The importance of Networks and Savings in your consumer lending offering in India
With inputs from Bala Srinivasa
Consumer lending products thrive on Networks which are a complex intertwining of layers of institutions — bankers, lenders, rating bureaus, regulators, and collection agencies. The collaboration among these institutions is vital to the unit economics of the product because it keeps the cost in control. Most importantly, the exchange of information within this Network helps put necessary checks and balances to mitigate the associated risks that come with a financial services product.
As India witnesses the much talked about expansion in the consumer lending market, it is important to discuss what does it take to win these new 300M+ consumers. In my view, these consumers are fundamentally different from the top 50M Indians in terms of their lower unit price of consumption. Thus, Networks become even more important in establishing the profitability of products for this market. Furthermore, because of lack of penetration of formal consumer loan products among the next 300M+ consumers, savings become important. They help in building underwriting data and in making the consumer adopt new behaviour.
I’ll explain the role of Networks in consumption of consumer lending products in an established market. I’ll also argue for the need of deepening these Networks and the role of savings in product design, as providers think about addressing the next 300M borrowers. This segment is estimated to be as big as $600B. You can read the market estimation post here (Decoding India`s consumer lending opportunity). The image below is a summary of this post and depicts how the middle of the pyramid is a market to watch out for.
Look at the top of income pyramid, there are Networks everywhere
There is a proliferation of consumer lending products today for people who are at the top of the income pyramid. Products cater to various consumer needs — home, car, consumer appliances, smartphone, and healthcare etc. And underneath these products, there are Networks - a complex intertwining of layers of institutions exchanging information and mitigating risks.
Think, Motor Loan. In majority of the cases, the vehicle dealership originates a motor loan with its tie-up with a financial institution. The credit finds its way directly to the dealership without touching consumer pocket. In a scenario like this, the quality of the dealership also determines the nature of credit terms. For example, a particular dealership may have better rate of interest than other because of its turnover, brand, and among other things, location. Look deeply, credit cards are offered on top of a Network built by POS machine providers which help you swipe your card, merchants who accept these cards and work with banks to create custom offers (lounge benefits, cashback offers etc.)
Let us take another example of a newer category Student Loans. The loan lets a student purchase curated products — smartphones, laptops etc. — off e-Commerce websites. The underwriting model also takes into account the education institution of the student, geography, and among other things, social circle. This kind of plumbing enables loan providers to influence repayment behaviour. For example, some student lending companies have campus ambassadors (a student in the educational institute) who act as physical touch-point to nudge students to pay their instalments on time. Therefore, distribution of this product is done by opening educational institute by institute and tying up with e-Commerce websites — which is nothing but a form of Network.
Consumer profiling — Do I/we know you well? Do I/we believe that you can repay me/us back in time? — alone is not enough today. Consumer lending products leverage Network to underwrite not only a consumer but also her relationship with the Network. It is not always up to the consumer to decide on how and when to use the money. Now, money is given directly to product/service provider, making it less riskier than former. That is the reason why cash limits on credit cards are generally a fraction of the credit limit.
In summary, Networks enable creation of contextualised loan products. They decrease the cost of origination of the loan. The availability of more information to underwrite the consumer and the role of the Network in nudging the consumer to repay the instalments help drive the cost of risk downwards.
Go a couple of levels down the income pyramid, Networks disappear
It is no surprise that there are credit needs at the middle and lower-end of the income spectrum. These needs maybe similar to those at the top — house, vehicle, etc., or maybe different — private school education for kids, pilgrimage travel, and planned medical procedures etc. What is surprising is that there is virtually no presence of Networks. Consequently, there is a dearth of products for this category of consumers. Thus, these consumers are underwritten as individuals or simply, they only have personal loans available to them.
Banks have failed to extend personal loans to this segment because of lack of data and high cost of loan origination & loan servicing vis-a-vis the small ticket size of the loan. Informal lending is a big channel of financing for these consumers. We estimate that outstanding informal consumer credit to be as big as the outstanding formal consumer credit at ~$300B. Despite contextual needs, families that belong to middle-income and low-income segments majorly rely on savings, friends, relatives and informal moneylenders to meet these expenditures. While micro-finance (Self Help Groups SHGs included) has made some strides to capture this segment, it has not addressed the Network problem and remains small at $15–20B in the overall scheme of things. I see micro-finance institutions (MFIs) also deploying credit to new products in future rather than creating Network leveraging products themselves.
Savings are key to Product Design
As I have studied many established companies and startups operating in the next 300M consumer segment, I have realised that savings are at the core of a successful winning product. A rural cooperative bank operating out of Ahmedabad offers a combination of savings and credit product to women in low-income families. The product starts with allowing users to open a recurring deposit with a monthly instalment. After a certain tenure, say 18 months, these women are extended a credit-line amounting to x% of the total money saved. Savings are playing an important role here in determining consumers` ability & intent to pay.
In another example, a healthcare financing startup offers savings-based plans to middle-income families for planned medical procedures such as pregnancies, cataract, and dental surgeries in private hospitals. The idea is to lock-in customers ahead of time in exchange for discounted prices. These families do not have enough disposable cash to pay at private hospitals in one single transaction and, as a result, are turned away by private hospitals. The plan also brings in ecosystem benefits by giving the customer medicine and diagnostics at a cheaper rate as well. It should be noted that savings are a major source of financing for healthcare treatments for more than 70% of Indians. Here savings are playing an important role by leveraging an existing consumer behaviour as opposed to encouraging consumer to move to products such as Insurance which they are not used to.
What is even more interesting is that the savings driven approach in the example above is indirectly building a Network — hospitals, chemists, and diagnostic labs. In short, multiple point of sales are plumbed together in a Network on top of which a credit product can work. Now, this startup can later bundle credit along with these plans, having already established consumers` ability and intent to pay; probably, insurance as well.
Talking about insurance, if we look closely, the most successful insurance product in India in terms of penetration and premium — Life Insurance by LIC — is sold as a savings product rather than an insurance product. LIC`s 400k+ agent network has played a key role in establishing LIC`s trust among families from generations. Indians see LIC as a safe place to park their hard-earned money.
Products offerings could be differentiated
Use cases are many. In my view, it is about building the right Network with a combination of a right product design to peel apart this consumer lending market, product by product. In the image below I have attempted to list some of the product categories that may fit this bill. Blue boxes are existing product categories and white ones are what could be possible.
Let’s consider pilgrimage travel as a consumer loan category that could be disrupted/created via Network creation and a savings-driven design.
Top 5 pilgrimages in India — Vaishno Devi Temple, Shirdi Sai Baba Temple, Tirupati Balaji Temple, Ajmer Sharif Dargah, and Jaganaath Puri Temple — alone attract 100M visitors a year. A bulk of these visitors are middle-income and low-income families. Today, savings, borrowings from friends and family, and informal lending, continue to be a major source of financing to meet these needs.
Imagine a loan product of Rs. 6999 or $100 designed to provide a a family of four a 2-day trip to one of the pilgrimage destinations. The credit is never given to this family as hard cash. It is extended directly to the Network stakeholders — partnered budget hotel chains and bus/train ticketing providers, for example, — as the family takes the trip. Travel agencies could act as a great distribution or loan-origination point in this Network if the customers are finding it difficult to transact online. One could also argue to use savings in this product as these trips are anyway planned ahead of time and customers are used to savings for this category. The quantum of savings as percentage of ticket value shall decrease as the repeat purchases increase.
Credit access does not improve on its own. It needs to be accompanied or driven by new product design that solves for the needs of the next 300M consumers.