India seems like an attractive country for a consumer lending startup: it is the most densely populated country in the world (over 1.4 billion people) yet financial services penetration is still very low – unsecured loans, for example, account for just 5% of GDP.
In India, you can start lending without a banking license; all you need is a Non-Banking Financial Company license. The number of NBFC lenders is much higher than the number of banks: about 10,000 compared to 100 traditional banks. Traditional banks are not as developed in mobile applications and remote interaction channels with customers, which is why partnerships between banks and fintech companies are becoming increasingly popular.
Digital Lending Platform Viva Money A pilot program for lending via a mobile application will begin in December 2023.
We are a so-called lending service provider and have tie-ups with financial partners (NBFCs) which gives us a competitive advantage. We can work with an unlimited number of partners, which increases the chances of a customer getting a loan.
Though the Indian market is very attractive and has low barriers to entry, surviving and gaining a strong foothold in it can be difficult. Before entering the Indian market, we thoroughly studied the experience of various companies with a similar business profile.
In the past two years, several lending platforms in India have gone bankrupt or changed hands to avoid bankruptcy, including companies like Zest Money and Bold Finance.
We have taken a closer look at why this happened, so that we can avoid making the same mistakes again. Here are some risks to look out for:
Risk #1 – Miscalculating the score
As a financing platform, Viva Money They can partner with banks and non-bank lenders, in which case loan applications are submitted to different lenders.
Every Fintech has its own unique lending strategy that it offers to its partners, which is usually high risk. This means high levels of overdue debt in the segments where the Fintechs offer loans. This overdue debt is likely to be compensated with high interest rates and high fees. Hence, finance NBFC partners usually have their own personal loan products as well as a range of loan products that they offer to their Fintech partners.
Here are some of the conditions under which fintech companies may go under: The first issue is that they have not adequately calibrated their scoring with their NBFC partners, made miscalculations and generally overestimated their ability to manage credit risk.
That was the mistake made by Zest Money Platform. The platform was sold off at a much lower price than it was valued at in an investment round about six months ago. It was a fire sale. The company was operating in the BNPL segment. The company issued a lot of loans, but the risks were higher than expected and it was unable to cross-sell other companies’ products.
Risk #2 – Avoiding regulatory procedures
There is a strong temptation for fintechs to circumvent regulations. The Indian regulator, RBI, allows several lending schemes, the main one being the First Loan Default Guarantee, which covers only 5% risk. If the risk goes higher, say 10% or 15%, such loans have to be bought back from the financial partner’s books using other parts of the lender’s balance sheet. Since there is no exhaustive or adequate regulation on buyback activities, the RBI may see this as circumvention of the FLDG rules.
RBI is trying to stop fintechs from transacting with high-risk segments. But as fintechs primarily operate in the unsecured segment, a conflict of interest has arisen. Operating under FLDG rules carries risks in itself as it does not allow fintechs to transact with the segments they primarily target.
As a result, companies are using schemes to get around the 5% threshold, which regulators see as illegal and have ordered changes to their models. Regulators believe that interest rates will be lower if risk falls below 10%, but in reality, many Indians are losing out on credit.
Some firms have gone further and are not only engaging in grey schemes but also predatory lending, in direct violation of RBI rules.
Companies without an NBFC license can lend up to 50% of their assets. Once they reach this limit, they are required to obtain a license to lend. So what do companies do? They can buy 5-6 entities that are doing other business and start lending using their balance sheets. This can directly lead to blocking of accounts and other sanctions by regulators, but some companies are playing this game and losing, as they are directly circumventing the requirement of being a regulated company.
Another option is to offer loans at interest rates of 200% or more per annum.A recent example is Acemoney, which lost its license for not meeting RBI requirements for verification of new customers and failing to adhere to regulators’ expectations regarding the legitimacy of its interest rate policy towards customers.
Risk 3 – Rising funding costs
Capital market conditions have changed over the past two years, putting increasing pressure on funding costs. There are two reasons for this. The first is global: inflation is rising and central banks are raising interest rates, increasing borrowing costs. The second reason is regional.
The RBI has forced an adjustment in unsecured lending by increasing risk weightings. The risk weighting for unsecured loans was 100% earlier and is now 125%. Moreover, bank loans to NBFC players, who have more than half their assets in unsecured loans, also now require a risk weighting of 125%. Fintech players have had to increase interest rates to compensate for the increased cost of bank loans. Promoting the sale of unsecured loans is capital-draining but also earns higher returns.
Risk 4 – The wrong, wasteful business model
If startup founders don’t know how to manage costs, they risk not being able to break even or going bankrupt. There are several examples of fintech companies, including Simple, Coinswitch, and Wint Wealth, that were forced to cut costs and make massive layoffs from their teams because their revenue growth rate couldn’t cover the growing expenses.
summary
Although there are many hidden pitfalls in operating in the Indian market, it is both possible and rewarding to do business in the Indian market if you closely monitor the changes in the external environment and regulatory policies.
We review cases where fintech companies have exited the market, examine what they were banned for, and ensure that their mistakes are not repeated.
It is also very important to keep an eye on the compliance side. The revocation of Paytm Payments Bank’s license in early 2024 was undoubtedly due to such violations. Not disclosing the name of the financial product issuer to customers before signing an agreement is a mistake made by almost all digital players in the field, who partner with multiple financial partners instead of one, as is the case with Paytm Payments Bank.
