On an unsurprisingly sweltering day in Chennai in May 2018, we took the elevator to the top floor of one of the new high rises in the heart of the city to meet a seed stage startup in financial services. We were early for the meeting but were promptly ushered, first through a sparse and rather enormous foyer and then into a dense maze of conference rooms named after the great football stadiums across the world, finally ending up in a very large conference room appropriately named Camp Nou.
We had known Gaurav and Vineet for close to a decade as brilliant and competent operators from their careers at IFMR but their new startup Vivriti, housed in these sprawling premises was already starting to exhibit an intimidating edge to it. Even before the meeting started, we were already contemplating the symbolism of the countless conference rooms for a company that had just incorporated – from the philosophical: had the founders got ahead of themselves? Are they running multiple businesses?, to the banal: what are rentals like in Chennai? did they pay for the fit-out?
Thankfully, the two hours of sparkling conversation that ensued defused all apprehensions of misplaced founder optimism. In fact, here was a set of founders that could not only “see the matrix” (in the Keanu Reeves sense of the word) of debt markets in India but also had a compelling and audacious plan to transform it.
As an early backer of fintech lending for enterprises in India starting in 2013 with seed investments in companies such as Capital Float and Neogrowth, we had seen game changing products and technologies. At the same time, it made us appreciate the systemic limitations of the financing infrastructure in India and the need for big ecosystem transforming moves – How do you reimagine the ratings market to narrow the gap between rating and creditworthiness? When will bond markets move away from the monoculture of AAA? Who is going to standardize contracts for loans like what ISDA did for derivatives?
Each of these questions was a complex standalone problem in our head but on that warm day in Chennai, Vivriti laid out a blueprint that showed us that they were not just interconnected but tractable – through scalable digital plumbing, disruptive product design and thoughtful interface design. It was an epiphany and one of the rare moments in our investing journey of sharing ‘preternatural coherence’ with someone you meet. I describe this feeling in an earlier article.
After the meeting, we were determined to move fast to get over the line but were still late to join their seed round. When Vivriti came back to the market 12 months later for a fundraise, all we needed was a 45-minute update, this time in their more royal Santiago Bernebeu conference room to reinforce our belief in the model and team. This time we took no chances in putting our best foot forward to invest and our year long journey from ‘Barcelona’ to ‘Madrid’ proved fruitful.
Fast forward 18 months and a testing pandemic, Vivriti has established itself beyond doubt as the undisputed prime mover in reinventing India’s enterprise debt industrial complex with CredAvenue and its Asset Management business, each emerging as important pillars of transformation.
Unlocking a trillion dollars of debt for the enterprises of tomorrow
The debt stack for businesses in India suffers from both size and diversity issues. Not only is our debt market small – credit to GDP ratio is 0.6 vs global average of 1.5 but also is highly skewed towards bank loans and higher rated credits – 75% is bank loans vs. global average of 35%; 68% of bonds are higher rated AAA/AA compared to 7% in the US.
Lending side innovation has historically never been a core focus for banks in India. The low cost of deposits (current and savings accounts) has meant that banks have meaningful interest spreads even on low-risk assets resulting in a highly conservative lending approach focused on secured asset-backed lending and that too with significant risk coverage (can only lend up to say 60% of the asset value). A highly controlled banking license regime and large credit gap even in high rated asset backed companies has further ensured that their decision to stick with conservative lending norms hasn’t slowed down growth.
NBFCs have therefore played a crucial role in innovating on both underwriting and lending operations, be it through technology or social engineering (think microfinance), especially when it came to unsecured lending – a crucial and large need in a service driven economy comprised of asset-light businesses. It is therefore hardly surprising that the NBFC industry has been able to add an incremental $300 billion in assets over the last two decades serving a vital gap in the economy that banks have vacated.
Still, we remain woefully short of credit to unshackle the economic engine of the missing middle of small businesses in India. In number terms, if we need to move to 1x of GDP vs. 0.6 currently, that’s well over a trillion dollars of new debt. Solving this is not just about i) increasing the supply of debt, but also ii) getting the debt stack to match the actual risk stack of enterprises.
On the first, increasing the supply of debt is quite simply, more new capital. Indian debt stock currently is predominantly built up of loans from financial institutions (75% of stock) with bond issuances from corporates constituting a mere 20% (this number in contrast is over 70% in the US). While there is momentum around a number of initiatives to further capitalize the system – more equity flows into NBFCs and banks, bringing unproductive household assets such as gold into the financial system – the big push will need to come from the emergence of a strong and resilient corporate bond market.
On the second, even if we manage to get all this new capital into the system, there is still the complex task of making sure that more of the new debt is actually constituted by the underrepresented higher risk segments vs. more AA credit. Two factors make this a complex problem to solve. First, there is the gap between credit rating (perceived risk of lending) and credit worthiness (real risk), technically referred to as the failure of risk-ordinality in central bank parlance. In lay terms, this refers to financial institutions or capital markets being ill equipped to assess the real risk of lending to small businesses and therefore ending up either pricing the debt too high (indirectly creating more risk) or not making the loan at all.
Second is the problem of distribution – notwithstanding the ability to underwrite the risk of lending to small businesses accurately, can one deliver (discover, fulfil and monitor) the loan or bond at a transaction cost that makes sense?
Solving for the stock of debt capital and effective distribution may seem to be disparate problems but are in fact two sides of the same coin.
