Home Framework Explained | Why did the RBI come up with a framework to regulate digital lending?

Explained | Why did the RBI come up with a framework to regulate digital lending?


The story so far: On August 10, the Reserve Bank of India (RBI) instituted a framework to regulate the digital lending landscape in the country. He pointed to concerns such as unbridled third-party engagement, mis-selling, breach of data privacy, unfair business conduct, charging exorbitant interest rates and unethical clawback practices that disturb consumer confidence and said they needed to be mitigated. The latest set of regulations is based on recommendations received from its “digital lending, including lending via online platforms and mobile applications” (WGDL) working group, which was constituted last January.

What does the digital lending landscape look like?

Digital lending uses automated technologies and algorithms for decision making, customer acquisition, disbursements and collections. Not only does this reduce costs, but also ensures quick disbursement.

Loan Service Providers (LSPs) partner with Non-Banking Financial Companies (NBFCs) who extend credit (or a line of credit) to the customer using the former’s platform, making it a non-banking platform. multifaceted form. In order to solidify their presence in a space with multiple peers, LSPs often resort to reckless lending practices by extending credit beyond a borrower’s ability to repay. The risk is mitigated by spreading it across all users by charging higher interest rates.

The lack of standardized disclosure and regulatory standards made it difficult to assess a participant’s operational legitimacy. Between January and the end of February last year, there were around 1,100 lending apps available for Indian Android users, of which around 600 were illegal. They were either not regulated by the RBI or had NBFC partners with an asset size of less than ₹1,000 crore, which raised doubts about its operability.

The space is largely dominated by NBFCs. Its clientele includes in particular small borrowers without a documented credit history and therefore not served by traditional financial institutions. As for their usefulness, it lies mainly in short-term loans of up to 30 days, constituting around 37.5% of the overall product mix, compared to 0.7% for banks, according to the WGDL. .

What are the new regulations?

The central premise is transparency. Loans must be made by entities that are either regulated by the RBI or licensed to operate under relevant law. Given the widespread outsourcing in the industry, this would also help combat regulatory arbitrage.

The RBI required that all loan disbursements and repayments 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 from the LSP.

Now, before executing the contract, lenders should inform the borrower in a standardized format of all fees, charges as well as the annual percentage rate (APR). The latter refers to the annual rate charged to borrow a loan and includes processing fees, penalties and all other fees associated with it. It would also help borrowers make better comparisons with their industry peers. In addition, FSLs cannot increase the credit limit of their customers without their prior consent.

Additionally, to address the need for a dedicated resolution framework, entities should appoint a grievance officer. The ecosystem would also fall under the jurisdiction of the RBI’s Integrated Ombudsman Scheme (RB-IOS) if the complaint is not resolved within 30 days of receipt.

Will data also need to be regulated?

Yes, all data collected by the applications must be “needs-based” and must be done with the prior and explicit consent of the borrower. Users can also revoke previously granted consent. The information to be collected must be indicated in the privacy policy during registration. Given the multifaceted nature of the business, the RBI has proposed that user consent should be required to share personal information with a third party.

Read also | Instant digital loan apps become an easy trap for cheating and harassment

This regulation would also address concerns from TechFin (companies that are primarily providers of technology-based services, e.g. e-commerce, and also offer financial services). They are known to leverage their existing user data from non-financial businesses to offer more tailored 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 could soon become big players. The implications here can have a ripple effect on the entire financial system. Krishnan Sitaraman, Senior Director and Deputy Director of Ratings at CRISIL, said The Hindu“We will have to see what kind of changes digital lenders make to their operating models in light of new regulations, how this affects the fees they charge, the speed of their disbursements, or how they continue to provide a seamless experience. to their customers.”

On the potential challenges of rising inflation, interest rates and their impact on credit growth in general, he said: “With economic activity picking up at a decent pace post-pandemic and our expectations for GDP growth of 7.3% this fiscal year, we expect demand for lending across the credit ecosystem to be higher this fiscal year despite inflation and higher interest rates.”