The foundation of a modern economy’s growth is built on a dynamic, resilient, and well-functioning financial sector. And the financial sector’s core responsibility is to channel savings toward productive investment opportunities through the process of lending.

Lending in India has traditionally been an exclusive domain of banks, NBFCs, and state-owned cooperative banks. However, advancements in technology and innovation have brought about a churn in the financial sector. Digital lending has been on a rise, with many fintech startups pushing to join the lending bandwagon.

Lending: The Traditional Way

Usually, savers deposit their money with banks to earn interest. This money is then lent out by banks to borrowers, including firms and households. This process mandates that banks screen their borrowers for creditworthiness to ensure the best allocation of scarce capital. 

Banks screen borrowers by combining hard information, such as their credit scores, incomes, and educational background, with soft information acquired through relationship management with the borrower.  

Lenders may also require collateral for borrowers that are difficult to screen. This is because collateral can be seized and sold to recoup losses in case of failure of repayment. Such collateral requirements thus align incentives and help in mitigating information asymmetry. 

But this process has resulted in many borrowers being unable to avail of loans as they have thin credit profiles and lack collateral. The digital lending industry thus paved the way to meet these unmet loan demands.

What is Fueling the Lending Industry?

The same sectors, i.e., individuals, corporates, and governments, lend and borrow funds. 

Generally, the motivation to save depends on current interest rates, expected inflation scenarios, and projections of future income and expenditures. 

Whereas borrowing is underlined by various demands. To illustrate, financial intermediaries borrow money to lend to others or to carry out further refinancing activities. Businesses may borrow money to meet their capital expenditures. Governments may lend out money through their sovereign wealth funds to other countries to hold reserves in stronger currencies. 

The key factors that drive the lending industry growth have been outlined below.

Supply Side Drivers

1. Profitability and Capitalization of Financial Institutions (FIs)

Financial intermediaries can lend more if they are heavily capitalized. This rings especially true in the case of banks on whom ‘reserve requirements’ have been imposed by the RBI. Their lending is also impacted by their ability to absorb repayment losses. 

A surge in non-performing loans (NPAs) forces banks to create more provisions and limits their lending. FIs may also tighten supply if they anticipate their loan performance will worsen in the near future.

2. Competition in the Lending Market

Only recently has the central bank begun to open up the financial sector by approving licenses for payment banks, small finance banks, neobanks, etc. This increased competition with traditional banks and NBFCs has transformed the lending industry. 

Lenders are now interested in growing their loan books by offering loans tailored to a customer’s circumstances and needs.

Additionally, lenders that are looking for higher yields, such as VCs, Angel investors, and PE firms, are willing to finance riskier investments if offered suitable terms.

3. Macro factors 

Global slowdown, geo-political uncertainty, and global supply chain risks tend to affect the loan supply negatively. For instance, global shortages of key commodities (e.g., wheat and oil) and components (e.g., semiconductor chips) have increased the chances of business disruption. 

This impacts the company’s profitability and repayment capacity, thus necessitating higher due diligence at the time of loan sanctions.

4. Investments in India’s Fintech sector

The business of lending has witnessed a shift from branch banking to digital banking. Most of the VC money has been pumped into the payments segment of the FinTech sector. This has led to an increase in loan supply, especially to the remotest corners of the country, and has incentivized the formalization of lending to MSMEs.

5. Big Data Analytics, Artificial Intelligence (AI), and Machine Learning (ML) 

‘Data is the new oil,’ and is being used by lenders to better understand the needs of their customers. 

Lending activity has been given a fillip through technological advances, including Big Data, AI, ML, and blockchain.  Data analytics has enabled lenders to perform timely underwriting and improve fraud detection, thus ensuring prompt disbursal of loans.

6. Technological Enablers

Various government measures, such as e-KYC, e-Sign, UPI, etc., have streamlined the lending process further. Lenders can now base their decisions on the information available on the Account Aggregators platform. This provides them with a holistic picture of a borrower’s creditworthiness and ensures speedy disbursal of loans.

7. Conducive Ecosystem 

RBI’s recently released guidelines on digital lending are targeted at creating a conducive environment for lending by weeding out any unauthorized lenders/entities. This regulatory framework will lead to newer banking solutions, such as FinTechs co-lending with banks and NBFCs. 

This will ensure that network effects can be leveraged to promote higher penetration of lending products. In fact, India is touted as the fintech hub globally and is expected to grow to $515 billion by 2030.

Demand-side Drivers

1. State of Economy

Borrowing and lending tend to be procyclical in nature. As a result, if the economy’s growth rate is expected to accelerate in the future, then there would be a higher demand and supply for loans. These loans are likely to be used for infrastructure and human capital formation, which will further increase the economy’s growth and development.

2. Policy Rates

Expected inflation and interest rates influence how the economy will grow, and this, in turn, determines the loan demand. Also, low-interest rates support the growth of leveraged finance as credit is cheap. 

3. Multiple Sources of Credit

Demand for loans is also impacted by the number of channels available to a business corporation to access loans. For instance, large companies may choose to access bond markets to raise money instead of borrowing directly from banks. 

Similarly, MSMEs tend to benefit when they can tap into finances from NBFCs or FinTech companies that aren’t solely focused on credit scores.

4. Level of Indebtedness

The existing level of indebtedness of households and businesses will also impact loan demand. This is also taken into consideration by lending institutions to ascertain a borrower’s creditworthiness. 

High debt proportions make these households susceptible to an economic slowdown. India’s household debt to nominal GDP ratio stood at 14.5% in FY21.

5. Demographic Dividend

India’s population has a high proportion of youth, with a median age of 29. This consumer base is driven by lifestyle needs and is looking for easy options, including credit cards, BNPL, EMIs, etc., to finance its consumption expenditures. 

Indian youth is also increasingly adopting digital technology, especially in rural areas. This fast-emerging tech-savvy consumer base has been opting for smartphone banking and lending products. 

6. Smartphone Revolution

From 100 million in 2014, the number of smartphone users in India surged to 750 million in 2021. And it is poised to increase to 1 billion by 2026, driven majorly by demand from rural areas for internet-enabled phones. 

The easy availability of low-cost smartphones powered by cheap data rates has enabled users to borrow from digital platforms. This smartphone revolution has propelled borrowers to avail of small-ticket, customized loans digitally through the lender’s website or app.

7. Increased Awareness

The regulatory bodies, along with financial companies, are increasingly making efforts to make the Indian population financially literate. This has resulted in people becoming aware of digital lending products and the extension of credit lines for meeting short-term needs. 

This financial awareness has enabled people to tap into loans during contingencies.

Wrapping Up

A healthy lending industry is pivotal for ensuring the growth of the economy. With the advent of new technology, the lending arena has been undergoing a transformation, especially with the arrival of FinTech and mobile banking. This trend is expected to continue on the back of Bank 5.0, which will involve embedded banking, decentralized finance, and Robo-advisory services.