Way To Profitability For Fintech Companies Cannot Be Through Unsecured Lending

It has been widely reported that of late, there has been an increasing trend of availing small-ticket loans to pay for regular expenses like rents, credit card bills, and even utility bills. These loans are offered by fintech companies and are easily available on their platforms. While these companies insist that the customer’s ability to repay the loan is thoroughly verified, these loans are unsecured in nature. The Reserve Bank of India (RBI) has, for a while now, been cautioning against the rise in unsecured lending and the threat it poses to the entire financial system. 

The RBI has now finally announced a slew of measures to check the growth in unsecured lending. It banned loan products like 'eCOM' and 'Insta EMI Card' and announced increasing the risk weightage on personal loans - excluding housing, education and vehicle loans, and loans secured by gold and gold jewellery - from 100% to 125%. This is expected to increase the capital requirements for lenders, which in turn would increase the lending rate for borrowers.

“Now the RBI aims to curtail the growth which has become quite aggressive in the digital lending segment. A lot of NBFCs (non-banking financial companies) are into co-lending with the fintechs and they are providing both asset side and liability side support for these fintechs,” said Jinay Gala, analyst and associate director, India Ratings and Research. 

Gala explains that in the event of fintech companies facing larger challenges, the model of unsecured lending would have a cascading effect on the NBFCs too. Currently, fintech companies tie up with banks and NBFCs to jointly disburse loans. In the event of larger macro-economic challenges, banks and NBFCs, therefore, carry the risk of collapsing. 

 

Not Profitable Yet

The fintech boom was seen as the next-big innovation that was expected to address the last-mile connectivity gap that the traditional banking system was facing. Fintech companies proposed to provide digital solutions to financial institutions by improving financial inclusion and tap into areas that were traditionally beyond the reach of banks. 

The biggest success of fintech companies came in the form of digital wallets and the Unified Payments Interface (UPI). But these companies failed to become profitable and to become a self-sustaining business model they moved to lending. The latest RBI guidelines bring into focus the business proposition of these companies and whether they can at all become profitable without offering lending services. 

Analysts highlighted that lending proved to be the most commercially successful model for fintechs and it was becoming difficult to generate profit without getting into the same. “There was not enough money to be made in the pure tech business. If we look at fintechs like PhonePe and Google Pay too, where was the profit coming from? Whatever services they were offering, consumers were not paying fees as such for that. Money is to be made in the lending business,”  Prakash Agarwal, independent credit analyst and former head of BFSI in ratings and research firm India Ratings & Industry.

If we look at the journey of fintech in India, the companies primarily started off as a digital innovation hub that was supposed to help banks in their digital inclusion. However, in due course of time, they gradually deviated and got into lending business. “Some fintechs are partnering with the banks for tech innovations, but the success on that front has been very calibrated. They need to figure out ways to mobilize revenues on tech innovation in partnership with banks," Gala said.

 

Ballooning Personal Loans

The RBI for a while now has been cautioning about the rise of unsecured personal loans, particularly in the sub-Rs 50,000 category. It has increased interest rates in the last 18 months, which has made borrowing an expensive affair for existing borrowers. Larger macro-economic stress means that new borrowers are few and far between. Unsecured loans for consumer spending is making up for negligible loan growth in the corporate side. 

While the ticket size of the loans disbursed by fintech companies may be small, there is a sizable population that avails these loans. A recent report by Equifax showed that the highest number of personal loans have been disbursed in the less-than Rs 5,000 category. In the consumer segment, the Rs 5,000-10,000 ticket size category witnessed the highest growth of 493% in the April-September 2022 period from the same period a year ago. The proportion of credit-active consumers availing small-ticket personal loans has increased to 8% in the second quarter of FY23 from 3% in the second quarter of FY19. During this period, approximately half of the consumers already had more than four credit products, compared to just 17% in that category in the second quarter of FY19.

Fintechs have been targeting this segment of borrowers to provide loans in order to become profitable. Companies in this sector shifted to chasing growth through lending from being a payments-first platform. That these companies are struggling with revenues is known for years now. Regulatory interventions have made UPI revenue-wise unviable for payments platforms. Slow-growing credit card base has also made card-related fintech services unviable. 

Road To Profitability Can’t Be Through Delinquencies

Experts believe that fintechs need to focus on the pre-provision operating profit (PPOP) model if they want to keep the growth unaffected in the absence of unsecured lending. PPOP is the amount of income a bank or similar type of financial institution earns in a given time period, before taking into account funds set aside to provide for future bad debts.

