Lack Of Transparency To Dodgy Underwriting Models: Why Is RBI Wary Of BNPL Industry?

‘Buy Now, Pay Later’ (BNPL) businesses are caught in a regulatory cauldron now. The Reserve Bank of India (RBI) has disallowed non-bank PPI issuers from loading their prepaid instruments (PPI) such as wallets through credit lines. This particular RBI move, a section of BNPL players fear, could toll the death knell for them.

The central bank has further said the BNPL model needs to be examined and guidelines framed for this relatively new product in the lending space. 

In its Payments Vision 2025, the RBI said, “BNPL services have developed into a new payment mode alongside the existing payment modes like cards, UPI, and net banking. This channel, facilitated by a few payment aggregators, leverages the existing nodal account (escrow account after authorisation) to route payments between a BNPL customer and a merchant. This novel method shall be explored.”

The twin moves – restrictions on PPI and proposed BNPL guidelines – have put the cat among pigeons. When contacted by Inc42, not many were willing to offer their comments as they were still contemplating their action plans in the aftermath of the RBI directive. 

As BNPL Gains Popularity, Complexities Too Grow

Instant disbursal, convenience, low interest rate, short tenure and small ticket size made BNPL a favoured loan product, particularly among Gen-Z customers.

BNPL has been around for the last few years or so. In this model, fintech players, with their digital prowess, connect financiers (typically NBFCs) with merchants/customers. As it requires little or no paperwork, BNPL gained instant acceptance among borrowers of small amounts. The model got wider acceptance in travel and tourism, edtech, high-end consumer items, etc. which involve larger loan amounts. Along the way, BNPL turned a little complex and opaque and the model came under the lens of the RBI.  

“The fintech payment and the lending space have grown in the last few years. Multiple fintech players have come up with exciting products to offer the credit at perusal of the customers. The new BNPL credit-line card products are directly challenging the credit card segment of banks. These credit lines are offered by NBFCs but on prepaid instruments like cards and vouchers,” said Ajay Chaurasia, head of product at digital lending platform RupeeRedee.

What perhaps made the RBI take a more serious note of the BNPL model was FLDG or ‘First Loan Default Guarantee’. FLDG is an arrangement under which a certain portion of the risk is underwritten by the digital partner. With a rise in defaults in the aftermath of Covid-19 pandemic, FLDG came into question. The regulator was uncomfortable because digital partners were outside the regulatory capital buffer requirement.

“Banks and NBFCs are well-equipped in terms of credit underwriting, collection infrastructure and ensuring compliance. The lender-fintech partnership needs to utilise respective strengths and complement each other. NBFCs should utilise their strength in underwriting, collection and compliance rather than transferring risk to fintech,” said Pallav Jain, co-founder and CEO of ShopSe.

If adequate risk assessment is not done, the fintech companies run the risk of engaging into lending practices which may lead to higher risks in the ecosystem, he added. 

BNPL Is Like An Education Loan, It Is Unpredictable

BNPL is still to be understood as a concept as a whole. As a top executive of a private bank observed, the concept is basically to induce consumerism. But from the lenders’ point of view, the puzzle is how to assess the ability and the intent of a borrower to pay back the loan later.

Drawing a parallel with education loan portfolio, which is a “mixed experience across the banking system”, he said students are given a moratorium during their studies and this moratorium is further extended by a year after completing their studies.

“Yet, you do not find many honest borrowers who come back and pay. They just vanish. If there are defaults in education, which is close to the Indian psyche, you can imagine in consumables.” 

BNPL Per Se Is Not The Problem, But Grey Areas Are

According to Chaurasia, the RBI doesn’t seem to have a problem with BNPL per se. He said that BNPL products like Bajaj Finserv and HomeCredit have been around for a long time now. BNPL products at PoS are also not a problem, he said, adding that the RBI’s focus primarily is on grey areas of BNPL operations.

Chaurasia said the RBI’s apprehensions could be on the following points:

• Credit line card issuance with 0% or no interest for three months
• Credit line of INR 1 Lakh to INR 10 Lakh on prepaid instruments like cards
• Regulatory compliances for KYC and process of issuance
• Income-debt ratio for consumers offering a huge credit line to customers.

The central bank has said that even though the amount disbursed under BNPL loans is only 0.73% (SCBs) and 2.07 per cent (NBFCs) of the total amount disbursed, the volumes are quite significant.

Tighter regulations are definitely going to come, said Chaurasia. “We can already see the change in product done by a few BNPL card players post RBI’s notifications to PPI licence holders,” he added.

Better Transparency Is Need Of The Hour

The BNPL model, since its inception, has received both bouquets and brickbats. It faced the maximum criticism for the lack of transparency. The borrower never knew who the lender was. The borrowing terms and conditions were not always made clear upfront to customers. Identity theft of customers too marred its image. Slack KYC compliance by shady operators only compounds the problems. It is now widely expected that the proposed RBI guidelines would address these core issues.

“By focusing on the tech angle and eliminating risks, the regulatory body is trying to incorporate transparency into the lending ecosystem and avoid customer debt trap,” Jain said.

According to Chaurasia, a majority of BNPL credit-line products are offered at zero percent or minimal interest because the cost is either covered by the shopping brand via subvention or well-funded companies take a hit.

An RBI working group study had earlier said, “The (BNPL) platforms do take creative steps once a loan turns to NPA, including post-facto creation of a loan on the books of NBFC. RBI must clearly re-define what constitutes credit so as to classify BNPL as a loan and hence bring it under regulatory coverage.” It had also recommended bringing BNPL within the definition of credit.

The philosophy of the BNPL should be to protect the interest of the end consumer. The system and transaction should be transparent, providing customers clear knowledge about the financier approving the limit, terms of the loan, charges involved, among others, said Jain.

As the RBI is planning to frame guidelines on BNPL products, the regulator should find ways to address the challenges faced by BNPL companies. “These products are boon for customers and if the RBI can give some relaxation to both BNPL players and customers it would be a win-win for both,” Chaurasia said.

Fintech-NBFC Tie-Up Should Look At Smarter Underwriting Models

The RBI is aware of the industry and the practices required to maintain ecosystem stability. It aims to ensure the right kind of collaboration between fintech and NBFCs. As Jain said, fintech is the tech layer between the lender and customer. Fintech companies will have to ensure transparency and convenience at the point of credit disbursal while leveraging expertise of lenders in risk assessment and collection.

“Today, the number of data points which can be collected has increased multifold with smart use of technology. Both players should look at a partnership where these data points and insights can be used to build smarter underwriting models which may be more effective than traditional risk policies,” Jain said.

The present system calls for building transparency and operating within the regulation. BNPL needs to move in the direction of balancing convenience and transparency while operating within the regulatory framework.

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