Micro-entrepreneurs are grossly underserved by traditional lenders, as they typically do not have collateral or credit histories to make them creditworthy. In this article, Pande, Memon and Goyal of Dalberg Global Development Advisors, describe how digital infrastructure created by ‘India Stack’ can help provide paperless, presence-less, and cashless credit to micro-entrepreneurs, in a way that is sustainable for lenders.

We recently met Ajay, a fruit vendor in Mumbai, who struggles to pay interest on a working-capital loan he took at an annual interest rate of about 60% from his local moneylender. Ajay believed he could never get a loan from a bank to refinance this usurious debt or raise more capital to buy a second fruit cart. But a few months ago, this changed. Using just his mobile phone, Ajay was able to get approval for a loan of Rs. 15,000 from one of India’s largest private banks in five minutes, and at a moderate interest rate¹. We also met Rajesh, an agent for Eko (a financial services company that carries out remittance transactions), at his mobile phone repair store in Delhi. Rajesh too went through a similar process, and got a Rs. 50,000 working-capital loan on his mobile phone without stepping out of his store. No filling of lengthy loan applications, no complicated documentation, no queuing up in bank branches on futile visits. “Mujhe yakeen nahi hota ki aisa bhi ho sakta hai” (I cannot believe that this is even possible) – was the common sentiment that both expressed in our conversations with them.

These are not dream scenarios, but real stories of empowerment that are being enabled through the digital infrastructure created by ‘India Stack’² - a set of powerful, open and programmable capabilities that build on India’s digital ID programme. India Stack comprises four layers – presence-less, paperless, cashless, and consent. Each layer is supported by different technologies such as Aadhaar³ authentication, eKYC (electronic Know Your Customer)⁴, eSign⁵, and Digilocker⁶.

Small loans and ‘India Stack’

The size of ‘missing credit’ in India has been extensively reported. For example, the 4^th All-India Survey of Micro, Small and Medium Enterprises (MSMEs) states that 90% of MSMEs are dependent on informal sources for credit. Our recent work on financial health in India shows that three in five people continue to borrow informally.  Micro-entrepreneurs are grossly underserved by traditional lenders, as they typically do not have collateral or credit histories to make them creditworthy. Microfinance was the first step in providing the underserved with small-ticket loans without collaterals by using joint liability as proxy for creditworthiness. But we are now at the cusp of something bigger - an opportunity to lend to micro-entrepreneurs like Ajay and Rajesh, even smaller amounts at more flexible terms, instantly, in a sustainable way where lenders can lend profitably by building their models on the layers of India Stack.

India Stack disrupts the market for small-ticket loans in two ways. First, it allows the use of customers’ digital transactions data (example, data on remittance flows, phone recharge top-ups, e-commerce transactions, etc.) that customers agree to share for credit appraisal and loan-product design. This circumvents the need for bank statements, collateral documents, tax returns, and so on, which most micro-entrepreneurs and other financially-excluded customers lack. Second, it dramatically lowers the costs of serving customers by simplifying loan processing and replacing the collection and storage of physical documents with digital versions, using Aadhaar-based eKYC and eSign, and disbursing loans digitally. These data flows and cost savings provide flexibility to lenders to design products that better align with the financing needs of low-income customers. Think super-customised loans for Ajay with terms that work for him, and instant disbursement - as opposed to the one-size-fits-all loan products available off-the-shelf.

Our study

We studied two pilots in Mumbai and Delhi in July 2016. The first brought together Capital Float (marketplace/lender), Aditya Birla Finance Limited (lender) and Eko (remittance data provider). Eko merchants, who carried out remittance-based transactions through the Eko wallet, received small-ticket loans for 3-6 months within 10 minutes of applying for the loan on a mobile-based app created by Capital Float. The processes of authentication and loan agreement were undertaken through eKYC and eSign and the money was deposited through IMPS (Immediate Payment Service)⁸. The loan was disbursed to nine merchants.

