Challenges and Opportunities Facing India’s Digital Microfinance

The Internet revolution and increased mobile penetration across rural markets have fuelled the emergence of digital technologies in India’s microfinance sector over the last decade.

MFIs have now begun to adapt to new technology trends for faster loan origination, efficient customer service and delivering flexible lending requirements using alternate channels.

The proliferation of low-cost mobile devices has accelerated the expansion of digitally-literate populations, allowing traditional microfinance institution (MFI) borrowers to evolve into more tech-savvy, social media-friendly, and experience-driven clients.

Therefore, increased knowledge and usage of digital platforms and a broader digital payment acceptance network will help minimise reliance on cash-based transactions and pave the way for MFI customers to adopt digital repayment methods.

Digitisation Journey of India’s Microfinance Sector: Important Breakthroughs

Since the early 2000s, technology adoption has been an essential component of the Indian microfinance sector.

In 2008, the Rangarajan committee report recommended that technology-based solutions be increased for financial inclusion in India. The report served as the foundation for establishing the Financial Inclusion Technology Fund (FITF), which invests in information and communication technology.

Furthermore, the government’s Digital India programme helped accelerate the transition to a digital economy. For example, Aadhaar facilitated the transition from traditional banking to a digital model by providing a supportive ecosystem for technology providers to launch electronic “know your customer” (KYC) and authentication services.

The other precursor of technological breakthroughs in MFIs was the Government of India promoting the growth of financial technology via the Jan Dhan- Aadhaar-Mobile (JAM) trinity and IndiaStack.

The presence-less, paperless, cashless, and consent layers of IndiaStack enable lenders to unbundle their services and layer them in partnership with fintech companies to build products and value for a plethora of different customer demands.

Current Status of Digitisation in the Microfinance Sector

According to KPMG’s study on microfinance institutions, the current status of MFI digitisation is as follows:

• Various technology stacks allow fintech within the microfinance sector to do more than just carry out basic operations via collaboration and development.
• MFIs are managing everyday operations with the help of Fintech companies that offer core systems (loan origination and management systems). In contrast, advanced systems harness data from many sources and handle complicated analytics to facilitate effective sales and collection.
• Identification technologies enable better KYC procedures, alternate credit scoring allows deeper customer insights, and cashless loan disbursements are expanding thanks to mobile-banking technologies.
• Now, tech is aiding early warnings for MFI loan portfolios and creating customised financial products based on customer data.
• Only 50% of MFIs have a core banking system (CBS) and a customer relationship management (CRM) system in place. Around 12% of MFIs have deployed either CBS or CRM.
• For their customer on-boarding operations, one out of every four MFIs uses robotic process automation. However, only half of MFIs use emerging technologies like AI and ML to assess credit.
• Only over 40% of MFIs use emerging technology for customer onboarding. Almost all MFIs use cashless channels to disburse loans. NEFT/RTGS/IMPS are the most widely used cashless channels, followed by AePS.

Challenges in Technology Implementation and Adoption in Microfinance

While the advantages of technological integration for MFIs are clear, some concerns and problems are to be addressed.

1. Digital adoption

MFIs have specific problems; they usually deal with personnel and business correspondent partners with weak financial literacy and inadequate formal education. The limited adoption of cashless transactions in the ecosystem is due to a lack of awareness of the banking infrastructure and digital services available.

Also read: How Account Aggregators can Lead to Safe Lending Decisions

Customers receiving loans disbursed straight into their bank accounts end up withdrawing these funds to spend in cash since the ecosystem continues to be cash-based. Because customers perceive no benefit in keeping their money digital, loan repayments are also cash. Repayment through cash can lead to delay in repaying loans by customers, affecting MFIs efficiency in loan recovery.

2. The human touch

The microfinance industry has always been known for its high-touch approach to customer service. However, with technology making inroads into the industry, opinions on how customer service dynamics are evolving are split.

The ‘on-the-ground’ field agents are crucial for understanding the financial possibilities available to the target segment that MFIs serve. As a result, any technology installation must keep customers connected while maximising company resources.

There’s also the issue of repayment. Big data and machine learning algorithms based on many data sources do not take into account certain softer evaluation characteristics that human field agents are adept at.

Hence, algorithm-based lending has a higher chance of default. While Joint Lending Group (JLG) or Self-Help Group (SHG) formats ensure group guarantees are in place, giving peer pressure to repay the loan, and centre meetings reinforce the repayment habit; nonetheless, MFIs must take a multipronged approach to solve this problem.

