RBI’s Surveillance of Digital Lending Apps: Productive or Obstructive?

The Indian digital lending sector, an industry virtually non-existent nearly a decade back, has grown by leaps and bounds in the last three to four years.

The market valued at $14 billion in 2013, is expected to reach $350 billion by 2023 and $1.3 trillion by 2030. An enormous credit demand in the economy fuelled this exponential expansion of digital lending It was coupled with high customer fintech adoption rates and a rise in e-commerce due to mobility constraints during the pandemic days.

Despite the promising prospects, the sector was, until recently, the Wild West. It was full of problems like unethical lending practices and coercive recovery measures, unfair interest rates and charges, credit scams, data privacy violations, security issues, etc.

To safeguard customer interests and provide a legal framework for the operation of the industry, the Reserve Bank of India (RBI) issued the guidelines on digital lending in September 2022. It came to effect on December 1st, 2022.

The Industry Response and Implications

The guidelines are based on the study conducted by RBI’s Working Group on Digital Lending (WGDL) from January to November 2021. The new norms lay down through instructions about customer protection, lender behaviour, data collection, storage and sharing, regulatory framework, etc.

When the norms were published, the industry welcomed them with anxiety, caution, and confusion. While the stakeholders’ responses were generally positive, a few of these directives were considered excessively strict and vague. The objections arose because of the changes in existing operational models necessitated by the new norms.

Therefore, the guidelines will-

1. Require the Regulated Entities (REs) to entirely re-calibrate their systems, business models, and service agreements with their Lending Service Providers (LSPs) and Digital Lending Applications(DLAs),
2. Increase the operational intensity and operating cost in doing business, and
3. For effective implementation require, further clarifications from the central bank on specific points.

The Rationale Behind Stringent Digital Lending Norms

From its advent until now, the Indian digital lending market neither had a uniform procedure nor a regulator to set the market discipline. RBI’s intervention is a response to the increasing customer complaints about credit fraud and dubious lending practices and a remedy for the uncontrolled growth of the digital lending industry.

The WGDL, after studying the sector, has identified some issues detrimental to the well-being of the digital lending ecosystem, such as,

1. Presence of unregulated loan sharks
   There are many unregistered, unauthorised, and shady lending apps engaged in unfair business practices in the digital lending space.
2. Unwarranted scrubbing of customers’ smartphones
   Before the norms, there was a prevalent practice of misusing customer consent and accessing private data in users’ mobile phones. Some digital lenders even used customers’ high-risk data to harass them into repaying the loans, causing mental agony to the borrower. Irresponsible handling of sensitive customer information also raises cyber security concerns like risks of synthetic identity fraud.
3. Threat of money laundering
   There were widespread concerns of money laundering using shadow lending, where unregistered and faceless entities with no regional presence hide their activities under layers of REs. Loan repayment proceeds are often diverted to offshore locations where these app owners are based.
4. The risks of using First Loss Default Guarantee (FLDG)-FLDG agreements between regulated REs and unregulated Lending Service Providers (LSPs) enable REs to lend on the underwriting skills of LSPs. In such cases, the LSP, usually a digital lending app, will bear the credit risk without maintaining any regulatory capital needed to cover that risk.

Restrictive Features of the New Guidelines

A vital point to note is that the new lending norms are directed toward the banks, Non-banking Financial Companies (NBFCs), and other Microfinance Institutions (MFIs) which come under the purview of RBI, known as the Regulated Entities (REs). The DLAs and LSPs are outside the central bank’s regulatory ambit.

In its report, the WGDL has recommended the government to formally establish a Self-regulatory Organisation (SRO) that oversees the conduct of DLAs and LSPs.

RBI’s strict directives to its regulated entities have increased the pressure to improve due diligence and transparency, heighten data protection measures, and augment privacy policies in the fintech lending market.

This change presents a few challenges to the DLAs in the short term until the ecosystem realigns itself with the extant guidelines.

1. Prohibits non-bank Prepaid Payment Instruments (PPIs) from loading using credit lines
   
   According to another guideline issued by the RBI in June this year, non-banking finance institutions cannot use credit to load their prepaid payment instruments (PPIs) like e-wallets, prepaid cards, etc.This instruction directly impacted 37 non-bank PPI issuers currently operating in the digital lending market. Many fintech lenders paused their services until they could modify their operating procedures to comply with the instruction, while others were completely shut down.
2. Increases overhead costs

The operating expenditure increases as the apps have to reshuffle their business model to fit into the new framework. For example, fintech lenders using foreign servers will now have to hire a server in India to store customer data.

1. Discourage banks and NBFCs from undertaking digital lending

Restriction on using the first loss default guarantee will make the risk-averse banks and NBFCs reluctant to continue lending in the digital space. This will affect the availability of online credit, dampening the growth of digital lending.

Closing Notes

On the surface, the RBI’s Guidelines on Digital Lending appear to limit the growth of digital lending apps. However, the central bank’s goal is to remove undesirable entities and practices from the fintech lending space to protect the vulnerable and promote a healthy and competitive lending market.

To that end, the Ministry of Electronics and Information Technology has asked the RBI to create a safelist of approved digital lending apps that will be available for public download on popular app stores. Such moves can be considered progressive, concerted efforts to support digital lending in India.

As competition increases in the digital lending market and customers have multiple options to choose from, service delivery becomes the differentiating factor. Borrowers move to digital space for a fast, and seamless lending experience.

A robust application programming interface(API) plays a significant role in enhancing this competitive advantage.

Finezza brings mobile ecosystems and APIs suited to the requirements of both digital lenders and borrowers. We have custom apps for clients, the feet-on-street app for assisting the sales force on the ground, and credit management and collection apps for monitoring and managing the entire lifecycle of the digital loan.

Are you thinking of replacing your legacy lending platform? Contact us for a demo of our smart apps.