November 2020 State of Digital Lending Towards Msmes in India

Introduc�on S. 113 allows persons to self-iden�fy as unorganised sector workers. We further note that terms “informal sector worker” does not encompass all those in need of social protec�on. Dvara Research | Research Brief | November 2020 The PLFS found that about 9% of workers were unemployed. Further, India has an old age dependency ra�o of The Code on Social Security Bill, 2019 [“the Bill”], introduced in Parliament in December 2019, is the most • The Na�onal Commission for Enterprises in the Unorganised Sector (2007)4proposed two defini�ons for around 9.3%, which is likely to increase to 12.4% by 2026.6 Many others may not be in the workforce for recent a�empt to ra�onalise patchwork of social security legisla�on into a comprehensive Code. One of the unorganised sector workers. These are as follows: reasons of age, disability, or the need to provide unpaid care work at home. There is a need to include all these State of Digital Lending towards MSMEs in India key differences between the 2019 Bill and the versions in 2018 and 2017 is the chapter on unorganised sector o "The unorganised sector consists of all unincorporated private enterprises owned by individuals or classes of individuals within the protec�on of a formal social security net. We therefore propose that any social workers. Earlier versions of the Bill provided for equal social security benefits for all categories of workers. households engaged in the sale and production of goods and services operated on a proprietary or security floor be made universally applicable to all persons.7 1 Sarah Stanley , Future of Finance Initiative, Dvara Research However, the 2019 Bill treats informal sector workers as a separate category and provides that the partnership basis and with less than ten total workers". government will frame schemes for their welfare. o “Unorganised workers consist of those working in the unorganised enterprises or households, 2. Informal Sector Workers Under the Code For Social Security Bill, 2019 excluding regular workers with social security benefits, and the workers in the formal sector without any Summary: As we have noted in our comments to the Ministry of Labour in 2019,2there is a lack of clarity on who employment/ social security benefits provided by the employers". S. 109 of the Bill reads: informal sector workers are, meaning that there is a further lack of clarity on whom the interven�ons target. (1) The Central Government shall formulate and notify, from time to time, suitable welfare schemes This research brief examines the state of digital lending accessible to MSMEs in India. It builds Further, it is unclear why informal sector workers are treated as a separate class from organised sector Based on these defini�ons, the NCEUS found that about 86% of India’s workforce in 2004-05 would fall within for unorganised workers (including audio visual workers, beedi workers, non-coal workers) on matters relating on extensive secondary research, and semi-structured interviews with digital lenders workers, or why informal sector workers receive far less protec�on under the Statute. Under the Bill, welfare the unorganised sector. to— currently active in the lending space to (i) create a typology of digital lenders in India, (ii) for unorganised sector workers is to be provided by schemes designed by the Central or State governments, (i) life and disability cover; analyse the different types of loans that they offer to MSMEs, (iii) create a generic framework while formal sector workers have clear en�tlements to provident fund, gratuity, employees’ state insurance • The Periodic Labour Force Survey 2017-18 (PLFS) relies on the defini�ons by the 17th Interna�onal (ii) health and maternity benefits; for an end-to-end digital lending process, and (iv) examine the cost components involved in and maternity benefits. This is deeply problema�c, as informal sector workers comprise more than 75% of Conference of Labour Sta�s�cians for workers in the informal sector. The report lists some categories of (iii) old age protection; providing credit through digital lending. It also seeks to provide a preliminary assessment of the workforce.3There is an urgent need to evaluate the structure of social security available to unorganised informal workers, including: (iv) education; the relative strengths and challenges that digital lenders face in serving MSMEs in India. The workers. o own-account workers and employers who have their own informal sector enterprises; (v) housing; and analysis revealed that there is no substantial reduction in the interest rates offered by digital o contributing family workers, irrespective of whether they work in formal or informal sector (vi) any other benefit as may be determined by the Central Government. lenders, compared to traditional financial service providers, and that lenders adopt an In this policy brief, we discuss: enterprises; assisted tech model as opposed to a purely digital process. By outlining these and other o employees who have informal jobs … whether employed by formal sector enterprises, informal (2) The State Government shall formulate and notify, from time to time, suitable welfare schemes for insights about the current state of digital lending towards the MSME sector, the brief hopes i. The many defini�ons of informal sector workers, and whether social security should be universal sector enterprises, or as paid domestic workers by households; unorganised workers, including schemes relating to— to enable a deeper discussion on what role digital lending can play in improving suitable ii. Unorganised workers in the Code on Social Security Bill, 2019 o members of informal producers‟ cooperatives; and (i) provident fund; access to credit to small businesses in the country. iii. Design principles for social security interven�ons by the state and the private sector. o persons engaged in the own-account production of goods exclusively for own final use by their (ii) employment injury benefit; household, such as subsistence farming or do-it-yourself construction of own dwellings.5 (iii) housing; About Future of Finance Initiative: 1. Who is an Informal Sector Worker? (iv) educational schemes for children; The PLFS also considered only proprietorships and partnerships as informal sector enterprises. (v) skill upgradation of workers; The Future of Finance Initiative seeks to identify and address new challenges for policy and The following defini�ons in the Bill are of interest. (vi) funeral assistance; and regulation in India given the waves of digital innovation currently sweeping financial services. • The ILO Recommenda�on No. 202 defines the informal economy as covering “all economic activities by (vii) old age homes. Our work in this initiative studies the impacts of digitisation and technological innovation in • S. 2(35): "gig worker" means a person who performs work or participates in a work arrangement and earns workers and economic units that are – in law or in practice – not covered or insufficiently covered by formal Indian finance, leading from the consumer perspective on these issues. Our research agenda from such activities outside of traditional employer-employee relationship; arrangement.” The Recommendation also clarifies that “informal work may be found across all sectors of Unlike the 2018 Dra�, the present Bill does not treat unorganised and organised sector workers in exactly the is focussed on issues that impact particularly lower income individuals as a result of the economy, in both public and private spaces.” same way. Instead, while organised sector workers are covered under the chapters on provident fund, • S. 2(77): "unorganised sector" means an enterprise owned by individuals or self-employed workers and employees’ state insurance, gratuity, old age and maternity benefits, unorganised workers are only provided • the disintermediation of financial services, engaged in the production or sale of goods or providing service of any kind whatsoever, and where the We note that the Bill classifies informal sector enterprises by size of the establishment, rather than in terms for under Chapter VII. • the large scale investment in public infrastructure for digital finance and enterprise employs workers, the number of such workers is less than ten; of access to social security. This defini�on may leave out many workers from statutory social protec�on • the increased use of consumer data and analytics in finance. measures. According to the PLFS 2017-18, only 22.8% of Indian workers are in regular wage or salaried Chapter VII is based on the Unorganised Workers Social Security Act, 2008 (“UWSSA”). As with the UWSSA, the • S. 2 (82) "wage worker" means a person employed for remuneration in the unorganised sector, directly by employment. 52.2% are self-employed, while 24.9% are in casual labour. The PLFS notes that 68.4% of Bill does not provide for content of the rights referred to in S. 109. Rather, these are le� to the discre�on of the an employer or through any contractor, irrespective of place of work, whether exclusively for one employer workers employed outside of agriculture are employed in these informal sector enterprises. Further, 71% of execu�ve, which is to frame schemes. or for one or more employers, whether in cash or in kind, whether as a home-based worker, or as a regular wage employees have no wri�en job contract, while 49.6% of regular wage employees were not temporary or casual worker, or as a migrant worker, or workers employed by households including eligible for any form of social security. Restric�ng social protec�on measures only to those in informal sector This is problema�c – schemes do not provide for jus�ciable rights which ci�zens can enforce in court. Further, domestic workers, with a monthly wage of an amount as may be notified by the Central Government and enterprises, as defined in the Bill, would leave many workers out of coverage. Moreover, it is unclear why the they may be modified at any �me, at the discre�on of the government, and even to the detriment of the end State Government, as the case may be. Bill carves out gig workers and pla�orm workers as a separate category from informal sector workers. 1The author works with Dvara Research, Mumbai, India and can be reached at [email protected]. The author thanks Ms. Malavika Raghavan for her continued intellectual engagement and support. The study has also benefitted from discussions with Dr. Indradeep Ghosh, Ms. Malavika Raghavan and Ms. Beni Chugh. All errors and omissions remain those of the author.

beneficiary.8 Moreover, since schemes cannot be enforced in Court, their implementa�on depends on the refers expressly to “full and produc�ve employment and decent work for all.”16 availability of funds from the government. As reports have shown, the budget alloca�ons for schemes vary wildly from year to year,9meaning that the implementa�on of many important schemes is haphazard at best. To give effect to these obliga�ons, it is necessary for the state to put social security mechanisms in place. We refrain from making any specific recommenda�ons with respect to the content of the social security floor to Further, while the Bill provides for self-iden�fica�on as an unorganised sector worker in s. 113, it does not clarify be provided by the government. Further research is required to evaluate the needs of those outside formal what the implica�ons of such registra�on – or the failure to do so – might be. social security nets and how this should be delivered. However, we suggest the following design principles for a state-provided social security floor: Finally, the Bill does not envisage any role for the employer (except in the case of pla�orm workers in s. 114). This is problema�c, as it may mean that employers do not take responsibility for social security of their workers 1. Floor level social protec�ons should be made available to all persons and not only those in the workforce. by keeping them in casual work arrangements. We note that the Contract Labour (Regula�on and Aboli�on) Act, 2. The social security tools available to those in the formal sector may not be appropriate for all persons. 1970 only applies to establishments with more than 20 workers and does not apply where work is of an Instruments such as PF or Employees’ State Insurance require regular payment of contribu�ons from wages “intermi�ent” or “casual nature.” Where work is contracted out to contractors and sub-contractors, it could and a lack of liquidity. These may not be appropriate for those workers with seasonal occupa�ons or those become impossible to ascertain where the liability for workers’ welfare may lie. who earn much less than minimum wage.

In sum, we iden�fy three key concerns with the Bill in its present form: 3. Par�cular a�en�on must be paid to providing basic income security. The Code on Wages, 2019 provides that minimum wages are to be determined by skill and geographical region,17 not by consump�on requirements of individuals. As the PLFS highlights, many workers earn far less than the na�onal floor level 1. The Bill does not elaborate on the content of social security rights for the informal sector. Instead, it leaves minimum wage of Rs. 176.18There is, therefore, an urgent need to ensure that the social security floor this to the discre�on of the government. This in turn means that there is li�le certainty on what ci�zens may be provides enough income security for persons to meet their consump�on requirements. en�tled to. Moreover, the government schemes referred to do not confer any jus�ciable rights on ci�zens. 4. There is a need for both clarity and certainty in en�tlements due to persons. As set out above, this can be 2. This means that there is a stark difference in the types of rights formal sector workers receive and those provided by ensuring that social security floors are enshrined in statutes that set out basic en�tlements. Some ma�ers, such as the rupee amount of a transfer or the delivery architecture for a payment, may be available to informal sector workers. In this respect, the Bill is not an improvement over the Unorganised determined by subordinate legisla�on. However, the content of social security rights must be set out in Workers Social Security Act, 2008. statute.

