Recently, the Reserve Bank of India (RBI) issued the ‘Guidelines on Digital Lending’ to banks and non- banking financial companies (NBFCs), which disburse loans through digital lending platforms. This follows the press release issued by the RBI on the implementation of the recommendations of the working group set up by the RBI last year to study the market practices followed in the digital lending industry.
Fintech companies, which operated digital lending platforms offered unique credit products which were tailor-made to the requirements of a specific user base. These platforms gained popularity in a short span of time, especially in the aftermath of the COVID-19 lockdowns imposed by the government. Such platforms used alternative data for credit assessment and devised completely digital customer onboarding and loan disbursement processes. Given that only banks and licensed NBFCs had legitimate access to capital, fintech companies had to enter into partnerships with such lenders who outsourced customer acquisition, portfolio monitoring, and loan recovery functions to them.
With increasing cases of borrower harassment and suicides being reported pursuant to loans availed through such digital lending platforms, the RBI was forced to take notice of the rapid growth of the digital lending industry, and closely monitor the arrangements entered into by regulated lenders and technology companies operating the digital lending platforms.
The RBI has laid clear emphasis to protect digital lending borrowers who have been the worst affected parties due to the unethical practices, and harsh recovery methods adopted by some digital lending platforms. Regulatory measures such as prescribing uniform T&C disclosure formats to be adopted by all digital lenders, permitting customers to exit the loan arrangement within a specified time-period, prohibiting hidden charges, mandating appointment of a nodal officer by both the regulated lenders as well as the digital lending platforms to address customer complaints, and the introduction of data minimisation norms will go a long way in boosting customer confidence and trust in digital lending platforms.
The digital lending industry thrived until now since banks and other regulated lenders were ready to provide capital on the assurance that if the borrowers default, they would be compensated by the fintech companies operating the digital lending platforms, and in sourcing new customers. Such compensation arrangements were structured though first loss default guarantee (FLDG) arrangements, and the extent of such credit comfort offered was commercially negotiated based on the quality of the loan portfolio, among other factors.
The RBI working group had recommended a complete ban on such arrangements as it viewed such credit comfort obtained from unregulated fintech companies as posing systemic risks to the market. It appears that the RBI has accepted this recommendation since the digital lending guidelines effectively restrict any such FLDG arrangements.
This could drastically affect access to capital for fintech companies who are working towards designing new-age credit products, and increasing offerings to new-to-credit borrowers. While the RBI as a prudent regulator intends to plug any loopholes which might result in systemic risks to India’s financial ecosystem, the FLDG restriction under the digital lending guidelines may lead to slow death of many digital lending platforms. This would also adversely impact the financial inclusion efforts of the RBI, as regulated lenders would be less incentivised to support new fintech companies innovating in this space without any skin in the game of such companies.
Overall, while the new digital lending guidelines will help to streamline and standardise digital lending practices relating to customer transparency and data collection, the restrictions on FLDG could force fintech companies to rethink their strategy. Some market players may not have the means to directly obtain lending licenses and fund their customers using their own capital. Fintech companies may have to explore adoption of public market infrastructure such as the account aggregator network and open credit enablement network to survive in an increasingly competitive and evolving market.
Prashanth Ramdas is Partner, and Pritish Mishra is Senior Associate, Khaitan & Co. Views are personal, and do not represent the stand of this publication.
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