Digital lending for small businesses and merchants

It is estimated that there are 1.2 crore micro, small and medium enterprises (msMEs) in Bangladesh. This estimate is based on the 2013 BBS National Economic Census, which reported 78 lakh msMEs and an annual growth rate of 6%. msMEs contribute about 25% of our national GDP,  31% of the industrial sector productivity, and employ 3 crore people - 80% of industrial employment in the country.

Not surprisingly, the msME sector is called the employment generation machine of the country. Even with such a large contribution to the economy, the msME sector is one of the most underserved sectors when it comes to access to finance, not only in Bangladesh, but also in other developing countries. In Bangladesh, more than 60% of micro-enterprises remain unable to access credit, and the ones with access to credit pay exorbitantly high interest rates, such as 24-40%.

We have made a lot of progress in the financial services sector using digital technologies since the adoption of the vision of Digital Bangladesh in 2008. Mobile Financial Services (MFS) are widely adopted around the country. People are using mobile phones to send money to family members, pay utility bills or recharge their mobile phones. There are more than one crore active customers making more than Tk30 billion transactions per day.

The government is also disbursing safety net money and education stipends to crores of families using MFS. Other areas where we have made progress include internet banking, app-based banking, and inter-operable ATMs. BB and the government's Information and Communication Technology Division is working closely to soon launch a real-time interoperable payment platform named Binimoy. 

This will be a big step forward for the payment sector in the country, triggering exponential growth, paving the way towards the coveted less-cash and cashless society, and facilitating expansion of complementary financial services such as savings, credit, and insurance. 

Although new technology has disrupted the payment sector, credit services have not changed much in the last few decades. It is time to disrupt the credit system and services using new financial technology such as the internet, smartphones, big data, and artificial intelligence. In recent years, digital lending is being used to expand access to credit in the msME sector in many countries, including neighbouring India and China.

Ant Financial in China has built a strong digital credit business using its "3-1-0 model," wherein applicants apply for the loan in three minutes, funds are disbursed within one second, and human involvement is zero. Within four years of its inception, Ant's MYbank platform made 1.6 crore loans and created a loan book of $290 billion in partnership with 400 banks. Their end-to-end digital lending platform achieved a loan approval rate of 60%, kept a loan default rate of 1.3%, and acquired a 50% market share in msME lending. 

Bangladesh Bank encourages digital loans

Recently, Bangladesh Bank (BB) issued a circular to encourage small digital loans in order to reduce the financing gap among underserved and marginal people, and expedite an inclusive and sustainable financial sector growth. Here, digital loan denotes loans offered by scheduled banks using an end-to-end digital process through digital channels (such as internet banking, mobile apps, MFS, and electronic or digital wallets). 

On top of this, BB also created a Tk100 crore refinancing fund for digital loans in order to incentivise the banks. Under this scheme, banks will get funds at a 1% interest rate from BB, and they can then lend to customers at a 9% interest rate. 

This circular represented a shift in gear wherein BB started encouraging banks to develop end-to-end loan products where all steps, from customer selection, underwriting decision, fund disbursement, to repayment, will be done using digital systems and processes. This also implies that banks do not need to meet customers face-to-face and that no wet-ink signature is required for loan application or acceptance.

Moreover, digital loans are expected to be unsecured loans. Traditional collateral-based lending will not be suitable for these. Bankers will have to assess the repayment capability of applicants using a projected cash flow analysis based on business category and transaction data, and assess repayment willingness based on alternate data such as supplier payment history and regularity of in business transactions.

This drive by BB is expected to work as a major booster for banks to move towards innovative digital loan products. Traditionally banks are used to following BB guidelines in designing loan products, but currently there are not a lot of differentiations in product offerings between banks in the market. Development of digital loan products will involve some investment and experimentation from the banks. 

Assuming that banks lend to customers at a 9% interest rate and get funds at a 1% from BB, digital loans will have an 8% margin. Even if the product has an overall cost and a non-performance cost of 5-6% at the beginning, it will still provide 3-4% net profit, which will encourage banks to venture into the new world of digital lending.

Developing an end-to-end digital loan product

To develop an end-to-end digital loan product, a bank needs to work on the following areas:

Providing a proper mandate to digital loan teams, including research and development as well as launching and piloting before full scale deployment.

