Non-banking finance companies and fintechs operating in the digital lending space are staring at a major overhaul of operations, tweaking of business models and a rise in costs after the Reserve Bank tightened the guidelines for such lending.
Digital lenders had put in place such a system wherein a customer’s entire loan journey passes through a technologically enabled system, which includes loan underwriting through alternative data sources and artificial intelligence (AI), among others.
Now, with the new rules, the underlying processes, customer-facing interface, disclosures, consent, smartphone access and communication protocols will have to be changed.
What are RBI's new guidelines?
Under the new rules, regulated entities (REs) are required to disclose all costs upfront in a digital loan product to the customer, even as they are not allowed to scrub or read borrowers’ smartphones.
Also, among other requirements, all loan disbursals and repayments must now be executed only between borrowers’ bank accounts and the RE without any pass-through or pool account of the lending service provider (LSP), or any other third party. Further, any fees or charges payable to LSPs in the credit intermediation process shall be paid directly by the RE and not by the borrower.
Raising operational intensity
The new rules, though formed with the right spirit of customer protection, will raise the operational intensity and compliance costs for lenders in the near term, rating agency CRISIL said in an August 19 note.
“The regulations on direct transfer of disbursements, repayments between borrowers and lenders will impact the ‘buy now, pay later’ services and prepaid instruments being offered. Business models will have to be tweaked to conform with the new regulations,” Krishnan Sitaraman, senior director and deputy chief ratings officer at CRISIL said.
“Another important change is the restriction imposed on scrubbing/reading the smartphones of borrowers. This was a typical part of the underwriting regimen for digital consumer loans, and it will have to be rejigged now,” he added.
Y S Chakravarti, managing director and chief executive officer at Shriram City Union Finance, said the digital lending guidelines will lead to greater regulation of fintechs.
“For digital lending at Shriram City Union Finance and Shriram Transport Finance, all disbursements are done only through the customer bank account and disclosure of interest rates takes place upfront,” Chakravarti said.
“We don’t facilitate automatic increases in borrower credit limit and have always followed a conservative approach. The mandatory submission of data to credit bureaus by LSPs, fintechs and aggregators is positive for banks and NBFCs. As market players adapt to the new regulations, there will be stronger oversight built over time, as was the case with banks or NBFCs,” he said.
How fintechs are impacted
Fintech firms, which are loan intermediaries, are gearing up to comply with the new norms.
As per industry group Fintech Association for Consumer Empowerment (FACE), which has KreditBee, EarlySalary, Kissht, Yubi, Paisa Bazaar, mPokket, LoanTap, PayU as its partner members, fintechs have made RBI’s new guidelines their immediate priority and are working to implement the same fully.
“Many underlying processes must be updated including the customer-facing interface, disclosures, APR (average percentage rate), consent and communication protocols,” said Sugandh Saxena, CEO of FACE.
REs and LSPs will also have to rework their various servicing agreements as well for compliance with the new guidelines, Saxena said.
Aditya Kumar, co-founder at fintech Niro, said the digital lending guidelines ensure the highest levels of customer protection in the form of data privacy, security, transparency and mandatory disclosures, as well as provide flexibility in terms of penalty-free loan cancellations.
“While these disclosures will create short-term challenges for certain fintechs, the long-term protection of consumers, coupled with the RBI's recognition of fintechs as LSPs will, no doubt, be a boon for digital lending in the medium term," Kumar said.
As per Shilpa Ahluwalia, partner at Shardul Amarchand & Mangaldas & Co, the central bank has indicated that the regulation of first loan default guarantees (FLDGs) is still under consideration, which will likely be viewed as a very positive outcome given that the fintech industry feared a complete ban of the FLDG model.
FLDG is an arrangement whereby a third party compensates a lender if the borrower defaults.
From the LSP’s perspective, offering FLDG acts as a demonstration of its underwriting skills whereas from the lender’s perspective, it ensures the platform’s skin in the business. For all practical purposes, credit risk is borne by the LSP without having to maintain any regulatory capital.
Ahluwalia said the new rules do require all FLDG structures to comply with the RBI’s 2021 securitisation of standard assets norms. Most requirements concerning FLDG structures will likely be introduced, she said.
"Going forward, it appears that only LSPs that have an NBFC within their group structure will likely be able to continue to rely on the FLDG lending model,” Ahluwalia said.
Amit Das, CEO and Co-founder of Think360.ai concurred.
“In the current guidelines, there are several changes that hit at the heart of fintech-RE relationships, commercial structures, and product design and possibly bring the fintech growth to a halt,” Das said, adding that this will subsequently impact financial inclusion imperatives.
For Think360.ai, Das said there was not any significant impact in continuing functioning as an LSP given the company is aligned to the RBI circulars.
It will be difficult for fintechs to maintain their current value trajectory while complying with the guidelines, Das said, adding that the scales are heavily tilted towards becoming a RE and having their own NBFC licence.
“I think, in the short, all parties will struggle. In the medium term, tech agility will become a key differentiation amongst NBFCs,” Das said.
But who checks the unregulated loan apps?
While the RBI is expected to release further digital lending guidelines in consultation with stakeholders and the government, it must also crack down on illegal loan apps that defraud customers, experts said.
Out of the 1,100 unique loan applications available on over 81 app stores as on February 28, 2021, about 600 were illegal, as per the finding of the RBI’s 2021 working group committee on digital lending.
Saxena said financially less aware customers, who are in desperate need of money, continue to download apps from various regulated and unregulated mobile application stores and websites.
