digital banking: New RBI rules under development could allow neobanks and digital platforms to thrive and deepen inclusion

In December 2020, Hyderabad police arrested seven people involved in digital lending activities after a wave of suicides in the capital of Telangana, a grim reminder of the social chaos of the past decade caused by a similar network of elaborate deception.

Almost 75 bank accounts with deposits of Rs 423 crore have been frozen. These people ran a digital money lending business through multiple mobile apps, providing low-cost loans without regulatory approval.

The suicides were the result of the harassment and humiliation of these modern day Shylocks after borrowers failed to repay their dues which were magnified due to the makeup of interest rates, which were astronomical anyway. compared to normal lending standards.

The Reserve Bank of India (RBI) took action and formed a task force (WG) to study all aspects of digital lending, so that proper regulations could be put in place.

“We are a country of 1.25 billion with only about 35 to 40 million credit cards. Digital lenders can broaden the credit base just like NBFCs did at one point. Unfortunately, a few bad apples ruined the party. But it also put an industry in the spotlight for regulation, ”said Anuj Kacker, co-founder of digital lender MoneyTap, which has now switched to neobank Freo. It is a credit platform that helps

and HDB Financial, among others, to acquire clients.

The six-member working group was also expected to identify risks to financial stability, regulated entities and consumers, and suggest regulatory changes, a code of best practice, and measures for strong data governance.

In November 2021, the committee recommended regulatory, technological and consumer changes.

The main recommendations that can be implemented in the short term include restricting lending activities only to entities regulated by the RBI. A self-regulatory organization (SRO) to oversee standards and best practices among digital lending companies is another crucial suggestion.

It was also up to a digital trust agency of India (DIGITA) to detail the minimum technical standards and verify compliance.

Small loans, big growth

The digital lending ecosystem has evolved into two broad categories of businesses: Balance Sheet Lenders (BSL), or businesses that lend on their own online books, and Lending Service Providers (LSPs), which provide their platform to obtain loans for banks or NBFCs for a fee. Certainly, these lenders form a tiny part of the lending ecosystem in India. What’s more, even among banks, digitally lending is only a tiny fraction of the loan portfolio.

The working group analyzed a representative sample of banks and NBFCs and observed that loans in digital mode versus physical mode are still at an incipient stage in the case of banks (Rs 1.12 lakh crore via the numerical vis-à-vis Rs 53.08 lakh crore via physical mode) while for NBFC, the comparative figures are Rs 0.23 lakh crore against Rs 1.93 lakh crore.

However, the overall volume of disbursements via the digital mode for the sampled entities increased by more than twelve times between 2017 and 2020 (from Rs 11,671 crore to Rs 1.41 crore lakh).

Industry executives say the strong growth in digital loans indicates the huge untapped credit potential in India which can be effectively met through the use of technology. Kacker, who is also a member of the executive committee of the 80-member Digital Lenders Association of India (DLAI), says bringing digital lenders under RBI regulation will help eliminate bad apples and ensure that only serious players survive, because cost compliance can be too high. for troublemakers.

Villains with deep pockets

Digital lending has taken off over the past two years, also helped by the distress in the salaried class segment after Covid – and led by shady and deep mobile apps.

The typical modus operandi of these companies is to attract clients with small loans of Rs 5,000, which can be repaid in a matter of weeks with interest – usually Rs 500 per month.

However, if the borrower does not repay this amount, it is compounded at 120% per annum (10% per month), making repayment difficult for the borrower.

This loan is sometimes masked as a service called Buy Now, Pay Later (BNPL), which allows buyers to buy something but pay it off later within an interest-free period stipulated in three installments. or more. These loans primarily target young people, new creditors, and cash strapped millennials.

However, if a buyer does not pay the amount within the set repayment window, the lender will charge interest on the unpaid amount as well as a large late fee.

Until the RBI crackdown earlier this year, many apps offered loans without any credit checks or loan agreements for small notes.

These loans would be accounted for by little-known NBFCs and backed by investors with generous pockets – sometimes from China or registered in other developed markets.

Madhusudan Ekambaram, co-founder and CEO of KreditBee, an NBFC-licensed digital lender, said these foreign investors either took over an NBFC by installing fictitious directors or offered huge incentives for small NBFCs to use. their loan books for loans.

“Typically, these investors offered a first default guarantee (FLDG) of 80% while the industry trend was 10%. Such a high guarantee for defaults, lucrative fees and a growing market have meant that many small NBFCs have joined in and lending practices have spiraled out of control, ”Ekambaram said.

In banking jargon, FLDG is offered to a small partner or co-lender to cover initial defaults. For example, in a business correspondent model, banks used to provide an FLDG of 6% to 7% to insulate partners against any default. However, an 80% guarantee means that a small NBFC may never suffer a loss, forcing them to compromise on underwriting standards.

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Global experience

Ekambaram says India is not the first market where these deep-pocketed investors have breached.

“About a year earlier, the story was similar in Indonesia. When the regulatory heat rose there, they came to India. It was China before Indonesia. So in a sense we’re only a few years behind. If you ask people where these investors are now, some say they settled in Bangladesh and Mexico, ”he said.

Industry leaders say the task force’s recommendations are essential when the industry seeks direction. Groups like DLAI and individual companies like MoneyTap, Kreditbee will also give their own suggestions to the RBI before the December 31 deadline.

Anurag Jain, co-founder of KredX, a bill discounting platform for micro and small businesses, said the recommendations include ensuring easy availability of credit at the right price while complying with all regulations established by RBI.

“One thing is clear, you cannot be a credit institution if you do not comply with regulations, do not have a risk management system in place or if you do not have sufficient capital. But yes, there is a need to deepen the credit base and digital lending companies can do the same as microfinance companies, but just like them we will have to follow the regulations, ”said Jain, who is also a member. by DLAI.

The task force report could form the crux of central bank regulation of digital lending going forward. As neo-banks and digital platforms thrive, these entities can only expect more regulatory attention, which could mean a growth rate below the desired growth rate, but a stable track in the long run. .

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