At its core, lending transcends mere financial transactions; it's an exercise in understanding the borrower — their financial capacity, willingness to repay, and overall intent.
In this quest for insight-to-lend, data becomes a lender’s most valuable ally. Be it structured or unstructured, any data that provides a glimpse into a borrower’s past behaviour, financial health, and personal circumstances can empower lenders to make informed decisions and price the risk appropriately.
In the digital age, this data-driven understanding of borrowers has become more critical than ever, as it enables lenders to strike the delicate balance between offering accessible credit and safeguarding their financial interests.
For example, the sheer volume of digital footprints left by individuals in their online activities provides a wealth of information that goes far beyond traditional credit scores. From analysing transaction histories and spending patterns to scrutinising social media interactions, lenders can now piece together a comprehensive profile of a borrower’s financial behaviour and personal circumstances.
This granular understanding of borrowers is invaluable as it allows lenders to navigate the fine line between extending accessible credit to those who need it and preserving the financial health of their institutions. It enables them to tailor loan terms, interest rates, and credit limits to match the specific risk profiles of borrowers, ultimately minimising defaults and optimising their lending portfolios.
Moreover, the data-driven approach to lending also benefits borrowers themselves. Those with limited credit histories or unconventional financial backgrounds can find opportunities to access credit that may have previously been elusive. By harnessing a broader spectrum of data, lenders can extend credit to a more diverse range of individuals, fostering financial inclusion and opening doors to economic opportunities.
Frictionless Credit
In recent years, the financial world has been abuzz with the concept of frictionless credit, a system that promises to revolutionise the way we access and utilise credit using cutting-edge technologies. One of the most significant advantages of frictionless credit is the speed and efficiency it brings to the lending process.
By harnessing technologies, financial institutions can quickly assess a borrower’s creditworthiness, reducing the time it takes to approve and disburse loans.
Frictionless credit has the potential to extend financial services to underserved populations. Traditional credit assessments often exclude individuals with no credit history. By using alternative data sources, such as digital footprints and transaction histories, more people can gain access to credit. However, automated credit decision algorithms may inadvertently perpetuate biases present in historical data, leading to discrimination against certain groups.
Now we have a regulator also. A pilot project for a public tech platform created by the Reserve Bank Innovation Hub aims to facilitate the seamless flow of crucial information to lenders. This platform aim to serve as a conduit, collecting and presenting data from various agencies to lenders, allowing them to make informed credit decisions swiftly. It assembles data necessary for loan approval, including Aadhaar e-KYC, Aadhaar e-signing, account aggregation by Account Aggregators (AAs), and PAN validation, all essential components of KYC. While this concept may appear to be a digital utopia, we must tread cautiously, for the path to frictionless credit is not without its thorns.
But Friction — seemingly undesirable, serves a vital role in lending, much like it does in the physical world.
It acts as a safeguard against hasty and ill-informed decisions, particularly in a highly leveraged environment like banking. While the pursuit of frictionless processes is laudable for efficiency, the judicious introduction of friction ensures that lenders conduct comprehensive due diligence, reducing the risk of defaults and fraud.
By imposing reasonable obstacles, such as documentation requirements and verification processes, lending institutions uphold their fiduciary duty to protect the funds of depositors while fostering a balanced and secure financial ecosystem. In essence, controlled friction in lending helps strike the right equilibrium between accessibility to credit and the preservation of financial integrity.
In areas where efficiency is the top priority, friction reduction can be immensely beneficial. For instance, automating the credit assessment process through advanced data analytics and AI can significantly expedite loan approvals while maintaining a high level of accuracy. Lenders, whether traditional banks or NBFCs or fintech innovators, must recognise that a one-size-fits-all approach won't suffice in the complex world of lending. Each financial institution should embark on the journey of developing its unique lending model, tailored to its risk tolerance, customer base, and operational capabilities.
However, it's equally vital to identify those points in the lending process where introducing friction is paramount. For instance, robust identity verification and KYC (Know Your Customer) procedures are essential to prevent fraud and ensure regulatory compliance. In such cases, thorough due diligence may require additional steps that may appear as friction but are essential for security.
Furthermore, the level of friction introduced can be aligned with the type of loan being offered. For low-risk, small-value loans, a lighter touch in terms of documentation and verification may be acceptable. Still, for high-value, complex transactions, more comprehensive due diligence and documentation are crucial.
Without a formal regulatory nudge or framework that incentivises banks to engage with underserved consumers, it is unlikely that frictionless credit alone will motivate them to change their risk-averse lending practices. Regulatory guidelines that provide clear pathways for responsible lending to this segment of the population are crucial to ensure that the potential of frictionless credit is harnessed effectively in bridging financial inclusion gaps.
The transformation towards frictionless credit and a digital-first approach in banking raises crucial questions about the banks’ ability to adapt to a new paradigm. Can they truly embrace a world with reduced reliance on extensive documentation? Can they shift their mindset towards a digital-first approach? In examining the state of some of our banks, it becomes apparent that many may still reside in the era of computerisation, not fully embracing the modern digital age.
This sandbox from RBI signals a fundamental shift from a focus on traditional documentation to a deeper engagement with digital data. Are the banks it regulates ready for this frictionless credit? For they will need to overhaul their operational mindset and groom digital-enabled credit thinking. The devil in the modern age indeed resides in data and digital systems, not just in physical documents.
At this point, the concern is that the regulator — the RBI — is far ahead in digital thinking, than many of the banks that it regulates!
(Edited by : C H Unnikrishnan)
