INTRODUCTION
It is the end of the month, and you have already used a portion of your savings to pay for that mandatory cathartic trip to Manali but then you come across this beautiful bag on Amazon which is seductively looking straight into your eyes, luring you into buying it. At the same time, you could feel the burden of your pocket, nudging you to look away from that expensive treat. Enter, BNPL or Buy Now Pay Later service providers to temporarily relieve you from that burden by issuing an alternative credit card without any procedural requirements through which you can buy that bag now, even when your pocket would recommend otherwise, and pay the company later.
Now, what are exactly those BNPL services? How do they operate in India? What are the regulations for such BNPL service providers in India? This article will answer these questions and more.
WHAT ARE BNPL SERVICES?
As per RBI guidelines, only banks are allowed to issue credit cards. However, there has been a recent innovative phenomenon in the fintech space of alternatives to credit cards which are Prepaid Payment Instruments or PPIs. These prepaid instruments are like digital wallets, cards, etc., and are loaded with money for facilitating transactions and fund transfers. Such PPI operators also provide BNPL or Buy Now Pay Later services which are credit lines or pre-set borrowing limits that allow customers to access credit as and when required up to the prescribed limit. In this model, fintech companies connect financiers which are mostly NBFCs with the merchants/customers. Such services are most beneficial and alluring to people with poor CIBIL scores or those who do not have a credible background.
To roll out PPIs, companies require a bank to issue PPI as BNPL service providers are not authorized to do so, and a lender who could extend credit.
For example, Uni’s pay later card product, allows customers to split their large purchases into three installments. Uni has partnered with RBL Bank and SBM Bank to issue these cards. However, in the event of a customer defaulting on the payments, the loss would be shared between Uni and DMI Finance, an NBFC (Non-Banking Financial Company). RBL Bank and SBM Bank, as issuers of the card, would not be directly affected by the default.
WHY THERE IS A NEED TO REGULATE BNPL SERVICES IN INDIA?
BNPL services enable people to access loans easily and have smoother regulatory compliance but it involves a lot of challenges and risks which have now come under RBI’s radar.
Financial institutions, including banks and NBFCs, are subject to stringent capital adequacy requirements and are required to conduct KYC checks before granting loans.
On the other hand, some PPI operators may not be subject to the same level of regulatory oversight and standardized KYC and underwriting standards. This can lead to varying risk levels and potential challenges in assessing creditworthiness.
To address this disparity and promote a more consistent and regulated lending environment, RBI aims to streamline even small ticket-size loans through regular banking channels. The RBI aims to curtail operations that allow unsecured lines of credit, especially for NBFCs, which may carry higher risks. Through such measures, the RBI seeks to ensure better risk management, customer protection, and overall stability in the lending ecosystem. This approach aims to minimize the potential risks associated with unsecured lines of credit and promote a more regulated lending environment for the benefit of both borrowers and lenders.
Another reason why RBI is concerned about BNPL services being outside the purview of standard regulations is FLDG or “First Loss Default Guarantee,” which is an arrangement where a digital partner, underwrites a certain portion of the risk associated with loan defaults. In this arrangement, if a borrower defaults on a loan, the digital partner would bear the initial losses up to a specified amount, while the remaining risk would be absorbed by the lender or financial institution.
Following the Covid-19 pandemic, there has been an increase in loan defaults, which has brought the FLDG arrangement into question. One of the concerns raised by regulators is that digital partners, who provide the first loss guarantee, may not be subject to the same regulatory capital buffer requirements as traditional financial institutions.
Regulatory capital buffer requirements are established to ensure that financial institutions maintain a sufficient level of capital to absorb losses and withstand financial shocks. These requirements are intended to safeguard the stability of the financial system and protect depositors and borrowers.
The discomfort of regulators with the FLDG arrangement stems from the fact that digital partners, being outside the regulatory capital buffer requirement, may not have the same level of financial resilience or accountability as regulated financial institutions. In the event of a significant increase in defaults, the ability of digital partners to absorb losses and fulfill their guarantee obligations could come into question.
To address this concern and ensure a level playing field, regulators may consider imposing regulatory oversight or capital adequacy requirements on digital partners participating in FLDG arrangements. This would subject them to similar standards as traditional financial institutions, enhancing overall risk management and safeguarding the interests of borrowers, lenders, and the financial system as a whole.
Other grey areas concerning BNPL services involve these companies charging enormous late fees and interest rates from people without proper transparency regarding it. As a result of such a lack of transparency, the borrower does not get to know who the lender is and, in many instances, the terms and conditions are vaguely explained. Moreover, cases of identity theft and poor data protection measures by the companies have also caused damage to public perception regarding BNPL services.
Therefore, regulation of these services is the need of the hour but these regulations should not hurt innovation as well.
WHAT IS THE RECENT RBI NOTIFICATION ON BNPL SERVICES?
On June 20, 2022, the Reserve Bank of India (RBI) issued directions to non-bank PPI issuers to discontinue the practice of loading their PPIs through credit lines. This directive was aimed at addressing concerns related to unregulated lending practices and reducing the potential risks associated with unsecured lines of credit provided by PPI issuers.
The current framework categorizes PPIs as payment systems, and they are not explicitly authorized to offer credit or loan facilities. The recent directive from the RBI is in line with its previous clarification in December 2020, which highlighted that public lending activities should be undertaken only by banks, registered NBFCs, and other state government-regulated statutory bodies.
Given the regulatory framework and the RBI’s caution against unregulated digital lending platforms, there is a possibility that the recent directive affects PPIs partnering with banks as well. This is because the framework for issuing credit cards clearly states that only banks and, soon, NBFCs with prior approval from the RBI can issue credit cards.
However, it is essential to note that the precise impact on PPIs partnering with banks would require further clarification from the RBI.
Moreover, the present directive seeks to minimize a potential credit pile-up for retail customers (which can ultimately affect the user’s credit score) and reduce the risk of NPAs on the books of NBFCs and banks.
However, the abrupt disruption of BNPL services has caused concerns among industry participants regarding the lack of predictability and uniformity in the fintech regulatory space as it has been criticized for not providing clarity to existing BNPL customers who have already availed such credit arrangements. Additionally, there is no grace period mentioned in the circular for the termination of these arrangements. This lack of clarity and sudden change adversely affects the customer base of PPI operators.
Industry bodies such as the Payment Council of India, the Digital Lenders Association of India, and the Fintech Association for Consumer Empowerment have raised these concerns and have sought clarifications from the RBI. They have also requested a sunset clause of at least a year, which would provide a reasonable timeframe for PPI operators to adjust their business models and comply with any new regulations that may be introduced.
WAY FORWARD AND CONCLUSION
In conclusion, it can be noted that BNPL services can play a crucial role in expanding access to credit and promoting consumer convenience. However, the concerns regarding systemic safety and consumer protection must be addressed before allowing this model to operate at scale. To enable the sustainable growth of BNPL services, it is crucial to establish clear regulatory frameworks that provide consumer protection, enforce transparency with respect to terms and conditions, and address potential risks associated with unsecured lending. This would involve setting standards for underwriting, risk assessment, dispute resolution, and disclosure practices. Thus, striking a balance between financial inclusion and consumer protection is paramount.
Author(s) Name: Shailja Vikram Singh (Law Center-1, Faculty of Law, Delhi University)
