By Shilpa Mankar Ahluwalia
The digital lending sector finds itself in a unique position. It has a clear road-map for a regulatory framework but not the detail around what the exact guidelines will include. The Reserve Bank of India (RBI) released a regulatory framework for digital lending on August 10, 2022 (DL Regulations) which includes an implementation plan for the recommendations of the Working Group on Digital Lending (Working Group) (constituted by the RBI on January 13, 2021). These rules apply to all entities regulated by the RBI (REs) and the Fintech platforms or lending service providers (LSPs) / digital lending applications (DLAs) that have partnered with REs to offer digital lending products.
The DL Regulations include a three-stage plan for implementation: (i) rules under Part I which will have immediate effect; (ii) rules under Part II which reflect recommendations of the Working Group that are accepted in-principle, but require further consideration; and (iii) recommendations under Part III for the Government of India to consider.
The digital lending sector has been anxiously awaiting this regulatory framework. Even though more clarity is needed on several aspects (which will likely be included in the detailed guidelines), there is now a clear indication of the key themes of regulation for digital lending in India.
Two big positives for the industry are that the first loss default guarantee model (FLDG) for lending has not been prohibited (but will be regulated) and there is unlikely to be regulation or caps on interest rates. The DL Regulation will, however, have some significant implications for business.
Implications for buy now pay later (BNPL) products: REs are required to ensure that fund flow occurs directly between the RE bank account and the borrower bank account (such as loan disbursement, servicing, and repayment). While the DL Regulations do indicate that exceptions will be considered for statutory or regulatory reasons, and for co-lending, it is unclear whether an exception will be made for BNPL products where the consumer loan amount is credited directly into the account of the merchant. If not, the fund flow underlying these products will need to be re-worked.
Relationship between REs + LSP: the DL regulations contemplate a clear supervisory and “lead” role for an RE vis-à-vis its LSP partner. The RE will need to ensure that: (i) all fees payable by the borrower are paid directly to the RE (and not via the LSP); (ii) all digitally signed documentation underlying the loan must be sent directly from the RE to borrower (LSPs cannot control the documentation process); (iii) the grievance officer of the RE must also deal with complaints against LSP; (iv) the RE (not DLA) must provide a key fact statement setting out all loan terms and features and also outline the recovery process that will be adopted.
The DL Regulations seem to contemplate a more limited role for Fintech platforms given that a large part of the consumer facing processes is now required to be controlled by the RE.
How will the First loss default guarantee (FLDG) be regulated: a large part of digital lending in the Indian market is undertaken on the strength of an FLDG or other form of credit support provided to the RE by the LSP or DLA that does the loan origination. The RBI has indicated that the regulation of FLDGs is still under consideration, however, all FLDG structures must comply with the Master Directions – RBI (Securitisation of Standard Assets) Directions 2021 (Securitisation Guidelines). It is not entirely clear which aspects of these the Securitisation Directions will apply. Most likely, the requirements governing credit enhancements, servicing facilities, and capital adequacy requirements will need to be complied with. A key question is whether only entities regulated by at least one financial services regulator are eligible to issue FLDGs. It is likely that going forward only NBFCs (or entities regulated by any other financial services regulator) will be able to provide credit enhancement or guarantees to RE lenders and many of the existing FLDG based lending models will need to be re-worked.
Data: The DL Regulations outline a few key principles for data protection. There can be no data over-reach, i.e. only data that is strictly required can be collected by LSPs on an “as needed” basis. A borrower must be given control over his/her data, i.e. the ability to withdraw or alter the terms of consent at all times. REs must ensure that LSPs implement strong data privacy and security controls.
The DL Regulations will play a key role in creating a digital lending ecosystem that protects borrowers and builds consumer trust. An important question is whether the regulatory framework will continue to allow Fintech platforms to power product development. Given that there is a clear requirement for REs to supervise and monitor LSPs and DLAs, the RBI may consider giving Fintech platforms greater access to data so that they are able to continue to innovate and build customized financial solutions.
(Shilpa Mankar Ahluwalia, Partner & Head Fintech Shardul Amarchand Mangaldas & Co. Views expressed are the author’s own.)