RBI Press Release on Digital Loans
To address regulatory concerns arising from the offering of various digital lending and credit products and services, the Reserve Bank of India issued a press release on August 10, 2022 to immediately implement certain recommendations made by the task force on the digital loan. Detailed instructions are expected to be issued separately by the Reserve Bank of India.
Given the dynamic innovations in financial lending products and services and its perceived risks, the Reserve Bank of India (RBI) set up a working group on January 13, 2021 (Work group) to study the digital lending landscape in India and recommend a regulatory framework to address concerns arising from unregulated lending activities. Along with various recommendations, the task force, in its report dated November 18, 2021, identified the key digital lending stakeholders, namely a lending service provider (PSL) and one ‘balance sheet lender’. The task force noted that a PSL is “an on-balance sheet lender’s agent” that assists with, among other things, customer acquisition, underwriting or pricing, disbursement, monitoring, collection or liquidation of specific loans. Its role is limited to a loan originator, unlike a ‘balance sheet lender’ which is classified as an entity in the lending industry which is equipped to bear credit risk, and to whom the LSP transfers the loan. Our detailed analysis of this report is accessible here.
Further to the above, on August 10, 2022, RBI issued a press release (Press release) requiring the immediate implementation of certain recommendations of the working group, detailed in Annex I of the press release. The press release also sets out the recommendations of the task force that are accepted in principle but require further consideration, under Annex II of the press release, and recommendations requiring engagements with the government and other parties. stakeholders, under Annex III of the press release. The press release is intended to curb unregulated lending activities, protect consumer interests and ensure data privacy and, therefore, is likely to impact pre-existing agreements between RBI-regulated entities (RE) and LSPs for digital lending.
2. Key considerations for stakeholders
2.1 Funds flow process
To address concerns arising from the lack of transparency in the disbursement and repayment of loans through an LSP, REs are prohibited from using pool or transfer accounts for the disbursement or repayment of loans . The limited exemption to this rule is: (i) disbursements covered by statutory or regulatory mandates; (ii) co-lending transactions inter se Res; and (iii) disbursements for a specified end use in accordance with applicable regulatory guidelines. While this mandate ostensibly prevents unregulated entities from participating in the process of disbursing or reimbursing funds, the reasons for introducing this exemption are unclear. Further instructions under the press release may possibly outline this exemption.
In particular, although an express prohibition has not been introduced, REs are instructed to ensure that any third-party guarantees (such as first-loss default guarantee) to offset defaults in a loan portfolio of the ER adheres to the Master Direction – Reserve Bank of India (Securitization of Standard Assets) Instructions, 2021 dated 24 September 2021. Since the role of an LSP is limited to a ‘loan originator’and the adoption of credit risk is a core function of RE, the reasons for the lack of an express bar remain unclear.
2.2 Pricing Implications
The press release prohibits a language service provider from charging fees directly to borrowers. These charges shall be accrued by the SO at the annual percentage rate (i.e. all-in cost) (APR) of the loan. In practice, fees are usually charged by LSPs for support services on a lump sum basis and it is common for these to be borne by the borrower. Given this, it remains to be seen whether the net effect of this ban would change the price exposure for the borrower, since it only changes how the borrower is charged the LSP fee.
In addition to the APR, the press release demands disclosure of the terms and conditions of the collection mechanism and the contact details of the designated complaints officer to handle “digital loans or related matters”, under the statement of key facts (KFS) provided to borrowers. Any charges not specified in the KFS cannot be charged to the borrower at any time during the term of the loan. Also, an express restriction was introduced on increasing credit limits without the consent of the borrower.
Considering the above and the mandate given to all REs (instead of only banks and NBFCs as previously stipulated by the RBI) to disclose the list of LSPs engaged by them and the role envisaged for LSPs, the commercial viability of the relationship between the LSP, RE and a borrower will need to be reconsidered.
