Credit is an extremely important engine which drives economic activity in the short run. The RBI knows this all too well. It has done a phenomenal job of increasing credit availability to individuals and businesses in India irrespective of their credit score. The 33 scheduled commercial banks (SCBs) have collectively lent out over Rs.100 trillion rupees as of March 2020. And that is not including the over 350 NBFCs, HFCs and other regional lenders who account for nearly a quarter of all lending activities in India. Total outstanding credit grew by 40% in the period between 2016 and 2020. NBFC’s have increased their loan assets by a staggering 58% in just 2.5 years between March 2017 and September 2019 for which data is available.
In spite of all of this, India’s credit to GDP ratio, at 54%, is one of the lowest compared to its peers in the developing and developed world. Our credit to GDP gap ratio* is -5.5%, indicating there is more headroom to create credit in the economy.
*Credit to GDP gap ratio is a Basel iii metric measuring the difference between credit to gdp ratio and the credit to gdp ratio trend. The interpretation is that a negative credit to gdp gap ratio means that current credit situation is less than optimal. A positive number would be mean the opposite of it.
The RBI, government and Nandan Nilekani’s crew have all been hard at work to resolve this. But first, we need to go back to the basics of how credit works to be able to appreciate the credit revolution that India is about to witness.
How does credit work?
There are savers who want to invest their money in profitable ways. There are borrowers who either want to consume in excess of their income or want to invest in their businesses. And then there are banks who act as the intermediaries connecting savers and borrowers by taking deposits and making loans. When a loan becomes due for repayment, borrowers return the principle with an interest to the banks who then pay it out to the deposit holders.
What makes credit happen?
In one word – Trust. In order for credit to happen, lenders must trust that borrowers will have the means to repay the money lent when it is time. This is at the absolute fundamentals of it. When a borrower is trustworthy, banks line up to offer him/her a loan at lucrative rates. When a borrower isn’t, fewer banks are ready to offer a loan. And the ones who are ready to offer a loan will want to charge a high interest rate (high risk premium).
how do banks decide if you are creditworthy?
CIBIL in India is one of four privately owned CICs (credit information company). It generates a 3-digit number, ranging from 300 to 900, indicating your credit score. They take into consideration 4 key factors
- Payment history (if you have a history of making regular payments on your loans)
- Credit mix (if you have a mix of secured e.g, mortgage and unsecured loans e.g, credit card)
- Number of enquiries made for loans (too many enquiries mean you are too desperate for credit)
- And credit utilisation(debt burden tracked over time).
The higher your credit score, the better your chances are of getting a loan at favourable interest rates.
But surely, someone who has a high income should be considered credit worthy also?
Absolutely. Banks do take into consideration other factors too – salary levels, trade income, amount of GST paid by small business owners etc. But this is done discretionally on a loan-by-loan basis and not at a credit score level. Also, corporates have other sources funding which the credit score does not capture – foreign currency convertible bonds, masala bonds, intercorporate borrowings etc. Banks have to make their own effort to verify if corporate borrowers have any additional debt outstanding in these instruments.
So, the information asymmetry between the banks and borrowers has still not been fully fixed by the CICs?
Spot on! Credit score only does half the job of bridging the information gap between borrowers and lenders. Fixing this information asymmetry will be a game changer in India to increasing credit in the economy. And that is precisely what the RBI and the government are going to fix – In a way that is unimaginable to the western world.
Enter PCR – The Public Credit Registry (PCR)
The public credit registry (PCR) was conceived in a 2018 report to the RBI by the YM Deosthalee committee. What they said in the 151-page report in simple words was this – We need a non-profit company (unlike the CICs who are for-profit organisations) to create and maintain a public registry of borrowers of all sizes. The PCR will capture borrower data of various kinds including all existing debt, utility payments data, tax payments data, GST data, and other primary information sources. SEBI, ministry of corporate affairs, GST network, the insolvency bankruptcy board of India will all contribute data to the PCR.
The report brought out some excellent points. Think first-time borrowers. With no credit history at all, their CIBIL score would be 0 (or a number between 0 and 5). PCR will fix that by tapping into data sources other than historic loans availed. The hope is that after this issue is fixed, more credit will flow out to the MSME sector and the underserved population of the country.