"So an alternative for them could be to focus on generating profit on the secured side, as most of them are solely focusing on the unsecured loans. They can also do origination for other NBFCs, where they can build fee income that could help them navigate the volatility, that could be there on the unsecured side," Gala said.

Analysts also highlighted that as an alternate source of revenue generation, some fintechs are partnering with the banks for tech innovations, but the success on that front has been very calibrated. According to them, fintech companies have to figure out ways to mobilise revenues through technology innovation in partnership with banks.

Fintech companies dabbed into several models to become profitable. Buy-now-pay-later (BNPL), Peer-to-peer (P2P) lending, and insurance were among them. Small-ticket BNPL spending, available on online food delivery or grocery delivery, has very little revenue potential. Most companies operating in the P2P space operate as distribution agents for registered P2P NBFCs who do the actual lending. Companies depend on a thin margin while the bulk income goes to registered P2P players. Insurance too has failed to become a revenue-generating business for fintech companies. The distribution commission and fees that these companies earn for insurance is insignificant when compared to the direct revenue that dedicated players with required licences (insurer or AMC) earn from customers. 

“Fintechs also offer P2P lending, insurance products etc. But P2P lending doesn't have a long history in India. Thus, P2P remains a very small part of the lending ecosystem in India. Be it insurance products or P2P lending, none actually worked commercially too well for the fintechs, so far,” Agarwal said.

With nothing working out for these companies as far as becoming a sustainable, profitable business proposition goes, the RBI’s recent directives are a clear indication that the road to profitability cannot be through delinquency in personal loans. Be it the banning of insta EMI or increased risk weightage, analysts believe that these measures are being implemented to curb the exponential growth in personal loans, primarily lifestyle consumption, seen in the past few years in the digital lending space. India has seen an annual growth of 39.5% in digital lending over the past 10 years, as per a report by IIFL Fintech.  

Several digital lenders The Core reached out to highlight the fact that individuals are even taking loans with an average ticket size of Rs 7,000-8,000 for paying their rents or for other retail purposes. According to experts, more than the amount of the disbursed loans, the major point of concern is the pace at which these loans are growing. 

“RBI is concerned about the pace at which these unsecured loans are growing. Given that these loans have very limited visibility in terms of who these borrowers are and where is the end use of it, the RBI fears that this doesn’t build up to the systemic problem. If delinquency starts building up, it will rise very fast as these NBFC and fintechs have expanded their books quite significantly on these loans and there will be very less time for them to turn around,if something adverse happens,” Agarwal said.

 

Stricter Loan Disbursals

While the RBI has not explicitly banned unsecured personal loans, all the steps it has taken so far are cautionary in nature to address rising risks. Several digital lenders agreed to the fact that though there has not been a lot of cases of defaults yet, most of them refrain from giving small ticket loans as the chances of delay or default might be higher. While the delinquency rate across the age group of borrowers has been under 5% for the digital lenders, they said that they prefer to stick to some stringent measures to ensure an even lesser delinquency rate. 

Recent TransUnion CIBIL data suggests that fintech lenders experienced the highest delinquency rate among borrowers under 25 years old, which stood at nearly 5%. In contrast, the delinquency rate for borrowers aged 26-45 stood at a lower 3%, while borrowers over 45 exhibited the lowest delinquency rate at 1%. Furthermore, urban and rural areas reported higher delinquency rates at 3% each, whereas metro and semi-urban areas had slightly lower rates of 2%. The data also reveals that there was 4% delinquency among consumers with at least one small-ticket personal loan and thus, digital lenders have become more stringent in terms of disbursing very small ticket loans. 

“The chances of approval of small ticket loans is around 20-30% on our platform. Also, the probability gets even minimised if there is any history of auto payment getting bounced or the individuals have any gambling app on their phones,” said Mukesh Bubna, founder & CEO of Monexo, a digital lending platform. 

 

Exposure Needs To Be Balanced

While platforms might plug all gaps before extending loans, encouraging a culture of easy access to small-ticket loans could prove to be a recipe for imminent disaster. Several small loans add up to a significant amount, and in a situation of larger macro-economic stress could pose a challenge to the financial system. 

Experts believe that the RBI’s directives aim to put a better stress testing framework in place. Credit analysts said that historically, delinquency rate has not been alarming so far in terms of unsecured loans. These measures are to make the credit model more sustainable. 

“Most of the stress tests are done using the variable that they have done in the past. They need  to consider global uncertainties and what could be the impact. Is their stress test framework really incorporating these scenarios? The idea of the stress testing framework is to keep aside more capital,” said Vivek Iyer, partner and national leader for financial services risk at Grant Thornton.

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