The Reserve Bank of India (RBI) tightened norms for digital lending to prevent charging of exorbitant interest rates by certain entities and also check unethical loan recovery practices.

The growth of digital lending

• Technological innovations have led to marked improvements in efficiency, productivity, quality, inclusion and competitiveness in extension of financial services, especially in the area of digital lending. 

• However, there have been unintended consequences on account of greater reliance on third-party lending service providers mis-selling to the unsuspecting customers, concerns over breach of data privacy, unethical business conduct and illegitimate operations. 

• While the current share of digital lending in the overall credit pie of the financial sector is not significant for it to affect financial stability, the growth momentum has compelling stability implications. 

• It is believed that ease of accessing digital financial services, technological innovations and cost-efficient business models will eventually lead to meteoric rise in the share of digital lending in the overall credit. 

• The world has been talking about Bank 4.0 since 2014 indicating the arrival of fourth generation in evolution of financial services comprising FinTech, online/mobile banking, virtual global market and questioning the sustainability of conventional banking.

• As has been seen during the pandemic-led growth of digital lending, unbridled extension of financial services to retail individuals is susceptible to a host of conduct and governance issues. 

• Mushrooming growth of technology companies extending and aiding financial services has made the regulatory role more challenging. In view of the ease of scalability, anonymity and velocity provided by technology, it has become imperative to address the existing and potential risks in the digital lending ecosystem without stifling innovation. 

• Digital lending is one of the most prominent off-shoots of FinTech in India.

• In India, the digital lending ecosystem is still evolving and presents a patchy picture. While banks have been increasingly adopting innovative approaches in digital processes, NBFCs have been at the forefront of partnered digital lending.

Regulatory framework for digital lending

• The RBI is statutorily mandated to operate the credit system of the country to its advantage. In this endeavour, the RBI has encouraged innovation in the financial system, products and credit delivery methods while ensuring their orderly growth, preserving financing stability and ensuring protection of depositors’ and customers’ interest. 

• Recently, innovative methods of designing and delivery of credit products and their servicing through digital lending route have acquired prominence. 

• However, certain concerns have also emerged which, if not mitigated, may erode the confidence of members of the public in the digital lending ecosystem. 

• The concerns primarily relate to unbridled engagement of third parties, mis-selling, breach of data privacy, unfair business conduct, charging of exorbitant interest rates, and unethical recovery practices.

• Against this background, the RBI had constituted a Working Group on Digital Lending (WGDL) on January 13, 2021. A regulatory framework to support orderly growth of credit delivery through digital lending methods while mitigating the regulatory concerns, has been firmed up. 

• This regulatory framework is based on the principle that lending business can be carried out only by entities that are either regulated by the Reserve Bank or entities permitted to do so under any other law.

What are the new norms?

The universe of digital lenders is classified into three groups:

i) Entities regulated by the RBI and permitted to carry out lending business.

ii) Entities authorised to carry out lending as per other statutory/regulatory provisions but not regulated by RBI.

iii) Entities lending outside the purview of any statutory/ regulatory provisions.

• The Reserve Bank’s regulatory framework is focused on the digital lending ecosystem of RBI’s Regulated Entities (REs) and the Lending Service Providers (LSPs) engaged by them to extend various permissible credit facilitation services. 

• Digital Lending Apps (DLAs) refer to mobile and web-based applications with user interface that facilitate borrowing by a borrower from a digital lender. DLAs will include apps of REs as well as operated by LSPs which are engaged by REs for extension of any credit facilitation services.

• As regards entities falling in the second category, the respective regulator/ controlling authority may consider formulating or enacting appropriate rules/regulations on digital lending based on the recommendations of WGDL. 

• For the entities in the third category, the WGDL has suggested specific legislative and institutional interventions for consideration by the central government to curb the illegitimate lending activity being carried out by such entities.

• Under the new norms, all loan disbursals and repayments are required to be executed only between the bank accounts of the borrower and the regulated entities (like banks and NBFCs) without any pass-through/ pool account of the Lending Service Providers (LSPs).

• Also, any fees, charges, etc, payable to LSPs in the credit intermediation process shall be paid directly by RE and not by the borrower.

• A standardised Key Fact Statement (KFS) must be provided to the borrower before executing the loan contract.

• An automatic increase in credit limit without explicit consent of borrower is prohibited.

• A cooling-off/ look-up period during which the borrowers can exit digital loans by paying the principal and the proportionate APR (annual percentage rate) without any penalty shall be provided as part of the loan contract.

• If any complaint lodged by the borrower is not resolved by the RE within the stipulated period (currently 30 days), he/she can lodge a complaint under the Reserve Bank - Integrated Ombudsman Scheme (RB-IOS).

• Data collected by DLAs should be need-based, have clear audit trails and only done with prior explicit consent of the borrower.

• Option may be provided for borrowers to accept or deny consent for use of specific data, including option to revoke previously granted consent, besides option to delete the data collected from borrowers by DLAs/LSPs.

• RBI also said certain recommendations of the working group have been accepted in-principle, but they require further examination.

• REs will have to ensure that they and the LSPs engaged by them have a suitable nodal grievance redressal officer to deal with FinTech/ digital lending related complaints. Such grievance redressal officer shall also deal with complaints against their respective DLAs. The details of the grievance redressal officer shall be prominently indicated on the website of the RE, its LSPs and on DLAs, as applicable.

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