3. There is a need to envisage a framework that assigns responsibility to different en��es – such as employers 5. Any social security policy must account for migra�on within India and the need for workers to be able to and contractors – in providing and delivering social security to workers. This is par�cularly relevant for those in access benefits in different states. We note that the Bill does not make any express reference to migrant workers, nor any reference to the Inter-State Migrant Workers Act, 1979. This must be remedied and clear the formal sector. guidelines framed for migrant workers’ access to benefits. 3. Designing Social Security Floors For India 6. There must be a simple and accessible grievance redressal mechanism available to persons. A. Social Security Provided by the Government 7. There may be a need to s�pulate mandatory contribu�ons by the employer and employee for social security. These contribu�ons must take the vola�le and seasonal nature of informal sector work into account As noted above, there is a need for social protec�ons to be made available universally, and not only to informal and allow for flexibility in payments. sector workers. A number of rights, including the right to health,10 shelter,11 and old-age pensions12 have been read into the right to life under Ar�cle 21 of the Cons�tu�on. Further, the Direc�ve Principles require the State to provide for the right to work,13 just and humane condi�ons of work14 and a living wage15.

The Code on Social Security Bill, 2019 [“the Bill”], introduced in Parliament in December 2019, is the most • The Na�onal Commission for Enterprises in the Unorganised Sector (2007)4proposed two defini�ons for 1. Introduction...... 1 recent a�empt to ra�onalise patchwork of social security legisla�on into a comprehensive Code. One of the unorganised sector workers. These are as follows: 1.1. Background...... 1 key differences between the 2019 Bill and the versions in 2018 and 2017 is the chapter on unorganised sector o "The unorganised sector consists of all unincorporated private enterprises owned by individuals or workers. Earlier versions of the Bill provided for equal social security benefits for all categories of workers. households engaged in the sale and production of goods and services operated on a proprietary or 1.2. Research Objectives ...... 2 partnership basis and with less than ten total workers". However, the 2019 Bill treats informal sector workers as a separate category and provides that the 1.3. Methodology...... 3 government will frame schemes for their welfare. o “Unorganised workers consist of those working in the unorganised enterprises or households, excluding regular workers with social security benefits, and the workers in the formal sector without any 2. Digital Lending Models in India...... 4 As we have noted in our comments to the Ministry of Labour in 2019,2there is a lack of clarity on who employment/ social security benefits provided by the employers". 2.1. Defining digital lending...... 4 informal sector workers are, meaning that there is a further lack of clarity on whom the interven�ons target. Further, it is unclear why informal sector workers are treated as a separate class from organised sector Based on these defini�ons, the NCEUS found that about 86% of India’s workforce in 2004-05 would fall within 2.2. Models of digital lenders identified through literature review...... 4 workers, or why informal sector workers receive far less protec�on under the Statute. Under the Bill, welfare the unorganised sector. for unorganised sector workers is to be provided by schemes designed by the Central or State governments, 2.3. Typology of providers serving MSMEs in India...... 6 • The Periodic Labour Force Survey 2017-18 (PLFS) relies on the defini�ons by the 17th Interna�onal while formal sector workers have clear en�tlements to provident fund, gratuity, employees’ state insurance 3. Digital Loans available to MSMEs...... 8 and maternity benefits. This is deeply problema�c, as informal sector workers comprise more than 75% of Conference of Labour Sta�s�cians for workers in the informal sector. The report lists some categories of the workforce.3There is an urgent need to evaluate the structure of social security available to unorganised informal workers, including: 3.1. Types of loans offered by digital lenders in India...... 9 workers. o own-account workers and employers who have their own informal sector enterprises; o contributing family workers, irrespective of whether they work in formal or informal sector 3.2. Insights on the various digital loans and their features...... 11 In this policy brief, we discuss: enterprises; 4. Digital Lending Process...... 11 o employees who have informal jobs … whether employed by formal sector enterprises, informal i. The many defini�ons of informal sector workers, and whether social security should be universal sector enterprises, or as paid domestic workers by households; 4.1. A description of the digital lending process in India...... 13 ii. Unorganised workers in the Code on Social Security Bill, 2019 o members of informal producers‟ cooperatives; and 4.2. Insights from various steps of the digital lending process...... 14 iii. Design principles for social security interven�ons by the state and the private sector. o persons engaged in the own-account production of goods exclusively for own final use by their household, such as subsistence farming or do-it-yourself construction of own dwellings.5 5. Cost of providing credit through digital lending...... 15 1. Who is an Informal Sector Worker? The PLFS also considered only proprietorships and partnerships as informal sector enterprises. 5.1. Insights on the cost of delivering credit through digital lending...... 15 The following defini�ons in the Bill are of interest. 6. Conclusion...... 17 • The ILO Recommenda�on No. 202 defines the informal economy as covering “all economic activities by References...... 19 • S. 2(35): "gig worker" means a person who performs work or participates in a work arrangement and earns workers and economic units that are – in law or in practice – not covered or insufficiently covered by formal from such activities outside of traditional employer-employee relationship; arrangement.” The Recommendation also clarifies that “informal work may be found across all sectors of the economy, in both public and private spaces.” • S. 2(77): "unorganised sector" means an enterprise owned by individuals or self-employed workers and engaged in the production or sale of goods or providing service of any kind whatsoever, and where the We note that the Bill classifies informal sector enterprises by size of the establishment, rather than in terms enterprise employs workers, the number of such workers is less than ten; of access to social security. This defini�on may leave out many workers from statutory social protec�on measures. According to the PLFS 2017-18, only 22.8% of Indian workers are in regular wage or salaried • S. 2 (82) "wage worker" means a person employed for remuneration in the unorganised sector, directly by employment. 52.2% are self-employed, while 24.9% are in casual labour. The PLFS notes that 68.4% of an employer or through any contractor, irrespective of place of work, whether exclusively for one employer workers employed outside of agriculture are employed in these informal sector enterprises. Further, 71% of or for one or more employers, whether in cash or in kind, whether as a home-based worker, or as a regular wage employees have no wri�en job contract, while 49.6% of regular wage employees were not temporary or casual worker, or as a migrant worker, or workers employed by households including eligible for any form of social security. Restric�ng social protec�on measures only to those in informal sector domestic workers, with a monthly wage of an amount as may be notified by the Central Government and enterprises, as defined in the Bill, would leave many workers out of coverage. Moreover, it is unclear why the State Government, as the case may be. Bill carves out gig workers and pla�orm workers as a separate category from informal sector workers.

beneficiary.8 Moreover, since schemes cannot be enforced in Court, their implementa�on depends on the refers expressly to “full and produc�ve employment and decent work for all.”16 availability of funds from the government. As reports have shown, the budget alloca�ons for schemes vary wildly from year to year,9meaning that the implementa�on of many important schemes is haphazard at best. To give effect to these obliga�ons, it is necessary for the state to put social security mechanisms in place. We refrain from making any specific recommenda�ons with respect to the content of the social security floor to Further, while the Bill provides for self-iden�fica�on as an unorganised sector worker in s. 113, it does not clarify be provided by the government. Further research is required to evaluate the needs of those outside formal what the implica�ons of such registra�on – or the failure to do so – might be. social security nets and how this should be delivered. However, we suggest the following design principles for a state-provided social security floor: Finally, the Bill does not envisage any role for the employer (except in the case of pla�orm workers in s. 114). This is problema�c, as it may mean that employers do not take responsibility for social security of their workers 1. Floor level social protec�ons should be made available to all persons and not only those in the workforce. by keeping them in casual work arrangements. We note that the Contract Labour (Regula�on and Aboli�on) Act, 2. The social security tools available to those in the formal sector may not be appropriate for all persons. 1970 only applies to establishments with more than 20 workers and does not apply where work is of an Instruments such as PF or Employees’ State Insurance require regular payment of contribu�ons from wages “intermi�ent” or “casual nature.” Where work is contracted out to contractors and sub-contractors, it could and a lack of liquidity. These may not be appropriate for those workers with seasonal occupa�ons or those become impossible to ascertain where the liability for workers’ welfare may lie. who earn much less than minimum wage.