The second pilot was based on the partnership between Suvidhaa (a company that works in the payments and remittances space) and Axis bank, where Suvidhaa customers, comprising the financially underserved segment, received small-ticket size loans for a period of 18 months at Suvidhaa retail outlets. Even though this was an assisted model where retailers carried out the eKYC process and eventually handed over a prepaid card to the customer, the entire process was cashless and the customer was able to access the money within 24 hours. The loan was given to 800 customers.

Borrower and lender experiences

Our research shows that the customer experience is quite positive. A new (better) channel for credit has become available to them, and they are willing to make the effort to learn how to make it work. With some assistance, even low-income, limited-literacy consumers are able to navigate the workflow quite well - applying for a loan, providing consent to share data, receiving competing offers from lenders, selecting the offer they preferred, completing eKYC requirements, signing off on the loan agreement using eSign – all on a mobile application on their smartphones, and receiving the money in their accounts. All within a few minutes. They see value in the offering and are willing to give consent to share their digital data (including remittance data and SMS history).

There were some initial apprehensions in using a mobile phone to access loans, and assistance was required to get people started. Making the user interface (UI) more intuitive and multi-lingual in subsequent versions will be important. Initial assistance to navigate the experience and build trust will also be important. Customers also do not appear to make the link between transacting digitally and creation of data trails that brought them the credit options. Awareness-building around this link will play a key role in ensuring that India Stack realises its full potential.

Lenders and data providers in both pilots echoed the promise of India Stack. A new segment of consumers opened up for the lenders and the cost of lending was considerably low as compared to traditional lending (Rs. 55-130 a loan). Our analysis shows that fuller integration with elements of India Stack could bring this down to about Rs. 30.

Way forward

Lenders will have to continue innovating to develop better UI, tap other sources of data, and ensure regulatory compliance.

There are also areas that require some regulatory clarity, example, around the applicability of Aadhaar-based authentication and eKYC processes in the lending business. And there are areas where the government can push further, example, supporting consumers to update Aadhaar records (especially mobile numbers), and promoting competition amongst certifying agencies to drive down cost of eSign. Full-scale roll-out of the Universal Payment Interface (UPI) (and subsequent streamlining of auto-debit mechanisms) will further smooth the payment flows. The DigiLocker, which, over time, will allow Indians to store (and control access to) their personal digital data that can be unlocked on demand, will further strengthen the value proposition of an India Stack-linked lending platform.

Over time, the benefits of India Stack could go much beyond lending. From micro-savings and miniaturised mutual-fund investments, to employment registries (integrating skills and background checks), India Stack has the potential to improve the lives of every Indian in myriad ways.

Ajay and Rajesh have experienced something that - when done at scale - could truly transform the lives of millions of micro-entrepreneurs in India.

Notes:

1. The loan was for a period of 18 months and at an interest rate of about 22% per annum - much lesser than credit available through informal channels or other microfinance institutions (MFIs).
2. India Stack has been developed by iSpirt, a think tank dedicated to technology innovations focusing on the public good and policy advocacy. 
3. Launched in 2009, Aadhaar or Unique Identification number (UID) is a 12-digit individual identification number issued by the Unique Identification Authority of India (UIDAI) on behalf of the Government of India. It captures the biometric identity – 10 fingerprints, iris and photograph – of every resident, and serves as a proof of identity and address anywhere in India.
4. eKYC service enables a resident having an Aadhaar number to share their demographic information and photograph with a UIDAI partner organisation in an online, secure, and auditable manner with the resident’s consent. The consent by the resident can be given via a biometric authentication or One-Time Password (OTP) authentication.
5. eSign is an online electronic signature service which can be integrated with service delivery applications via an open API (Application Programming Interface) to facilitate an Aadhaar holder to digitally sign a document.
6. DigiLocker is a key initiative under Government of India’s Digital India programme that provides citizens a shareable private space on a public cloud where all documents/certificates can be stored.
7. This study was carried out for the CFSI (Center for Financial Services Innovation) and involved the analysis of credit habits of marginalised consumers in India and Kenya.
8. Immediate Payment Service (IMPS) is an instant real-time inter-bank electronic funds transfer system.