Frictionless credit aims to create a smoother and hassle-free experience for customers, unlike the traditional systems which require laborious paperwork, approvals and credit checks. It also intends to be a quicker process and facilitate disbursal of loans more efficiently.
But is there more caution to be exercised for frictionless credit? In a conversation with ET Digital, Ram Iyer, Founder and CEO of trade finance platform Vayana Network, explains why credit receivers should increase preparedness and why getting educated on the potential pitfalls of unnecessary credit is crucial for MSME borrowers. Edited excerpts:
The Economic Times (ET): What is frictionless credit? Why is it risky for economic stability?
Ram Iyer (RI): Frictionless credit refers to a seamless, digital process of extending loans without the need for physical documentation, or traditional bank visits. While it offers instant access to credit, it poses risks. The inherent danger lies in the lack of checkpoints and a clear understanding on the part of the borrowers. Instances like ‘buy now, pay later’ (BNPL) schemes have shown how individuals, especially the younger demographic, can unknowingly accumulate debt. The allure of cashback and pay-later schemes often leads to overspending, with borrowers realising the consequences only when faced with hefty credit card bills.
Unless the borrower is credit-ready and fully understands the liability, we are entering a frightening future of unpaid debt. The rise of instant loan apps further exacerbated the situation, resulting in harassment for repayment and a parallel to historical money-lending practices.
Regulatory interventions, such as P2P regulations in 2017, guidelines for account aggregators in 2016, and digital lending guidelines have been crucial for consumer protection.
The historic example of the US housing crisis serves as a stark reminder of the consequences of uncontrolled lending, a situation echoed in many present-day economies. It is here that supply chain finance (SCF) comes into play as far as lending to businesses is concerned.
SCF is a form of metered credit, tightly linked to a trade transaction, and is disbursed on demand after analysing the buyer-seller relationship. The regulator has also been proactive in developing programmes such as TReDS to enable MSMEs to access collateral-free loans with proper safety measures.
ET: How can a right balance be struck in the credit cycle among borrowers and lenders?
RI: Balancing the credit cycle between borrowers and lenders is a complex task influenced by macroeconomic policies, largely dictated by the central bank. The central bank decides whether to tighten or loosen the money supply, affecting interest rates and the overall borrowing environment. An expansionary credit cycle with lower interest rates stimulates borrowing to boost the economy, while a contractionary cycle involves higher interest rates to withdraw excess money from the market.
Achieving real-time balance is challenging as individual and business needs may not align with credit cycles. During periods of ample money supply, lower interest rates tempt increased borrowing, anticipating repayment through higher or stable future earnings. Conversely, tightening the money supply reduces demand, prompting lenders to adopt a cautious stance.
For the lenders, a key consideration is the thorough assessment of the borrower’s creditworthiness. Utilising GST data emerges as a credible source for evaluating business health. Advanced analytical tools not only assess historical data but also predict cash flows, aiding lenders in making informed decisions. The use of analytics enables lenders to extend appropriate credit amounts, potentially offering lending rate discounts for robust businesses.
Additionally, monitoring the utilisation of lent funds is crucial. In India, small business owners often resort to personal loans and credit cards for working capital. Lenders must ensure transparency in loan terms, provide easily understandable documentation, educate borrowers and diligently monitor fund usage and repayments.
Borrowers share responsibility by recognising the obligation to repay and borrowing only within manageable limits. Applications accessible to small businesses can assist in the real-time monitoring of accounts receivables and payables, providing insights into their cash flows.
Both lenders and borrowers can leverage analytical tools to bring predictability and safeguard against future shocks. Identifying red flags enables proactive measures to address potential challenges.
ET: What role can fintechs play in credit disbursement that leads to more responsible borrowing choices?
RI: In India, out of the 65 million MSMEs, a mere 2.3% — 1.5 million — are deemed creditworthy. A majority of small businesses are made of the neighbourhood mom-and-pop stores and traders who operate on thin margins. They have limited to no collateral. Such businesses cannot afford credit at interest rates higher than 12% per annum. So fintechs can play a crucial role in making MSMEs credit ready through business compliance tools and bringing down the cost of acquisition and servicing using technology. Technological advancements in the lending landscape introduced by fintech companies have ensured credit accessibility for a diverse range of small businesses nationwide.
