Digital lending, though small in India today, has come to stay and there is no doubt that it will grow very big. However, it comes with its own problems, mainly due to the greater reliance on third party lending service providers (LSP) leading to mis-selling and breach of data privacy.
To prepare the country against these, the Reserve Bank of India (RBI) had constituted a Working Group in January 2021 and the group gave its report a few days ago.
It studies the current market condition along with the potential risks in the digital lending ecosystem and provides recommendations for regulation of this space, which are piloted by tenets of safeguarding technology neutrality, formulating principle-backed approach instead of a rule-based regime and addressing regulatory arbitrage without throttling digital innovation. The recommendations seek to administer a standard business conduct protocol across three levels viz entities regulated by RBI, other regulated/authorised entities and unregulated entities including third-party service providers functioning in the digital financial sector.
Studies reveal some significant findings which underscore the need to step up the game to lay a more robust legal and regulatory framework governing players in the digital lending space. Towards this, the Group has recommended that a nodal agency be set up to primarily verify the technological credentials of Digital Lending Apps (DLAs) of balance sheet lenders (these are lenders that retain the loan and associated credit risk on their balance sheet) and LSPs along with maintenance of a public register of verified apps.
Balance sheet lending through DLAs is sought to be restricted to regulated entities or entities that are authorised to provide lending services. Introduction of a separate legislation for banning unregulated lending activities, constitution of a Self-Regulatory Organisation (SRO) covering participants in the digital lending space are amongst the other recommendations, under the first pillar of the three-pronged approach.
To maintain transparency on the loan servicing front, the Group proposes that all loan services, repayments, and other related activities should be executed directly in a bank account of the balance sheet lender without any pass-through or pool account of any third party. A similar approach is envisaged for disbursement of loans. The burgeoning amplification of short-term credits, deferred payments and concepts like ‘Buy Now, Pay Later’ through digital channels which do not meet requirements of traditional credit facilities have been identified as an area of concern requiring calibration of existing regulations and as an off-shoot of this, such arrangements are sought be reckoned as part of the balance sheet lending and regulated accordingly.
Further, the report lays groundwork for opening digital-only NBFCs/ banks and the possible inclusion of digital/ neo-banks under the RBI regulations. Measures for broadening credit reporting to enable better credit decisions are also suggested.
‘Technology’ being a major driver of the evolving fintech scenario, the second set of measures in the report are anchored with propositions crafted with the objective of conceptualising an outcome-focused regulatory framework on the tech front.
Mandates like observing prescribed baseline technology standards, storage of data in servers located in India, detailed disclosures on the app/ website coupled with increased emphasis on digitally signed documents are key highlights. From a data governance perspective, the Data Protection Authority proposed in the Personal Data Protection Bill is given credence to oversee the financial apps.
Make responsible ads
India has been a stalwart in protecting consumer interests/ rights and therefore, the third set of measures are excogitated to rev up this consumer-friendly image. The report of the Group advocates responsible advertising and marketing standards in like with a code of conduct to be put in place by the proposed SRO. Adequate user education and designing simplified loan products are encouraged to ease decision making. Further, the names of identified unscrupulous lenders should be made available to REs to enable them to do enhanced due diligence while allowing customers to use banking/payment/telecom channels. Policies around anti-predatory lending and anti-usurious lending are urged.
Digital innovations along with the possible entry of BigTech companies have a potential to alter the institutional role played by the existing financial service providers and regulated entities. If these recommendations become guidelines, the participants of the digital lending arena, mostly the unregulated ones, will have to jump on to the regulatory bandwagon and may have to overhaul their operational mechanism. Some of them may even be barred from operations. While the government awaits public comments till December 31, 2021, it is advisable that such service providers deep dive into their operating models and acclimatise themselves to the recommendations and suggestions of the Working Group report, especially on the tech-front. Also, while re-examining the report, regulators/government agencies should maintain a level playing field to ensure not only fair competition and consumer protection but also armour the sentiments of the digi-players given the recommended shift in the operational environment.
The author is Partner, Nangia Andersen LLP, a law firm