How can Digital Lenders adapt to post-COVID world?

2020-06-23 · Aman Shah · Growth

How has Economic Slowdown affected lending? What can lenders do now?

An economic slowdown started last year, and now it has turned very severe due to the Lockdown. This self-imposed lockdown mandated by our government in light of COVID-19 pandemic crisis has paralysed businesses and resulted in large-scale job losses.

Impact of Economic Slowdown on Credit Demand

Indian households were already struggling with reduced income growth over the past few years, coupled with a fall in savings and high household debt. Steep salary cuts, job losses and reverse migration due to the Lockdown have only added to the dwindling consumption demand. We will most likely see the actual impact on the repayment ability of the borrowers and the demand for fresh loans now after the lockdown is over.

Banking Credit growth is likely to decline dramatically (Source: RBI, CRISIL Estimates)

Macro-economic problems will start showing up as credit risk.

With consumers tightly holding onto their purses, manufacturers of non-essential goods are likely to suffer due to reduced demands in the near future. With labourers migrating to rural areas, experts believe many of the workers will be reluctant to undertake long-distance trips again till the end of the year. This could result in labour-shortage in the short term, thereby limiting the manufacturing from picking up again.

Since both manufacturing and services are hit badly, workers employed by these sectors are worst hit in the short term. SME lending is already seeing higher defaults. If people lose jobs, higher default segments that rely on financing, EMI purchases will be adversely hit.

Retail and Corporate Credit Demand may get severely affected, MSME credit demand likely to grow strong. (Source: RBI, CRISIL Estimates)

Eventually, all past business recoveries have to be led by credit.

The government is already pushing banks to lend. Experts believe that the impact of Covid-19 is likely to be prolonged and the recovery would take more time compared to what was experienced during Demonetization. In the short term, only the demand from low-risk customer segments may get fulfilled.

There is a silver lining for digital lenders.

Experts believe just as Demonetization pushed Digital Payments; COVID is likely to push Digital Lending. With people incited to follow safety measures like ‘social distancing’, usage of cash is likely to decline to avoid COVID transmission through human touch and cash exchange. Besides health concerns, the low cost of onboarding and the reduced turnaround time of digitized loans will push banks and NBFCs to eagerly adopt the complete digital loan disbursement process.

How is the Government trying to ease the situation?

As part of the COVID-19 relief measures, the RBI first announced EMIs moratorium facility for all term loans falling due between March 1 and May 31, to help borrowers face the dire liquidity scenario. This was further extended till August 31 in view of the prolonged nationwide lockdown to fight COVID-19.

A significant number of borrowers opted in for EMI moratorium

Almost all big private banks have seen a significant number of borrowers opt-in for the loan moratorium. Up to 1 in every 4–5 borrowers opted in.

* Bank of Baroda offered ‘Opt-out’ facility offered to customers, whereas others offered ‘Opt-in’ facility. (Source: Financial Express, Jun’20)

As per industry estimates, up to 35% of SME customers, and 59% of NBFC-MFIs were seeking moratoriums. About 65% of the borrowers across the commercial banks and non-banking financial corporations (NBFCs) may have already opted for the moratorium.

India’s Economic Stimulus Package to make credit more accessible

Additionally, the government of India has announced a 20 Cr economic stimulus package to revive the economy. Under the economic package, the government had announced liquidity schemes worth Rs 75,000 crore for NBFCs. Of this, Rs 30,000 crore is backed by full government guarantee and Rs 45,000 crore is covered by partial credit guarantee. The government had also announced loan packages targeting micro, small and medium enterprises (MSMEs) with a government guarantee. Companies can avail 20 percent of their outstanding loan amount under this scheme.

It seems this package has been designed with the primary aim of making it easier for the industry to avail more credit to compensate for the revenue loss due to lockdown and ensuring that the current coronavirus outbreak does not result in a liquidity crisis for businesses. The industry has already harped onto this package. Under the Emergency Credit Line Guarantee Scheme that provides emergency credit lines and working capital to businesses, Public sector banks (PSBs) sanctioned collateral-free loans worth Rs 3,200 crore to the MSME sector in a single day on June 1.

The government has begun with a series of supply-side measures that still don’t address the issue of credit demand loss in the future. Unless demand-side measures are taken, it is tough to imagine any serious economic recovery.

Impact on Credit Supply Situation

Indian Banks could possibly now get thrust into the beginning of a new NPA cycle. The banking system was already burdened with Rs 8 lakh crore worth of NPAs. The onset of COVID-19 might just be the final nail in the coffin.

COVID crisis might push our banking system into another NPA cycle

Lockdown has seriously paralysed businesses across the country and has adversely affected the repayment ability of the borrowers and demand for fresh loans. Even though the government plans to support MSMEs and NBFCs with additional loans, without demand creation, merely pushing additional credit to the industry will likely add to the bad loan burden. Banks may want to prevent creating another NPA cycle, and focus more on the collection of Rs 8 lakh crore of outstanding loans, much of which has been lent by NBFCs to real estate, mortgage financing and other consumption-related loans.

