Towards universal credit inclusion

Multiplicity of regulations can hamper the growth of the nascent digital lending sector. Much of the innovation is currently driven by younger start-ups, and these have limited ability to invest in compliance overheads

Reinterpreting them in context of digital lending—where screen space is scant and attention is scarcer—is a welcome step.
Reinterpreting them in context of digital lending—where screen space is scant and attention is scarcer—is a welcome step.

By Alok Mittal
Digital lending has grown rapidly over the past few years. Rapid growth puts pressure at the seams, and some of the harmful effects of fast growth of digital lending expressed themselves last year through lack of compliance with customer protection norms. As a proactive but measured regulator, RBI constituted a working committee to recommend certain guardrails that can allow digital lending to grow in a more orderly fashion.

The report of the working committee has viewed digital lending with the primary lens of consumer protection. It does so well in terms of re-emphasising some of the existing guidelines, such as Key Fact Sheets, Fair Practices Code, Outsourced Service Provider Guidelines, and others. Reinterpreting them in context of digital lending—where screen space is scant and attention is scarcer—is a welcome step. Similarly, the proposal to set up a self-regulating organisation (SRO) that can provide guidance and oversight to this growing industry is an opportune one. An industry-led SRO will also help ensure that guidelines can keep pace with the rapid evolution of the industry and underlying technological developments.

One of the most important recommendations of the working committee is in ensuring that unregulated lending activities are curbed. Unregulated lenders were a prime source for many of the aberrations observed last year. Curbing such players is especially important because such lending activities bypass supervision and guidelines for responsible lending. Today, these activities may go by several names such as purchase advances and buy-now-pay-later, but if something feels like lending and smells like lending, it probably is lending.

Similarly, curbing fraudulent apps through technology-based measures, and through app marketplace gatekeepers such as Google and Apple, will help contain the spread of unscrupulous lending.
One of the elements that may require deeper examination is the need for additional regulations, such as Agency

Financial Service Regulation, National Financial Consumer Protection Regulation, etc. Multiplicity of regulations can hamper the growth of the nascent digital lending sector, especially since much of the innovation is currently driven by younger startups, which have limited ability to invest in compliance overheads. Existing regulations, interpreted afresh for digital processes, have greater potential to allow growth and innovation while ensuring necessary safeguards. Alternatively, a scale-based regulatory architecture, on lines of that applicable to NBFCs, may be considered. Cross-sectoral regulations, such as the pending Personal Data Privacy regulations, may also be factored in to avoid overlapping regulations.

Second, the role that embedded finance can play in reducing information asymmetry may be revisited. Information asymmetry is the fundamental problem in extending credit. Embedded finance promises to solve for it by providing strong end-use control and repayment mechanisms, as well as by enabling a set of last mile operational controls that are otherwise infeasible for financiers to exercise.

These are key building blocks of lending, especially in business lending, and hence are already used extensively in supply chain financing (SCF). Here money often flows to the supplier accounts, is paid back through an intermediary account, and the risk is often shared with an anchor corporate that has better information visibility and operational risk management capability for the said financing transaction. Disallowing such intermediary accounts and all forms of risk sharing will restrict the ability of risk to flow where it can be operationally managed the best—the last mile of a transaction.

To enforce better governance in such risk sharing arrangement, the regulators may consider mandating a board approved policy for such risk-sharing mechanisms, as well as due provisioning by banks for such counterparty exposure.

The Report of the Expert Committee on Micro, Small and Medium Enterprises conceptualized Loan Service Providers (LSPs) as an agent of borrower responsible for acting in borrower’s best interest. This role of LSPs needs to be protected. Restricting their income to only arise from lenders, and not allowing them to directly charge borrowers for services provided, may compromise their fiduciary role as an agent of borrowers. The objective of ensuring transparency, and avoiding duplicity of charges, can be addressed through disclosure norms enforced through regulated entities. Similarly, providing consent-based access to customer data, including credit bureau information, to such LSPs will amplify their ability to safeguard customers’ interests by restricting access of consumer data to only qualifying lenders, and avoiding score suppression due to repeated bureau enquiries by multiple lenders.

Given the massive growth potential, the robust financial systems, and rollout of the public financial infrastructure, India today stands poised to offer its citizens and businesses the benefits of universal credit access. Digital lending is a core piece of the puzzle, and with the right regulatory architecture, has the potential to serve act as a key driver to the growth and prosperity of the country. The industry once again looks forward to an enabling framework to delivering on this potential.

Co-founder and CEO of Indifi Technologies. Views are personal

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