Taming The Loan Wolf: Why The RBI Is Looking To Regulate Digital Lending

The Reserve Bank of India (RBI) had set up a working group to study the digital lending space, as the RBI looks to regulate the space.

Another report has highlighted that India has the highest rate of fintech adoption, which stands at 87 per cent as of 2020. Consequently, loans facilitated through digital platforms have grown at an exponential pace as well.

As a result, the central bank is looking to impose stronger restrictions on the space.

The Growth of Digital Lending

The share of digital lending in the total disbursal pie has increased over the years with greater technological adoption. Non-banking financial companies (NBFCs) have grown their digital lending books to 11 per cent of disbursals for FY20.

In contrast, for scheduled commercial banks, the digital loans from banks stand at 1.79 per cent of their loan books. However, the share of such loans in the total loan volumes is much higher. This indicates that these are small-value loans used mainly for consumption.

Total loans disbursed through digital channels grew from Rs 11,671 crore in FY17 to Rs 1,41,821 crore in FY20.

NBFCs have grown their share in digital lending from around 6.3 per cent to 30.3 per cent. In contrast, banks have lost ground quickly, with their market share decreasing from 89 per cent to 55 per cent.

NBFCs and private banks are quite heavily dependent on third-party digital lending apps to source loans. In contrast, public sector banks and foreign banks have disbursed most of their loans through their own digital offerings.

Digital lending apps acts as sales agents for partner NBFCs or banks. Most digital lending apps do not loan out money on their own account. They facilitate loans for customers through financial partners (banks and NBFCs), and receive commissions in exchange.

The Problems

According to the RBI report, there are around 1,100 lending apps across 81 application stores in India. Of these, 600 are illegal apps. In addition, the numbers of complaints against digital lending apps have grown exponentially.

Between February and November 2020, the total number of complaints stood at 218. But in December 2020 alone, the total complaints rose to 919.

Similarly, between January and March 2021, the total number of complaints stood at 1,303.

Most of these complaints have been registered against the unauthorised apps available on the app stores. As a result, in December 2020, the RBI asked the public to file complaints against such unauthorised apps.

Further, the report also raised issues with the First Loss Default Guarantee (FLDG) model. Under FLDG, lending service providers, the entities that operate digital apps, pay the partner bank or NBFC as pre-determined part of the loan amount if the borrower defaults.

According to reports, with growing competition among fintech companies to partner with premium lenders, they have agreed to pay high FLDG rates.

Therefore, effectively, they are underwriting the loans, and holding the credit risk for the loans. And these companies are doing so without having to follow the regulatory capital guidelines that NBFCs and banks have to follow.

The RBI has compared such guarantees to an “off balance sheet portfolio” held by such lending service providers, that are ultimately leading to a risk build-up on the platforms.

Further, according to reports, some lending service providers have been lending on their own account, though such lending is unauthorised. The growth in the buy-now-pay-later schemes has come with its share of problems, as a large percentage of the loans could turn into NPAs.

According to a report, LazyPay has seen gross non-performing assets of up to 19 per cent.

The permissions required by fintech apps are another point of concern for regulators. In the past, there have been complaints about lending apps collect user data, and using it to harass borrowers.

“Several consumer complaints were analysed that cite instances of digital lenders or digital lending apps misusing the high-risk data collected. For example, certain lending apps are collecting users’ entire phone contacts, media, gallery, etc. and using it to harass borrowers and their contacts in case of delays in repayment,” said the RBI report.

What Has The RBI Suggested?

Consequently, the RBI has suggested several measures to regulate the space, and increase transparency. These suggestions include setting up a nodal agency to supervise and verify the credentials of digital lenders, given the large number of illegal digital lenders.

The companies would also have to make their data storage policies publicly available, thereby increasing transparency. In addition, only regulated entities would be authorised to lend on their own balance sheets or enter into FLDG transactions with lending partners.

The RBI appears to be reining in the digital lending segment before it becomes too large. China, for instance, saw peer-to-peer loans (P2P) and buy-now-pay-later schemes becoming incredibly large before regulators cracked down on the space.

The RBI believes that digital lending is here to stay, and hence, is looking to regulate it better. While alternative lending products contribute to a small percentage of overall loans, the unregulated growth of such financial products could create a ticking time bomb.

“Currently, the share of digital lending in overall credit is too small to have any significant impact on financial stability. However, given their ease of scalability, it may assume greater significance sooner than later. It is, therefore, pertinent to address existing and potential risks while leveraging on the benefits of emerging FinTechs,” the report said.