Digital Credit for CMSME Financing and Financial Inclusion
‘Credit’ is a basic human right. Digital credit is nothing but the same as an emergency credit balance on a cell phone. Worldwide insta-credit is known as digital credit. Digital credit focused on the instant, automated and remote. Customer interactions and credit processes are handled remotely or automatically, including loan applications, approvals, repayments and collections. Bangladesh has come a long way in digitizing its financial sector amid the fast-moving world of Industry 4.0. With the inception of online banking, followed by mobile financial services (MFS), we stepped into a new era of finance powered by technology.
BACKGROUND
Access to financial services is considered one of the most effective tools among policymakers around the world to ensure inclusive and sustainable economic development. Bangladesh Bank has undertaken various initiatives, but about half of the adult population of the county are still unbanked. They have no or very limited access to basic products and services offered by formal financial institutions. While efforts to promote financial inclusion predominantly have been in the means of providing access to FI accounts and savings products, COVID-19 has underscored the access to credit for the unbanked population in times of economic turmoil. On the other hand, access to credit for the cottage, micro, small, and medium enterprises (CMSME) has been a priority in the government’s COVID-19 response since these enterprises have been the hardest hit by the economic shutdown. A large number of CMSMEs operate in the informal sector, representing a lion’s share of the country’s 13 million business entities with 35.5% of total employment and contributing 25% of the country’s GDP. Only 28% of them have access to finance. Hence, severe concern remains whether the vast number of informal enterprises will have access to the COVID-19 recovery loans distributed by the financial institutions. Digital credit has received growing attention in the COVID-19 context due to its potential to increase access to credit by transforming appraisal, approval, disbursement, and repayment of loans with the use of big data, sophisticated technologies, and innovative channels such as Mobile Financial Services (MFS). However, digital credit’s relevance and significance in Bangladesh’s socio-economic context go beyond COVID-1.
DEMAND FOR DIGITAL CREDIT
Historically, serving the CMSME with credit products have been difficult for the financial institutions due to heavy operational costs and the process involved. Furthermore, the regulator has introduced a 9% interest rate cap and a 6% deposit cap starting from April 2020 for all types of loans. Whereas licensed MFI’s effective, interest rate is about 23%- 28%. However, in the case of regulatory violations in micro financing, there may be a higher interest rate.
Although these regulatory directives provide praiseworthy support to the CMSME sector, the banking sector has felt mounting pressure on them. Credit Guarantee Scheme (CGS) has been initiated by Bangladesh Bank to support CMSME that fail to meet the collateral requirements of the banks or other FIs. The operational cost and risks of the CMSME compared to corporate loans is higher across the banking sector. Due to the unavailable of easy solutions, borrowers forced to resort illegal means to get credit. Various mobile apps e.g. Radidcash, Baki, Cashman, etc. not registered in any regulatory body, provide credit to anyone at a high rate of interest. Financial institutions are increasingly interested in digital credit, this could streamline their CMSME loan operations and lower the operational costs of loans significantly. Hence, financial institutions, such as banks, have started to see digital credit as the inevitable future.
Microfinance institutions (MFIs) are often criticized for the high-interest rates applied to the bottom of the pyramid population. Digital credit in the microfinance sector could transform loan operations from human-intensive to technology-intensive. As a result, MFIs can bring down the loan operation cost and lower the interest rates. Graduating from the microenterprise (ME) loans provided by the MFIs to bank loans is often challenging due to the lack of digital footprints of the cottage, micro and small enterprises. Once digital credit takes effect in this sector, the digital footprints of these enterprises could facilitate their graduation from ME loans to bank loans at much lower interest rates. Hence, digital credit in the microfinance sector could have positive spillover effects on the country’s banking sector.
CHALLENGES
CMSME’s are getting adequate financing from the banks. Borrowers are demand-side and Bank/ NBFI are on the supply-side. In this case, the banks are claiming that they are giving loans but the entrepreneurs are saying that they are not getting loans. There are several reasons for this miss-match. Such as lots of documentation, TIN certificate, proper accounting records, balance sheet, bank statements, etc. As a result, small entrepreneurs are not able to take loans from banks. Block situation in last two years of the pandemic, there was no alternate way to use a digital system, digital channels, even daily business sectors, banking sector, formal/informal sector all are depending on the digital channel. The safety and security of digital lending systems will monitor by law enforcement.