Lockdown has seriously paralysed businesses across the country and has adversely affected the repayment ability of the borrowers and demand for fresh loans. Even though the government plans to support MSMEs and NBFCs with additional loans, without demand creation, merely pushing additional credit to the industry will likely add to the bad loan burden. Banks may want to prevent creating another NPA cycle, and focus more on the collection of Rs 8 lakh crore of outstanding loans, much of which has been lent by NBFCs to real estate, mortgage financing and other consumption-related loans.

NBFCs with less liquidity to suffer due to reduced cash flows

This won’t bode well for several NBFCs in India that have been dealing with one bad news after another in the past two years, including cash crunch, high cost of capital, and burgeoning bad loans. NBFCs without substantial on-balance sheet liquidity will suffer because it will become difficult to manage liquidity due to reducing cash inflows from loan repayments by customers and imminent cash outflows to repay their own liabilities to the banks.

Lenders need to focus on collections to survive this liquidity crisis. Major digital lenders have already begun tightening collection schedules, and this might just be the right move for all lenders in the short term. It will become even more important to lend to the right customer.

This crisis is an opportunity for companies with strong balance sheets as the supply of credit has fallen short of demand:

  1. Focus on Safe bet — narrow the customer base to only include “super-prime” borrowers

  2. Identify pockets of least risk — people employed by essential services such as grocery providers

  3. Bet on COVID-triggered growth sectors — MSMEs from resilient sectors like healthcare, telecom and essential services supply chain or from sunrise sectors that are involved in the manufacturing of hand sanitisers, masks, gloves, headgear, bodysuits, etc. can still present significant opportunities to focus on.

  4. Cross-selling is king — get data of existing borrowers and create models to cross-sell loans to the best customers from your existing user base before your competitors do

But there is a bigger challenge of COVID and our subsequent economic response has adversely affected conventional risk assessment methodology.

Lenders’ ability to assess credit risk will be severely affected.

The number of borrowers seeking moratorium is growing by the day as they want to hold back whatever liquidity they have with no or less cash flow. For microloans, the percentage of borrowers seeking moratorium has shot upto ~70% in May, up from ~30% in April. It clearly shows the depletion of household savings in the last six weeks of lockdown.

According to a survey by Economic Times, upto 45% of moratorium seekers are either not really facing financial difficulties or prospects of salary cuts, or just fear they may lose their job or face a pay cut. They have opted for relief before such an eventuality actually happens.

Source: Economic Times Survey

Even a lot of borrowers may have opted for the moratorium facility unintentionally or due to the ongoing uncertainty and not due to cash crunch. Borrowers who are not savvy may have failed to opt-out of the moratorium, a requirement by some banks.

The impact of Government-provided moratorium will start showing up in the next 6 months. With an extension of another 3 months, high uncertainty will prevail with CIBIL data, since reporting to CIBIL bureau is erratic. Further, data quality on the bureau is going to be bad for the next 6 months and this data will not predict anything until 10 months post moratorium. CIBIL ratings won’t help much during this time.

Lenders need to adapt to post-COVID underwriting

Post-COVID underwriting is nothing like pre-COVID underwriting as bureau data is of no help. Lenders will have to find alternate ways to assess risk effectively. Here are some steps we feel lenders can take:

  • Focus on Digitisation: More lenders will start offering better products to existing “prime” lenders. To stay competitive, lenders should reduce operating costs of lending with greater usage of technology and data analytics. Lenders could focus on opportunities where credit can be digitally delivered and collected.

  • Focus on Cash flow-based underwriting: In the absence of credit ratings/formal data, cashflows-based assessment is a more efficient and safe way of mitigating risk as it reduces discretion on the part of the lender. This could be done by adding cash-flow measuring products such as BankConnect, that could provide the required information in real-time and help you build customised income-assessment techniques

  • Focus on using Alternate Data: While working within the framework of privacy laws, lenders can speed up and improve their underwriting process utilizing the digital footprints, mobile data scraping, geo-tagging and profiling. Alternate data has been used to corroborate and supplement borrower information. This could be done by adding alternate data risk assessments solutions like DeviceConnect, that could help you identify lesser risks borrowers and could also help you offer pre-approved loans to your borrowers.

Underwriting adapted to COVID can readily help lenders gain market share in the near future and pull through the crisis strongly. Although collections might help lenders survive the lockdown, lenders need to be growing to come out on top after this crisis.

FinBox is a Lending & Risk intelligence SaaS provider, supporting leading NBFCs to use alternate data-based credit scoring at scale for retail & SME lending.

To power your organisation with Alternative Data, reach out to us at query@finbox.in. To learn more about FinBox, click here.


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