Light touch needed

Online retail platforms in India have flourished without a formal regulatory framework and scaled up to a size where they now have significant stakeholders among consumers, employees and investors. Having allowed them to flourish in a regulatory hiatus, policymakers are now faced with the challenge of laying down basic rules of the game without undermining their business. This is why it is good to see the RBI and SEBI flagging off the debate on regulating digital businesses in the financial space while these firms are still in their infancy. The RBI’s recent discussion paper on regulating peer-to-peer (P2P) lending follows SEBI’s paper last year on regulating equity crowd-funding. The business models of P2P lending platforms differ from conventional NBFCs or banks in relying on fee income, rather than the spreads between borrowing and lending costs, to generate revenues. P2P platforms earn loan origination fees from borrowers and service fees from lenders for credit scoring, collection and recovery services. India is said to have 20 online P2P platforms currently, with most of them facilitating unsecured loans to social projects or smaller borrowers who cannot easily access banks for credit. Globally, the regulatory framework for P2P lending ranges between two extremes with some jurisdictions (Japan and Israel) banning the activity, while others (China and South Korea) not recognising it as a formal activity at all.

The hands-free approach may not work in India. Given the low levels of financial awareness, individuals transacting on the platforms may be unable to make the necessary distinction between the regulated financial firms and unregulated online marketplaces, and may therefore be at risk from fly-by-night online firms. The proliferation of Ponzi schemes offering illegal ‘deposits’ and ‘debentures’, despite both products being heavily regulated by SEBI and the RBI, is ample proof of this. Also, as P2P platforms offer services such as curation and credit assessment of borrowers and loan recovery services, there are retail consumer interests to be protected. The RBI’s discussion paper proposes a middle path on regulation, by not subjecting P2P platforms to stringent rules on provisioning, reserve ratios or capital adequacy rules which apply to banks. But to protect consumers, the RBI does propose to register and permit only marketplace models, filter out non-serious players through minimum net worth and fit-and-proper criteria, and call for regular filings from them.

Given that P2P lenders will be making actual recommendations to borrowers on their lending decisions, more safeguards may be needed to ensure that these platforms have the necessary skills to conduct credit assessments of borrowers. Adequate fee disclosures are essential to avoid conflicts of interest. Such checks may in fact be more effective than minimum net worth (proposed at ₹2 crore) or RBI’s fit-and-proper criteria to ensure strong players. The best approach may be to start out with light-touch regulations that specify entry criteria that allow only quality players into this business. Operational guidelines can be evolved on the fly as the players figure out their business models.

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