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The Reserve Bank of India has come out with norms that aim to regulate digital lending specifically, with a focus on consumer interest.

While lending is highly regulated in India, digital lending is not, and the central bank saw a regulatory gap in such lending and constituted a working group.

Highlighting “renting an NBFC” or off-balance sheet lending models as an area of concern, the working group has proposed that all lending, including the buy now pay later products, must be done only “on balance sheet” by licensed entities.

This, if implemented, is set to alter the business models of several products, where the non-licensed entities provide some credit support such as first loan default guarantees, and assume part of the credit risk of the loan.

Maintaining transparency

To maintain transparency on the loan servicing front, the Group proposes that all loan services, repayments, and other related activities should be executed directly in a bank account of the balance sheet lender. A similar approach is envisaged for the disbursement of loans.

It has recommended the setting up of a nodal agency to primarily verify the technological credentials of Digital Lending Apps (DLAs) of balance sheet lenders along with maintenance of a public register of verified apps.

The digital lending apps will have to disclose their data and credit assessments and defend credit underwriting strategies. Unlike the credit bureaus, which rely on historical data trends and are highly regulated, the lending apps rely on AI and algorithms to analyse and price credit risk that remains highly unregulated. This will give consumers access to their credit underwriting data.

Interest rate regulation

While the RBI has stayed away from interest rate caps, the working group discusses the concept of an annual percentage rate (APR) that includes interest rates and all other costs associated with a loan to prevent over-charging by way of “hidden costs”. The report talks about the “need to bring in” interest rate regulation. The proposed transparency in pricing could have serious implications for the sector.

The report lays the groundwork for opening digital-only NBFCs/ banks, and the possible inclusion of digital/ neo-banks under the RBI regulations. and suggests measures for broadening credit reporting to enable better credit decisions.

Technology front

The second set of regulations are focused on strengthening the tech part of regulation given that technology is the backbone of the fintech revolution. For this, it has suggested observing prescribed baseline technology standards, storage of data in servers located in India, detailed disclosures on the app/ website coupled with increased emphasis on digitally signed documents.

The report envisages a self regulating organisation (SRO) for the segment, which will evolve codes of conduct for all participants, develop standardised contracts, build a model to calculate APR, prescribe and monitor technology standards that ensure the security of mobile-based apps, and institutionalise a consumer redressal mechanism. The reasoning of the RBI working group is that in the scenario of rapid technological changes, an SRO is well-positioned to understand the risks of newer business models.

Further, the names of identified unscrupulous lenders should be made available to the regulated entities to enable them to do enhanced due diligence while allowing customers to use banking/payment/telecom channels. Policies around anti-predatory lending and anti-usurious lending are urged.

The implications

For consumers, the new norms are likely to improve standards of transparency and disclosure, prevent unfair lending practices and give greater control over data.

However, the smaller players and technology intermediaries are likely to be affected by the proposed regulations and the sector is likely to see consolidation as rising cost of compliance and certain business models becoming unviable.