Taking Lending into the Future of Finance
Lending is one of the primary processes that drive revenues for financial institutions. With increasing investment and business opportunities, borrower heterogeneity is also adding to the complexity of loan origination for manual loan processors. The borrower, on the other hand, is increasingly impatient and quick to switch lenders if one fails to satisfy their needs. Add to it the tedium of scrutinisation process that adds to manual effort (though essential from the lenders’ perspective to keep risk at the minimum) and also acts as a decision marker for the borrower.
The Digital Revolution
It has become imperative for loan origination to catch up with digitisation, given that all financial processes ahead of it have already gone digital. Plus, today’s borrowers are inclined toward finding convenient lending solutions with flexible loan disbursement facilities.
Advanced technologies, such as data analytics, predictive modelling, mobility and even social media help in building a composite scorecard and have been enabling financial institutions to conduct business transactions and manage customer relationships more efficiently. However, financial institutions are yet to optimally employ technology for loan origination, disbursement and repayment.
Loan Origination Solutions
The finance industry is leaning once again on technology to lend support to redefine the most essential business process – lending. Reportedly, 44% of the global loan IT spending in 2021 was for loan origination systems (LOS), at $7.3 billion. This number is expected to reach $9.7 billion by 2025.
The reason for this growth is the competitive advantage that LOS solutions offer, such as:
LOS automates borrower authentication, data collection, credit decision-making and information validation, eliminating manual intervention at each step of the process. They also remove inconsistencies that could arise due to manual bias and human errors.
With diverse loan opportunities across diverse borrower requirements, there are enormous compliance requirements to be met. Any deviation may land the lender in trouble in the future. Tedious paperwork and data duplication via the manual route gives rise to inconsistencies in the database. Automation verifies and validates data at each step, thus preventing such confusion.
Enhanced Customer Experience
Digital applications come with relevant data pre-filled. The borrower needs to supply only the details that may not already be available to the lender. Now, manual processes may miss out if any mandatory details are misleading or missing. But digital LOS eliminates any such issue. Faster loan disbursement and easy access through mobile apps allow customers to keep track of their loan status, improving the overall customer experience.
Better Control over Risk Exposure
Automated analytical tools are far more accurate, and reports can be generated in a matter of minutes. These reports provide deep insights into investor behaviour, spending patterns and borrowing tendencies, helping lenders make informed decisions and minimise risk exposure. Predictive analysis also aids offering customer-centric services.
Streamlined processes, compliant loan disbursements, automated credit tracking and borrower profiling all can be accomplished in a matter of seconds. This improves audit timing and eases the auditor’s job too.
Financial Inclusion and the Role of the RBI
In its attempt to ensure a planned and structured approach to financial inclusion, the Reserve Bank of India (RBI) has advised banks to put plans in place based on specific parameters like credit facilities to minorities, SC/ST and Deendayal Antyodaya Yojana to bring inclusiveness and institutionally backed financial support systems.
The central bank has also undertaken a variety of initiatives to promote financial inclusion, such as:
1-No Frills Accounts
These are the most basic bank accounts that require very low or zero balance. Over the years, the RBI has made several changes to these accounts, such as the accounts being converted into Basic Savings Bank Deposit Accounts (BSBDA), a basic savings bank deposit account.
2-Basic Savings Bank Deposit Account
Apart from no requirement for a minimum balance to be maintained in the account, BSBDAs offer several facilities to account holders, such as deposits and withdrawals of cash at the bank branch or ATM, sending and receiving of money via electronic payment or cheques and the facility of an ATM or ATM-cum-debit card for account holders.
3-Lead Banking Scheme
This scheme is applicable for both private and public banks and gives a specific bank the lead role within the district allotted to it. The lead bank becomes the point of contact for the particular district for coordination with credit institutions providing services in that district. The RBI’s aim with this scheme is to increase cash flow for small-scale industries, agriculture and other economic services.
4-Pradhan Mantri Jan Dhan Yojana
With the slogan “Mera Khata – Bhagya Vidhata,” this scheme ensures “access to various financial services like availability of basic savings bank account, access to need based credit, remittances facility, insurance and pension to the excluded sections, i.e., weaker sections & low-income groups,” according to the Ministry of Finance.
5-Business Correspondent System
This system includes bank representatives who individually visit areas assigned to them to carry out various banking tasks. These representatives are responsible for helping villagers open bank accounts and conduct regular transactions. For every account opened, the representative receives a commission from the bank. Business correspondents are a practical solution for extending basic banking services to more than 6,00,000 village habitations across India.
Microfinance is playing a major role in providing access to credit for Indian at the bottom of the economic pyramid. It has proven to be an effective means to support income generating activities in rural and urban India and thereby impacting livelihoods. It is also a powerful tool for the empowerment of women, who account for the largest percentage of microfinance borrower base.
