By Shivanand Pandit
The latest set of rules to regulate the digital lending scene in India by the Reserve Bank of India (RBI) says it has agreed a set of standards to be executed immediately, primarily aimed at customer security and emphasizing transparency in reporting on lending activities. to credit rating agencies. RBI’s action indicates concerns including unchecked third party engagement, wrongful selling, breach of data privacy, unfair business conduct, charging excessive interest rates and unethical clawbacks that undermine consumer confidence. The new set of rules centers on advice obtained from its Working Group on Digital Lending (WGDL), including lending through online platforms and mobile apps, which presented its report in November 2021.
What is Digital Lending? Traditionally, lending is an agreement in which the lender gives money to the borrower in return for a return on the money called interest. Although there are complex categories of advance and financing instruments, loans are always focused on one thing: the ability to recover the money.
Historically, this segment was extremely messy. However, it has evolved over time from pawnshops advancing funds against collateral to a more organized way involving banks and/or financial institutions. Rapid advances in cloud computing, artificial intelligence and blockchain, faster and more affordable internet connectivity have spurred the growth of fintech startups, and lending has also transformed and gone “digital”.
Digital lending involves lending through web platforms or mobile apps, using technology for credit verification and reporting. Over the years, the digital lending industry in India has grown tremendously. The value of digital loans grew from $33 billion in fiscal year 2014-2015 to $150 billion in 2019-2020 and is expected to reach $350 billion by 2022-23. Over the past few years, machine learning has radically changed conventional money lending. The functions of lenders are overseen by governmental financial associations which offer several regulatory guidelines.
Digital lending uses technology and computerized processes for decision-making, customer provisioning, disbursement and collection. It reduces the cost of operations and ensures rapid disbursement. Loan Service Providers (LSPs) work in conjunction with Non-Banking Financial Companies (NBFCs) who extend credit or line of credit to the customer using the LSPs platform, making it a multi-sided platform . In order to bolster their existence in a galaxy with many associates, LSPs frequently resort to negligent lending customs by extending credit beyond the borrower’s ability to repay. However, the risk is removed by extending it to all customers by charging higher interest rates.
The lack of regulated disclosure and oversight standards made it difficult to assess a participant’s operational legality. Between January and the end of February 2021, there were around 1,100 loaner apps available for Indian Android users, of which around 600 were illegitimate. They were either uncontrolled by the RBI or had NBFC associates with an asset size of less than Rs 1,000 crore, raising suspicions about its operability. Overall, the digital lending space is dominated by NBFCs. Its clients mainly include small borrowers with no recorded credit history and therefore not helped by conventional financial companies.
According to the long-awaited guidelines for the digital lending space, all credit disbursements and repayments will have to be implemented only between the bank accounts of the borrowers and the regulated entities (RE), namely a bank or a non-bank financial company. . without any intermediary account or pool of FSL or any third party. The new rules state that the bank or NBFC, and not the borrower, must directly pay any fees or charges payable to LSPs under the credit intermediation process.
In addition, a standardized Statement of Key Facts (KFS) must be provided to the borrower prior to execution of the loan agreement and the total cost of digital loans in the form of Annual Percentage Rate (APR) must be disclosed to borrowers. The new standard prohibits any involuntary increase in the credit threshold without the specific consent of the borrower. It also stipulates, as part of the loan agreement, a cooling-off period during which borrowers can exit digital loans by disbursing the principal and the annual percentage rate without any penalty.
Banks will need to confirm that they, and the financial service providers they have contracted, must have an appropriate nodal grievance officer to handle complaints related to fintech or digital lending. This agent will also handle grievances against their respective Digital Lending Applications (DLAs). Under current guidelines, if a complaint filed by borrowers is not resolved by the RE within the prescribed 30-day period, they can file a complaint under the central bank’s integrated ombudsman system. Any advance obtained through the DLAs will have to be reported to the credit bureaus by the REs, regardless of its nature or purpose. Any new digital lending products offered by REs on merchant platforms regarding short-term credit or deferred payments must also be reported to credit bureaus by REs.
The central bank has grouped digital lenders into three categories, such as entities controlled by the RBI and authorized to carry out lending activities, entities authorized to make loans in accordance with other legal or governmental stipulations, but not regulated by the RBI and lending entities beyond the jurisdiction of any statutory or regulatory provision. Regarding entities under the second classification, the respective regulators could consider developing digital lending regulations, based on the suggestions of the working group. For entities in the third classification, the working group recommended precise legislative and institutional mechanisms for mediation.
Taken together, this set of new rules is rational and the framework is well-intentioned with consumer welfare at heart. In recent times, fintech entities have proliferated and have had an important role to play in helping retail borrowers deal with financial emergencies, especially during the pandemic. However, many of these entities operate outside the realm of surveillance. They used unethical and coercive methods to collect dues and levy extremely high interest rates and fees.
In this context, the digital lending regulatory framework framed by the RBI is welcome as it speaks to the concerns of borrowers in this sector. The framework strikes the right balance by allowing digital lenders to continue operating, but under regulatory oversight. Nevertheless, some major concerns still need to be addressed.
The need to regulate digital loans arose in 2020 after many innocent customers fell prey to rogue Chinese apps and many of them committed suicide after being harassed for repayments. However, almost two years later, a direct statute to curb these entities has still not come out. The Law Enforcement Branch has been cracking down on these apps for a few months and the RBI has revoked the licenses of some suspicious entities.
According to the RBI, the government is still considering legislation to limit unregulated lending activities. The new rules announced by the RBI do little to address the main concern of fake loan applications. It seems that only circular loan operating standards have been issued. With everything in the rules assigned to regulated entities, the main questions remain unanswered – what about unregulated entities and non-financial lending scammers? With the current incompetence to hunt these, how can the watchdog avoid unwarranted pessimism for regulated entities?
The RBI must prioritize engagement with other regulators and the government to restrict unregulated entities. In addition, the establishment of an independent body to validate legal applications is still pending. The independent body is important because it would have created a list of safe apps. Until this is done, clients have no record to refer to before borrowing and will continue to be at great risk.
The stricter framework also limits the operations of digital service providers and many of them may even close shop, locking in the lending base of many retail borrowers. Fintechs have been chosen by many because of their ease, speed of disbursement and faster processing. Now, the wait for credit may increase and will contain cumbersome paperwork and administration. The central bank should see how it can come up with other ways to provide accelerated lending to small borrowers so that their needs are also met.
—The author is a financial and tax specialist, author and lecturer based in Margao, Goa