By: Ananda Padmanaban Suresh & Arvind S Monipally
In the previous installment the complexities and challenges within the BNPL sector while emphasising the need for RBI intervention were examined. In this second and final part of the series, the authors shift their focus to FLDG regulations and RBI’s working group suggestion. To enhance the quality of discussion on this topic, the authors also provide their own suggestions for the improvement of the sector and also to strike a balance between regulation and innovation.
FLDG REGULATIONS AND EMBRACING ADAPTATION
RBI’s concerns regarding fintech companies were not limited to shadow credit card-like, PPI’s. BNPL service providers had started an arrangement with Regulated Entities wherein the former would source and underwrite the loan whereas the lending would be undertaken by the latter. This bank-fintech partnership model is also known as First Loss Default Guarantee (hereinafter ‘FLDG’). Within this arrangement, the arduous task of raising funds for fintech companies became noticeably less challenging. Since the credit risk is borne by the BNPL service providers without having to maintain any regulatory capital and in some cases with the guarantee to cover loss going up to 100%, RBI was dubious about the Loan Service Providers’ (hereinafter ‘LSPs’) ability to indemnify the loss. In addition to the inability to repay, RBI was also apprehensive of the prospect of issuing of riskier loans by LSPs and securitisation of the same without guarantee due to the unregulated underwriting of loans by fintech companies.
As a result, the central bank in its September 2022 guidelines, made it necessary that underwriting can only be done by regulated entities, therefore only permitting FLDGs between regulated entities. Additionally, RBI also introduced certain measures to control the flow of funds in existing loans and repayments, which includes prohibiting the extension of credit through e- wallets, overseeing the collection of fees by lending apps, enforcing mandatory reporting of all digital loans to credit bureaus, regulating the collection and utilization of customer data by fintech firms, and restricting the arrangements related to fraudulent lending.
This relationship between regulated entities and LSPs was put to an end for a very short period until RBI’s recent guidelines which allowed FLDGs with the total guarantee of the portfolio amount not exceeding 5%. The relaxation of restrictions not only enabled unregulated entities like BNPL companies to enter into FLDG arrangements but also provided an opportunity for new players in the fintech market to source loans without an NBFC license. Furthermore, the RBI also made it mandatory for fintech companies to declare details of all their DLGs (Default Loss Guarantee) with different regulated entities upfront. In addition to that, the regulated entities will also have FLDG policies that are board approved. The underlying principle of this regulatory framework is that only entities regulated by the RBI or those authorized by other applicable laws are allowed to engage in lending activities.
In addition, RBI has also recently proposed linking UPI with pre-sanctioned credit lines by banks. This will allow users to transfer through credit on a platform which earlier did not have such a feature. This development comes after the central bank had earlier allowed the linking of UPI with only RuPay credit cards. This feature now being expanded to other forms of credit lines, the scope of payments through credit as a source will increase and also strengthen UPI services being used to facilitate such payments. It will also reduce the number of cards one carries around for credit payments. Even though the proposal has no linkage to the BNPL model, this shows the RBI’s propensity to accommodate the model, which also functions on pre sanctioned credit lines, acknowledging its access to the underbanked in the country’s financial system with the right amount of regulations.
REACHING OUT TO THE UNDERBANKED: RBI WORKING GROUP SUGGESTIONS
Sachet, a portal established by the Reserve Bank of India, saw a significant increase in complaints against digital lending apps registering around 2562 complaints from January 2020 to March 2021. Most of these complaints were against lending apps promoted by entities not regulated by the RBI with a significant portion of these complaints relating to lending apps partnering with NBFCs.
In response, RBI put together a working group which published a report on Digital Lending on 13th January 2021, which took into cognizance these complaints and suggested recommendations. Some significant and notable suggestions included enforcing mandatory reporting of lending information to Credit Information Companies (CICs) by a broader group of lenders, including Digital Lending Applications (DLAs). These should be reported at shorter intervals and non- compliance with timely reporting should trigger restrictions on certain post-origination activities. This will address data marginalization, foster financial inclusion, and provide individuals with formal credit histories for increased access to financial services.
Additionally, a nodal independent body was to be set up in the form of Digital India Trust Agency (hereinafter ‘DIGITA’) fostering financial consumer protection. DIGITA should maintain a public register of verified apps with essential details on its website and unverified apps should be deemed unauthorized for law enforcement purposes. The Agency should monitor subsequent app changes for potential non-compliance and possess the authority to revoke the ‘verified’ status.
Moreover, DIGITA should provide continuous support for digital market intelligence concerning potentially harmful public apps interacting with the regulated financial system.
Furthermore, the central government should consider the implementation of a legislation designated “Banning of Unregulated Lending Activities (hereinafter ‘BULA’) Act” to regulate and authorize lending entities operating without proper oversight. The legislation should define “public lending” to ensure precise interpretation and enforcement. By enacting the BULA Act, the government can protect borrowers from unregulated lending practices and establish a safer lending environment. Currently, there may be a regulatory gap in the Fair Practices Code regarding explicit guidelines to curb reckless lending and predatory practices such as debt entrapment, debt treadmill, and debt criminalization. These practices involve strategies that make it difficult for borrowers to repay loans, leading to defaults and exploitative fee payments. To address these concerns, it is necessary to introduce specific guidelines within the Fair Practices Code that prohibit these predatory practices, protect borrowers from unfair practices, and promote responsible lending.
The recommendations outlined in the report have yet to be effectively put into practice. The proper implementation of these suggestions could lead to noticeable transformations in the functioning of the BNPL sector. This has the potential to bring benefits and garner satisfaction from both regulatory authorities and industry professionals.
SUGGESTIONS AND CONCLUSION
Financial inclusivity within the unbanked or the underbanked should be in a manner where they are protected from predatory pricing and usurious lending. Financial inclusion in its truest sense can only be achieved through financial literacy. Evils such as debt entrapment often come as a consequence of lack of understanding especially among the vulnerable and low-income groups who avail these services for instant credit. A remarkable approach in this regard can be seen in Philippines where a fintech start-up called Plentina educated its users through a gamification model on the introductory screen of their BNPL module.
BNPL has proved itself to be a necessary tool for Financial Inclusion, but there exists a need for the central bank to adopt a balanced approach in regulating the same. While an oversight mechanism is necessary, excessive regulation in this regard would result in the antithesis of this model, contradicting its purpose of inclusivity among the financially deprived. Relaxation in the use of FLDGs and the inclusion of pre-sanctioned credit cards within UPI show a positive change towards the RBI accommodating this deferred payment system. RBI, while coming out with the proposed legislation should adopt an all-inclusive approach where the interests of the service providers in dispersing credit as well as the consumers acquiring the same are accommodated. A regulated-consumer friendly approach coupled with ease-in-access of credit primarily to the underbanked and the unbanked can prove to make this deferred payment model effective and sustainable in achieving financial inclusivity.
(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 II, 7 November 2023<https://rmlnlulawreview.com/2023/11/07/the-changing-face-of-credit-bnpl-financial-inclusion-and-the-rbis-regulatory-dilemma-part-ii/>date of access.
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