digital lending Archives

New Digital Lending Guidelines and Their Impact on NBFCs

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.

Closing Notes

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.

Finezza’s robust Loan Origination and Document Management tools help NBFCs and other lending institutions manage their loan portfolios efficiently. Contact us right away to learn more about our products.

Why Digital Lending Needs Factoring and Invoice Financing

Lending Lifecycle Management

It is common for companies to offer credit terms to their customers to increase sales and build customer relations. As a result, the company cannot access their money until the customers pay all the invoices. This leads to cash flow problems for the company, making it difficult to manage day-to-day operations and invest in the future expansion of the enterprise.

Invoice Financing and Factoring can help businesses access external sources other than traditional lines of credit, like banks, to maintain their supply lines, logistics, warehousing, and employees from time to time.

Typically, banks can finance businesses by giving out credit, but this requires collateral, considerable documentation, and unforeseen delays that take away crucial time from the business.

In this article, understand how to leverage unpaid invoices from businesses through Invoice Financing and Factoring to get the best return from your lending operations without risking too much in this digital environment.

What is Invoice Financing for a lender?

Invoice Financing is a short-term loan provided to businesses by keeping unpaid invoices as collateral. Once the customers pay, the lender can pay back the remaining amount after deducting the agreed-upon fees during the agreement.

The Invoice Financing process helps businesses shorten the time to convert inventory investments into cash and fund their working capital needs, including paying employees, suppliers, and other vendors.

Invoice Financing includes both factoring and discounting. The difference between Invoice Factoring and Invoice Discounting is the payment collection mechanism from the customer.

In Invoice Financing, the burden of collecting customer payments is on the business. In contrast, in Invoice Factoring, the lender collects the customer’s payment and charges a premium from the business for their services.

There are many benefits to Invoice Financing (discounting):

Business-to-business transactions and reliable customers reduce default risks.
The company needs to provide fewer documents.
Quicker recovery time from customers.

Invoice Financing (discounting) in action:

For instance, small business A, which has various customers with outstanding invoices, requires short-term capital for its business needs.

In such a case, it approaches lender B with its invoices of $1000. B lends 80% of the amount, i.e. $800, and keeps the invoices as collateral. When the customers pay back the amount to B, the lender can pay the remaining amount to A minus an agreed-upon fee.

This way, the pending and unpaid invoices in business A can provide an alternative for a short-term loan, and the lender can access a risk-free lending option, provided the paperwork of contracts and invoices is solid.

What is Invoice Factoring for a lender?

Invoice Factoring is a form of borrowing through which businesses sell unpaid invoices to a lender in exchange for a percentage of their value.

The lender pays a percentage of the invoice amount upfront according to the advance rate of the industry. An advance rate is the perceived risk taken by the lender and it varies from industry to industry.

The lender takes over the risk of the invoices to collect the payment from the customers, for which the lender charges a premium from the company.

Benefits of Invoice Factoring:

It is prevalent in B2B transactions because of lengthy supply lines where credit is preferred over cash, so the risk is lower.
The lender can charge a premium for seeking payments on company’s behalf.

Invoice Factoring in action:

Company A is in a seasonal business and requires immediate cash for its operations. It approaches Lender B with its invoices of $1000 and receives $600-900 (60-90%) as an advance.

The lender takes over the invoices and approaches the customers for payment. Lender B pays back company A minus factoring fees.

The factoring fee is the premium charge by the lender for taking the risk on behalf of A, and it is more than the amount of Invoice Financing. Company A gets access to cash immediately to finance its operations with the pending invoices.

Invoice Financing v/s Invoice Factoring

The opportunities offered by Invoice Financing and Factoring

Invoice Financing and Factoring provide an excellent opportunity for the lender to profit by taking a relatively minor risk and seeking the correct details from the business like:

The amount of Invoice Financing required by the business
Financial turnover of the business
The customer base of the business
Total outstanding invoices of the business and the invoices furnished
Bank statement of the business
Credit analysis of the business
Document identification and verification
Collection Delinquency risk
Taxation formalities

The lender can make an informed decision about the business invoices by getting the correct information and furnishing loans accordingly.

How Finezza can aid your lending journey

Invoice Financing and Factoring allow businesses to borrow money against the sums owed to them by customers. It can boost the cash flow and help reinvest in operations and business expansion.

In Invoice Financing, the company collects the payment from the customer and pays back the lender.

In Invoice Factoring the lender takes over the risk of tracking down the customers.

Therefore, the lender must make an informed decision about the credentials of the business and its customers.