3. Digital talent gap

Even though digital adoption rates and Internet connectivity have been continuously expanding across India, there is a scarcity of expertise capable of adapting to the latest digital interventions in the Microfinance value chain.

Also read: How Collaborative Lending Can Extend Credit to the Underbanked

This is partly due to NBFC-MFIs’ geographic focus on rural and semi-urban areas, where staffing needs are directly satisfied by recruiting from the locally available pool in areas where significant digital skill gaps exist. For example, according to research, only 24% of the rural population between 15 and 29 can operate a computer, compared to 56% in metropolitan areas.

4. Technology partnership

Many sections of the country continue to be neglected in terms of infrastructure. According to a World Bank assessment, around 33% of villages lack access to all-weather roads and are cut off during the rainy season; India’s northern and northeastern regions are the least well-connected, with problems with electricity, payment infrastructure, and the Internet.

According to a survey, only 1417 of the 18452 communities have 100% household connectivity. Therefore, it will be challenging to make significant investments reliant on agreement among multiple industry players/factors in the ecosystem.

5. Regulations

Many people are concerned about the lack of clear IT regulations for MFIs, such as data protection, business continuity, security, cybersecurity, etc., leading to security breaches and customers’ lack of trust in sharing personal data with lenders.

If passed, the Personal Data Protection Bill, 2019, introduced in the Lok Sabha in December 2019, will address some of the above problems; MFIs will be compelled to comply and modernise their IT infrastructure correspondingly.

Also read: What are Payment Service Providers and how do they Work?

The challenges of providing a consent-based framework for protecting personal information, such as the “right to be forgotten,” and maintaining a safe and encrypted database that stores personal data and the consent format, would necessitate extensive design and execution work.

Future Roadmap: Opportunities for Microfinance

Fintech collaborations are transforming the microfinance sector, which will witness significant investments in digital capabilities in the next few years.

• Nearly 75% of the surveyed MFIs have formed partnerships with Fintech companies, with the remaining MFIs planning to do so as part of their IT roadmap.
• MFIs will need a customer-centric approach that strikes the right blend of technology and human touch.
• MFIs should have a broader vision of where they want to be in three, five, or 10 years, from how they work with their clients to the efficiency of their operations, including their people and culture.
• Fintech firms must take advantage of these opportunities and meet specific client needs.
• MFIs have the opportunity to use fintech advances throughout the transaction cycle. Machine Learning and alternative data capabilities are projected to disrupt the microfinance industry by providing critical differentiators in asset sourcing and asset quality improvement.
• Digital will shape the microfinance environment in the future. Microfinance operations will require a connected business infrastructure to be efficient and scalable.
• MFIs will reduce expenses and establish more reliable credit profiles by integrating with Account Aggregator (AA) platforms to allow effective risk management solutions.
• Training and equipping the MFI personnel with the skills needed to become digitally proficient should be prioritised.
• Increased adoption of digital solutions across the value chain will assist MFIs in increasing overall productivity and efficiency.  MFIs invest a significant amount of money in the workforce.
• MFIs will boost their workforce productivity across customer sourcing, the credit assessment, customer servicing, and collection by implementing digital technologies. As a result, MFIs may be able to “do more with less” as a result of higher productivity.
• Regulators in the financial services industry must make the required efforts to harmonise digital operations within the MFI space such that operational processes are consistent across all institutions.

Takeaways

Customers’ exposure and, as a result, their expectations from microfinance institutions will vary as literacy and mobile phone usage among the poor and rural regions rise.

Microfinance customers would expect personalised solutions based on automated analytics, machine learning, and artificial intelligence (AI) related to their life or business events.

Also read: 6 Reasons Why You Must Choose a Trusted LOS Partner

Customer service, on the other hand, will remain crucial, and the winners will be those who can supply low-cost, high-quality solutions via intuitive, user-friendly platforms.

Furthermore, as new technologies lower the cost of serving customers, more new entrants will increase competition in the microfinance business.

Finezza lending management software is a well-integrated solution for microfinance institutions and non-bank financial companies (NBFCs). The software solution enables MFIs to gain world-class banking capabilities, allowing them to compete effectively with mainstream commercial banks.

The 360-degree suite not only gives lenders a complete picture of the borrower, allowing them to make more balanced decisions, but the utilisation of AI and ML technologies also makes the process more risk-free.