Module 5

Digital Lending

Contents

1. Understanding Lending- An Introduction

2. Digital Lending

3. Core of the Digital Lending model

4. Digital Lending- Industry examples

Introduction

Hello, I am Abhijeet.

I am here to help you understand below mentioned topics today:

1. Lending

2. Traditional lending

3. Digital lending

4. Alternative Credit Decision & alternate data sources

5. Industry examples

Let’s Begin!

Understanding Lending-

An Introduction

1

In this section, we will understand about lending.

Let us understand it from our friends Abhijeet and

Sakshi

1.1a Introduction to lending

1.1b Introduction to lending

Hi Sakshi, How are you?

Hi Abhijeet, I am fine. How about you?

I am good. You look worried. What happened?

I am in need for money and not sure how to get the same

Why don’t you borrow money from

a lender?

Who is a lender? What options do I

have?

Lending is the temporary transfer of money with the expectation that it will be

repaid with an interest

I understand, but who will give me this

money?

Lenders will provide you the same. These are generally

businesses or financial institutions

Thanks Abhijeet. Can you give me more

information on lenders

There are two types of lenders: Traditional Lenders

& Digital Lenders

Below mentioned points should be remembered

What is Lending?

• Lending is the temporary transfer of money with the expectation

that it will be repaid with an interest. Generally, interest is higher

if risk of not paying back the money is higher

Who is a Lender?

• Lenders are businesses or financial institutions that lend money,

with the expectation that it will be paid back with interest.

Let us continue with the conversation..

Points to remember

1.2 Introduction to traditional lending

Let me start with traditional lenders

Sure. Please do.

Traditional lenders are bank (private, public, co-operative), NBFC(large and small) or MFI which provides loans to businesses or individuals

These institutions are regulated by RBI and must follow

designated rules in order to provide any loans

They consider multiple factors before they lend to an individual or business like amount needed, cash

flows, & collateral provided

What are the types of loan they provide?

There are 2 types of loans. First is Secured Loans where the borrower keeps some asset as collateral

(as a guarantee) with the lender in return of the money. E.g.: Home loan, Vehicle loan

Second is Unsecured Loans where no collateral is provided to the lender by the borrower. Example: personal loan, student

loans, credit card etc.

On what basis do they provide

loans?

Points to remember

Below mentioned points should be remembered

Who are traditional Lenders?

• A bank (private, public, co-operative), NBFC - Non Banking Financial

Company (large and small) or MFI - Micro finance Institution, which

provides loans to businesses or individuals.

• Factors considered for lending by traditional lenders

• Amount of lending

• Cash flows of an individual

• Collateral provided

There are 2 kinds of loans:

• Secured loans – collateral provided

• Unsecured loans – no collateral provided

Let us continue with the conversation..

Collateral

Asset that works as a guarantee for the

lender, in case the borrower fails to repay

1.3 Gaps in traditional lending and need for digital lending

Supply vs demand gap• Traditional lenders could not bridge the gap between credit demand and its

supply

Unable to finance customers with Insufficient

credit history

• Traditional lenders could only lend to the customers with sufficient and

credible credit history

• They require lot of documents which might not be available with all the

customers

Unable to finance unqualified business owners

• Traditional lenders can only finance to qualified business owners having

reasonable credit history such as GST, tax file receipts, etc.

• Thus small businesses like shopkeepers, vegetable vendors are left out from

financing

1

2

3

The traditional lending model failed to meet the evolving needs of borrowers and lenders and faced several issues that were unaddressed. Following are few of those:

1.4 Introduction to Digital/ Alternate lending

Digital/ Alternative lending is providing loans through online platforms that use technology to

bring together borrowers who are underserved by traditional lenders

These underserved borrowers range from small and medium enterprises (SMEs) to

individuals

Partner

Bank

Alternative

lending

platform

Individuals/

Consumers

Small and

medium

Businesses

Lenders/Investors

The key players in the digital lending ecosystem are the borrowers: who could be individuals or small or medium businesses, the lenders: who could be individuals or institutional investors, andThe partner bank: the bank who owns the platform

The alternative lending platform acts as a facilitator that connects the 3 key players

1.5 Difference between a Traditional & Digital lender

Qualification

❖ Stricter requirements to qualify for a

loan. For example, business owners

should have excellent credit score

Traditional Lenders Digital Lenders

❖Minimal requirements to qualify for a

loan. For example: Minimum credit

score or revenue requirement are

much lower for some digital lenders

Paperwork

❖ Requires significant amount of

paperwork and documentation

❖ Requires less paperwork and

documentation

Funding Time

❖ Takes anywhere from few

days to a few weeks to

provide the loan

❖ Takes 2-3 days to provide

the loan

Digital lending is advantageous over traditional lending with lesser paperwork, lesser processing time and lesser qualification requirements.

