Payday Loans: As Startups Target Young India, Are These Loans Worth It?

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The concept of payday loan was very popular in developed countries where the lender gave loans that were given before the next paycheck to blue collar workers who led their lives from paycheck to paycheck.

Some time ago payday loans were used by blue collar workers who received their wages on a weekly basis. Recently, many start-ups have embarked on this activity targeting the young, highly mobile and aspiring population. Let us discuss the merits and limitations of availing such a loan.

Understanding the payday loan
The concept of payday loan was very popular in developed countries where the lender gave loans that were given before the next paycheck to blue collar workers who led their lives from paycheck to paycheck. The interest charged on these loans was generally higher because they are unsecured.

The same concept is presented in a new form and sold to a different set of customers now. In India, many start-ups are now offering payday loans to the young and aspiring population.

Potential market

According to some market research agencies, the payday loan market in India is estimated at 70,000 crore and is expected to grow at the rate of 14% per year. About a hundred start-ups have already entered this market over the past 18 months. Banks never lend money for 7 to 15 days and it is not profitable for them to offer low value loans of R 10,000 to R 30,000. The credit card option comes with a higher interest rate, especially if money is withdrawn from the card.

Hoit works?
Targeted customers are typically young people who are looking for funds to buy the latest cell phone or finance a short vacation, tuition, or unexpected expenses towards the end of the month. The typical loan size is R10,000 to R30,000. The loans must be applied online and are approved and sanctioned within five to ten days.

Start-ups use technology to assess loan eligibility, amount, interest rate, etc. They even check your social media profile, comments, status, timeline, number of followers, and more. The typical interest rate is one percent per day. The primary collateral is the next month’s salary and the loan must be repaid on the next paycheck.

Is this a possible trap?
A major concern in this model is the flat rate interest rate which could potentially impact the borrower if they are not careful. The majority of payday loan providers do not have a non-bank license but have links with other non-bank finance companies for loan disbursement. At present, there are not too many legal regulations for lending through electronic platforms. In conclusion, disruptive technological innovations should not lead to irrational enthusiasm for credit.

The writer is associate professor of finance and accounting, IIM Shillong

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