By Karam Daulet-Singh and Sameeksha Chowla
Although still in its nascent stages (and by no means big enough to threaten financial stability), with the rapid expansion of the digital lending sector over the past decade, the Reserve Bank of India (RBI) took several steps in 2022 to regulate the sector. A press release was issued by the RBI on 10 August 2022 for implementing the recommendations of the working group that was formed for studying the sector. This was quickly followed by the issuance of the Guidelines on Digital Lending on 2 September 2022 (the Guidelines) to formalise some of the recommendations, while some of the other recommendations of the working group are parked for wider discussion with various stakeholders.
In brief, the Guidelines set out the parameters within which banks and NBFCs should operate while lending through digital lending platforms operated by the new-age financial intermediaries, the FinTechs. The key parameters include all fund flows to be restricted to the borrower and lender, fees/charges payable to the FinTech to be paid directly by the lenders, regulation of first loss default guarantees (FLDGs), periodic reporting of digital loans by the lenders to credit information companies and detailed data protection related requirements. As is evident, the onus for complying with the Guidelines has been placed on the lenders. In terms of timelines for complying with the Guidelines, lenders were required to ensure that all digital loans disbursed post the date of issuance of the Guidelines are compliant from day 1, while the terms of the loans which had been given out until 2 September 2022 were required to be amended by 30 November 2022.
With the 30 November deadline having just expired, this note examines the impact of the Guidelines on the business models adopted by FinTechs. We also analyse the overall approach adopted by the RBI to regulate the digital lending sector.
First responses, and plan Bs
Up until the introduction of the Guidelines, in a typical digital lending structure, the facility was offered by the FinTech, which would in turn partner with banks and / or NBFCs (in-house or external or both), for extending a short-term credit facility to borrowers, which was then loaded either on a co-branded credit card or on a co-branded pre-paid instrument (PPI).
The Guidelines hit this second model adopted by FinTechs most directly as digital lending players scrambled to adopt various stop-gap measures as a first response. Most FinTechs stopped offering their facilities for the time being, with the top PPI card issuer – State Bank of Mauritius – putting a pause on the onboarding of new users. With the passage of time though, business models were tweaked and operations overhauled to comply with the Guidelines. Taking the example of two key players, Slice and Uni, in turn. Slice has reverted to its much older features to adopt a credit model whereby funds will be sent directly to a borrower’s bank account by the bank / NBFC partner. In addition, borrowers will now be able to load their own funds (and not loans or credit lines) to a newly launched pre-paid account, which will, in turn, be linked to the borrower’s Slice Card and UPI functionality on Slice for daily transactions, with borrowers being eligible to receive cashback for transactions conducted through the account. Uni, on the other hand, is set to replace its pre-paid card offerings with co-branded credit card operations. In addition, Uni will be launching a new feature that will enable its borrowers to access short-term loans in the middle of the month pending the receipt of their salaries, which will be directly disbursed into the borrowers’ accounts.
Not all FinTechs, however, and particularly the younger ones, had what it takes to weather the storm of fast-paced regulatory changes. Case in point, a potential sale to PhonePe may be on the cards for ZestMoney – a BNPL platform which provides retail shopping services to consumers at checkout. A number of other FinTechs have also had to completely shut shop.
For the one’s which re-modelled their businesses to comply with the Guidelines, it remains to be seen if the modifications will take any toll, in terms of not only limiting the pool of borrowers that may be onboarded given the increased role of banks / NBFCs, but also the platform itself being as attractive as before to borrowers over traditional forms of credit. Reporting to credit information companies would mean that repeated extensions of the time for repayment will be restricted thereby further limiting the attractiveness. In terms of revenues, given that all charges are required to be paid by the banks and/or NBFCs to the FinTech and any disciplinary charges need to be linked to the outstanding amount of the loan, which will also need to be repaid in time, and given further that cashback schemes would still continue, it will need to be seen if the revenue stream of FinTechs such as Slice which earlier relied on service fees from the customers and late charges fees will be impacted. On the other hand, the Uni platform worked on a zero-interest and no-fee policy on its products and services for customers and earned revenues from the lenders, so its revenue stream is unlikely to be impacted.
Another aspect that involves some grappling with is identifying well-capitalised banks / NBFC who are willing to partner with FinTechs. The more, the better would be the reach of FinTech. However, the RBI’s wobbly stance on business models of FinTechs generally has made traditional lenders wary. The stance on FLDGs is creating further trouble with all such provisions having to be removed from the principal contracts. Resultantly, at least the external bank / NBFC partners for FinTechs could be risk-averse and wary of continuing their arrangements with them, thus, reducing the pool of available credit. This is of course unless the loans are underwritten through different means and modes – say marketing support expenses payable to lenders – though such “cute” structures, we believe, will trip up the regulator sooner rather than later since the mandate restricts any synthetic structures being adopted in “both letter and spirit”.
Lastly, until now, FinTechs also enjoyed a relatively free hand in relation to collecting and storing data points – but these operations are no longer as smooth sailing going forward. The stricter data collection, storage, and protection compliances under the Guidelines, along with the borrower awareness shored up by these Guidelines, have made it challenging for FinTechs to retrieve user consent at each stage. In addition to the costs for complying, the avenues to monetise data, albeit not always kosher, have also been seemingly limited given the consent requirement, further denting revenues.
Is the RBI’s approach correct?
One question that may be worth pondering is whether the RBI’s approach of issuing piecemeal directions to regulate the digital lending sector is indeed the correct one.
Jurisdictions across the globe have broadly been applying two models to regulate digital lending. The first model extends the existing banking laws and regulations in place to bring digital banking innovators into the fold. The second model involves building new regulatory frameworks targeted specifically toward digital banking. The RBI model of regulating, however, seems to be a different one altogether. The RBI has seemingly adopted a third approach of regulating the FinTechs through the lenders. What it seems to us to be doing is holding out and taking time to learn from the early regulatory experiences across various jurisdictions as well as the specific responses to the light touch regulations being issued by it in the Indian context. One hopes that this may prove to be prudent approach after all – allowing the RBI to strike the right balance between promoting digital banking ventures while appropriately curtailing malpractices and defaults!
Karam Daulet-Singh is the managing partner, Touchstone Partners and Sameeksha Chowla is the senior associate, Touchstone Partners