But the PCR still does not capture salary information or your net-worth in stocks and bonds for the lender to be able to get a full picture!
Enter AA - Account Aggregators
The open banking framework was first launched in the UK in 2016 in response to problems including high overdraft costs, low interest rates etc. India went a step further with DEPA (data empowerment and protection architecture). The idea behind DEPA and AA is to unchain the large volume of data sitting behind the walls of banks and regulators.
Account aggregators classify the world into 3 kinds
- Financial information providers (your banks, your demat account holder, your stockbroker, utility providers etc),
- Financial information users (lenders, neobanks, your chartered accountant etc.,)
- And consumers (you, corporate borrowers).
AAs are the conduits between them all.
How would it work?
Let’s say you are applying for a loan with Baja finance.
Today, you’d have to generate a bank statement through online banking, print it as PDF and share it. You’d probably have to do the same with your equity transactions, mutual fund investments, address proof, form 16, salary slips, KYC documents, tax filings, GST payments etc. All manually.
But AAs are going to change that.When you register with one of the account aggregators and request them to transfer data via an app, they will send an instant electronic request to all the financial information providers. Once they receive the data, AAs will electronically transfer it to your lender. All you’ll have to do, is just press a few buttons. Lenders will have more confidence in the data they receive from the AAs and will be more willing to lend. This will further overcome information asymmetry between borrowers & lenders and consequently increase credit in the financial system.
- Not just that, your investment advisors will be able to keep track of your portfolio performance better without having to go through the hassle of data collection.
- Your tax filing company will be able to get all of the data electronically without having to give them photocopies.
- New age banks (neo-banks) will be able to provide you with a consolidated view of all of your bank balances in a single app without having to check them individually.
But from the perspective of growing credit in the financial system, this is still not ground-breaking. To grow credit, it needs to be made ubiquitous, omnipresent! And that is precisely what OCEN will do.
Enter the mother of all credit enablers, OCEN
OCEN stands for open credit enablement network. OCEN is going to make it possible for literally anyone selling products to customers to offer credit. Allow me to explain.
You’ve probably seen it in the movies – an old telephone exchange which looks something like this.
What?! How is it relevant here?
Hear me out. This is how telephone exchanges used to work.
- A caller dialled into the exchange and spoke to the operator (commonly referred to as “hello girls” since women came to dominate this scene. They were really good at it compared to men).
- The caller made a request to connect to someone else.
- The operator connected the call by plugging the ringing cable into the relevant jack on the switchboard.
In a really, really simplified sense, OCEN is like the physical switchboard infrastructure. It is the framework through which borrowers and lenders are going to communicate with each other. The caller is the borrower who wants a loan. The call receiver is one of the many lenders we have in the country – banks, NBFCs etc. And the switchboard operator, the hello girl, is the merchant platform who makes this connection possible.
But how will it really work?
I will borrow the example that iSpirt volunteers used to describe this. (iSpirt is the organistation behind OCEN).
Let’s say Swiggy wants to roll out personal loans to the restaurants they work with. They could go to Bajaj Finance and work a deal out to offer loans on Swiggy’s App. The IT teams from both the companies will spend the next several months integrating their Apps. Eventually the restaurant owners might end up seeing an option to take personal loans through Swiggy’s App.
When one such owner makes a loan request on the App, Bajaj Finance will get access to high quality information from Swiggy. This includes number of orders received by that particular joint, the total value of all purchases, average order size etc. This, together with other data from account aggregators, credit bureaus, public credit registry, will help Bajaj finance gauge whether the restaurant owner can be trusted with a loan. Seems like everybody is a winner, no? – No!
Swiggy and its customers will be stuck with Bajaj Finance. They will not get the best deals. To get the best deals, Swiggy will have to sign up with a number of other lenders and all of this is both time consuming and costly. And what about small-time merchants and Swiggy-like start-ups? They don’t have the money or the reputation to be able to tie up with big-name lenders. What of them?
Enter OCEN – OCEN is going to act as the central platform on which Swiggys of the world and Bajaj Finances of the world can plug in to. OCEN will be the common technology framework that would enable any App or marketplace to offer credit to its suppliers/customers from any lender who is also connected to the platform.