RBI’s action against Paytm hurts Buy-Now-Pay-Later ecosystem

RBI is uncomfortable with the unregulated nature of the business model, followed by BNPL providers.

The RBI’s recent invoking of its powers under Section 35A of the Banking Regulations Act, 1949, against a payment bank, in this case Paytm Payments Bank, appears to be a hasty decision. The fact of the matter is that Section 35A is generally utilised when depositors’ money is at risk in a bank. While a payments bank is technically deposit-taking, the threshold imposed per customer is just Rs 2 lakh.

Such low limits mean that availing customers merely use their accounts as transactional, and not abodes of their life savings. Going by the business model of the sector, the players in this space are financial enablers at best and cannot be treated as financial institutions.

When Payment Banks Turned Credit Providers

The payments bank in question might be under vigilance over regulatory concerns, and KYC related glitches, the bigger question here pertains to the future of the Fintech space in general, and its association with banking per se.

Payment bank as a concept, seems to be a sound one and is envisioned by the RBI itself. Nevertheless, disputes started to occur after the emergence of the Buy-Now-Pay-Later (BNPL) model, within this space.

Payment banks were envisioned to be enablers, and not credit provisioners. Precisely why, these institutions were never allowed by the RBI to perform such functions in the first place.

However, India’s credit boom allowed the BNPL model to flourish, on the back of digitalisation, ushered by the likes of Paytm, and the RBI was forced to bring successive regulations to govern the sector since 2021.

Consequently, payment banks, associated with FinTech companies are merely collateral damage, finding themselves caught in regulatory crossfire.

From this perspective, it can therefore be argued that RBI is uncomfortable
with the unregulated nature of the business model, followed by BNPL providers. RBI feels that such lending goes against reasonable credit rules and may aid in indebting unsuspecting customers.

This belief system has become even more entrenched given the unsustainable growth in non-collateralised personal loans, which are growing faster than the overall credit offtake itself.

New Regulatory Category Needed

Given these insecurities and the fact that innovating FinTechs may become sitting ducks to regulatory activism, special categories must be introduced to govern the nascent sector.

Instead of suffocating FinTech companies in performing their lending business, RBI must treat such companies as full-fledged ‘Non-Deposit Taking’ NBFCs. This would be on the lines of Micro Finance Institutions (MFIs) operating in rural and semi-urban areas. Therefore, RBI must regulate BNPL providers by creating a new regulatory category, i.e., NBFC – BNPL.

First and foremost, the RBI must consequently constitute a regulatory committee, on the lines of the NBFC–MFI-focused Malegam Committee for recommending interest rate caps and formulating lending regulations for the NBFC – BNPL operators.

This is perhaps the only way to unleash the animal spirit of this new yet very promising category, allowing players to innovate and expand the segment further on a level playing field.

Secondly, under the direct supervision of the RBI, the BNPL-focused FinTech enterprises must come up with a credit limit-setting mechanism that evolves with borrower repayment success rate and unlocks incremental limits.

Regulating Buy-Now-Pay-Later Apps

In other words, an initial credit limit can be set equal for all first-time borrowers with a higher credit limit being available to only those who have maintained a steady repayment schedule. For such borrowers, the lenders may consider raising credit limits on a quarterly/ annual basis, based on repayment performance. For this purpose, credit exposure thresholds may be set in the lending model and regulated by the RBI.

Thirdly, just as NBFC – MFIs, BNPL operators must set an upper limit to total individual borrower exposure. Since the purpose of the BNPL is largely limited to household consumer goods financing, maximum exposure for each borrower should be limited, as a standard practice, etched in stone.

Fourthly, to deal with inter-app arbitrage, access to each borrower must be limited to no more than two BNPL operators and KYC must involve AADHAR-based borrower qualification. Such qualification settings have already begun in this space and should remain on the lines of NBFC-MFI regulations.

Similarly, as a first step towards being considered specialised NBFCs, provisions for First Loan Default Guarantee (FLDG) arrangements with commercial banks/NBFCs, on lines of MFIs have been already provisioned by the RBI. Nevertheless, the Off-Balance Sheet Financing (OBSF) issue pertaining to BNPL operations will remain a bone of contention and its use questionable.

However, this arrangement must be strictly by choice and not forced upon the BNPL operators, checked by regulatory limits and oversight, nonetheless. Also, comparable autonomy must be provided when it comes to pool account regulations applicable to involved Lending Service Providers (LSPs).

Don’t Stifle Buy-Now-Pay-Later Model

Policy makers must keep in mind that as the Indian economy gains strength, so would consumer aspirations. Therefore, attempts must be made to aid and not stifle household consumption.

However, care must be taken that in the regulatory process, innovation is not penalised. In the current context, regulators seem to force BNPL startups to partner with commercial banks in the name of consumer safety. As startups do not possess the kind of influence or financial might to compete with commercial banks or even larger, full-fledged NBFCs – the former run the risk of being subject to predatory takeovers.

It is high time that RBI realised that BNPL is a concept, whose time has come. BNPL providers are capable of the same type of revolution that was once ushered by MFIs in rural India.

On their part, as regulated entities, collectively represented by a separate category (NBFC-BNPL), operating FinTechs must promote themselves as consumer enablers and critical components of India’s macroeconomy.

A change in mindset is therefore the need of the hour and the right environment must be created that is conducive to the sector’s development.

Karan Mehrishi is an economist, specialising in monetary economics and fixed income. Views are personal and do not represent the stand of this publication.