digital lending

This article is authored by members of Yubi’s Platform Engagement team: Mithun R and Nikitha Jain.


India’s path to a USD 5 trillion economy will hinge on disruptive business models and digital technologies. This journey is expected to be partly powered by the fintech players. The pandemic has accelerated the growth of the fintech industry resulting in a golden era for the players, especially the digital lending industry. 

The Indian Fintech Market

It is a well-known fact that India is the world’s 3rd largest Fintech market (after the US and China). The fintech revolution in India has seen a significant growth in the recent past and is estimated to be USD 1.3 trillion by 2025, growing at a CAGR of 31% during 2021-2025. In the month of May’22, the Hon’ble Prime Minister of India, Shri. Narendra Modi said that 40% of digital transactions of the world in 2021 took place in India – home to 16 percent of the world’s population, indicating India’s contribution to digitalization of finance. 

Largely, the fintech landscape can be segmented into 7 buckets namely:

  • Lending tech
  • Fintech SaaS
  • Payments
  • InsurTech
  • Investech
  • Neo banking
  • Cryptocurrencies. 

With the concept of quick credit gaining traction, digital lending tech is likely to account for approx. 47% i.e., USD 616 billion. 

The Digital Lending Landscape

Digital lending/lending tech is the process of availing credit online and is characterized by instant disbursals of loans with paperless process and thus having wider financial inclusion. This pace of  digital lending has  given rise to dependence on third party lending service providers (LSP) by the lenders. Total lending volume in India doubled from 2017 to 2021, but the total digital lending grew at twelve-fold over the same period, as per the RBI’s 2021 Working Group Report on Digital Lending

However, every innovation comes with a list of pros and cons. Though the pros are appealing, digital lending also has a list of cons which includes entry of unauthorized lenders in the industry by way of direct lending activities by these LSP’s, exorbitant interest rates and mis-selling to unsuspecting customers, coercive repayment tactics and lack of data privacy/data breach. The above-mentioned working group report also mentioned that 600 out 1100 lending apps currently available are illegal as per RBI norms. 

Given the importance of this ever evolving fintech lending industry and concerns which emerged with the growth of the industry, RBI in multiple instances has intervened and issued guidelines or regulations on various subject matters. The recent guideline by RBI on digital lending (issued on 10 August 2022) is one such welcoming intervention towards protecting the rights of the customers and regulating the lending industry. 

Tracing Back the Events

The setting up of the working group on 13 Jan 2021 to study the aspects of digital lending activities by regulated as well as unregulated players was the first step towards setting up an appropriate regulatory approach for digital lending. The report by this group was submitted on 18 Nov 2021 which included lending through online platforms and mobile apps. The draft rules encouraged legitimate lenders while protecting the customer and data privacy. The report included recommendations to bring the LSP under a standard protocol of business conduct, which would be enforced by the regulated lending entities that they would tie-up with.

This was followed by the release of the implementation guidelines on recommendations of the working group on digital lending on 10th Aug 2022. While most of the recommendations of the working group were accepted by the RBI (listed in Annexure 1 of the guideline), RBI has placed few recommendations under consideration with no immediate impact (listed in Annexure 2 of the guideline). The implementation guidelines also include an additional Annexure (Annexure 3) listing out the required legal and institutional framework for consideration by the Government of India. 

Largely, the guidelines are expected to bring in transparency in the entire process coupled with ethical practices and eliminating unregulated entities. 

Impact on Digital Lending

As the whole objective of the guideline is to regulate the unauthorised lending practices by the digital lenders and LSP’s, the coverage of the guidelines is not limited to entities regulated by RBI (REs) but also includes: 

  • LSPs engaged by REs
  • Digital Lending Apps (DLAs) of REs and DLAs of LSPs engaged by REs
  • Borrower and Credit Information Companies (CICs)

The guideline comes as a roadblock for the new age BNPL players as they will have to report every payment as a loan to credit bureaus.  BNPL lenders have positioned their products as deferred payments rather than as loans which thus attracts the interest of retail consumer borrowers. Implementation of this guideline will entail change in marketing strategy and positioning of the product for these players.

The guideline through various rules is trying to address three major concerns in the digital lending industry

  • Increased cost by whatever name to the end borrower
  • Lack of data privacy to the end customer
  • Unvalidated recovery procedures.

