By Devaprakash Ramakrishnan
Devaprakash is a banker turned development professional with a deep interest in development finance, CSR and making markets work for the poor with a strong focus on private sector participation.
The Indian AltFin (Alternative Finance) market is growing prodigiously. The space for alternate banking has been created by the retreat of the mainstream-banks, which have been challenged by limited assets and capital constraints leading to a slow credit cycle and low returns on equity. The burgeoning demand for credit from the business and consumer markets—including India’s large informal market—have forced India’s banking regulator to encourage innovation.
Thus, the AltFin industry, originally treated as an unsavoury party of the informal market, is gaining traction. There is scope for an inclusive regulatory system that should include all AltFin players who are active in the domain of crowdfunding, peer-to-peer (P2P) lending, invoice trading and debt-based securities.
Size of the Alternative Finance market
Faulty and outdated business models are depressing the fortunes of the credit-shy banks. Inefficient money transfer practices cost banks $2 billion a year in foregone income, according to the McKinsey Global Institute. On the other hand, the online lending industry is projected to grow to $70 billion by 2020. This is occurring against the backdrop of a $300 billion SME lending market, while receipts from global remittances totalled $62.7 billion in 2016, according to the World Bank. With the consumer finance market reaching $1.2 trillion by 2020, as projected by Credit Suisse, there is a renewed impetus in India for more banking options.
The Indian credit market is at an inflexion point, with the industry undergoing rapid transformation, led by the disruption from the financial tech sector. The dominant government-supported model of providing low-cost capital to banks in order to generate credit has failed. Meanwhile, this practice has distorted the credit-market with most of the capital ending up on bloated bank balance sheets rather than trickling-down to ordinary businesses and consumers. However, outside India, whether in distributed banking landscapes such as in the US or centralised markets as in the UK, the Alternative Finance industry has risen to success by learning key market lessons.
Developing a healthy regulatory environment
The AltFin sector should continue to enjoy regulatory arbitrage until they can compete on a level playing field with the banks in terms of access to cheap capital. In order to reach this level, the AltFin sector will need some lee-way, freeing them from the strictures that apply to the traditional banks.
In an evolving industry which is maturing fast, leaving banks out of the P2P market would be disastrous for the financial system. However, P2P partnerships must be organic with the opportunity for banks to build, buy, partner or align as they wish. Nevertheless, bank referral must be mandated, as in the UK where banks are required to refer borrowers they have turned-down to an alternate lender. This would foster the natural complementarity of banks and the AltFin sector.
Enabling capital generation for non-bank entities
The Alternative Finance market deserves positive tax treatment and the ability to trade shares in the secondary market in order to rev up interest from investors. This will increase the availability of capital and generate higher returns. It will also provide an opportunity to invest in innovative financial products, like securitisation. Dedicated funding, along the lines of a UK-style business finance initiative, with a fair 5-10% share in AltFin businesses, will prime the pump for the expansion of the market.
Permitting banks to originate P2P loans, as in the US, by holding the portfolio until an investor buys the loan, will increase the opportunities for interested parties to sign on with the banks as business partners. Pure marketplace lending model has ended in many economies, giving way to hybrid systems. Hence, there is a need to recognise banks as capital providers.
The AltFin industry should be encouraged to work together and lobby for a more open regulatory system, as in the UK. Alternative Finance companies should not be forced to adopt just any guideline which may prevent their growth and stifle innovation. But there is also a need for a single regulator, unlike in the US where the remit for regulating loans may devolve to federal or state agencies. Similarly, we must learn from the Andhra Pradesh microfinance crisis during 2010, where a dual regulatory system inflicted damage on the sector.
Brand building and increased awareness
The AltFin market also suffers from a low level of awareness, measured at less than 10% in a sector that depends heavily on small business. This calls for a vigorous information and brand building campaign. Such a campaign needs to be driven by the government, given the low trust currently enjoyed by non-bank actors in a bank-led environment.
Positive credit reporting must also become a norm for credit providers. The sector must build a comprehensive credit referencing system as in the UK and the US for mutual sharing. However, discouraging large-loan models by placing a cap on investments and establishing a ‘know your customer’ requirement have been regressive steps that threaten to limit growth in the fledgeling AltFin sector. Also of concern are the capping of interest rates, as has happened in China, and steep capital-entry norms.
Banks still enjoy the advantage of being the sole source of low-cost debt-funds. However, this should not confer on them the advantage of being the sole lenders-of-last-resort. Many other consumer-cherished values are better protected by the non-bank actors and they should be given the opportunity to compete.
Featured Image Source: MaxPixel
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