The recommendations of the RBI initiated working group on Digital Lending – Implementation, should be welcome by the financial sector participants for an orderly digital transformation without elevating systemic and social risks. The objective is laudable but the challenge may lie in the implementation and the methods thereof. These issues, if not addressed, can impede the process of digital transformation with social equity.
The working group has classified digital lending ecosystem players into:-
a) RE or Regulated Entities either by RBI or by any other domestic regulatory body and
b) LSPs or Lending Service Providers, largely unregulated fintech platforms relying more on technology and analytical/modelling skills to make available their lending platforms to other regulated entities and/or unregulated Digital Sourcing Agent/ Aggregators.
Together they work for marketing and selling /originating retail loan proposals which are then passed on to Regulated Entities with or without value added scores or grading of the proposals for further processing and disbursements. The LSPs and DLAs are largely unregulated with LSPs using different digital credit assessment models/running different algorithms using diverse customer data (traditional and /or alternate data) available directly from customer and /or other behavioural and transactional data. Whilst LSPs and DLAs could be separate entities working together some of the LSPs may also double up as DLAs.
The DLAs/LSPs may also contracted by REs for delivering collection related follow up services
Customer data capture happens at multiple points
1. At the DLA end
2. At the LSP end
3. At the RE end and data may flow seamless through API across the lending process chain.
Any withdrawal of borrower’s consent for usage and storage of specific data will have to be implemented simultaneously at 1 and 2 referred above. The challenge will be in ensuring this happens since the onus would be on the RE to ensure the deletion of specific data against which the borrower has withdrawn consent. How this is implemented and complied with remains to be seen. It may be noted that the much touted DND feature, to avoid unwanted telephone calls have been an abject failure, given the all-pervasive way data gets distributed across digital platforms and marketers.
One of the possible approaches that REs could adopt to surmount this regulatory challenge is picking up stakes in select DLAs and LSPs and ensuring compliance as part of their digital transformation initiatives. This may witness a spate of acquisition of Fintech platforms by REs.
In a nutshell, the RBI guidelines puts the entire onus of compliance, transparency, actions and disclosure on the regulated entities for the services outsourced to other digital entities. These implementation challenges may slow down the rapid pace of growth of the digital lending ecosystem, reduce proliferation of multiple and often untried and untested players in the lending space in the near term. The guidelines are also expected to impact valuation and fund raising efforts of Fintechs till more clarity evolves.
The objective of RBI’s guidelines is expected to bring some semblance of order and domain depth into the digital lending ecosystem and in course of time put in some regulatory control on the digital lending space. It should mark the beginning of some degree of maturity of the digital lending ecosystem and start a process of shakeout of some players who hitched on to the digital lending bandwagon during the pandemic, a period which saw a tremendous burst of activity. The pandemic restricted mobility and the financial sector found effective alternative through the use of digital payment and lending systems.
Bryan Zhang, Co-Founder and Executive Director of the Cambridge Centre for Alternative Finance, noted that the “FinTech industry has been largely resilient in spite of COVID-19. Nonetheless, its growth must be interpreted with nuance and in the context of unevenness, and the opportunities for the industry should be juxtaposed with the challenges it faces.”
The guidelines for the digital lending ecosystem is likely to slow down the growth of newer Fintechs/ digital lending till the time the implementation modes are thought through to comply with the guidelines in letter and spirit. The guidelines are however silent on the onus when it comes to co-lending between two regulated entities. This will need further clarification before the implementation challenges can be deliberated.
Let us look at some of the key challenges emanating from the guidelines and possible approaches to resolving them
In the case of balance sheet lenders as well as LSP (traditional lenders) enforcement of the guidelines poses less of a challenge apart from ensuring that the systems and applications conform to the guidelines in terms of data privacy and security in the near term.
Further, RBI, under the legal and regulatory recommendation has recommended:-
A. The creation of a nodal agency which will verify the “technological credentials of the DLAs of balance sheet lenders and LSPs operating in the digital lending ecosystem. It will also maintain a public register of the verified apps on its website.”
B. Balance sheet lending through DLAs should be restricted to entities regulated and authorized by RBI or entities registered under any other law for specifically undertaking lending business. A suitable notification in this regard should be issued by the appropriate authority.
C. An SRO should be constituted covering the participants in the digital lending ecosystem.
D. All loan servicing, repayments, etc. should be executed directly in a bank account of the balance sheet lender and disbursements should always be made into the bank account of the borrower. However, borrowers having only PPI account and no bank account can be disbursed loan if the PPI accounts are fully KYC compliant.
Possible way forward
Whilst D is an immediate need and can be readily implemented A&C are excellent recommendations the scope of which may be extended to include all services providers , digital or otherwise who render any service to regulated entities be it credit origination, processing , collection and follow up. The providers may be classified under different service provider categories and the list publicly available on the internet and also accessed thru links on the REs website with details of the REs to whom the DLAs/LSP provide service to. This will obviate some major implementation and regulatory challenges that the financial services sector faces due to mis-selling, dissemination of wrong information and last but not the least checking agency originated fraudulent proposals due to oversight.
