The RBI has made fintech guarantees legal, but only to the extent of 5 per cent. This implies banks/NBFCs will exercise due diligence and not take too much exposure to high-risk loans, while fintechs too will not take undue risks
It is good to note that the Reserve Bank of India (RBI) has acceded to a long standing ask of the fintech industry and approved default loan guarantee arrangements, after being averse to it earlier. By way of background, in the fintech-driven lending ecosystem, fintech ‘loan service providers’ (LSPs) source customers for banks and NBFCs (‘regulated entities’ or REs), and secure a commission in return, while also ‘guaranteeing’, to varying degrees, the credentials of these potential customers.
The risks here are self-evident: the due diligence of banks/NBFCs could be put to the test in the face of a generous guarantee; this is despite the fact that banks have to formulate a policy for underwriting these digitally sourced loans. The RBI has put in place a defined regulation, after being uneasy about this issue. The fact is that fintech lenders are also performing a public good — of bringing the hitherto unbanked into the formal system. Besides, all fintechs cannot be tarred with the same allegation of identifying consumers and guaranteeing their credentials merely because of the commissions to be earned in the process. Hence, the RBI has made fintech guarantees legal, but only to the extent of 5 per cent. This implies that banks/NBFCs will exercise due diligence and not take too much exposure to high-risk loans, while fintechs too will not take undue risks. This amounts to a loss-sharing formula, wherein the global big guns in fintech too will be subject to regulatory oversight. With the digital lending portfolios growing exponentially, the RBI has rightly entered the fray with its rules on ‘first loan default guarantees’ without adopting a heavy-handed approach.
However, the loss guarantee related arrangements will need fine-tuning to deliver sustained benefits over the years. The limit of 5 per cent for the loss guarantee arrangements will need to be reviewed since the bad loans of most of the LSPs are over 7 per cent of their loan books; there could be a case for upward revision in this limit. Also, many LSPs already have informal synthetic securitisation arrangements, wherein the credit risk is transferred to another entity through credit derivatives or credit guarantees. It’s to be seen whether RBI’s rules requiring LSPs to disclose information on total loan portfolios and amount of each portfolio on which default loss guarantee has been offered, curb these pre-existing arrangements.
The costs and pricing model of LSPs need to be closely watched. They may not absorb the cost of guaranteeing the loans entirely, but price it in the product. As such, there is a huge difference between the lending rates offered directly by regulated entities and those sourced through LSPs. The difference is largely on account of LSPs focusing on new customers who don’t have proven credit history. While it is true that allowing LSPs to guarantee default losses brings them under the regulatory lens, it could also translate into much higher loan costs. The regulator should be vigilant in this regard.
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