One of the strongest achievers out of the Covid-19 pandemic was digital lending in India, second only to payments in the Indian fintech space. Between January and August 2021, lending tech companies received funding worth $806 million, making up the second-largest share—18 percent—in the fintech funding pie, according to Inc24 data. With an ever-expanding digital financial inclusion, proliferation of lending through unregulated, or flimsily regulated digital lending apps or platforms has also been on the rise.
After multiple reports of harassment and high-handed recovery methods used by agents of several digital lending app platforms, even pushing customers to suicide, the Reserve Bank of India (RBI) was forced to call for action.
According to the Reserve Bank of India, of the 1,100 unique loan apps available on app stores, 600 apps are wholly beyond the scope of regulation. Complaints against these apps have also been mounting since last December over mis-selling, breach of data privacy, and illegal and unethical conduct.
Need for suggestions
The working group on digital lending, including lending through online platforms and mobile apps, was constituted in January this year under the chairmanship of RBI Executive Director Jayant Kumar Dash. It was set up in the backdrop of rising concerns amid a spurt in digital lending activities.
Although the Digital Lenders Association of India (DLAI), formed by the stakeholders of the industry, had laid down a code of conduct for self-regulation, fraudulent activities continued in the absence of clear guidelines from the RBI.
Digitally lending companies mainly provide a digital layer between traditional banking entities and customers. What worries regulators and the industry is that online lending in partnership with banks and non-banking financial companies (NBFCs) alone currently does not fall under the purview of any regulations.
“The thrust of the report has been on enhancing customer protection and making the digital lending ecosystem safe and sound while encouraging innovation,” the RBI said in a release.
Format of reforms
The recommendations of the working group are based on three fronts; legal and regulatory, technology and financial consumer protection.
An important mention was the segregation of digital lenders into balance sheet lenders and lending service providers (LSPs). This would make it easier to frame rules. Balance sheet lenders who carry the credit risk in their balance sheet and have to provide the capital for these loans, pose a higher systemic risk. The suggestion that balance sheet lending should be limited to entities regulated by RBI or those registered under any other regulatory authority therefore may come across as a good idea.
To prevent regulatory arbitrage, the RBI could frame the rules for all balance sheet lenders, irrespective of the regulator with which they are registered. Along with this, an Act banning unregulated balance sheet lending activities will help check wrongdoers.
Regulating LSPs is however more difficult since they do not carry the loan on their balance sheet but mainly help to connect the lender and the borrower. Peer-to-peer lending platforms, namely neo-banks and Buy Now Pay Later (BNPL) players that have been grouped in the category of LSPs can be controlled only if all the transactions conducted by them are captured by the regulator.
Throughout the report, there is a clear distinction made between regulated and unregulated entities and what each of those can be allowed to do. For example, the working group suggested that lending should happen only through the books of regulated and recognised entities. What is not legal in the physical world cannot be considered legal only because it is happening online, it says.
In the case of known online credit players like Capital Float, ZestMoney, Slice, etc., most fall under the category of regulated entities as they possess an NBFC licence from the RBI. However, BNPL players like Simpl that do not have an NBFC licence face being barred if these recommendations turn into norms.
Apart from recommending a separate legislation to oversee such lending, the report by the working group suggested that digital lending apps be verified by a nodal agency set up in consultation with stakeholders.
The SRO will frame a standardised code of conduct for recovery. It will also maintain a ‘negative list’ of lending service providers.
The group also suggested that data be stored on servers located in India.
“The central government may consider bringing through a legislation styled as the ‘Banning of Unregulated Lending Activities (BULA) Act,’ which would cover all entities not regulated and authorised by RBI for undertaking lending business or entities not registered under any other law for specifically undertaking public lending business,” the committee proposed.
Reforms as a safety net
The concerns over unchecked growth in NPAs arise when it comes to credit and innovation driving the growth as well. BNPL app LazyPay’s gross non-performing loans, for example, stood at 19 percent in FY21, as per a Macquarie report.
“The question to ask is, are these BNPL players lending to subprime customers or the ones we call thin file customers who we have no data on? We need to see how this lending data is reported to credit bureaus,” an analyst said stating his take on the reforms.
According to the working group, some baseline standards of technology and compliance must be met as a precondition for offering digital lending solutions. It said loans should be directly disbursed to the bank accounts of borrowers and serviced through bank accounts of the digital lenders.
“These recommendations are about putting in place a structure for the digital lending industry and maybe putting some reins in place so that while the industry is growing, you’re able to look at more responsible lending,” Anurag Jain, DLAI President, told Moneycontrol.
The group has sought comments from stakeholders and members of the public on the report on the RBI website by December 31.