Impact of digitalisation on financial inclusion

1. Reaching underserved customers

MSME access to credit has improved, but only marginally due to technology adoption by incumbent players. Large new private banks are providing innovative solutions to MSMEs through collaborations with digital solution providers. However, access to credit using alternative credit metrics and leveraging AI/ML in under-banked regions are yet to gain significant traction across cohorts

Banks & NBFCs

• Large private banks, in collaboration with digital solution providers, are offering solutions such as virtual accounts, corporate credit cards, automated tax, and vendor payments. MSMEs are also sanctioned instant business loans on the basis of their transaction history.

• With close to 15% of kirana stores’ revenues coming from digital payments (fiscal 2021 panIndia average, as per CRISIL Research estimates), incumbents have collaborated to leverage this data for granting loans to these outlets.

• The aggregate number of MSME loan accounts across licensed banks and NBFCs remain low in relation to the overall MSME universe: CRISIL Research finds, less than 20% of the ~70 million MSMEs in India have access to any formal credit, as of March 2022. That said, NBFCs saw active MSME loan accounts ramp up at a strong ~24% CAGR between fiscals 2017 and 2022. In comparison, they rose merely by 0.6% for private sector banks and recorded a negative CAGR of 1.5% for public sector banks

• But at the systemic level, the semi-urban and rural segments are yet to reap significant benefits from digitalisation of large, as well as small- and mid-sized banks. The share of credit accounts for private sector banks in these regions increased to 37.7% in fiscal 2021 from 33.4% in fiscal 2017 due to an increasing push through offline channels.

Examples of steps taken and collaboration

• A couple of leading private sector banks and two established NBFCs have partnered with an NBFC licensee to provide BNPL facility to unorganised retailers (or kirana stores20).

20 Kirana stores account for 89% of the food and grocery retail market in India (CRISIL Research estimates)

• In August 2021, HDFC Bank collaborated with Paytm to offer products such as corporate credit card, BNPL, and EMIs to business merchants with a focus on tier 2 and 3 cities. Further, the two companies also propose to market a cobranded PoS product to merchants in partnership.

• A player from the large PSB cohort launched an agri-gold loan product exclusively through its inhouse digital platform.

Other financial service providers

• Insurers have limited product offerings for the financially excluded customer segment. There is significant scope for product innovation, especially offering more smaller-sized sachet products and contextual and need-based insurance

• To offer these products at a competitive cost to last-mile customers, insurers need to leverage the digital ecosystem extensively by collaborating with digital service providers

Booming BNPL Market

Digital-only NBFCs are driving small-ticket loan growth through platform lending, BNPL products

A reinvention of old-style consumer credit, BNPL through offline and online channels has led to a massive jump in disbursements of small-ticket-size loans (below Rs 50,000), especially since 2020. The number of personal loans of this ticket size extended by the industry in aggregate and by NBFCs as a player group rose a staggering 30 times and 42 times, respectively, over fiscals 2018-21. The growth gained further momentum in fiscal 2022 and on YTD basis (April 2021– December 2021) ~28.5 million loans were disbursed under the segment during the period as compared to 12.5 million loans in the whole of fiscal 2021. In volume terms, NBFCs’ share in small ticket size loans increased to 74.1% in fiscal 2022 (YTD basis) from 61.1% in fiscal 2018.

It is NBFCs and digital lenders that are mainly offering BNPL products offered through embedded lending and/or checkout finance in collaboration with e-commerce players.

Large, established public and private banks, however, are still testing the waters in segments such as BNPL or embedded finance, partly because of higher credit risk perception associated with credituntested customers jumping on to the bandwagon.

But here too, private banks are attempting to make their presence felt. Axis Bank launched its BNPL product in August 2021 through its subsidiary’s digital payment platform (Freecharge). The facility can be used for utility bills and other merchant payments. ICICI Bank also launched its PayLater product for utility bill payments through its mobile app and embedded the product on e-commerce platforms. However, these products are limited to the banks’ customers.

Trend in small-ticket-size personal loans

YTD: April-December 2021

Source: Experian Credit Bureau, CRISIL Research

Small-ticket size loan products originated by digital solution providers, including BNPL, have high demand from NTC (New to Credit) customers. These players leverage alternative data points to make credit decisions for such customers. Therefore, such products are pivotal in establishing digital presence and developing credit history of NTC customers. Further, the same eventually is likely to help them to avail big ticket-size products from licensed entities over the long term. In its working group report (Digital lending including lending through online platforms and mobile apps) in November 2021, the RBI recommended that all lending done through digital intermediaries even if interest-free, should be reported to the credit information companies (CICs) as they help develop credit history for the individuals.

