The Reserve Bank of India (“RBI”) has recently released ‘Guidelines on Digital Lending’ vide notification bearing reference number RBI/2022-23/111 DOR.CRE.REC.66/21.07.001/2022-23 dated September 2, 2022 (“Guidelines”). Accordingly, please refer to certain important factors to be noted under the Guidelines:
1. Applicability – The Guidelines are applicable from its date to all the existing customers availing new loans and as well as to new customers. However, the Guidelines have deferred applicability to ‘existing digital loans’ as on the date of the Guidelines, and have accordingly provided a time period till November 30, 2022, to put in place adequate systems and processes to ensure that existing digital loans sanctioned as on the date of the Guidelines are also in compliance with the Guidelines in both letter and spirit.
2. Loss sharing arrangement in case of default – The Guidelines specifically state as following: “As regards the industry practice of offering financial products involving contractual agreements such as First Loss Default Guarantee (FLDG) in which a third party guarantees to compensate up to a certain percentage of default in a loan portfolio of the RE, it is advised that REs shall adhere to the provisions of the Master Direction – Reserve Bank of India (Securitisation of Standard Assets) Directions, 2021 (“Securitisation Guidelines”) dated September 24, 2021, especially, synthetic securitisation contained in Para (6)(c)”. Further, the Guidelines define ‘synthetic securitisation’ as “a structure where credit risk of an underlying pool of exposures is transferred, in whole or in part, through the use of credit derivatives or credit guarantees that serve to hedge the credit risk of the portfolio which remains on the balance sheet of the lender”. It should be noted that as per Para 6 (c) of the Securitisation Guidelines, lenders, including overseas branches of Indian banks, shall not undertake synthetic securitisation. Accordingly, if literally interpreted, any form of risk transfer by a lender to a third party, while retaining the pool of loan on its book, is not permitted. Therefore, a question arises whether this prohibition also extends to scenarios where a regulated entity is the thirty party? In relation to this, the working group on digital lending vide its report dated November 18, 2021, had only recommended prohibiting first loss default guarantee structures where credit risk is shared by unregulated entities and not regulated entities. Also, in a press release on recommendations of the working group on digital lending on August 10, 2022, RBI had accepted the same in-principle but noted that it will require further examination.
3. Loan Disbursals, Co-Lending and Prepaid Payment Instruments (“PPI”) – Under Paragraph 3 of the Guidelines, RBI has stated that regulated entities (“RE”) shall ensure that all loan servicing, repayment, etc., shall be executed by the borrower directly in the RE’s bank account without any pass-through account/ pool account of any third party. The disbursements shall always be made into the bank account of the borrower except for disbursals covered exclusively under statutory or regulatory mandate (of RBI or of any other regulator), flow of money between REs for co-lending transactions and disbursals for specific end use, provided the loan is disbursed directly into the bank account of the end-beneficiary. Accordingly, RBI has taken another action for prohibiting disbursement of loans to a PPI. In relation to this, it should be noted that on June 20, 2022, RBI had clarified that PPI master directions do not permit loading PPIs from credit lines whereby industry of co-branding credit card models took a hit. Further, as noted above, RBI has created an exception for co-lending transactions for indirect disbursements. However, RBI has only recognised co-lending transactions covered under RBI’s circular on Co-lending by Banks and NBFCs to Priority Sector dated November 5, 2020 (“Co-Lending Circular”). Accordingly, those co-lending transactions which are covered by Co-Lending Circular shall be exempted from the restriction on flow of funds to a third-party account. In relation to this, it should be noted that, the said restriction will still apply for other co-lending arrangements, like those between NBFC and NBFC as well as those for non-priority sector loans.
4. Concept of loan service provider (“LSP”) – LSP has been defined as an agent of an RE who carries out one or more of lender’s functions or part thereof. Accordingly, even if one function i.e., for example, of lead generation is carried out by an entity for a lender, the same shall qualify as a LSP for the purposes of these Guidelines and accordingly, all the provisions with respect to a LSP has to be adhered to. Interestingly, one of the new obligations on a LSP is to have a nodal grievance redressal officer to deal with FinTech/ digital lending related complaints/ issues raised by the borrowers.
5. Digitally signed documents – The Guidelines under Clause 5.3 state that REs shall ensure that digitally signed documents (on the letter head of the RE) shall automatically flow to the borrowers on their registered and verified email/ SMS upon execution of the loan contract/ transactions. It should be noted that digitally signed documents are defined to mean a document signed using digital signature. Digital Signature is defined under Section 2(1) (p) of the Information Technology Act, 2000 (“IT Act”) as authentication of any electronic record by a subscriber by means of an electronic method or procedure in accordance with the provisions of section 3 of the IT Act. Section 3 (2) of the IT Act states that authentication of the electronic record shall be effected by the use of asymmetric crypto system and hash function which envelop and transform the initial electronic record into another electronic record. Accordingly, RE should ensure compliance of the same and should procure necessary digital signature certificates.