How Zip Code can determine your loan?

Everyday financial institutions such as banks and NBFCs carry out complex analyses to improve the underwriting process for a loan. However, they do not completely assume to recover from all the disbursed loans. They frequently upgrade the definitions and goals to increase the efficiency of loan process and apply innovative tools to increase productivity.

Underwriting includes the challenging task of finding a potential client. The process includes assessing a customer looking for loan. It is used to determine the creditworthiness of a borrower and his ability to pay the loan amount.

When we apply for a loan, we only provide the required documents and don't bother about the process of loan sanction. It's interesting to know what the lenders take into consideration before approving your loan.

The major factors include your credit score (CIBIL score) and net monthly income. Other factors include your age, city, and employer and so on.  

Ever wondered that a zip code could be one of those factors? In India a zip code represents the sub region and the delivery post office of a particular area. While providing loans, financial institutions such as banks and NBFCs need to assure two things about the borrower: the ability and the intention to repay.  All lenders in the country give emphasis to zip code and is an important criteria while assessing the eligibility. Most players analyse trend across different zip codes and track monthly performance of their portfolio.

Historical performance data

With the help of a zip code, banks and NBFCs determine the historical performance of a particular area, towards repaying a loan. Residents of a less affluent area may not have a very huge income and hence have a higher tendency to default on loans.  

Even if they manage to get a loan, their historical records may reflect uncertain payments due to insufficient income. Disability to pay the loan amount is a major risk to underwriting process for lenders. Lenders mark these zip codes as negative areas and carry out selective targeting for such regions.  

According to a Census report, nearly 70% of Indians live in rural areas. Besides that, every metro has an area which is impoverished and home to many lower middle class segments. Lenders use these pin codes as a base to reject loan applications from such areas.  

Zip codes (or pin codes) help banks and NBFCs to find out the areas which are unreachable and pose security threat to recovery agents. There are specific areas which do not allow entry for recovery agents. Consequently, the financial institutions tend to write-off the loans. Though they do not prefer to write-off loans but certain loans which are highly difficult to recover reflect poorly on their financial statements.  

To name a few, the north east part of Delhi is less affluent and the slums in Mumbai do not allow recovery agents to enter the area. Sometimes, the locality of borrowers is so far from the urban area that the commute becomes expensive compared to the total loan amount. Such rare situations leave lenders with no other alternative but to label these loans as 'charge-offs' and remove them from the balance sheet. Other alternative that the lenders go for is to sell off bad loans to third party collection agencies.

In order to avoid the above discussed circumstances financial institutions utilise zip codes of such areas as a segment to be treated separately or put them in rejection list. This avoids loss of loan portfolios which are their primary source of revenue.  

 (The writer is  Founder & CEO of Qbera.com)