The central bank's latest guidelines on fintech have a customer focus, but they also have a fair share of misses
The Reserve Bank of India's (RBI) recently released regulatory framework for digital lending, directed towards curbing rampant malpractices in the system, has customer centricity at its core. The structure is based on the recommendations of a Working Group on Digital Lending (WGDL), which RBI set up in January 2021 after complaints about harassment by digital lenders surged during the past couple of years.
While analysts and other industry stakeholders have largely appreciated this move, some experts cited the need for more clarity on the compliance requirements for First Loss Default Guarantee (FLDG) products. These allow a third party to compensate a lender if the borrower defaults.
During the pandemic, scores of digital lending apps—many illegal—mushroomed across the country. These entities charged insanely high-interest rates, capitalising on most borrowers' lack of financial literacy. In some cases, they even resorted to unethical loan collection tactics, leading to several suicides.
Globally, too, there has been a crackdown on such platforms. Google has blocked hundreds of apps from its Play Store to protect borrowers from being exploited, while countries like China, Indonesia and Kenya have shut several such apps that were duping start-ups and end-consumers alike.
WHAT HITS THE RIGHT SPOT
The RBI framework has a clear consumer protection focus based on the principle that only entities regulated by the central bank or permitted to do so under any other law can carry out lending business. It broadly ensures the entire lending chain is regulated, thereby providing transparency to borrowers and defining good data privacy practices.
"The framework addresses the need to protect consumer data. Moreover, user consent is required to access any data, and all such information must be on a 'need to know basis. This was a key regulatory gap that has now been plugged," said Shilpa Mankar Ahluwalia, Partner, Shardul Amarchand Mangaldas.
To keep an eye on the movement of money through the digital lending chain, RBI has stipulated that all loan disbursements should be made into the borrower's bank account. Repayments should be executed directly in the bank accounts of regulated entities (including banks, NBFCs and microfinance institutions). It has further clarified that no amount of money should pass through any third-party pool accounts.
It is apparent that the framework wants to keep a clean audit trail to pull the plug on money laundering. It has taken steps to ensure that money doesn't flow into any dark accounts, which can't be traced in the need arises.
Bringing transparency was another objective of the framework, and it does that well. It mandates that regulated entities (REs) should disclose everything about the loan a borrower is signing up for in easy-to-understand language. This includes the total annual percentage rate (APR), the cumulative interest rate on the loan, fees, origination charges, agency fees and any other charges related to servicing the loan.
Also, lenders have to come clean on the Key Fact Statement (KFS). They have to provide details of the grievance redressal officers at the RE, the lending service provider (LSP) and the digital lending applications (DLA). Moreover, all fees and service charges, terms and conditions of the loan recovery mechanism, and details of the lending service provider will act as the recovery agent must be clearly stated.
WHAT MISSES THE SPOT
India's fintech leap is widely seen as a success given its scale of catering to a billion people. Beginning with Unified Payments Interface (UPI), the country is augmenting its existing financial infrastructure.
This includes the accounts aggregator platform and Open Network for Digital Commerce (ONDC), which has attracted the attention and support of global tech companies. It is considered one of the most promising markets for financial products such as Buy Now Pay Later (BNPL).
In that context, one of the most watched spaces has been the approach to regulating the FLDG product. RBI has accepted in-principal the need to regulate this model but has indicated that detailed rules are under further consideration.
"In the interim, REs and LSPs must comply with the Master Directions for Securitisation of Standard Assets, 2021. Given that these directions primarily regulate inter-se licensed balance sheet exposures, how the framework will apply to the FLDG product will need to be seen. However, it appears that the rules regarding credit enhancements, loan servicing and capital adequacy (for both the RE and the FLDG provider) will have to be complied with," added Ahluwalia.
In its 2021 'Report of Working Group on Digital Lending including Lending through Online Platforms and Mobile', RBI expressed its reservations against FLDGs. It had mentioned that they offer a back-door entry to the licensing regime since LSPs bear the credit risk without maintaining any regulatory capital or complying with norms applicable to regulated lending.
Another concern was that the cost of LSPs undertaking the credit risk gets passed on to the borrowers in the form of high platform charges, processing fees or default interest. The central bank observed that many illegal lenders operate without licenses, creating an informal market.
Mandar Kagade, Founder-Principal of Black Dot Public Policy Advisors, also voiced his concerns about FLDGs. "The guidelines require (allow) the originator to hold 10 per cent of the securitised book as Minimum Retention Requirement for ensuring skin in the game (own investment). Since FLDGs from fintech and other aggregating platforms also serve the skin in the game objective, this interim permission reflects that RBI may be comfortable with up to 10 per cent FLDG. Clearly, this prohibits the 'rent a balance sheet' model that outsourced all credit risk from the REs to non- REs."
The RBI also mandated that entities would have to provide a cooling-off period during which the borrowers can exit digital loans by paying the principal and the proportionate costs without any penalty. However, experts say the cooling-off period for digital loans is asymmetric regulation.
"Cooling off period for digitally sourced loans (so the consumer who faces buyer's remorse can exit a loan within a window) is an example of asymmetric regulation of identical products. A loan is a loan is a loan," said Kagade. "Brick and mortar or digitally sourced loans must be treated identically. Exit on one and not on the other just puts costs on digital lenders and incrementally benefits the large banks. Also, buyer's remorse can equally apply in a brick-and-mortar context."
TIME FOR A NODAL AGENCY
The RBI has asked the government to give further thought to a nodal agency (Digital India Trust Agency) that will supervise and verify digital lending applications before they are permitted to onboard consumers. Experts suggest that it is vital to ensure that such a system does not create bottlenecks that could stall product innovation. The central bank has also suggested the government consider legislation to ban the unregulated lending activity.
Besides bettering transparency, privacy and oversight for entities regulated by RBI, the guidelines will enhance data safety for borrowers and provide better customer protection, believe experts. "The recommendations will enable increased collaboration between NBFCs and fintech as well as digital aggregators, which are still at early stages of evolution and will provide better credit penetration in the long run. As market players adapt to the new regulations, stronger oversight will be built over time, as was the case with banks or NBFCs," said YS Chakravarti, MD and CEO of Shriram City Union Finance on RBI's WGDL.
The RBI has finally taken several steps in the right direction to protect consumers without clipping the wings of digital lenders. However, it remains to be seen whether this new framework can successfully plug the pain points in the fintech space.