Developing technology for customer acquisition, lending, client management, and recovery.

Harvesting enough data to assess ability and willingness to repay loans, that is, harvesting data for credit risk assessment.

Developing digital payment platforms such as MFSs or e-wallets (a simple mechanism for fund disbursement, usage, and loan repayment).

A bank may want to develop all four of these by themselves. Traditionally, some of this work is outside the expertise and experience of banks, and therefore will require a large investment of both time and money, and it will involve significant risks. Alternatively, a bank may work with financial technology platforms and specialised partners to launch lucrative digital loan products that can be quickly released in the market.

TallyKhata platform for msME lending

TallyKhata (TK) is the leading digital msME platform in Bangladesh. It is an intuitive app helping small businesses to maintain transaction records and accept or make digital payments. Launched during the beginning of the Covid pandemic in 2020, TK is the fastest growing platform of its kind, with 40 lakh registered small businesses and more than 10 lakh transactions recorded each day.

TK is integrated with a digital wallet named TallyPay under a payment service provider (PSP) licence from BB. The wallet is opened using BB e-Know-Your-Customer guidelines, and features online verification against the national ID database. This wallet provides a complete digital payment solution for small businesses, including such features as accepting in-store QR code payment and online payments, collecting dues from customers, paying utility bills, and making payments to suppliers and distributors. 

TK is ready to collaborate with banks and provide an end-to-end digital lending platform for micro and small enterprises, especially micro-merchants. It is a complete solution consisting of origination, underwriting, disbursement, repayment collection, portfolio monitoring, and collection assistance. 

TK collects more than a thousand data points on businesses using sources such as cash-flow data, transaction data, owner Know-Your-Customer, shop photos, utility bills and major fast-moving consumer goods invoices. TK generates a credit score for each applicant using advanced data analytics and artificial intelligence. A digital lending portal is provided to bankers where they can view loan applications including key business KPIs, credit score and business profile, conduct loan assessment, communicate with applicants, take underwriting decisions and even activate loans and disburse funds.

Digital lending portals may be customised to include the bank's own assessment mechanism with integration of its credit management and core banking systems. After a lending decision is made, a borrower can access the loan fund using own bank account or directly using the TallyPay wallet within the app. For example, a shopkeeper can use the available fund to pay suppliers for purchasing products the shop sells. 

Apart from acquiring new loan customers, TK also helps banks with loan repayment by sending timely in-app payment reminder messages to the borrowers. Both bankers and TK back-end team monitor the portfolio performance using a dashboard, and intervene when certain borrowers' repayments become irregular. TK field officers may also visit the borrowers to assist in repayment collection if and when required.

TK was recently selected by the Visa APAC accelerator program 2022. The other four companies selected are from New Zealand, Japan, Singapore and India. TK is the first Bangladeshi financial technology company to be selected by this prestigious cohort. Here TK is working with local banks to issue virtual Visa cards for cash-flow based working capital loans to micro-merchants.

Building a scalable msME lending business

TK is adopted by millions of small businesses in the country for their day-to-day business records. It has been especially popular among the retailers around the country, including general stores, mudi shops, and neighbourhood shops. We have more than one lakh regular TK users and there is a high demand for working capital loans from them. These are businesses with permanent shops with regular cash-flow and visible inventory on their shelves, a good category of clients for launching a digital loan product.

For micro and small enterprises, digital loans promise simple and easy access to working capital loans from banks. It offers a simple process, a quick turn-around time, and reasonable interest rates. For a bank, digital lending promises a low cost of customer acquisition, a low default rate, and a low operations cost. It is a great opportunity to build an msME loan portfolio all over the country outside the limitation of the branch network. Currently, there is a more than $2.8 billion (more than Tk280 crore) credit gap in the micro-merchant sector alone. If a bank moves early, it is possible to capture 10% of this market in a few years while having a micro and small enterprises portfolio of 2,500 crore taka.

We have a great opportunity to improve the credit system in Bangladesh using digital data, credit scoring, and artificial intelligence technologies. This provides a great opportunity to expand credit into the msME sector, impact the livelihoods of millions of families, and expedite national economic growth using increased productivity and employment. Digital lending for msMEs will be an important smart solution for the smart Bangladesh we want to build.

Shahadat Khan is CEO, TallyKhata.

Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinions and views of The Business Standard.