While many fintech companies as part of their good governance practice follow some of the guidelines laid down by the RBI, few of the guidelines will have an impact on the business model and operations of some of the fintech lenders. Notable changes would be visible in the processes of the lending institutions while it would also entail increased operational cost in execution (burden shift from end customer to the lending institution). 

Highlights of the Guidelines

  • Guidelines regarding disbursement and repayment

Fintech entities are currently following the mechanism of routing money through pooled accounts and settling money to the borrowers/lenders. The guideline mandates disbursements and repayments into the bank account of borrower or lender respectively. This will entail significant changes to the existing process of these players which will also result in increase in operational cost. Further, borrowers with only PPI account and no bank account, disbursements can be made only to fully KYC compliant PPIs.

  • Stricter regulations for LSP’s & DLA’s – Solving for data privacy issues and reducing cost for end borrower

The current practice is that the fees payable to LSP for their services are borne by the end borrower. These LSPs also store all the personal information which are collected by the ultimate lender (REs). The guideline mandates that any fees charged by LSPs for processing, underwriting etc should be borne by the REs. The guideline further places the responsibility of data storage and data privacy on the REs and prohibits LSPs from storing any personal information of the borrowers except for a few basic minimal data that is necessary to carry out the operation. 

This addresses the contentious issue of usage of phone records with malafied intent to abuse the borrower. This also reduces the cost burden on the borrower. However, unless a clarification is issued by the RBI, these guidelines will negatively impact those entities which follow alternative credit assessment & monitoring procedures. Collection of data by DLAs will also get monitored under the guideline. 

Access to a wide range of data by these DLA’s will come to a halt as it will now become mandatory to collect only need-based and with prior & explicit consent of the borrower. DLAs will thus not be able access or store any data of the borrowers except for onboarding or KYC requirements and with the specific consent of the borrower. 

  • Higher transparency & ease to borrowers 

To further protect the borrowers from predatory lending practices like charging flat rate on principal basis etc, the guidelines mandates highlighting the product features and Annual Percentage Rates (‘APR’) to be disclosed upfront by REs. REs should provide a key fact statement (‘KFS’) to the borrower. This ensures high transparency to the borrowers. Any fees, charge, etc., which is not mentioned in the KFS cannot be charged anytime during the term of the loan. 

The digital lenders also need to provide a cooling off period, as determined by the board of the RE, to the borrowers for exiting the digital loan. This allows the borrower to terminate the loan contract by repaying the principal and proportionate APR without any penalty. 

The guideline has also prohibited automatic increase in credit limit. It is interesting to note that this was not part of the draft guideline submitted by the working group. The existing mechanism of automatically increasing the credit limit is followed by many fintechs, especially with new-to-credit customers. With these guidelines coming into effect, unless there is consent from the borrower, REs can’t suo-moto increase the credit limit of the borrower. This might result in customers dropping off due to operational challenges.  

  • Safety to borrowers from predatory collection methods

The guideline mandates formation of a Self regulatory organisation (SRO). SRO’s will set the code of conduct in consultation with RBI which will incorporate best business practices, ensuring compliance of their members with regulatory guidelines and providing a mechanism for grievance redressal of customers.

Further, the REs should communicate the details of the LSP acting as recovery agent to the borrower at the time of sanctioning of the loan and also at the time of passing on the recovery responsibilities to an LSP. REs should also carry out periodic review of the conduct of the LSPs engaged by them. All these steps are expected to give peace to the borrowers from the harsh recovery procedures of RE’s and their agents. Till the time SRO is set-up, guidance on fair recovery practices will be issued to REs by RBI.

  • Rules regarding FLDG

RBI is yet to clarify the recommendation pertaining to the prohibition of first loss default guarantee arrangements for unregulated entities. Therefore, for now, fintech entities shall follow the guidelines applicable to a securitisation transaction. 

Conclusion

While we await clarifications / further guidance from RBI on a few points, Yubi believes that the guidelines are extremely positive from the perspective of the borrowers where the focus is on transparency & data privacy. From the perspective of Fintech, a transformation of the business model and an increase in compliance costs would be inevitable for a few.

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