Finezza has developed a product suite of software that helps the lender in:

Tracking and managing credit applications
Process KYC documents faster
Assess lending risk and loan origination
Perform credit analysis
Loan Management

What Does RBI’s Latest Digital Lending Guidelines Signify?

Lending Lifecycle Management

India’s digital lending market has grown considerably in recent years. Many fin-tech providers are offering easy loans to customers without collateral. While these loans are helpful for some customers who may be unable to get approved loans by a bank, the unregulated nature of this sphere proposed quite a few problems.

Violations of customer data privacy, extremely high-interest rates, aggressive loan recovery methods and other issues have plagued the digital lending sector in India for quite a while now.

So, now the government has decided to intervene and lay down laws to protect customers and provide ethical online lenders with more legitimacy. The new RBI regulations over digital lending will make the process more transparent and reduce the problem of customers ending up with unfeasible loans.

A Brief Summary of RBI Regulations for Online Lenders

These new rules are designed to safeguard consumers against fraud in the digital lending space. People now have the choice of dealing with legitimate Regulated Entities (REs) and Lending Service Providers (LSPs) under the statutory laws.

REs will be authorised digital lenders, and all service providers working with them must be government-regulated LSPs. As the RBI rules start coming into effect, it will be highly beneficial for fin-tech firms to get RE status because customers will also have more confidence in them.

Let’s take a look at the crux of this new press release about digital lending and its intended purpose:

The RBI allows REs to give loans and accept repayment directly to and from the customer’s bank account. There is no need for third-party involvement in this process.
The RE, not the borrower, shall pay all fees, charges, etc., payable to LSPs in the credit intermediation process.
The RBI has made it mandatory for REs to share a KFS (Key Facts Statement) about their online loan/credit product with the customer before finalising the deal.
An extremely important section under the KFS will be the APR (Annual Percentage Rate) which will give customers an idea about the total cost of the loan, including all additional charges.

This is meant to provide customers complete clarity about the kind of financial commitment that they are getting into (misrepresentation is one of the primary complaints against digital lenders).

The RBI has prohibited fin-tech firms from raising a customer’s credit limit without their explicit consent.
As per the new guidelines, REs will be expected to provide all customers with a cooling-off period/look-up interest phase where the customer will have the option to exit the loan contract by simply paying off the loan amount and proportionate APR.
REs (& LSPs engaged by them) will require a nodal officer for complaint redressal per the new RBI guidelines.

Not only this, the information about the grievance redressal officer should be prominently visible on their website so that customers can easily contact them via the website.

The RBI has laid down a 30-day period during which the REs will have to take action for grievance redressal after a complaint has been filed. If no action is taken during this period, the customer has the right to file a complaint with the RBI directly under their Integrated Ombudsman Scheme.
Before collecting any information from the customer, the RE has to take explicit consent from the customer to ensure data security & privacy.

Moreover, a customer can revoke the permission (given to the RE/LSP for using their data) at any point of their contract/relationship with the concerned entities.

The RBI has also stated that all REs and LSPs will have to provide complete detailed information about all digital lending activity (including short-term credits and deferred payment schemes) to companies collecting credit information. There can be no exceptions to this rule, irrespective of the length of tenure of the loans.

You can go through the press release for more details via this link.

Will the RBI Guidelines Be Effective?

The RBI guidelines above show that most of the attention has been paid to increasing transparency between customers and lenders about the digital lending process. This move has been made in light of the recent discovery that more than half the digital lenders operating in the country were involved in illegal practices.

With increased information in the form of KFS and APRs, customers will likely not fall into traps of debt that they cannot recover from. Data protection is also a major concern for the RBI since cybercrime via Digital Lending Apps (DLAs) has now become a significant threat to the safety of Indian civilians.

The RBI has also reserved some rights to gather information about the practices of these lending companies and to take action against lenders that do not satisfy all the regulatory guidelines.

The end goal of this system is to ensure that digital lending becomes a clean and regulated process that Indian citizens can use at their convenience without getting duped out of their hard-earned money. A regulated system will also bring in more customers and benefit digital lenders in the long run.

But these rules are new, and implementation has not yet begun, so customers and lenders need to be careful & avoid legal pitfalls. Customers should seek as much information as possible before signing the loan contract, and digital lenders also need to provide customers with as much standardised, accurate information as they can. The RBI may upgrade these regulations in the future as the digital lending market expands. Lenders must keep an eye out for these updates and modifications to retain their RE status.

Read here to learn about the mobile banking trends to look out for in 2022.

Final Thoughts

The rapid influx of RBI guidelines may have some digital lenders worried, but this action represents a huge advancement in the sector. The government accepts and acknowledges the digital credit market as a legitimate place of business by introducing rules. This simply hints that digital lending will only keep growing and becoming more popular in the coming years.

