Is India ready for a digital lending overhaul?

By Anu Tiwari and Anindita Bhowmik, Cyril Amarchand Mangaldas

The digital lending industry in India has witnessed immense growth in recent years, posting a 12-fold increase in loan disbursement between 2017 and 2020. While this rapid growth increased credit accessibility in the country, it also brought concerns regarding unregulated entities, illegal digital lending applications (DLAs) and coercive recovery tactics.

Anu Tiwari
Cyril Amarchand Mangaldas

Against this backdrop, the Reserve Bank of India (RBI) had notified the constitution of a working group on digital lending, on 13 January, to study all aspects of digital lending activities in regulated financial segments and unregulated entities. The working group released its report on 18 November – titled “Report of the Working Group on Digital Lending including Lending through Online Platforms and Mobile Apps” – suggesting significant changes to regulate the digital lending landscape.

Reining in unregulated lending

An important focus area for the working group has been restricting the role of unregulated entities in digital lending. To this end, the report suggested that balance sheet lenders (BSLs) – i.e. entities that take on credit risk while lending – should only be RBI-regulated entities, or entities authorised by any other law to undertake lending business. Lending service providers (LSPs) such as fintech platforms should also be subject to enhanced due diligence standards and monitoring by BSLs.

Anindita Bhowmik, Partners, Cyril Amarchand Mangaldas
Anindita Bhowmik
Cyril Amarchand Mangaldas

Significantly, the report recommended a prohibition on first loss default guarantee structures utilised by regulated entities that extend loans while passing on the credit risk to unregulated entities, either partially or wholly. The report cautioned that such synthetic structures might lead to increased risk in the overall stability of the financial system.

The working group also recommended treating buy now pay later (BNPL) arrangements, which allow consumers to purchase products on a deferred payment basis, as balance sheet lending, if not as operational credit by merchants. Consequently, know your customer (KYC) and credit score checks may be required before extending BNPL options to such purchasers of goods.

This recommendation follows rising concerns on BNPL arrangements from jurisdictions such as the US, the UK and Australia. A key distinction is that, unlike these jurisdictions where BNPL arrangements are primarily entered into with retail borrowers, many fintech entities in India use BNPL structures to serve micro, small and medium-sized enterprises borrowers with longer credit cycles. The working group recommended disbursement of loaned funds only to bank accounts, adding that prepaid payment instruments may be permitted to be utilised once full interoperability is achieved. In the interim, loans may be disbursed to full-KYC prepaid payment instruments if the customer does not hold a bank account.

Regulatory oversight

The working group recommended constituting a nodal agency, styled as the Digital India Trust Agency (DIGITA), to subject DLAs (both BSLs and LSPs) to a verification process before making such DLAs available for download to end-users. The DIGITA will also be tasked with maintaining a public register containing verified DLAs. DLAs that are not verified by the DIGITA should be considered as unauthorised for the purpose of law enforcement.

The working group also recommended setting up a self-regulatory organisation for all market participants in the digital lending ecosystem. This self-regulatory organisation is required to maintain a “negative list” of LSPs and formulate a standardised code of conduct for recovery practices. This approach follows the working group’s concerns about illegal DLAs, as its survey noted that out of 1,100 publicly available DLAs, 600 were illegal. On this front, the working group also recommended enacting new legislation to prohibit illegal lending.

Other recommendations

Formulation of baseline technology standards and compliance has been suggested by the working group as a precondition for regulated entities to offer digital lending. This is in line with the RBI’s approach towards other segments such as payment aggregators, which are subject to compliance with baseline technology standards as a precondition to the granting of a licence.

The working group recommended that all data storage be localised, and that data should be collected only with the borrower’s explicit consent. The working group further suggested that the Data Protection Authority envisaged under the Data Protection Bill, 2019, could serve as the designated regulatory authority.

The report has suggested much-needed customer protection reforms that will boost public confidence in the ever-growing digital lending space. With the RBI inviting comments on the working group’s report, it will be interesting to see the final shape that the draft regulations take.

Anu Tiwari and Anindita Bhowmik are partners at Cyril Amarchand Mangaldas. Senior associate Utkarsh Bhatnagar and associate Rohil Deshpande also contributed to this article

Cyril amarchand

Cyril Amarchand Mangaldas
Peninsula Chambers, Peninsula Corporate Park
Lower Parel
Mumbai 400 013, India


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