RBI'S DIGITAL LENDING RULES – A STEP IN THE RIGHT DIRECTIONAccording to the RBI, the Guidelines have been designed to protect borrowers and end regulatory arbitrage. While borrowers may perceive this as a welcome change, these Guidelines will certainly have an impact on the thriving Indian fintech industry requiring some of them to tweak their business models The Reserve Bank of India...
RBI'S DIGITAL LENDING RULES – A STEP IN THE RIGHT DIRECTION
According to the RBI, the Guidelines have been designed to protect borrowers and end regulatory arbitrage. While borrowers may perceive this as a welcome change, these Guidelines will certainly have an impact on the thriving Indian fintech industry requiring some of them to tweak their business models
The Reserve Bank of India ("RBI") notified the Guidelines on Digital Lending ("Guidelines") on 2 September 2022. The Guidelines are a result of the Recommendations of the Working Group on Digital Lending, which were released by the RBI on 10 August 2022.
The Guidelines are applicable to existing as well as fresh customers of regulated entities from the date of their notification. Regulated entities ("REs") are entities that are regulated by the RBI or otherwise permitted to carry on lending under any other law. For a smooth transition, REs have been provided a time frame till 30 November 2022 to put in place adequate systems and processes to be compliant with the Guidelines.
According to the RBI, the Guidelines have been designed to protect borrowers and end regulatory arbitrage. While borrowers may perceive this as a welcome change, these Guidelines will certainly have an impact on the thriving Indian fintech industry requiring some of them to tweak their business models. In this article. we look at the general impact of these Guidelines on borrowers and REs.
PROTECTION TO BORROWERS
1. Customer Data Protection: The Guidelines specifically prohibit digital lending applications ("DLAs") from accessing mobile phone resources such as media, contact lists, call logs of the borrower except for the one-time KYC requirement.
2. Data Storage: Borrowers must be informed about the storage of data and the type of data which is being stored.
3. Key Fact Statement: Borrowers are to be provided with a key fact statement at the time of disbursement of the loans and before the execution of contracts in a standardized format. Some of the details which the key fact statement must contain are:
• all-inclusive cost of digital loans;
• rate of penal interest or charges levied;
• annual percentage rate;
• recovery mechanism;
• details of grievance officer; and
• cooling-off period.
4. LSP Charges – Borrowers do not have to bear any charges which the lending service providers ("LSP") might charge. These are to be borne by the REs.
5. Cooling Off / Lock-In Period: Borrowers have been provided with a cooling-off / lock-in period, by which they are given time to decide if they wish to discontinue after availing the facility. The cooling-off period provided is 3 (three) days for a loan tenor of 7 (seven) days or more and 1 (one) day for a loan tenor of less than 7 (seven) days.
6. Key Information Post Disbursement: On successful execution of the loan transaction, the borrower must be sent information including but not limited to the key information statement, a summary of the loan product, sanction letter and terms and conditions to their verified email ID and via SMS.
7. Publication by REs: REs must publish the list of the DLAs and LSPs engaged by them on their website.
8. Credit Limit Increase: There cannot be an automatic increase in the credit limit unless explicit consent is taken from the borrower on record.
ISSUES FOR REs & LSPs
While the Guidelines will lead to an increase in compliances and risk management controls for fin-techs, on the whole they seem to be a step in the right direction to regulate an otherwise unregulated and growing sector.
1. Flow of Funds: Loan disbursement under the Guidelines must happen directly from the lender's account to the borrower's account. The funds cannot be routed through the LSP's or other third-party service provider's account to the borrower. Exceptions have been made for co-lending arrangements governed by existing regulations, disbursals covered exclusively under statutory or regulatory mandates of the RBI or any other regulator and for disbursals for specific end uses. Since this would not cover digital payment methods, some LSPs may need to change their business models to accommodate this requirement.
2. Deferred Payment Products: Buy Now Pay Later ("BNPL") lenders might face higher scrutiny because they would now have to report every loan to Credit Information Companies (CICs) irrespective of the nature or tenor of the loan. Also, the requirement for disclosing the annual percentage rate upfront in the key fact statement could hamper the fast-growing BNPL lender industry since this is contrary to the current practice of certain BNPL lenders who tend to charge a flat rate fee for small, short-term loans.
3. First Loss Default Guarantee ("FLDG"): This has been one of the most talked about and highly debated issues stemming from the Guidelines. A FLDG is used widely by digital lenders where the LSP compensates the RE for a certain agreed percentage of the loan portfolio if the borrower defaults. It is basically an underwriting of the loan by the LSP. The "skin in the game" contention has been argued extensively here, stating that FLDGs enable LSPs to have skin in the game, thereby enabling them to ensure that they screen borrowers meticulously. This avoids defaults and protects the LSPs and the REs to the extent of the FLDG provided. The Guidelines have not been very clear on FLDGs. They simply state that REs must adhere to RBIs directions on securitisation of standard assets especially in relation to synthetic securitisation. Clarifications from the RBI are expected on this issue.
4. Cooling-off Period: While a cooling-off period gives a borrower the opportunity to exit without any repercussions, this aspect could be misused by a borrower who is shopping for loans with better terms.
5. Monitoring Data Policy: The REs in addition to monitoring their own data policies, have to also monitor the data policies of their LSPs and ensure that there is no misuse of such data by the DLAs and the LSPs. This might create an unnecessary hassle on the REs to regulate the data policies of each of their LSPs.
As evident from the above, there are certainly a lot of positives as far as these Guidelines are concerned. While the Guidelines will lead to an increase in compliances and risk management controls for fin-techs, on the whole they seem to be a step in the right direction to regulate an otherwise unregulated and growing sector. While there may be some hiccups in the short-term, in the long run these Guidelines will benefit not just borrowers but fin-techs as well.
Natasha’s practice focusses on mergers and acquisitions, divestments, joint ventures, structured finance and general corporate law. She regularly advises on large cross-borders M&As as well as on secured and unsecured credit facilities with a particular focus on non-convertible debenture and bond issues. Her clients include large domestic companies, multinational corporations, commercial and investment banks, financial institutions, private equity sponsors and borrowers. She works closely with her clients, who value her solution-oriented approach in helping them achieve their goals in a timely and efficient manner.
By: - Harsh Desai
Harsh focusses on mergers and acquisitions, debt financing and general corporate matters. His experience includes structuring transactions pertaining to the sale of equity, secured facilities focusing on non-convertible debentures and bond issuances, assignment of large loan portfolios as well as general corporate advisory work.