Authored by Veena Sivaramakrishnan and Utkarsh Bandhu
With the mantra of “financial inclusion”, credit reach to the vast Indian population has been an economic concern and financial institutions have viewed this untapped market as a potential growth opportunity.
As last mile outreach is a challenge, better internet connectivity and access to financing at the fingertips of a smartphone plays a huge role. NBFCs have been at the forefront of this revolution and are either “digital” or have tied up with various digital platforms in order to connect with potential market participants.
This has also garnered interest on account of COVID -19 pandemic.
On June 24, 2020, the Reserve Bank of India (“RBI”) issued a notification dealing with loans sourced by banks and NBFCs over digital platforms. RBI has considered the existing practice of an outsourcing arrangement and mandated that to the role that is played by the digital platform and the NBFCs.
The notification reiterates the principles of privity between the NBFC and the borrower within the existing regulatory framework and the need for “best practices” in the digital lending world.
The crucial change on account of digital lending is the ease in the operational processes. Gone are the days of lengthy loan agreements, executing each page, multiple visits to lenders, etc. Loan at fingertips started with catering to borrowers looking for small loans, but once the processes are set up, the quantum will be immaterial. It is widely believed that digital lending platforms have the potential to change the landscape of retail lending in the days to come.
While there are platforms which provide the “matchmaking” facility for a NBFC and a Borrower, RBI as it regulates the NBFCs as a lender, has reiterated that the guidelines on outsourcing of financial services, continues to apply for digital lending. The NBFC continues to be ultimately responsible for the activities which are outsourced by it.
NBFCs using digital lending platforms need to be mindful of the following:
Key Parameters Disclose if it has its own digital platform or if it has a third party digital platform (if latter, it needs to be specified that the platform is not the lender);
Even if the third party digital platform is an “aggregator”, the NBFC and the digital platform must execute an outsourcing arrangement;
Adherence to Fair Practices Code is critical;
NBFCs should own the loan documentation and vet the same (not outsource it);
NBFCs should own the information relating to the financing extended by it to the borrower on the platform and ensure that there is no misrepresentation/ miscommunication;
As confidentiality of the customer information is a major concern, the outsourcing arrangement must specifically provide protection to customer data, even post termination of the arrangement; and
Recovery is an inherent part of lending and NBFCs which use the digital platform and its outreach for recovery must have code of conduct for operations of recovery agent.
Third party digital platforms - Caution
NBFCs are ultimately “only” responsible for the “activities outsourced” to digital platforms.
Some of the factors which the third party digital platforms must note include:
There should be no miscommunication or misrepresentation in relation to the loan, specifically the rate of interest and reset or the role of the platform itself.
Digital platforms must bear in mind that lending is a regulated activity in India and carrying on or even representing that they are carrying on such activity, without disclosing the role of the NBFC, could lead to contravention of RBI norms and may attract penal action;
If the digital platform has a tie up with more than one NBFC, then the products being extended by a relevant NBFC must be clearly specified;
In case of algorithms being used for selecting the right lender for a particular Borrower, transparency is the key. The say that a borrower has in selecting the lender (and vice versa) must be clear; and
If the digital platforms are further outsourcing their services, it should be ensured that such sub delegation is not restricted and an agreement is executed on similar terms.
The development in the digital lending space is rapid and many new players are being innovative and making a mark in this sector. While focusing on technological advancement for better customer convenience and experience, ensuring compliance with regulations and laws at the onset would be critical to ensure sustainable growth.
Veena Sivaramakrishnan is Partner and Utkarsh Bandhu is Principal Associate, Shardul Amarchand Mangaldas & Co. Views are personal