The role of financial servicesNevertheless, these high numbers may not exclude the troubles many faced when trying to finance their businesses. Even before the coronavirus (COVID-19) pandemic, the demand for small business loans through official channels had been higher than the supply. This trend intensified during the pandemic. Therefore, some MSME turned to traditional money lending in their neighborhoods, risking interest rates of up to 30 percent. Additionally, a number of alternative financing methods from microfinance to digital lending emerged in recent years stimulating the non-banking financial companies (NBFCs) in the country.
With start-ups like Razorpay reaching unicorn status, the NBFC segment gained popularity. These companies provide loans and advances or services related to stocks, shares, and bonds. Compared to scheduled banks, the latter’s scope was limited, with customers not needing a bank account. Moreover, the company structure is more streamlined, and foreign investments are allowed to up to 100 percent. Institutions which focused exclusively on microfinance were grouped as microfinance institutions (MFI). NBFCs were regulated by the Reserve Bank of India but did not need a banking license.
Scheduled banks and NBFCs which offer online lending services form the digital lending market. This was expected to be worth over 350 billion dollars by 2023, indicating an extraordinary growth. Many digital lending platforms lend not only to MSMEs, but to individuals as well. Theses financial services range from small personal loans for buying a new TV, to buy-now-pay-later-loans and educational loans, car, or even small housing loans. The main advantages of digital lending was the comfortable and easy access via mobile devices as well as less paperwork and eligibility checks than in a bank branch office. Ahmedabad-based Lendingkart was the leading lending tech start-up in terms of assets under management, followed by Mumbai-based InCred and Aye Finance from Gurugram.
Challenges within the segmentAlthough digital lending platforms and NBFCs in general set out to fill the demand gap, this did not come without shortcomings. Reports of suicides as a result of bullying by dubious lending companies shocked the entire sector. The spread of peer-to-peer (P2P) lending platforms, especially, produced difficulties in regulating the sector, despite the Reserve Bank of India reviewing its master directions on NBFC-lending and tightening regulations in 2019. Other challenges were connected to the business models of NBFCs. During the same time period, only seven lending tech start-ups were profitable. As loans were given to business which scheduled banks would categorize as too risky, the share of non-performing assets within NFBCs was expected to grow similarly to those of scheduled banks.
Despite these challenges the non-banking financial sector was expected to play a crucial role for economic recovery in India. Firstly, the MSME sector was one of the key funding areas within the huge atmannirbhar bharat abhiyaan packages. Secondly, the government aimed at supporting consumption. Therefore, small and easy-to-access loans were crucial for both these targets.