The platform could be run on the lines of AMFI which is a self-regulatory body or on the line of IRDA’s registration of insurance agents. The platform could also deal with complaints against DLAs/LSPs by appointing nodal complaint redressal officers and also have a definite grading model to grade performance and compliance by DLAs w.r.t operational and customer grievance , compliance and origination issues . This will go a long way in building up a robust and transparent financial services delivery system where the customer will not have to run from pillar to post to get transaction issues and false commitments resolved apart from reducing frauds in the lending system. There should also be provision for withdrawing registration of non-compliant DLAs/ LSPs, thereby preventing any of the REs to deal with such DLA/LSP. Borrowers and REs can verify details of the DLA/ LSP from a notified website before providing any data or entering into any transactions or downloading an application for the purpose of transacting.
The creation of a separate registration and compliance platform will significantly reduce the compliance burden and costs of the REs.
Under the technology framework recommendation, the three key recommendation apart from compliance to baseline technology standard are:-
Possible way forward.
Whilst 1 will be relatively easy to implement 2 &3 could pose challenges in implementation considering that algorithms are varied and often based on different data sources (both direct and indirect). Further, disclosure of algorithms which are key differentiators for different LSPs/lending platforms could lead to IP concerns. As an alternative, the LSP may be required, by mandate, to disclose all the data points, required and captured, to provide a lending decision and be certified by a separate agency thru back testing based on the available/historical data from different pools of customers or portfolios. The independent agency will not only validate and certify the model but also certify compliance to extant regulatory guidelines.
In this effort different academic institutions of national importance like the IITs, IIMs and other accredited universities may be roped in to provide certification. This will also increase Industry academia collaboration apart from ensuring that the lending models are ethical and not exclusion driven. Only certified LSPs may be accorded registration on the platform of the nodal agency, discussed earlier. Additional institutional certification would be a great value addition to the fintechs given that 34% of the workforce in fintechs have less than 2 years of experience and 60% of them have less than 5 years of experience. (source: PWC/Finextra)
Other Challenges and borrower /lender bargaining power asymmetry
In the lending space there is a tremendous asymmetry when it comes to the large corporate borrowers viz a viz retail borrowers which is perhaps one of the reasons that PSU banks , NBFCs and Private sector banks have taken to retail lending in a big way to compensate for lack of corporate credit appetite pursuant to NPA challenges in the banking system. This is apart from the benefits arising due to granularity of retail loans.
Having had to write off huge corporate loans the banks turned to retail loans where returns were higher with much lower borrower negotiating power. This is has been a source of tremendous comfort for banks /NBFCs. This has led to low consumer protection against mis-selling of loans and adverse one sided agreement which retail borrowers are made to sign on “take it or leave it basis.” Every enquiry for an alternate lender impacts the CIBIL score of the retail borrower who is left with no choice but to agree to such terms and conditions even if adverse . Given the circumstances, RBI’s guideline for providing a window / cooling off period is a very welcome move to improve borrower’s bargaining power and protection. This, in my opinion, can prove to be a game changer when it comes to consumer interest protection measure. The challenge lies in the implementation of the guideline and the method thereof, to comply in letter and spirit. Once a loan is disbursed it should be mandatory for the lending organization to provide a signed and complete copy of the agreement to the borrower digitally over email other digital medium with a translated copy in the vernacular language of the borrower. This has been addressed in the guidelines but will need some more clarity.
The window /look-in period should commence from the date such communication is sent to the borrower over the digital medium. The communication should be provided with a self-expiry link through which the borrower can repay the entire loan and cancel the loan contract, anytime in the look in period with appropriate interest payment. There are no such provisions at present from the REs against any loan contract. The window / look in period is a great move by RBI for enhancing customer service, enhance borrowers interest protection and bargaining power. This feature, if implemented properly, will provide a level playing field and enhance consumer confidence and trust in the Indian financial system.
Summing up
The guidelines could have not been better timed and is expected to be a game changer in the digital lending space.
As per data from RBI’s sectoral loan deployment released on August 30,2022 the retail consumption driven loans grew the strongest between July 2020 and July 2022 at 15.3 % of which credit card outstanding grew by 20% and unsecured personal loans grew 17.4% whilst loan against gold jewellery grew by more than 41%.
Personal loans are unsecured loans primarily against pre-approved credit aided by fintech platforms which allow for a quick sanction and disbursal. Digitization of credit appraisal and disbursement processes has had a very positive impact in lending without security using various available data points for alternative approach to lending.
Whilst these may look positive to indicate a healthy rise in household consumptions it does not augur well in terms equality in recovery given the K shaped growth that economists are talking of. Should employment growth and job recovery not proceed as expected and with rising inflation it does raise the spectre of retail loan defaults coming to haunt the banking system in a matter of time with overleveraged, income starved households unable to repay their loans. It will impact financial inclusion efforts which has done well so far.
Sanjoy Banerjee, Principal Consultant, I-Cube Insights Business Consulting and Training LLP
These are the author’s personal views
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