If you’re stuck in Roorkee or Warangal and run out of cash in your wallet or bank account, all you have to do to get some emergency cash is download one of the fintech apps and avail a 30-second loan. Yes, that’s true. The latest report by FACE-Equifax, titled FinTech Lending Trends FY22-23, indicates that a whooping 40 per cent of the loans disbursed through loan apps is sought after by customers in the Tier-3 cities. For the urban elite, it may be quick to dismiss the possibly of these loan options, but the statistics establish two important aspects – there is a cut-out user base for digital loans and that this category of loans is here to stay.

Fintechs have been at the forefront of innovative lending practices, often catering to segments that traditional financial institutions might not reach. They have launched lending products in partnership with financial institutions to cater to the small-ticket size unsecured personal loans. 

The number story  

According to the FACE-Equifax Fintech Lending Trends report, fintech players disbursed loans worth ₹92,267 crore in the year ended March 2023, up by 21 per cent year-on-year from ₹76,396 crore in FY22. While in FY22, the total loan amount disbursed saw a whooping 64 per cent increase from ₹46,616 crore in FY21.

The number of loans disbursed rose 49 per cent year-on-year to 71 million in FY23, compared to 47.7 million. Personal loans dominated digital lending products, with their share accounting for 83 per cent in disbursement volume in FY23. The share of personal loans in terms of disbursement value increased to 72 per cent in FY23 from 65 per cent in FY22 and 51 per cent in FY21. 

The market share of short-tenure loans, those with less than a six-month tenor, increased to 88 per cent of the total disbursement value in FY23 from 65 per cent in FY22, with most customers pre-closing loans earlier than the original tenure, the report added. 

Let’s look at the broader data published by the Reserve Bank of India. Total unsecured personal loan market stood at ₹1,100,404 crore as of March 2023, up 24 per cent, against 18.2 per cent growth in the same period of the previous year.

It’s worth noting that the unsecured loan portfolio of the banking sector has doubled from ₹6.9-lakh crore in March 2020 to ₹11.1-lakh crore in March 2023. Interestingly, it’s also the second largest retail loan category, next only to home loans.

According to CARE Research, the robust growth in unsecured loans is an effect of granularisation of credit, digitalisation of loans, and preferences for premium consumer products, indirectly indicating the penetration of digital lenders.

Fintech players such as Paytm, Navi, KreditBee, Moneyview, Mobikwik and others can cover a grey space in the area after the government banned several illicit loan apps that were charging obscene charges for short-tenured personal loans. 

Central bank intervention 

What’s also important to note is the share of digital loans to unsecured personal loans stood at 8.4 per cent in FY23 versus 5.4 per cent in FY20, up 300 basis points in three years, and the phenomenal growth of FY23 is notwithstanding the introduction of digital lending guidelines, a step that propelled lenders to lend responsibly and disclose adequate information to the borrower while lending.

Just to add perspective, loans from digital lenders could cost between 20 and 42 per cent, as expensive as a credit card loan and, in some cases, it could land at even 50 per cent rate of interest. Personal loans from banks could, at best, cost around 16 per cent.

Clearly then, what explains the fancy towards digital loans despite the steep differences in rates is the convenience, or the ability to top-up the loans if required. The gap between disbursements and loan outstanding for FY23 explains the same.

According to data from FACE-Equifax Fintech Lending Trends report, the disbursement amount for FY23 stood at ₹92,267 crore, while the loan outstanding in the same period was at ₹60,922 crore.

“Most of the fintech platforms, provide short-term credit to its users, which is for a period of 3 months, 6 months or for around a year, or at best two years, in some cases. These loans are repaid within the time frame and hence the difference between disbursement and outstanding,” said Ketan Patel, CEO, Mswipe Technologies.

The overall asset quality of digital loans improved, with the 90-day-plus delinquency rate declining to 4.04 per cent for FY23 from 4.7 per cent in FY22 and 8.6 per cent in FY21. However, in pockets such as consumer loans and business loans, signs of stress resurface (see table).

This data is very critical, thanks to the recent cap on first loss default guarantee (FLDG) that came in at 5 per cent. While the overall trend seems to suggest that the current threshold should be a good starting point, the question is what happens when there are breaches.

Genesis for FLDG

Fintechs stand out for their ability to innovate, and this includes even the lending contracts. To be sure, it’s not that FLDG did not exist before the RBI officiated it. Some called it service fee while a few others loaded it quietly on their pricing to ensure that if there are any losses to cover, the ultimate lender, which is the bank or NBFC, doesn’t take the hit. In simple words, the losses end up being a private deal between the fintech and the customer, and the quality of the book never percolates to the ultimate lender.

As a result, what was not known was whether the digital lender or the fintech, who is often the face to the customer, had enough capital to bear these losses. If not, it would ultimately be a hit to the banks; perhaps not in the near-term, but over a longer period.

Such practices also lead to what is famously called evergreening of a loan or camouflaging the quality of a loan to such an extent that it would always remain standard in the books of the lender. The only problem with this is that the borrower may not quite have the ability to repay.

The objective of FLDG and its vehement enforcement, including ensuring that the amount guaranteed is parked by the digital lender in a separate arrangement and backed by liquid funds, is to clamp down these practices. Given how the pace of growth of digital lending is far outstripping that of the banking sector, the move was expected.

But does it mean service fee or contract charges are becoming a thing of the past? Yes and no, say people in the industry. While the bid for transparency is mandating digital lenders to ensure that FLDG contracts don’t get known differently, many say, as a practice, it hasn’t gone away entirely.

“For the first time, digital lenders who don’t maintain balance sheets, will be forced to acknowledge the quality of their book. My guess is only a very small proportion of these lenders are comfortable with these numbers. For the large portion which remains uncomfortable with these disclosures, they may have two options – one to relook at their lending practices or continue doing what they’ve always done for year,” said a partner of venture capital invested in fintech.

For those who mend ways, accessing capital in a year or so may not be a challenge. For the rest, it might be an extended funding winter.  But mending ways would also mean having to balance or even choosing between growth and quality.