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ANALYSIS OF UNREGULATED DIGITAL LENDING AND THE WAY FORWARD

Updated: Mar 5

Author: Arpit Jhanwar, IV year of B.A.,LL.B.(Hons.) from Symbiosis Law School, Pune


Introduction

The increased use of technology in the financial sector to provide hassle-free services such as lending has encouraged entities such as Nonbanking Financial Companies (“NBFCs”) to collaborate with digital lending platforms (“DLPs”) in order to reach out to their customers..[1] Over the years the NBFC sector has gone through various highs and lows to achieved systemic importance due to their interlinkage with banks, capital market and diverse portfolio of services. They have evolved their business model in terms of the growing economy and evolving regulatory milieu. [2]


Under NBFCs portfolio, lending through DLP segment is struggling over the past few years and a lot of negative factors have come to light including incidents of suicides[3] amongst those who failed to repay loans taken digitally through mobile apps. The cause of these incidents includes high-handed methods of recovery and use of personal information. This has brought concerns surrounding digital lending under the radar of the Reserve Bank of India (RBI). RBI strengthened its regulatory oversight over the sector and issued norms to ensure that the DLPs and NBFCs strictly comply with the Fair Practices Code and Outsourcing Guidelines[4]. Currently, it has set up a working group[5] to recommend a framework to regulate the digital lending industry.


In this article, I will examine the regulatory gaps that allowed lending apps to take up such exploitative practices in the first place. Further, I will analyze the existing guidelines and finally, I will explore the way forward to prevent these incidents.


Research Question

  • Existing regulatory vacuum- narrow scope of regulatory framework or lack of enforcement mechanism?

  • What is the impact and effectiveness of RBI issued norms ensuing strict and additional compliance with the Fair Practices Code and Outsourcing Guidelines?

  • What is the way forward?


Hypothesis

It is evident from the evidence available on record that unregulated lending has created havoc in the masses mostly the informal sector. This can be clearly attributed to either narrow scope of regulatory framework or lack of enforcement. The author is of the view that both of these factors are equally responsible.


Furthermore, the RBI has taken a cognizance of the lack of regulatory framework and issue particular guidelines in that regards. Even after these guidelines the unregulated lending is rampant across India. Taking this as premise the author will further look into the possible way forward to regulate the lending market as the RBI itself is in the process of releasing a working committee report aimed to strengthen the regulatory framework.


Scope and Objective

Scope

This article focuses on the online based and mobile app based lending by NBFCs through DLPs and DLPs working independently. As such it makes use of existing rules and guidelines issued by RBI and various state governments to analyze the regulatory gap or lack of enforcement.


This is a comprehensive article with India as its geographic area of research and unregulated lending as its area of focus. The author has taken a problem-based approach to study into the existing regulatory gap, analyzing the effectiveness of proposed or currently implemented solutions by RBI. Finally, proposing a new solution to enhance the overall efficiency of the sector.


Objective

The primary objective of this research is to determine the existing regulatory gap and lack of implementation. Followed by, looking into the impact and effectiveness of newly proposed or upcoming regulations. Finally, proposing a way forward to deal with the issue of unregulated lending. The secondary objective includes identifying the modus operandi of these lending apps and the quantum at which they operate.


Chapter I - Existing regulatory vacuum- narrow scope of regulatory framework or lack of enforcement mechanism?

Online platform based and digital lending apps, which acts as bridge between the consumers and the financial institutions, have to be registered with banks or NBFCs. These intermediaries or facilitators have to follow and strictly adhere to the “Fair Practice Code”[6] (FPC) as envisaged by the RBI, both in form and substance (A detailed analysis of the FPC will be taken up in Chapter II). While going through the FPC it must be noted that the same applies to those DLPs which are linked to NCFCs or banks. Hence, DLPs whose money lending source does not arise from public deposit are outside its purview. These Apps are basically governed by specific Money lending statues of respective states.


The RBI has received complaint against 1,509 digital lending apps out of which 1,019 are unregulated or unregistered and 490 are registered NBFCs engaged in the business of digital lending.[7] Taking a note of the same, it is imperative to look into the existing legislative frame work.


RBI Guidelines[8]

  • Except as stipulated in the terms and circumstances of the loan sanction agreements, lenders shall refrain from interfering in the affairs of borrowers.

  • In case of recovery of loans, no resort should be made to undue harassment

State Lending Statue

  • In General- imposes a requirement of obtaining license and the same is sanctioned after making a security deposit based on the money being invested in the lending activity. This ensures that even though the amount may be small but the same does not go unnoticed.

  • For Instance, Karnataka Money Lending Statue[9] imposes restrictions against exorbitant interest rates.

The RBI guidelines even with the introduction of new norms of FPC and specific state statue have a limited oversight as these applies to DLPs linked with NBFCs and DLPs licensed form the state statue respectively.


Google Play Store- As a Regulator

As these pay day loan apps are accessible from Google Play stores making them responsible for hosting such apps. It has a Global Safety Policy[10] against lending app but the same is insufficient to regulate issues like exorbitant interest rates, harassment during recovery, misuse of personal data, etc.

