Over the last decade, there has been a sizeable rise in the number of digital lenders. It is an easy business to experiment with. The investment required is less vis-à-vis setting up a traditional lending company. Lack of reach by existing lenders to unbanked areas throw up a huge opportunity for the digital lending business to bridge banks and borrowers.
Till late 2022, there were no clear rules in the business. Regulated banks often had no clue - or, they perhaps chose to act so, on how the third parties operate in terms of identifying the borrower and recover their dues.
Pressure to grow business
The rising pressure on banks and non-banking finance companies (NBFCs) to grow their businesses also aided the growth for digital lending. Anyone with a lending app and some investments could throw their hat in the digital lending space and operate in the way they wanted. Originating lenders gradually lost the control on credit.
This led to a lack of transparency in key disclosures, including the rate of interest and other fees charged. Lending apps soon morphed into modern-
era loan sharks, charging exorbitant margins, using the lure of easy, instant credit without much documentation. When it came to recovery, the lenders often turned to digital goons. There have been numerous instances of suicide by borrowers after public harassment when they failed to repay on time.
The RBI eventually woke up to the problem, though a little late, and drew up guidelines for the business of digital lending. The September 2022 guidelines clearly specified the rules on interest rates, key fact statements, grievance mechanism, assessing the borrowers’ credit worthiness, and customer privacy. This brought in some much-needed discipline in the unruly domain of digital lending in India.
Yet, last week’s RBI action showed that not all is well, indeed. The rampant growth in unsecured credit to an increasing number of credit-unworthy borrowers mainly by digital lenders triggered the alarm for the central bank. The regulator’s concerns included multiple loans to same borrowers and exorbitant rates charged. The RBI, it is learned, is worried that bad lending practices in good times will lead to a painful bad loan cycle during bad times.
Remember, these rules pertain to consumer loans, including credit card loans and not asset-backed loans such as housing, vehicle or gold loans. In these categories, the risk weight has gone up by 25 percent. Banks and non-banks will be more careful now while issuing such loans. That’s what exactly the RBI wants.
The way ahead for the industry is to self-regulate first rather than waiting for the regulator to crack the whip by keeping a strict check on operations of LSPs (lending service providers), key fact statement rules, and how the digital lending agencies operate.
Likely, last week’s guidelines are unlikely to be the last from the central bank. The RBI is likely to keep a close watch and act further if banks and NBFCs do not get the message in this round.
Banking Central is a weekly column that keeps a close watch and connects the dots about the sector's most important events for readers.