Digitalization has driven financial inclusion in India, enabling mass access to savings accounts and digital payments. Yet penetration of credit remains underwhelming. Just 12% of Indians over the age of 15 had borrowed from a formal financial institution prior to 2021--less than half the global average of 28%. Borrowing from formal financial institutions among lower earners is even less frequent, meaning many households have little access to capital for investment that might help them escape poverty and, in turn, support India's long-term economic growth.

S&P Global Ratings expects India's household debt to triple to about US$2.5 trillion by 2030. At the same time, micro loans to lower income earners is democratizing lending and growing faster than overall household debt (see chart 1), though the activity remains peripheral to the lending landscape.

Chart 1

That expansion in lending is underpinned by savings account penetration and a rapid increase in digital transactions, which provide the data required for lenders to make informed underwriting decisions. Meanwhile, improved digital payment infrastructure is supporting lenders' ability to collect payments and reducing barriers to lending-market competition. We expect that will strengthen India's economy and provide growth opportunities for the financial sector.

There are, however, risks for financial sector credit quality. The creditworthiness of the financially excluded and underserved is generally low, which could weaken lenders' asset quality and contribute to increased credit losses. However, the impact on major banks should be small due to their still-limited exposure to this riskier lending activity.

India's JAM Trinity Has Driven Financial Inclusion

The transformation of India's savings landscape, and the prospects for lending growth, are underpinned by three key elements, dubbed JAM (Jan Dhan-Aadhaar-Mobile). They are:

Pradhan Mantri Jan Dhan Yojana (Jan Dhan or PMJDY),  the Indian government's financial inclusion plan, which envisages at least one basic banking account per household, improved financial literacy, and access to credit, insurance, and pension facilities. Launched in 2014, PMJDY accounts are now about 23% of India's total savings accounts by number.

Aadhaar,  a biometric-based National identification number issued to residents of India. Aadhar is at the center of India Stack, the digital infrastructure that has enabled financial inclusion (see the box below for more details: "How India Stack Revolutionized Digital Services").

Mobile penetration,  which has increased significantly and rapidly in India, such that about 81% of the population (or 1.14 billion people) have a mobile cellular subscription, including about 800 million smartphone users with cheap data costs, at about $0.16 per gigabyte. Meanwhile, Unstructured Supplementary Service Data enables Indians without internet access to use text-based menus to check balances, transfer funds, and generate mini statements.

No Frills Savings Accounts: Low Growth And Lacking Competition

PMJDY accounts have proven popular with the underbanked but have provoked little competition among providers. The accounts hold only 3% of India's total savings despite comprising 23% of total accounts by numbers. Furthermore, growth in the accounts has plateaued, with 77% of the population, age 15 years and over, already onboarded, while 15% of accounts are inactive. In 2023, PMJDY deposit growth lagged overall growth in savings accounts. However, we anticipate a gradual increase in total savings in PMJDY accounts as incomes rise and with increased emphasis on, and adoption of, digital payments.

India's public sector banks and regional rural banks hold about 97% of all PMJDY deposits, reflecting their social role as providers of services to smaller population centers and the economically disadvantaged. Private sector banks' miniscule share of PMJDY deposits reflects the absence of competition in the sector (see chart 2).

Chart 2

Savings And Digital Payments: A Bridge To Credit

While no-frills savings accounts may have proven of limited interest to India's private sector banks, the growing market for small loans is attracting attention of both the banks and finance companies, leading to competition and market expansion.

PMJDY's success has paved the way for retail credit growth by formalizing an increased share of economic activity. Access to basic financial services has, and should continue to, promote savings, improve personal financial stability, encourage financial planning, and familiarize the public with financial products. Those factors also provide the foundation for credit growth (and collateral for some types of loans).

Meanwhile, increased flows of digital data (including payments, account-aggregator data, and social data) complement comprehensive credit bureau data, providing opportunities to improve credit underwriting. About 72% of micro, small, and medium enterprises (MSMEs) transact digitally, according to India Brand Equity Foundation, facilitating new products including invoice-based overdraft facilities and small-ticket personal loans.