At all stages of loan operations- starting from customer on boarding and approval to disbursement and repayment of digital credit pose is a complex set of challenges. The major two problems are (i) assessing the loan because financial institutions lack the data, and (ii) the loan repayment collection cost. Lack of digital infrastructure for appraisal and approval of loan applications is a major bottleneck for digital credit deployment. Financial institutions often do not have real-time online access to documents necessary for credit appraisal and decisions. Verification of the bank statement, trade license, land and properties, etc. still requires repetitive physical visits. Furthermore, while banks and non-banking financial institutions can verify the National Identity Cards (NID) electronically, MFIs cannot. Considering the huge segment MFIs serve, a market of 40 million customers, this is a major setback.
SOLUTIONS
Digital credit operations require building an infrastructure that would facilitate the customer on boarding process digitally. Digital Identity, as well as e-KYC, will take, from an individual. Legal barriers and the absence of appropriate laws for dispute handling related to digital signature, digital consent, and digital documents impede digital on boarding significantly. Digital on boarding, with the use of e-KYC and other technologies, could simplify the loan application process further and facilitate the subsequent stages of loan operations.
Digital transformation of MFIs is also equally important to create digital data footprint of the customers that can open up new avenues for offering other financial services for the bottom of the pyramid population. Building a digital infrastructure that would enable financial institutions to verify all types of documents in real-time is a prerequisite for the diffusion of digital credit.
Extending the scope of NID cards can facilitate such digital transformation by connecting the data warehouse residing in servers across governmental institutions, financial and non-financial institutions, and regulators.
Mass acceptance of MFS across the country over the last few years has created a great avenue for the disbursement and repayment of loans. Existing limits on the transaction value and the costs associated with the transaction are bottlenecks for the repayment of loans through MFS. Moreover, transaction data of more than 800 million MFS wallets can be used as an important component for alternative credit scoring.
Telecom operators have many consumer data in their custody that can be utilized to understand consumers’ behavioral patterns. At the same time, digital lenders need to know which data they should be extracted. Nevertheless, Telecommunication Act and License Framework have strict rules to use consumers’ data for very limited purposes and those do not allow it to be used to assess creditworthiness. However, it can be examined if data can be shared with third parties upon informed consent of the customers or they can collect their data from the telecom provider and share it with other institutions for credit assessment.
Alternative credit scoring (ACS) speeds up loan processing and lowers the cost of evaluation of creditworthiness, bankers and micro-lenders. Its focus on eight major issues -Personal information authenticity; Identifying characteristics; financial well-being ability, Consumption ability, Psychometric and behavior preferences; Interconnectivity and social connection; Credit history; and Legal data can be inferred using some of the non-conventional data. Data do not move to the Scoring system, only results will be converted into a reference number. It is fully encrypted maintaining all the data privacy laws of the People’s Republic of Bangladesh.
CIB of Bangladesh Bank and CIB-MFIs enable the assessment of the creditworthiness of a large population. “Credit Rating Rule-1990” of BSEC needs amending in a few circumstances to allow credit rating of individuals along with large corporate entities.
WAY FORWARD
Different MFS, Fintech, Telco come forward to financial Business or support financial institutions doing business. They do not how they will get permission to do their business legally. So efforts should be made by the appropriate authorities to formulate the regulations for digital credit/small credit after judging the issues. The Banking Act, financial acts, and other acts for regulating microfinance digitally.
The Banking Act, financial acts, and other acts for regulating microfinance digitally. Therefore, MRA allowed accommodating in case of providing micro-finance to the unbanked people. If Fintech wants to get a license from MRA to become an MFI, then the organization can conduct operations. Fintech thinks that there are five things in the policy guidelines and these are paid-up capital, sources of funds, data protection, continual audit and tracking, and regulatory frameworks and supports. So efforts should be made by the appropriate authorities to formulate the regulations for digital credit/small credit after judging the issues.
IMPACT
In Bangladesh, people are often compelled to take loans from informal sources at high-interest rates and complex terms and conditions to meet emergency needs such as a medical crisis or financial loss caused by natural disasters or even engaging in small trade. In many cases, due to high costs and onerous terms and conditions, unbanked people find it difficult to repay those loans and are over-burdened with even higher debt. Therefore, right now many fin-tech companies are addressing these problems by introducing digital loan platforms with simple repayment terms and conditions. So efforts should be made by the appropriate authorities to formulate the regulations for digital credit/small credit after judging the issues. Whenever any service would approach the central bank, then the central bank will consider the application. Nevertheless, the central bank would not proactively ask a market player to apply as long as the market is not ready and he also thought that the service provider has not approached until now for account aggregation but there is a merchant for aggregating service and Payment System Department already allowed for account aggregation.
Written by Shaila Afrin Mousumi, CDFP (Deputy Director, Bangladesh Bank)
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