Many interna�onal instruments also relate to the need to provide for social security and basic economic rights to ci�zens. The Interna�onal Labour Organisa�on’s Recommenda�on No. 202 on Basic Social Security Floors and Recommenda�on No. 204 on the Transi�on from the Informal to the Formal Economy both refer to the need to put systems in place to protect the needs of informal sector workers. Further, the UN Sustainable Goal No. 8 Introduc�on S. 113 allows persons to self-iden�fy as unorganised sector workers. We further note that terms “informal sector worker” does not encompass all those in need of social protec�on. The PLFS found that about 9% of workers were unemployed. Further, India has an old age dependency ra�o of The Code on Social Security Bill, 2019 [“the Bill”], introduced in Parliament in December 2019, is the most • The Na�onal Commission for Enterprises in the Unorganised Sector (2007)4proposed two defini�ons for around 9.3%, which is likely to increase to 12.4% by 2026.6 Many others may not be in the workforce for recent a�empt to ra�onalise patchwork of social security legisla�on into a comprehensive Code. One of the unorganised sector workers. These are as follows: reasons of age, disability, or the need to provide unpaid care work at home. There is a need to include all these key differences between the 2019 Bill and the versions in 2018 and 2017 is the chapter on unorganised sector o "The unorganised sector consists of all unincorporated private enterprises owned by individuals or classes of individuals within the protec�on of a formal social security net. We therefore propose that any social workers. Earlier versions of the Bill provided for equal social security benefits for all categories of workers. households engaged in the sale and production of goods and services operated on a proprietary or security floor be made universally applicable to all persons.7 However, the 2019 Bill treats informal sector workers as a separate category and provides that the partnership basis and with less than ten total workers". government will frame schemes for their welfare. o “Unorganised workers consist of those working in the unorganised enterprises or households, 2. Informal Sector Workers Under the Code For Social Security Bill, 2019 excluding regular workers with social security benefits, and the workers in the formal sector without any As we have noted in our comments to the Ministry of Labour in 2019,2there is a lack of clarity on who employment/ social security benefits provided by the employers". S. 109 of the Bill reads: informal sector workers are, meaning that there is a further lack of clarity on whom the interven�ons target. (1) The Central Government shall formulate and notify, from time to time, suitable welfare schemes Further, it is unclear why informal sector workers are treated as a separate class from organised sector Based on these defini�ons, the NCEUS found that about 86% of India’s workforce in 2004-05 would fall within for unorganised workers (including audio visual workers, beedi workers, non-coal workers) on matters relating workers, or why informal sector workers receive far less protec�on under the Statute. Under the Bill, welfare the unorganised sector. to— for unorganised sector workers is to be provided by schemes designed by the Central or State governments, (i) life and disability cover; while formal sector workers have clear en�tlements to provident fund, gratuity, employees’ state insurance • The Periodic Labour Force Survey 2017-18 (PLFS) relies on the defini�ons by the 17th Interna�onal (ii) health and maternity benefits; and maternity benefits. This is deeply problema�c, as informal sector workers comprise more than 75% of Conference of Labour Sta�s�cians for workers in the informal sector. The report lists some categories of (iii) old age protection; the workforce.3There is an urgent need to evaluate the structure of social security available to unorganised informal workers, including: (iv) education; workers. o own-account workers and employers who have their own informal sector enterprises; (v) housing; and o contributing family workers, irrespective of whether they work in formal or informal sector (vi) any other benefit as may be determined by the Central Government. In this policy brief, we discuss: enterprises; o employees who have informal jobs … whether employed by formal sector enterprises, informal (2) The State Government shall formulate and notify, from time to time, suitable welfare schemes for i. The many defini�ons of informal sector workers, and whether social security should be universal sector enterprises, or as paid domestic workers by households; unorganised workers, including schemes relating to— ii. Unorganised workers in the Code on Social Security Bill, 2019 o members of informal producers‟ cooperatives; and (i) provident fund; iii. Design principles for social security interven�ons by the state and the private sector. o persons engaged in the own-account production of goods exclusively for own final use by their (ii) employment injury benefit; household, such as subsistence farming or do-it-yourself construction of own dwellings.5 (iii) housing; 1. Who is an Informal Sector Worker? (iv) educational schemes for children; The PLFS also considered only proprietorships and partnerships as informal sector enterprises. (v) skill upgradation of workers; The following defini�ons in the Bill are of interest. (vi) funeral assistance; and • The ILO Recommenda�on No. 202 defines the informal economy as covering “all economic activities by (vii) old age homes. • S. 2(35): "gig worker" means a person who performs work or participates in a work arrangement and earns workers and economic units that are – in law or in practice – not covered or insufficiently covered by formal from such activities outside of traditional employer-employee relationship; arrangement.” The Recommendation also clarifies that “informal work may be found across all sectors of Unlike the 2018 Dra�, the present Bill does not treat unorganised and organised sector workers in exactly the the economy, in both public and private spaces.” same way. Instead, while organised sector workers are covered under the chapters on provident fund, • S. 2(77): "unorganised sector" means an enterprise owned by individuals or self-employed workers and employees’ state insurance, gratuity, old age and maternity benefits, unorganised workers are only provided engaged in the production or sale of goods or providing service of any kind whatsoever, and where the We note that the Bill classifies informal sector enterprises by size of the establishment, rather than in terms for under Chapter VII. enterprise employs workers, the number of such workers is less than ten; of access to social security. This defini�on may leave out many workers from statutory social protec�on measures. According to the PLFS 2017-18, only 22.8% of Indian workers are in regular wage or salaried Chapter VII is based on the Unorganised Workers Social Security Act, 2008 (“UWSSA”). As with the UWSSA, the • S. 2 (82) "wage worker" means a person employed for remuneration in the unorganised sector, directly by employment. 52.2% are self-employed, while 24.9% are in casual labour. The PLFS notes that 68.4% of Bill does not provide for content of the rights referred to in S. 109. Rather, these are le� to the discre�on of the an employer or through any contractor, irrespective of place of work, whether exclusively for one employer workers employed outside of agriculture are employed in these informal sector enterprises. Further, 71% of execu�ve, which is to frame schemes. or for one or more employers, whether in cash or in kind, whether as a home-based worker, or as a regular wage employees have no wri�en job contract, while 49.6% of regular wage employees were not temporary or casual worker, or as a migrant worker, or workers employed by households including eligible for any form of social security. Restric�ng social protec�on measures only to those in informal sector This is problema�c – schemes do not provide for jus�ciable rights which ci�zens can enforce in court. Further, domestic workers, with a monthly wage of an amount as may be notified by the Central Government and enterprises, as defined in the Bill, would leave many workers out of coverage. Moreover, it is unclear why the they may be modified at any �me, at the discre�on of the government, and even to the detriment of the end State Government, as the case may be. Bill carves out gig workers and pla�orm workers as a separate category from informal sector workers.

refers expressly to “full and produc�ve employment and decent work for all.”16 1. Introduction To give effect to these obliga�ons, it is necessary for the state to put social security mechanisms in place. We 1.1. Background refrain from making any specific recommenda�ons with respect to the content of the social security floor to be provided by the government. Further research is required to evaluate the needs of those outside formal social security nets and how this should be delivered. However, we suggest the following design principles for New technologies have been hailed as having the capacity to overcome the barriers that stand in the way of a state-provided social security floor: achieving financial inclusion (RBI, 2019b), for both individuals and enterprises. They can overcome the barriers of information asymmetry between providers and users of finance, and potentially even reduce the cost of 1. Floor level social protec�ons should be made available to all persons and not only those in the workforce. finance to the end user. In the past few years, fintechs2 and other new business models, that use innovative approaches and different sources of data to assess the creditworthiness of borrowers, have begun lending to 2. The social security tools available to those in the formal sector may not be appropriate for all persons. Instruments such as PF or Employees’ State Insurance require regular payment of contribu�ons from wages the Micro, Small, and Medium enterprises (MSME). Given the increasing push for digitisation, especially as a and a lack of liquidity. These may not be appropriate for those workers with seasonal occupa�ons or those means to achieve financial inclusion, there is a need to understand the effectiveness of digital lending in who earn much less than minimum wage. addressing the barriers that MSMEs face in accessing credit. 3. Par�cular a�en�on must be paid to providing basic income security. The Code on Wages, 2019 provides Lack of access to finance has been cited time and again as a major bottleneck in the growth of MSMEs that minimum wages are to be determined by skill and geographical region,17 not by consump�on requirements of individuals. As the PLFS highlights, many workers earn far less than the na�onal floor level (Kamath, 2015). Some of the most commonly cited challenges, both from the lenders’ and borrowers’ minimum wage of Rs. 176.18There is, therefore, an urgent need to ensure that the social security floor perspective, include (i) lack of formal data for credit assessment, especially with regard to informal MSMEs, (ii) provides enough income security for persons to meet their consump�on requirements. lack of bespoke products that suit lender appetite and the risk profiles of borrowers, (iii) long turn-around-time for receiving loans, (iv) requirement of collaterals/guarantees by traditional lenders, (v) high interest rates, and 4. There is a need for both clarity and certainty in en�tlements due to persons. As set out above, this can be (vi) complex application procedures (Balakrishnan & Srinivasan, 2019; Sinha, 2019). Impediments to credit provided by ensuring that social security floors are enshrined in statutes that set out basic en�tlements. access also seem to be a major contributor to the ‘missing middle’ phenomenon in India, where a majority of Some ma�ers, such as the rupee amount of a transfer or the delivery architecture for a payment, may be determined by subordinate legisla�on. However, the content of social security rights must be set out in firms tend to cluster in the micro-enterprise category and are not able to graduate to a small or medium statute. enterprise. In India, 90 firms out of every 100 are micro-enterprises and the remaining fall in the small and medium category. This is in contrast with the developed countries where the number of micro-enterprises falls 5. Any social security policy must account for migra�on within India and the need for workers to be able to in the range of 50-55 out of 100 enterprises (Sinha, 2019). Moreover, the credit gap2 for MSMEs has increased access benefits in different states. We note that the Bill does not make any express reference to migrant over the last five years, despite policy efforts to expand the reach of formal finance (Borpuzari, 2019). workers, nor any reference to the Inter-State Migrant Workers Act, 1979. This must be remedied and clear guidelines framed for migrant workers’ access to benefits.

Digital lenders appear to have several relative advantages over traditional banks in addressing these barriers. 6. There must be a simple and accessible grievance redressal mechanism available to persons. In the absence of historical financial data, they make use of differentiated credit underwriting models to assess the creditworthiness of a borrower. These underwriting models are based on alternative sources of data such 7. There may be a need to s�pulate mandatory contribu�ons by the employer and employee for social as seasonality of cash flows, and industry or cluster risks. Based on this assessment of creditworthiness they security. These contribu�ons must take the vola�le and seasonal nature of informal sector work into account also extend risk-based pricing, wherein different interest rates and loan terms are offered to different and allow for ﬂexibility in payments. consumers. Additionally, they offer solutions that are designed to suit a particular target segment, such as flexible collateral structures, and customised products tailored to working capital cycles (Balakrishnan & Srinivasan, 2019). Digital lenders are therefore able to cater to new-to-credit customers who were previously unbanked or had thin credit files, and bring them into the fold of formal finance (PwC, 2019).

Emerging research estimates that digital lending models are also capable of delivering a cost advantage of around 30-40% over traditional models (Omidyar & BCG, 2018). Advocates of digital lending argue that even when digital lenders face a higher cost of credit, the efficiency gains from the use of technology can reduce the cost of acquisition, operating expenditure and the cost of collections. This could allow them to operate on a low-cost, high-volume scale (Omidyar & BCG, 2018; Ramanathan, 2020).

2As per the Financial Stability Board (FSB) ‘FinTech’ is defined as “technology-enabled innovation in financial services that could result in new business models, applications, processes or products with an associated material effect on the provision of financial services”. Based on this definition, ‘fintech companies’ cannot be considered as a ‘new industry’ but rather it just forms a part of the financial industry, which questions the business model of the traditional players (incumbents) (C Schena, 2018). 3Credit gap arises when the total addressable demand for external credit is larger compared to the overall supply of finance from formal sources (IFC & Intellecap, 2018).

