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India vs Bharat
The starkness of India’s growth story becomes clear once one looks beyond the four metropolitan cities. The country is neatly divided i nto haves and have nots. Those who make the bulk of income and the rest who live a hand-to-mouth existence.
The former have abundant access - to food, water, shelter, healthcare, justice and so on, while the latter struggle to meet the basic requirements of human life.
When it comes to formal credit, the story is not too different. Despite increasing access to technology, rural credit seekers continue to reel under the high interest rates and unfair practices that plague informal credit.
A vicious cycle
The Indian government has long focused on making formal credit accessible to rural areas, but the fundamental flaws in the lending process are something that traditional banks find hard to overcome.
Lending is a contract, in which the risk is heavily biased towards the lender. They face the fallout of both adverse selection (hidden information), and moral hazard (hidden action).
Many rural loan seekers are new-to-credit, which means they have no credit history to show, and in many cases, lack formal documentation. Due to this, lenders aren’t able to identify the likelihood of default.
In response, informal lenders add a default premium to hike up the interest rate - an option which is not available to banks which are regulated by the government. They, instead, request additional documents and frequent visits by the borrower (leading to higher borrower-side transaction costs), and demand immovable collateral as a guarantee.
Safe to say that many rural Indians aren’t in a position to provide the same. In short - not having credit prevents access to credit.
MasterCard’s 2015 Financial Literacy Index (Asia Pacific) placed India at a dismal 60th place. When combined, these factors result in the financial exclusion of large swathes of the Indian population.
Change is on its way
There has never been a better time to work towards the financial inclusion of rural India, thanks to the smartphone revolution and growing access to fast, cheap internet. Digital lending is slowly but surely gaining ground, and conditions are right for Embedded Finance/FinTech companies to tap into the opportunity and boost credit access in rural India.
How is Embedded Finance equipped to boost financial inclusion?
Embedded Finance reduces the barriers to access for new-to-credit customers and enables innovation in financial services.
Enables alternative data underwriting
Rural borrowers often do not possess the traditional data that banks use for credit scoring - such as current debts, number of open accounts, and credit utilization ratios. Embedded Finance addresses this by allowing alternative data based underwriting i.e. assessing borrowers with the data they actually have, such as mobile device data which includes Apps, texts, device location, call logs, and contacts.
Facilitates a smooth, simple user experience
Embedded Finance helps customize loan application processes within the customer-facing platforms that borrowers are already on. It leverages this platform data for a better understanding of the customer, making the process guided and simplified. This reduces the effort needed for digital discovery and makes it easier for borrowers to access loans.
Enables sachetized loans
According to a Google + CIBIL report, between 2017-2020, there was a 23x increase in loans of ticket size under INR 25,000, and 71% of new-to-credit customers came from non-Tier 1 cities. This points to a clear need for small, ‘sachetized’ loans outside of urban India. Embedded Finance leverages customer data from the customer-facing platform it's embedded in, and assesses this platform data to provide small loans at flexible terms suited to rural borrowers.
Customer experience is taking center stage across industries - but when rural India isn’t even considered in this customer base, their needs and expectations are unlikely to be met. Borrowers from this segment thus rely on money lenders who charge exceptionally high interest rates and trap them in a crushing cycle of debt. Rural economic development therefore remains stunted, affecting the country’s overall economic growth.Technological innovation and Embedded Finance must then work together to create customized financial products that can be accessed even by the most underserved segments of the Indian population. Finance is a service, and more so, a right - it must go to where its customers are, and not vice versa.
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