The growing demand for credit access among retail consumers and businesses has led to the accelerated growth of alternative lending in India. The key factors driving growth include limited credit access within traditional banking, fintech innovation, and widespread smartphone penetration.
The market size of this category is expected to grow from $7.53 billion in 2023 to a projected $18.24 billion by 2028.
However, alternative lenders are now being closely scrutinised by the Reserve Bank of India (RBI). For instance, it recently halted loan disbursal by four Non-Banking Financial Companies (NBFCs) for engaging in irregular practices.
Such cases can be detrimental to the sustainable growth of alternative lenders.
In this article, we offer a brief overview of the advantages and challenges associated with alternative lending. We also outline how lenders can strategically build sustainable, compliant businesses.
What is Alternative Lending?
Alternative lending, also known as shadow lending, refers to the practice of organisations and platforms offering loans and credit products outside the traditional banking ecosystem.
Alternative lenders do not possess a banking license. So, the RBI must authorise them to operate with specific parameters. Despite this, these lenders are important in accelerating and democratising credit access. The key beneficiaries include underserved retail consumers and business borrowers in the Micro, Small, and Medium Enterprises (MSME) sector.
As of March 2024, for instance, loans to self-employed individuals grew to a value of INR 35.7 trillion, while loans to MSMEs reached INR 28.4 trillion. Alternative lending continues to be a key player in serving these segments.
Notable Players in Alternative Lending Segment
Here is an overview of key players in India’s alternative lending market:
NBFCs
An NBFC does not need a banking license to offer loans and other financial services. However, it needs to be recognised by the RBI to be eligible to offer lending products.
As of the financial year 2023, there were 9480 NBFCs in India that offered a range of loan products, including housing loans and microfinance loans.
Recently, the RBI governor warned NBFCs that had indulged in unchecked growth in the pursuit of financial goals about potential consequences.
Peer-to-Peer Lending Platforms
These tech-enabled platforms have created a structured mechanism by which borrowers can directly access loans from other consumers without the involvement of banks. Innovative technology solutions make the entire process simple and easy to navigate for borrowers.
Peer-to-peer lending companies, however, recently featured in the news as they came under RBI’s scrutiny for potential compliance violations. RBI has placed a cap on the aggregate lending value, which must be in alignment with the lender’s total net worth.
Payment Apps
Today, many payment apps are doubling up as loan providers to their existing customer base. The instant nature of the loan, ease of use, and seamless credit disbursal have nudged consumers to consider credit access from these apps.
3 Key Advantages of Alternative Lending
Here is how alternative lending simplifies processes, especially for underserved borrowers:
1. Drives Credit Access and Inclusion
The rise of the organised alternative lending sector has been a game changer for inclusive lending. Unlike the banking sector, these lenders look at alternative financial data beyond credit scores and assets.
This way, lenders can target newer customer segments typically excluded from the banking system.
2. Higher Approval Rates
The relaxation of eligibility criteria translates to much higher loan approval rates for alternative lenders as compared to bank lenders. As a result, they can drive conversions and capitalise on the potential to turn first-time borrowers into lifelong customers.
3. More Flexibility
Lenders outside of the banking ecosystem have an opportunity to be flexible in various aspects of the loan process.
For instance, they can offer small-value loans, and these terms are more attractive, especially for borrowers seeking loans of a smaller ticket size.
Alternative Lending: Some Challenges
While shadow lending comes with several pros, lenders also struggle with the following challenges:
Overall Loan Cost
Loans to borrowers with limited or negative credit histories often come with higher interest rates and fees. While lenders may justify these charges, a sustainable business model requires a different approach.
Higher Risk
Opening up credit access to a large audience with limited assets and poor credit history can also put lenders at risk. They may experience growth of Non-performing Assets (NPAs) and loan delinquencies.
Lenders also risk bankruptcy and potential shutdown if the business becomes financially unviable.
Shorter Repayment Tenures
Alternative lenders often impose shorter repayment terms, which can be a disadvantage. Underserved borrowers typically prefer longer tenures, even for smaller loans, to align with their monthly budgets.
Tackling the Challenges: 3 Best Practices for Alternative Lending Businesses
Alternative lenders can completely transform operations with a mix of technology and strategy:
1. Deliver Personalised Solutions
The underserved lending market is extremely diverse, comprising unique user profiles, multiple sectors, and loan value requirements. The use of AI-powered loan management software enables lenders to offer customised solutions at scale.
By understanding and addressing the specific needs of underserved borrowers, alternative lenders can provide more relevant solutions. This, in turn, can significantly accelerate the conversion.
2. Automate Key Processes
Lenders need to perform key processes like financial analysis with speed and accuracy. This involves quickly extracting data, categorising it, and analysing it without errors.
Automating this process allows for a comprehensive, data-driven analysis of a borrower’s financial health, including superior fraud detection. This leads to more accurate lending decisions, reducing the risk of non-performing assets (NPAs) and loan delinquencies.
3. Proactive Loan Recovery Strategies
Since alternative lending companies serve borrowers with a limited or no credit history, they need a robust, customer-centric loan recovery function.
A combination of strategies, such as personalised loan reminders, quick escalation of delinquencies, a superior monitoring system, and assignment of cases to experienced agents, helps lenders recover debt quickly.
The Takeaway
With increased regulatory scrutiny of the alternative lending sector, lenders like NBFCs and fintech platforms must prioritise AI-powered automation for loan management.
This technology enhances financial analysis, compliance, and debt recovery, leading to a more customer-centric, resilient, and profitable business model.
As a Lending lifecycle management and credit evaluation services platform, Finezza offers comprehensive tools and solutions to manage your lending portfolio.
Our end-to-end lending management solutions are trusted by brands like ftcash, Hiranandani Financial Services, gromor Finance, and UC Inclusive Credit, to name a few.
Finezza’s intuitive bank statement analysis software is geared to analyse bank statements with speed and accuracy. The software also comes equipped with superior fraud detection capabilities.
Book a demo to know more.
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