01 Introduc�on S. 113 allows persons to self-iden�fy as unorganised sector workers. We further note that terms “informal sector worker” does not encompass all those in need of social protec�on. The PLFS found that about 9% of workers were unemployed. Further, India has an old age dependency ra�o of The Code on Social Security Bill, 2019 [“the Bill”], introduced in Parliament in December 2019, is the most • The Na�onal Commission for Enterprises in the Unorganised Sector (2007)4proposed two defini�ons for around 9.3%, which is likely to increase to 12.4% by 2026.6 Many others may not be in the workforce for recent a�empt to ra�onalise patchwork of social security legisla�on into a comprehensive Code. One of the unorganised sector workers. These are as follows: reasons of age, disability, or the need to provide unpaid care work at home. There is a need to include all these key differences between the 2019 Bill and the versions in 2018 and 2017 is the chapter on unorganised sector o "The unorganised sector consists of all unincorporated private enterprises owned by individuals or classes of individuals within the protec�on of a formal social security net. We therefore propose that any social workers. Earlier versions of the Bill provided for equal social security benefits for all categories of workers. households engaged in the sale and production of goods and services operated on a proprietary or security floor be made universally applicable to all persons.7 However, the 2019 Bill treats informal sector workers as a separate category and provides that the partnership basis and with less than ten total workers". government will frame schemes for their welfare. o “Unorganised workers consist of those working in the unorganised enterprises or households, 2. Informal Sector Workers Under the Code For Social Security Bill, 2019 excluding regular workers with social security benefits, and the workers in the formal sector without any As we have noted in our comments to the Ministry of Labour in 2019,2there is a lack of clarity on who employment/ social security benefits provided by the employers". S. 109 of the Bill reads: informal sector workers are, meaning that there is a further lack of clarity on whom the interven�ons target. (1) The Central Government shall formulate and notify, from time to time, suitable welfare schemes Further, it is unclear why informal sector workers are treated as a separate class from organised sector Based on these defini�ons, the NCEUS found that about 86% of India’s workforce in 2004-05 would fall within for unorganised workers (including audio visual workers, beedi workers, non-coal workers) on matters relating workers, or why informal sector workers receive far less protec�on under the Statute. Under the Bill, welfare the unorganised sector. to— for unorganised sector workers is to be provided by schemes designed by the Central or State governments, (i) life and disability cover; while formal sector workers have clear en�tlements to provident fund, gratuity, employees’ state insurance • The Periodic Labour Force Survey 2017-18 (PLFS) relies on the defini�ons by the 17th Interna�onal (ii) health and maternity benefits; and maternity benefits. This is deeply problema�c, as informal sector workers comprise more than 75% of Conference of Labour Sta�s�cians for workers in the informal sector. The report lists some categories of (iii) old age protection; the workforce.3There is an urgent need to evaluate the structure of social security available to unorganised informal workers, including: (iv) education; workers. o own-account workers and employers who have their own informal sector enterprises; (v) housing; and o contributing family workers, irrespective of whether they work in formal or informal sector (vi) any other benefit as may be determined by the Central Government. In this policy brief, we discuss: enterprises; o employees who have informal jobs … whether employed by formal sector enterprises, informal (2) The State Government shall formulate and notify, from time to time, suitable welfare schemes for i. The many defini�ons of informal sector workers, and whether social security should be universal sector enterprises, or as paid domestic workers by households; unorganised workers, including schemes relating to— ii. Unorganised workers in the Code on Social Security Bill, 2019 o members of informal producers‟ cooperatives; and (i) provident fund; iii. Design principles for social security interven�ons by the state and the private sector. o persons engaged in the own-account production of goods exclusively for own final use by their (ii) employment injury benefit; household, such as subsistence farming or do-it-yourself construction of own dwellings.5 (iii) housing; 1. Who is an Informal Sector Worker? (iv) educational schemes for children; The PLFS also considered only proprietorships and partnerships as informal sector enterprises. (v) skill upgradation of workers; The following defini�ons in the Bill are of interest. (vi) funeral assistance; and • The ILO Recommenda�on No. 202 defines the informal economy as covering “all economic activities by (vii) old age homes. • S. 2(35): "gig worker" means a person who performs work or participates in a work arrangement and earns workers and economic units that are – in law or in practice – not covered or insufficiently covered by formal from such activities outside of traditional employer-employee relationship; arrangement.” The Recommendation also clarifies that “informal work may be found across all sectors of Unlike the 2018 Dra�, the present Bill does not treat unorganised and organised sector workers in exactly the the economy, in both public and private spaces.” same way. Instead, while organised sector workers are covered under the chapters on provident fund, • S. 2(77): "unorganised sector" means an enterprise owned by individuals or self-employed workers and employees’ state insurance, gratuity, old age and maternity benefits, unorganised workers are only provided engaged in the production or sale of goods or providing service of any kind whatsoever, and where the We note that the Bill classifies informal sector enterprises by size of the establishment, rather than in terms for under Chapter VII. enterprise employs workers, the number of such workers is less than ten; of access to social security. This defini�on may leave out many workers from statutory social protec�on measures. According to the PLFS 2017-18, only 22.8% of Indian workers are in regular wage or salaried Chapter VII is based on the Unorganised Workers Social Security Act, 2008 (“UWSSA”). As with the UWSSA, the • S. 2 (82) "wage worker" means a person employed for remuneration in the unorganised sector, directly by employment. 52.2% are self-employed, while 24.9% are in casual labour. The PLFS notes that 68.4% of Bill does not provide for content of the rights referred to in S. 109. Rather, these are le� to the discre�on of the an employer or through any contractor, irrespective of place of work, whether exclusively for one employer workers employed outside of agriculture are employed in these informal sector enterprises. Further, 71% of execu�ve, which is to frame schemes. or for one or more employers, whether in cash or in kind, whether as a home-based worker, or as a regular wage employees have no wri�en job contract, while 49.6% of regular wage employees were not temporary or casual worker, or as a migrant worker, or workers employed by households including eligible for any form of social security. Restric�ng social protec�on measures only to those in informal sector This is problema�c – schemes do not provide for jus�ciable rights which ci�zens can enforce in court. Further, domestic workers, with a monthly wage of an amount as may be notified by the Central Government and enterprises, as defined in the Bill, would leave many workers out of coverage. Moreover, it is unclear why the they may be modified at any �me, at the discre�on of the government, and even to the detriment of the end State Government, as the case may be. Bill carves out gig workers and pla�orm workers as a separate category from informal sector workers.

beneficiary.8 Moreover, since schemes cannot be enforced in Court, their implementa�on depends on the availability of funds from the government. As reports have shown, the budget alloca�ons for schemes vary With MSME digital lending estimated to reach INR 6-7 lakh crore in annual disbursements by the year 2023, wildly from year to year,9meaning that the implementa�on of many important schemes is haphazard at best. there is the possibility of a shift in the market structure of provision of credit to MSMEs (Omidyar & BCG, Further, while the Bill provides for self-iden�fica�on as an unorganised sector worker in s. 113, it does not clarify 2018). In India, the Sen Committee Report had recommended the need to identify and develop a deeper what the implica�ons of such registra�on – or the failure to do so – might be. awareness of the various fintech products and its interplay with the financial sector, and the regulatory approaches of various financial sector regulators before devising the appropriate regulatory approach Finally, the Bill does not envisage any role for the employer (except in the case of pla�orm workers in s. 114). (Reserve Bank of India, 2018). International institutions such as the Financial Stability Board (FSB) and the US This is problema�c, as it may mean that employers do not take responsibility for social security of their workers Department of Treasury have also highlighted the need to monitor developments in the fintech credit market by keeping them in casual work arrangements. We note that the Contract Labour (Regula�on and Aboli�on) Act, so as to incorporate them into financial stability assessment frameworks (Claessens, Frost, Turner, & Zhu, 1970 only applies to establishments with more than 20 workers and does not apply where work is of an 2018). “intermi�ent” or “casual nature.” Where work is contracted out to contractors and sub-contractors, it could become impossible to ascertain where the liability for workers’ welfare may lie. However, despite their perceived advantages and potential for financial inclusion, there are limited studies assessing the basic characteristics of digital lending markets such as provider models, the channels through In sum, we iden�fy three key concerns with the Bill in its present form: which these markets operate, the instruments used etc. A nuanced understanding of the industry is essential to assess the wider questions relevant to policymaking such as the effect that digital lending has on serving 1. The Bill does not elaborate on the content of social security rights for the informal sector. Instead, it leaves new-to-credit customers, distant geographies, the challenges that it faces and so on. this to the discre�on of the government. This in turn means that there is li�le certainty on what ci�zens may be en�tled to. Moreover, the government schemes referred to do not confer any jus�ciable rights on ci�zens. In this context, our research attempts to bridge this important knowledge gap in the literature by systematically examining the current state of digital lending towards the MSME sector in India. We hope that 2. This means that there is a stark difference in the types of rights formal sector workers receive and those this research brief will enable a deeper discussion on what role digital lending can play in improving suitable available to informal sector workers. In this respect, the Bill is not an improvement over the Unorganised access to credit to small businesses in the country. Accordingly, we present insights on the spectrum of digital Workers Social Security Act, 2008. lenders that serve MSMEs in India, the different credit solutions they offer, the steps involved in the end-to- end process of digital lending, and the costs that digital lenders incur in offering credit. 3. There is a need to envisage a framework that assigns responsibility to different en��es – such as employers and contractors – in providing and delivering social security to workers. This is par�cularly relevant for those in The research brief is organised into 6 sections. The first section lays out the context of the study, the research the formal sector. objectives, and methodology. The second section summarises some of the prominent frameworks set out in the literature that classify digital lenders, and proposes a typology of digital lenders serving MSMEs in India. The third section enumerates the various types of digital loans being offered in the market, as well as a 3. Designing Social Security Floors For India comparison of their features. Next, a framework of a generic digital lending process is introduced, with a view A. Social Security Provided by the Government to understanding the extent of digitisation present in the process. The fifth section identifies the various cost components that a lender accounts for in the course of provision of credit. Section six concludes the work and As noted above, there is a need for social protec�ons to be made available universally, and not only to informal highlights areas for future research. sector workers. A number of rights, including the right to health,10 shelter,11 and old-age pensions12 have been read into the right to life under Ar�cle 21 of the Cons�tu�on. Further, the Direc�ve Principles require the State to provide for the right to work,13 just and humane condi�ons of work14 and a living wage15. 1.2. Research Objectives

Many interna�onal instruments also relate to the need to provide for social security and basic economic rights The rise of technology-enabled innovations in financial services is an important and comparatively unfamiliar to ci�zens. The Interna�onal Labour Organisa�on’s Recommenda�on No. 202 on Basic Social Security Floors and phenomenon that encompasses a variety of changes including the role of information technology, customer Recommenda�on No. 204 on the Transi�on from the Informal to the Formal Economy both refer to the need to put systems in place to protect the needs of informal sector workers. Further, the UN Sustainable Goal No. 8 behaviour, ecosystems, as well as regulations in the financial services industry (Puschmann, 2017). While the innovations in fintech have spanned the spectrum of financial services, this research brief focuses on the current landscape of digital lending towards the MSME sector in India. It attempts to organize this landscape along the lines of Puschmann (2017), who has stated that the primary fintech innovation objects are business models, products and services, organisations, processes, and systems (Puschmann, 2017). Accordingly, we analyse the:

i. Typology of digital lenders: serving the MSME sector in India to provide an understanding of the basic architecture of the firms operating in this space.

