India’s central bank is asking banks to submit a report on the various agreements they have with fintech companies, The Hindu Businessline reported on March 14.
“The purpose of this report is to pinpoint certain critical aspects of the contracts, such as which entity has the ultimate ownership of the customer, whether the full responsibility of assessing the customer credit worthiness lies with the bank, fintech, or split between the two, and who is ultimately bearing the credit risk of the contract. In short, the objective is to ascertain whether the bank has full control of the underwriting process before onboarding the customer and would bear the credit risk in full, in case of defaults,” the report stated citing unnamed sources.
Why does this matter: The Reserve Bank of India (RBI) appears to be checking adherence to the digital lending guidelines issued last September. These guidelines were issued to curb “unbridled engagement of third parties, mis-selling, breach of data privacy, unfair business conduct, charging of exorbitant interest rates, and unethical recovery practices,” RBI remarked back then.
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Why is RBI examining contracts: RBI could be looking at contracts between banks and fintechs to specifically check for compliance with the following three requirements of the digital lending guidelines:
- Lending can only be done by regulated entities: The digital lending guidelines state that regulated entities (banks, NBFCs) can engage with fintechs that act as lending service providers or digital lending apps, but the actual act of lending money and receiving repayments can only be carried out by the regulated entities and not any third-party fintech companies.
- Risk sharing arrangement between banks and fintechs: Fintechs and banks get into agreements to share the risk of lending. A popular risk-sharing method is the First Loss Default Guarantee (FLDG), whereby the fintech compensates lenders if the borrower defaults up to a certain amount. For fintechs, “offering FLDG acts as a demonstration of its under-writing skills whereas from the lender’s perspective, it ensures platform’s skin in the business,” an RBI working group report explained. Following this report, the RBI, in its digital lending guidelines, stated that regulated entities that engage in FLDG arrangements must adhere to the provisions of the Master Direction – Reserve Bank of India (Securitisation of Standard Assets) Directions, 2021. RBI could be checking for adherence to these directions.
- Banks are responsible for the conduct of fintechs: The digital lending guidelines also state that it is the responsibility of the regulated entities (banks, NBFCs) to ensure that the lending service providers and digital lending apps engaged by them comply with the guidelines.
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