Technology will also reduce operational costs (notably linked to cash collection) while potentially reducing barriers to entry and encouraging new competition . For example, digital repayments by microfinance borrowers accounted for 13% of total retail debt repayments in 2022, up from 5% in 2019, according to NPCI. That should continue to increase, including due to improved technology solutions such as Bharat Pay, which provides automated reconciliation with micro finance institutions' (MFIs) loan-management systems.

Social data, employment history, and broader online habits, are also being used to provide insights into a borrower's financial habits and risk profile and should facilitate credit underwriting.

Retail Credit Penetration Is Poised For Robust Expansion

We expect a combination of supportive demand and supply dynamics to increase retail credit penetration in India. Demand will be driven by strong economic growth, urbanization, and favorable demographics that should increase purchasing of houses, vehicles, and consumer durables (see chart 3). At the same time, improved access to credit, coupled with lower interest rates, should encourage borrowing.

That combination underpins our forecast that the total value of India's retail credit will almost triple over the next seven years, to about $2.5 trillion by 2030, equating to a household debt to GDP (excluding agriculture and SMEs) of 34%, up from the current 23.8%. That increase would come after retail lending doubled over the past five years, despite slower growth in some years due to COVID-19 related disruptions.

Chart 3

We expect the growth in lending to be partially driven by increased credit to lower-income and underbanked sections of society. That should deliver benefits, including greater financial security and improved standards of living, for poorer people and ultimately benefit the wider population through greater social stability, diminished political risks, and increased economic growth and stability.

The Private Sector Is Driving Growth In More Lucrative Lending

Tech-savvy private sector banks and finance companies are leading the growth in retail lending. Finance companies are the dominant player in mass market loans, accounting for 70% to 85% of loan origination for commercial vehicles, small ticket personal loans, consumer durables, and two-wheel vehicles. Additionally, finance companies had a market share of about 40% in affordable-housing loans, as of September 2022 (see chart 4).

Chart 4

Finance companies and small finance banks are, collectively, also leaders in the micro finance segment, which is playing a key role in improving financial inclusion for India's unbanked and underbanked. The total value of micro loans has grown at a compound annual growth rate (CAGR) of 18% for the last three years and now accounts for about 2% of total loans, according to Equifax figures. India's micro-loan borrowers have an average Indian rupee 35,156 (about $400) of borrowing according to National Bank For Agriculture And Rural Development. In 2021, the Reserve Bank of India (RBI) provided freedom to set interest rates for microloans when it lifted an interest rate cap of 24%. The higher rates are sufficient to provide a reasonable profit margin, even accounting for higher operational costs and credit losses in the subsector, and have encouraged lenders to enter the market (see chart 5).

Chart 5

The Expansion Of Lending Comes With Risks

Low-income earners are more vulnerable to economic downturn. For instance, about 9.1% of India's micro loans were 180 or more days past due, as of December 2023. Likewise, about 5.4% of small ticket personal loans, which are more common with low-income earners, were over 90 days past due. This contrasts poorly against the overall nonperforming loan ratio of 1.6% for all retail loans (see table 1).

Table 1

Higher delinquencies among small-ticket personal loans, and concerns surrounding the rapid growth in unsecured personal loans (excluding micro loans) prompted the RBI to impose, in 2023, a higher risk weighting on unsecured personal loans. The resulting increase in capital required to meet reserve requirements for unsecured personal loans, is likely to weigh on the growth of credit available to lower earners. Banks have low exposure to high-risk unsecured loans of less than INR 50,000, which account for just 0.4% of total retail lending by value.

Despite the caution, we expect continued growth in lending to low-income and mass-market sectors. Micro loans alone will account for about 7% of household debt by March 31, 2031, up from 5.5% as of March 2024.

That financial inclusion will come with greater-than-usual costs for lenders, but it appears to be a burden that private finance companies are willing to bare. If they can prove the business case for lending to lower-income sectors, we expect top-tier banks and finance companies will increasingly target lower-income markets, further boosting financial inclusion to the benefit of all of India.

Writer: Paul Whitfield