02 Introduc�on S. 113 allows persons to self-iden�fy as unorganised sector workers. We further note that terms “informal sector worker” does not encompass all those in need of social protec�on. The PLFS found that about 9% of workers were unemployed. Further, India has an old age dependency ra�o of The Code on Social Security Bill, 2019 [“the Bill”], introduced in Parliament in December 2019, is the most • The Na�onal Commission for Enterprises in the Unorganised Sector (2007)4proposed two defini�ons for around 9.3%, which is likely to increase to 12.4% by 2026.6 Many others may not be in the workforce for recent a�empt to ra�onalise patchwork of social security legisla�on into a comprehensive Code. One of the unorganised sector workers. These are as follows: reasons of age, disability, or the need to provide unpaid care work at home. There is a need to include all these key differences between the 2019 Bill and the versions in 2018 and 2017 is the chapter on unorganised sector o "The unorganised sector consists of all unincorporated private enterprises owned by individuals or classes of individuals within the protec�on of a formal social security net. We therefore propose that any social workers. Earlier versions of the Bill provided for equal social security benefits for all categories of workers. households engaged in the sale and production of goods and services operated on a proprietary or security floor be made universally applicable to all persons.7 However, the 2019 Bill treats informal sector workers as a separate category and provides that the partnership basis and with less than ten total workers". government will frame schemes for their welfare. o “Unorganised workers consist of those working in the unorganised enterprises or households, 2. Informal Sector Workers Under the Code For Social Security Bill, 2019 excluding regular workers with social security benefits, and the workers in the formal sector without any As we have noted in our comments to the Ministry of Labour in 2019,2there is a lack of clarity on who employment/ social security benefits provided by the employers". S. 109 of the Bill reads: informal sector workers are, meaning that there is a further lack of clarity on whom the interven�ons target. (1) The Central Government shall formulate and notify, from time to time, suitable welfare schemes Further, it is unclear why informal sector workers are treated as a separate class from organised sector Based on these defini�ons, the NCEUS found that about 86% of India’s workforce in 2004-05 would fall within for unorganised workers (including audio visual workers, beedi workers, non-coal workers) on matters relating workers, or why informal sector workers receive far less protec�on under the Statute. Under the Bill, welfare the unorganised sector. to— for unorganised sector workers is to be provided by schemes designed by the Central or State governments, (i) life and disability cover; while formal sector workers have clear en�tlements to provident fund, gratuity, employees’ state insurance • The Periodic Labour Force Survey 2017-18 (PLFS) relies on the defini�ons by the 17th Interna�onal (ii) health and maternity benefits; and maternity benefits. This is deeply problema�c, as informal sector workers comprise more than 75% of Conference of Labour Sta�s�cians for workers in the informal sector. The report lists some categories of (iii) old age protection; the workforce.3There is an urgent need to evaluate the structure of social security available to unorganised informal workers, including: (iv) education; workers. o own-account workers and employers who have their own informal sector enterprises; (v) housing; and o contributing family workers, irrespective of whether they work in formal or informal sector (vi) any other benefit as may be determined by the Central Government. In this policy brief, we discuss: enterprises; o employees who have informal jobs … whether employed by formal sector enterprises, informal (2) The State Government shall formulate and notify, from time to time, suitable welfare schemes for i. The many defini�ons of informal sector workers, and whether social security should be universal sector enterprises, or as paid domestic workers by households; unorganised workers, including schemes relating to— ii. Unorganised workers in the Code on Social Security Bill, 2019 o members of informal producers‟ cooperatives; and (i) provident fund; iii. Design principles for social security interven�ons by the state and the private sector. o persons engaged in the own-account production of goods exclusively for own final use by their (ii) employment injury benefit; household, such as subsistence farming or do-it-yourself construction of own dwellings.5 (iii) housing; 1. Who is an Informal Sector Worker? (iv) educational schemes for children; The PLFS also considered only proprietorships and partnerships as informal sector enterprises. (v) skill upgradation of workers; The following defini�ons in the Bill are of interest. (vi) funeral assistance; and • The ILO Recommenda�on No. 202 defines the informal economy as covering “all economic activities by (vii) old age homes. • S. 2(35): "gig worker" means a person who performs work or participates in a work arrangement and earns workers and economic units that are – in law or in practice – not covered or insufficiently covered by formal from such activities outside of traditional employer-employee relationship; arrangement.” The Recommendation also clarifies that “informal work may be found across all sectors of Unlike the 2018 Dra�, the present Bill does not treat unorganised and organised sector workers in exactly the the economy, in both public and private spaces.” same way. Instead, while organised sector workers are covered under the chapters on provident fund, • S. 2(77): "unorganised sector" means an enterprise owned by individuals or self-employed workers and employees’ state insurance, gratuity, old age and maternity benefits, unorganised workers are only provided engaged in the production or sale of goods or providing service of any kind whatsoever, and where the We note that the Bill classifies informal sector enterprises by size of the establishment, rather than in terms for under Chapter VII. enterprise employs workers, the number of such workers is less than ten; of access to social security. This defini�on may leave out many workers from statutory social protec�on measures. According to the PLFS 2017-18, only 22.8% of Indian workers are in regular wage or salaried Chapter VII is based on the Unorganised Workers Social Security Act, 2008 (“UWSSA”). As with the UWSSA, the • S. 2 (82) "wage worker" means a person employed for remuneration in the unorganised sector, directly by employment. 52.2% are self-employed, while 24.9% are in casual labour. The PLFS notes that 68.4% of Bill does not provide for content of the rights referred to in S. 109. Rather, these are le� to the discre�on of the an employer or through any contractor, irrespective of place of work, whether exclusively for one employer workers employed outside of agriculture are employed in these informal sector enterprises. Further, 71% of execu�ve, which is to frame schemes. or for one or more employers, whether in cash or in kind, whether as a home-based worker, or as a regular wage employees have no wri�en job contract, while 49.6% of regular wage employees were not temporary or casual worker, or as a migrant worker, or workers employed by households including eligible for any form of social security. Restric�ng social protec�on measures only to those in informal sector This is problema�c – schemes do not provide for jus�ciable rights which ci�zens can enforce in court. Further, domestic workers, with a monthly wage of an amount as may be notified by the Central Government and enterprises, as defined in the Bill, would leave many workers out of coverage. Moreover, it is unclear why the they may be modified at any �me, at the discre�on of the government, and even to the detriment of the end State Government, as the case may be. Bill carves out gig workers and pla�orm workers as a separate category from informal sector workers.

beneficiary.8 Moreover, since schemes cannot be enforced in Court, their implementa�on depends on the refers expressly to “full and produc�ve employment and decent work for all.”16 ii. Types of digital loans and their features: to provide insights into the value that digital lenders offer to availability of funds from the government. As reports have shown, the budget alloca�ons for schemes vary the MSME segment through its various products. wildly from year to year,9meaning that the implementa�on of many important schemes is haphazard at best. To give effect to these obliga�ons, it is necessary for the state to put social security mechanisms in place. We refrain from making any specific recommenda�ons with respect to the content of the social security floor to Further, while the Bill provides for self-iden�fica�on as an unorganised sector worker in s. 113, it does not clarify iii. End-to-end digital lending process: to grasp the extent of digitisation that is present in the digital lending be provided by the government. Further research is required to evaluate the needs of those outside formal process. what the implica�ons of such registra�on – or the failure to do so – might be. social security nets and how this should be delivered. However, we suggest the following design principles for a state-provided social security floor: iv. Cost of providing credit through digital lending: to identify the areas in which digital lenders have a cost Finally, the Bill does not envisage any role for the employer (except in the case of pla�orm workers in s. 114). advantage. This is problema�c, as it may mean that employers do not take responsibility for social security of their workers 1. Floor level social protec�ons should be made available to all persons and not only those in the workforce. by keeping them in casual work arrangements. We note that the Contract Labour (Regula�on and Aboli�on) Act, 2. The social security tools available to those in the formal sector may not be appropriate for all persons. 1970 only applies to establishments with more than 20 workers and does not apply where work is of an Instruments such as PF or Employees’ State Insurance require regular payment of contribu�ons from wages 1.3. Methodology “intermi�ent” or “casual nature.” Where work is contracted out to contractors and sub-contractors, it could and a lack of liquidity. These may not be appropriate for those workers with seasonal occupa�ons or those become impossible to ascertain where the liability for workers’ welfare may lie. who earn much less than minimum wage. The study was conducted over three phases: In sum, we iden�fy three key concerns with the Bill in its present form: 3. Par�cular a�en�on must be paid to providing basic income security. The Code on Wages, 2019 provides that minimum wages are to be determined by skill and geographical region,17 not by consump�on Literature review: A comprehensive literature review and synthesis of well-known studies, databases and requirements of individuals. As the PLFS highlights, many workers earn far less than the na�onal floor level academic research papers was undertaken. Publicly available data from the SIDBI MSME Pulse Reports, the 1. The Bill does not elaborate on the content of social security rights for the informal sector. Instead, it leaves minimum wage of Rs. 176.18There is, therefore, an urgent need to ensure that the social security floor Ministry of MSME Annual Reports, and Tracxn were analysed to arrive at a basic understanding of the this to the discre�on of the government. This in turn means that there is li�le certainty on what ci�zens may be provides enough income security for persons to meet their consump�on requirements. landscape of digital lenders serving MSMEs in India. This was supplemented by a review of research reports en�tled to. Moreover, the government schemes referred to do not confer any jus�ciable rights on ci�zens. 4. There is a need for both clarity and certainty in en�tlements due to persons. As set out above, this can be from the International Finance Corporation (IFC), the Bank for International Settlements (BIS), Accion International, the Omidyar Network, the Boston Consulting Group (BCG), PwC and Deloitte. Non-academic 2. This means that there is a stark difference in the types of rights formal sector workers receive and those provided by ensuring that social security floors are enshrined in statutes that set out basic en�tlements. Some ma�ers, such as the rupee amount of a transfer or the delivery architecture for a payment, may be publications, including reports from management consultancies, are included in the literature review, as available to informal sector workers. In this respect, the Bill is not an improvement over the Unorganised determined by subordinate legisla�on. However, the content of social security rights must be set out in academic literature on the subject matter is limited. Workers Social Security Act, 2008. statute. To analyse the types of digital lenders serving the MSME segment, we reviewed literature focusing on: (i) the 3. There is a need to envisage a framework that assigns responsibility to different en��es – such as employers 5. Any social security policy must account for migra�on within India and the need for workers to be able to types of digital lenders prevalent globally; and (ii) the types of digital lenders prevalent in India. This was useful and contractors – in providing and delivering social security to workers. This is par�cularly relevant for those in access benefits in different states. We note that the Bill does not make any express reference to migrant workers, nor any reference to the Inter-State Migrant Workers Act, 1979. This must be remedied and clear to understand the different types of lenders that have been previously identified, the business models that the formal sector. guidelines framed for migrant workers’ access to benefits. they adopt, and the criteria they use to lend. The literature review also contributed to identifying the cost components faced by a lender in the provision of credit. 3. Designing Social Security Floors For India 6. There must be a simple and accessible grievance redressal mechanism available to persons. A. Social Security Provided by the Government 7. There may be a need to s�pulate mandatory contribu�ons by the employer and employee for social Market scoping: Guided by the literature review, the second phase of the study identified the different digital security. These contribu�ons must take the vola�le and seasonal nature of informal sector work into account lending business models active in the Indian market. We undertook a market scoping and research exercise As noted above, there is a need for social protec�ons to be made available universally, and not only to informal and allow for flexibility in payments. and were able to identify over 60 digital lenders that are active in the MSME lending space. Further research sector workers. A number of rights, including the right to health,10 shelter,11 and old-age pensions12 have been was undertaken to identify the various types of loans these lenders offer their customers. This was read into the right to life under Ar�cle 21 of the Cons�tu�on. Further, the Direc�ve Principles require the State supplemented with information from publicly available reports and other secondary sources (such as the to provide for the right to work,13 just and humane condi�ons of work14 and a living wage15. official websites of digital lenders). Additionally, based on the literature review and the market scoping Many interna�onal instruments also relate to the need to provide for social security and basic economic rights exercise, a schematic was also created to map a typical end-to-end digital lending process. to ci�zens. The Interna�onal Labour Organisa�on’s Recommenda�on No. 202 on Basic Social Security Floors and Recommenda�on No. 204 on the Transi�on from the Informal to the Formal Economy both refer to the need to Interviews with practitioners: In the third phase, the study undertook stakeholder consultations with digital put systems in place to protect the needs of informal sector workers. Further, the UN Sustainable Goal No. 8 lenders currently active in the MSME lending space. Semi-structured interviews of the Founder/Chief Executive Officer (CEO)/Chief Data Officer of 7 digital lenders were utilised to validate and clarify our understanding of the digital lending process, the extent of digitisation present in the lending process, and the associated costs faced by lenders. Based on the typology identified in Section 2.3 of the study, the lenders interviewed include 5 independent platforms or balance sheet lenders, a hybrid lender, and a lender functioning on a partnership model. All interviews were conducted under conditions of strict confidentiality, and as such, the brief does not make any direct attributions to them.

