RBI's digital lending guidelines: A tectonic shift in the fintech world

With the central bank having issued new guidelines governing the lending activities of financial technology firms, some may find themselves fighting for survival

A term which I see bandied about by fintechs is ‘white spaces’. It’s a reference to the fact that banks have legacy burdens, and so, fintechs will have the road to themselves,” says Romesh Sobti, the former boss of IndusInd Bank. He reckons banks have largely closed this gap vis-à-vis fintechs, and can take the game to them.

“I have long held the view that it’s only a matter of time before Mint Road sets the ground rules,” adds Sobti, who in his new avatar wears two hats — he is operating partner at Advent, and an advisor to Multiples, both private equity (PE) firms.

Sobti has proven prescient. Last fortnight, the Reserve Bank of India (RBI) issued guidelines based on the feedback to the Report of the Working Group on Digital Lending including Lending through Online Platforms and Mobile Apps, which it had unveiled in November 2021.

The report divided digital lenders into three groups — entities that are regulated by the RBI and permitted to carry out lending; entities that are authorised to carry out lending according to other statutory and regulatory provisions, but not regulated by the RBI; and entities that are involved in lending, but are outside the purview of any oversight.

The RBI is not done yet with setting the new regulatory topography. More housekeeping measures are on their way, and it would be fair to expect a significant amount of coordination among all financial regulators.

Not business as usual

From here on, for all RBI-regulated entities, their lending service providers (LSPs), and digital lending apps), loan disbursals and repayments are to be executed only between the bank account of the borrower and the regulated entity, without any pass-through, or pool account of the LSP, or any third-party.

Regulated entities will have to ensure that fees to LSPs are paid directly by them, and are not charged (by LSPs) to the borrower. The all-inclusive cost of digital loans — in the form of the annual percentage rate (APR) — is to be disclosed to the borrower. Furthermore, regulated entities will have to provide a “key-fact statement” (KFS) to borrowers before the execution of the contract for digital lending products.

The KFS is a standardised form listing all the fees, charges and other key credit information that consumers need in order to make informed decisions, which promotes transparency and healthy competition and ensures that they are not blindsided. 

“What you are seeing is a tectonic shift. The old distribution and origination model will have to give way to a more asset-driven NBFC structure,” notes V Raman Kumar, founder and chairman of CASHe, a mobile-only credit platform focused on financial inclusion for the millennials. “Some players may have to revisit their revenue models. The guidelines on APR mean that you can’t pocket fees like you did earlier.”

So, what do you do to increase your fee income? “Well, that has to be seen. It will not be business as usual,” says Kumar.

Wider consultations

What has got relatively less attention in the RBI’s circular on digital lending is the call for wider consultations with the government for a comprehensive legal and institutional framework. This is because some of the recommendations require wider engagement with the government and other stakeholders, given the technical complexities, and the setting up of institutional mechanisms and legislative interventions which are needed. 

These recommendations include:

• Restrict balance-sheet lending using digital lending apps to regulated entities, and entities registered under any other law (for specifically undertaking lending activities);
• The government should consider bringing a law banning unregulated lending activities, which would cover all entities not authorised by RBI, and not registered under any other law;
• An independent body — the Digital India Trust Agency (Digita) — should be set up to ensure that consumers use only authorised and trusted digital lending apps;
• Digita should discharge the functions of verifying digital lending apps before such apps can be publicly distributed through app stores, with eligible apps not carrying the “verified” signature of Digita being considered unauthorised for the purpose of law enforcement.
• Relevant input from the proposed Digital Intelligence Unit of the government, the Telecom Analytics for Fraud Management and Consumer Protection (Tafcop), and the Telecom Commercial Communications Customer Preference Regulations (TCCCPR: 2018) is to be made available to the respective supervisors.

Tafcop is a portal of the Department of Telecommunication which enables Aadhaar-card holders to check mobile cards issued in their name. TCCCPR: 2018 aims to curb the problem of unsolicited commercial communication. Besides, a National Financial Crime Records Bureau — akin to the National Crime Records Bureau — with a registry similar to crime and criminal tracking networks and systems is also on the cards.

