Banking | A need for borrower-centric regulations in lending

Retail lending is undergoing a major transformation in India, with technology giving it a boost. New-age digital lending has forced the regulator to not only setup an expert committee, but to also setup the first regulatory sandbox.

With financial Inclusion taking shape in India, we are witnessing a surge in demand for credit. While, the regulator is working on the design and structure of the regulatory framework for digital lending, it is time to change the approach towards regulation in business lending.

Broadly, we have three types of lenders — banks (including small finance banks, regional rural banks, co-operative banks), non-banking finance companies (including housing finance companies, P2P lending NBFCs, and micro financing NBFC-MFIs) and All India Financial Institutions (like SIDBI, NABARD etc.). All three are regulated by the Reserve Bank of India (RBI). Historically, the regulatory framework for these lender categories falls into separate buckets backed by the provisions of the respective statutes governing various lenders. This was a direct fall out of the different nature of lending activities carried out by each of these lenders.

Get More Granular

With the growth of the economy and economic reforms in recent times, India witnessed a surge in demand for credit. This led to overlaps in the type of lending done by each of the lender categories. This, in turn, resulted in the RBI ‘harmonising’ these regulations for the lenders. Due to this change, we have witnessed greater convergence and harmony in the norms, especially, the prudential norms prescribed for banks, the NBFCs, and the FIs. For this, the RBI shifted focus to an activity-based regulation as against entity-based regulation. The RBI circular on March 14 on the master directions for microfinance loans, which is applicable to all the lenders, is a good example.

However, with lending getting more diversified, covering a larger segment of the society, including the unbanked, the need of the hour is for the regulations to get more granular. A mere activity-based approach does not suffice, and there is a strong case for a borrower-based approach.

The NPA Tag

The RBI issued a circular (November 12, 2021) on prudential norms on income recognition, asset classification and provisioning pertaining to advances. This was addressed to all the Regulated Entities (REs), which meant that they were applicable to each of these lenders. As per this, it is mandatory for lenders to ensure that by the end of 90th day of default, they have to classify the defaulting borrower account as a non-performing asset (NPA). The circular also clarifies that once a borrower account is classified as an NPA, it can be upgraded back to the ‘standard’ category only when the borrower repays the due amount (principal plus interest plus penal interest) in full.

Imagine these provisions in the case of a loan of Rs 50,000 given to an individual running a kiosk/shop or a service provider like a plumber/mechanic or a factory worker, as against a loan of Rs 500 crore given to a corporate. How prudent it is to have same norms for both the borrowers, when the poor, small borrower’s earnings, and cash flows are extremely fragile, and they are the first to bear the brunt of any misfortune like a natural calamity, or a pandemic, or local unrests, etc. Further, in the case of small service providers, the cash inflows happen during the month end, and in some cases even at the end of a quarter. Added to it are the unforeseen expenses like medical exigencies, etc.

At the end of the 90 days, if the borrower defaults, they will be forced to bear an NPA tag. The natural fallout of this shall be an early NPA tag which shall last longer. With the NPA tag, they become untouchables as far as the REs are concerned. Give this, the borrower is forced to turn to the local moneylender, or borrow from kith and kin.

Flexibility Matters

The point is that ‘flexibility’ has to be an essential element of any regulatory norm(s) prescribed for small borrowers, or borrowers whose cash inflows happen only once a month or quarter. Rigid regulations impact borrowing capacities, and also force lenders to become more risk averse. This goes against the agenda of financial inclusion.

Often a counter argument put forth to this is that the lenders have the flexibility to prescribe the repayment schedule based on the nature and needs of the borrowers. But the key issue that is missed out is that the needs and cash flows of small borrowers change so fast that it is impossible to foresee them at the beginning of the loan agreement. It is important to ensure flexibility right through the tenure of the loan, and not merely when it starts.

Credit Availability

At a recent discussion organised by an MSME organisation, credit was one of the key subjects. All the MSME borrowers had similar opinions and concerns on credit availability. While they are flooded with phone calls from banks and NBFCs offering loans, they struggle to meet their credit needs due to:

• Mismatch in timing
• Terms of the loan products not in sync with their nature of business
• No provisions to cater to the disruptions caused in their cash flows unless the disruption is at the state or national level
• Some businesses demand specialised treatment
• Need for increased level of handholding in case of an exigency

The key to the impressive growth of NBFCs is their focus on lending to the unbanked and under-banked. ‘Flexibility based on the borrower’s needs’ is the key which draws the small borrowers despite the lending rates of NBFCs being higher than that of banks and FIs.

Focus On Borrower

The world has evolved to put human behaviour as the key focus area for any policy-making process. Even the latest advances in technology have the user as the main focus area. Therefore, it is important for the regulator and the policy-makers to start looking at lending regulations from the lens of the borrower, and not merely the lender.

In the effort towards harmonising regulations of different lenders, it is important to ensure that the flexibility required to cater to the needs of the borrowers is not impacted. Inclusive financing has to be backed by inclusive regulations.

Raman Aggarwal is Director, Finance Industry Development Council, and Area Head-NBFCs, Council for International Economic Understanding. Views are personal, and do not represent the stand of this publication.