Microfinance Institutions Network (MFIN) has called on the Reserve Bank of India to review and address the overlap between microfinance and digital lending.

MFIN wants the RBI to ensure that fintech lenders comply with microfinance regulations, and failing to do so would lead to weak underwriting and customer protection. Further, the data should be reported to the microfinance bureau and not the retail credit bureau, and the central bank should review their interest rates and recovery practices.

“They are basically microfinance lenders as per microfinance regulation albeit with focus on consumer loans over income-generating loans,” said MFIN in its India Microfinance Review for FY23.

While digital lenders typically refer to entities that lend without a physical presence based on mobile applications, the RBI defines digital lending as a “remote and automated lending process, majorly by use of seamless digital technologies”.

Microfinance institutions (MFIs) also qualify as digital lenders, given that their client onboarding, credit bureau check, loan disbursement and repayment are all digital. Further, over 60 per cent of digital lending is to low-income, new-to-credit (NTC) borrowers, which is defined as the microfinance segment by the RBI (households having annual income of less than ₹3 lakh).

“Lending to such customers using a remote and automated process is not only a potent mix, it is also done without adhering to microfinance regulations like household income assessment and repayment capacity check. The use of surrogate indicators is a poor replacement for in-person interactions and runs the risk of nudging borrowers inadvertently into over-indebtedness,” MFIN said.

Lending to NTC low-income borrowers needs to operate as a ‘seller beware’ model, keeping in mind their level of financial literacy, which is acquired over a period of time through experience with financial products, peer-group discussions and regular lender interactions. Avoiding these practices and lending in the same market gives rise to “regulatory arbitrage and runs the risk of client over indebtedness”.

“The RBI needs to review the whole digital market dynamics, identify the overlap with microfinance and in such cases enforce microfinance regulation on them,” it said.

Consumer loans

Personal loans and consumer loans account for 75 per cent of fintech lending. The share of non-collateralised loans, reported as personal loans to the credit bureaus, stood at 72 per cent of the gross loan portfolio and 83 per cent of the number of loans. As per borrower profile, over 50 per cent digital loans qualify as microfinance.

Further, 61 per cent loans were to individuals with annual income of less than ₹3 lakh at an interest of 30-60 per cent and processing fees of 2-10 per cent. 88 per cent loans had a loan tenure of below 6 months with an average ticket size of ₹12,989.

Most of these loans qualify as microfinance loans but remain out of current microfinance regulations and are reported to consumer bureaus as personal loans (or short-term personal loans) instead of microfinance loans as the microfinance bureau.

While microfinance lenders have started exploring completely digital modes of lending, accuracy of automated underwriting depends on accurate identification of the borrower so that their credit history can be retrieved from the credit bureaus, said MFIN.

It proposed that RBI should mandate all regulated entities active in microfinance to adhere to daily reporting as monthly report is not ideal in case of microfinance clients “where an amount of even ₹50,000, not captured, could make the difference between responsible finance and over indebtedness”.