In addition, the National Bank for Agriculture and Rural Development (NABARD) has pioneered a Self-Help Group-Bank Linkage Programme (SHG-BLP), which is contributing significantly to the overall microfinance segment. As on March 31, 2020, there were 56.77 lakh SHGs, with loans outstanding worth ₹1.08 lakh crore under SHG-BLP.
The RBI is focused on addressing the vulnerable segments of the Indian economy, while ensuring consumer protection. The aim is to enhance the capacity of customers to drive responsible and sustainable use of financial services. The central bank has been promoting financial literacy, grievance redressal and customer protection to further the cause of sustainable financial inclusion. The latest move in this regard has been the setting up of the National Centre for Financial Education and the Centre for Financial Literacy.
In addition, the RBI has created the Financial Inclusion Index, which it intends to publish regularly. The index includes parameters across three dimensions of inclusion – Access, Usage and Quality.
Analysing Willingness to Pay vs Ability to Pay is the Future of Lending
The Indian customer is infamous for their pursuit of value of money. However, given that different customers will have different needs, they will also value products and services differently. This makes it vital for the BFSI sector to understand how to analyse willingness to pay. This will determine how they position their offerings and establish their value proposition. Care Risk adds value in providing insights (through various data/credit/statistical models) and offering pre-delinquency alerts. This further empowers FS firms to serve the segment that has an appetite for payment and yet don’t pay up.
On the other hand, willingness to pay doesn’t automatically translate into the ability to pay. How does one reconcile low affordability or ability to pay with high willingness? One way is to lower the pricing model or offer higher discounts. But this is not a sustainable route. This is where financing plans come to the rescue.
Latest Amendments in Risk Governance in India
The RBI has introduced various changes through 2022 to strengthen risk mitigation for NBFCs. Firstly, NBFCs in the Upper Layer (NBFC-UL) and Middle Layer (NBFC-ML) are now required to have an independent risk models along with a Compliance Function and a Chief Compliance Officer (CCO). The central bank has introduced certain standards, principles and procedures for the Compliance Function. In addition, for NBFC-ULs, the RBI has introduced guidelines on exposure norms to address the concentration of credit risk in NBFCs.
This amendment sets out instructions to identify large exposure, put reporting norms in place for such exposure and refine the criteria for grouping connected counterparties. With this reform, exposure can be offset through credit risk transfer instruments, as defined by the RBI. These instruments include cash margin, caution money, security deposit, etc., held as collateral.
The large exposure limit has been set for single counterparties at not higher than 20% of the NBFC-UL’s “available eligible capital base at all times.” The NBFC-UL’s board can allow an additional 5% exposure beyond this limit. For groups of connected counterparties, the exposure of an NBFC-UL to a group of such counterparties cannot exceed 25% of the NBFC-UL’s “available eligible capital base at all times.”
In addition, the RBI has introduced some guideline revisions for Indian branches of foreign banks.
Care Risk Solutions supports businesses with end-to-end, holistic credit risk analysis, helping organisations to quantify, track, monitor and report credit risk effectively. For instance, with CRSPL’s offerings around Enterprise Risk Management solutions, banks are empowered to identify, assess and track key risks by:
Computing risk components, such as PD, LGD, EAD, RAROC Risk Based Pricing, etc that enable bank/NBFC have a handle on credit risk.
Computing Capital Charge under Standardised, FIRB and AIRB approaches under BASEL II and III
Helping Banks and NBFCs digitise and automate their credit risk processes with efficient workflows
Supporting data aggregation and processing with smart financial data processing that simultaneously covers multiple data sources
Empowering organisations to integrate custom-built , proprietary as well as pre-configured risk models seamlessly
Ensuring robust limit monitoring, utilisation analysis, violation reporting and stress testing
Comprehensive Model Validation using statistical techniques as well as AI/ML
With a robust risk analysis model, lenders will be in a better position to evaluate willingness vs ability to pay and build offerings accordingly.
The Bottom Line
LOS solutions remove the need for manual labour and prove to be a one-time investment that provides long-term returns.
Digitisation increases loan throughput, thus improving the institution’s production capacity. It helps discover cross-selling opportunities and offer concise loan pricing, giving higher returns on investment to the organisation.
Additionally upcoming reforms and amendments in BFSI and Financial Risk Management through the initiatives taken by RBI and GOI should offer both acceptable AI/ML intervention as well as safeguard end consumers interest.
Author: Chiranjibi Panda, Director - R&C Practice, CARE Risk Solutions
“Over the last one-decade Enterprise Risk, Regulatory and Compliance functions have emerged as key business drivers. Global Financial institutes (FIs) have swiftly adopted them as part of their long-term strategy and growth plans"