How Zerodha is reinventing the rules of lending with an age-old product

The country’s third-largest brokerage Zerodha has received a lending licence from the RBI, and is now gearing up to launch operations by June end.

Loan against a security, be it a movable or immovable asset, is an age-old practice. While banks have traditionally occupied the largest piece of the lending pie in this space, there are others like non-banking finance companies that are also establishing themselves.

Loans against shares have been a popular product in the retail category, but of late, these loans seen some degrowth. Clocking a growth rate of 21.5 percent in FY2015, the growth of loans against shares grew by 16.5 percent in FY2017, according to the RBI Bulletin.

However, it saw some recovery, posting a growth of 17 percent in the year ended March 2018 with an outstanding loan book of 5,600 crore.

Now, the category has a new entrant.

Come June end and Zerodha, the country’s third-largest brokerage in terms of active users, will launch lending against collateral. The company received a lending licence from the RBI in March.

Zerodha Founder Nithin Kamath says the category almost looked like an obvious choice for the brokerage, and called it a ‘natural extension’.

“The opportunity we have is that as we have grown our business over time, and the holdings of our customers have also grown. So, with lending against shares, we do not have to handle individual credit risk of the customer, but focus on the health of the overall portfolio, which is our business as a broker. Hence, a natural extension.”

Zerodha handles close to $2 billion in client holdings on its platform. Another fact which works in the company's favour is the cost of loans.

With customers already on the platform, customer acquisition costs are minimal, also considering onboarding and digital signatures are handled right when the customer wants to trade on the platform. Further, a collateral further reduces risk, allowing the platform to give a competent interest rate of 12-13 percent, as opposed to the industry average of 23 percent for collateral-free loans.

“Banks will not pitch you a collateral credit product unless you have close to Rs 50 lakh worth of collateral with them. But in Zerodha we want to take that collateral to a much lesser amount,” adds Nithin.

Zerodha claims that close to 3.5 lakh customers keep coming back to its platform to see the value of their portfolio, which is an active opportunity to push credit. The company is also betting big on convenience for the success of the product.

With client data in place, and a good understanding of the collateral held on the platform, loans can be availed on Zerodha with just a click.

The company's foray into this space is also particularly interesting as no other startup player has experimented with this model. Apart from banks, the only other player working on this model is Sharekhan.

Digital NBFC players like Lendingkart and Capital Float have over $400 million in debt and equity capital and have kept to unsecured business loans.

The mutual fund bet

There is another advantage here as well. Not only shares, but mutual fund units held on the Zerodha platform can be can be used as collateral.

Zerodha had launched its direct mutual fund platform Coin in March 2017, and it has close to Rs 1,100 crore in assets under management at present. Since mutual funds offer a diverse stock portfolio, the risks are balanced out and consumers can get a higher amount of credit, making it safer for the platform, and more lucrative for the customer.

“Lending against a single stock is obviously riskier as compared to lending against a mutual fund, which already has a basket of 25 stocks. Further, mutual funds are held longer by an investor,” adds Nithin.

While borrowing, a pledge will be marked against mutual fund units or shares, and the borrower cannot sell them until the loan is repaid. Nithin says the effort is to get as many people to take loans against mutual funds as possible, followed by the top 15 pedigree stocks held by the borrower on Zerodha.

What would the action be on the ticket sizes of the loans?

Nithin says he expects most of the borrowings to be under Rs 10 lakh, and the platform will see most demand for loans of Rs 1 lakh - Rs 2 lakh. 

Non-payment woes

For Zerodha, what matters is the portfolio risk. Nithin says if a customer continuously fails to pay interest for a month or more, the portfolio will automatically be liquidated with an intimation.

“The strength of the model is that the customer has a pledge with us, just like a Gold loan. We only have to worry about the value of the portfolio. The credit risk engine is checking the value of the holdings and the borrowing taken against it. So, in the worst case, we liquidate the portfolio and cover the risk if the value of the portfolio deteriorates more than the borrowing,” adds Nithin.

Therefore, mutual funds units become a lucrative option, where, according to Nithin, the value of the portfolio can fall up to two percent on bad days.

There, however, remains a high risk given cases such as the Nirav Modi scam hit share prices, like was seen in the case of Geetanjali Jewels. “Even if we liquidate those stocks, there are no buyers in the market for such stocks. So, you are stuck with them and these can possibly become NPAs. But as an NBFC, we can take legal recourse,” adds Nithin.

According to the Reserve Bank of India's directive, a maximum of 50 percent cash can be lent against shares, and lenders need to keep a strict check on the rating of stocks against which the institutions are lending.

The idea, he says, is to keep the ticket sizes small.

The company is looking to make a spread of 3-4 percent on average per loan. Further, the company expects to lend out Rs 2000 crore over the next two fiscals. 

Will Zerodha be able to scale this up?

Over the last one year, Zerodha has added close to 75,000 users on Coin, with only five percent coming exclusively to buy mutual fund units. Considering Zerodha’s base of 8 lakh trading accounts, this growth seems a bit conservative.

And Nithin is cognisant,

“Close to 70 percent of our customer base might be having mutual funds. But the numbers do not reflect on our platform. The challenge is because users do not understand the benefit of investing in mutual funds directly. We believe that there will be a tipping point. Once 150,000 Indians understand the real benefits, then products in the market will pick up due to the network effect.”

One of the biggest financial players in the market, Paytm, also seems to be gearing up to take this challenge, especially after receiving approval from Sebi (Securities and Exchange Board of India) for its investment arm, Paytm Money.

For loans against shares and securities, Zerodha may be faced with challenges of customer education. What, however, will work for Zerodha is the rate at which it is adding new accounts every month. Nithin says the brokerage adds 50,000 – 70,000 new accounts every month, half of which are first-timers.

The platform has 576,319 active users on Zerodha. This is the target pool for Zerodha to fly its lending product. There are other factors too that might help catch customers' attention.

The RBI has capped loans against shares given by banks at Rs 20 lakh for retail customers and this has led them to not go aggressive on the segment. These restrictions, though, do not apply for NBFCs.

In March last year, HDFC Bank launched a digital Loan against Securities (LAS) product, allowing customers to avail a loan in less than three minutes. During the launch, the bank had pegged its interest rates at around 10.5 percent.

Will Zerodha look at collateral-free loans and move towards other lending categories?

Nithin denies any such plans. Further, as he puts it, unlike other NBFC businesses, he does not have to worry about raising more funds, which is important for lenders, keeping the business asset light.

Concluding, he jokes,

“A niche lending product, where we have expertise, at least helps you sleep better in the night.”

Zerodha, however, does not deny considering P2P lending as an option in the future.