Points to remember

Below mentioned points should be remembered

What is digital/ alternative lending?

• Digital/ Alternative lending is providing loans through

online platforms that use technology to bring together

borrowers who are underserved by traditional lenders.

• These underserved borrowers range from small and

medium enterprises (SMEs) to individuals.

Next section will help you understand more about digital

lending.

Digital Lending

2

2.1 Digital lending mechanisms

Let me start with digital lending mechanisms

SureThere are several types of alternate lending models

Let’s discuss in detail these 3 types:

• P2P lending • Crowdfunding• Direct lending

Growth in digital lending segment in India

• More than 225 alternate lending companies had been founded in India as of 2017

• The segment is the second most funded in the Indian FinTech space and the fastest growing as well

India’s share of Alternate Lending funding has steadily increased vis a vis other Asian countries

That’s interesting. Please explain these

digital lending mechanisms

Alternative lending occurs using online platforms that leverage technology to match borrowers (who remained underserved by traditional lending mechanisms) and lenders, who seek to lend at higher yields than traditional lending institutions.

2.2 P2P lendingLet me start with P2P lending. Peer-to-

peer (P2P) lending offers lower rates on loans by connecting people-to-people

over the internet

The risk assessment is made through a combination of the consumer’s

underlying creditworthiness, loan amount and purpose

P2P platform firm

Lender 1

Lender 2

Lender 3Borrower (SMEs,

individuals, corporates)

Illustration of the P2P lending model

Peer to peer lending, abbreviated as P2P lending is an emerging lending model that matches individual lenders and borrowers through an online platform without any intermediary such as a bank. The concept is gaining popularity as:

1. Loans are cheaper as the intermediary’s commission is avoided2. Better matching of the lender-borrower pair as per their needs

TypeForms of contribution

Forms of returnMotivation of funder

Donation Crowdfunding

DonationIntangiblebenefits

Intrinsic and social motivation

Reward Crowdfunding

Donation pre-purchase

Rewards but also intangible benefits

Combination of intrinsic and social motivation and desire for reward

2.3a Crowdfunding

Crowdfunding entails raising external finance from a large group of investors. The investors

can interact with the investees andview their ideas on a crowdfunding platform

There are 2 types of crowdfunding:1. Community crowdfunding2. Financial return crowdfunding

1. Community Crowdfunding

Crowdfunding is a type of P2P lending- but for organizations or start-ups. Small companies can raise funds from the general public through crowdfunding. Each individual lender extends a small loan, which gets compiled from similar loans from several other lenders, effectively forming a large fund for the company.

There are 2 major types of crowdfunding:

2.3b Crowdfunding

Crowdfunding entails raising external finance from a large group of investors. The investors

can interact with the investees andview their ideas on a crowdfunding platform

TypeForms of contribution

Forms of returnMotivation of funder

P2PCrowdfunding

LoanRepayment of loans with interest

Primarily financially motivated

Equity

CrowdfundingInvestment

Return on investment in time if the business does well. Rewards

also sometimes offer intangible benefits, another factor for many investors

Combination of intrinsic, social

and financial motivation

There are 4 types of crowdfundingThese two are collectively known as

“financial return crowdfunding”

2. Financial Return Crowdfunding

While community crowdfunding is lending with a social benefit objective, financial return crowdfunding is lending with the expectation of a return in the future.

2.4 Direct Lending (FinTech NBFCs)

Have you understood the two types of digital lending?

Yes The next one is direct lending

Direct Lending services are offered through online platforms, by NBFCs that have a lending license. The digitization of processes allows for reduced costs and

gives NBFCs an edge over banks (they can extend loans at cheaper interest rates than banks)

Compared to banks, NBFCs have benefitted by leveraging technology to rapidly scale their

operations and to customize traditional processes and change minimal borrower qualifications in order

to penetrate underserved segments

Main Segments they target are individuals

like us and small businesses

Regulator is the Reserve Bank of India (RBI)

Who are the regulators?

