Digital Lending Norms

Syllabus: General Studies Paper 3

Aiming to curb rising malpractices in the digital lending ecosystem, the Reserve Bank of India (RBI) issued guidelines for entities engaged in digital lending.

The norms stating that all digital loans must be disbursed and repaid through bank accounts of regulated entities only, without pass-through of lending service providers (LSPs) or other third parties.

• The norms follow the recommendations of a working group for digital lending, whose report was made public last November. 
• 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.

The regulator classified digital lenders into three categories: 

• Entities regulated by the RBI and permitted to carry out lending business, 
• Entities authorised to carry out lending as per other statutory or regulatory provisions but not regulated by the RBI.
• Entities lending outside the purview of any statutory or regulatory provisions.
• The latest regulatory framework is focussed on the digital lending ecosystem of RBI’s regulated entities (REs) and the LSPs engaged by them to extend credit facilitation services. 
• As for entities falling in the second category, the respective regulator may consider formulating rules on digital lending, based on the recommendations of the working group.
• For entities in the third category, the working group has suggested specific legislative and institutional interventions for consideration by the government to curb illegitimate lending.
• Apart from direct disbursals and repayments of digital loans, the norms mandate that any fees or charges payable to LSPs in the credit intermediation process shall be paid directly by the RE and not by the borrower.
• A standardised key fact statement (KFS) must be provided to the borrower before executing the loan contract. 
• The all-inclusive cost of digital loans in the form of annual percentage rate (APR) will have to be disclosed to borrowers. The APR shall also form part of KFS. 
• Automatic increases in credit limit without the explicit consent of borrowers has been prohibited. 
• The loan contract must provide for a cooling-off or look-up period during which borrowers can exit digital loans by paying the principal and the proportionate APR without any penalty.
• All digital lending products extended by REs over merchant platforms involving short term credit or deferred payments must also be reported to credit bureaus by the REs.

What is digital lending?

• Digital lending refers to the online disbursal of loans where all processes, including loan approval and recovery, take place remotely, typically through mobile apps.
• A borrower-friendly approach, reduced paperwork, high availability, and economic implications of the covid pandemic are the reasons for the increased surge in digital lending.

Significance of Digital Lending

• It helps in meeting the huge unmet credit need, particularly in the micro enterprise and low-income consumer segment in India.
• It helps in reducing informal borrowings as it simplifies the process of borrowing.
• It decreases time spent on working loan applications in-branch. Digital lending platforms have also been known to cut overhead costs by 30-50%.

Challenges

• Rising bad loans in the retail segment could be a big worry.
• Aggressive growth of digital lending at the cost of quality of lending can lead to deterioration of asset quality for banks.

Steps Taken by RBI:

• Non-Banking Financial Companies (NBFCs) and banks need to state the names of online platforms they are working with.
• A separate legislation should be enacted to oversee Digital Lending.
• Digital lending apps should be subjected to a verification process by a nodal agency to be set up in consultation with stakeholders.
• Regulators may consider introducing interest rate caps in a phased manner, broadly in line with the effective interest rates of credit cards.
• Disbursement of loans should be made directly into the bank accounts of borrowers, and servicing of loans should be done only through the bank accounts of the digital lenders.