RBI lends weight to digital lending

By: |
November 23, 2021 6:00 AM

It believes there are serious issues with lending practices and is, therefore, spelling out the rules

To this end, the RBI’s working group has done well to recommend the creation of a nodal agency to verify the technological credentials of all lending apps and also dedicated legislation to curb illegal lending.To this end, the RBI’s working group has done well to recommend the creation of a nodal agency to verify the technological credentials of all lending apps and also dedicated legislation to curb illegal lending.

Given how half the digital lending apps for Android users have been found to be illegal—600 out of a universe of 1,100—the Reserve Bank of India’s initiative on regulating digital lenders hasn’t come a day too soon. There is absolutely no doubt that fintech is revolutionising lending in India; leveraging the JAM (Jan Dhan-Aadhaar-Mobile) trinity, they are making credit accessible to those who can never hope for a bank loan, essentially in the unsecured lending space. Retail digital lending grew at a compounded 40%-plus in the seven years to 2019.

It is critical digital apps continue to lend so, since penetration of formal finance in the country is abysmally low and, by one estimate, is probably less than 10% of the demand. However, we cannot let the lending ecosystem become vitiated by defaults or terrorised consumers, and we certainly must rein in systemic risks. To this end, the RBI’s working group has done well to recommend the creation of a nodal agency to verify the technological credentials of all lending apps and also dedicated legislation to curb illegal lending.

Moreover, the panel has recommended that lending from the balance sheet of apps be restricted to entities that are registered specifically for purposes of lending. The disbursements and repayments must be made directly into the bank accounts of borrowers and lenders so that there is a proper trail of transactions. If prepaid instruments are used, these must be preceded by proper know your customer (KYC) processes.

Importantly, lending by regulated entities (REs) through lending apps must be reported to credit bureaus; there needs to be a record of credit flows. Again, only regulated entities can access bureau data for the purpose of collecting or reporting data on behalf of borrowers. The working group has done well to say that all data must be stored in servers in India. That is a justified requirement given the enormous value of the information being gathered by these lenders. The guidelines relating to the storage of data and the privacy policy must be articulated in the public domain.

These conditions might seem onerous but are required to ensure lending practices are kosher and that any data collected is not being misused. The committee also wants that the algorithms being used for underwriting credit be auditable and that ethical artificial intelligence be used. This, again, is a valid ask to ensure sound lending practices. Indeed, the working group has gone so far as to specify the manner in which interest and fees are to be charged so as to rule out any ambiguity. In particular, it wants to prevent usurious lending; the recommendation is that any fee included in calculation of annual percentage rate (APR) must be reasonable and meant to cover costs closely related to the reason for the fee.

Moreover, interest must be calculated on the basis of the actual number of days and no prepayment penal rate of interest for short-term consumer credit (STCCs) for full or proportionate closure should be levied, except a nominal administrative fee, if at all.

Clearly, the committee believes there are serious issues with lending practices and is, therefore, spelling out the rules. The several instances of lenders using coercive tactics to recover loans may also have prompted such detailed guidelines. Regulated entities are barred from using coercive methods of recovery, but nothing stops an unregulated app from acting on their behalf.

There is nothing in the tone of the report to suggest the panel is uncomfortable with new or existing lenders being innovative; the panel seems to want to encourage more lenders. It is now up to digital apps to play by the rules and self-regulate themselves. As the universe of fintech grows, RBI must arm itself with the necessary technology and technical expertise needed to track lending apps on a real-time basis.

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