Too Good To Be True reveals the gaps in our financial products

Recently there has been a significant increase in mobile applications that provide instant credit to individuals. This credit is often short-term in nature, it is unsecured and digitally transferred into the account of a borrower in a short span of time. Some of these products provide instant credit approvals up to Rs 10,000-Rs 50,000 while others grant an approval within 24 hours.

There are a series of interesting observations that have been made by several people over the last few weeks as the Reserve Bank of India warned borrowers and customers from availing loans from these websites and mobile apps – which are essentially unregulated entities. Some of these applications have been removed from the app stores since then based on directives from regulators. The RBI warning has come with the backdrop of several borrowers complaining about harassment faced by collection agencies of these lending platforms while several have even committed suicide.

A key strategy of these lending platforms is to provide low ticket amounts to borrowers which attract a high interest rate. The exercise of pooling several low-ticket loans combined with details of borrowers’ information allows the platforms to reduce the chances of defaults – while where the high interest rates make it possible for them to meet defaults. These apps and their products have proved to be debt traps as they practice predatory lending practices. Unfortunately, they were not regulated by the RBI which allowed them to go unnoticed for a long period.

The existence of these applications, however, points at the need for several households to borrow short-term credit to tide over cash-flow troubles. The use of mobile application for instant approvals etc ensures that this need can be catered to by the prevalent digital infrastructure in the country. While predatory lending and these unregulated applications must be curbed, it also highlights the gap in the existing formal credit instruments.

This gap has become more apparent as many during the covid-19 pandemic resorted to short-term credit to tide over cash-flow imbalances. For instance, lockdowns affected several small and medium businesses that operate on very thin margins. To ensure that they could operate once the lockdown restrictions were lifted, they had to meet some of their fixed expenditures even as they were not generating any revenue. To meet this expense, many may have run down their savings while others may have borrowed money to keep their operations going. For formal small businesses, there are some credit options that are available to finance their short-term credit needs whether through banks or NBFCs. But for many, the formal system is inaccessible either due to lack of product or due to delays in processing of the same.

However, there is an opportunity here for NBFCs, banks and other fintech companies. This opportunity is with respect to using the existing digital infrastructure with Aadhar and PAN Cards as documents to provide credit approvals digitally in a short span of time. Many private banks have already established their platforms while SBI too allows people to request for credit cards and submit the application on its YoNo application. However, the demand is for a short-term-unsecured-credit which caters to those who may not be able to access sophisticated products such as credit cards.

By allowing for banks, NBFCs and fintech companies to come together and create a new product for this segment, there is a possibility of ensuring that volume of transactions using digital technology makes low ticket short-term credit economically feasible for banks allowing them to improve their margins. Pooling of large number of such loans can also help diversify the default risks to a reasonable extent. Of course, banks will have to evaluate the criteria for selection and providing automatic approvals to reduce the selection errors that happen through this process.

A good example to replicate is the system created by the government for SMEs to avail a loan up to Rs 1 crore in under 59 minutes. The system leverages available information to grant on the spot approvals based on pre-determined metrics post which a borrower can approach banks to avail the loan.

We must accept that the mushrooming of these predatory lending platforms was an outcome of a gap in existing products while there was a market that was not being catered to by our formal financial system. It is therefore important to regulate lending activities in the country while also simultaneously looking at possible lessons from this exercise to better design our financial products.

There is a need to use technological developments and out digital infrastructure to further deepen the access to financial instruments. This is consistent with the attempt by the government to push for greater financial inclusion over the last few decades. However, achieving the same would require the regulator and the private sector to consistently identify product and regulatory gaps that need to be filled by their proactive cooperation.

Here is hoping that the recent developments could pave way for a more inclusive financial system that is able to meet the short-term cash-flow mismatch needs of our low-middle-income families. For those that have encountered some of these applications or are willing to try them out, here is a word of advice: don’t; because if it is too good to be true, it probably isn’t that great!

(The writer is an economist and policy-researcher. Views expressed are personal)