The trend is still in its infancy, but there are also concerns. Privacy issues and unethical or illegitimate credit deals pose risks to financial stability given the speed at which digital credit is growing, the report said.

With good regulation, innovative and cost-efficient models can help digital lending overtake traditional types of lending in the future. Here’s more about the phenomenon:

1. Increasing slope

Digital lending refers to the online loan disbursement where all processes, even loan approval and collection, are done remotely, usually through mobile apps. The shift is part of the digital transformation driven by the pandemic. Rental apps made up just 4.9% of all apps installed in India in October 2020, but it was 11% in October 2021, analytics firm AppsFlyer said.

“While the economic impact of the pandemic may have played a role in the demand, a borrower-friendly approach, less paperwork and high availability were also key to the increased usage,” said Aditya Maheshwari, Head of Customer Success at AppsFlyer India.

This is also pointed out by the RBI panel, which found a 12-fold increase in loans disbursed digitally ( ₹1.4 trillion) from a sample of Commercial Banks and Non-Bank Financial Firms (NBFCs) between 2017 and 2020. Low overheads and the use of technology help digital lenders operate efficiently to meet the aggressive economic needs of the post-Covid pandemic, it says in the report.

2. Strictly personal

Private banks and NBFCs dominate the digital lending sector with shares of 55% and 30% respectively (2019-20). The share of public sector banks increased from 0.3% to 13% between 2016-17 and 2019-20, the RBI data showed.

Personal loans made up the lion’s share – slightly more than half in value – of all digital loans issued by banks. This was followed by loans to small and medium-sized enterprises (16%). Buy Now, Pay Later loans were less than 1% in value but 37% in number of loans.

This is, in large part, a symptom of a growing demand for retail small loans in general. NBFCs in particular now give more than half of their loans digitally, but digital loans still have a share of 11% in terms of value. This was shaped by the increasing demand for housing, vehicles and educational loans during the pandemic. The trend has brought so much attention to industrial credit that retail will become the largest segment of the Indian credit market for the first time in 2021.

3. Impressive jump

With a significant portion of private lender loan portfolios coming from this rapidly growing retail segment, the conventional lending landscape will change dramatically. This, in turn, will increase the share of digital lending in total lending.

Digital sourcing is already making its way into retail products. ICICI Bank, India’s second largest private lender, processed 94% of its personal loans digitally from April to September 2021, compared to 62% in 2019-20. Kotak Mahindra Bank saw 120% quarter-over-quarter growth in digital personal loans and sequential growth of 105% in digital home loans from July through September.

Not all banks provide comparable data every quarter, but the bigger trend is similar. Banks responded well to this digitization during the pandemic, with public banks and leading private lenders developing their own loan disbursement apps. However, the RBI report also points to the use of unsecured third-party lending apps that are used by some private banks and NBFCs.

4. Legal clutter

This creates the risk of unsafe transactions. The RBI panel found that more than 50% of the loan apps on the market may be illegal, and the trend could only rise as more apps are added. Between January 2020 and March, around 2,562 complaints against digital credit apps were filed on the RBI sachet portal 2021. Of these, 919 were in a single month in December 2020 when the central bank asked consumers to report such apps. Complaints usually relate to apps advertised by unregulated institutions.

In light of this patchy and evolving credit ecosystem, the report proposed norms aimed at “orderly growth” of the sector. The panel recommended protective laws and the creation of self-regulatory organizations that can review and regulate the behavior of credit apps.

Anand Dama, banking analyst at Emkay Global, said the proposals seemed largely constructive and in line with expectations for the digital lending space, but believed that regulations could curb the rapid growth rate of Digi lending.

5. Repayment Challenge

Rising non-performing loans in the retail segment could be a major concern as the trend gains momentum. For example, commercial banks gross distressed claims for two major sectors – agriculture and industry – decreased in 2020-21, but increased for retail lending from 1.7% in September 2020 to 2.1% by March 2021.

While technology could be a boon in lending to the banking sector, aggressive growth at the expense of credit quality may lead to asset quality deterioration for banks below tier 1 in the future, said Vinod Nair, research director at Geojit Financial Services.

This will increasingly come into the spotlight as banks can remain cautious about adopting new technologies. Responsible lending will remain a “distant goal” without customer awareness and vigilant enforcement, said the RBI panel.

All in all, digital lending is a positive technological upheaval that is inevitable in modern business and banking