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When it emerged, digital lending was a wave of disruption in the lending space. It lowered processing costs and increased revenue per loan for lenders, and improved customer experience and reduced processing times drastically. In fact, many leading banks have now brought down approval time to five minutes, and disbursal time down to less than 24 hours.
However, digital lending is constantly evolving.
This article gives an in-depth description of digital lending, and covers the newest evolution of digital lending - Embedded Finance. Embedded Finance is a form of digital lending in which credit products can be offered via any non-digital business at the point of demand creation, i.e. Amazon offering loans at check-out, completely within their app.
Prior to the advent of digital lending, the traditional lending journey was characterized by inefficiency and error, and was made of several time-consuming steps. It involved finding a suitable bank, gathering physical copies of required documentation, multiple branch visits, and a lengthy manual verification process. In addition, narrow eligibility criteria and underwriting based on past credit history means that many MSMEs and new-to-credit customers are excluded from the ambit of traditional lending. Those seeking small loans too find it difficult to secure desired credit from banks since loans of less than a certain amount are considered risky by traditional lenders.
However, growing access to low-cost internet in recent years and a massive boom in smartphone penetration meant India was primed for digital lending to take root. There were about 34 internet subscribers per 100 people in India in 2017, which grew by 20 percentage points in just two years. By the end of 2019, there were about 54 internet subscribers per 100 people. When it comes to smartphones, the penetration rate is estimated to reach 51 percent in 2025 - more than double of 2016, when it was just 24 percent.
These factors, coupled with a growing need for quick, small ticket loans, have led to the rise of digital lending platforms offering micro-loans within minutes. Digital lending in India is poised to grow to $350 billion in 2023, from $110 billion in 2019. Currently, the market size in India stands at approximately $200 billion dollars.
Benefits of digital lending
Minimal documentation requirements: New-age digital lending platforms underwrite borrowers based on alternative data, minimizing the need for lengthy documentation.
Strict data privacy: Digital lenders leverage best-in-class data encryption standards like AES/PGP, advanced 2FA security models, and undergo regular data security audits and vendor reviews to ensure complete protection of user data.
Faster loan processing: The use of both conventional and alternative data, advanced algorithms, and state-of-the-art technology allows digital lenders to make lending decisions far quicker than their traditional counterparts.
Ease of use: Loan applications can be done anytime and anywhere via smartphone. The entire workflow is optimized based on the type of application. Most details can be filled in with auto-fill technologies that gather data from various sources, which are then checked and verified with no human interaction involved.
Transparency: Digital platforms maintain complete transparency in their operations by implementing the following guidelines that were put in place by the RBI:
Non-Banking Financial Companies (NBFCs) and banks need to state the names of online platforms they are working with
Digital lending platforms which are used on behalf of Banks and NBFCs should disclose the name of the bank(s) or NBFC(s) to customers
Lending apps must issue a sanction letter to the borrower on the letter head of the bank/NBFC concerned before the execution of the loan agreement
Adequate efforts should be made towards the creation of awareness about the grievance redressal mechanism
Trends in digital lending
AI and ML driven processes
The popularity of AI and ML in digital lending is only set to increase. Investing in these technologies automates compliance and form requirements, which leaves resources free to focus on complex business problems. This machine-first approach to lending enables the extraction of real-time customer insights and generates a complete view of customer credit lifecycles. This results in customized, low-risk credit offerings that keep customers coming back to the digital platform.
Moving to the cloud
When it comes to investing in digital transformation, traditional banks and NBFCs are focusing their capital on moving to the cloud. The latest cloud solutions leverage data and analytics to enhance customer experiences, reduce risk, facilitate innovation, and more. The end-result for businesses include improved efficiency, greater agility, and a reduced risk of security or business continuity breaches. In terms of cost, leveraging the cloud proves optimal since it involves lower rollout costs, paying as per usage, and standardization of processes.
Notably, lenders can choose from on-premise, public cloud, managed cloud and SaaS cloud based on what works best for them, Software can be customised to requirements and comes with state-of-the-art credit rating and scoring features.
