The story so far: On August 10, the Reserve Bank of India (RBI) instituted a framework for regulating the digital lending landscape in the country. It pointed to concerns such as unbridled engagement of third parties, mis-selling, breach of data privacy, unfair business conduct, charging of exorbitant interest rates, and unethical recovery practices bothering consumer confidence and said that they had to be mitigated. The latest set of regulations are based on recommendations received from its Working Group on ‘Digital Lending including lending through online platforms and mobile apps’ (WGDL) which was constituted last January.
What is the digital lending landscape like?
Digital lending utilises automated technologies and algorithms for decision making, customer acquisition, disbursements and recovery. Not only does it lower costs but also ensures speedy disbursal.
Lending Service Providers (LSPs) act in partnership with Non-Banking Financial Companies (NBFCs) who disburse credit (or a line of credit) to the customer using the former’s platform, making it a multi-sided platform. In order to cement their presence in a space with multiple peers, LSPs often resort to reckless lending practices by endowing credit beyond a borrower’s repayment capacity. The risk is mitigated by spreading it to all users by charging higher interest rates.
The absence of standardised disclosure and regulatory norms made it cumbersome to assess a participant’s operational legitimacy. Between January and the end of February last year, there were about 1,100 lending apps available for Indian android users of which about 600 were illegal. They were either unregulated by the RBI or had NBFC partners with an asset size of less than ₹1,000 crore, prompting doubts on its operability.
The space is largely dominated by NBFCs. Its customers particularly include small borrowers without a documented credit history and thus, not served by traditional financial institutions. As for their utility, it primarily lies with short-term loans having tenures of up to 30 days, constituting about 37.5% of the overall product mix, compared to 0.7% for banks, as per the WGDL.
What are the new regulations?
The central premise is transparency. Lending must be carried out by entities that are either regulated by the RBI or possess permission to operate under a relevant law. Considering the large-scale outsourcing in the industry, this would also help address regulatory arbitrage.
The RBI has mandated that all loan disbursals and repayments are to be executed directly between the bank accounts of the borrower and the entity. Thus, it eliminates the presence of a nodal pass-through or pool account of the LSP.
Henceforth, before executing the contract, lenders would have to inform the borrower in a standardised format about all fees, charges as well as the annual percentage rate (APR). The latter refers to the annual rate that is charged for borrowing a loan and is inclusive of processing fees, penalties and all other charges associated with it. This would also help borrowers make better comparisons with industry peers. Further, LSPs cannot raise the credit limit of their customers without prior consent.
Also, to address the need for a dedicated resolution framework, entities would have to appoint a grievance redressal officer. The ecosystem would also fall under the purview of the RBI’s Integrated Ombudsman Scheme (RB-IOS) should the complaint not be resolved within 30 days of receipt.
Will data also have to be regulated?
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This regulation would also address concerns emanating from TechFin (companies that are primarily tech-based service providers, say e-commerce, and also offer financial services). They are known to leverage their existing user data from non-financial business to offer more suitable financial services, which may involve third parties and vice-versa.
What is the outlook for the industry?
The share of digital lending may be small at present, but given their scalability they may potentially become significant players soon. Implications here may have a spillover effect on the broader financial system. Senior Director and Deputy Chief Ratings Officer at CRISIL, Krishnan Sitaraman, told The Hindu“We will have to see what kind of changes the digital lenders make to their operating models in light of the new regulations, how it impacts the fees they charge, the speed of their disbursements or how they continue to provide seamless experience to their customers.”
On the potential challenges from rising inflation, interest rates and their impact on credit growth in general, he indicated, “With the economic activity reviving at a decent pace post pandemic and our expectations of a GDP growth of 7.3% this fiscal, we expect demand for loans across the credit ecosystem to be higher this fiscal despite higher inflation and interest rates.”