Right now, it is the most exciting phase of digital lending in India, and early birds that gain RE status and provide efficient service will be able to capture the lion’s share of this growing sector. Contact us for an end-to-end lending solution portfolio.

5 Key Factors Responsible for the Growth of the Global Digital Lending Industry

Loan Origination System

Digital lending has been gaining popularity all around the world. Not only are FinTech start-ups adopting digital lending, but even established multi-national banks are leveraging digital tools for the purposes of lending.

The financial sector, in India and around the world, is now in the midst of digital transformation. All processes of such institutions are being moved online thanks to the developments in information technology. Let’s see how these developments have benefited the lending industry.

Primary Factors Leading to Growth in Digital Lending

In this article, we’ll discuss 5 of the main reasons why digital lending is becoming more popular with borrowers and lenders alike.

1. Easier Process

Digital infrastructure has made it possible for lending companies to make the process much simpler. The borrower doesn’t have to travel to the bank multiple times. They don’t have to stand in line at the bank for hours. They don’t have to wait for a minimum of two weeks before the loan is processed. And so on.

Almost everyone these days prefers to operate online rather than in-person.

Further, borrowers prefer to get all the information at their fingertips. They can compare different lending products with each other. They can read the terms and conditions. They can judge the credibility of the lending company. And it can all be done online.

This makes it easier not only for the borrower but also for the lender. The lender does not have to spend on maintaining costly branches all around their catchment area. They do not have to spend on costly traditional marketing methods. All they need is a robust website, a good executive team, and investing in some digital marketing to reach potential customers.

2. User-Friendly Interface

Most digital lenders give particular attention to the user interface of their online digital lending platform. This platform can be in the form of a mobile app or a website or both. It is important to make the interface user-friendly because otherwise the borrower might get confused or it might take too long.

Thanks to developments in UX and UI research, lenders now have the ability to make interfaces highly attractive and super smooth. The entire process, as long as the loan is unsecured, does not take more than half an hour.

Most of the time, the user interface also has built-in customer support. This means that the borrower can chat or talk with a customer support executive in case they have any doubts and ask for clarifications. This ensures that support is provided on every step of the way, and the borrower is not left to navigate the process on his own.

3. Partially Automated Decision-Making

With developments in software and artificial intelligence, the loan decision-making process has been made much easier and quicker. Traditionally, loan officers had to manually sift through and analyse thousands of loan applications. It used to take at least a couple of weeks before a loan could be processed. There used to be several turnarounds as various stakeholders provided their inputs.

Nowadays, highly sophisticated loan processing software is available. You can enter the details and finances of a loan applicant, and the software will analyse all the data. Once the data has been analysed, you will receive a report containing all the relevant information along with red flags (if there are any).

Overall, the processing time for a loan has been made much quicker due to such software. Hence, digital lending companies are leveraging these tools to be able to process loans much quicker than was earlier possible.

4. Quicker Disbursement

Further, the entire timeline of processing a loan has become much faster. Earlier, it used to take weeks. Nowadays, borrowers can avail of a simple unsecured loan within the space of a few hours.

A lot of digital lenders are now “pre-approving” loans. This means that the bank analyses the borrower’s financial statements and determines which loans they are suitable for. This has been made possible because banks have the financial data as well as the CIBIL score in a digital format. Hence, they can rely on software to analyse the data and come up with custom-made loan packages for each of their customers.

If a borrower wants to avail of a pre-approved loan, all they have to do is make a few clicks and upload a few documents. The loan will be disbursed to their bank account within the space of a few hours.

Further, even if they want to apply for a loan that is not pre-approved, the process has become much quicker. Nowadays, a lot of digital lenders are promising disbursement within 24 or 48 hours of application.

5. Minimal Paperwork

Traditionally, it was a headache to apply for a loan and process it. Mountains of paperwork were involved since all the documents were in physical form. A loan applicant had to fill in at least three or four forms, provide documentation relating to all aspects of the loan, and also provide photocopies of all the documents that were submitted.

Thanks to digital transformation, all this paperwork can now be avoided. All that the modern borrower needs to do is fill out the online loan application form and upload the relevant documents.

Wrapping Up

Digital lending is here to stay. It has made the process of lending much more convenient for both borrowers and lenders. Banks are quickly overhauling their old processes and embracing the new technology that makes it all possible. Online lenders are changing the game, and the lending business is modernising faster than ever.

Contact Finezza if you are a financial institution looking for a Loan Management System; to stay in the lending game and ace. Also, check out our blog for more such articles.