India needs more lending — but not to everyone

By Mihir Sharma

Indians are justifiably proud of how easy it has become for them to pay for stuff. If you have an Indian phone number and bank account, instant digital transactions are fairly seamless. Now, the Reserve Bank of India wants to expand the country’s unified payments interface, or UPI, to lending: The central bank’s governor has repeatedly promised that a “unified lending interface” will soon be rolled out. That carries great potential — and not a little risk.

India’s model for financial interconnectedness is based around what it calls “digital public infrastructure.” The idea is simple: The government, or a closely regulated quasi-public entity, invests in, manages, and pays for the system through which digital transactions take place. Businesses can create apps that use this infrastructure; interoperability is built in, so those apps must compete on cost and quality rather than on the size of their network.

Consumers can decide how much of their information they are willing to share with specific apps or for specific transactions, and theoretically the seller’s access to private data is neither permanent nor very deep. The Indian IT whizzes who designed the system insist it avoids the worst of the US model (which is fragmented, insecure, and expensive), European systems (which are overregulated, lecture to business, and stifle innovation) and the Chinese network (which does not privilege privacy or allow for accountability to civil society).

Quite a bit of information has been put on India’s UPI, from educational certificates and medical history, to land records. Now that instant payments linked to bank accounts have been in use for years, there’s also a lot of financial data that could be put to work.

At least, that’s what the RBI hopes. Its governor argued that the availability of granular transfer data — as well as tax payments and land records — should make it easier for financial institutions to lend to farmers and small businesses that had previously struggled to access credit.

That task has been a constant headache for India’s financial policymakers. The formal banking system is dominated by the public sector, which lacks much of a profit motive and thus has deeply conservative lending practices.

When the government wants to juice lending, it creates schemes that target specific groups. Then the system switches to the other extreme, handing out cash to anyone and everyone without much discrimination.

That’s risky. Meanwhile, the private sector naturally doesn’t want to make the effort to enter a lending market dominated by borrowers with little access to collateral, minimal documentation, and few formal records.

Now those same borrowers have a paper trail on the various digital platforms that the government secures. Even the amount of milk sold to various cooperatives by individual dairy farmers is on there somewhere.

Getting that information to lenders in a way that incentivizes them to create a business model for small borrowers, while also protecting citizens’ data, is the problem the central bank claims to have solved.

The payoff could be vast. Indian small businesses typically do not grow larger — partly because of constraining regulation, but also because of differential access to credit. India’s unproductive agricultural sector, in particular, is short of capital investment and heavily dependent on public finance; it is both credit-hungry and lacks avenues to access cash on demand.

So, what’s the worry? Simply this: the potential impact on Indian household behavior.

Throughout India’s modern economic history, household debt has been pretty low. That’s slowly begun to change. According to the RBI, net household savings are at a 47-year low. In fact, they fell by two whole percentage points of GDP just between 2022 and 2023.

Indian households are stressed and borrowing more. The new system might make it much easier to take out collateral-free loans. The potential for this structural shift to become a macro risk is easy to see.

That isn’t enough of a reason to hold back financial innovation, especially if it might pay dividends in the longer term. But the government needs to be very watchful indeed for unintended consequences.

India has long boasted that its growth model has been led by demand and consumption. If increased consumer spending winds up leading to unsustainable household borrowing patterns, the economy will be in real trouble.