2.5 Industry trends in digital lending

Clear distinction

between business

models for developed

and developing

economiesEmergence of digital loans

as a viable asset class

Traditional players are

reacting with agility

Evolving secondary

market for online loans

Following are the 4 major trends in the digital lending space that have

the potential to define how this space develops in the near future

1

2

3

4

2.5a Industry trends in digital lending

Clear distinction between business models for developed and

developing economies

• In developed economies such as the US and UK, the focus is largely on

consumer financing (refinancing existing loans, purchasing

goods/services, payment of credit card dues or education loans)

• On the other hand, in developing economies, the goal of most firms is

to reach under-/unbanked borrowers. These borrowers range from

small and medium enterprises (SMEs) who find it difficult to obtain bank

loans on amicable terms, to individuals who are subprime for

traditional lenders

2.5b Industry trends in digital lending

Emergence as a viable asset class (a group of similar assets)

• Alternative lending has evolved as a viable and relatively less volatile

asset class for both retail and institutional investors

• Less complex investment decisions and higher rates make it an

attractive avenue for retail investors to place short-term funds

• Investment banks, hedge funds and insurance companies have

deployed massive amounts of funds by partnering with online lenders,

thus altering the structure of the industry

2.5c Industry trends in digital lending

Traditional players are reacting with agility

• Banks across the world are closely watching this segment to ascertain

the sustainability of the business models, and many are starting to get

involved in some form or the other

• A few large banks have partnered with various online lenders and are

looking to join the bandwagon as investors

• A few others have taken strategic equity stakes in some of these firms,

while several others are looking to start their own online lending arms

Seci

2.5d Industry trends in digital lending

Evolving secondary market for online loans

• Some online lenders are looking to bundle small-ticket size loans and

sell them to institutional lenders – this is called securitization*

• Securitization enables lenders to spread some of the risk and provides

additional sources of funding

• Some firms have formed internal hedge funds and affiliated entities to

act as investment advisors and participate in the securitization of loans

*Securitization is the process of bundling of small sized loans into marketable securities that are then sold to larger investors.For example: A bank who has given out several small house loans in the form of mortgages can combine these into groups to form Mortgage backed securities (MBS), which it can sell to investors such as insurance companies. The insurance company gains interest on these small loans with the houses as collateral and the bank transfers the risk of default on the house loans to the insurance company.

Points to remember

Below mentioned points should be remembered

What is P2P lending?

• Peer-to-peer (P2P) lending offers lower rates on loans by

connecting people-to-people over the internet.

What is Crowdfunding?

• Crowdfunding entails raising external finance from a large

group of investors over a platform.

What is Direct Lending?

• Direct Lending includes platforms that have a lending license.

By leveraging technology to penetrate underserved segments,

NBFCs have capitalized on the inability of banks to rapidly scale

operations and customize rigid policies.

Core of the Digital Lending model

3

3.1 Alternative credit decision model (ACD)

Thanks Abhijeet. You earlier said that digital lenders require less

documents, then how do they make the decision to loan or not?

Good question Sakshi. They use alternate data sources for credit decision. It is called Alternative

Credit Decision

Let me first tell you what are the traditional data sources used by banks for credit appraisal of a borrower. Some of these are:1. Bureau data such as: Credit accounts and applications,

address and ID verification and, fraud prevention and detection

2. Banks generally use data from Indian credit information companies such as CIBIL, Experian, Equifax and Highmark

Alternate data sources are being used recently by lenders to get additional and more accurate info about borrowers. These include, financial transaction data, social data, property data, etc.

Alternative Credit Decision (ACD) involves leveraging both1. Unconventional consumer information 2. Conventional credit sources to assess the creditworthiness of an individual.

