Amit Kumar, Co-founder, GalaxyCard, a digital credit card start-up, had just gone live with a non-banking finance company (NBFC) when the IL&FS default crisis erupted in September 2018. The NBFC, which had started discussions with GalaxyCard in January 2018, had big plans but changed its mind. "Nine months of integration, legal paper work and banking transactions went for a toss in just 10 days," says Kumar. Many NBFCs that had tied up with fintech firms or were in the process of doing so are not even willing to talk, says Kumar. As a result, a lot of fintech lenders are finding it difficult to raise funds. Some are even closing down.
The liquidity crunch has put a spanner in the works for such firms despite the fact that the potential market of millennials and salaried professionals remains. Akshay Mehrotra, Co-founder and CEO, EarlySalary, sees a huge untapped market in consumers with credit scores of less than 750 and loan size below Rs 1 lakh for less than one year tenure. "The salaried individual segment is a Rs 4.5 lakh crore opportunity (by 2023/24) based on 201 million individuals," he says.
India is the second-biggest fintech hub in the world, after the US, with 2,035 start-ups in the sector against just 737 in 2014, according to the India Fintech Report 2019 by Medici.
However, fast paced growth in a short span doesn't guarantee sustainability. China's peer-to-peer (P2P) lending segment flourished in the past four-five years but witnessed multiple defaults from June 2018 after it surfaced that a few P2P operators had duped investors. Thousands of platforms disappeared over two years.
In India, regulations are trying to put things right.
Road to Regulations
The Reserve Bank of India's, or RBI's, recent draft circular on liquidity risk management for NBFCs and Core Investment Companies proposes to focus more on granular buckets (0-7 days, 8-14 days and 15-30 days instead of 30 days now) for asset liability management. It also talks of introducing liquidity coverage ratio requirements in line with banks and having more transparency in borrower or concentration details.
While a long-term positive, the regulations will pressurise margins. Yields on liquid assets would be lower than cost of funds for most NBFCs, says brokerage PhillipCapital's report. But most large NBFCs have cash balances (after IL&FS default) that cover around 60-120 days of net outflow.
The Securities and Exchange Board of India also has a framework on 'innovation sandbox' to provide an ecosystem to test at a small scale.
There are, however, concerns around cyber security. "The proposed framework has not provided for user privacy and data security," says Deepika Sawhney, Partner, Corporate Professionals. Besides, in the current set of proposals, compliance with data protection laws lies with the participating entities. "The cost of compliance may be too high for a company that is starting out," says Monish Anand, Founder, Shubh Loans.
Deep pockets would help fintech firms ride this storm, but many do not have that kind of backing. This has led some to look at other ways of staying in action, as a lot depends on their model of operations.
Recovery, Not Lending, Is Key
Fintech players have realised that survival depends not on giving away money but in getting it back. "Fintechs are focussing more on collection of delinquent loans, as their scale and geography grow. The growth among fintechs and new age NBFCs will not be uniform and will largely depend on credit loss measures," says Sanjay Sharma, Co-founder, and MD, Aye Finance.
Another way is to use new technologies such as machine learning, Artificial Intelligence and blockchain to verify credit worthiness of borrowers and thus reduce defaults.
NeoGrowth, for example, offers loans to small businesses based on digital spends on their POS machines, as the number of swipes is a good indicator of business potential, seasonality changes and customer footfalls, says Piyush Khaitan, founder and MD, NeoGrowth. Shubh Loans considers parameters such as insurance coverage, number of dependents on the borrower and shopping history.
Targeting niche segments is another model. For example, Bon only gives loans to gig workers such as Uber drivers and delivery personnel. Shubh Loans focusses on people earning below Rs 10,000-12,000. Samunnati offers agriculture loans while LivFin lends to SMEs based on invoices.
According to KPMG, on an average, the industry level of non-performing assets (NPAs) is around 8 per cent for lending start-ups and 14 per cent for peer-to-peer lenders. While there are delinquencies, the default rate is low against the average ticket size.
Tying up with others is, however, the more popular route. Broadly, fintech players have adopted three kinds of models. One model is lead generation where fintech firms only provide a marketplace and don't bear the risk of default. Bankbazaar, Paisabazaar and MyLoanCare, for example, function as digital direct sales agents. The second model is a hybrid one in which fintechs disburse loans on their own as well as through partners such as banks. For example, CapitalFloat has co-lending partnerships with banks and NBFCs, and Shubh Loans has applied for its own NBFC licence. Fintechs also partner with third parties to get customers on board. For example, Bon has tied up with Uber and Swiggy.
The advantage with the partnership model is that the risk is shared. But a few fintech players with their own NBFC licences prefer to maintain independent loan books. NeoGrowth, LoanTap, LivFin and Samunnati have adopted this model.
Industry players say partnerships are the future. "As focussed and digital data-driven lenders, fintech players bring a unique perspective to the table in underwriting loans, whereas large banks have the capital to deploy, and also have multiple small merchant relationships," says Khaitan of NeoGrowth.
Banks can develop their own credit assessment tools but the cost of doing so will be higher for them, says Gaurav Gupta, Founder and CEO, MyLoanCare. "Start-ups can handle a large number of applications without deploying more manpower," he says.
The shortcoming in the partnership model, however, is that innovation could be stunted as banks may not permit experimentation.
New Sources of Funds
One positive outcome of the entire IL&FS episode is that start-up founders have realised that over-dependence on banks, mutual funds and NBFCs is not healthy for them. "Many global institutions, family offices and insurance companies are willing to provide credit to consumption class but the cost of compliance must come down," says Satyam Kumar, Co-founder and CEO, LoanTap.
Another avenue of funds is mezzanine financing - a hybrid of debt and equity financing that gives the lender the right to convert her debt into equity if the loan is not paid back on time and in full.
Khaitan of NeoGrowth says institutions like SIDBI, LIC and NABARD should come up with lending schemes for fintechs. "This is because customer segments within MSMEs that fintechs cater to are very different from the traditional SME customers where incumbent financial institutions already have product offerings."
For example, Anil Kumar S.G., Founder and CEO, Samunnati, says his start-up provides loans only to farmers and entities engaged in agriculture, but lending to Samunnati doesn't fall under priority sector lending for banks. "The government should look into a policy where, for example, NBFCs or financial institutions with 75 per cent or more exposure in agriculture could be given priority sector benefit," he suggests.
In addition, raising capital through securitising loan books, crowd-funding, masala bonds, external commercial borrowings as well as raising money directly from foreign investors are also becoming popular.
As per Nasscom, the Indian fintech market is poised to touch $2.4 billion by 2020. While the IL&FS crisis decelerated growth, it has also led to sifting of fintech firms at a time when lending to borrowers with lower credit scores had picked pace.
Hopes of a turnaround are high, and the soonicorns among fintech firms look set to turn into unicorns over the next two-three years.