Overall, moving to cloud-based lending improves decision making by leveraging other cloud-based data sources, Risk, identity, and valuation data sources are accessed and returned in a standard format, which helps accurately assess the creditworthiness of borrowers who may not have a detailed credit history.
The potential of blockchain to revolutionize financial services is only just being realized. According to research, compliance, automation of fraud checks, allied with blockchain-based verification of digital identity, should enable savings of up to 50% for banks within a few years.
Blockchain enables unprecedented levels of transparency in digital lending transactions. When passed through blockchain, each transaction receives a unique timestamp which reduces risk of data misrepresentation. It gives lending immunity from hacker threats and data breaches, thereby instilling trust and transparency across the digital lending ecosystem.
Physical point of sale lending
The potential to transform the physical point of sale lending experience is now being recognized. It is increasing in popularity thanks to a younger generation of borrowers who are more comfortable taking loans for specific purposes rather than being saddled with rolling credit card balances.
Tech startups are reviving physical (POS) lending to consumers, allowing them to choose from a marketplace of lenders when making a purchase at a store.
Some FinTech startups also allow consumers to apply for loans in-store with a specialty card. This increasing focus on non-card lending at the physical point of sale ties into increasing consumer expectations of a smooth omnichannel lending experience across web, apps, and stores.
Digital point of sale financing
Customer experience is paramount and users no longer want to be redirected to third-party websites for access to credit. With the help of Embedded Finance, digital platforms can offer credit in-context and at the point of sale.
By leveraging their vast amounts of customer data, lenders can also customize their credit products to customer needs. The result is this - customers can leverage a Buy Now Pay Later (BNPL) option at checkout itself, and pay for the purchase over a fixed time period, usually at zero or minimal interest. The retailer is paid upfront by the Embedded Finance provider (who enables BNPL), and the latter collects funds from the end-customer.
Let’s take a deeper look into Embedded Finance in the following section.
Embedded Finance - the next stage of digital lending
Embedded Finance, also known as embedded banking, is the seamless integration of financial services into a traditionally non-financial service. It enables customers to access financial services within the app and in-context. For example, customers can make cashless payments within a ride-hailing app.
How Embedded Finance improves digital lending
As mentioned earlier, digital lenders run partnership-based strategies with customer-facing digital platforms (anchor platforms). Through this, non-financial anchor platforms passed off their leads to the lender to help them get credit.
Take for example a shop owner looking to stock up 3X his usual order value for an upcoming festive weekend. He visits the B2B E-Commerce platform he usually makes purchases from. This time, he sees an ‘Apply for a loan’ option. When he clicks, He is immediately thrown to a new webpage, of a bank he doesn’t recognize.
There, he has to input his information and upload documents, which we may already have done on the E-Commerce platform for a prior use-case.With Embedded Finance, this scenario turns completely seamless. The loan application process is embedded entirely into the customer-facing platform.
The shop owner could have applied for the loan within the platform he was familiar with, and it would have been underwritten with the help of the platform data he has already provided.
Here's how Embedded Finance improves this scenario.
Seamless lending journey
This is the key aspect in which Embedded Finance represents a significant improvement over digital lending. It enables the digital platform to bring the entire lending lifecycle on its platform, customise credit products for their customer base, and proactively assist their customers. In short, it makes for a unified customer experience, where purchases can be made and loans can be sought within the same platform. In addition, communication around the loan and the repayment mechanisms are also covered by the Embedded Finance provider.
The platform can leverage its already engaged customer base to cross-sell loans at relevant points in the user’s journey. The convenience of Embedded Credit provided in-context and a smooth user experience in turn drives repeat transactions on the platform.
Lower default rates
It also helps bring down loan defaults through prequalification - a process through which platform data is leveraged to show particular loan options only to those who are already eligible.Larger lender networkEmbedded Finance connects the digital platform with multiple lenders. This helps them cater to a diverse demographic and ensure higher approval rates alongside better-than-market interest rates for customers.
Embedded Finance represents the next stage in the evolution of digital lending. It is built on deep collaboration between the anchor platform and the lender, and enables platforms to offer tailored credit products to the end customer. The business model as a whole improvest on loan approval rates, facilitates best in class interest rates, and ensures optimal outcomes for every stakeholder.
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