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In order to step into the world of digital lending, one must get to it through the gateway of Fintech. Embracing and building on the Reserve Bank of India’s (“RBI”) description, Fintech is nothing but a broad category of different digital technologies and software applications deployed by service providers that provide innovative financial services competing with or supplementing traditional financial services.1 Fintech plays the bedrock on which the world of digital lending is being built upon and is the bifrost for the consumer to explore digital lending.
Digital lending effectively is an automated lending ecosystem which includes processes such as customer acquisition, credit assessment, loan approval, disbursement, recovery, and associated customer services.
Digital lending is wiping time-consuming traditional banking processes from opening bank accounts to credit scoring to collaterals to miscellaneous paperwork off the board and ensures that a loan disbursement is done within minutes. Innovation towards having swifter processes of KYC including Aadhaar authentication and e-KYC have really paved the way for digital lending.
Digital lending businesses target the demographic which do not have access to traditional finance such as bank loans and credit cards. Further, the ticket size of loans disbursed through digital lending generally varies from USD 100 to USD 6,000, with the major chunk of disbursement being in the range of USD 100 to USD 1,500. The overall volume of disbursement through digital mode has exhibited a growth of more than twelvefold between 2017 and 2020 (from ₹11,671 crore to ₹1,41,821 crore). NBFCs play an important role in lending given the regulatory flexibility enjoyed by them. For instance, the share of NBFCs has increased from 6.3 per cent in 2017 to 30.3 per cent in 2020, driven predominantly by technological innovations.2
Nishith Desai Associates (NDA) has advised several capital funds, lending platforms and virtual digital asset platforms on lending, staking and derivative products. Our full range of services include:
Strategic Advice on Structuring Effective Models: NDA advises on structuring digital lending models, neo banks and cross-border remittance models (including for non-Indian merchants who may or may not have a presence in India). We also regularly advice on peer-to-peer, NBFC digital lending structures, white-labelling, bill discounting, factoring and buy now pay later (BNPL) models.
Regulatory and Policy Advice: We provide regulatory and strategic advice to industry players including risk mitigation strategies for navigating challenging areas of law. We regularly submit representations to the Government on various policy issues and participate in public consultations. In addition, we validate and provide insights on business models which are on the intersection of finance and law.
Documentation: We assist in drafting, negotiating and advising on lending contracts, terms, disclaimers, licensing and assignment agreements for necessary use of intellectual property and other documentation requirements with banks, non-banking financial companies and other Fintech companies. We also provide inputs on outsourcing arrangements with regulated entities and private parties (especially in the lending space).
KYC: We provide advice to digital lending platforms and technology service providers and assist them in navigating through the regulatory framework on KYC (Know-Your-Customer) processes such as those prescribed by the Reserve Bank of India or under various rules and procedures regarding Aadhaar authentication and offline verification.
Banking Regulation Act, 1949: The Banking Regulation Act, 1949 provides a registration requirement and compliance requirements on all banks (public and private sector) including small finance banks, regional rural banks and co-operative banks for undertaking operations including digital lending.
Reserve Bank of India Act, 1934: The Reserve Bank of India Act, 1934 establishes the RBI as the apex bank in the country that regulates banks and other financial institutions such as Non-Banking Finance Companies (“NBFCs”). NBFCs have a flexible regulatory regime in comparison to banks, and are at times the preferred partners for digital lenders who opt for Rent-an-NBFC models. This is a mechanism which is used by entities to offer lending solutions by leveraging the licences of the NBFC. Any credit risk is underwritten by the unregulated entity by way of a First Loss Default Guarantee in favour of the NBFC. At times the funds required by the NBFC are arranged for by the unregulated entity by way of inter-corporate deposits. The RBI has also issued guidelines for outsourcing by various regulated entities such as banks, co-operative banks, NBFCs and payment system operators which prescribe that non-core services may be outsourced subject to certain compliance requirements.
State Money Lenders Acts: Most of the states have their respective money lenders legislations in place. Many of these are comprehensive legislations aimed at protecting the borrowers and provide detailed and stringent provisions for regulation and supervision of the money lending business.
Payment and Settlement Systems Act, 2007: The Payment and Settlement Systems Act, 2007 regulates systems that enable payments to be effected between a payer and a beneficiary, involving clearing, payment or settlement service or all of them (not including a stock exchange). Any participant or intermediary intending to be a payment system must obtain authorization from the RBI to avoid being in violation of the Payment and Settlement Systems Act, 2007 and the various rules and regulations framed thereunder.
Data protection: With an ever-increasing reliance on big data for automation, data protection and privacy laws play a key role in this industry. While India does not have a dedicated data protection statute yet, the Data Protection Bill, 2021 is under discussion in the Parliament, and the Government is also considering an independent framework on non-personal data. This is in addition to laws regulating special categories of data especially in the fintech space. For instance, RBI has issued some localization norms for financial data.
Credit and liquidity creation are important economic tools for consumers and merchants, as well as financiers, as it is reflective of a market willing to spend, which in turn boosts businesses. Digital lending models are playing an important role and will continue to do so in the time to come and with evolving business, so is the legislation expected to evolve. The end-goal being to create an effective environment for innovative structuring in the Fintech space, with customers and end-users benefitting from such models.
1Report of the Working Group on Digital Lending including Lending through Online Platforms and Mobile Apps – Reserve Bank of India, available at https://www.rbi.org.in/Scripts/PublicationReportDetails.aspx?UrlPage=&ID=1189
2Report of the Working Group on Digital Lending including Lending through Online Platforms and Mobile Apps – Reserve Bank of India, available at https://www.rbi.org.in/Scripts/PublicationReportDetails.aspx?UrlPage=&ID=1189