Payday lending is an unsecured loan of a small amount of money with a very short payback period, and the payback is usually deducted from the next paycheck of the individual. People would largely take these loans to meet financial commitments like paying for car insurance, etc. The financial commitments for an individual seeking payday loans typically do not have enough cash available, but there is a fixed date for paying out the commitments. The individual is confident that if he/she takes a loan to pay-off the immediate financial needs, he/she would be able to pay the same back from his/her next paycheck. Payday lenders usually in most of the cases verify that the person is employed and is expected to get a next paycheck.
The process in a traditional set-up works with an individual visiting a payday lender and getting a cash amount as a payday loan. In return, the customer gives a post-dated check to the lender. At the decided date and time—usually, within a month’s time—the borrower pays back the money and takes his/her check back from the lender. But in case the borrower is not able to pay the loan back in time, then the lender cashes the check and then goes after the borrower for the interest payment. In the digital age, the same is done by the borrower applying through online channels, and then the lender crediting the borrower’s account with the said amount. On the due date, borrower’s account is debited with the amount equivalent to the borrowed amount or the predecided EMI amount. The average borrower for payday loans according to a study by leading analysts is indebted for about half of the year. Payday loans are usually availed by the low-income and unbanked persons to meet their living expenses and the interest rate charged by traditional lenders is usually very high and could range from 30% to 50% annual percentage rates (APRs). There are country-specific regulations to limit the interest that can be charged for low-income and unbanked persons, but more often than not, it is the informal agents that are making such lending expensive and in turn, making the low-income communities poorer.
Though interest rates for most payday loans may seem extraordinarily high, studies have proven that the average payday lender is making less profit margins than players in the traditional lending space. Less profits can be attributed to high operational costs involved and high default rates involved in the entire business. The high operational cost is also because of multiple entities involved. Though pawnshops and credit unions have tried to make new avenues available for most of the payday borrowers, the success has been mixed. Some of the large banks and FIs tried entering into payday loans using multiple channels including SMS text from mobile phones, but owing to regulatory pressure, have scaled back their operations. A large U.S. bank also offers its version of payday loans. It is a service that works primarily on the same principle as payday loans with a substantial high interest rate.
Besides credit unions, there are FinTechs around the world that are transform-ing the payday lending space through multiple different propositions. The P2P lending platforms described earlier has also been actively used by payday borrowers and lenders. Additionally, the entire arrangement for payday lending has been made simple and is more convenient for anybody to now become a payday lender. With increased lender availability and low default rates owing to proprietary AI-driven algorithms, the overall operation costs have also come down. This is enabling most of these lending companies to charge lower interest rates, thus making the entire proposition financially appealing for most of the stakeholders.
A large number of payday lending FinTechs are disrupting the entire lending industry through some of the alternative business models mentioned below.
- Since payday lending involves lending to people who are not able to save enough money to address financial contingencies until he/she receives their next paycheck, the traditional credit scoring mechanisms to identify the cred-itworthiness of an individual is not very helpful. A large number of FinTechs have therefore built their own proprietary risk assessment platforms that ana-lyze the profiles of customers who have defaulted in the past and accordingly indicate the probability of default by the applicant (borrower). The profiles of customers are also analyzed by enriching the same with inputs from traditional credit scoring mechanisms as well as from social media. These FinTechs use data available for processing to predict the repayment capa-bilities of the borrowers. Some of the FinTechs have been able to achieve a 90% accuracy with their platforms and have had the highest repayment rates even during the peak of the financial crisis. Consequent to low default rates, these FinTechs have been able to manage profitably even with increased loan applications.
- A large number of these FinTech targets are tech-savvy young professionals who are salaried and have a decent payback capability. These people earlier were borrowing from banks and did not have enough money available on their credit card balances as well. The main need for borrowing was to pay-back an unexpected bill or a financial emergency.
- Some of the other FinTech companies are using machine-learning algorithms to underwrite customers like millennials. The traditional underwriting sys-tems, owing to millennials not having good credit scores, would have not qualified them for a loan. These platforms, built for creditworthy payday bor-rowers, has now evolved as one of the standards for credit ratings. FinTechs are making these platforms available to others through APIs for using the same in their lending systems. Consequently, these FinTechs have been quite successful in partnering around the globe with banks and FIs to provide credit scores for borrowers, especially for the short-term borrowers with no credit scores, but having a better repayment capability.
- One of the alternative business models some of the other FinTechs are adopt-ing is to allow anyone to borrow from them as long as they have a checking account with their employer. The salaries are typically paid at the end of the month. They enable a borrower to withdraw his/her accrued income for that month to pay for a short-term emergency before their actual pay arrives at months end. The entire process is similar to any payday lender, but what makes it interesting is this mechanism does not require any credit checks nor needs sophisticated machine-learning capabilities to assess the repayment capability of the borrower. Since the salary account is available to the lender to withdraw money automatically, the chances of default are also very low. Some of the FinTechs have made this more interesting by not charging any fees for the loan, but instead run through voluntary donations or tips. Since this helps the salaried community a lot, they are more than willing to give a donation or tip to such a service.
A payday lending firm named Kadki is revolutionizing the payday lending space. Kadki is a company based in Pune, India that bridges small finance require-ments for individuals. Kadki was started by young entrepreneurs who were primarily doing informal P2P lending to their friends and family. Soon they realized that there were lot of young salaried individuals who wanted an easy way of borrowing and refunding, to bridge their expenses until the months end. Therefore, Kadki helps such borrowers provide payday loans to these individu-als. The customers who were earlier borrowing from friends and family now do not have to take these loans, and instead can borrow using the Kadki platform. A customer usually gives a request by providing very basic information through Kadki’s website. representatives, then contact these individuals and then the loan application procedure begins. The service-level agreement (SLA) for Kadki representative is to complete the loan application process, verify the process and credit the requester’s account in 48 hours. The overall processes are paperless and very quick. They approve/disapprove loans based on the repayment capability of the individual and evaluating related factors like employment records, etc. In comparison, the established banks
and lenders in India would typically take
about a week to deliver personal loans. If one wants to borrow smaller amounts, usually the effort is not worth it. These are one of the many reasons they have been quite popular (Source: www.kadki.in).