Digital lenders for long have operated without a regulatory framework. Most fintech companies are app-based lenders, which work with non-banking finance companies (NBFCs) or others to source money for their clients. They typically don’t lend from their own books.
Technology enables them to reach out to young, tech-savvy customers faster than banks. The speed at which they process the loan is another reason they are popular among the young but their problems are no different from those of the banks when the money has to be recovered.
Samit Ghosh, a senior banker who built a large microfinance firm, sums it up succinctly—fintech companies have good software to evaluate loan applicants but loans have to be collected from the ground as well.
“If they are in the lending business, they will be the worst affected in a crisis and a lot of them will have to be merged or sell their business to banks,” says Ghosh who founded Ujjivan Financial Services Limited.
Terrorising customers
The problems in getting the money back have triggered the use of harsh recovery practices—threats, arm-twisting and harassment—that have led to a rise in deaths by suicides.
Moneycontrol has written how app-based loan sharks were laying death traps for borrowers, highlighting the lack of regulation in the segment.
There have been a series of reports about customers ending their lives following harassment at the hands of illegal money-lending apps, forcing the central bank to intervene.
On January 13, the RBI constituted a working group of top officials and some external members to study the segment and suggest regulations.
After nine months of work, the committee has finally come out with proposals to regulate the sector. Perhaps, the most important suggestion is to frame a separate law to prevent illegal digital lending.
This is a key proposal as the law will, hopefully, give teeth to the regulator and law enforcement agencies to tackle the wrongdoers.
Another key recommendation is subjecting the digital lending apps to a verification process by a nodal agency to be set up in consultation with stakeholders. A Self-Regulatory Organisation covering the participants in the digital lending ecosystem has been suggested.
To make the process transparent, the working group has said that the loan should directly be disbursed into the bank accounts of borrowers. Disbursement and servicing of loans should only be done through bank accounts of digital lenders.
Stakeholders have time till December 31 to comment on the recommendations. The proposed rules, if accepted, can give a new start to the digital lenders to operate within the legal framework and with a certain degree of discipline, which is lacking at this point.
A good start but a long road ahead
These regulations are promising. Similar checks have worked well in the microfinance sector where lack of oversight culminated in the 2010 Andhra Pradesh microfinance crisis. The coercive recovery practices of certain rogue microlenders had cost several lives. Regulations proposed by the YH Malegam committee in 2011 brought the much-needed order to the fast-growing, highly-sensitive sector.
Illegal digital lenders are no different from illegal moneylenders who have been operating in India for ages and typically lend against land or gold ornaments to low-income groups.
They too, like moneylenders, engage in coercive lending practices to get back their money. Naming and shaming the borrower among is common. The only difference is that the new crop use technology to offer loans, especially to the young customer segment for their consumption.
Self-regulation is the first step but more needs to be done. Only tighter RBI supervision enabled by a law can rein in the violators. The recommendations are a step in the right direction. Let this be a new start for digital lenders and their customers.
(Banking Central is a weekly column that keeps a close watch and connects the dots about the sector's most important events for readers.)
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