Reserve Bank of India constituted a working group on digital lending on January 13, 2021 to study digital lending activities undertaken by both regulated financial sector and unregulated players to develop a regulatory approach for easy working. Its report running 151 pages is now available. It has 5 sections with the following broad contour.
Section 1: Constitution of the group, processes followed, foreground etc.
Section 2: Digital lending landscape – digital lending meaning, its eco – system, global/Indian scene.
Section 3: Regulatory policy approach to digital lending, extant Indian legal regimes, global regulatory practices, case for regulatory/supervisory review, recommendations in this regard.
Section 4.: Technology standards of digital lending, life cycle of digital lending, regulatory perspectives, suitable recommendations.
Section 5: Financial consumer protection, frameworks available in India, global practices, conduct aspects of digital lending, recommendations of the committee.
Anyone interested to refer to the main report gets the reference at the end. This whole write-up is based on this working group report only.
With broad contour in detailed explanations, let us learn the report for clear understanding.
Why was the committee constituted?
Digital lending in regulated bodies, less emphasized, along with its wide reach through unregulated bodies (both webs based and even cell based) at an alarming scale prompted RBI to constitute a six -member committee with the following “terms of reference”.
- To evaluate digital lending activities and assess the standards of outsourced digital lending activities of RBI regulated entities.
- To identify the financial risk posed by unregulated entities under digital lending.
- To suggest regulatory changes to have an orderly growth of digital lending.
- To give recommendations for expansion of specific regulatory or statutory perimeter and suggest the role of various regulatory and government agencies.
Before we proceed with our detailed analysis or deeper understanding of the issues involved with digital lending with its complex subjects involved, why not clarify some terms widely used so far? (Yes, from main report only)
1. Balance Sheet Lenders: Lenders who undertake balance sheet lending. Yes, scheduled commercial banks, recognized NBFCs, mostly big ones etc.
2. Consumer Protection Risk: Derived from the definition of misconduct risk, consumer protection risk is the risk that the behavior of a financial services entity, throughout the product life cycle, will cause undesired effects and impacts on customers. How does the entity using my information for sanctioning of digital loans protect me?
3. Cyber Security: Protecting information, equipment, devices, computer, computer resource, communication device and information stored therein from unauthorized access, use, disclosure, disruption, modification, or destruction.
4. Digital Lending: A remote and automated lending process, majorly by use of seamless digital technologies in customer acquisition, credit assessment, loan approval, disbursement, recovery, and associated customer service.
5. Digital Lending Apps: Mobile and web-based applications with user interface that facilitate borrowing by a financial consumer from a digital lender.
6. Regulated Entity: Entities regulated by Reserve Bank of India.
7. Lending Service Provider: Lending Service Provider is an agent of a balance sheet lender who carries out one or more of lender’s functions in customer acquisition, underwriting support, pricing support, disbursement, servicing, monitoring, collection, liquidation of specific loan or loan portfolio for compensation from the balance sheet lender. Most of these entities falling under this category are non- recognized entities and hence not regulated by RBI or others and cause maximum digital loans to emanate from them.
Discussion
With ballooning of credit from non- regulated entities, the committee had no option other than studying the current scene of digital lending in India. Let us soak ourselves with the information on current scene of digital lending in India.
Expectedly, banks with their wallets or other debit/credit cards have not matched up to the credit by non-regulated entities.
NBFCs have lent, higher proportion of lending (₹0.23 lakh crore via digital mode vis-à-vis ₹1.93 lakh crore via physical mode) as on March 31, 2020.
What about banks with their most dislike way of lending through digital means?
Let us look at their performance.
Why not look at some figures of performance from page 25-26 of RBI report.
I shall be quoting the figures of digital lending from banks, NBFCs etc.
Overall volume of disbursement through digital mode for the sampled entities has exhibited a growth of more than twelvefold between 2017 and 2020 (from ₹11,671 crore to ₹1,41,821 crore).
Private sector banks and NBFCs with 55 per cent and 30 per cent share respectively are the dominant entities in digital lending ecosystem. Also, share of NBFCs has increased from 6.3 per cent in 2017 to 30.3 per cent in 2020 indicating their increasing adoption of technological innovations.
