Buy Now Pay Later | RBI’s timely move will check explosive growth of unsecured credit

Representative image.

Recently, the Reserve Bank of India (RBI) issued new guidelines for the use of the Pre-Paid Instruments (PPI). Essentially, it prohibited lenders from linking these instruments to a credit line issued by them to a customer. With these regulations, the RBI has effectively put an end to the so-called Buy Now Pay Later (BNPL) schemes offered by some non-banking lenders linked to customer purchases on electronic retail platforms. This is a welcome step, and the RBI has proactively intervened to stop a potentially dangerous unsecured credit bubble from building up in the financial system.

The PPIs are essentially payment instruments that are meant to facilitate easy electronic payments, especially for customers who do not have access to other more commonly used modes of payments — credit and debit cards. The PPIs were never intended to be nor regulated as a ‘store of value’ like a bank deposit. Customers could preload these instruments from their bank accounts to a tightly defined limit, and then use them to carry out electronic transactions.

Under the BNPL programmes, lenders would link these instruments to a credit line (or a loan) from a non-banking (NBFC) lender. At the time the customer used the instrument at a transaction point, the loan was considered ‘disbursed’ loading the PPI. Essentially, these schemes mimicked a credit card for customers who, obviously, would not have one and needed credit at the transaction point.

Credit doled out under these schemes offered by a host of the NBFCs has been growing exponentially. It is important to keep in mind that this credit was given to customers who did not qualify to get a credit card, even one with low limits. Credit extended under such schemes was what we could term as India’s subprime, unsecured lending, which was likely developing into a bubble.

The RBI’s new guidelines have re-established the basic purpose of the PPIs. It has affirmed that these were meant to be purely payment instruments, and not Trojan horses to extend unsecured credit to customers with questionable quality, and bypass all the regulatory oversight over a normal customer loan account. This absolutely the right step.

Proponents of the BNPL schemes offer some standard arguments in their support. Let’s review them to debunk them.

The first argument is that these schemes are extending credit to people who are not getting credit from other formal lenders, and hence they are doing ‘financial inclusion’. It is highly-questionable if giving someone Rs 2,000 to buy a shirt on an online retail store constitutes financial inclusion.

More importantly, the RBI’s regulations do not forbid the lenders from giving credit, but prohibits just the method of disbursing the credit. If these ‘inclusion focused’ NBFCs want to lend to these customers they can still do so like other NBFCs do it — through a personal loan disbursed into a bank account. Bank account opening has become so easy now with the Aadhaar infrastructure, it is very easy to open an account for a customer to use to disburse loans.

The loan account then can be used to load up the PPI and the money can be used by the customer to carry out transactions. Further, the RBI has recently announced that it would permit NBFCs to issue credit cards. If the BNPL lenders are keen to offer credit card-like services, they should formally apply for a credit card issuance license and offer cards to their customers.

The second argument is that regulations like these impede innovation. This is baseless. What the BNPL lenders were doing was not innovative innovation, but were working in an area of regulatory ambiguity which has now been clarified.

Finally, there is the argument that these players were providing superior customer experience. Nothing in the RBI’s regulation prohibits them from continuing to provide such an experience. The regulations, in fact, imply that they must compete based on such superior customer experience and not on regulatory ambiguity.

It is heartening that the RBI has stepped in on time and clarified the rules on the use of the PPIs. Explosive growth of unsecured credit to customers at the lowest rung of credit quality could have turned into a system-wide problem, and would have had social repercussions. We should all welcome these new rules.

Harsh Vardhan, a Mumbai-based management consultant, serves as an independent director on the board of Karur Vysya Bank. Views are personal, and do not represent the stand of this publication.