Home collateral Jack Ma’s point on unsecured loans is relevant in India

Jack Ma’s point on unsecured loans is relevant in India


I recently read Jack Ma’s speech at the Bund Finance Summit in October 2020. It was shared by the Marcellus Investment Managers team in their newsletter. The speech is now believed to have sparked a series of events, starting with the cancellation of an initial public offering by Ma’s Ant Financial, which led to the Chinese government’s ongoing crackdown on internet companies. However, beyond the political impact, some points Ma raised about digital finance during her speech are worth reading in the context of the advances in Indian digital finance in recent years.

Ma threw firebombs on traditional financial architecture. One of his targets is what he evocatively describes as the collateral-based ‘pawnshop mentality’ of established banks that was necessary for their development but now conflicts with new possibilities. loan forms. One part deserves to be cited in full. : “Collateralization with a pawnshop mentality is not going to support the world’s development finance needs over the next 30 years. We need to replace this pawnshop mentality with a credit-based system rooted in Big Data using today’s technological capabilities.This credit-based system is not built on traditional IT, not a relationship-oriented society, but must be built on big data, so that credit is really equal to wealth. Even the beggar must have some credit; without credit you can’t even beg for food. I think every beggar is (can be) creditworthy. “

These remarks about the need to move from a collateral-based lending system to a big data-based system resonate at a time when India has inaugurated an aggregator system, which its enthusiasts say will help businesses. small businesses with inadequate collateral or a credit history to access credit. at rates well below what they are currently doing. Account aggregators working through a secure public credit registry can do for credit what United Payments Interface (UPI) has done for retail payments in India.

A lot of research shows that small businesses pay much higher interest rates than their default rates expect, and that’s when they can access any form of credit. By relaxing these credit constraints, the account aggregation system has the potential to shift from asset-based lending to cash-flow-based lending, at least to small businesses that have a digital and tax footprint. Lenders can access data on bank statements, GST returns, personal expenses, etc.

There are two broader macro questions to focus on in these new forms of lending. First, can cash flow-based loans overcome what Tim Besley and Maitreesh Ghatak of the London School of Economics called the “De Soto effect”? The reference is to a famous argument by Peruvian economist Hernando De Soto that the world’s poor working in tiny informal businesses are in fact excluded from the formal credit system, and therefore doomed to live in poverty, due to a lack of clear property rights. makes it difficult for them to offer their land assets as collateral to banks.

A woman living in a slum without formal land title must therefore depend on informal sources of money which leaves her little to reinvest in the business. It is highly likely that a successful transition to lending based on borrowers’ cash flows will alleviate the pervasive credit constraints on informal businesses. Of course, this still leaves the question of the sanctity of credit agreements unanswered. Even lenders with rich small business cash flow data will need to make sure they can get money back in the event of a default.

Second, can the new credit system change the dynamics of structural transformation in India, or the way people migrate from low productivity to high productivity activities? This can happen in two ways: one by closing the global productivity gap and the other by closing the domestic productivity gap. The first is the classic pattern observed when people trapped in farms or informal enterprises are employed in large enterprises. This transition has been common in much of Asia east of our borders, but such labor-intensive industrialization has so far not been enough to absorb the surplus labor. work of India.

The second path is when informal enterprises gain momentum while closing their productivity gap with large enterprises in the organized sector. Such a shift from informal to formal is not easy (see Cafe Economics, April 26, 2017, bit.ly/39l7ebY), but is now part of the national conversation on the late formalization of the Indian economy. Credit constraints are among the reasons small businesses fail to grow in India, although there is also the hard truth that all neighborhood businesses – many of which are a form of struggling entrepreneurship – cannot survive the transition even if their borrowing costs go down. . The opportunities offered by cash flow based loans can have a profound influence on alleviating some of the constraints on the small businesses that employ most of the Indians who have given up farming.

Niranjan Rajadhyaksha is a member of the Academic Council of the Meghnad Desai Academy of Economics

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