As on March 31, 2020), it was noted that lending through digital mode relative to physical mode was still at a nascent stage in case of banks (₹1.12 lakh crore via digital mode vis-à-vis ₹53.08 lakh crore via physical mode). Most of the banks show least inclination towards increasing digital loans.
To lend more credibility to our discussion, can we have the product mix for comparison purposes?
- The major products disbursed digitally by banks are personal loans followed by SME loans. A few private sector banks and foreign banks are also offering Buy Now Pay Later (BNPL) loans. Loans under ‘others’ category for banks comprise mostly of small business and trade loans, home loans and education loans.
- Majority of loans disbursed digitally by NBFCs were personal loans followed by ‘others’ loans. In case of NBFCs, ‘others’ loans primarily included consumer finance loans. Even though the amount disbursed under BNPL loans is only 0.73 per cent (SCBs) and 2.07 per cent (NBFCs) of the total amount disbursed, the volumes are quite significant indicating many small size loans for consumption.
- It is of no surprise to me if you too have availed temporary loans from any NBFC since my nationalized bank dispersing my pension did not agree till 4 P.M to give even one month advance of my pension though substantial fixed deposits outstand in my name for the past three decades. Incidentally, its name figured primarily against an advance worth thousands of Crores under so called foreign exchange which became fraud prone and invited huge help from the central government for meeting NPA requirements.
- One difference between banks and NBFCs is in terms of tenure of loans disbursed through digital channels. NBBFCs gave for short term loans up to one year while others went for long term loans.
- With tall claims from regulatory authorities, it is true that Credit offered through digital channels by public sector banks is mostly secured whereas for private sector banks and foreign banks, most of the digital lending portfolio is unsecured and specifically, the third-party app sourced loans in private sector banks are unsecured.
Let us deal with regulatory policy approach towards digital lending. The RBI group dealt extensively towards the FinTech which deals new data, algorithm, software applications to perform traditional financial service provisions without significant change in the underlying functions – popularly known as incrementalistic Fin tech.
I can easily recollect the popular laws like Banking Regulations Act 1949, Reserve Bank of India Act, 1934, Companies Act 2013, State Money Lenders Act, and Chit Funds Act, 1982. Other regulations or instructions of relevant authorities do play their roles in affecting digital lending practices.
Pages 34 and 35 deal with the Global Regulatory Practices. A comparative study of global regulatory practices about ‘FinTech platform financing’ undertaken by Bank for International Settlements (BIS) in its publication released in August, 20201 mentioned FinTech platform financing as under:
(i) FinTech balance sheet lending.
(ii) Crowdfunding.
Most jurisdictions do not have any specific regulatory framework for FinTech balance sheet lending, and it is governed by regulations applicable to other non-bank lending institutions which are briefly explained below.
- Some like Austria and Germany do need banking license to do even digital lending.
- What about non-banking license requirements of other areas?
- Money lenders’ license in Hong Kong, an authorization from Bank of Italy for providing finance in any form, and adherence to state laws in USA for money lending,
- In the European Union, alternative investment fund managers using investment funds for lending are subject to authorization requirements under the ‘Alternative Investment Fund Managers Directive’.
- The China Banking and Insurance Regulatory Commission (CBIRC) and the People’s Bank of China (PBoC) jointly released interim rules on online micro loan business for feedback on November 2, 2020.
What should be done to regulate digital lending for all types of entities?
The committee’s report has dwelt on this both for short term as well as medium term with specific recommendations, and also gave advice to RBI or others by the way of recommendations. (Kindly refer pages 43-51 for recommendations addressed to Government of India/RBI)
Recommendations
The approach adopted by the committee should be the beacon holder for deeper understanding.
“The approach adopted in this Report is guided by the following three principles:
- Technology Neutrality: Neutrality towards technological differentials or business models while encouraging competition to maximize the benefits to the financial system.
- Principle Backed Regulation: Instead of a rule-based regime, a principle- backed approach to provide sufficient scope for innovation and adaptability in a dynamic environment.
- Addressing Regulatory Arbitrage: Addressing the arbitrage between different sets of entities in the digital lending ecosystem to ensure level playing field and market integrity.”