Households where the head of household is involved in blue collar employment, which includes wage laborers and industrial workers, have the lowest mean household income across all occupations. The pattern obtained, when we analyze participation in assets for blue collar employees, reveals that they have the lowest level of participation in almost all financial assets. This pattern appears again, when we analyze participation across income quintiles and find that households in the lowest income quintile exhibit very low levels of participation in nearly all financial assets. An exactly converse relation emerges when we consider white collar employees (which include managers, technical employees, and other white-collar employees directly mentioned in the data set) whose households have high mean income, exhibit a high level of participation across all assets (Figure 4). 2. Digital Lending Models in India

2.1. Defining digital lending

The digital lending ecosystem has myriad levels of complexity and is in a constant state of evolution. Digital lending models across the globe are conditioned by distinct market structures, regulatory environments of the country that they operate in, as well as the needs of the consumer that they cater to (Accion, 2018).

For the purpose of this study, ‘digital lending’ is the process of offering loans that are applied for, disbursed, and managed through digital channels. In this process, lenders use digitised data to make credit decisions and build intelligent customer engagement (Accion, 2018).

This definition captures three components of digital lending which are use of digital channels, use of digitised data, and a focus on digital customer experience and engagement (Accion, 2018). The study is concerned with fintech players that operate in the digital lending space and offer ‘digital credit’. Digital credit would encompass all credit facilitated by online lending platforms that are not operated by commercial banks (Bertsch & Rosenvinge, 2019).

2.2. Models of digital lenders identified through literature review

In what follows, we summarise some of the prominent typologies of digital lenders identified in the literature.

The G20 Global Partnership for Financial Inclusion (2017) showed that general institutional models were increasingly making use of alternative digital data in order to arrive at lending decisions. Based on this criterion, it is possible to divide digital lenders into the following broad categories. a. Marketplace lenders, which are non-bank digital lenders that originate loans by making use of intermediary platforms. The platforms digitally access and make use of alternative data to substitute for conventional data or to enhance it. b. Tech, e-commerce, and payment giants, are companies that leverage the myriad alternative data points available, through their platforms or through other partnerships, to offer loans and other financial services. These companies usually start off as online marketplaces, search engine providers, e-commerce, social networks and such. c. Supply chain platforms provide financing for transactions that occur between buyers and sellers trading and collaborating along the supply chain. Supply chain financing platforms differ widely, offering finance based on invoices or receivables, payables, inventory etc., and also based on the source of funds. d. Mobile-data based lending models provide loans of small amounts based on credit scores derived from mobile calling patterns, mobile transactions, e-money usage and savings, in addition to credit history. e. Digital bank models include incumbents that are directly involved in developing their own alternative lending systems, by either opening up their APIs to third-party service providers or by partnering with alternative lenders.

04 Digital lenders were also classified into distinct archetypes based on the source of their funds, by the IFC (2018), as follows: a. Marketplace lenders, those who acted as intermediaries connecting borrowers to institutional or even retail credit suppliers; b. Balance sheet lenders, those who took on the risk of lending themselves, often as NBFCs, and c. Marketplace hybrid lenders, entities that offered loans both directly from their own balance sheets in addition to offering marketplace funding options (IFC & Intellecap, 2018).

The Americas Alternative Finance Benchmarking Report (2016) reported a slightly different working taxonomy of lending models. The models were distinguished on the basis of the source of financing, the use of proceeds provided by the financing and the instrument used to provide the financing. This taxonomy of online alternative finance models included marketplace models, balance sheet lending and crowdfunding. According to the report, crowdfunding comprised all non-debt forms of financing that could be further divided into sub-segments of equity-based, rewards-based and donation-based crowdfunding (Wardrop et al., 2016).

BCG (2018) proposed that digital lending models were seeing growth because of their use of innovative operating models, and therefore placed digital lenders into a broad (non-exhaustive) set of categories as follows: a. Independent platforms, which are usually fintech start-ups that lend to customers without partnering with an incumbent bank. These platforms raise debt and equity funds through institutions, with the customers approaching them through an online channel. b. Aggregator/partnership models are those in which the fintech partners with banks in order to provide loans to customers. Scalable acquisition channels and proven underwriting models were indicated to be the value propositions provided by such platforms. c. Peer-to-peer platforms are not defined in the study, but as per the RBI Master Directions, they are “an intermediary providing the services of loan facilitation via online medium or otherwise, to the participants” (RBI, 2017b). d. Value+ service models are built around existing large businesses that offer a core service, with the financing options provided as a ‘value add’ service (BCG, 2018).

The Cambridge Centre for Alternative Finance (CCAF) and MicroSave (2018) classified fintechs operating in the lending space into the following categories: a. P2P Consumer and P2P Business are forms of digital lending where unrelated individuals or institutional investors provide loans, either secured or unsecured, to customers. A financial institution is indicated to be involved only when money had to be transferred to the borrower. b. In Balance Sheet Consumer and Balance Sheet Business models the lender assumes the credit risk of the loan on its own balance sheet, whose liabilities side is built up from the equity, debt, and retail deposits from investors.

05 c. Asset-backed financing is a form of digital lending in which physical and psychological collaterals4 form the basis for the loans and advances made to individuals and businesses. d. The Real estate model includes digital lending platforms that cater to construction and real estate owners and lenders (CCAF & MicroSave, 2018).

The prominent frameworks summarised above are broadly based on factors such as:

i. the source of financing for digital lenders, where the lender either partners with an incumbent or receives funding from various institutional or retail credit suppliers

ii. loans based on alternative data, which the digital lender has access to either on its own or through partnerships, and

iii. innovative operating models.

We apply the above frameworks to the multitude of digital lenders5 operating in the MSME segment in India, and thereby create our own typology of digital lenders serving the MSME sector in India.

2.3. Typology of providers serving MSMEs in India

Research indicates that there are an estimated 2000 fintech start-ups in the country, with over 300 being digital lenders (Goyal, 2020). The source of financing was the dominant basis for analysing the models of digital lenders, as identified through literature. Using this lens, we have identified 4 types of models existing in India, which have been set out in Figure 1 with some prominent examples. Figure 1: A Typology of Digital Lending Models

Source: Examples identified by author, and from BCG (2018)

4The concept of “psychological collateral” emerged from the Entrepreneurial Finance Lab’s (EFL) psychometric credit-scoring tool, which focuses on the psychological profile of a borrower – their attitudes and beliefs, performance, and integrity (Leslie, 2016). 5Extensive desk research of around 60 digital lenders operating in the MSME segment was done. The digital lenders were identified from public resources of organisations such as the Digital Lenders Association of India (DLAI) and Tracxn, as well as from media articles and reports.

06 A. Independent Platforms or Balance sheet Lenders: These types of digital lenders raise funds from various sources (private equity firms, institutional investors, and family offices etc.) to make loans on their own balance sheet.

- Intellegrow is a Non-Banking Finance Company (NBFC) that provides customised debt finance to small and growing businesses. It has Aavishkaar, the Shell Foundation, Developing World Markets, Omidyar Network and others (Intellegrow, n.d.) as its investors.

- U GRO, a BSE-listed NBFC, is a technology-focused small business lending platform. It is indicated to have raised ~INR 950 crore of capital from a diversified set of private equity funds, institutional investors, and well-known family offices (U GRO, n.d.)

B. Aggregator/Partnership Model: In this model incumbents, such as banks and NBFCs, partner with fintech companies that support them in sourcing customers, assessing creditworthiness, and collections etc.

- Indifi is a technology platform that facilitates tailor-made small business loans without security to serve the requirements of small businesses. It partners with online marketplaces, software companies, and data providers to leverage business data. Northern Arc, Lendingkart, Fullerton India, IDFC First Bank, and Manappuram Finance Limited are some of its lending partners (Indifi, n.d.)

- Vayana Network is a fintech that enables MSMEs to avail of credit against trade documents. It works with the buyer, seller and financing institution to create a network. Through this network, it facilitates the flow of trade documents electronically and provides enterprises with easy, digital access to low-cost financing (Vayana, n.d.)

C. Hybrid Lender Model: These lenders have partnerships with incumbents, and also lend on their own balance sheets. They are essentially a combination of the first two models, i.e. the balance sheet lender model and the aggregator/partnership model.

- CapitalFloat is a fintech lender that uses funding received from banks and other lenders to finance loans (IFC & Intellecap, 2018). It also houses a model wherein it partners with banks and NBFCs to co- lend to SMEs (Capital Float, n.d.)

- Kinara Capital is an NBFC that has secured funding from private equity and impact investors such as Gaja Capital, Gawa Capital, Michael & Susan Dell Foundation, Sorenson Impact Foundation etc. The firm also serves as a co-lending partner of Northern Arc Capital and Vivriti Capital (Kinara Capital, n.d.).

