Balancing Act: Navigating the Future of NBFC Lending in India

By Anand Krishnan --
Wednesday, 22 May, 2024

In recent years, Non-Banking Financial Companies (NBFCs) in India have increasingly relied on historical data and AI-powered algorithms to underwrite loans, particularly for Micro, Small, and Medium Enterprises (MSMEs). This trend, driven by the ease of access to digital financial records and the efficiency of AI in assessing creditworthiness, has transformed the lending landscape. However, the Reserve Bank of India (RBI) is urging caution.

Swaminathan J, Deputy Governor of the RBI, recently addressed the risks associated with over-reliance on rule-based credit engines. Speaking at the Conference of Heads of Assurance of NBFCs on May 15, he emphasized that these models are only as robust as the data and criteria they utilize. Historical data, while valuable, may not always predict future market dynamics accurately. This is particularly true for NBFCs, which often engage heavily in retail unsecured lending, top-up loans, and capital market funding.

Swaminathan pointed out that over-reliance on such models could lead to significant oversights in credit assessment. "Over-reliance on such products may bring grief at some point in time later," he warned, noting that the risk limits set for certain products or segments, like unsecured lending, are sometimes unsustainably high.

However, the human element remains crucial. While AI can automate many aspects of loan underwriting, subjective evaluation still requires human judgment. The market conditions are ever-changing, and assumptions based on historical data might not hold true indefinitely.

Experts like Tirthankar Datta, Partner at JSA Advocates and Solicitors, suggest that NBFCs need to develop advanced algorithms capable of dynamically adjusting to new data. This includes leveraging non-traditional data sources, such as mobile payments and UPI transactions, to gain insights into unbanked MSMEs or lower-income individuals.

While the RBI's concerns highlight the need for vigilance, NBFCs are optimistic about balancing innovation with caution. By integrating AI with traditional methods and continuously refining their models to reflect current realities, they can navigate the challenges of MSME lending effectively.

As RBI Governor Shaktikanta Das noted earlier this year, it’s crucial to monitor and adapt to changing ground realities. Ensuring that credit models remain in tune with the times and recognizing potential risks will be key to sustaining growth in the NBFC sector.

By embracing a balanced approach that combines the strengths of AI and human insight, NBFCs in India can continue to support MSMEs while safeguarding against future uncertainties. This careful navigation will be essential for fostering sustainable growth in the ever-evolving financial landscape.

Balancing Act: Navigating the Future of NBFC Lending in India. In recent years, Non-Banking Financial Companies (NBFCs) in India have increasingly relied on historical data and AI-powered algorithms to underwrite loans, particularly for Micro, Small, and Medium Enterprises (MSMEs). This trend, driven by the ease of access to digital financial records and the efficiency of AI in assessing creditworthiness, has transformed the lending landscape. However, the Reserve Bank of India (RBI) is urging caution.

Swaminathan J, Deputy Governor of the RBI, recently addressed the risks associated with over-reliance on rule-based credit engines. Speaking at the Conference of Heads of Assurance of NBFCs on May 15, he emphasized that these models are only as robust as the data and criteria they utilize. Historical data, while valuable, may not always predict future market dynamics accurately. This is particularly true for NBFCs, which often engage heavily in retail unsecured lending, top-up loans, and capital market funding.

Swaminathan pointed out that over-reliance on such models could lead to significant oversights in credit assessment. "Over-reliance on such products may bring grief at some point in time later," he warned, noting that the risk limits set for certain products or segments, like unsecured lending, are sometimes unsustainably high.

However, the human element remains crucial. While AI can automate many aspects of loan underwriting, subjective evaluation still requires human judgment. The market conditions are ever-changing, and assumptions based on historical data might not hold true indefinitely.

Experts like Tirthankar Datta, Partner at JSA Advocates and Solicitors, suggest that NBFCs need to develop advanced algorithms capable of dynamically adjusting to new data. This includes leveraging non-traditional data sources, such as mobile payments and UPI transactions, to gain insights into unbanked MSMEs or lower-income individuals.

While the RBI's concerns highlight the need for vigilance, NBFCs are optimistic about balancing innovation with caution. By integrating AI with traditional methods and continuously refining their models to reflect current realities, they can navigate the challenges of MSME lending effectively.

As RBI Governor Shaktikanta Das noted earlier this year, it’s crucial to monitor and adapt to changing ground realities. Ensuring that credit models remain in tune with the times and recognizing potential risks will be key to sustaining growth in the NBFC sector.

By embracing a balanced approach that combines the strengths of AI and human insight, NBFCs in India can continue to support MSMEs while safeguarding against future uncertainties. This careful navigation will be essential for fostering sustainable growth in the ever-evolving financial landscape.