Digital lending guidelines – turning point or folly?

Introduction
Key aspects
Comment

Introduction

In a measure consistent with its consumer protection orientation and its hawkish stance on the fintech sector, the Reserve Bank of India (RBI) put together a working group in January 2021 to evaluate "digital lending including lending through online platforms and mobile apps". The working group's report was placed on the RBI's website for comments on November 2021, which was followed by a period of silence not uncommon for the RBI. On 10 August 2022, the RBI issued a press release highlighting that, while it is keen to foster innovation in the financial system, it has concerns with some aspects of digital lending and would seek to regulate it to "support orderly growth of credit delivery through digital lending methods while mitigating the regulatory concerns". The press release sets out some recommendations that had been accepted for "immediate implementation". This was followed on 2 September 2022 by the RBI's digital lending guidelines.

Key aspects

The digital lending guidelines are applicable to all commercial banks and non-banking financial companies, including housing finance companies (regulated entities (REs)). The guidelines accomplish some notable firsts in the field of regulation by defining:

• "digital lending" as "a remote and automated lending process, largely by use of seamless digital technologies for customer acquisition, credit assessment, loan approval, disbursement, recovery, and associated customer service";
• "digital lending apps/platforms" (DLAs) as "mobile and web-based applications with user interface that facilitate digital lending services"; and
• a "lending service provider" (LSP) as an agent of an RE that carries out or assists an RE in "customer acquisition, underwriting support, pricing support, servicing, monitoring, recovery of specific loan or loan portfolio".

While the above are intended to be broad-based and future-facing definitions, given the proliferation of technology in all aspects of lending, these definitions have an unintended consequence of covering and applying to all loan products offered by the REs on their webpages or mobile apps except where customers are not acquired through digital means and where loan applications are processed offline.

The digital lending guidelines require REs to provide borrowers a "key fact statement" prior to the execution of the loan contract. The guidelines prescribe the format of the "key fact statement" and require the disclosure of an "all-inclusive cost and margin" (including cost of funds, a processing fee, penal charges and late payment charges) to be expressed as an effective annualised rate. Among other loan-related details, this statement must also provide:

• the details of the recovery mechanism;
• the details of grievance redressal officer designated to deal with digital lending; and
• a "cooling-off/look-up period", defined as a window to be provided to borrowers to exit a digital loan.

Any fees or charges that are not mentioned in the key fact statement cannot be charged to a borrower.

Possibly in an effort to prevent borrower-unfriendly practices, the guidelines prescribe that any fees or charges of an LSP are to be paid directly by an RE to an LSP and are not to be charged by the LSP to the borrower. The guidelines require an RE to assess the creditworthiness of a borrower by recording their economic profile on the basis of factors such as age, income and occupation prior to providing any loan through either a digital lending app or through an LSP. Further, no automatic increase in credit limit can be provided to a borrower without the explicit consent of the borrower for each such increase.

All payments and repayments are also required to be made by the borrower directly in the RE's bank accounts without any pass-through account or pool account of any third party or LSP. These prescriptions may have the effect of stifling innovation and disallowing useful loan products offered by REs, such as merchant discounting products, which serve a genuine purpose and provide last-mile financial connectivity.

Another key aspect considered (but not completely elaborated on) by the digital lending guidelines is credit enhancement and support provided by the LSPs to REs, amont other things, in the form of first loss default guarantees. While the digital lending guidelines contain a reference to such credit enhancement, these only further prescribe that REs are required to adhere to the RBI's guidelines on securitisation of loan receivables. As digital lending products by themselves are not securitisation transactions, and mostly come in the form of co-lending, this prescription has created certain uncertainty and would need to be further clarified by the RBI. Some reports in the public domain mention that the RBI is likely to further clarify this aspect.

Comment

In view of the RBI's mandate to regulate entities licensed by it, the guidelines do not apply to pure-play technology companies that may also be involved in "digital lending". The guidelines instead rely on such companies needing to partner with REs to ensure, indirectly, that consumer interests are protected. For example, an RE is now required to conduct "enhanced" due diligence before entering into a partnership with a LSP for digital lending, "taking into account its technical abilities, data privacy policies and storage systems, fairness in conduct with borrowers and ability to comply with regulations and statutes".

The guidelines are well intentioned and seek to create a level playing field for digital lending, as well as an ecosystem that protects consumers. However, it is questionable whether these guidelines were required at all. REs are mandatorily required to comply with all directions and guidelines issued by the RBI for any loan products offered by the RE (whether offline, on any DLAs or through any LSPs). A more stringent implementation of the RBI's existing directions on corporate governance and outsourcing would have achieved a similar effect.

By creating a new regulation, the RBI is increasing the possibility of regulatory inconsistency and arbitrage. For example, credit card marketing and telemarketing by banks do not appear to be covered under the digital lending guidelines. A more holistic approach would be to have a comprehensive code of conduct for REs and LSPs providing DLAs and working under the digital lending sector, which dovetails with the existing directions issued by the RBI to REs.

It must be surmised that the RBI does not intend to tilt the balance in favour of conventional banks and will follow these guidelines with similar measures for other parts of the financial sector.

For further information on this topic please contact Aditya Bhargava, Mithila Bhati or Sristi Yadav at Phoenix Legal by telephone (+91 22 4340 8500) or email ([email protected], [email protected] or [email protected]). The Phoenix Legal website can be accessed at www.phoenixlegal.in.