The Reserve Bank of India (RBI) has released the first set of regulations for digital lending in an effort to rein in players that engage in illicit activity.
Digital Lending is an automated and remote lending procedure that heavily relies on seamless digital technology for customer acquisition, credit scoring, loan approval, disbursem*nt, recovery, and related customer support.
A working group on digital lending named “Digital Lending, including Lending through Online Platforms and Mobile Apps” (WGDL) in January 2021 presented some recommendations.
The working group made its report public in November 2021. Following such recommendations, RBI has made public the digital lending norms/guidelines.
Table of Contents
Aim of Digital Lending Norms
In order to curb the rising malpractice in the digital lending ecosystem, the Reserve Bank of India has issued a guideline for entities engaged in digital lending.
As per the norms, all the loans must be disbursed and repaid through bank accounts of regulated bank entities only. That must be without passing through Lending Service Providers (LSPs) or other third parties.
Classification of Digital Lenders
As per the regulators, the ‘Digital Lenders’ are classified into three groups:
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- Entities regulated by the RBI and permitted to carry out lending business; for example, Banks and NBFCs.
- Entities that are authorized to carry out a lending as per other statutory or regulatory provisions but are not regulated by RBI. For example, Rural cooperatives like ‘Primary Agriculture Credit Societies (PACS), are regulated by State Governments.
- Entities lending outside the purview of any statutory or regulatory provisions. For example, informal lenders.
Scope of Application of Digital Lending Norms
These guidelines are applicable to digital lending extended by:
- All Commercial Banks,
- Primary (Urban) Co-operative Banks, State Co-operative Banks, District Central Co-operative Banks; and
- Non-Banking Financial Companies (including Housing Finance Companies)
Concerns related to Digital Lending
RBI released Guidelines related to digital lending. The primary matter of concern that needed to be curbed or solved is related to the engagement of third parties, breach of data privacy, mis-selling of info, unfair means of business conduct, exorbitant interest rates charged on the loans and over all of it, unethical recovery practices followed.
Why Such Norms are Needed
Analyzing a participant’s operational legitimacy was challenging in the absence of standardized disclosure and regulatory standards. There were over 1,100 lending apps available for Indian Android users between January and the end of February of last year, of which approximately 600 were illegal.
NBFCs have a significant impact on the market. Small borrowers without a history of credit documentation, who are typically underserved by traditional financial institutions, are among its consumers in particular.
Transparency is the main tenet. Lending must be done by organizations that are either under RBI regulation or have been granted a license to operate by relevant law. This would also aid in addressing regulatory arbitrage given the industry’s extensive outsourcing.
RBI Guidelines on Digital Lending
All loan payments and disbursem*nts must be made directly between the borrower’s and the RE’s bank accounts (banks, NBFCs) and not through a pass-through or pool account of the LSPs (lending service providers) or any other entity.
The RE, not the borrower, shall pay all fees, charges, etc., payable to LSPs in the credit intermediation process.
The borrower must get a standardized Key Fact Statement (KFS) before executing the loan contract.
Borrowers must be informed of the total cost of digital loans in the form of the annual percentage rate (APR). APR shall also form part of KFS.
It is forbidden to automatically increase the credit limit without the borrower’s explicit consent.
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The loan contract must include a cooling-off or look-up period during which borrowers can cancel their digital loans by paying the principal plus the appropriate APR without incurring any penalties.
To handle complaints relating to FinTech and digital lending, REs must make sure that they and the LSPs,bothhaveaccess to an appropriate nodal grievance redressal officer.
Data acquired by DLAs should only be done with the explicit prior consent of the borrower, be need-based, and have clear audit trails.
Any lending sourced through Digital Lending Apps (DLAs) is required to be reported to Credit Information Companies (CICs) by REs irrespective of its nature or tenor.
All new digital lending products that REs extend over merchant platforms (for instance, when you purchase something via an EMI facility) and that involve short-term credit or deferred payments must be reported by REs to CICs. [ Credit Bureaus are another name for Credit Information Companies].
Definitions of Important Terms Used in the Guidelines
Annual Percentage Rate (APR): APR refers to the effective annualized rate that is charged to a borrower of a digital loan.APR shall be based on an all-inclusive cost and margin, including Cost of Funds, Credit Cost, Operating Cost, Processing Fee, Verification Charges, Maintenance Charges, etc., and excluding Contingent Charges such as Penal Charges, Late Payment Charges, etc.,
Cooling off/look-up period: If a borrower decides not to continue with the loan, they will be given a window of time, as set by the Board of the RE, during which they can quit their digital debts.
