Regulating digital lending

Source: The post is based on an article “Regulating digital lending” published in the Business Standard on 12^th August 2022.

Syllabus: GS 2 – Government Policies and Interventions for Development in various sectors and issues arising out of their Design and Implementation.

Relevance: Digital Lending Framework in India

News: The Reserve Bank of India (RBI) has published the first set of norms to regulate digital lending in India. Norms are based on the recommendations of a working group that was set up In January 2021.

Needs for regulation on digital lending

At present, digital lending is a nascent segment in the Indian financial sector.

There are anecdotal allegations of many frauds in this segment in India. Therefore, actions must be taken to protect citizens from such frauds.

The digital lenders are finding it hard to sell such products to digitally unaware customers who don’t understand the implications and fine print.

The central bank is concerned about the possibility of widespread defaults in this segment and cascading effects.

New Set of Norms

The RBI has created three buckets for entities in the digital loans market: (1) entities directly regulated by the RBI, (2) entities not regulated by the RBI but authorized to carry out lending in accordance with other provisions, and (3) entities involved in digital lending while being outside the purview of any regulations.

Set of new norms for the digital loan market

This market works on the basis of digital entities known as Lending Service Providers (LSP). These LSP act as intermediaries to arrange personal loans between lender and borrower. The loans are provided by a regulated entity, such as a bank.

In such cases, loan disbursements and repayments must be executed by direct transfers between the account of the borrower and the regulated entity providing the loan.

In this, any charges payable to the LSP in intermediation are paid by the regulated entity providing the loans, and not by the borrower.

Also, in any digital loan, a standardized key fact statement (KFS) must be provided to the borrower. Further, entities have to disclose the all-inclusive cost of digital loans in the form of an annual percentage rate (APR), which will be part of the KFS.

Any data collected from borrowers must be need-based, collected with a clear audit trail, and with explicit prior consent.

The borrower must have the “right to forget” where personal data can be deleted.

All digital lending products must be reported to credit information companies.

All digital loans must come with a cooling-off/look-up period during which the borrower can exit the loan by repaying the principal and the proportionate APR without penalty.

The regulated entities and the LSPs working with them must also have a nodal grievance redress officer to deal with FinTech and complaints related to digital lending. If any complaint is not resolved within a stipulated period of 30 days, a complaint can be lodged under the RBI’s integrated ombudsman scheme.

What should be done?

The RBI has said it would release a second set of norms after engagement with the government and other stakeholders.

The government needs to legislate for the norms and entities within the regulatory purview and should set up an institutional mechanism

The RBI could ensure greater transparency by mandating disclosure of all fees and charges.

The RBI could regularly release aggregated and anonymized data to give a sense of market size and growth rates.