Traditionally, lending in India has remained hard-coded to analysing borrowers’ credit scores and repayment histories to assess their eligibility to avail a loan. It worked effortlessly for borrowers with visible financial footprints. Still, it left millions outside the formal credit system- not because they could not repay, but because they lacked a documented financial history.
The landscape has shifted significantly in recent years. With India strongly building world-leading digital public infrastructure, the lending sector is moving beyond traditional credit models by adopting a more data-driven and inclusive approach to assess risk than offering credit traditionally.
More than a technological shift, the approach helps recognise financial behaviour in all its forms and extends formal credit to individuals and businesses that remained unserved due to the conventional underwriting models.
The transformation has paved a strong path for Non-Banking Financial Companies (NBFCs), Housing Finance Companies (HFCs), and Microfinance Institutions (MFIs), all of which serve customers for whom traditional credit assessment remained wary.
The NBFC sector’s journey – From scale to sophistication
In a little over a decade, the NBFC sector has witnessed a boom like never before in India’s financial services sector. In 2010-11, India was home to 12,000 registered NBFCs, yet digital lending was still in its infancy. During this period, operations were almost entirely manual and heavily reliant on physical documentation, with credit bureau scores serving as the primary metric for lending decisions
Loan applications moved through multiple layers of paperwork, physical verification, and manual underwriting. While the sector was expanding, the operating model remained largely unchanged. More importantly, access to formal credit was still restricted to a relatively small section of the population with documented income and credit histories.
By 2014, the sector had certainly grown in size, but not necessarily in capability. Lending volumes increased, yet underwriting continued to rely on the same conventional parameters. The financial ecosystem was serving larger numbers, but it had not fundamentally addressed the country’s enormous credit access gap.
The IL&FS crisis in 2018 served as a strong reminder of regulatory surveillance. The dried-up liquidity indicated that the sector should declare age-old practices obsolete and discontinue them. Governance standards improved, and several weaker players either consolidated or exited the market.
Currently, India has close to 9,000 NBFCs managing assets close to ₹38–40 lakh crore. Essentially, the new-age institutions have leveraged technology to serve diverse, underserved customer profiles that traditional banking and lending institutions couldn’t serve. Digital underwriting, automated risk assessment, and real-time data analysis have fundamentally strengthened the viability of the NBFCs in the current times.
The limitations of traditional credit scores
Credit bureau scores remain valuable. They provide a reliable summary of an individual’s historical borrowing behaviour and continue to play an important role in risk assessment. However, they were never designed to solve India’s financial inclusion challenge.
Only around 300 to 350 million Indians have a meaningful credit bureau history. It translates into a larger population of 500 million people remaining excluded from having access to a formal credit channel. Most of them actively participate in the economy through incomes, payments, running businesses and managing household finances, but poor financial discipline/lack of credit history keeps them “Credit Invisible” for the traditional lenders.
A credit score is, by design, a reflection of past borrowing behaviour. It functions much like a rearview mirror – valuable for understanding where someone has been, but less effective at predicting the financial potential of individuals entering the formal credit ecosystem for the first time.
The rise of alternative risk assessment
Lending in the coming times will assess financial behaviour instead of depending on historical credit data of the borrowers. Digitisation of the sector is aiding lenders with improved evaluation of borrowers’ profiles, which, using multiple indicators, virtually provides a detailed, all-inclusive picture of repayment capacity.
Moreover, UPI transaction behaviour, GST filings in case of MSMEs, bank statements, and digitally verified financial records have become dominant alternative sources for lenders to evaluate borrower profiles. Instead of depending on a single numerical credit score, lenders can evaluate a borrower’s actual financial activity through these channels. Unlike traditional scorecards that remain relatively static, modern models continuously learn from new repayment behaviour, identify emerging risk patterns and adapt to changing market conditions.
HFCs and MFIs are arriving at the same conclusion
Perhaps the strongest validation of alternative risk assessment comes from sectors whose customer base has always existed outside traditional lending frameworks.
Housing Finance Companies (HFCs) offer a strong example of this shift. Since coming under the Reserve Bank of India’s regulatory framework in 2022, many HFCs have expanded deeper into Tier 2 and 3 cities through digital and virtual operations. Their customer base often includes shop owners, artisans, small traders, and self-employed individuals working in informal setups with irregular incomes and limited documentation. As a result, traditional bureau-led assessments frequently fail to capture their actual repayment capacity.
To bridge this gap, HFCs and NBFCs are increasingly turning to alternative data points such as cash-flow patterns, banking behaviour, and transaction histories alongside bureau scores to assess creditworthiness more accurately.
Microfinance Institutions have experienced a similar evolution. The Andhra Pradesh microfinance crisis in 2010 led the sector to transform on the back of noteworthy reforms, including governance, customer protection, and mindful lending. While HFCs and MFIs operate in different lending segments, both have reached the same conclusion – conventional credit assessment alone cannot adequately evaluate customers operating within India’s informal economy.
Innovation must remain responsible
As lending becomes increasingly data-driven, the conversation naturally extends beyond technology toward trust. More data does not automatically translate into improved lending decisions. The quality of underwriting ultimately depends on how responsibly that data is collected, interpreted, and applied.
With rising automated underwritings with institutions leveraging Machine Learning, India’s regulatory approach is bringing balance to avert any unintended bias by the models. RBI’s digital lending guidelines bolster customer protection, while the Digital Personal Data Protection Act highlights the crucial framework that focuses on consent, data privacy, and its accountable usage.
Looking ahead
Digital public infrastructure, consent-based data sharing, advanced analytics, and progressive regulation have integrally helped the Indian credit system to attain new heights, even outpacing systems in more developed economies. Only a handful of countries have a strong combination of access to data, including digital payments, financial identity, data-sharing frameworks, and technology adoption that now exists across India’s financial sector.
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With such an alternative, non-credit data framework in place that is continuously expanding, combined with India’s incredible AI talent, digital NBFCs are becoming primary catalysts for credit penetration into the country’s previously underserved populations. By leveraging Digital Public Infrastructure (DPI) and AI-driven underwriting, these tech-forward institutions enrich credit history data by converting alternative data into highly precise risk signals. This capability allows them to outpace traditional banks in rapid credit delivery and spearhead powerful partnerships. Ultimately, while balancing aggressive market growth with strict RBI compliance remains a critical challenge, the tech prowess of these digital NBFCs to sustainably underwrite “thin-file” customers is set to significantly reshape financial inclusion.
Views expressed by: Sharath Pareddy, India Head of Credit, Branch International
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