“Fintechs must shoulder greater responsibility and scrutiny on their business model, customer protection, and data, among other things,” says a candid Sugandh Saxena, chief executive officer (CEO) of the Fintech Association for Consumer Empowerment. “A fascinating aspect of this interplay would be how fintechs keep the roots of their agility, innovation and customer experience intact.” 

 

Too fast, too soon?

Digital lenders may have reason to feel that the regulatory approach — if not tilting towards legacy players — is turning harsh towards them. There is some justification for this view, because the RBI never overtly gave the impression until recently that it was uncomfortable with the ground realities.

There is a feeling in some quarters that fast-paced regulatory change can affect fintechs’ business models, as these are young firms that may not have the bandwidth to digest the measures.

Respondents to a Boston Consulting Group Survey (with Matrix Partners, an investment firm) carried in its report — State of the Fintech Union (August 2022) — offered a mixed outlook when queried on regulatory moves on the anvil vis-à-vis the enablers needed for the industry.

While 70 per cent said that regulatory moves would adversely impact innovation, 75-80 per cent also felt they would curtail bad lending practices and improve portfolio quality, and that there is a need for “a regulatory framework enabling healthy partnerships, with guardrails to check systemic risk.”

Will this trip up fund-raising by fintechs? Says Krishnan Sitaraman, senior director and deputy chief ratings officer, CRISIL Ratings: “PE firms may want to take stock of the new guidelines and carry out a detailed assessment of companies’ compliance with the guidelines and sustainability of business models for further funding rounds.”

Take Indifi Technologies. It raised $45 million — in debt and equity — last November. Is this to be seen as affirmation that investors thought Indifi would not be adversely affected by the emerging regulatory topography? And will this hold true for others in this space?

“Investors wanted comfort that they are investing in a company which will have the freedom to be able to comply with the key issues that have come up. For example, we have a digital lending entity, but we also have a shadow bank (a non-banking financial company, or NBFC),” says Alok Mittal, co-founder and CEO of Indifi Technologies. “Indifi is a technology company, but we also have a subsidiary, Riviera (which is an RBI-certified NBFC). So, that is why 12 months back investors felt comfortable.” 

“Fintechs are reaching a large scale collectively, but are individually quite diverse and small, and are going through a rapid pace of innovation and new launches,” explains Saurabh Tripathi, global lead (fintech & payments) at BCG.

He makes a case for “a differentiated regulatory approach for early-stage versus scaled-up businesses, and introducing regulatory sandboxes for controlled environment operations and testing. This will be essential to promote innovation and avoid disruption”. 

“Regulatory sandbox” refers to live testing of new products or services in a controlled regulatory environment, for which regulators may — or may not — permit certain regulatory relaxations for the limited purpose of testing.

Tripathi’s suggestion on a differentiated regulatory approach for fintechs mirrors the RBI’s scale-based supervision architecture for NBFCs, which does not take a one-size-fits-all approach.

Governance to the fore 

This brings us to governance. As fintechs get mainstreamed, they will have to adhere to the same standards as legacy entities, on this front.

“The Articles of Association of several of these companies provide that some can continue to be on the board for eternity.

This is very different from legacy RBI-regulated entities. This may need to be revisited given that governance for all manner of regulated entities of RBI has to have uniformity”, says Amit Tandon, founder and managing director of Institutional Investor Advisory Services, a proxy advisory firm.

“Governance will have to come to the fore, as the stakes are higher with banks and fintechs collaborating in a bigger way. A weak link poses systemic risks. Sooner or later, PEs will awaken to these issues rather than merely chasing valuations,” he adds.

RBI governor Shaktikanta Das, while speaking on ‘Disruptions and Opportunities in the Financial Sector’ at a media event on June 17, pointed out that while the trend of technology-driven change in the financial services sector will continue, players will have to strive to remain relevant by continuously improving the quality of their governance; reworking their business strategies and business models; designing products and services with the customer in mind; ensuring operational resilience and risk management; and focusing on more efficient products and services by leveraging technology.

“The possibilities are immense only if we are ready to embrace them while meeting the challenges,” he said.

Clearly, the undercurrents are getting stronger.