RBI's proposed legal framework for the online P2P lending industry in India seeks to regulate an unregulated industry to avoid unhealthy practices creeping in and disrupting the financial sector and traditional banking channels.
The e-commerce sector has witnessed tremendous growth in India over the past few years, with the Government recently formulating regulations governing foreign direct investment in online marketplaces. An online platform that has recently attracted the attention of investors and regulators alike is the Peer to Peer (P2P) lending platform.
The basic business model of a P2P player is to provide a platform to connect lenders with borrowers. Lenders and borrowers communicate through the P2P platform, agree on various details of the loan, sign an agreement, following which the loan amount is transferred directly by the lender to the borrower. A few of these P2P platforms also provide additional services such as (a) fixing interest rates, (b) collecting loan repayments, (c) escrow services for safe keeping of cheques, loan agreement, etc. and (d) assessing creditworthiness of borrowers and lender verification.
Unlike a banking company or a non-banking financial company (NBFC), a P2P platform's source of revenue is not interest income but transaction fees (including any fees for additional services) paid by borrowers and lenders to the platform.
A P2P platform provides an information technology platform for the borrowers and lenders to strike a deal and does not itself engage in the business of lending or taking deposits. Given that it only acts as a facilitator between the borrower and lender, its activities do not fall within the ambit of a conventional lending business and are not regulated under our current financial services laws.
While the sector is still nascent, the Reserve Bank of India (RBI), recognizing the potential of this developing business model and its probable impact on the financial services industry, has proposed to regulate such P2P players. The RBI, after reviewing the approach taken by regulators in different jurisdictions towards the P2P lending business, has proposed a broad outline of the legal framework to be adopted in India through its consultation paper released on 28 April 2016.
Proposed P2P Framework
One of the key concerns of the RBI is to ensure that the role of the P2P platform is restricted to a 'financial intermediary'. While the platform could provide additional services (such as opine on the suitability of a lender and creditworthiness of a borrower) to facilitate the transaction, it should not itself lend or guarantee the loan and expose its own balance sheet. To safeguard this and to curb improper practices, the RBI has proposed that:
- the money should move directly from a lender's bank account to a borrower's bank account;
- platforms which also assist lenders in loan recovery should follow the regulations applicable to NBFCs regarding their recovery practice;
- the promoters, directors and chief executive officer of the platform should fulfil the required 'fit and proper' criteria and a requisite number of board members should be experienced in the financial sector;
- the P2P platforms should submit regular reports to the RBI on various matters including the financial position of the platform, updates on transactions undertaken through the platform.
- no loan should be reflected on the balance sheet of the platform;
- the platform cannot give or guarantee any assured return to the lender.
The RBI proposes to set up P2P platforms as a category of NBFC with a minimum capital of at least INR 2,00,00,000 (USD 0.3 million). The consultation paper also indicates that the RBI would prescribe a leverage ratio for the platform and caps on the amount of funds that can be lent by a lender to each borrower or segment of activity.
Additionally, the P2P platform is expected to maintain transparency in its operations, make adequate disclosures to lenders as well as borrowers and operate under a fair practices code. The platform should have a grievance redress mechanism to deal with lender and customer complaints. The platform will also be responsible for confidentiality and security of customer data.
The banking and financial services sector in India is highly specialized and heavily regulated. However, the P2P business is not strictly covered within the existing regulations and has been largely unregulated so far. Given the potential that this industry has to promote and facilitate alternative forms of finance, RBI's decision to regulate this nascent yet growing industry seems to stem from the need to formalize a business, which if left unregulated could significantly disrupt the financial market. RBI's proposal to regulate this industry has also provided sanctity to the P2P business model, which has been operating in a grey area in the absence of any legal framework.
The consultation paper released by the RBI provides a broad overview of the proposed regulations and it appears that the RBI has focused on the operations of the P2P platform and its dealings with the borrowers and the lenders. However, it is short of adequate on the eligibility criteria and norms applicable to the financial players themselves, i.e., the lenders and the borrowers. Clear prescriptions on eligible lenders and borrowers, lender registration, net worth adequacy and caps on amounts is necessary to avoid instability in financial markets.
Further, since the platform itself does not have any financial exposure as it is not the lender and is not allowed to provide any assured returns, the proposed prudential requirements, of minimum capital and leverage ratio, appear to be excessive.
The RBI currently proposes to regulate P2P platforms as a category of NBFCs. However, basis the business model of a P2P platform, it may be more appropriate to regulate it only as an intermediary without imposing the other, more onerous requirements and conditions applicable to NBFCs generally.
The RBI has sought public feedback on the proposed regulations and it is expected that the gaps and ambiguities in the consultation paper will be addressed in the regulations formulated by the RBI.