For decades, banks have been trying to serve rural borrowers in India and give them formal credit but it has been largely in vain. The Indian government too, on its part, has long focused on making formal credit accessible to rural areas.
But despite its efforts, 19 percent of the Indian population lacks access to formal banking, and only 40 percent of India’s rural farmers have access to formal credit.
These numbers can be attributed largely to some fundamental flaws in the lending process.
Many rural loan seekers are new-to-formal credit, which means they have no formal bureau history to show, and in many cases, lack formal documentation. Due to this, lenders find it tough to identify the scale and likelihood of both repayments and default.
In response, informal lenders tend to add a default premium to hike up the interest rate - thus becoming terribly expensive for the end borrower.
Meanwhile, banks insist on additional documents and frequent visits by the borrower (leading to higher borrower-side transaction costs) and demand immovable collateral as a guarantee. It is safe to say that many rural Indians aren’t in a position to provide the same.
In addition to this, low levels of financial literacy across the country ensure that borrowers are never able to avail the credit they need so desperately. Data suggests that only 24 percent of the Indian adult population is financially literate.
When combined, these factors result in the financial exclusion of large swathes of the Indian population.
A push for change
In 2015, the Indian government launched the 'Digital India' campaign with the aim to bring the country’s unbanked population under the umbrella of formal financial services. Due to the concerted push, initiatives such as the Kisan Credit Card and the Unified Payments Interface (UPI) have given a significant boost to financial inclusion in the country.
This digitization of financial transactions is a journey not a landmark, it continues to deepen with higher smartphone penetration, the improved reach of financial products and more financial literacy. The next stage in this digital journey will be the wave of Embedded Finance, which enables non-financial businesses to embed financial products into their own offerings.
How is Embedded Finance equipped to boost financial inclusion?
Embedded Finance can deepen formal financial services in rural areas because it reduces the barriers to access for new-to-credit customers and enables innovation in financial services.
Enables alternative data underwriting
Rural and new-to-credit borrowers often do not possess the traditional data that banks use for credit scoring - such as current debts, number of open accounts, and credit utilization ratios. Embedded Finance addresses this by allowing alternative data-based underwriting i.e. assessing borrowers with the data they actually have, such as mobile device data which includes apps, texts, device location, call logs, and contacts which help lenders build strong decisioning systems that serve as proxies for creditworthiness apart from other forms of data such as transactions and tax returns, etc.
Facilitates a smooth and simple user experience
Embedded Finance helps customize loan application processes within the customer-facing platforms that borrowers are already on. It leverages the platform data for a better understanding of the customer, making the process guided and simplified. This reduces the effort needed for digital discovery and makes it easier for borrowers to access loans.
Enables sachetized loans
According to a Google + CIBIL report, there was a 23x increase in loans of ticket size under INR 25,000, and 71 percent of new-to-credit customers came from non-Tier 1 cities, between 2017-2020. This points to a clear demand for small, ‘sachetized’ loans outside of urban India. Embedded Finance leverages customer data from the customer-facing platform it's embedded in, and assesses this platform data to provide small loans at flexible terms suited to rural borrowers.
It is true that the state of financial inclusion in India has improved in the last few years - but there’s a lot more to be done. Due to low financial literacy rates, even among those who have bank accounts, 48 percent remain inactive.
New-age FinTechs and traditional banks must come together to play to their strengths, and innovate customizable financial solutions in the partnership that empower those who need formal financing the most.
The author, Rajat Deshpande, is Co-founder and CEO at FinBox. The views expressed are personal