Businesses are evaluated on factors such as business relationship vintage, payment terms, actual payment history, GST records and credit scores in order to facilitate responsible borrowing. Although supply chain finance provides immediate funding, it avoids the risk of overdrawing credit as the financing is based on invoice value, making it a type of metered credit.
Some of the supply chain finance platforms also deploy blockchain to de-duplicate invoices before the disbursement of funds to avoid double financing of a specific invoice.
Similarly, for retail and individual credit, fintechs offer analytical tools for credit assessment followed by early warning systems to proactively address potential defaults. Initiatives like account aggregator and public credit registry will contribute to a more comprehensive credit profile by providing recent information along with credit scores from credit information bureaus.
Another critical role fintechs can play is by using rapid and scalable deployment offering borrowers a user friendly interface that presents loan terms in a clear and understandable manner. However, this could be particularly challenging in a linguistically diverse country like India, though, in order to grow credit penetration responsibly, necessitating increased investment in financial literacy becomes essential.
ET: How can MSMEs be made more aware of the perils of frictionless credit? What lines of credit should they opt for?
RI: To enhance awareness among MSMEs about the potential risks associated with frictionless credit, it is crucial to emphasise that credit is not merely a convenience but a financial liability that demands repayment. While frictionless credit may offer easy accessibility, MSMEs must recognise the long-term consequences. They should be educated about the potential pitfalls of unnecessary credit, as it can adversely impact their business, particularly in times of economic shocks. There is a risk of lenders becoming complacent in their risk assessment, while providing additional credit to existing credit-worthy borrowers, leading to careless lending practices. Striking a balance between enhanced credit accessibility and ethical lending is crucial and lenders play an integral part in attaining this balance.
For MSME borrowers, there should be a focus on credit mechanisms that incorporate a distributed risk model. Cash flow-based lending, for example, distributes the liability among multiple parties, offering a more sustainable approach. This type of borrowing not only enhances the cash flow cycle for the MSMEs but also helps in reducing their net debt and steepens the growth of any business.
ET: What is the responsibility of credit receivers in such a scenario? How can they exercise better preparedness?
RI: Credit receivers should exercise judicious decision-making and increase preparedness. They should approach credit usage with a thoughtful assessment of whether it is genuinely necessary, refraining from making it their default option in transactions. A key responsibility lies in having a thorough understanding of the costs and risks associated with obtaining credit. A responsible borrowing approach not only increases the likelihood of securing credit on favourable terms but also contributes to reducing net interest payments, which are a significant component of overall costs.
For credit receivers, opting for credit should be accompanied by a well-defined repayment strategy, especially in the face of financial volatility. This proactive approach ensures a structured and well-managed repayment process, mitigating potential challenges associated with financial instability.
ET: In what way can the government maintain a balanced approach towards credit accessibility and responsible borrowing?
RI: The government, along with the Reserve Bank, has historically focused on financial inclusion and literacy in India, addressing credit accessibility through initiatives like SLBC, PSL, micro-credit support, and digital financial inclusion via business correspondents. Challenges persist due to India’s diversity, with domestic credit to the private sector remaining around 55% of GDP which is remarkably below global and Asian averages. The MSME credit penetration is hovering around 14%. The efforts by the government and regulators on the innovations and reforms have significantly improved credit growth. Gross bank credit has witnessed a growth of 19.8% YoY.
From a government and regulatory perspective, one of the key tasks is to provide an environment of growth and innovation coupled with policy stability which we can see across the various Union budgets. Second, create an inclusive environment where small and marginal players access credit and simplify access to government-sponsored credit guarantee schemes Efforts must focus on making individuals and MSMEs credit-ready, encouraging formal finance access as the majority of the small businesses still rely on informal finance. Responsible growth in credit is considered one of the key variables of economic growth.
Regulators and the government play pivotal roles in overseeing lending practices, ensuring a balance between accessibility and prudence. The recent announcement by the RBI exemplifies this, promoting innovation while maintaining a cautious stance on frictionless lending. Notably, the announcement of increased risk weightage on unsecured lending underscores the commitment to responsible financial practices.
The development of digital public infrastructure (DPI) has significantly enhanced credit accessibility. Emerging platforms like account aggregators (AA), OCEN (Open Credit Enablement Network), and others are poised to aid efforts, facilitating affordable credit for last-mile borrowers.
However, there is a need for measures promoting responsible lending. Key regulations on multiple loan accounts, regular monitoring and health checkups in business lending are crucial preventive measures against bad assets.
