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Move over EMIs: Understanding Equated Daily Instalments (EDIs) and how it’ll bring formal credit to 4 crore MSMEs

Anna Catherine   /    Content Specialist    /    2022-05-30

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Formal credit has never ever touched 60.5% of MSMEs in India, according to the recent report of the Standing Committee on Finance, 2021-22. This is despite banks achieving stringent Priority Sector Lending (PSL) targets and the government enabling numerous schemes for MSMEs such as Mudra. As to why these schemes failed to make a dent on MSME lending, we explore in great detail in this piece. It all boils down to the dearth of effective mechanisms to disburse low-ticket size loans at low-cost and low risk

This is where an Equated Daily Instalment (EDI) programme shines. As the name suggests, it’s a set of daily payments borrowers make towards their loans. How it’s different from or better than EMIs, is a subject for later discussion. Let’s first understand how lenders can tackle cost and risk to be able to successfully run EDI programmes for the bottom of the pyramid. 

A lot can happen at the corridors of commerce

One of the biggest roadblocks in providing adequate and timely funds to MSMEs is the lack of reliable and consolidated data about this sector. More than 70% of these enterprises are unincorporated and cannot be traced back to data pertaining to GST, Income Tax, or other such formal data sources for underwriting. 

Well, if the data won’t come to Muhammad, then Muhammad must go to the data. 

The information gap can be bridged by partnering with ‘Amazons of the world’ who sit on treasure troves of transaction data of merchants. They have a view into their vendors’ cash flows and can give critical insight into prospective borrowers. However, even these digital marketplace companies don’t have access to data of micro enterprises who don’t sell online.

This is what makes ‘QR code payment platforms’ natural partners for disbursing micro loans. The smallest of businesses such as kirana stores and street vendors use QR codes for accepting payments. QR codes are almost ubiquitous, so much that even mendicants have taken to cashless begging. 

Supremely high costs for origination, underwriting, and credit processing end up being value destroyers for a lender’s bottom line. Hence, forming partnerships with ‘payment platforms’ is the way forward for microlending. 

In this digital age, ‘payment providers’ are the new corridors of commerce

QR code platforms could once and for all solve the problem of high transaction cost of small-value loans. They have a ready user base that needs credit. They are armed with data and analytics for lending decision-making.  

This solves the problem of high origination, underwriting, and processing costs. But the best part is, it also solves a hitherto unsolved problem — collections.

Strategic control over collections

The only good loan is the one that gets paid back. There’s no doubt that collections are the most important part of the lending business. But it’s the part that lenders have least control over. 

This, however, changes in a payment provider-driven EDI programme. Besides access to real-time transaction data, payment providers also have full control over loan recovery. Let’s understand this better through an example. 

For instance, a large accounting app with more than 10 million active monthly users (anchor platform) has partnered with FinBox to disburse EDI-based loans. The users of the accounting app make for a ready customer base. Also, the app provides QR codes for accepting payments to its users i.e., MSMEs — thereby, giving them critical insights into customer behaviour that’s critical for lending. 

FinBox, on the other hand, has the capability to build an end-to-end journey along with underwriting capabilities that complement the anchor platform’s decision-making abilities.  

The anchor platform has virtual accounts dedicated to each user that records real-time transactions and routes payments. In fact, all the money transacted via the QR codes sits in nodal accounts under individual virtual accounts until reconciliation at day end. With customer’s consent for automatic debits in place, the anchor platform has to simply call on FinBox’s APIs to deduct overdue amounts from borrowers’ virtual accounts as and when they identify sufficient balance. 

Post recovery of outstanding dues, the anchor platform can settle transactions for the day. Borrowers can be given options other than these for loan repayment such as UPI, debit cards, etc. However, with these methods the platform will have less grip on collections. 

Besides some measure of control over loan recovery, it also drives down the cost of collections. For instance, if the lender were to present eNACH as opposed to this system of auto debits, the cost of collections would be 7.5X higher — they would incur interchange fees, irrespective of whether the payment was recovered or not and borrowers will have to pay a heavy penalty should the NACH transfer fail. 

Apart from this, the fact that repayments are made daily helps lenders identify defaulters early on. Early warning signals can be detected well in advance, as the lender will not have to wait an entire month to know whether the borrower will renege on the payment or not.

When risk is high, distribute

Risk is another key factor that deters lenders from giving loans to new-to-credit customers. In the EDI method of repayment, risk gets distributed better. Because the value at risk reduces on a daily basis, and the recovery rate is considerably higher in EDIs as opposed to EMIs. 

Key ingredients of a successful EDI programme 

  • EDI loans work best when given to customers with daily cash inflows.

  • EDI programmes are best driven by anchor platforms in the payments space, especially those that provide Point of Sale solutions.

  • Access to either transaction data or device data is necessary to paint a clear picture of prospective borrower’s cash flows. 

  • In the absence of a ‘payment provider’ as anchor, the lender can have the technology partner pull ‘device data’ for underwriting.

  • Opex will go through the roof if EDI programmes are run manually. Thus, a technology partner is non-negotiable. 

  • A technology player with capabilities to automate operations end-to-end is a must, as reconciliation will have to happen every day in an EDI programme.

  • If amortisation happens on a reducing-balance basis, day-to-day mathematical computations can get complex. Hence, the technology partner’s algorithms should have an in-built amortisation function. 

Conclusion

The embedded finance era enables innovation in financial products, and something as old as credit can also be innovated according to the needs of the borrowers when the right technology meets expertise. 

EDI-based credit is one such example of bridging the financial divide without taking additional risk. As it grows in popularity and more borrowers make use of EDI-based credit facilities, underwriting for even larger loans will get substantially easier and ensure a true win-win-win across the board. 

To learn more about new-age underwriting models and how credit scoring can work without credit scores, read our whitepaper here