So, for you to understand, encouraging competition among all business models, not rule based but principle based, and regulatory measures with equality among all entities are the enshrined principles.
But what are the recommendations?
a) Legal & Regulatory Recommendations Near Term (up to one year)
b) A nodal agency to verify the technological credentials of DLAs of the balance sheet lenders and LSPs operating in the digital lending ecosystem.
c) Balance sheet lending through DLAs to be restricted to entities regulated and authorized by RBI.
d) An SRO (self- regulatory organization) to be constituted covering the participants in the digital lending ecosystem.
e) All loan servicing, repayments, to be executed directly in a bank account of the balance sheet lender and disbursements should always be made into the bank account of the borrower.
f) However, borrowers having only PPI account and no bank account would avail PPI accounts which are fully KYC compliant.
Now about medium- term implementations (above one year)
- The central government to bring a suitable legislation to ban illegal lending activities by introducing the ‘Banning of Unregulated Lending Activities Act’.
- RBI to have an Agency Financial Service Regulation (AFSR) for all customer-facing/ fully outsourced activities of REs including LSPs.
Now to talk about technology regulation
Short term measures
- To comply with prescribed baseline technology standards by the REs and by LSPs providing support to Res for digital lending.
- Each DLA to have publicly accessible policies regarding data storage, privacy, and its usage.
- Data to be stored in servers located in India.
- REs to document the rationale for the algorithmic features aiding transparent lending decisions
- Data are collected from the borrower/ prospective borrower with transparency and prior consent.
Medium term measures
- An adaptive comprehensive regulatory framework for FinTechs and TechFins.
- Algorithm used for underwriting should be auditable and lenders shall ensure that outputs from such algorithms are knitted in ethical AI design. Yes, regular audit should be done by experts well versed in online trading or loans disbursement.
Now to deal with consumer protection.
- Near Term
- Each lender should provide a key fact statement in a standardized format. Basic data input needs the attention of the borrower to verify and satisfy his/her requirements. It is customer’s duty to wet the information.
- A look-up period of certain days should be provided for all digital loans with the option of exit by paying proportionate APR without any penalty.
Medium Term
An anti-predatory lending policy should be framed by each lender based on the characteristics to be defined by RBI/ proposed SRO.
My observation
Yes, technology would crowd pull customers in unheard of measures since the current banking/regulatory/big financial institutions live in past, prescribe regulatory measures totally devoid of practical utility, and in a way encourage mediocrity.
It is firmly believed by REs that security is a must for business like existence. Do you believe that several cell calls impede me with personal loans by private sector banks/unregulated agencies even during the writing of this article?
Being banking literate, I fear misuse of personal data, improper storage by my bank, a very big- nationalized bank with unbridled regulation by authorities, and more harm than temporary gains.
Yes, my personal avoidance of modern technology for getting finance or utilization of funds may not hold good for ever. Latest unregulated entities offer fastest investment options, immediate gain in wealth, and more prosperity in near/medium term.
I expect the committee of RBI filled with older members to be more open with the realities of modern India.
Yes, report invites suggestions from you before implementation. I shall write my own but what about you?
In general terms, faster loans, timely ones, but with secured storage of my data, well preserved in India, audited periodically, and available for easy growth to meet future still uncertain but sure towards prosperity.
Reference
(The above web site contains 12 of its recommendations, though I have dealt with the report in a holistic and homogenous manner)
Please send your recommendations to [email protected] by 31 December 2021. Yes, please do act.
Disclaimer: The contents of this article are for information purposes only and do not constitute an advice or a legal opinion and are personal views of the author. It is based upon relevant law and/or facts available at that point of time and prepared with due accuracy & reliability. Readers are requested to check and refer relevant provisions of statute, latest judicial pronouncements, circulars, clarifications etc. before acting because of the above write up. The possibility of other views on the subject matter cannot be ruled out. By use of the said information, you agree that Author/TaxGuru is not responsible or liable in any manner for the authenticity, accuracy, completeness, errors, or any kind of omissions in this piece of information for any action taken thereof. This is not any kind of advertisement or solicitation of work by a professional.
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Sir , i like your articles .Digital banking is my interest area.
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