D. Marketplaces: In this model, fintechs function as intermediaries to connect borrowers with institutional creditors. Peer-to-peer lending models are a sub-segment of marketplaces. In India, as per the RBI Master Directions, P2P platforms are “an intermediary providing the services of loan facilitation via online medium or otherwise, to the participants” (RBI, 2017b), and have to be registered as an NBFC-P2P. They often connect borrowers to retail credit suppliers.

- Faircent is a peer-to-peer lending platform that is registered as an NBFC-P2P with the RBI. It creates a web-based marketplace using technology to connect prospective borrowers with willing lenders, including individuals and institutes (Faircent, n.d.).

- OMLP2P is another peer-to-peer lending platform that offers unsecured loans to help consumers manage their diverse financial needs (OMLP2P, n.d.).

07 3. Digital Loans available to MSMEs in India

This section builds on extensive desk research on the different types of digital loans offered to MSMEs. The infographic below displays the various loans along with a few of their features. The loan features were compiled from various company websites and aggregated to arrive at a range.

Figure 2: Digital Loans and their features

Source: Author’s analysis based on publicly available sources including fintech websites.

08 3.1. Types of loans offered by digital lenders in India

This section briefly describes the types of loans identified in Figure 2 and offers examples of providers that offer these loans. Please note that there are lenders who offer more than one type of digital loan, and more lenders than cited in the examples for each product. This is not an exhaustive list.

A. Business Loans and MSME Loans: MSME and Business Loans are loans offered to enterprises to meet a variety of their business-related expenses. The loan is usually customised according to the needs of the business, and is available with or without collateral (BajajFinserve, n.d.) (CreditMantri, n.d.).

- SMECorner provides access to business financing through their unsecured business loan product, which is customisable according to the needs of the business (SMECorner, n.d.)

- SMC Finance extends a collateral-free business loan with flexible repayment options for expansion of business, upgradation of equipment etc. (SMCFinance, n.d.).

B. Working Capital: Working Capital loans are used by enterprises to fund their day-to-day operations. The loans can be either secured or unsecured (Lendingkart, n.d.).

- Tribe3 issues tailor-made working capital loans to e-commerce business owners looking to increase their online presence on various platforms, or to build up inventory for peak seasons (Tribe3, n.d.).

C. Term Loans: Terms loans are extended to MSMEs to fulfil their requirements for capacity expansion, capital expenditure, and for buying fixed assets (MyLoanCare, n.d.).

- Mintifi, an online lending platform, extends customised term loans to its customers to meet its capital requirements for modernising a unit, setting up a new project, expansion of an existing unit etc. (Mintifi, n.d.).

- Pincap Business Loans provides unsecured term loans to businesses for maintaining their cash flow and working capital requirements. The loan is stated to be based on the sustainability of the business and is offered to SMEs supplying goods or services to medium or large-sized corporates (PinCap, n.d.).

D. Supply Chain Finance: Supply Chain Finance focuses on providing immediate working capital to enterprises to counteract any impact that arises due to delayed payments. It enables MSMEs to receive an earlier, up-front payment on their invoices (IFC & Intellecap, 2018). It is also referred to as ‘supplier finance’ or ‘reverse factoring’ (Investopedia, n.d.).

- M1Xchange is a trade receivable exchange that provides MSMEs access to capital through invoice discounting. The discounting platform comprises of 3 participants, the MSME supplier, the Corporate Buyer and the Financier. An invoice can be uploaded by either the supplier or the buyer, which on verification by the other is placed on the platform for financiers to bid on. The discounted amount is then given to the supplier (M1xchange, n.d.).

- Drip Capital provides a cash advance to businesses against their trade receivables up to 80% of the invoice value. The firm then collects 100% of the payment from the buyers, and returns the remaining amount to the customer less charges (DripCapital, n.d.).

09 - KredX extends capex discounting and helps large enterprises source funds to address capital expenditure requirements. The product allows businesses to use their rental receipts as collateral, and avail of funds upfront at a discount (KredX, n.d.).

E. Merchant Cash Advance: Merchant Cash Advance is essentially an advance an enterprise can avail based on their receivables. The enterprise has the option of making small EMI payments daily based on daily credit/debit card settlements (Anand, 2019).

- Clix Capital extends loans against electronic payments (LAEP) or loans against point of sale (POS) machines payments. This product allows a business to avail of a loan against the payments made through a card swipe machine (ClixCapital, n.d.).

- Indifi gives merchant advance loan against POS machines, with the loan amount aligned to the volume of the business’ monthly card-based transactions (Indifi, n.d.).

F. Franchise Finance: Franchise Finance is a digital loan to aid both new and existing franchises cover their business financing requirements such as working capital, inventory, payment of royalty fees etc. (BajajFinserve, n.d.).

- Flexiloans offers a franchise business loan to owners to cover their capital requirements for expansion, introduction of new products etc. Business owners from a variety of industry segments such as electronics, appliances, automobiles, garments etc. are eligible for this product (FlexiLoans, n.d.).

G. Purchase Finance: Purchase finance offers credit that can be used by businesses at the point of purchase. It helps in leveraging the main features of both payment and credit (CXO, 2019).

- OfBusiness offers this loan instrument as an alternative to distributor financing for sectors such as manufacturing and infrastructure. It is aligned with the cash flow cycles of these sectors of the economy (OfBusiness, n.d.).

- NeoGrowth offers purchase financing to service providers, traders, and manufacturers who purchase raw materials and trading goods from large corporate firms or channel partners of large corporates. (Neogrowth, n.d.).

H. Equipment Financing: Equipment Financing allows businesses the option to obtain the use of machinery, vehicles, or other equipment on a rental basis or a lease (FinanceCorp, n.d.).

- Loans4SME issues a long-term commercial finance option known as an operating lease to help companies buy assets or equipment. This product allows an enterprise to lease an asset or equipment by paying a monthly lease rental to the leasing company, that maintains ownership of the asset. The enterprise also has the option to purchase the asset at the close of the lease term (Loans4SME, n.d.).

10 3.2. Insights on the various digital loans and their features

An analysis of the various digital loans and their features, as given above, revealed the following:

No substantial reduction in interest rates

Our analysis revealed that there is no substantial reduction in the interest rates offered by digital lenders, compared to the interest rates offered by traditional financial service providers. While interest rates charged by digital lenders can be anywhere between 12% to 28%, International Monetary Fund (IMF) data on lending rates for various countries shows that the lending interest rate in India was 9.5% as of 2019. The lending rate is stated to be the bank rate that fulfils the short-term and medium-term financing requirements of the private sector (IFC, n.d.). Therefore, although the range in interest rates offered by digital lenders is broad, it is generally not below the interest rates offered by traditional financial service providers.

Use of risk-based pricing policy

Digital lenders are seen to follow a risk-based pricing policy, where different interest rates and loan terms are offered to customers. The lender provides an interest range within which the product will be priced. The true interest rate will be decided based on the creditworthiness of the customer, and the risk posed by her. Therefore, for a similar loan amount, a higher risk customer might be charged a higher interest rate compared to a low-risk borrower. This is in contrast to incumbent banks where credit risk premium spreads are arbitrarily adjusted, with some banks not even having a board approved policy on what components should be considered to arrive at the spread (RBI, 2017).

Segment level customisation

An examination of the various digital loans offered in the market revealed that digital lenders attempt to provide products with features that cater to the specific needs of various segments under the MSME sector. For instance, OfBusiness provides purchase financing in the manufacture and infrastructure segments, which is aligned with the cash flow cycles of these particular sectors. Indifi offers merchant cash advance against POS machines, with the loan amount being aligned with the volume of the business’ monthly card-based transactions. KredX offers capex discounting where firms can use even their rental receipts as collateral and avail funds upfront at a discount.

4. Digital Lending Process

The digital lending process is a series of activities that are undertaken by a financial service provider to offer credit. Based on the understanding of the purest form of ‘digital lending’, the steps involved include: customer acquisition, approval and analytics, disbursement, and collections. Throughout the process, there is also the element of customer engagement dedicated to improving the customer experience, increasing operational efficiencies, and increasing opportunities for cross-selling (Accion, 2018).

This basic understanding of the steps in providing a digital loan was used to create a schematic to map an end-to-end digital lending process in India. It represents the various steps, actors, and actions required at each stage of the digital lending journey. The schematic was corroborated through the semi-structured interviews with practitioners. The rows of the schematic indicate specific steps in the digital lending process, and the columns reflect the relevant actors. For the customer and digital lender columns, each cell specifies the action taken by them at each step of the lending process. The column under third parties indicates the actors that could be employed by the digital lender at each step of the lending process.

11 Figure 3: Schematic of a generic digital lending process

Source: Based on authors’ analysis and inputs from experts. Visualisations of the author.

12 4.1. A description of the digital lending process in India

The following is a description of the digital lending process towards the MSME segment, centred on the practice of the seven lenders who were interviewed for this study. i. Customer Acquisition: The first step in the digital lending process is customer acquisition. Digital lenders may approach potential customers either through direct or indirect channels. Direct digital modes of acquisition/marketing that lenders use include short message service (SMS), and social media advertising. Lenders may also acquire customers by maintaining a partnership with a ‘data-rich’ entity such as a mobile network operator or e-commerce marketplace and leverage the customer segment information that they already possess. There is also the alternative of indirect acquisition of customer data, which requires lenders to purchase access to customer data basis a contract (Accion, 2018).

Insights from practitioners in India indicated that the customer acquisition process is designed as a combination of a tech and touch model, instead of a fully digitised process.

The customers were seen to be sourced mainly through the following methods:

- Brick and mortar branch: The lenders rely on their physical infrastructure, including branch offices, loan officers or relationship managers to source borrowers. The relationship managers assist the customers in the onboarding process.

- Channel partners: Lenders also rely on partnerships with e-commerce platforms, aggregators or marketplaces (such as Amazon, Flipkart etc.), mobile wallet companies, participants in the supply chain (such as machine manufacturers, Fast-moving Consumer Goods (FMCG) distributors) etc. to source borrowers.

- Direct Selling Agents (DSA): Authorised DSAs function as referral agents for the lender, and find potential borrowers for the lender to service (BankBazaar, n.d.).

- Referrals from current borrowers of the digital lender, and

- Repeat loans to borrowers that have already been serviced by the lender.