Without creating a superior engine to deliver (underwrite, distribute and collect) debt especially for lower rated credits, you can’t really crowd in massive new debt stock in the economy. This is true especially for the development of the bond market – while the dominant narrative is around de-bottlenecking regulation, what really is holding the bond market back is the lack of the cookie cutter to design and deliver these instruments at low cost.
On the flip side, even if you have this engine in place, there is an important proactive effort needed in unlocking a vast pools of new debt capital through active asset management support.
Marrying both of these is the grail to unlocking debt markets. This is Vivriti’s vision for the operating system of debt.
Towards a new operating system of enterprise debt
In the mid 2000s, IFMR in Chennai emerged as the premier laboratory for innovations in financial services space in the country. Not only did they attract and nurture the smartest thought leaders for the financial services industry but were the early vanguards of a now rarified quality of responsible mercantilism - a potent coming together of social impact, intellectual idealism and pragmatic business execution.
From business design to policy frameworks, IFMR did not stop at putting together the cerebral scaffolding but went further, investing significant capital in seeding and scaling a variety of businesses that have since become foundational in enabling both financial innovation and inclusion in the country. To this day, the gang at IFMR (now Dvara), along with the team behind Aadhaar/UPI, represent the most influential set of leaders transforming financial services in India. Companies that have emerged from the IFMR stable (and its alumni) such as Northern Arc, KGFS, Samunnati, Kaleidofin and Vivriti continue to be in the forefront of financial innovation.
Having watched IFMR evolve from close quarters for over a decade, it was clear to us that Gaurav, Vineet and the other co-founders of Vivriti had both the intellectual heft and commercial acumen to build a systemically important business of purpose. What gave us the goosebumps though was the size of the canvas they had chosen to paint on and the velocity with which they were learning to fill it.
While we initially started building Vivriti as a highly efficient and automated transaction discovery/execution platform that is coupled with a strong asset gathering and management platform, it became clear as more of the canvas got painted that there was more that could be unlocked by building these as multiple businesses – businesses that feed into a virtuous cycle towards building the operating ecosystem of fixed income in India. The graphic below describes this approach.
At the centre of the new debt ecosystem is CredAvenue’s operating system; not merely a marketplace or exchange but an OS. This is an important distinction to make, as CA is not just a place for investors and borrowers to transact but also a full-fledged environment to discover, design, fulfil and monitor debt portfolios. In its short period of existence, CA has already become the day-to-day operating environment for top banks and financial institutions to originate and fulfil their targets for products such as securitisation. This kind of dominance is rare to see and is a result of their methodical approach in building distinctiveness in each of the three gears that drive the business: First, onboarding a large enough base of enterprises (over 2,500) as well as lenders/debt-buyers (over 250) to create critical scale of discovery and underwriting. Second, developing a scalable product/underwriting rubric that makes sure that everyone (lenders and borrowers) on the platform is able to find something they need or want that is uniquely available only here. CA already has over a dozen unique products with unprecedented market acceptance that are exclusive to the platform. The end state here is to create an API type environment for bespoke products to be assembled on-the-fly by users. Last and most important is the innovation on the process automation side that CA has delivered. Be it standardizing and digitizing documentation, technology for orchestrating complex transactions that historically took days, now in minutes, or the low friction digital interface for multi-stakeholder negotiations – all have been game changers.
When the three gears mesh together, a powerful engine is unleashed that leads to a) an increase in choice of products to bring a wide variety of new stakeholders into the debt market, b) significant decreases in transaction costs creating a real opportunity for bond buyers and lenders to meaningfully transact at the low ticket/higher risk end of the spectrum, and c) dramatic reduction in execution friction that opens up the market for higher inflows.
The interplay between a, b and c is a virtuous cycle and creates the quantum leap in systemically solving the problems of matching risk and increasing supply that we talked about in the earlier section.
Add Vivriti’s ecosystem-layer and we get to the next level. While CA’s self-serve debt OS is transformational in itself, additional strategic elements on both the lender and borrower side are needed to make the system omnipotent. On the borrower side, while Credavenue creates direct access to medium and large enterprises, it needs a symbiotic relationship with lending institutions that are focused on the consumer lending and micro-business segments, which are too granular to serve directly. It has already done well here in becoming an important capital structuring partner for almost all of the leading consumer NBFCs.
On the lender side, while a large share of local financial institutions are first-person users of the operating system, there is an equally large opportunity that can be unlocked through active asset management platforms that use the kernel of the CA platform to bring new investors into the Indian debt ecosystem. Investors, especially the global ones, that prefer to work with an active manager vs. a DIY approach.
Here, Vivriti’s asset management platform consisting of an NBFC and a series of AIFs (Alternate Investment Funds) is already well on its way to building India’s fastest growing asset management platform for debt by extending the tech platform at CA to building sophisticated capital gathering, fund design and risk management tools. Over a very short period of time, the asset management business of Vivriti has grown into a $500M AuM business and one of the few businesses in India that has the technology led scalability to deliver 20x growth in next five years. That’s only the India opportunity. Notwithstanding the structure of debt markets, both CA and Vivriti Asset Management are extraordinarily replicable in both developed and emerging economies. This is the next horizon of growth.
Gaurav and Vineet over dinner a few weeks ago told me that one of their ‘pinch yourself’ moments over the last year was when one of senior folks from one of the largest banks said to them, ”You guys are going to become the UPI of lenders and we won’t be able to effectively function without sitting deep inside the infrastructure you are building.” Had they really become systemic? Yes, my friends and with this comes great hope, privilege and responsibility.
By Kartik Srivatsa
Managing Partner, Lightrock India