Regulating digital lending to help grow space and protect consumer interests

The development of some basic technology standards to offer digital lending solutions, as well as the requirement that all data be stored on servers located in India and an appropriate consent mechanism for data collection and use, is a welcome step.

By Sanjay Doshi and Vinay Narkar

the RBI-the working group formed on digital lending recommends, in its recently submitted report, the creation of an independent body called Digital india Trust Agency (DIGITA) to verify digital lending applications (DLA) and ensure ongoing monitoring of audited DLAs as well as the establishment of a self-regulatory body (SRO) covering participants in the digital lending ecosystem to Identify bogus / unauthorized lending apps or websites using the created whitelist.

The establishment of an SRO is a step forward and the publication of a list of loan service providers (LSPs) engaged by regulated entities (REs) on their website via an SRO code of conduct will bring better transparency from the customer’s point of view. But expectations about the effectiveness of SRO regulatory institutions may be in moderate territory. While the public registry of “verified” applications maintained by DIGITA is a welcome idea, the Need of the Hour is a framework that describes the triggers when approvals are needed once DLAs have reached a certain threshold level so that entry is not restricted and, at the same time, scaling is closely monitored.

Recommendations restricting balance sheet lending through DLAs to REs and bans on synthetic structures aim to end the practice of the “rent-an-NBFC” model. Shutting down the First Default Guarantee (FLDG) model may slow the growth of digital lending, especially in small and mid-sized segments, as traditional banks / NBFCs may not take the required risks in the absence of FLDG. This would impact fintechs or pure lending LSPs, as they will need an NBFC license if the FLDG model is discontinued.

The ‘buy now, pay later’ (BNPL) treatment on loans (so far excluded), except those offered by sellers as merchant credit, will lead to better reporting to credit bureaus. credit. The BNPL segment, especially the very low priced BNPL, will be impacted given the higher operational costs of the KYC, CKYC and office reports involved, especially for REs that onboard new clients through BNPL. More clarity is required on the “definition of credit” for companies that are not regulated by the RBI but offer BNPL as deferred payments through their balance sheet.

The development of some basic technology standards to offer digital lending solutions, as well as the requirement that all data be stored on servers located in India and an appropriate consent mechanism for data collection and use, is a welcome step. This would allow some of the cloud platform providers who do not currently have data centers in India to install them here in order to serve the customers.

In addition, the requirement that the rationale for algorithmic features used in digital lending must be documented to make it explainable will allow for more transparency and audit trails, thereby minimizing the unfair practices that some DLAs use.

In order to protect the interests of consumers, the recommendation of the Task Force on Standardization of Fact Reporting will facilitate transparency and allow comparability for the borrower. But the initial disclosure of the annual percentage rate may not work for all products, especially payday loans or short-term loans.

Other recommendations, such as regulating unsolicited commercial communications for digital loans under a code of conduct put in place by the proposed SRO, will prevent coercion and abusive sales; this will prevent customers from purchasing programs with misguided communication strategies.

Maintaining a “negative list” of LSPs will allow REs and customers to identify fraudulent DLAs. But to ensure successful execution and use of such a list, it needs to be data-rich and match the questionable companies that later pop up with information from the existing list.

The working group suggested many other measures on reporting, payment and settlement systems, storage of biometric data, simplification of digital products, governance, etc., to ensure financial stability, integrity of the market and consumer protection in the objectives of financial regulation in comparison to create a level playing field.

In the short term, some of the measures may be restrictive and impact or even slow the growth of digital credit, particularly in the small / medium note segment. It will also impact installation, technology, compliance and operating costs for digital lending players. Companies using alternative channels or pseudo-finance products like BNPL will need to revise the design of their products.

In addition, privacy and data protection laws, clarity of outsourcing guidelines, transparency in product design, ability to conduct audit trails on the AI-based underwriting algorithm / ML will provide much needed oversight and governance to the segment.

Overall, the recommendations will certainly provide the required regulatory oversight, help build confidence in digital lending, and provide more transparency.

Doshi is Partner and Head, Financial Services Advisory, KPMG in India; Narkar is partner, KPMG in India

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