Regulatory Policy Approach to Digital Lending
From a regulatory policy outlook, the FinTech landscape can be divided into two spheres, viz. Incrementalism FinTech and Futuristic FinTech8. The former uses new data, algorithm, software applications to perform traditional financial service provisions without significant change in the underlying functions. The latter disrupts the financial markets in manners that effectively supersede regulation. The work of the WG is generally centered around the first sphere of FinTech which is under current focus.
Extant Indian Legal Regimes
In India, lending activity, online or otherwise, is governed by following laws, in addition to various regulatory instructions issued by RBI for its regulated entities:
- Banking Regulation (BR) Act, 1949: Business of banking as defined in Section5(b) of the BR Act, includes providing loans inter alia by a banking company, through online mode or otherwise. All banks (public and private sector) including small finance banks, regional rural banks and co-operative banks are required to get themselves registered with the Reserve Bank for undertaking digital lending.
- Reserve Bank of India (RBI) Act, 1934: Besides banks, NBFCs, complying with principal business criteria are required to be registered with RBI as per provisions of RBI Act. For this purpose, an NBFC is defined as a company registered under the Companies Act whose principal business is financial activity i.e. business of loans and advances, acquisition of shares/ stocks/ bonds/ debentures/ securities issued by Government or local authority or other marketable securities of a like nature, leasing, hire-purchase, insurance business, chit business. This does not include any institution whose principal business is agriculture activity, industrial activity, purchase or sale of any goods (other than securities) or providing any services and sale/ purchase/ construction of immovable property.
To obviate dual regulation, certain categories of NBFCs, regulated by other regulators, have been exempted from the requirement of registration with RBI, viz. Alternative investment fund companies/ merchant banking companies/ stock exchanges/ stock broking companies registered with SEBI, insurance companies registered with IRDAI, Nidhi companies/ mutual benefit companies under Companies Act, and chit companies under Chit Funds Act.
- Companies Act, 2013: Companies, which are not meeting principal business criteria for registration as an NBFC with RBI, can also undertake lending activities subject to applicable provisions of the Companies Act, 2013 such as Section 1869 of the Companies Act, 2013 which prescribes certain restrictions on the loan amount and minimum interest rate for such loans. Besides, there are nidhi companies/ mutual benefit companies which are permitted to receive deposits from and lending to their rembers as per provisions of Section 406 of the Companies Act, 2013 and ‘Nidhi Rules, 2014’.
- State Money Lenders Acts: The Constitution of India has conferred the power to legislate on matters relating to money lending and moneylenders to the States. Most of the states have their respective money lenders legislations in place (Annex D). Many of these are comprehensive legislations providing detailed and stringent provisions for regulation and supervision of the money lending business. These legislations contain provisions aimed at protecting the borrowers from malpractices of the moneylender. Some of the salient aspects of these laws are as below:
a)Registration requirement for carrying on the business of money lending in the State.
b)Maintaining and providing statements of accounts to the debtors.
c)Powers to prescribe maximum interest rate.
d)Penalties for carrying on business without licence and for intimidating the debtors or interfering with their day-to-day activities, including the cognizability of such offences.
e)Dispute resolution mechanism.
5 Chit Funds Act, 1982: Chit Fund companies are regulated under the Chit Funds Act, 1982, which is a Central Act, and is implemented by the State Governments. Those chit funds, which are registered under this Act, can legally carry on chit fund business which involves contributions by members in instalments by way of subscription to the chit and each member of the chit receives the chit amount by rotation.
Global Regulatory Practices
- A comparative study of global regulatory practices in respect of ‘FinTech platform financing’ has been undertaken by Bank for International Settlements (BIS) in its publication released in August, 2020 . FinTech platform financing has been defined as a mechanism for intermediating financing over the internet using an electronic platform. However, this does not include banks, for which this activity has been separately classified as digital banking. FinTech platform financing is further bifurcated under following sub-categories:
(i) FinTech balance sheet lending
2 Most jurisdictions do not have any specific regulatory framework for FinTech balance sheet lending and it is governed by regulations applicable to other non-bank lending institutions as described below:
(i) Banking license
(ii) Non-bank license
(iii) No license requirement
The Case for Regulatory/ Supervisory Review in India
In recent times, technological innovations have brought about growth in digital financial services, including digital lending, at exponential rate. While the regulator-led developments in India, such as that in payment space, come with a basic regulatory perimeter around it ab initio, market-led innovations always reveal certain initial regulatory and enforcement lags which need to be verged upon. Globally, in digital lending, an ex-post approach is preferred to an ex-ante approach for a more proportionate intervention, which supports both innovation and competition. The WG identified cases for regulatory/ supervisory interpositions in three areas of digital financial services. While the current section deals with regulations around digital financial services, the following two sections deal with technology and consumer protection issues respectively.
1 Regulatory Perimeter
The assumption that because something is technologically possible, it should be allowed, is flawed and needs to be challenged: the law or regulation cannot just be wished away13 . Lending activity, whether online or otherwise, by any legitimate lender is governed by the respective applicable legislation. Apart from these legitimate lenders engaged in balance sheet lending organically, there are essentially two types of entities operating in the digital lending ecosystem which require attention:
(i) Lending Service Providers (LSPs
(ii) Fringe lenders
2 Rent-an-NBFC model by digital lenders
A synthetic structure enabling unregulated entities to lend without complying with prudential norms is through credit risk sharing arrangements by way of a “First Loss Default Guarantee (FLDG)” extended by the LSPs. Under this, the LSP provides certain credit enhancement features such as first loss guarantee up to a pre-decided percentage of loans generated by it. From the LSP’s perspective, offering FLDG acts as a demonstration of its under-writing skills whereas from the lender’s perspective, it ensures the platform’s skin in the business. For all practical purposes, credit risk is borne by the LSP without having to maintain any regulatory capital. The loan portfolio backed by FLDG is akin to off-balance sheet portfolio of the LSP wherein the nominal loans sit in the books of the lender without having to partake in any lending process. In some cases, the LSP,as a non-banking non-financial company (NBNC) may be undertaking a balance sheet.
Recommendations and Suggestions on Statutory-Regulatory Approach
Besides recommending concrete action points, the WG has also made several suggestions. The suggestions would require wider consultation with stakeholders and further examination by the regulators and government agencies.
1 Calibrating Existing Regulations
Being a responsible activity and use of digital channels amplifying its impact velocity, balance sheet lending through DLAs should be restricted to entities regulated and authorized by RBI or entities registered under any other law for specifically undertaking lending business, for which a suitable notification may be issued by appropriate authority .
(Recommendation – GoI)
Regulatory bodies for other authorized lenders such as credit societies, registered money lenders, non-banking non-finance companies (NBNCs), etc. may consider stipulating appropriate guidelines consistent/ proportionate with that of RBI, to prevent/ minimize environment of regulatory arbitrage in the businesses of digital lending.
(Suggestion – GoI)