Last year around this time Hyderabad and Bengaluru were rattled by news of unauthorised digital lending apps landing loan defaulters in socially difficult circumstances due to the harassment they faced. Following the suicide of an agriculture department employee of Telangana government in Siddipet and a software engineer in Rajendranagar, Telangana police began registering criminal cases against apps offering instant loans that were harassing defaulters.

It was alleged then that these Chinese-promoted mobile applications were actually finance technology companies who had tied up with local non-banking finance companies (NBFCs), to increase their business and book huge profit by charging exorbitant rates of interest. The police authorities had found more than 200 apps which disbursed loans. Their recovery executives harassed and defamed the defaulting borrowers by sending fake notices to all members in the contact list of the victims. As the matter was spinning out of control, the banking regulator moved swiftly and came out with a press release cautioning the members of public “not to fall prey to such unscrupulous activities and verify the antecedents of the company/firm offering loans online or through mobile apps.”

Between January 2020 and March 2021, the RBI received 2,562 complaints against digital lending apps, 65 per cent of which was recorded during only two months (Dec.’20-Jan.’21); and Maharashtra clocked the highest number of complaints.

On January 13, 2021, the RBI constituted a six-member working group (WG) under the chair of an executive director to “evaluate digital lending activities and assess the penetration and standards of outsourced digital lending activities, identify risks posed by unregulated digital lending to financial activity and suggest regulatory changes to promote orderly growth of digital lending.” Although the WG was to submit its report within three months, the group submitted its report only recently.

As a central bank, the RBI undertakes many developmental functions, such as, the development of the financial system, promotion of banking habits and research in industrial finance, agriculture and technological developments.

The RBI appoints committees at intermittent intervals to examine emergent issues, and recommend steps to achieve those goals. Some of the reports which have led to path-breaking change in the banking industry are: (a) Rangarajan Committee on Bank Computerisation (1988), (b) Narasimham Committee Reports on the Financial System (1991) and Banking Sector Reforms (1998), Madhav Rao Committee on Urban Cooperative Banks (1999) and Malegam Committee Report on MFI sector (2010).

The recent Report on Digital Lending including Lending through Online Platforms and Mobile Apps has all the makings of a pathfinder document and is likely to be a valuable guide to India’s fledgling fintech sector.

This report takes into consideration the concerns of all stakeholders and provides a step-by-step approach to digital lending.

An attempt here is made to review some the report’s key recommendations.

Regulation and technology

In recent times, the promoters and advocates of technology have often taken a stand that all technological innovations must be supported, irrespective of the prevailing legal framework, country specific needs, cross-border implications and established financial architecture.

The Report borrows from a speech of the Chairman, Financial Stability Institute, Bank for International Settlements and emphatically postures that “the assumption that because something is technologically possible, it should be allowed, is flawed and needs to be challenged: the law or regulation cannot just be wished away.”

This clarion pronouncement should not only be a slogan but a mission for all digital innovators, present and future.

Regulatory arbitrage

The report draws upon the experience of regulators in important jurisdictions and intends to protect consumer interests, ensure fair markets, while encouraging emerging technologies and businesses to flourish. That is perhaps the reason why the report has limited digital lending only to regulated entities.

It exhorts non-centralised regulators and authorities to frame appropriate guidelines, in line with the RBI, to “minimize environment of regulatory arbitrage in the business of digital lending.”

In line with the scale-based approach announced earlier and the need to align the practices and precepts governing NBFCs and banks, time has come for the sector to mature and eschew mollycoddling regulation.

DIGITA, the new BIS

Digital lenders mostly provide finance to quasi-prime borrowers having minimal credit history and at times fluctuating sources of income. With a view to making the lending apps more transparent, unbiased and devoid of restrictive practices, the report puts the customer at the heart and recommends setting up of an independent body — Digital India Trust Agency (DIGITA) — whose prime task would be to audit all lending apps before they are hosted on the digital platforms.

This body could ultimately prove to be the Bureau of Indian Standards for the digital lending ecosystem. Going forward, the RBI must post all approved digi-lending apps on its website, the way it disseminates names of all licensed entities under its ambit and ask the apps to give a backward link to the RBI website on their app for prospective customers to check.

DIGITA could be financed by collection of fees from applicants just as SEBI collects licence fees from FPIs and other entities wanting to enter the Indian market. Further, to strengthen consumer protection, the Report rightly advocates enacting a separate set of National Financial Consumer Protection regulation under the existing Consumer Protection Act, 2019.

Skin-in-the-game lending

The loophole exploited by more than 200 unauthorised digital lending apps backed by Chinese lenders was the ability to offer first loss default guarantee (FLDG) where the finance technology companies with synthetic structures offered the host NBFC protection against credit risk by guaranteeing loan repayment even if the borrower defaulted.

To offer this guarantee the guarantor charged a hefty processing fee for each loan and if the customer did not repay by their due date, publicly disclosed the borrower’s inability to repay on time and even threatened her with dire consequences if repayments were further delayed.

The working group’s identification of the problem at its core is commendable. Its suggestions to do away with the FLDG programme and recommendation of making the NBFC responsible for all its credit could make way for more responsible lending.

These suggestions and recommendations will put checks on NBFCs that want to grow rapidly by partnering with unscrupulous entities and at the cost of the borrower.

The writer is a former Chief General Manager of Reserve Bank of India. Views expressed are personal