[Jeezan and Aakash are students at National Law Institute University, Bhopal.]
Selling goods and services on credit is an age-old idea. For the most part, it appears to be a win-win situation for the buyer and the seller. Since buyers need not worry about the necessary resources needed within a stipulated timeframe, on the other hand, the sellers are most happy when they are able to clear out their stock much quicker. In recent years, several fintech companies in India have developed products to cater to this segment of the market. However, an RBI short circular address issued on 20 June 2022 (not uploaded to the RBI website) seems to restrict or strictly regulate, by reiterating its bank vs non-bank position, the credit flows.
In India, several fintech firms in this segment have structured their products using the pre-paid instruments (PPIs) to their benefit. Some of these popular products are often dubbed as ‘buy now, pay later’ options available across a variety of e-commerce portals wherein the instrument itself is issued by a partner who holds a PPI licence and it is loaded by the credit from another partner typically a bank or a non-banking financial company (NBFC). For instance, let us take the example of cards issued by X. It has partnered with Y (Bank), which holds a valid PPI license, for the purpose of issuing cards. Now, X uses its quadrillion finance strategy by asking the partnered NBFC to load credit in the card instead of approaching the formal credit structures, i.e., the financial institutions. This structure involves several players contributing to making available credit products that cater to the simple needs of a customer.
However, what the RBI’s recent diktat essentially does is to rule out NBFCs from extending credit by narrowly interpreting the provisions contained in the master directions on PPIs to hold that such loading cannot be permitted since only cash, debit or credit cards, PPIs (as permitted) and other payment instruments issued by regulated entities in India is allowed. In simple words, the RBI has sought to disrupt the existing structures as aforementioned to clearly demarcate between the bank credit and non-bank credit over PPIs. The post intends to analyze the RBI’s master direction on PPIs while scrutinizing the validity of the fintech spaces and the ever-expanding partnership model between NBFCs and fintech companies.
Bank v/s Non-Bank Credit
Back in the day, availing of credit was strenuous as it was out of the reach of the poorer section of the society and the student community in general; therefore, in order to bridge this aperture, NBFCs were established. The bequest of NBFCs in supporting the economic activities has been colossal and their role as a derivative channel of credit arbitrament alongside banks is well acknowledged. This is because if an individual possesses a card, and cannot load money into their wallet, the same shall be taken care off by the NBFCs, giving a hassle free facility of availing of credit. Herein, the facility in terms of credit, provided by the NBFCs would not come from a bank but from a revolving line of credit, which has been disapproved by the RBI.
The logic behind the RBI’s emphasis on the separation of bank and non-bank credit can be traced to the fact that bank credit usually is availed after taking into account factors such as collateral or a person’s credit history or worthiness to pay back the secured amount. In contrast, the non-bank credit line is a predetermined borrowing limit. Such credit lines allow for flexibility as one can access credit at any time, as per need and give the borrower a levy to tap a straight line of credit for its intended use.
NBFCs also provide for regulatory support as loading of money through a revolving line of credit was recognized by the RBI in Prudential Framework for the Resolution of Stressed Assets and accordingly is permitted to issue all categories of prepaid payment instruments, provided it meets the requisites laid down by the RBI. But now, the RBI is keen on regulating PPIs with security over flexibility in mind. Therefore, if a customer is not in a position to repay the amount, the onus is on the NBFC and not the partnered bank to ensure that the debts are not accumulated in the economy.
Effect on Products such as BNPL
With credit percolating and the fintech companies permeating liquidity into the market, RBI has become skeptical of such an orchestration, and accordingly discredited the ‘buy now, pay later’ (BNPL) model. The circular does not restrict funding PPIs through credit cards but credit lines, as many fintech companies offering BNPL products are funded through receipts, availed from a revolving line of credit, specifically an NBFC, even though it is beyond comprehension as far as now, whether or not the intention of the RBI is to allow funding PPIs through credit lines, approved and authorized by banks.
This comes against the backdrop of the emergence of BNPL companies in the fora which usually partner with traditional banks (some market examples include SBM, RBL and IDFC) to issue PPIs (including physical cards) and further partner with NBFCs to load amounts in the wallet over a credit line. As a consequence, now the BNPL companies find themselves in a pickle since they would have to reimagine the existing structures with credit only flowing from the banks and without the involvement of NBFCs in such an equation.
The banks will have to step up their role in this partnership for the sake of the survival of such structured BNPL companies. However, as mentioned earlier, several factors such as security or a person’s creditworthiness determine the scope of availing of formal bank credit. Therefore, BNPL companies that typically aim to facilitate very short-term minor amounts of credit might not be in a position to fully address their existing market requirements with formal bank credit into the equation.
Social Impact of This Move
The RBI does not allow setting up neo-banks or fully digital banks without the appropriate blend of physical and digital infrastructure. The opposition comes from negating the human touch from the design. Therefore, neo-banks can operate only by the way of an outsourcing arrangement. In such a structure, they only provide an interface and undertake initial steps, which is ultimately backed by the credit from the banks and non-banks under supervision and control the reserve bank.
Interestingly, RBI seems that there is a strong backing for this sort of banking arrangement. Quoting the present RBI Governor Mr Shaktikanta Das, “the existing architecture is sufficient to enable existing players to leverage the innovations.” He went on to comment that BNPL companies should be approached carefully without causing interference. Incongruously, this view is in stark contrast to what the reserve bank has done in the instant case.
Not only has the RBI put restrictions on the concerned fintech companies from leveraging the existing infrastructures to its benefit for building scale, but it has also restricted the flow of credit to such ‘uncreditworthy’ sections of the society. Such sections that are largely kept out of the formal credit system earlier found access to minor credit for purchases. It is anticipated that in India, the BNPL industry would flourish as the number of users could rise to 80-100 million by 2026, as compared to 10-15 million customers currently. However, the issuance of bank credit instruments such as credit cards has not kept up with the credit appetite.
Therefore, this move has not only dented an industry quickly working to create innovative products to cater to this market, which is predicted to grow up to 7% of the total retail GMV by end of FY 2026 but also affected the poorer section of the society, who will have to go back to the hassles of the formal credit lending structures as RBI wanted the economy to do away with “no credit loaded cards through a revolving line”.
Conclusion with Remarks
The fintech space in India has a steep potential to bank the unbanked but the sharp pull from the RBI has disrupted the entire status quo of these spaces as loading of wallets through credit lines. The main drawback of the findings of the RBI is premised on the growing partnership between fintech companies and NBFCs.
In a similar vein, RBI is telling the ecosystem that innovation can only be brought about by the banks and not non-banking financial institutions, which is a serious concern amidst the ever-expanding fintech space. Therefore, in light of the same, RBI curbs innovation as a lot of the private equity and venture capital monies have come into the fintech space in the last few years. Even the delinquent ratio (used to characterize a financial institution’s lending portfolio) in terms of ticket lending of these NBFCs or PPIs is preposterously low as compared to the big corporate loans. If such an overly precautionary approach continues in India, then she will eventually be losing out on fintech advancements and will lag behind the techno-powerful markets of China, America and the European Union.