The Reserve Bank of India has come out with two pronouncements recently on digital lending guidelines and outsourcing of recovery agents by regulated entities (read financial lenders) to ensure orderly growth and protect borrowers in this space. The digital loan product is a creation of mobile and web-based application where the entire life cycle that is - the lead generation, customer onboarding, credit underwriting, document sign up, disbursal and servicing are conducted electronically on digital platform through various algorithms, Artificial Intelligence (AI) and embedded Application Programming Interface (APIs). While this is definitely a technological innovation to increase productivity, efficiency and competitiveness, there have been unintended consequences on account of greater reliance on third-party lending service providers (LSPs) mis-selling to the unsuspecting customers, concerns over breach of data privacy, unethical business conduct and illegitimate operations.
In January 2021, when the pandemic was still in rage, RBI set up a working group on digital lending. The group invited inputs, views from various stakeholders like financial institutions, government bodies, law enforcing agencies, fintech companies and above all, the borrowers.
To put things in the right perspective, during the pandemic, the unbridled growth of digital lending to serve the retail credit hungry individuals, have been susceptible to a host of conduct and governance issues. The WG’s recommendations are likely to set the new contour of RBI guidelines and address these issues going ahead.
Under the new set of guidelines, the lending business can be carried out only by entities that are either regulated by the apex bank or by entities permitted to do so under any other law. Moreover, a Regulated Entity (RE) must ensure that loan servicing and repayments are executed directly from / to its bank account without any third party pass through or pool account. While disbursing the payment to be directly affected to the declared bank account of the borrower.
The fees or charges payable to the third party lending service provider for the service provided by them has been one more bone of contention which also came under the WG’s scrutiny. In the new guideline, the central bank categorically restricted collection of any fee / charge from the borrowers. Any such payments will be paid directly by the RE.
Another major takeaway from the WG’s recommendations is a mandatory offering of a “cooling off period” by the RE during which the borrower can exit digital loans by paying the principal and proportionate cost without paying any penalty. This is akin to the “free look period” that comes with every life policy and certain health insurance under Insurance Regulatory & Development Act (1999).
The apex bank also pushed forward a greater transparency and disclosure of the borrowers and a standardised “key fact statement” which must be provided to the borrowers clearly stating all associated costs, interest rate, discount, agency fees and the Annual Percentage Rate (APR) that is charged for borrowing a loan. An APR includes processing fees, penalties and all other charges that are applicable to the loan throughout its life. Automatic increase of credit limit without explicit consent of the borrower is also made prohibitive under the new rules.
Large scale data requirements and its processing through technology is the backbone of the digital lending ecosystem. RBI said that applications should collect data on need basis with prior explicit consent of the borrowers and maintain clear audit trails of its use. It should also offer options to negate earlier consent given by a borrower. This is a very positive step in upholding data security which in today’s context is an issue which can not be downplayed.
The REs must also take up the periodic reporting to credit rating companies about the digital loans irrespective of its nature so that the repository database is updated for future referrals and its algorithm throws up a dependable credit score.
Creation of a self-regulated body of the digital lenders and an independent body styled as Digital India Trust Agency which will ensure only authorised and trusted lending apps are used by customers have also found a mention in the Report.
While some of the WG’s recommendations are expected to get immediately implemented others like First Loss Default Guarantee (FLDG) are still under RBI’s examination as this has got a wider ramification for the ecosystem.
Overall, the entire effort of the WG is focussed on bringing in a transparency in the digital lending space which is long awaited.
The circular on outsourcing of recovery agents by REs issued on August 12,2022 is also a well timed one. In the lending space it has been observed that the agents employed by REs have been deviating from the extant instructions governing the outsourcing of financial services as they resort to intimidation or harassment of any kind, either verbal or physical, against any person in their debt collection efforts, including acts intended to humiliate publicly or intrude upon the privacy of the debtors' family members, referees and friends, sending inappropriate messages either on mobile or through social media, making threatening and/ or anonymous calls, persistently. Digital lending being largely faceless and distributed over a large geography, such acts of recovery agents have been rampant. So some kind of control is required to bring in a discipline in the system.
To conclude, the world has been talking about Bank 4.00 since 2014 indicating the arrival of the 4th generation transformation of financial services comprising FinTech, online/ mobile banking, virtual global market and questioning the sustainability of conventional banking. In his book “Bank 4.0”, published in 2018, Brett King carried the sub-title “Banking Everywhere, Never at a Bank” which talked about this digital transformation in financial services around the globe. India is a part of that transformation which RBI and other institutions should manage steadily.
Saptarshi Roy Bardhan, works as DGM Operations at Peerless Financial Services Limited.
Views expressed are his personal