Zubin Mehta, Mohit Bhatia, and Jasraj Singh Narula
While the narrative in recent times has been about credit line-backed prepaid cards questioning the role of credit cards, the onset of 2022 has reflected a blow to the Buy Now Pay Later (BNPL) industry. With increase in inflation, sudden reduction of dry powder, and the aftermath of defaults faced by global players such as AfterPay and Zip, it appears that the Reserve Bank of India (RBI) wants to ensure that there are no potential systemic risks or surprises in the Indian financial system.
It appears that it was in the aftershock of these global signals, coupled with perceivably questionable practices around data collection and recoveries, that the RBI issued the notification on Loading of PPIs through Credit Lines on June 20. The notification is issued to non-bank prepaid payment instrument (PPI) issuers on a ‘private circulation’ basis, and has caused an unrest within the PPI and the BNPL industry by directing the non-bank PPI issuers to not load/re-load the PPIs from credit lines — a practice that allowed the BNPL platforms to effectively operate pseudo credit cards without having a license.
Interestingly, the notification is addressed only to non-bank PPI issuers, and the conspicuous omission of banks poses a question whether bank-led PPIs can be loaded with credit lines. It is also important to note that the RBI’s directions on PPIs permits PPIs to be loaded by cash, debit to a bank account, credit/debit cards, PPIs and other payment instruments issued by regulated entities in India, but does not permit loading from a credit line.
Market Landscape
The BNPL players have gained popularity by offering customers short-term credit with a seamless payment experience, friendly consumer facing apps, rewards/cash backs, and reduced credit checks — a clear edge over their bank counterparts.
It is at the crosshairs of credit penetration and potential systematic risks through modern age lending backed on data analytics that a question arises — should the RBI restore the balance in favour of banks, thereby impacting the existing BNPL models, or should it adopt a moderate approach focused on bringing prudence in the BNPL business models?
While evaluating the risks emanating from the BNPL platforms, or other data driven lending models, one must understand that credit scoring undertaken by such platforms is driven by data analytics which typically gets refined over time, and the recent spurt of defaults may just be the beginning of a peak which could eventually plateau as the models develop. The BNPL providers may argue that they have played a pivotal role in line with RBI’s vision of increasing credit penetration while working within the regulatory framework. Some argue, if the PPIs can be loaded with credit cards, loading/re-loading through credit lines should not be off the table.
Credit-backed PPIs
The credit line-backed PPIs are perceived and marketed as credit card challengers as they offer revolving credit lines to customers with the ease of spending at merchant outlets using a co-branded PPI card. The RBI seems to be viewing these card challengers as blurring of the line between a credit card and credit line-backed PPI. The expectation could be that pseudo credit card issuers meet specific controls and compliance requirements, or apply for relevant licenses to issue credit cards.
Currently, regulated entities are permitted to issue credit cards subject to certain compliances, including fit and proper checks, capital adequacy requirements, underwriting standards, interest rates, and charges. Now, the RBI seems to be taking a stand that the regulatory arbitrage enjoyed by such BNPL players will not be blessed.
The Road Ahead
Many industry players have reached out to the RBI for reconsidering the blanket restriction. It is likely that some may look at restructuring their business models to explore a potential leeway where credit lines could be routed through a specific bank account of the BNPL entity — as the PPIs can be loaded from any bank account. Others may implement the notification in spirit, and explore partnerships with banks for co-branded credit cards.
As deliberations continue, a balanced approach at regulating the BNPL space is needed — the RBI recognises the challenge of ensuring innovation with risks to financial stability. It appears that the RBI is now addressing the issue of arresting system exposure to the NBFCs, and borrowers being overleveraged.
To curb the issue of unregulated lending by digital lending apps, the RBI is expected to clarify its stand on the issue of first loss default guarantees by fintech platforms in favour of the NBFCs/banks to make-good the borrower defaults. While we wait for the RBI’s digital lending guidelines, the broad issues that need to be addressed include fintech entities having improved compliance with KYC norms, regulating the interest rates for such products, issuing a fair practices code, requiring more robust underwriting and credit scoring models, and clarification on whether the PPIs can be loaded through a bank account (funded by a credit line).
A ban will impact investor confidence in the fintech industry, and stifle innovation and potential investments in the sector. The expectation is to not have a knee-jerk reaction, and provide a reasonable compliance period for the existing players to rework their models, and reduce the disruption that would be caused to customers.
Zubin Mehta (Partner), Mohit Bhatia (Counsel), and Jasraj Singh Narula (Senior Associate) are part of the Banking and Financial Regulatory practise at Shardul Amarachand and Mangaldas. Views are personal, and do not represent the stand of this publication.
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