By Salman S H
Several digital lenders have raised concerns over the banking regulator’s proposal to regulate proprietary underwriting algorithms used by them.
The Reserve Bank of India (RBI) recently put out recommendations to bring in a fresh set of regulations for digital lenders. Primarily, the banking regulator has sought to differentiate between Balance Sheet Lenders (BSLs) and Loan Service Providers (LSPs).
BSLs include licensed digital lenders who own an NBFC and therefore take a direct risk by lending money from their own balance sheets. LSPs include digital lenders who act as loan outsourcing partners by tying up with regulated banks and NBFCs. However, since LSPs don’t necessarily take on risks and don’t lend from their own balance sheet, they don’t come under greater regulatory scrutiny.
Lately, several rogue app-based lenders who operate on the outsourced LSP model came under the regulator’s scanner for lending money on exorbitant interest rates of 60-70% and above. After the Covid-19 pandemic brought havoc in the country, several borrowers reportedly turned to these lenders for quick cash.
But many borrowers who were unable to repay in time were subjected to predatory tactics by rogue lenders who had unfettered access to the borrower’s phone contacts, call logs, and through the mobile app. Recovery agents reportedly used these common contacts to shame the borrower into repayment. Several news reports in early 2021 pointed out that such tactics have led to suicides and state police including Telangana, Haryana, and Kerala hammered down on rogue lenders. The RBI has already identified more than 600 such digital lenders who were able to tap demand from Android and iPhone app stores.
Akshay Mehrotra, co-founder and chief executive of consumer lending app EarlySalary told FE that rogue lenders charge exorbitant interest rates to absorb risk since many of them lend to consumers with low or no credit scores.
“That’s not the right way of doing running a lending business. You cannot give loans to 100 people expecting to only recover money from only 50 of them by charging high interest rates. This is something that RBI is trying to address by trying to protect the end consumer from borrowing money from institutions that don’t care about consumer safety” added Mehrotra.
One of the key recommendations made by RBI last month sought to end this menace by regulating the cash flow of loans from the lender to the borrower. The regulator said that all loans must be repaid directly into a bank account owned and maintained by the balance sheet lender. Furthermore, RBI said that loan disbursements must always be made into the bank account of the borrower. The other suggestion also included setting-up a public registry of verified lenders maintained by a nodal body.
“Clear specifications on the flow of money ensures any intermediary firm, managing money cash for a customer does not also pose as a lender. Lending requires both short term and long-term management of funds and miscalculation has high systematic risks. Rules on flow of money ensures safety of both customers and the firm in the long run,” said Anurag Jain, Founder of KredX and Executive Committee member of Digital Lenders Association of India.
In addition, the RBI also sought transparency on proprietary algorithms employed by digital lenders to underwrite the risk of a potential borrower. Conventionally, banks underwrite loans using tangible collateral but lately, the new breed of digital lenders have developed underwriting algorithms that make use of sensitive user data and other online footprints left by borrowers. RBI said that such algorithms must be available for regular auditing to weed out discriminatory practices.
“RBI’s want to ensure that new-age underwriting algorithms are fair and non-discriminatory, because lenders shouldn’t discriminate against certain segments or certain types of consumers especially basis on gender, etc. It is in fact a fair ask but such algorithms are in fact confidential company information and may include proprietary technology that lenders may not want to potentially disclose publicly,” said Adhil Shetty, CEO, of the online lending marketplace Bankbazaar.
Mehrotra of EarlySalary which processes over Rs 250 crores in monthly loans using such proprietary algorithms said that new-age underwriting can help digital lenders not just underwrite risk, but also predict the repayment ability of borrowers who are new to credit.
“One of our variables used in the algorithm include how a user interacts within our app itself…If a user moves through the touch screen with multiple clicks in a fast-paced manner while applying for a loan, we assign a negative score to the borrower. So we have figured out that users who are too fidgety while applying for loans don’t necessarily pay back on time,” added Mehrotra.
Buy Now Pay Later (BNPL) lenders heavily depend on such algorithms and the RBI has also taken a deep look into this new category of digital lenders. Currently, BNPL service providers such as LazyPay, Simpl, ePayLater and others are not legally classified as credit products since they charge zero interest rates with a 15-30 days repayment period.
RBI’s estimates show that around 0.73% of scheduled commercial banks and another 2.07% of NBFCs have exposure to BNPL loans in terms of the amount disbursed in CY2021. The regulator is seeking to change this by potentially looking to create a new framework for BNPL products and classifying them as credit services.