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Synopsis: The opportunities that cash-flow-based lending offer can have a profound influence on easing some of the constraints on smaller enterprises
Some of the points made by Jack Ma on digital finance at the Bund Finance Summit are worth reading in the context of the progress made in Indian digital finance over the past few years.
What criticism did Jack Ma levy on traditional credit disbursal?
He described the current system of credit disbursal by bank, based on collateral as “pawnshop mentality”. He stated that though this was necessary for banks development but is now at odds with the possibilities of new forms of lending.
According to Jack ma, collateralization with a pawnshop mentality is not going to support the financial needs of the world’s development over the next 30 years.
What alternative did he suggest?
He wants to replace this pawnshop mentality with a credit-based system rooted in big data using today’s technological capabilities.
This credit-based system is not built on traditional IT, not based on a personal relationship-driven society, but must be built on big data, in order to truly make credit equal wealth.
Why Jack Ma’s vision holds significance for India?
These remarks on the need to move from a lending system based on collateral to one based on big data are significant especially at a time when India has inaugurated an account-aggregator system.
It will help small businesses with inadequate collateral or credit histories access credit at far lower rates than they do now.
Account aggregators working through a secure public credit registry can do for the credit sector, what the United Payments Interface (UPI) has done for retail payments in India.
How the shift towards cash-flow-based lending can revolutionise Indian economy?
Access to cheap credit for small businesses: There is ample research to show that tiny enterprises pay interest rates that are far higher than what their default rates predict. By easing these credit constraints, the account-aggregator system can lend to small enterprises that have some digital and tax footprints. Lenders can access data on bank statements, GST returns, personal spending, etc., to price loans to enterprises they would earlier stay away from.
Will help to overcome ‘the De Soto Effect’: De Soto effect states that the global poor working in tiny informal enterprises are in effect shut out of the formal credit system. Hence, they are forced to live in poverty, because a lack of clear property rights makes it difficult for them to offer their land assets as collateral to banks.
A slum dweller with no formal land title thus has to depend on informal sources of money that leave her with little to reinvest in the business.
It is quite likely that a successful shift to lending based on borrower cash-flows will ease the credit constraints on informal enterprises.
Can ease the formalisation process in India: Formalization of the Indian economy is under overdue. One suggestion to enable fromalisation process is, by closing the domestic productivity gap. The informal enterprises should grow in scale that allows them to close their productivity gap with larger firms in the organized sector.
However, credit constraints are part of the reason why small firms fail to scale up in India, which employ most Indians who have left farming behind. Cash-flow-based lending can help in this regard.
Source: This post is based on the article “Jack Ma’s point on collateral-free lending holds relevance in India” published in Livemint on 22nd September 2021.