GS Paper 3
Syllabus: Indian Economy and related issues
Source: IE
Direction: The article discusses the current digital lending ecosystem, the need to regulate it, RBI guidelines and confusion regarding it.
Context: Two months after the RBI issued guidelines on digital lending, Banks, non-banking financial companies (NBFCs) and fintech players are still awaiting clarity on many aspects, including the FLDG system.
First Loss Default Guarantee (FLDG): It is a lending model between a fintech and a regulated entity in which a third party guarantees to compensate up to a certain percentage of default in a loan portfolio of the regulated entities (REs – banks or NBFCs).
Digital lending:
- It involves giving and recovering loans through web platforms or mobile apps by digital lenders.
- Lending Service Providers (LSPs) are engaged by the REs to carry out some functions of RE in connection with lenders’ functions on digital platforms.
- These LSPs may be engaged in customer acquisition, underwriting support, recovery of loans, etc.
- According to the RBI, as many as 600 out of 1100 lending apps currently available are illegal apps and stringent norms for digital lenders, including separate legislation to prevent illegal digital lending activities, are the need of the hour.
The guidelines on digital lending:
- The RE will have to –
- Disclose upfront the rate charged to the borrower of a digital loan,
- Ensure that borrowers are aware of the products and
- Capture the economic profile of the borrowers before offering the loans.
- On FLDG, RBI advised the RE to follow directions on securitisation, especially, synthetic securitisation.
- In synthetic securitisation, a bank buys credit protection on a portfolio of loans from an investor.
- This means that if a loan in the portfolio defaults, the investor reimburses the bank for losses on loans in the portfolio up to a certain amount, which is the amount invested.
- The RBI asked regulated entities like banks to ensure that LSP and Digital Lending App (DLA) comply with the guidelines.
Significance of the guidelines: They aimed at protecting customers from unethical business practices, such as mis-selling, breach of data privacy, unfair business conduct and charging of exorbitant interest rates.
Why is there so much confusion?
- Guidelines are very stringent as far as the data storage, confidentiality, role and responsibility of digital partners are concerned.
- For example, REs should ensure that LSPs or DLAs engaged by them do not store the personal information of borrowers except for some basic minimal data.
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