February 2, 2023


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Digitisation is the best hope for alternatives to collateral-based lending

One way of categorizing lending practices in India is by dividing them into collateral-based lending and reputation-based, or non-collateral, loans. Loosely, commercial banks and other financial intermediaries in the regulated markets resort to collateral-based lending. Reputation-based lending is widely prevalent elsewhere, particularly for relatively poorer borrowers.

As farmers’ agitations are in the news these days, their sources of borrowing are both topical and relevant to the subject of India’s lending practices.

Professor Satish Verma, the RBI Chair at the Centre for Research in Industrial and Rural Development, Chandigarh, in an interview to Times of India on 16/6/20, observed that arhtiyas (commission agents) of Punjab’s agricultural marketing system also double up as lenders to farmers.

According to Professor Verma, “an arhtiya is a farmer’s anytime, anywhere, hassle-free and purpose neutral source of borrowing.” It is therefore an important factor in the durability of arhtiyas in Punjab’s rural economy.

The nature of this kind of borrowing is reputation-based. A farmer’s reputation secures a loan at short notice, regardless of the end-use. Reputation is the alternative to tangible collateral that dominates the lending in the commercial banking space.

The absence of adequate collateral is an important reason for the challenges faced by smaller firms when they seek to access credit from commercial banks. Therefore, the search for viable alternatives to collateral has been an important objective of financial policy making in India and other parts of the world.

The increasing incidence of digitisation holds the promise of becoming a viable alternative to collateral. Digitisation potentially offers the possibility of creating a reliable database on the cash flows of smaller businesses. This database can then be used by lenders as a substitute for collateral.

In this context, Hong Kong witnessed an important development this week. The Hong Kong Monetary Authority announced the creation of the Commercial Data Interchange (CDI).

CDI aims to be a consent-based common standard for data owners to share their digital footprint with banks. The database of potential borrowers is expected to help them access loans from banks. Here, technology holds the possibility of a viable alternative to collateral in the lending process. The performance of CDI will of interest to the Indian financial system. Digitisation holds the promise making access to capital easier for smaller businesses. The task ahead is find the ways in which this can happen.



Views expressed above are the author’s own.