As a result of these factors, a regulatory vacuum is created in which these DLPs operate unchecked and benefit from unsuspecting borrowers. Inadequate security for the user’s personal data has led to use of harassment as a common practice[11].


Chapter II- What is the impact and effectiveness of RBI issued norms ensuring strict and additional compliance with the Fair Practices Code and Outsourcing Guidelines?

The RBI vide its notification[12], issued norms to ensure that the DLPs and the banks/ NBFCs strictly comply with the Fair Practices Code and Outsourcing Guidelines. This comes in light of various complaints received by RBI against such DLP. The main highlights of the notification are as follows:




Impact on NBFCs and DLPs

The existing regulatory framework in terms of FPC contains a robust set of instructions. With the introduction of these norms RBI is trying to ensure to create an interface between the NBFC and the final consumer who are sourced through DLPs.[13] It is imperative to note that under these norms does not bring DLPs under the regulatory supervision of RBI as the same are intermediaries providing technology services. As per RBI the obligation of statutory compliance lies on NBFCs and Banks.[14] According to the author such stance is incorrect and some form of control over DLPs is a necessity. (The same will be discussed in Chapter III).


After the introduction of these additional norms NBFCs and Banks operating in digital lending segment may witness increased inspection in terms of their outsourcing agreement with DLPs and in some case may require changes including the need for providing grievance redressal mechanism system of NBFs and Banks to customers. DLPs will have to change their existing customer onboarding agreements to show upfront the name of the specific lender prior to the disbursement of the loan.[15]


Absence of Penal Actions

It is important to note that RBI has not specified any particular penal consequence in case the NBFCs or DLPs fails to comply with these norms. All it as mentioned is that violation will be taken up seriously.[16]


Regulatory Vacuum Still Exists

Even after the introduction of these measures the issues highlighted in Chapter I still exists to a large extent and a proposed resolution to the same will be provided in Chapter III.


Chapter III- What is the way forward?

The current judicial trend in terms of the petition filed, including the Save Them India Foundation petition[17] seeking a complete ban of these digital lending platforms and the recent Madras high court notice[18] to the state and center in a petition seeking a ban on the same matter, indicates a negative approach.


While the requests for a ban on fast lending applications are justified, the author argues that a total ban would be too harsh, as it would stifle the capital flow that the market need following the nationwide lockdown. A better way would be to regulate these applications by establishing a framework with which these apps would be forced to comply. The RBI has noticed this as well, and has formed a working committee (WG) for the same purpose.[19]


It is clear from the setting up of the WG that the light tough that was given by RBI to these DLPs may be facing a major overhaul. Whilst there is no doubt that a swift action is required to curb the malpractices followed by these DLPs but RBI and the WG should not tar the whole industry with the same brush imposing unnecessary strict regulations as it will act as a deterrent to the whole digital lending segment which has seen an increase foreign investment recently.

Keeping a balanced perspective of the risks involved and the growing digital lending segment including the protection of investors’ interest , the RBI and WG should consider the following ideas and suggestions as a part of its terms of reference and while framing its final recommendations.


Avoid introduction of separate platform licensing- Introducing a new category of NBFC (like it did in the case of P2P lending) for DLPs will be an easy fix but the same would suffocate the industry, and digital innovation, which has always been the crucial aspect of India’s Fintech revolution.


Introduction of Self-Regulatory Organization (SROs)- RBI is still finding its place as regulator in digital lending segment like most other Central banks around the globe. It can introduce a SRO for the segment which can ensure a healthy mix of regulatory and developmental needs of the industry. With RBI’s backing it can act as board for policy decisions and as a enforcement agent of RBI.


Technology Standard and Consumer Data Protection- Technology is the base for Digital lening and the WG may prescribe baseline technology standards which can ensure security, data privacy and good governance. This will also ensure that those who can’t keep up with the standard will be weeded out.

With regards to the Data protection, the author suggests that the same should be left with Personal Data Protection Bill and RBI imposing new norms in this regards will be uncalled for.


Consumer Grievance Redressal- In line with the existing Ombudsman scheme for Banks and NBFC, RBI can introduce a similar system for DLPs whilst the same can made eligible and authorized to deal with consumer grievance in this segment.


Holistic Approach- To encourage global investment and entry of big players in the market, the WG and RBI at a policy level should take a holistic approach. Hence, should refrain from imposing harsh restriction and ensure that some liberal approach is taken keeping in mind the ‘Digital India’ movement.[20]


However this problem is not limited to regulatory aspect alone but its lack of implementation too. The author propose that the Google Play store should ensure that those apps which are registered or linked with NBFCs or Banks and thus under the regulatory authority of RBI or apps that are licensed under state money lending statue should be allowed to be registered on its platform on a pre-screening basis. In this way the current vacuum can come to an end. Meanwhile the WG set up by RBI should create a holistic regulatory framework and also look into the feasibility of above-mentioned enforcement mechanism.


