3 things to consider before you start a lending business
2018 saw a whopping $938 million raised in funding by lending startups, that’s 47% of all the deals made within the fintech sector
For a startup founder considering Fintech, lending remains an unexplored market and with a larger number of young potential customers entering the foray, it becomes more lucrative than ever.
Having said that, starting a finance company in India has its own problems, government regulations and RBI guidelines are just the few of those. And like any nascent market, these guidelines and rules tend to evolve with time and geo-political situation.
In this article we try to list down 3 things that you as a Lending company founder should consider before you start the business.
1. RBI governs you
Over 225 lending companies were registered in India as of 2017. Almost all of them were aimed at different borrowing needs, including consumer loans, SME loans working capital loans, and payday loan among others.– PWC Fintech Report
Lending in India is a regulated industry, governed under RBI and all its associated regulations. Specifically, lending comes within the purview of an NBFC, a non -banking financial company.
What this means is, as a lending company you will have to follow the regulations defined by RBI and register as an NBFC with them.
While lending itself seems like an easy business to do (you have money you lend it to people), there are 2 broad business models that you can consider which will directly affect the way you function,
- Manufacturer – Originator of loans
- Distributor – connect borrowers with lenders
As a manufacturer – originator of loans, you have the funds, you use these funds to lend loans to individuals and businesses. Manufacturers fall under the purview of NBFC and are mandated to get a lending license while following the guidelines given by RBI.
As a distributor, you would be responsible for connecting borrowers to lenders via a platform over web or mobile or phone. In this case the originator of loans i.e. the lenders on your platform need to have the required license and follow RBI guidelines.
Though as a distributor you are not directly related to laws and regulations given out for NBFC, you are still expected to follow guidelines and rules provided by RBI.
In case of P2P lending companies, which essentially are a distributor of loans, there exists a specific P2P lending license that needs to be activated before they start the business.
You can also register as a not-for-profit organisation or an NGO which are regulated by the state governments. From a business perspective, it makes more sense to register as an NBFC with MCA and RBI, though this is a discussion better left for another time.
2. Risk management is both a regulatory and business necessity
In case of NBFC and financial companies in general, risk management is an area of great importance and a chunk of business resources go into mitigating and reducing risk as much as possible.
The success of lending company not only relies on the volume of loan disbursed but also on how many of these loans are paid back. For you to minimize the risk that comes with giving out unsecured loans, it becomes necessary to assess the risk of giving loan to a borrower.
There are 2 methods you can use to minimize this
- By conducting a sound credit assessment
- By following the KYC process
In accordance with the RBI mandate lending companies need to be a part of all the credit bureaus present in India, these include CIBIL, CRICIL, Equifax, ICRA, CRIF and Experian.
The credit bureaus get all this information from banks, who send this under another mandate by RBI. This data that is acquired by CIBIL or any other credit bureau, gives lending companies an insight on the repayment history of the borrower. This is done by assigning a score to the behaviour of the borrower while repaying what was borrowed from the bank. This is what we call a credit score.
Alternate sources of credit assessment
Fintech companies have also been using alternate sources of credit assessment to make their lending decisions. In this case lending companies consider payment, social and profile data acquired from companies like Lenddo , to understand the financial behaviour of the borrower before approving the loan.
As an NBFC registered with RBI, you would have access to APIs and other infrastructure that can be used to access credit scores of the customers applying for loan from your organisation.
KYC allows you as company to verify if the customer is who she says she is. The usual way would be to get a self attested OVD (Officially Valid Document) to verify the identity. OVDs include Aadhaar, Driving License, Passport and Voter ID among others.
You can access the RBI circular regarding the same in the link below,
The easiest way to KYC was to use Aadhaar based eKYC to authenticate the customer’s identity. Though, post supreme court ruling, usage of Aadhaar eKYC by private companies has been seized.
Another way that can be explored and the one we recommend & provide services for, is to digitally collect and verify IDs using OCR (Optical Character Recognition) and Face Match algorithms. We call this solution Video ID KYC.
Video ID KYC allows lending companies to integrate KYC verification system in to their own platform and use AI driven OCR (Optical Character Recognition) to authenticate the document itself before using it to verify the identity using face match.
3. Capital Requirement
Net owned funds
RBI guidelines and Section 45-IA of the Reserve Bank of India Act, 1934 , the Net Owned Fund (NOF) refers to an aggregate of the paid-up equity capital and free reserves as disclosed in the latest balance sheet of the company after deducting therefrom.
Usually this consists of paid up equity capital, free reserves, balance in share premium account and capital reserves, representing surplus arising out of sale proceeds of assets but not reserves created by revaluation of assets.
This means before you can start doing business as a lending company you would need a minimum capital of Rs 2 crores, the definition of what NOF/capital means is mentioned above.
Over the last 2 years, more than 300 new age lending companies have entered Indian market. As of now the business model seems to be working and revenue seems to be flowing in, though it still remains to be seen what the future holds.