The fintech lending ecosystem in India was largely unregulated for a long time. A large section of the population that was ignored by the traditional banking industry received timely financial assistance, thanks to new technologies and innovative products. But the digital lending sector was beset with problems such as exorbitant interest rates, unrestricted employment of third parties, unethical sales and recovery measures, data privacy violations, etc.
To ensure the orderly growth of digital lending while protecting customer interests, the Reserve Bank of India (RBI) constituted a Working Group on Digital Lending (WGDL) in January 2021. Based on the recommendations of WGDL, RBI published detailed Guidelines on Digital Lending on September 2nd, 2022.
Some provisions in the new digital lending rules call for changes in the existing operating models of some regulated entities (REs), especially Non-Banking Financial Companies (NBFCs). Some NBFCs will have to completely revamp their systems and procedures to comply with different requirements concerning information disclosure, data privacy, grievance redressal, corporate governance, etc.
A Broad Outline of New Digital Lending Norms
Before examining how the new digital lending norms will affect the NBFCs, one must understand what the new guidelines signify. At the outset, the WGDL has grouped digital lenders into three categories. The first group includes those entities authorised and regulated by RBI to enter the lending business. Institutions that fall outside the purview of the RBI but are authorised to lend under other statutory or regulatory provisions belong to the second category. The third group consists of organisations that lend outside the scope of any regulatory framework. RBI has specified that the new norms will only apply to the first group. This includes Regulated Entities (REs) and the Lending Service Providers (LSPs) employed for rendering various digital lending services.
The new rules cover three main domains:
- Customer protection and conduct issues
- Technology and data requirements
- Regulatory framework
The guidelines will apply to new loans as well as existing loans. RBI has given REs time till November 30th of this year to ensure compliance of existing loans to the new norms.
Significance of New Guidelines on NBFCs
Many NBFCs already adhere to these requirements. For others, the new norms will increase the operational intensity and compliance expenses. The conditions in this circular change the existing lender-borrower relationship in the digital lending environment, impacting the operating model of NBFCs. Let us examine the ramifications of new guidelines on the existing NBFC working structure in fintech lending.
1. Impact on Existing BNPL Model
The new regulations mandate that the disbursements and repayments flow only between the bank accounts of the lender (REs) and the borrower. It prevents routing funds through intermediary accounts belonging to LSPs or other third parties. This will affect the preferred Buy Now, Pay Later (BNPL) service and other prepaid payment instruments (PPIs) funded through credit.
Under the current BNPL operating model, many fintech LSPs have been responsible for disbursing the loans and recovering the EMIs. They act as facilitators between the lender and the borrower. This relationship will change with the new guidelines; consequently, NBFCs must modify their operating structures.
2. Need to Restructure the Underwriting Process
Barring the initial one-time access with the customer’s explicit consent, the REs and the Digital Lending Apps (DLAs) are prohibited access to the smartphone data of the borrower, such as contact list, files, documents, call registry, etc. This norm will significantly change the existing underwriting process of digital loans.
Digital lenders use tools like Robotic Process Automation (RPA), Machine Learning (ML), Artificial Intelligence (AI), etc., for underwriting loans. Automated underwriting resorted to phone scrubbing (reading mobile phones) to gain customer information. NBFCs will now have to reorganise their underwriting methods.
3. Changes in First Loss Default Guarantee Models
In First Loss Default Guarantee (FLDG) arrangements, the fintech companies agree to compensate their partner REs (digital lenders) a certain percentage of the customer default loans. In the digital lending guidelines, RBI has instructed REs to follow The Master Direction on Securitisation of Standards Assets provisions. FLDG is an important feature of many NBFC digital lending business models. Change in regulations necessitates revamping the existing FLDG structure.
4. Impact on the Data Storage Requirements
The new guidelines place strict provisions for protecting customer data. REs will have to formulate comprehensive policy guidelines concerning the collection, storage, usage and sharing, and destruction of customer information. Data collection must be need-based and only with the customer’s explicit consent. Also, the norms permit the storage of customer data only on servers located in India. NBFCs that do not currently follow this requirement must comply with these regulations.
5. Refashion the Current Collaboration Model With the LSPs
The new guidelines on digital lending have made the REs more accountable on matters related to customers. Their responsibility extends beyond the core lending activities. From disclosure of information to supervising the operations and conduct of their LSPs and DLAs, the regulated entities will have a bigger role in the revised framework of digital lending.
NBFCs will need to adjust their business models and operating structures to fit into the new order. They must strengthen their due diligence, audit, and compliance models, remodel their contractual relationships with the LSPs and DLAs, and revise their customer loan contracts to align with the new rules.
While the new regulations may seem stringent, causing a significant impact on the operating models of some NBFCs, and adding to their operational costs, they will benefit the NBFCs in the long run. The new guidelines aim to curb malpractices and bring transparency to the digital lending process. A regulated market will improve customers’ trust and confidence in digital lending and increase growth potential.
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