Conclusion

While these digital loan apps are undoubtedly a source of concern, it is crucial to highlight that these lending apps offer a lifeline for individuals who have been overlooked by our country's traditional credit system. By analyzing the problem caused by these apps and the policy vacuum that enabled such problems, this article identifies the lack of implementation of the existing frameworks, analyses the impact of new regulations and attempts to provide an enforcement mechanism that could help regulate the digital lending industry in an efficient manner with some suggestions for WC consideration while framing its final recommendations. The RBI, the state government, and platforms like Google and Apple must work in tandem to deal with the issue of unregulated digital lending apps

[1]Arunabh Choudhary &Adithi Joshi, Fair Practices Code for Digital Lending Platforms: An Analysis, Law Street India (Oct. 5, 2021, 9:29 PM), http://www.lawstreetindia.com/experts/column?sid=465 [2] Press Release, RBI, Performance of NBFCs during the Pandemic: A Snapshot (May 17, 2021), https://www.rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=51588 [3]Abhinay Deshpande , Harassed by online loan apps, defaulter ends life in Telangana, The Hindu (Oct. 5, 2021, 11:45 PM), https://www.thehindu.com/news/national/telangana/one-more-online-loan-defaulter-ends-life-in-telangana/article33482585.ece [4] RBI, Loans Sourced by Banks and NBFCs over Digital Lending Platforms: Adherence to Fair Practices Code and Outsourcing Guidelines, No. RBI/2019-20/258 (Notified on June 24, 2020) (India). [5] Press release, RBI, Reserve Bank constitutes a Working Group on digital lending including lending through online platforms and mobile apps (Jan. 13, 2021), https://www.rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=50961 [6]RBI, Guidelines on Fair Practices Code for Lenders, No. BC. 104 /09.07.007/2002-03 (Notified on May 5, 2003) (India). [7] PTI, RBI received complaints against 1,509 digital lending apps, The Hindu (Oct. 6, 2021, 9:00 PM), https://www.hindustantimes.com/business/rbi-received-complaints-against-1-509-digital-lending-apps-101612799455633.html [8]RBI, Master Circular,Fair Practices Code, RBI/2015-16/16 DNBR (PD) CC.No.054/03.10.119/2015-16(Issued onJuly 01, 2015). [9] Karnataka Money-Lenders Act 1961, § 28, No. 12, Acts of Karnataka State Legislation, 1961 (India). [10] J. Jagannath, Have removed personal loan apps that violated safety policies: Google India, LiveMint (Oct. 6, 2021, 11:00 AM) https://www.livemint.com/companies/news/have-removed-personal-loan-apps-that-violated-safety-policies-google-india-11610613360479.html [11] Srinath Vudali&Anam Ajmal, How instant loan apps became a death trap, The Times of India (Oct. 6, 2021, 1:00 PM), https://timesofindia.indiatimes.com/business/india-business/how-instant-loan-apps-became-a-death-trap/articleshow/80263999.cms [12]rbi notification, supra note 4, at 3. [13] Sanjay Khan Nagra, Smita Jha &Prashanth Ramdas, Engaging With Digital Lending Platforms – Stricter Compliances For Banks And NBFCs, Mondaq (Oct. 6, 2021, 11:00 PM),https://www.mondaq.com/india/fin-tech/960624/engaging-with-digital-lending-platforms-stricter-compliances-for-banks-and-nbfcs [14] Ranvir Singh, RBI’s Fair Practices Code to help eradicate digital lenders acting as agents for non-registered NBFCs, Financial Express (Oct. 6, 2021, 3:00 PM) , https://www.financialexpress.com/industry/rbis-fair-practices-code-to-help-eradicate-digital-lenders-acting-as-agents-for-non-registered-nbfcs/2229655/ [15]Abhinay Deshpande , Harassed by online loan apps, defaulter ends life in Telangana, The Hindu (Oct. 6, 2021, 5:00 PM), https://www.thehindu.com/news/national/telangana/one-more-online-loan-defaulter-ends-life-in-telangana/article33482585.ece [16]sanjay khan, supra note 13, at 7. [17]Nilanjana Chakraborty, What to expect if your lending app gets banned, LiveMint (Oct. 6, 2021, 7:00 PM), https://www.livemint.com/money/personal-finance/what-to-expect-if-your-lending-app-gets-banned-11601278372873.html [18] B. Tilak Chandar , HC notice to Centre, State on plea against loan apps, The Hindu (Oct. 6, 2021, 9:00 PM), https://www.thehindu.com/news/national/tamil-nadu/hc-notice-to-centre-state-on-plea-against-loan-apps/article33515362.ece [19]press release, supra note 5, at 3. [20] Anu Tiwari & Tanya Nayyar, FIG Papers (No. 1) : RBI Working Group on Digital Lending – Policy Suggestions, Cyril AmarchandMangaldas (Oct. 6, 2021, 10:00 PM) , https://corporate.cyrilamarchandblogs.com/2021/01/rbi-working-group-on-digital-lending-policy-suggestions/#more-4198