Residential Data

Utility Payments Profile

Assets Ownership

Social Media

Other Payment/ Behavioural Data

Conventional Sources such as bureau reports

Alternative Credit Scores

Data from various sources is collectedSent to ACD engine having

algorithms for processingOutput is used for

taking decision

ACD Engine(Algorithms)

Measure of creditworthiness

3.2 Advantages of ACD

Main advantages of Alternative credit decision model(ACD) are: Expand Scope

of customers

Increased Accuracy of Underwriting

• Leveraging alternate data sources expands the

scope of customers who can be catered to

• Applicants with less documents can now be

potential customers

• Increasing ability to accurately assess risk for a

subprime borrower, while keeping

documentation requirements for applicants

unchanged

Subprime borrower

Person considered to have relatively

high credit risk for a lender

3.3a Alternate data sources used in ACD model

Please explain more about the data sources

There are 2 types of data sources

Conventional & Unconventional

Conventional

Sources

Demographic, Financial & Bureau Data

• This data is used to assess the creditworthiness of the

borrower: i.e. whether the borrower would be able to

repay the loan with a reasonably low default risk

• Data used includes, income data, past repayment

behavior (available from credit bureau organizations

such as CIBIL) and demographic data (age, location,

job profile)

• Limited effectiveness for ”thin-file” customers ('Thin-file'

customers are those who have very little repayment

behavior data)

3.3b Alternate data sources used in ACD model

Please explain more about the data sources

There are 2 types of data sources

Conventional & Unconventional

Unconventional

data approaches

and models

Social DataBuilding more robust customer profiles based

on social media behavior and usage

Location InformationGPS information coupled with financial

transaction behavior

Transaction BehaviorUtilizing customer search, product, purchase,

payment behavior, telecom, Utility bill

payments

App based data accessSmart phones provide a host of data to

leverage - texts, emails, GPS, social-media

posts, retail receipts, conversation lengths

3.4 Data sources used in retail lending

Alternate data can assist in developing robust underwriting* models to

• Target new customer segments• Reduce cost of acquisition

Digital loan applications,

• Reduce the cost of on-boarding (acquiring the customer), thus making small ticket loans feasible

• Provide access to valuable information for existing and future customers

The cost of on-boarding new customers is lower for digital lenders because:

• Lesser documentation is required,• Lower operational cost due to

elimination of activities such as document collections, verification, salesperson visit, etc.

• Faster application processing time due to digitization of back end processes

*Underwriting is the process banks follow to determine if the risk level associated with extending the loan to the borrower is within acceptable limits.

Points to remember

Below mentioned points should be remembered

What is ACD?

• Alternative Credit Decision (ACD) involves leveraging of

unconventional consumer information in combination with

the conventional credit sources such as credit bureau

reports to predict creditworthiness of a customer.

• ACD is used by Alternative lenders to assess the credit

worthiness of an individual before lending.

What are the types of data sources

• There are two types of data sources: Conventional:

Demographic Data & Bureau Data

• Unconventional: Social data, location information,

transaction behavior etc.

Digital Lending: Industry Examples

4

4.1a Digital Lending: Industry Examples in India

Offering OverviewCompany Name

• Provides short term, small ticket size loans at point of checkout at a wide variety of online-merchants

• Eliminates payment step at merchant, significantly improving checkout conversion

• Machine learning technology allows it to lend to consumers who might not qualify for credit cards, utilizing additional data, such as ecommerce payment behavior

• FlexiLoans.com is a pure digital lending FinTech platform that provides paperless, collateral free working capital financing to small and medium business across India

• Its proprietary technology and algorithms are built to remove the friction points in the borrower’s application process, data gathering, credit decisioning, scoring, loan funding, customer servicing, regulatory compliance and fraud detection

4.1b Digital Lending: Industry Examples in India

Offering OverviewCompany Name

• Instant small business loans using creative alternative data to underwrite loans and reduce dependency on documentation

• Partnerships with merchant aggregators provide access to merchant and Small and Medium Enterprises’ (SMEs) sales information

• Provide finance management services in exchange for data on SME performance for better underwriting

• Digital financial community that connects borrowers and investors, providing different forms of credit and investment options

• Pairs borrowers and investors based on built in algorithms

• Provides additional services related to loan servicing and collections

4.2 Popular Digital Lending Platforms

Invoice Finance

Digital Mortgage

Virtual Credit Lines

Debt Collection

Point of Sale (PoS) Lending

P2P Lending

SME Lending

Alternate Lending Models

Mobile Lending

Wholesale Mortgage Financing

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End of Module