RBI Press Release on Digital Lending

Partners: Rahul Matthan, Nikhil Narendran and Jyotsna Jayaram, Senior Associate: Rachana Rautray, Associates: Akanksha Singh, Sidharth Ray, Sindhu A and Vartika Tiwari

Introduction

Considering dynamic innovations in financial lending products and services and its perceived risks, the Reserve Bank of India (RBI) constituted a working group on 13 January 2021 (Working Group) to study the digital lending landscape in India and recommend a regulatory framework to address concerns arising out of unregulated lending activities. Along with various recommendations, the Working Group through its report dated 18 November 2021, identified key stakeholders for digital lending, i.e., a lending service provider (LSP) and a ‘balance sheet lender’. The Working Group noted that an LSP is ‘an agent of a balance sheet lender’ that assists, inter alia, with customer acquisition, underwriting or pricing support, disbursement, monitoring, collection, or liquidation of specific loans. Its role is restricted to a loan originator, unlike a ‘balance sheet lender’ that is categorised as an entity in the business of lending which is equipped to carry credit risk, and to whom the LSP transfers the loan. Our detailed analysis on this report, may be accessed here.

Further to the above, on 10 August 2022, RBI has issued a press release (Press Release) requiring the immediate implementation of certain recommendations of the Working Group, specified under Annex I of the Press Release. The Press Release also sets out recommendations of the Working Group that are accepted in principle but require further examination, under Annex II of the Press Release, and those recommendations requiring engagements with the Government and other stakeholders, under Annex III of the Press Release. The Press Release seeks to curb unregulated lending activities, protect consumer interest, and ensure data privacy and accordingly, will likely impact pre-existing arrangements between RBI regulated entities (RE) and LSPs for digital lending.

Key Considerations for Stakeholders

Fund Flow Process

To address concerns arising out of the lack of transparency in the disbursement and repayment of loans through an LSP, REs are prohibited from utilising pooling or pass-through accounts for loan disbursal or repayment. The limited exemption to this is – (i) disbursals covered under statutory or regulatory mandates; (ii) co-lending transactions inter-se Res; and (iii) disbursements for specified end-use in accordance with applicable regulatory guidelines. While this mandate ostensibly restricts unregulated entities from participating in fund disbursements or repayments process, reasons for the introduction of this exemption are unclear. Further instructions pursuant to the Press Release may possibly provide insight into this exemption.

Notably, although an express prohibition has not been introduced, REs are instructed to ensure any third party guarantee (such as First Loss Default Guarantee) to compensate for defaults in a loan portfolio of the RE adheres to the Master Direction – Reserve Bank of India (Securitisation of Standard Assets) Directions, 2021 dated 24 September 2021. Given that an LSP’s role is limited to an ‘originator of loans’, and adopting credit risk is a core RE function, the reasons for the lack of an express bar remains unclear.

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