Posted by : Ashi Atre Digital Lending Guidelines – Part 1
From pawnbrokers lending money in exchange for collateral to the use of sophisticated technologies to carry out credit underwriting, the landscape of lending business has evolved significantly in the last century. It is hard to find a financial institution which is carrying on business without digitising any aspect of its lending process today. With rapid advancements in cloud computing, artificial intelligence, and blockchain, as well as faster and more affordable internet connectivity, it is safe to say that the physical only model will soon be a matter of the past in number of processes in the lending business, while not entirely being substituted.
Digital lending refers to the practice of providing financial loans or credit services through online platforms and digital channels. It leverages technology and digital platforms to streamline and simplify the lending process, making it more accessible, convenient, and efficient for borrowers, as substantiated by a study conducted at Harvard Business School in 2023 (Digital Lending and Financial Well-Being: Through the Lens of Mobile Phone Data-Harvard Study) . Here, borrowers can submit loan applications, provide necessary documentation, and complete the entire loan process online. Lenders, on the other hand, can use advanced algorithms and data analytics to assess the creditworthiness of borrowers, determine loan eligibility, and make quicker lending decisions.
Digital lending methodologies have been accelerated by financial technology companies often called fintechs… The fintech technologies that have revolutionised the way loans are obtained and disbursed are largely the reason for the recent growth in popularity of the banking, financial services, and insurance industries wherein they have introduced digital lending platforms that connect borrowers directly with lenders, cutting out intermediaries such as banks. Fintech, is frequently praised as a potent instrument for fostering financial inclusion in India
The Global Digital Lending Market is projected to grow at a CAGR of 13.30% from 2022 to 2030, reaching a value of USD 30.77 billion which can be ascribed to the increased adoption of digital solutions by banking operations with the application of artificial intelligence and machine learning, which has streamlined company operations and enhanced the sector’s overall functioning and efficiency. Technology is the primary facilitator of the digital lending business.
Even India’s digital lending business has grown dramatically over the years, and by 2027, 40% of lending is predicted to take place online. With a stake of 55% and 30%, respectively, private sector banks and NBFCs are the major players in the digital lending ecosystem, where in, the most popular digital loans in India being personal loans, SME loans, two-wheeler loans, car loans, and home loans.
Amid the growing popularity of online loans, RBI came up with the digital lending guidelines which came into effect in the beginning of September 2022. These measures are aimed at protecting consumers and thereby include a restriction on Fin-Techs and other unregulated entities.
The universe of digital lenders is classified into three groups –
- Entities regulated by the RBI and permitted to carry out lending;
- Entities authorized to carry out lending as per other statutory/regulatory provisions but not regulated by RBI for example Merchant Banking Companies, Stock Exchanges, Companies engaged in the business of stock-broking/sub-broking, Venture Capital Fund Companies, Nidhi Companies, Insurance companies and Chit Fund Companies;
- Entities lending outside the purview of any statutory or 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. As regards entities falling in the second the respective regulator/ controlling authority may consider formulating or enacting appropriate rules/regulations on digital lending based on the recommendations of Working Group on Digital Lending (WGDL) formed by the RBI. The third category includes entities carrying out illegitimate operations. 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.
There are 3 Parties on which the RBI imposes its guidelines, Regulated entities or REs which are all Scheduled Commercial Banks (SCBs), Regional Rural Banks (RRBs), Local Area Banks (LABs), Primary (Urban) Co-operative Banks (UCBs), State and Central Co-operative Banks (StCBs / CCBs) and any other entity which has been licenced by Banking Regulation Act, 1949, which as a group shall be referred as ‘banks’ and includes All India Financial Institutions (AIFIs), All Non-Banking Finance Companies (NBFCs), Miscellaneous Non-Banking Companies (MNBCs) and Residuary Non-Banking Companies (RNBCs), All Payment System Providers (PSPs), System Participants (SPs), Prepaid Payment Instrument Issuers (PPI Issuers) and All authorised persons (APs) including those who are agents of Money Transfer Service Scheme (MTSS), regulated by the Regulator, Lending Service Providers (LSPs) which can be defined as an agent of an RE who carries out for a fee from the RE, one or more of lender’s functions in customer acquisition, underwriting support, pricing support, disbursement, servicing, monitoring, collection and customer servicing, recovery of specific loan or loan portfolio, otherwise known as a Fin-Tech, and Digital Lending Apps (DLAs) of the REs or of the LSP engaged by an RE, which shall be defined as Mobile and web-based applications with user interface that facilitate borrowing and servicing by a borrower from a digital lender.
Here are some key guidelines issued by the RBI related to digital lending which must be followed by all the 3 parties mentioned above:
- Regulation of Digital Lending Platforms: The RBI has emphasized that any entity engaging in digital lending activities should adhere to relevant regulatory frameworks. These platforms may include peer-to-peer (P2P) lending platforms, online aggregators, or other types of digital lending intermediaries.
- Fair Practices Code: Digital lending platforms are required to follow the RBI’s Fair Practices Code guidelines. These guidelines outline the fair treatment of borrowers, transparency in loan terms and conditions, and grievance redressal mechanisms.
- Outsourcing Guidelines: The RBI has issued guidelines on outsourcing of services by digital lending platforms. The platforms are required to ensure that the outsourcing arrangements do not compromise compliance with regulatory guidelines, including data security and customer privacy.
- Data Security and Customer Privacy: Digital lending platforms are expected to have robust systems and procedures in place to ensure the security and privacy of customer data. Compliance with the RBI’s data security and customer privacy regulations is essential.
- Grievance Redressal: The RBI emphasizes the importance of establishing effective grievance redressal mechanisms for borrowers. Digital lending platforms are required to have a clearly defined mechanism for addressing customer complaints and resolving disputes.
- Interest Rates and Charges: The RBI has stated that the interest rates and charges levied by digital lending platforms should be transparent and disclosed to borrowers upfront. There should be no hidden charges or unfair practices.
- Collection Practices: Digital lending platforms are expected to follow fair and ethical practices when it comes to loan recovery. The RBI has laid down guidelines to prevent harassment of borrowers during the collection process.
Overall, it can be said that digital lending is helping to level the playing field for MSMEs and SMEs, enabling them to access finance quickly and easily and compete more effectively in today’s fast-paced digital economy.