In the customer onboarding process, identity verification of the prospective customer is enabled through either the relationship managers/credit/sales team that sources them, or by employing third-party service providers for doing KYC. ii. Appraisal and Analytics: The interviews suggested that digital lenders use both traditional and alternative sources of data. The former usually include financial statements, business plans and credit bureau scores, while the latter comprise bank statements and cash flow analysis (customer’s income, expenditure, receivables, payables etc.), call data records, digital transactions (such as invoices, transaction data from point-of-sale machines etc.), and also data from social media. Alternate data was indicated to be used for customers who have a ‘thin file’, i.e. those who have a limited credit history or digital records that can be

13 used to evaluate credit risk. Verification of data is done through several methods such as personal interviews with the borrower, physical verification of the business, referential validation through buyers/ suppliers and so on. The lenders usually have their own proprietary algorithms and risk models to assess the creditworthiness of customers, based on the information collected. The lender might also partner with other third-party vendors for specific purposes, such as with API aggregators, verification agencies, valuation agencies, fraud control units etc. iii. Loan Sanction: Based on the results of the creditworthiness assessment, the lender decides on the loan amount to be offered, the tenure of repayment, as well as the interest rate to be charged. The borrower is charged a processing fee (which is usually 1-3% of the loan amount), if the offer is accepted. iv. Disbursement: Cashless channels [such as real-time gross settlement (RTGS) and National Electronic Fund Transfer (NEFT)] seem to be the preferred mode of disbursement to customers. The disbursement of funds is usually to the bank account of the customer. Disbursement is also sometimes done to the mobile wallets of customers. v. Collection: Digital lenders tend to leverage the data that they have, along with their algorithmic capabilities in order to anticipate and design an optimum collection process. Repayment is usually through automatic clearing house (ACH) payment or post-dated cheques (PCDs). Other repayment methods include cash, Unified Payments Interface (UPI), digital wallets etc. The collections process usually consists of three steps: (1) Initially, a reminder for repayment is sent through an SMS, WhatsApp message, or by a call centre representative; (2) In case there is a delay in repayment, then the customer is approached by the relationship manager; (3) The third point of contact is the collections team, which might be in-house or a third party. vi. Customer Engagement: The major points of customer engagement are the relationship managers in the branch offices, and the customer service team. The lenders also operate a customer care number, and an email for grievance redressal.

4.2. Insights from various steps of the digital lending process

An analysis of the various steps involved in the provision of a digital loan, as given above, revealed the following:

Assisted tech models are preferred for onboarding of customers

The study found that digital lenders seem to be adopting a tech-and-touch model keeping user convenience in mind, and do not resort to an absolute end-to-end digital process. A Centre for Financial Inclusion study found that borrowers wanted the human component in digital lending for three main reasons: to ensure that the financial service provider is legitimate, to understand the product being offered, and to resolve problems or complaints (Olsen, 2017). From our analysis of the lending process, we have seen that lenders employ relationship managers (in-house or through third parties) to help with the acquisition and onboarding process, in addition to having brick-and-mortar branches. This is to inspire confidence in the brand and the product. Relationship managers, along with centralised call centres, also ensure that the customers have a human

14 point of contact for raising issues or enquiries. Among the lenders who were interviewed, those who were registered as NBFCs stated that they used an assisted tech model to onboard customers. A fintech firm functioning on a partnership model stated that its onboarding process was completely digital and through its website. But it was indicated that their enterprise partner (from whom they sourced customers) provided the human touch point to help onboard customers.

Alternative data is used extensively to inform credit decisions

There is widespread usage of alternate data among the firms. Lenders compile a variety of data from personal and social information to business data in order to estimate the creditworthiness of a borrower, and the risk of default. All the digital lenders interviewed stated that they have their own proprietary algorithm for assessing the creditworthiness of borrowers. Alternative data is extensively relied on by the lenders who were interviewed, as traditional data such as credit bureau hits are too sparse to reliably predict creditworthiness. The lenders reported that around 15-50% of their customers were thin file, with no credit bureau hits or with hardly any information to drive credit decisioning. The credit bureau hits, where available, usually revolve around gold loans, two-wheeler loans, affordable housing etc. and not for formal business loans.

Research in other jurisdictions conducted on the credit scores tabulated by a fintech platform found that even though the proprietary scores were not highly correlated to a traditional credit score, it was able to serve as a good predictor of future loan delinquency (Jagtiani & Lemieux, 2019). The interviews conducted with practitioners revealed that the net non-performing assets (NPA) levels faced by the firms ranged anywhere between 2-3%. Therefore, the extensive use of alternative data could be a factor contributing to low default rates.

5. Cost of providing credit through digital lending

5.1. Insights on the cost of delivering credit through digital lending

Emerging research notes that digital lending models are capable of delivering a cost advantage of around 30-40% over traditional models (Omidyar & BCG, 2018). Advocates of digital lending argue that even when digital lenders face a higher cost of credit, the efficiency gains from the use of technology can reduce the cost of acquisition, operating expenditure and the cost of collections. This could allow them to operate on a low- cost, high-volume scale (Omidyar & BCG, 2018; Ramanathan, 2020). This apparent reduction in the cost of lending, which can then trickle down to consumers, is one of the potential gains that digital lenders are expected to deliver (FSD Kenya, 2019).

A study by Sahasranaman & George (2013) stated that for a traditional loan, the cost of delivering credit can be divided into four components: the cost of debt, loan loss provisions or expected loss, cost of equity or unexpected loss, and transaction costs. More recently, Omidyar & BCG’s (2018) research on emerging fintech models estimated the unit cost for an unsecured business loan of INR 10 lakh, for a tenure of a year. In this study, the cost components as a percentage of ticket size were indicated to include: the cost of acquisition, the cost of credit, operating expenditure, and the cost of collections.

15 However, the components outlined in Sahasranaman & George (2013) are not strictly comparable to the costs associated with a digital lending model. Further, the components related to the cost of digital lending as identified in Omidyar & BCG (2018) are not analysed explicitly. As such, based on our understanding and conversations with different providers, we identified certain components of costs that a digital lender faces in the provision of credit. These are set out below, together with some insights that were revealed through interviews with different providers: i. Cost of debt: The cost of debt is the cost faced by a digital lender in raising funds. The two major sources of capital are loans from other lending institutions such as banks or NBFCs, and equity capital from investors (Manikandan, 2020).

Reports show that fintech players have been incurring high premiums to avail credit, especially after the liquidity squeeze created by the failure of Infrastructure Leasing and Financial Services (IL&FS) (Manikandan, 2020). Interviews with digital lenders who borrow funds from both lending institutions and institutional investors indicated that their cost of capital can be anywhere between 12% - 15%.

This could result in the provision of credit through digital lending being procyclical. For instance, during times of stress, there might be a loss of investor confidence that could result in a pullback in credit to certain parts of the economy (BIS, 2017). This is actually becoming a reality in the current pandemic situation, where lenders are striving to raise low-cost debt. The lenders to the digital lenders (such as banks) are increasing loan rates, by up to 2 percentage points, to account for the increased risk premiums they themselves face due to stress on their books. However, digital lenders may not be in a position to pass this increase in cost on to the borrowers for fear of losing their customers, and thus affecting their margins (Manikandan, 2020). ii. Cost of credit: The cost of credit is the cost relating to provisioning and writing off of loans. This cost is usually reflected in the rate charged to the customer. Sahasranaman & George (2013) had indicated that observed default rates can be used as the basis for loan loss provision. Interviews with digital lenders indicated that their net NPA level ranged anywhere between 2-3%.

Research in other jurisdictions conducted on the credit scores tabulated by a fintech platform found that even though the scores were not highly correlated to a traditional credit score, it was able to serve as a good predictor of future loan delinquency (Jagtiani & Lemieux, 2019). The MSME Pulse Report for April 2020 (TransUnion CIBIL & SIDBI, 2020) indicated that private banks exhibited NPA levels in the range of 3-5%, whereas the NPA level of public sector banks (PSB) is around 18.7%. In comparison, the NPA levels cited by digital lenders are lower. Therefore, the extensive use of alternative data could be a factor contributing to low default rates. iii. Cost of operating expenditure: The cost of operating expenditure (opex) includes the costs incurred for customer acquisition, underwriting, operations, servicing, collections etc. It can be considered as the cost of administering credit. Through the course of the interviews, it was indicated that the cost of opex is dependent on the ticket size and can vary widely. Interviews with lenders functioning as balance sheet lenders and hybrid lender models indicated that they face a 10-12% acquisition cost for a first-time acquisition, in addition to other operating costs which average around 5%.

16 The high cost of debt is thus seen to be supplemented by substantial operating costs as well. This has mainly been due to maintaining human touch-points within the digital lending journey such as brick-and- mortar branches, and relationship managers similar to traditional players. Additionally, although algorithmic credit scoring is widely used in the appraisal and analytics process, lack of uniformly available or digitised data does increase the costs associated with collecting the information for assessing creditworthiness. iv. Other overheads: Other overheads include costs incurred for customer engagement, marketing as well as investments made in technology. Investment in technology was indicated to be a major sunk cost faced by digital lenders, which has to be distributed over a large number of customers in order to keep marginal costs low.

As previously noted, emerging research estimated that digital lending is capable of delivering a cost advantage compared to traditional models, thereby allowing it to operate on a low-cost, high-volume scale. This was highlighted in the Omidyar & BCG (2018) study, where digital models were indicated to be capable of delivering a cost advantage of around 30-40% over traditional models, which can then trickle down to customers. However, as seen in our analysis in Section 3.2, there is no substantial reduction in the interest rates offered by digital lenders, compared to the interest rates offered by traditional financial service providers. Further, as shown in our analysis above, digital lenders face a higher cost of debt, in addition to substantial operating expenditure, which might prove an obstacle in offering lower interest rates to consumers. Therefore, even if digital lenders have been able to capitalise on efficiency gains from the use of technology, this cost advantage is not being passed on to the final consumer. As such, a more granular understanding of the cost structure of digital lending is required to discern if there truly is a cost advantage in digital lending, and whether it can fulfil the promise of inclusive finance through the provision of lower interest rates.

6. Conclusion

India has a growing fintech lending ecosystem. Digital lending towards MSMEs is certainly seeing continued interest from investors, as well as innovations in the market. But there is reasonable uncertainty over the growth prospects of the digital lending market, especially with the current pandemic testing the resilience of these new and emerging models.

This research brief has attempted to examine the current landscape of digital lending serving the MSME sector in order to provide a nuanced understanding of the industry. However, this preliminary analysis has brought to the fore additional questions regarding the digital lending market.

An examination of the various digital loans offered in the market revealed that digital lenders are making attempts to provide products with features that cater to the specific needs of various segments under the MSME sector. This appetite to develop an intrinsic understanding of specific segments, coupled with the extensive use of alternate data to assess creditworthiness, could decrease information asymmetry. There is scope to explore whether, in the long run, this will result in lower risk premiums. A step-by-step analysis of the digital lending process indicated that providers make use of proprietary algorithms, and alternative data from various sources, to assess the creditworthiness of borrowers. This has enabled them to provide credit

17 to those customers who are new-to-credit or have a thin credit history. The increasing use of alternative data by providers also has important implications on data sharing, and there is a need to extensively examine the associated benefits and risks that come with it. Finally, a cursory estimation of the costs incurred by digital providers indicated that they face several barriers in reducing the cost of lending. These mainly include a high cost of debt, and substantial operating costs. As such, the potential advantage of digital lenders reducing the cost of lending does not seem to be materialising.

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