‘digital’. The journey of innovation, which started with internet banking and digital means of payments, graduated to account opening, digital lending, wealth-tech and invest-tech solutions, and now has moved close to digital banks with the advent of neo-banking models/‘banking-as-a-service’ platform providers. With rising customer demand for virtual banking, increasing significance of superior customer experience, growth of the e-commerce market, and the rise of the fintechs, digital has almost become synonymous with banking in current times. It has also made banking accessible to the non-banked/under-banked.
The lending business has also been influenced by digitisation. A riveting evolution of digitisation across the lending landscape in India over the past few years can be attributed to increasing internet penetration, amplified smartphone usage, emergence of advanced technologies, a favourable regulatory environment, and rising customer expectations, especially after the onset of the pandemic.
With the advent of diversified fintech players and digital lending models, the number of loans disbursed via digital went up by nearly 12 times by the end of 2020. Private banks and NBFCs play a major role in the new lending ecosystem and accounted for 55 per cent and 30 per cent of loans disbursed through digital channels, respectively, in 2020. Though private banks have a major share in digital lending, NBFCs have a higher proportion of lending via digital mode (>10 per cent) as compared to banks (~0.2-0.3 per cent), according to the Reserve Bank of India’s (RBI) Report of the Working Group on digital lending, including lending through online platforms and mobile apps.
Public sector banks have also gathered significant momentum towards digital lending through digital transformation of their business model, setting up digital lending business units, and increased investment in technology to improve customer experience and enable personalised products and services.
Key innovations
India’s lending landscape has seen an array of innovations in recent times that have been incremental in the rapid digitisation of the sector. Led by fintech NBFCs, technology providers and marketplace aggregators, digital lending has products ranging from unsecured loans to secured loans, personal loans to business loans to vehicle loans, loans to individuals and MSMEs, from salaried class to young generation, etc.
While banks have been increasingly adopting innovative approaches in digital processes, fintech NBFCs have been at the forefront of innovation in digital lending. With the growth of e-commerce, marketplace lending as a financing model has taken prominence. Banks and NBFCs have tied up with e-commerce firms to not only finance the buyers of products in the marketplace but also the suppliers and businesses listed therein. To cater to digital sourcing models, financial institutions are entering into partnerships with marketplaces, aggregators, wallet companies and payment facilitators, etc.
In addition to fintech NBFCs, technology service providers and marketplace aggregators are following the model of platform lending or ‘loan service providers’ (LSP) with banks and NBFCs at the backend as manufacturers where the loan is booked. However, this ‘rent-an-NBFC’ model wherein the LSP provides certain credit enhancement features such as first loss guarantee up to a pre-decided percentage of loans generated by it, has higher potential of risk build-up as these entities are not under the RBI’s regulatory purview.
Leveraging advanced technology to harbour innovations has led to the creation of newer products, differentiated by terms of loans, tenure of loans, characteristics of payment, ease of accessibility and much more. One of the products currently gaining traction is Buy Now, Pay Later (BNPL), a point-of-sale credit product. Financial institutions are partnering with various fintechs; however, many non-regulated marketplace players and fintech entities are assuming direct balance sheet exposures.
With increasing speculation around crypto-related regulations, crypto lending products can be seen picking up gradual pace. Low interest rates, no credit checks and faster loan funding are attracting the lenders towards the space. Decentralised finance (‘DeFi’) lending platforms—which enable lending and borrowing using crypto assets—can pose serious issues in the absence of any regulatory framework.
Emerging tech deployments
Financial institutions are using emerging technologies like data analytics to create digitalised databases, alternate data models, and data-based underwriting models to reduce turnaround time and operational costs. They are partnering with account aggregators to make informed credit decisions by leveraging data from other financial sources, to undertake income assessment, loan monitoring, KYC data assessment, and create a single view of the customer across their liabilities and assets. The introduction of account aggregators will result in significant ease of on-boarding new customers for banks.
Data aggregators are also supporting the financial institutions to help assess the customer’s risk profile while loan reimbursement, for a seamless and frictionless digital experience to customers.
There is also advanced use of emerging technologies like open banking wherein financial institutions are integrating with fintechs for a bouquet of financial services like lead acquisition, KYC verification, income verification, e-signing and e-stamping, processing fee payments and collections.