Disruption in supply chain finance has aided access to MSME credit

Technology has enabled streamlining of seemingly complex processes involving various touch points and multiple stakeholders through digital platforms. The ability of fintech platforms to develop APIs with capability and flexibility to integrate across core banking solution of various financiers and ERP of companies has further accentuated the digitalisation trend and streamlined the operational process involved in supply chain finance. The entire supply chain ecosystem of a particular anchor/corporate including its vendors is being on-boarded on digital platforms. Further, basis the purchase order generated by anchor, the MSME vendor is able to avail financing through bill discounting. The digital platforms have helped in increasing reach among MSMEs. Further, these platforms also work with MSMEs to help them on-board on their platforms.

Further, even TReDS (Trade Receivable Discounting System) platforms which commenced operation in 2014 has gained significant momentum over the last three years aided by digital processes adopted by businesses across supply chain.

Many incumbent banks have forged partnerships with digital platforms to drive their supply chain businesses. For example, Vayana Network has forged partnerships with Bank of Maharashtra, Axis Bank, Federal Bank & Tata Capital. 21

The digitalisation of the supply chain finance has helped in enhancing reach to MSME customers. Going forward as awareness among MSMEs further increases, the trend is expected to continue with more players on-boarding on such digital platforms and also availing financing through TReDS

2. Lowering cost to unserved and underserved customers

Though digitalisation has reduced interest rates for highly creditworthy customers, the underserved customers are yet to reap benefits. Going forward, it will be critical even for the smaller, local entities at the grassroot level to adopt technology.

Banks & NBFCs

• Despite the decline in operating costs across cohorts, especially in case of large banks, interest rate spreads for underserved customers with weak or limited access to formal credit have not been optimised. However, this can be attributed to risk aversion amid the pandemic.

• Small- and mid-sized NBFCs and small finance banks, which have a strong focus on catering to relatively unserved and/or underserved customers, have accelerated their focus on digitalisation and partnerships post pandemic.

• The operating cost per active loan for NBFCs catering in the affordable housing segment dropped by ~13% during fiscal 2017 to fiscal 2021; However, the risk premium (as measured by the interest rate paid by them over and above the 10-year G-sec yield) for small-ticket home loans (less than Rs 10 lakh), mostly availed of by self-employed customers with no formal income documentation, has hardly witnessed any change in the last four years

• However, these customers are yet to reap the benefits of lower interest rates amid digitalisation

Other financial service providers

• The adoption of technology by brokerage players especially in distribution has led to a steep drop in commission/brokerage cost across segments

• However, pricing benefits due to a leaner operating structure and streamlined workflows for players is yet to translate to optimised pricing for unserved and underserved customers in the insurance segment

Technology adoption at the grassroot level is critical for financial inclusion

Large financial institutions have taken the lead in digitalisation, which has already given them an edge over smaller peers. But it is critical for even smaller, local entities focused on serving a specific target segment, to adopt technology and enter relevant tieups with third parties after factoring in their consumer types. This would not only help them offer a wider suite of products and services, but also create efficiencies and eventually reduce product cost.

The small scale of operations of these institutions may restrict their ability to undertake substantial investment in technology. Nevertheless, the trust enjoyed by these smaller entities in their customer segment would also help them better connect with these customers with the most relevant offerings.

An illustration of the community banks in the US, which were the leaders in technology adoption, and how they reaped its benefits, is instructive here.

The US Federal Reserve defines community banks as those with consolidated assets of less than $10 billion. They accept deposits from local communities and deploy funds only in local businesses. As of December 2019, the US had 4,750 community banks compared with 427 non-community banks. The share of community banks in banking assets was ~12% as of December 2019, as per the FDIC22 .

Despite consolidation post 2008, the community banks have played a major role in helping local communities in the US, especially during the pandemic. The pandemic also prompted them to ramp up their technology investments through partnerships. According to the FDIC, community banks with high technology adoption witnessed substantially higher growth in assets post pandemic Further, banks with lower assets did not invest in technology, thereby further hampering growth and ability to provide solutions.

Community banks which were in the higher quartile based on IT spending to assets reported 60 bps higher loan growth in 2020 compared with players in the lowest quartile. Similarly, the community banks that had incorporated technologies in their processes and were part of the highest quartile reported ~80 bps higher performance in loan growth, compared with players in the lowest quartile of technology adoption.

With a stated intention of coming together for a greater common good and in order to tackle capital constraints, a group of 66 institutions, majorly community banks in the US, have formed a venture capital fund with a purpose to invest in financial technology companies and start-ups. These investee companies are tasked with helping the digital transformation journey for the community banking ecosystem in the US.