RBI takes credit for curbing PPI financing

On June 20, 2022, the Reserve Bank of India (RBI) issued directions to all non-bank prepaid payment instrument (PPI) issuers that loading of PPIs through credit lines was not permitted (PPI credit circular). This clarification was aimed at the several PPI credit-linked products offered by PPI issuers in partnership with banks and non-bank financial companies (NBFC).

There are several variations of these products in the market, some of which offer a one-time loan credit to the PPI to be repaid within agreed timelines without a specific end-use, a pre-approved credit line which can be drawn down as required, most commonly used for buy now, pay later (BNPL) purchases, or a single advance loaded on the PPI for a specific end-use. The RBI direction refers only to loading of PPIs through credit lines but the regulatory intent seems to prohibit all PPI-linked credit products. This position is reflected in paragraph 7.5 of the Master Directions on PPIs, to which the RBI refers in the PPI credit circular. Paragraph 7.5 states that PPIs may be loaded and reloaded using cash, debits to a bank account and credit and debit cards, implying that PPIs may not be loaded through credit lines, loans or advances.

The PPI credit circular appears to be directed at non-bank PPI issuers, but there is uncertainty over how bank-issued PPI credit products will be treated in the future, particularly given the RBI’s emphasis on paragraph 7.5 of the Master Directions.

A key concern of the RBI was that many PPI-linked credit lines operated like shadow credit cards. The repayment schedules, interest rates and terms and conditions of several such products are arguably closer to that of a credit card than to a simple loan product. However, the products do not comply with the regulatory framework for credit cards. The lack of reporting of defaults, fair practices linked to interest rates and minimum amounts due and comprehensive customer grievance redress mechanisms together with the treatment of fraud transactions are probably some of the regulatory gaps about which the RBI has been concerned.

The RBI, over the last 18 months, has been closely reviewing fintech credit products. In November 2021, the RBI Working Group on Digital Lending released its report, which flagged concerns not very different from the ones the RBI sought to address in its PPI credit circular. Those concerns centred on regulatory arbitrage and the systemic risk created by parties offering credit, in this case by way of credit cards, outside the prescribed regulatory framework. While each of these concerns is valid, an important question is whether prohibition is a preferred solution to regulation. The RBI recently released updated guidelines on the issue and operation of credit and debit cards. One option could have been for the RBI to regulate PPI-linked credit products under the same framework.

Banning PPI-linked credit does not technically prohibit the offering of all forms of short-term consumer credit or BNPL products, but it certainly makes the consumer interface more challenging. Loans and other credit products can be disbursed into a consumer bank account, but such products do not have the convenience factor of a PPI. PPIs are usually end-to-end digital, have an easy-to-use consumer interface and have the potential for greater product innovation than traditional bank accounts. Since the RBI permitted cash withdrawals and increased transaction limits, PPIs have been able to function as low-value, quasi-bank accounts and can increase financial access given their ease of issue and operation. Prohibiting PPI issuers from entering the credit segment will limit the functionality of all PPIs.

Regulating fintech requires a fine balance between protecting consumers and addressing the concerns of systemic risk, while at the same time continuing to foster growth and innovation. The RBI’s recent approach has been towards licensing and increased supervision, pushing fintech products towards more traditional regulation. As fintech product adoption increases, greater regulation is certainly needed to set standards, introduce regulatory oversight, ensure data protection and build consumer trust. However, it may be worth considering whether fintech-powered financial products require a completely separate regulatory framework altogether.

Shilpa Mankar Ahluwalia is a partner at Shardul Amarchand Mangaldas & Co.

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