2.3 Protective measures
To ensure transparency, several measures such as direct communication between the RE and the borrowers of the loan product, due diligence to be undertaken by the REs to assess the technical capabilities of the LSP, adherence to outsourcing guidelines by the LSPs and guidance to LSPs when acting as collection agents have been introduced. Although exhaustive, these requirements prevailed in spirit prior to the press release.
To combat regressive collection practices, the press release requires an RE to disclose details of the LSP responsible for collecting the loan from the borrower, at various stages of the loan sanctioning process.
As market practices differed, the press release specifically states that regardless of the nature or duration of the loan, including whether it is taken out through digital lending apps (DLA) operated by ERs or LSPs, details of all funding must be reported to credit reporting companies.
2.3.2 Handling grievances
REs should ensure that they and their LSPs appoint Grievance Officers to deal with FinTech, digital lending issues (such as complaints or issues raised by borrowers) or issues with a DLA. Contact details for the Grievance Officer, as well as details regarding the method of filing complaints should also be provided in the DLA, RE or LSP website (as applicable), as well as in the KFS. For language service providers, an assessment may be undertaken to determine whether a grievance officer appointed under the eCommerce Rules 2020 would suffice.
The press release also acknowledges the borrower’s right of recourse to the Reserve Bank – Integrated Ombudsman Scheme, 2021 if the ER fails to address the complaint within the stipulated time (currently 30 days).
2.3.3 Cooling off period
REs are required to provide borrowers with a cooling-off or search period (as determined by the RE’s Board of Directors) to exit the loan by paying only the principal amount and prorated APR, without incurring any penalty. Borrowers will also be allowed to make advance payments beyond the cooling-off period. Arguably, this recommendation would make digital loans preferable to traditional loans for similar amounts. However, different disbursement mechanisms may require different cooling-off periods.
2.4 Data location and data protection
REs are required to store all data relating to digital lending activities on servers located in India (Location requirement). This location requirement is akin to the direction prescribed by the RBI on payment system providers and P2P lenders of the NBFC (Payments Circular), reflecting the continued attempt to favor localization. However, unlike the circular on payments locating payment data, this mandate extends the scope to all data. In practice, LSPs may also have to restructure their functions related to processing and storage, as this could be contractually imposed by REs.
In addition, language service providers are only permitted to collect and store borrower information to the extent necessary to carry out their operations. However, since its data logs are auditable, language service providers may need to demonstrate this necessity at the time of the audit.
The RBI has also indicated that it may require REs to disclose proprietary algorithms used for loan underwriting in a bid to balance transparency with innovation and adopt ethical artificial intelligence standards (AI) to protect the interests of customers. These requirements are likely imposed to assess the bias in these algorithms and ensure that the welfare of the borrower is taken into account. Stakeholders may, however, continue to resist these measures to protect their proprietary interests in their algorithms.
The RBI has also strongly emphasized the need for a consent-driven framework for digital lending. Greater autonomy is sought to be extended to borrowers, requiring language service providers to obtain explicit consent to access phone features, allowing borrowers to revoke their consent or limit the disclosure of certain data, and by explicitly requiring language service providers to develop comprehensive privacy policies. This requirement therefore goes beyond the requirements set out in the existing rules of the Information Technology Act 2000.
2.5 Other proposals
While we can expect the Annex II recommendations to be implemented within a reasonable timeframe, the Annex III recommendations require significant structural and governance changes. The thrust of these recommendations is to monitor suspicious transactions and introduce accountability for actions on DLAs. Crucially, the RBI can greenlight the proposed self-regulatory organization for digital lending to frame various codes of conduct, standard agreements, maintain a negative list of LSPs, and more.
On top of that, the government is also considering legislation to ban unregulated lending and set up an independent DLA verification body. It remains to be seen how the regulators will interact with each other and resolve overlapping functions, if any.
3 keys to take away
According to the press release, it is clear that the role of a language service provider is similar to that of a commercial correspondent – to function as an agent of the CR. In light of this, as an immediate step, all language service providers should consider the nature of the deployment and integration of their services while engaging with REs (including any pre-existing relationships with REs) to assess whether such arrangements, fund flow structures and data processing practices are permitted.