RBI working group warns on digital lending by big tech players

The working group has recommended the formation of a nodal agency & SRO for digital lending apps

Big tech players entering the digital lending space could have regulatory implications on concentration and competition risks, a working group of the Reserve Bank of India (RBI) has cautioned.

The RBI should work on a framework for identifying and managing risks arising from big tech as well as decentralised finance through blockchain technology, it has advised.

The report said: “… digital innovations along with the possible entry of BigTech companies may alter the institutional role played by existing financial service providers and regulated entities. A fallout of this may get reflected in blurring of regulated and unregulated financial institutions/ activities.”

Big tech firms have a big customer base and they use this to move from non-financial businesses to financial services. They do so by providing the data they have to financial entities and shift towards financial services either in partnership or directly. The size of the entities is such that they pose significant systemic and concentration risks to the economy, the report said.

“Enhancing the traditional entity-based regulatory approach with activity-based regulations may be inadequate to ensure stability, level-playing-field/ competition and customer protection, in the case where a non-financial conglomerate or a BigTech firm in practice provides financial services across its associates in an integrated manner,” the report added.

They have also suggested that buy now, pay later’ products should be treated as part of balance sheet lending and the RBI should encourage creation of more digital only NBFCs and lay the groundwork for digital-only banks. They have also said that neo-banks should be brought under the regulations of the RBI. These are suggestions that the working group has given in its report, which require wider consultation with stakeholders and further examination by the regulators and government agencies. 

The working group, which was tasked with studying digital lending in the regulated financial sector as well as by unregulated players, has recommended forming a nodal agency that will verify the technological credentials of digital lending applications (DLAs) of balance sheet lenders and loan-service providers (LSPs). It will also ensure that a public register of the verified applications is maintained on its website.

Further, it has said balance sheet lending through DLAs should be restricted to RBI-regulated entities or entities that are allowed to do lending. Also, it has sought a self-regulatory organisation that will cover all the participants in the digital lending ecosystem.

The working group has recommended all loan repayments have to go to the bank account of the balance sheet lender and disbursements to the bank account of the borrower.

During the pandemic, the number of lending apps went up substantially as financial distress gripped the nation. But many apps are resorting to unfair practices, such as charging exorbitant rates, using illegal recovery practices, etc.

According to the report, there were approximately 1,100 lending apps for Indian android users across more than 80 application stores from January 1, 2021, to February 28, 2021. Of these, 600 were illegal. The RBI received hundreds of complaints following the cautionary circular it issued in late December 2020.

There are three players in the ecosystem: RBI-regulated entities; other regulated entities; and unregulated entities, including third-party service providers. The working group said the onus of subjecting third-party lending service providers to a standard protocol of business conduct would lie with the regulated entities, to which they are attached.

As far as the technology aspect is concerned, the working group has said regulated entities and LSPs should comply with prescribed baseline technology standards to offer digital lending. Also, DLAs should have publicly available policies regarding data storage, its usage, and privacy, and the data servers should be located in India. Further, the report says, the data should be collected from the borrowers with prior information on the purpose, usage and implication of such data and with the explicit consent of the borrower in an auditable way. In the medium term, an adaptive comprehensive regulatory framework for fintechs and techfins should be considered.

For consumer protection, it has been recommended that lenders have to provide a key fact statement in a standardised format for all digital lending products and the lender has to send SMS/ email with a summary of product information and ensure that the customers understand the lending terms and conditions. Also, a look up period of certain days should be provided for all digital loans with the option of exit by paying proportionate annual percentage rate without any penalty. Further to prevent over indebtness of borrowers the DLAs need to refrain from employing predatory lending practices that push the borrowers to unsustainable levels of personal debt and the working group has suggested the proposed SRO to develop guiding principles.

When it comes to pricing of loans, the RBI should establish standard definitions for the cost of digital short term consumer credit as Annual Percent Rate (APR). “The STCCs generally carry comparatively higher cost. While the WG does not recommend any hard cap on the APR, the SRO shall keep a tab on such market-mechanism, which can be considered as high cost STCCs”.

As far as recovery is concerned, the working group has recommended that a standardised code of conduct for recovery should be framed by the proposed SRO in consultation with RBI.