Make mine subprime

A little over a year ago, Jamir Khan was a worried man. As the owner of a one-man (himself) buffing workshop in Faridabad near Delhi, Khan was doing brisk business. In fact, things were so good that Khan began thinking along the lines of expanding his workshop. With a steady stream of orders flowing, the 29-year-old thought getting a bank loan would be a breeze. He couldn’t have been more wrong.

His own banker, who had been serving him with a savings account for eight years, said no. Reason: The colony he lived in was unauthorised and, therefore, the bank was worried about Khan’s status as a borrower.

Just when Khan was beginning to think of falling back on one of his friends or relatives, GE Money stepped in. Undeterred by the status of Khan’s colony, GE Money instead looked at the micro-entrepreneur’s cash flow and found it reassuring enough to lend him Rs 25,000, against his demand for Rs 50,000. Last month, the lender hiked Khan’s loan amount to Rs 68,000. He is happy as can be. “What I liked was that they gave me the money,” says Khan as a matter of fact.

Even as banks in the US run scared of ‘subprime’ (or, less than creditworthy) borrowers, lenders in India are going out of their way to woo them. Although the typical Indian subprime borrower (See A Subprime Profile) isn’t comparable to his American counterpart, the financial services industry here has taken to describing this category of borrowers as such.

In India, the subprime borrower tends to be under-banked, takes small-ticket personal loans (Rs 30,000-35,000), has no credit history to talk of, and usually is short on all the documentations that banks need to sanction a loan.

In the past, such borrowers have tended to rely on their family or friends or the traditional money lender. But growing awareness about small and personal loans, coupled with aggressive marketing by the financial services companies, has made them consider more mainstream sources.

“An increasing population of customers with younger age profiles, driven by the confidence of employment opportunities and the overall buoyant economy, has led to the emergence of new aspirations and hence new attitudes towards debt,” says Sandeep Soni, Managing Director, CitiFinancial India.

Virgin market

Many of India’s ‘subprime’ customers tend to be first time users of formal credit. Industry players estimate that the first time loan takers constitute 50-60 per cent of their total customer pool. Hence, as Pavan Dhamija, Chief Executive Officer (CEO) of Prime Financial India, a Standard Chartered arm, points out, the so-called Indian ‘subprime’ is not subprime in the true sense of the word. “Subprime does not really exist in India.

In the US, ‘subprime’ customers are the ones with a chequered credit history and a few defaults.” Adds Ravi Subramanian, Head of HSBC Pragati Finance: “It is much better to call the customers that we are targeting as the ones who have been under-served by the traditional banking channels.”

Perhaps in recognition of the potential of these customers to rise to the prime segment, CitiFinancial uses a more politically correct nomenclature of “near prime.” Names apart, this is a growing and very lucrative segment for financial services firms. And the underserved are, therefore, being spoilt for choice and rightly so. Apart from active market participants such as Citibank and GE Money, there are new ones offering credit nirvana.

Those include outfits such as Indiabulls, HSBC Pragati Finance, Prime Financial, and Fullerton India Credit Company, part of the Singapore government’s private equity arm, Temasek.

Not only is competition for the “underserved” customer far less, the market is huge—almost 50 million people, according to estimates. GE Money’s head of personal loans, Rajeev Yadav, points out that lenders to this untapped community are basically interested in two parameters—the intention and the ability to pay.

“It is impossible to ascertain the intention, but the ability to pay can certainly be gauged even through weak documentation.” HSBC Pragati believes in credit interviews for determining the ability to pay. Then there is field verification of cash flows of the customer. Typically such verification checks cost Rs 150-300 per customer. Add the risk of default, and the interest rates shoot up to 35-50 per cent.

Cheque bounce rates (cheques that bounce as a proportion of cheques presented for payment) range from 30-45 across the industry. HSBC Pragati, which claims a lower cheque bounce rate (25-26 per cent), has split the credit appraisal and sales functions into independent divisions to ensure sales targets don’t compromise the quality of assets. Seems a sound strategy given that the loan-loss ratio is 7 per cent and higher.

Most of the lenders have robust back-ends to slice and dice customer data, but more often than not they are shooting in the dark as far as the customer’s intention to pay is concerned. Some of that comes from systemic deficiencies. The absence of credit bureau data makes the job of the underwriter that much harder, since “few customers have histories and even fewer understand the implications of a negative credit history,” says Prime Financial’s Dhamija. However, the margins available on these assets make them well worth the risk. Typically the gross margins on a portfolio-wide basis are close to 30-40 per cent.

On a net basis it could fetch 10 per cent. And many believe that building a franchise and a relationship with the customer through a longer period would reap rich dividends as the Indian economy revs up. Some of the lenders are, therefore, thinking of increasing their product offering as they build credible credit histories of their customers.

“There is chance to grow a customer over a product lifecycle and then graduate him to higher exposures,” says Harmandar Mahal, Head of personal loans, Cholamandalam DBS Finance. In other words, while the US loses sleep over the subprime contagion, India is looking at its own ‘subprime’ market to take banking to the bottom of the consumer pyramid.