Digital Lending Apps/Platforms (DLAs): User-friendly mobile and online applications that support digital lending services. Applications run by Regulated Entities (REs) as well as Lending Service Providers (LSPs) hired by REs for providing any credit facilitation services in accordance with current outsourcing standards outlined by the Reserve Bank will be included in DLAs.
Lending Service Provider (LSP): An agent of a Regulated Entity who, in accordance with the Reserve Bank’s current outsourcing guidelines, performs one or more of the lender’s functions—or portions thereof—in customer acquisition, underwriting support, pricing support, servicing, monitoring, and recovery of a particular loan or loan portfolio—on behalf of REs.
Conclusion
Although the percentage of digital lending is now small, given their scalability, they have the potential to quickly become significant players. The wider financial system may be affected by these implications. Senior Director and Deputy Chief Ratings Officer at CRISIL, Krishnan Sitaraman, said, “We will have to see what kind of changes the digital lenders make to their operating models in light of the new regulations, how it impacts the fees they charge, the speed of their disbursem*nts, or how they continue to provide a seamless experience to their customers,”
With the economy recovering at a respectable pace after the pandemic and our expectations of a GDP growth of 7.3% this fiscal, we expect demand for loans across the credit ecosystem to be higher this fiscal even though higher inflation and interest rates. Digital lenders should proactively create and adhere to a code of conduct that specifies the values of honesty, openness, and consumer protection and includes specific guidelines for disclosure and complaint resolution. So, it is important to be under regulation in order to avoid a distorted financial system in the future.
Article Written By: Priti Raj
As a seasoned expert in financial regulations, particularly in the field of digital lending, I bring a wealth of knowledge and hands-on experience to dissect the intricacies of the Reserve Bank of India's (RBI) recent guidelines on digital lending. My expertise is underscored by a deep understanding of the regulatory landscape, having closely followed developments in this domain.
The RBI's move to release comprehensive regulations for digital lending is a pivotal step in addressing the challenges and concerns within the digital lending ecosystem. The aim of these norms is crystal clear: to combat the rising malpractices in the digital lending sector. One of the key provisions mandates that all loans must be disbursed and repaid through bank accounts of regulated entities, eliminating the involvement of Lending Service Providers (LSPs) or other third parties.
The classification of digital lenders into three distinct groups—Entities regulated by the RBI, Entities authorized under other statutory or regulatory provisions, and Entities lending outside any statutory or regulatory provisions—highlights the diverse landscape of players in the digital lending sphere.
The scope of application of these norms is extensive, covering all commercial banks, primary (urban) co-operative banks, state co-operative banks, district central co-operative banks, and non-banking financial companies (including housing finance companies).
The concerns addressed in the guidelines reflect the multifaceted challenges in digital lending, ranging from engagement with third parties to breach of data privacy, mis-selling of information, exorbitant interest rates, and unethical recovery practices. The need for such norms arises from the sheer volume of lending apps—over 1,100 for Indian Android users in a short period—where approximately 600 were identified as illegal.
The RBI's guidelines on digital lending outline various critical measures, including the direct transfer of loan payments and disbursem*nts between borrower and regulated entities' bank accounts, the prohibition of automatic credit limit increases without explicit borrower consent, and the requirement for a standardized Key Fact Statement (KFS) to inform borrowers about the total cost of digital loans.
Important terms used in the guidelines, such as Annual Percentage Rate (APR), Cooling off/look-up period, Digital Lending Apps/Platforms (DLAs), and Lending Service Provider (LSP), are defined with precision to ensure clarity and uniform interpretation.
In conclusion, the significance of these regulations cannot be overstated. They pave the way for a more transparent and accountable digital lending ecosystem. The impact on digital lenders, especially non-banking financial companies (NBFCs), is substantial. Transparency, standardized disclosure, and adherence to regulatory standards are crucial for ensuring the legitimacy of operations in this evolving financial landscape.
As we navigate the aftermath of the pandemic and witness the recovery of the economy, the role of digital lenders becomes increasingly pivotal. The emphasis on a code of conduct that upholds values of honesty, openness, and consumer protection underscores the need for responsible practices in the digital lending space. Regulatory compliance is not just a requirement; it is a prerequisite for maintaining the integrity of the financial system in the future.
