By: Ananda Padmanaban Suresh & Arvind S Monipally
INTRODUCTION
Financial inclusion is the effort to provide access to affordable and suitable financial services to all, especially those in underserved communities, to promote economic empowerment and inclusive growth. Extension of financial services to the unbanked population to help them achieve their growth potential is the prime objective of financial inclusion. Credit extension is crucial in integrating the unbanked population into the financial system by enabling them to establish a credit history. This credit history becomes a valuable resource for banks and Non-Banking Financial Companies (hereinafter ‘NBFCs’) to evaluate creditworthiness before extending loans or credit. However, due to low financial literacy, many cannot access their first credit product, which in turn results in no reliable data in the form of credit history to assess whether a person can repay. However, the concept of credit penetration in India was relatively limited, and it struggled to resonate with a significant portion of the population until the advent of Buy Now Pay Later (hereinafter ‘BNPL’), the primary target of which are the unbanked and the underbanked, which shows a tendency to bring about a transformative change. The authors intend to provide a comprehensive analysis of the BNPL landscape in two installments. In this first installment, the authors delve into the challenges faced by the BNPL sector, the imperative need for RBI intervention, and a thorough examination of the regulatory measures implemented thus far.
BNPL: REVOLUTIONIZING CREDIT ACCESS FOR THE UNDERBANKED
BNPL is a form of short-term lending instrument offered by various lending institutions, including banks and NBFCs. It allows users to make deferred payments in installments without any additional charges. This digital lending service provides interest-free repayment periods typically ranging from 15 to 30 days. Within a short period, BNPL gained significant popularity in the Indian market, particularly in online marketplaces, where it accounted for 2.9% of global e-commerce transactions in 2021.
BNPL has emerged as an alternative credit option, especially for the financially underbanked. Unlike traditional banks, which rely on extensive credit evaluation processes, BNPL’s soft credit checks enable easy access to credit for the unbanked or underbanked. This is particularly due to simplified Know Your Customer (KYC) processes and less stringent credit history checks. Moreover, BNPL proved to be a successful model benefitting the consumers, service providers and merchants alike, with consumers obtaining an ease-in-access interest free credit option, service providers making profit through charges upon commission from the merchants and the merchants enjoying reduced cart abandonment rate.
CHALLENGES AND THE NEED FOR RBI INTERVENTION
However, the factors that contributed to the success of BNPL services among the low-income group are the same elements that led to its key challenges. BNPL services appeal to the digitally savvy young adults with modest incomes due to their simplified and diluted KYC process. This relaxed approach to KYC makes BNPL more accessible than traditional credit cards, which further makes consumers prone to risks related to identity theft, fraud, and money laundering.
Additionally, BNPL operates as a deferred payment model, claiming to provide interest-free loans to consumers. This classification excludes BNPL services from the regulatory coverage of the RBI as it does not fall under credit and is denoted as ‘deferred payment’ in their balance sheet. Consequently, BNPL providers are not required to report these credit lines to credit bureaus. This lack of transparency hinders consumers’ ability to build their credit history and understand their complete debt picture. However, defaults on BNPL loans are reported, negatively affecting the credit scores of users and reducing their chances of obtaining credit in the future.
It’s ease of access and delayed payment have a tendency to attract financially illiterate, vulnerable, and low-income individuals, which can lead them to overextend themselves and make purchases beyond their means, resulting in a problematic repayment situation that exposes them to over-indebtedness. Furthermore, the misleading nature of zero-interest credit lines and seamless user experiences provided by BNPL services can lull consumers into a false sense of security. However, upon default, they are hit with unexpected penalties and default fees, further exacerbating the debt spiral. This has led to growing delinquency rates on BNPL apps, with Afterpay’s delinquency rate reaching as high as 4.1%, compared to the relatively steady delinquencies of credit cards at 1.4%.
The challenges associated with BNPL services, such as the lack of proper KYC implementation, insufficient transparency in reporting to credit bureaus, late fees leading to over-indebtedness, and the impact on credit history, have warranted intervention from the RBI.
REGULATORY INTERVENTIONS IN BNPL
The possibility of growing risk associated with BNPL coupled with it being the fastest-growing online payment method did not take much time to warrant RBI’s attention. This also can be attributed to Fintech companies offering credit lines through digital wallets linked to prepaid payment instruments (hereinafter ‘PPIs’) which operate like shadow credit cards. PPIs are issued by banks and non-bank entities with prior authorisation from the RBI, following the guidelines outlined in the Payments and Settlements Act, 2007. While PPIs were not originally intended for credit, fintech platforms strategically utilised them to bypass RBI regulations and provide convenient and fast approval processes for BNPL services.
Even though these were not by-default credit cards, their interest rates, repayment schedules, etc., resembled that of credit cards and were issued without complying with the credit card directions under the guise of a payment wallet. Since banks are the only authority that is allowed to issue credit cards in the country that too under a strict regulatory framework and with the NBFC’s requiring special authorisation from the RBI to do the same, the central bank brought out a directive in June 2022. According to the directive, non-banks could no longer load prepaid instruments using credit lines. Consequently, the credit card like experience that the BNPL users had enjoyed ended abruptly for the time being with startups like Slice not allowing their customers to use it anymore.
Building on the foundation that has been laid out, in the second part of this series, the authors will delve into the FLDG regulations, and furthermore will discuss the regulator’s working group suggestion and offer their own recommendations to enhance the landscape further.
(Ananda Padmanaban Suresh and Arvind S Monipally are law undergraduates at The National University of Advanced Legal Studies, Kochi. The authors may be contacted via mail at anandapadmanabansuresh@gmail.com or arvindsm3102@gmail.com)
Cite as: Ananda Padmanaban Suresh and Arvind S Monipally, The Changing Face of Credit: BNPL, Financial Inclusion and the RBI’s Regulatory Dilemma – Part I, 7 November 2023<https://rmlnlulawreview.com/2023/11/07/the-changing-face-of-credit-bnpl-financial-inclusion-and-the-rbis-regulatory-dilemma-part-i/>date of access.
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