Risks and challenges
The onset of digitisation and transformation in lending has also led to a spurt in digital lending applications sponsored by non-financial services entities or non-regulated entities resulting in unethical business practices, mis-selling, cybersecurity and data privacy concerns. Some of the key challenges of the current digital lending landscape include:
1. Absence of regulatory framework for digital loans such as consumer loans, instant loans, etc.
2. Absence of pre-emptive safeguarding mechanisms against fraudulent lending platforms
3. Lack of monitoring mechanisms for LSPs and digital lending apps
The digital lending loan lifecycle, from origination to collections, typically involves interplay amongst a number of third parties like fintech, distributors, SaaS providers, thus exposing borrowers and institutions to new and heightened levels of risk.
The innovative operating models and structures that evolved around digital lending necessitate the need for in-depth evaluation of risks to protect the borrowers, including data, and safeguard the institutions. Traditional ways of risk management will need to be transformed to more proactive risk management systems with necessary system controls/limits and early warning signals.
Current financial crime risk management frameworks of banks and NBFCs have started harnessing digital touch points for a proactive risk assessment of clients. However, the existing frameworks operate in silos, resulting in inadequate utilisation of intel generated across various surveillance platforms. Connecting the digital touch points across various risk types may provide an insightful and holistic risk score (one-view risk profile) for clients, thus empowering informed and insightful decision-making across the entire loan lifecycle. Further, rule engines and real-time behaviour identification capabilities may need to be tweaked to identify potential anomalous transactions.
In addition, it is extremely important to regulate and formulate better standards for cybersecurity, privacy, customer servicing, dispute management, system availability and performance, and fraud. Lenders should set up robust risk control self-assessment programmes. The existing RBI guidelines should be leveraged for assessing the cyber and system worthiness of these apps. Customer education around downloading of compliant apps, responsibly managing app permissions and access, careful reading of contractual terms and conditions, customer rights and awareness, dispute resolution, fraud management, etc., is another area which becomes extremely important.
Evolving regulations
The RBI has constituted a Working Group on digital lending and it has given its recommendations aimed at providing a balance between measures addressing concerns posed by digital evolution in financial services while ensuring the sector is able to reap benefits of digital innovation. Key recommendations of the Working Group were based on three guiding principles, viz: technology neutrality, principle-backed regulation and addressing regulatory arbitrage across the three pillars of legal and regulatory, technology and data security and consumer protection.
The group has provided recommendations around setting up a self-regulatory body to supervise digital lending applications, restricting balance sheet lending to regulated entities including BNPL being considered as lending, state level coordination committees to cover issues in the digital financing space, inducting TRAI as its member, development and compliance around baseline technology standards and data storage, transparency and audit trail in algorithm features used in digital lending, measures around consumer protection, disclosures, tracking defaulting lenders and LSPs, etc.
Further recommendations are around reporting, payments and settlement systems, storage of biometric data, simplification of digital products, governance, etc., to ensure that financial stability, market integrity and consumer protection take precedence in the objectives of financial regulation in comparison to creating a level playing field.
The suggestions have also provided a time-based approach with measures to be implemented in the short- to medium-term and long-term measures around covering formulation of regulations for ‘digital banks’/ ‘neo banks’, encouraging ‘digital-only’ NBFCs and providing groundwork for opening digital-only banks.
The measures may impact in the short-term the growth of digital lending, especially in the small- to medium ticket size segment. It will also have an impact on set up, technology, compliance, and operational costs for digital lending players. Laws around data privacy and protection, clarity on outsourcing guidelines, transparency in product design and ability to conduct audit-trails on AI/ML-based underwriting algorithms, will bring in the much-required monitoring and governance in the segment especially for existing non-regulated players.
The above recommendations will certainly bring in required regulatory oversight, help build trust in digital lending for customers and provide more transparency, thereby providing a comprehensive framework and progressive regulatory environment for the fast-growing digital lending segment in the medium- to long run.
As banks and NBFCs offer robust and seamless digital lending infrastructure to existing and potential borrowers, they also need to effectively address and mitigate issues pertaining to cybersecurity, data privacy, operational risk, third-party risk and fraud risk. The RBI’s balanced approach will create safe, efficient, and delightful customer experience, resulting in higher brand equity and higher market share. The recommendations and suggestions made by the RBI’s Working Group will help financial institutions and their partners reap the benefits of ensuing digital innovation while mitigating potential risks.
KPMG Partners Vinay Narkar, Kunal Pande, Suveer Khanna, Somdeb Sengupta and Chartered Accountant Minaar Malse contributed to this article