RBI takes a close look at digital lending apps

India’s digital lending industry, which is expected to be worth $1.3 trillion by the end of the decade, has come under a central bank crackdown. The Reserve Bank of India (RBI) has tightened its rules on digital lending following complaints about consumers being lured into a debt trap through quick loans. The digital lending guidelines issued by the RBI are consumer-centric and aim to protect digital borrowers from unethical business practices in loan collection by some of the digital lending apps.

The guidelines prescribe that uniform terms and conditions must be disclosed by all digital lenders. Clients must be allowed to withdraw from the loan agreement within a specified period. Hidden charges are prohibited and customer complaints will be dealt with by appointing a nodal agent. The guidelines also introduced data minimization standards aimed at boosting customer confidence in digital lending platforms.

RBI Governor Shaktikanta Das said the guidelines aimed to balance customer protection and business behavior while supporting innovation. The innovation is welcome, but it should improve the efficiency and resilience of the financial system while benefiting consumers, Das said.

The Indian constitution protects the right to privacy as a fundamental human right. This is exemplified in the RBI’s Digital Lending Guidelines, which state that regulated entities – namely banks and non-bank financial companies (NBFCs) – cannot store borrower data except for minimum information. basic.

A New Delhi-based white-collar crime lawyer commenting on the central bank’s proactivity said Indian Journal of Business Law that the RBI had ensured the protection of sensitive personal data even before Indian law warranted it. The country has not yet finalized its Personal Data protection Invoice.

Given the way fintech companies tend to accumulate and mine customer data, borrowers should be able to withdraw consent at any time, the attorney said. The guidelines aim to clean up the fintech ecosystem, which has recently gained a bad reputation, and the regulations will help focus on the customer, protect personal data and address grievances.

Given the proliferation of fintech companies, RBI’s Das said, “The need of the hour is to ensure security after going through a green light (whitelist) and due diligence process by regulated entities .”

Das added that regulated entities need to strengthen due diligence and oversight of their outsourced activities. They have been given until November 30 to get their houses in order and put systems and processes in place to ensure that existing digital loans comply with RBI’s digital loan guidelines.

While the fintech industry has had a positive impact in improving inclusion and increasing penetration of financial services, a huge amount of consumer data generated is being leveraged by a few Big Tech companies due of their large clientele.

This warrants the RBI’s attention to potential risks in the areas of public policy objectives in terms of maintaining competition, market and business conduct, operational resilience, data privacy, cybersecurity and stability. financial.

The guidelines are expected to increase regulatory pressure on fintech companies and bring new banking solutions as fintech companies continue to partner with banks and NBFCs for underwriting, loan disbursement and collection, said the Delhi-based lawyer.

Counterproductive and restrictive

However, some aspects of the guidelines may be counterproductive and there are fears that they will hamper digital lending activities. The RBI guidelines require digital lending platforms to disclose the names of the banks or NBFCs to which they extend credit.

While the guidelines aim to streamline practices, or rather curb malpractice, in the $270 billion fintech industry, they have imposed massive restrictions, forcing many fintech players to rethink their future strategy. .

The main problem is that the RBI prevents banks and NBFCs from the comfort of first default guarantee agreements. This lending model offers third-party guarantees to banks and NBFCs that they will be indemnified up to a certain percentage of the loan portfolio in the event of default.

First loss default guarantee has been adopted in the last four to five years since the evolution of digital lending in India and has helped banks and NBFCs to expand their lending reach and offer lending products innovative.

The RBI, however, views first-loss default guarantee as akin to synthetic securitization, says Prashanth Ramdas, a Bengaluru-based partner with Khaitan & Cie.

Although the exposure remains on the books of banks and NBFCs, the risk is covered by credit guarantees, which is not allowed in India, he adds.

The RBI’s digital lending guidelines are in line with international best practice, but the central bank has gone too far, similar to what Chinese regulators have done to crack down on peer-to-peer lending, says Ramdas.

Lenders are feeling the heat

The central bank has no jurisdiction to regulate service providers or fintech companies that operate lending applications and provide integration services. It has, however, prevented banks and NBFCs from getting the comfort of a first-to-default guarantee.

This had a major impact on the digital loan market. Most platforms seek out customers and refer customers to lenders who expect the fintech companies operating the platforms to “have skin in the game,” Ramdas says.

Banks expect fintech companies to bear default risk because they are not responsible for customer onboarding and are not geared towards this new segment of small loans and unsecured loans sold to the banking sector. retail and small business.

The RBI fears that the first-to-default guarantee could give rise to systemic risk if lenders lend based on fintech companies, which are unregulated.

This is a valid concern, given that there is little oversight of fintech companies and their ability to repay loans in the event of default has not been tested, Ramdas notes.

Nevertheless, there should not be a total ban on first-to-default guarantees, but rather a limit to reduce systemic risk, he suggests.

Many NBFCs are lobbying the central bank to be allowed to provide first-to-default guarantee, given that they are regulated by the RBI, two other industry lawyers point out.

It will be a challenge not just for unregulated fintech firms, but for the industry as a whole, if the RBI does not relent and allow the first loss default guarantee agreement, other industry watchers say. ‘industry. Banks may be reluctant to lend.

The ideal solution would be to monitor the financial capacity of those who offer collateral comfort, or to cap comfort at a specified percentage of the portfolio, considering that it is in the best interest that the partnership model continues, explains Ramdas.

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