There is abundant caution around unsecured loans, especially personal loans. But this category also seems to be growing without any restrictions. Are the red flags then being supressed, and is the pain deferred?

Both seem to be happening simultaneously. Lenders are growing their books at such a pace and volume that fresh loans written are masking the pain in vintage portfolios. This is an age-old practice and as such not a bad strategy because there’s still growth in the underlying assets. But what is supporting this growth is the manageable size of repayment.

In fintech language, the proliferation of equated daily instalments or EDI. As against the monthly repayment schedule, in EDI, the borrower repays the loan daily. One could call it a finetuned MFI model, which works daily instead of weekly. On paper, it’s a fantastic repayment scheme.

Sample this, a kirana store owner who has taken a loan for ₹3,00,000 has to pay only ₹300 a day to repay the loan as against upwards of ₹10,000. Since the repayment bullet it very manageable, for the shopkeeper it barely matters whether the lender is charging interest at 20 per cent, 40 per cent or 14 per cent, which is acceptable bank rate for personal loans. When his daily turnover of is ₹3,000-5,000, physiologically the amount he repays daily won’t dent the wallet. Low-wage salary earners also prefer the EDI.

The model is perfect until the first signs of stress emerge, which could arise due to some medical or personal emergency in the family, job loss, or any unforeseen reason. When three or five days of EDI isn’t paid, and there isn’t equivalent income accruing for the borrower, the trouble starts. To pay ₹1,800, along with penal charges on the sixth day, becomes burdensome and that’s when the lender will have to choose whether to stay with the borrower or not; either way it’s a tricky call. But since the interest rate charged was quite steep, the real hit on the lender’s financials may not be much, irrespective of the borrower’s behaviour. It is exactly for this reason that over personalisation of repayment may end up becoming counterproductive.

The potential stress of the borrower remains supressed, but everone in the ecosystem ends up making money. Presently, we are at the favourable end of the lending curve, and these models seem flawless. As the cycle reverses, the cracks will be revealed. But that may be too late to stand up against such innovation.