On Digital Lending – RBI should step up efforts to control illegal loan apps

Source: The post on Digital Lending is based on the article “RBI should step up efforts to control illegal loan apps” published in “Live mint” on 27th October 2023.

Syllabus: GS Paper 3 Indian Economy – RBI and banking system.

News: The article discusses the problem of illegal loan apps in India. The government and RBI are trying to find ways to regulate them. RBI has proposed some solutions but hasn’t implemented them all. Blockchain technology can help track valid lending partnerships.

What is digital lending?

Digital Lending refers to lending through web platforms or mobile apps by use of technology.

It utilizes automated technologies and algorithms for customer acquisition, credit evaluation, decision making, authentication, disbursements and recovery.

Not only does it lower costs but also ensures speedy disbursal.

Source: Maharashtra Government.

Read here for more details: Digital lending and its regulation

What are the guidelines of RBI related to digital lending?

Digital Lending Definition: Even if some steps involve a physical interface, lending can still be categorized as ‘Digital Lending’.

Lending Service Provider (LSP): Service providers are only designated as LSPs when the transaction falls under ‘Digital Lending’.

Grievance Redressal: LSPs interacting with borrowers must have a Grievance Redressal Officer. REs, however, are responsible for resolving complaints tied to LSPs.

Credit Card EMI Programs: Specific EMI programs on credit cards don’t fall under Digital Lending Guidelines, but other credit card loans do.

Third-party Control: No third party, including LSPs, should control the flow of funds in lending transactions.

Payment Aggregators: LSPs under Digital Lending Guidelines shouldn’t handle funds. Pure Payment Aggregators are not under this scope.

Recovery for Delinquent Loans: For delinquent loans, cash recoveries bypass the direct repayment to RE’s bank account requirement.

Salary-based Repayments: Loans repaid by employers deducting from salaries are allowed.

How is India doing in digital finance overall?

Retail Payments Growth: India witnessed significant growth, with 16% of all global real-time payments in 2022 originating from the country.

Digital Lending Surge: The digital lending sector expanded rapidly, disbursing close to 73 million loans in 2022-23.

What’s the issue with digital loan apps?

1) Harmful Effects: A BBC documentary revealed that aggressive recovery tactics of these apps have been linked to at least 60 suicides.

2) Regulation Challenges: MeitY has proposed additional KYC-like procedures for banks and finance companies, but a holistic approach might be more effective.

3) RBI’s Role: Despite its nodal role in supervising digital finance, the RBI hasn’t been proactive in direct supervision. They proposed the Digital India Trust Agency but never implemented it.

4) App Store Burden: App stores, like Google Play, face the immense task of filtering out unauthorized lenders, with the potential for errors in the process.

5) Potential for Fraud: With many banks and NBFCs, there’s a vast scope for misrepresentation of lender-app partnerships. Simple KYC might not be enough to deter bad actors.

What should be done?

RBI’s Role and Measures:

a.Direct Oversight: The RBI should assert a direct role in supervising digital lending.

b.Standardized Proof: Mandate a clear, standardized proof-of-partnership between digital lenders and regulated entities (REs).

c.Blockchain Utilization: Implement blockchain technology to validate and secure proofs of partnership, with REs issuing and tracking certificates.

Broader Perspective: Include state-level institutions and other relevant entities in the regulation process.

Consumer Awareness: Promote public education about the risks associated with unauthorized loan apps and the importance of responsible borrowing.

Strengthen Institutional Mechanisms: Collaborate with relevant stakeholders like app stores and public bodies to enhance app authenticity and safety.

Question for practice:

Enumerate and explain the guidelines issued by the Reserve Bank of India (RBI) pertaining to digital lending. How do these guidelines aim to ensure consumer protection and maintain financial stability?