Digital Lending

The Reserve Bank of India (RBI) recently issued the first set of guidelines for digital lending in order to combat illegal activities by certain players. This is in response to the recommendation of the Working Group on Digital Lending (WGDL), which recently submitted its report.

What is ‘Digital Lending’?

• Digital lending is the process of availing credit online.
• It involves lending through web platforms or mobile apps, utilising technology in customer acquisition, credit assessment, loan approval, disbursement, recovery and associated customer service.
• Its increased popularity amongst new-age lenders can be attributed to expanding smartphone penetration, credit range flexibility and speedy online transactions.
• It includes products like Buy Now, Pay Later (BNPL), which is a financing option (or simply a short-term loan product).
  • • It allows one to buy a product or avail a service without having to worry about paying for it immediately.
• There are many gaps that are existent in this model of lending. For example,
  • • There have been instances of unethical behaviour, such as unauthorised lenders providing credit to customers without any collateral, charging exorbitant interest rates and unethical recovery practices.
    • Unrestricted engagement of third parties, mis-selling, breach of data privacy, unfair business conduct.

Formation of Working Group on Digital Lending (WGDL) –

• The RBI constituted a WGDL in 2021 to evaluate digital lending activities and assess the standards of outsourced digital lending activities of RBI regulated entities.
• The current digital lending norms, issued by RBI, are based on the recommendation of this group.

Key highlights of the new digital lending norms –

• The RBI has classified the universe of digital lenders into three groups —
  • • Entities regulated by the RBI and permitted to carry out lending business;
    • Entities authorised to carry out lending as per other statutory or regulatory provisions but not regulated by RBI, and
    • Entities lending outside the purview of any statutory or regulatory provisions.
• The latest regulatory framework is focussed on the digital lending ecosystem of RBI’s regulated entities (REs) and the Lending Service Providers (LSPs) engaged by them to extend credit facilitation services.
  • • REs are entities regulated by RBI, such as a bank or a non-banking financial company (NBFC).
    • LSP is an agent of a balance sheet lender who carries out one or more of the lender’s functions in customer acquisition, pricing support, etc.
      • Balance sheet lender undertakes balance sheet lending/portfolio lending – where the platform entity provides a loan directly to a consumer or business borrower.
      • It is different from peer-to-peer lending in which the platform does not lend to the borrower. The platform links borrowers with investors.
      • On the other hand, in balance sheet lending, the P2P platform (or another type of balance sheet lender) assumes the risk itself.
    • The majority of LSPs are non-recognised and thus unregulated by the RBI or others, resulting in the majority of digital loans emanating from them.
• According to the new rules, all loan disbursements and repayments must be made between the borrower’s bank account and the REs, with no pass-through or pool account of the LSPs or any third party.
• The new rules require that any fees or charges owed to LSPs during the credit intermediation process be paid directly by the bank or NBFC rather than the borrower.
• A standardised Key Fact Statement (KFS) must be provided to the borrower before executing the loan contract.
  • • It also includes a cooling-off period in the loan contract, during which borrowers can exit digital loans by paying the principal and the proportionate annual percentage rate without penalty.
• All-inclusive cost of digital loans in the form of Annual Percentage Rate is required to be disclosed to the borrowers.
• The new norm prohibits any automatic increase in credit limit without the explicit consent of the borrower.
• Banks must ensure that they, as well as the LSPs they employ, have a suitable nodal grievance redressal officer to deal with digital lending-related complaints.
  • • Current guidelines allow borrowers to file a complaint with the RBI’s Integrated Ombudsman Scheme if their complaint is not resolved by the bank within 30 days.