By Shilpa Mankar Ahluwalia
Certain âbad practicesâ in the digital lending ecosystem related to unauthorized use of data and intrusive retrieval practices prompted RBI to form a digital lending task force which recently released its report. While loans in India are tightly regulated, digital loans are not. The report highlights the fact that the digital lending industry has evolved to such an extent that there is now a regulatory vacuum that must be filled with laws that address issues specific to digital lending. A central theme has been consumer protection.
Only licensed players can lend: The report presents a clear roadmap on how to regulate the sector. The market can be broadly classified into two groups of players: authorized entities (mainly NBFCs) which have the regulatory capacity to lend on their balance sheets; and unregulated technology intermediaries who help with customer acquisition, credit risk analysis and the development of customized credit solutions. The report highlights the “lease of an NBFC” or the off-balance sheet loan models as an issue of concern. Several digital loan products today are based on models in which unlicensed entities provide some form of credit support, such as first-default loan guarantees and assume some of the credit risk of the loan without having to go. comply with regulations that would generally apply to lenders (such as regulatory capital allocation and exposure standards). He asserts that all loans (such as many of the products buy now pay later) should be made only “on balance sheet” by approved entities. This will be a game-changer for the digital lending ecosystem and trigger a “reinvention” of several loan products on the underwriting model by a license-free technology platform that essentially gives approved lenders the confidence to lend to loan. some of these segments.
Credit risk analysis: One of the main strengths of digital lending apps is that they use alternative datasets to generate credit scores and make credit decisions. While credit scoring by bureaus based on historical financial data is a highly regulated activity, data analysis and credit scoring by digital lending applications is largely unregulated. Several loan models rely on AI and algorithms to analyze and assess credit risk. Such algorithms, the report notes, should disclose their underlying rationale, incorporate ethical AI, and be auditable. This will not only give consumers access to their credit underwriting data and analysis, but will also require technology platforms to disclose and defend credit underwriting strategies.
Are we moving towards interest rate caps: Transparency of processes and prices should be mandatory in the interest of consumer protection. It is in this context that the report discusses the concept of an Annual Percentage Rate (APR) which includes interest rates and all other costs associated with a loan to avoid overcharging through âhidden costsâ. . The digital lending industry has expressed concern about possible interest rate regulation. The report acknowledges that the RBI has generally tried to stay away from interest rate caps, which may tend to exclude certain sections of high-risk borrowers. However, he speaks of the “need to introduce” interest rate regulation. In general, price transparency is a preferred method over interest rate regulation, which could have serious consequences
implications for the sector.
SRO will play a central role: The constitution of a self-regulatory body (SRO) among digital credit players is a key recommendation of the report. This is probably related to the fact that in an industry where technological change is rapid, an SRO is well placed to understand the risks of new business models, develop codes of good practice aligned with market practices, and help with smooth application. The report notes that the SRO should develop codes of conduct for all participants, develop standardized contracts, create a model to calculate the APR, prescribe and monitor technological standards that ensure the security of mobile applications, and institutionalize a recourse mechanism for consumers.
Separate the good from the bad: One of the most difficult aspects of regulating the digital lending industry will be how to effectively screen illegal digital lending applications. Partnerships with app stores will be essential. The RBI may not be equipped to monitor this, which is probably why the report recommended setting up a nodal agency to verify a digital loan application before it could go live. Processing delays, however, could be a serious risk with this approach.
After that ?
The industry will have to “wait and watch” to see what form the final law will take, but the report provides useful information on the types of areas that may be regulated. Tech intermediaries and small platforms are likely to be more affected than large licensed NBFC players. As compliance costs increase and some business models become unsustainable, the industry may experience some consolidation. The new regulatory framework will certainly improve transparency and disclosure standards, prevent unfair lending practices and give borrowers greater control over their data. The key question will be whether the law is able to strike the right balance between promoting innovation and protecting consumer interests.
The author is Partner & Head (Fintech), Shardul Amarchand Mangaldas & Co
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