The Underbelly of Digital Lending

Just as data can be used to democratise credit, these technologies are easily misused. Today [[digital lending]] companies prey on the poor by offering high interest loans to advertising targetted to popup when they are vulnerable. Regulating this will call for coordination between the telecom department (for anti-spam regulations) and MeITy to regulate (in-app advertising).

This article was first published in The Mint. You can read the original at this link.

Over the weekend, I read a news report about the growing menace of fly-by-night digital lending companies. I have been coming across quite a few articles like this over the past few months, and this was yet another variation on a familiar theme. But as much as my instinct was to move on, something about the report made me pause.

Democratising Credit

As regular readers of this column know, I am a proponent of using digital technologies to democratize credit. I wrote last year about the OCEN framework and how it will unbundle loan services into its atomic parts:

But perhaps more significantly, by atomising loan services in this fashion we will have created an army of micro-service providers and given each of them the opportunity to develop a whole new set of highly atomised skills. We can then string some or all of these different service providers together in countless different ways giving rise to dozens of new and innovative products and several more novel and efficient ways of getting things done.

I believe we have an opportunity to leverage the platform architectures we have built to allow those currently overlooked by the financial system a chance to gain access to it. We do have some challenges, as I discussed last week — particularly in relation to issues such as KYC and generally doing all we can to make the digital lending process more efficient — but all in all, the benefits of going down this path are undeniable.

Digital Lending Apps

That said, reports of ugly incidents in this space are a stark reminder of the fact that lending has always had a dark underbelly, and as we increasingly rely on online lending platforms to enable wider access to credit, we will only create more opportunities for that ugliness to manifest itself in newer and more pernicious ways. According to the news report, loans worth nearly ₹300 crore have already been disbursed through a multitude of digital lending apps. These loans, ranging in ticket size from ₹5,000 to ₹50,000, are aimed at users in need of short-term cash who lack the credit history needed to access the formal banking sector.

Digital lending applications use innovative algorithms and non-conventional sources of data to bridge this gap. They make credit inferences that the traditional banking sector simply cannot, and, on the basis of that, offer loans to individuals who would otherwise have had no option but to turn to unorganised sector moneylenders for help. But the real reason these solutions are important is not that they offer credit to those who need it, but because they offer those who the banking system does not even acknowledge a clear path by which to enter the country’s formal credit market.

Since most of these loans envisage bullet repayment within relatively short time cycles, annualised interest rates can be as high as 60-100%. For those who are able to repay loans on these terms, digital lending is an invaluable source of short-term finance. It is what they need to tide them over an unexpected bad spell, or provide the money needed expand their business.

However, not everyone can do what it takes to repay loans under these circumstances. For those unfortunates, the very same digital features that assessed them worthy of a loan will quickly be turned against them to pressure them into repayment. Stories abound of apps accessing the address books of defaulters to send messages to their contacts, naming them as delinquents and using social shaming to get them to comply. It is tactics like this that resulted in the suicide of two hapless souls in Telangana, and which eventually led to Indian authorities looking more closely at digital lending in general.

Frameworks for Regulating Digital Lending

Any country looking to rely on digital systems to widen access to formal credit must set up appropriate frameworks to address these challenges. However this is easier said than done. Most unethical digital lending companies fly under the radar of regulation, by operating such businesses without registering themselves as Non-Banking Financial Companies (NBFCs). Since they can leverage the national payment infrastructure and provide loans so small that they lie below the thresholds of transactions that are routinely monitored, their activities go unnoticed for the most part. It is only when a customer commits suicide or files a complaint, despite the attendant public shame this entails, that their activities are put to any scrutiny at all.

It is instructive to understand how these digital lending companies find suitable victims to target. While the vast majority of digital lending apps design their customer acquisition systems to focus on bulk SMS marketing campaigns, many of the more sophisticated ones deploy clever in-app marketing strategies to ensure that their advertisements appear when victims are at their most vulnerable—when they need to buy a ‘boost’ to make it past a level in a game they are playing or purchase a coveted digital asset. Since many online games are thinly-veiled gambling apps, these strategies are extremely effective when used to algorithmically aim loan ads at game-players who happen to be on a losing streak.

It is practices like this that need to be regulated. No one should be allowed to acquire customers when they are at their most vulnerable, and advertising engines that enable this sort of targeting should be curtailed. If we can prohibit the advertisement of alcohol and cigarettes on TV because young children might be exposed to it, should we not take a similar approach to digital loan offers considering that they also target those who are vulnerable when they are at their weakest?

To be effective, regulation will need the cooperation of different arms of the government. It will be up to the telecom department to use anti-spam regulations to prevent unethical SMS marketing of loan products, and the ministry of electronics and information technology to look into how best to regulate in-app ads for loans that are designed to take advantage of moments of weakness.

As important as regulation is, we should also think of appropriate solutions that can be integrated into our new digital lending ecosystem. Since we are building much of this from the ground up, it’s not too late to bake protections into its design. We should make the most of this opportunity.