By Alok Misra & Vinay Kumar Singh
The debate on the regulatory regime for digital lenders has been re-ignited by the notification from the regulator on June 20. The circular debarred the loading of pre-paid instruments (PPIs)—the digital wallets customers use to pay for a cab, a dinner or a product or service purchased online—issued by non-banks through credit lines. Since then, a stream of articles in the media have interpreted this step as the revenge of the stodgy old financial establishment which felt challenged by young tech-knights in their shiny armours. Possibly influenced by the movie ‘Harry Potter 20th anniversary: Return to Hogwarts’, others have hinted at machinations by bankers in their pointy hoods in shadowy corners of Mint Street. While these articles introduce a dash of excitement to the drab topic of financial regulation, they add little to the debate. In this article, we leverage the data available in the public domain to evaluate the performance of the digital lenders against the promises made. We also suggest a customer-centric path to financial inclusion based on the experience of the last two decades. We believe that the ‘breaking news’ is not about the investors, the incumbents or the challengers. It is about the regulator’s desire to ensure fair practices, customer protection and check over-indebtedness of low-income borrowers.
Digital lenders promised to further the agenda of financial inclusion and to democratise credit. This promise was based on three important assumptions. The use of technology to reduce transaction costs was expected to lower interest rates. Newer ways of assessing the creditworthiness of the borrowers would make credit availability more widespread. Finally, fast adoption of app based digital interactions by the borrowers would allow lenders to not have a brick-and-mortar presence. Among other type of digital loans, buy now pay later (BNPL) schemes became quite popular. Linked to the digital wallets of the customer and available at the click of a button, these schemes provide instant loans for purchase of a product or service. Over a period, BNPL lenders started offering a credit line. This practice has been found to be unacceptable by Reserve Bank of India and is the object of the latest missive to non-banking financial companies (NBFCs).
By design or ignorance, the digital lenders seem to have side-stepped the regulations applicable to the customer segment they are lending to. Here, an appreciation of the equivalence between digital lending and microfinance is instructive. A large percentage of digital lending is unsecured and given to the low-income segment. The ticket sizes are small and the loans are given for a short period of time. A March 2022 report released by a fintech industry association mentions that 100% of the loans disbursed by its members were given without any collateral. Nearly 60% of these borrowers had an annual income of less than Rs 3 lakhs. The November 2021 report of the working group set up by RBI on digital lending had similar findings. Interestingly, as per the latest regulations by RBI, unsecured lending to households below an annual income of `3 lakhs per annum is defined as microfinance. Data on digital lending indicates that more than half of the loans qualify as microfinance. Regulatory guidelines on microfinance mention that such loans should not lead to over-indebtedness and the interest rates charged should not be usurious.
The digital loans are expensive—the maximum interest rates are up to 60% with an additional processing fee going up to 10%. Comparatively, the interest rates for microfinance lending with its high-touch, high-cost model are in the range of 22-24% with 1-2% of processing fee. The associated question of use of credit is equally troublesome. A majority of digital loan are for consumption purposes. On the contrary, the regulations for lending to low-income groups have always emphasised lending to support income-generation. Global experience, especially in Africa, has shown that fuelling easy credit for non-productive purposes to low-income groups often leads to distressing outcomes.
A lack of attention by the digital lenders to the regulatory guidelines about client centricity has been another area of concern. As per RBI regulations, a new loan to a low-income borrower should only be given if the total repayment obligation for all the loans does not exceed 50% of the monthly income of the household. The onus of ensuring against over-indebtedness lies with the lender. The digital lenders seem to be overlooking this critical requirement. This has the potential to create repayment problems for the borrowers in the future. Keeping in mind the behaviour of low-income borrowers, regulations also lay an emphasis on an easily accessible customer grievance redressal system. Low-income borrowers often have low education levels. This reflects in their limited ability to engage with formal organisations. Going by the media reports of distressed customers, the grievance redressal mechanism of digital lending platforms and apps leaves a lot to be desired. The lack of a brick-and-mortar presence further compounds the difficulties for an unhappy customer.
To promote responsible lending, all stakeholders should follow the sound regulatory framework crafted by RBI. Unsecured lending to low-income groups is defined as a specific ‘asset-class’ and the guidelines are applicable to all regulated entities like banks, small finance banks, NBFCs, and NBFC-microfinance companies. Digital lenders should voluntarily adhere to these guidelines.
A long-term approach to sustainable growth of digital lending should be underpinned by customer protection and improved transparency. An open embrace of applicable regulations instead of a short-term approach of benefiting from regulatory arbitrage should be the way forward for digital lenders.
The writers are, respectively, CEO and director, and SRO Head, Microfinance Institutions Network (MFIN).