Power of alternate data: The changing face of Neo lending

New-age fintechs are renewing their evaluation process

Meet Meeta, 32, who runs a small kirana shop in a small village in Madhya Pradesh. A mother of three, she is the sole breadwinner. She works hard and strives to provide her children with the best education. But, for a sustainable livelihood and a better future, she needs to expand her shop and offer more services to the customers. For this to happen and to keep her business up and running, she needs constant access to credit. But, with no formal credit history, Meeta is forced to use informal sources, pawn her jewellery as collateral to get the desired loan and that too, at a high interest rate.

Like Meeta, there are many hardworking small merchants who, due to lack of a credit score, are denied loans needed to keep their businesses afloat. While India is on its path to becoming the fintech capital of the world, access to basic financial services, such as credit, is still not available to the unorganized sector of the economy. It is estimated that there are 63.4 million Micro, Small and Medium Enterprises (MSMEs) in India. Out of the total, only 5-10 million MSMEs have access to formal credit. This presents the prevailing credit gap in the economy and the need for strengthening the credit data infrastructure to meet the unaddressed credit demand.

Even today, the creditworthiness of borrowers is still determined by their past credit and banking transactions. This has put a significant portion of the population, including MSMEs, under a lot of stress. For India to be truly financially inclusive, they need a solution that can help them avail loans as easily as businesses with an active credit history.

This is where alternate data comes in.

But before this, let’s look at India’s credit ecosystem. With formal financial footprints limited to a small size of the overall population, a majority of people still rely on primitive methods to procure funds, such as borrowing money from informal sources. Due to increased risk tolerance and the lack of regulatory oversight, borrowing costs from alternative sources like loan sharks often vary from 50–200%, which is sometimes ten times more expensive than the rates prevailing in formal lending institutions.

Moreover, a large percentage of individuals and businesses are new-to-credit (NTC), and credit bureaus still rely on credit card and loan history details to generate scores. This reliance on just credit history poses a significant lending challenge for formal financial institutions.

Additionally, the small ticket loan size, high cost of servicing the segment, absence of proper documentation in the segment, and limited ability to provide moveable collateral are few other reasons why formal financial institutions have limited their involvement in this sector. But, for MSMEs to expand and succeed, access to loans promptly at a reasonable cost is crucial.

New-age fintechs are renewing their evaluation process by making retailers eligible to avail their lending services. Here, the retailer evaluation for the loan process happens via cutting-edge techno-analytical abilities employed for digitizing the MSME lending process using alternative data. The digital lending ‘credit score’ methodology, which is big data and AI-based, evaluates over 100 factors and offers insights into the actions of each retailer. As a result, not only transactions can be processed faster, but applicants can also be offered the appropriate loan amounts. Based on the score, each qualifying retailer can apply for loans from lending partners.

With the increase in online transactions, merchants are rapidly expanding their acceptance infrastructure. They are now beginning to accept various digital payment solutions, including cards, mobile wallets, and UPI. This explosive growth in the payments industry, enabled by increasing internet and smartphone penetration, the shifting mindset and favourable regulations, is making alternate data a winner. By assessing creditworthiness based on non-traditional sources of data and advanced analytics, digital lending is fast becoming a major source of credit for small merchants who would otherwise not have had the means to procure loans on regular terms. This further cut the risks associated with unsecured lending.

When consumers are choosing digital means for even their grocery purchases, digital lenders are now customizing small-ticket loans to address the unique needs of merchants. Moreover, the uptake of digital payments by all segments has led to an increase in digital data points that these non-traditional lenders use to assess credit risk, further boosting the power of alternative data in this sector.

The biggest challenge still is financial literacy and the fact that the majority of India is still tech-shy. The MSMEs at the last mile require a more extensive handholding approach because of a lack of financial knowledge, inadequate education, and language limitations. Handholding them by constantly educating them through bite-size videos and leading them up the financial literacy curve is the key here.

Digital financing is now being redefined through collaborative models that are extremely scalable and accessible to the last mile. To serve and strengthen MSMEs in Bharat with their credit needs, fintechs are developing strong, technology-backed platforms like Distribution-as-a-Service (DaaS), to reach out to the deep pockets of the nation. This provides easy and efficient micro-lending experiences, enabling small merchants like Meeta, obtain loans with a single click and seamlessly scale their businesses.

Disclaimer: The views expressed in this article are those of the author and do not necessarily reflect the views of the Economic Times – ET Edge Insights, its management, or its members

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