Away from local loan sharks, these startups are changing how rural India borrows

The world of finance in India’s hinterland was quite different in the 2010s.

The ubiquitous QR codes that have become the norm even in the deeper pockets of the country’s rural belt had not taken off. Fintech players catering to this category of customers were coming up, but the segment was, and still is, too big for a handful of startups to cater to.

“Back then, the only alternative to microfinance available to them was local money lenders, who charged high rates,” says Rahul Chandra, managing director, Arkam Ventures, who had started investing in the rural credit space back in 2010.

Cut to 2024.

Credit literacy has improved. So, there are more borrowers from rural India with credit scores, making it easier for the ecosystem to assess their credit behaviour.

According to Nitin Agrawal, co-founder & CEO, Navadhan Capital, which lends to farmers and small businesses, improved smartphone and Internet penetration in the rural areas, combined with the UPI stack, had been a game changer.

Compounding it with incentives from the government to make credit access easier, there is a huge market that has opened which companies such as Navadhan Capital, SarvaGram, and others are trying to tap into.

Case in point is the loans disbursed to small businesses and farmers that has seen significant jump in the last few years as illustrated in the graphic below.

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While the market opportunity is expanding, the segment is also facing several challenges from the regulators and tough macroeconomic conditions.

ET Prime spoke to founders and investors to understand what is working for these startups and their biggest challenges.

One for the rural

It takes a separate breed of people, mostly veteran bankers and those worked in the financial-services space, to subject themselves to the tough task of building a lending business that focuses on rural India.

Over the last few years, as technological shifts brought more rural Indians online, this section of population was also aspiring more. That meant that just like urban centres, the region needed newer companies and business models that can satisfy the needs.

“That is how SarvaGram happened,” says Utpal Isser, co-founder, SarvaGram, a rural credit startup that recently raised USD67 million from Peak XV and others. Isser started SarvaGram in 2018 after working in rural and inclusive banking at the ICICI Bank for 18 years.

Instead of focusing on an individual or a business, SarvaGram looks at households as a unit, which includes cattle, labour, businesses, and agricultural produce considering that there are multiple sources of revenue streams. SarvaGram measures net surplus of each household and helps with interventions such as loans, farm mechanisation or other financial products to improve its income or productivity as Isser calls it.

The company has deployed a significant number of people to engage with its customer base in the rural pockets. Majority of SarvaGram customers are farmers.

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Then there are small businesses. Take Mohit Sahney, co-founder and CEO, Finova Capital, which he started in 2016. Having worked across roles including rural banking in ICICI Bank for over 15 years, he wanted to focus on solving credit access to the micro, small and medium enterprises (MSMEs). According to the company, there is an unmet gap of INR3 lakh crore presenting a significant opportunity to grow.

Navadhan Capital, too, was started in a similar vein. Its CEO Agrawal, who was cited earlier, says that after working in the banking and financial space for about 25 years, he found that the small businesses in the rural segment continued to be underbanked and did not get credit facilities. This becomes challenging for medium businesses in the region that need larger loans and do not get help from microfinance institutions despite the proliferation.

“We started with the view that we wanted to help these businesses with access to credit,” he tells ET Prime.

Both Finova and Navadhan have deployed technology-led solutions to assess the credit quality of customers, tight controls over loans disbursed, and diversified loan base for risk mitigation.

But despite all these safeguards, rural lending is largely unpredictable.

Navigating the challengesArkam’s Chandra says that one of the biggest challenges when it comes to rural lending is assessing borrowers’ income to check their ability to repay.

Unlike the urban regions, where majority of the borrowers are salaried with income proofs, Chandra said that in rural markets, income is a sum of various small streams making underwriting a challenging process.

In addition, as most of the rural market depends on agriculture, the vagaries of climate change also have an impact.

Chandra, who is also an investor in Agrifinance startup JaiKisan, said that the startup is going for a data-led assessment, where it is aggregating farm-level data including crop, weather, region, farmer history to assess the expected income generation. For instance, the company gives loans for buying seeds and fertilizers that are used for farming. “The general idea is to give credit for productive use of purchase and not for consumption,” he added.

In the case of SarvaGram, Chinmaya Golecha, principal, Peak XV Partners, which led the latest funding round in the startup, says the company requires at least three diverse incomes for a household to be eligible for the loan. In addition, Isser says that it is also important to assess the intent of the household based on their track record and their interaction with them for selection. The company has deployed a significant workforce on ground to engage with the customers.

Finova’s Sahney says the company has created over 40 templates for various businesses such as kirana stores, tea stalls to appraise the potential customer of various criteria before disbursing loans. There is also a huge focus on referencing. “If an individual business has a credit score, we look at that. In the absence of that, we send a credit manager from our end to visit the customers’ place to assess their ability to pay back the loans,” he adds.

This is one part of the problem. The other challenge is external which comes from the regulatory concerns and weak macroeconomic conditions that affect rural India.

External factors

Macroeconomic conditions and rising inflation have impacted rural lending with microfinance institutions and banks have seen rising loan defaults and decline in growth.

These are likely to impact startups as well. Finova’s Sahney says that FY24 has been largely muted. While loans defaults in this business are inevitable, the company has diversified its base. “Close to 40%-43% of our customers are new credit payers, which expands our base,” he adds.

After the rise in the unsecured lending boom in the last two years, the Reserve Bank of India has increased scrutiny in the lending space. Most of the rural credit startups ET Prime spoke to shared that this has not affected their business. Agrawal of Navadhan Capital says that this is a positive for companies that are playing by the book, as it will clean up those who do not follow the rules.

One of the investors in a rural-credit startup, on the condition of anonymity, says that while the developments have not impacted the rural credit firms in its portfolio, it is likely to impact newer startups coming up in this space. “With the regulator it is always either white or black, there is no grey in between,” the investor says.

The last word

If the latest developments are anything to go by, there is enough interest in the rural space. There is always higher risk considering the climate-related challenges and the lack of stable incomes in the region.

Peak XV Partners’ Golecha says, “I don’t think there is any doubt that the fact that the last 12-24 months have made a huge difference. What we have seen is that they have some purchasing power now and (rural) have become flatter. The market is riper today than we thought maybe three-five years ago,” he adds.