India: One Size Fits All? Regulating Peer-To-Peer Lending Platforms

Technological innovation is the new normal in the financial services sector. The evolution of every aspect of this industry in the past few years has been truly transformational, whether it is access to funds, demand creation/aggregation or even payment systems. The inception and growth of peer-to-peer (P2P) lending platforms in India is one such example. P2P platforms effectively function as an online marketplace for lenders and borrowers, for a commission. A need for regulatory oversight was considered by the Reserve Bank of India (RBI), given the recent rise in the number of such operators and their integration into the financial services sector.

The RBI outlined its proposal to regulate such platforms in its consultation paper issued last year. Following notification on August 24, 2017 categorising P2P lending platforms as Non-Banking Financial Companies (NBFCs), the RBI has finally issued its widely anticipated master directions on October 04, 2017 (Master Directions).

What does the RBI seek to regulate?

Briefly, as per the Master Directions:

• It is now mandatory for entities proposing to undertake this business to be registered as 'NBFC-P2P Lending Platforms' with the RBI (NBFC-P2P). To ensure business continuity, existing players have been given a period of three months to apply for this licence. Applicants will be scrutinised for scalable and secure technological capabilities, financial standing as well as fit and proper management.
• Fundamentally, the NBFC-P2P is expected to operate only as an intermediary and not undertake any lending activities itself or hold any funds of its participants (lenders or borrowers) on its books. Towards this end, an escrow mechanism for movement of funds has also been envisaged.
• The exposure of each lender and loans (not exceeding a three year maturity period) availed by each borrower across all NBFC-P2Ps has also been capped at INR 10 lakhs, with each borrower not permitted to avail more than INR 50,000 per lender.
• In addition, directions also prescribe that NBFC-P2Ps adopt minimum standards of transparency, disclosure requirements and fair practices.

Introduction of this framework according a regulatory status to P2P lending platforms, is expected to bring much-needed legal clarity with respect to operation of these platforms and may lead to wider acceptance of this concept amongst lenders and borrowers alike. However, the regulatory framework as it stands today appears to be fairly stringent – the RBI may need to probe into it further.

Impact on Aggregators

• To the extent P2P lending platforms are servicing individuals and/or unregulated entities, there is merit in regulating such operators to contain any systemic risks. However, there are existing players in the market who primarily service regulated financial institutions (viz. banks and NBFCs) as lenders. The Master Directions fail to recognise this distinction. In the latter case, given that the lender participant is independently required to adhere to its respective regulatory requirements (viz. KYC, recovery process, etc.), the need for a P2P operator to mandatorily obtain a registration and consequently comply with laws that apply to NBFCs may not be entirely justified and will result in excessive regulation and impact operational costs.

• Separately, banks and NBFCs today use distribution channels including web-based loan aggregators. These are online technological platforms that allow borrowers to compare loan products of those banks and NBFCs that partner with the aggregator operating the platform. These primarily focus on secured loan products including home loans, car loans, equipment and other business loans in addition to other financial products such as credit cards. In this regard, it is relevant to note that the term 'P2P Lending Platform' has been defined under the Master Directions to mean "an intermediary providing services of loan facilitation via online medium or otherwise", which is arguably wide enough to include these web-based loan aggregators. However, given the construct of the Master Directions (especially the restriction on NBFC-P2P to not facilitate any secured lending, capped exposure of the lenders and borrowers as well as the escrow based funding structure) it appears that this is an unintended consequence. If not, it will be impracticable for such aggregators to align their business model with the prescribed requirements.

• Additionally, from the standpoint of potential applicants, further clarity may also be required in relation to the following:
  • While the NBFC-P2P will be given flexibility to determine the eligibility criteria for its participants, the term 'participant' has been defined to mean a 'person' who enters into an arrangement with an NBFC-P2P. Further, the operational guidelines refer to participants as 'individual' lenders and 'individual' borrowers. It is unlikely that the RBI seeks to curb institutions from accessing this platform entirely. That said, further clarity from the RBI may be helpful to address this ambiguity.
  • The escrow mechanism that has been prescribed under the Master Directions contemplate that these will be operated through trusts promoted by the escrow banks. Whilst the rationale for this layer of arrangement with a trustee, is not set out in the framework, it is perhaps driven by the objective to further isolate the P2P lending platform from operation of the escrow accounts and management of funds. That said, this mechanism may add complexity (to an otherwise simple process expected by the participants being small lenders and borrowers) and also result in increased operational costs, till such time cost efficient structures are adopted as market practice evolves.
  • Further, the framework as it stands today does not clarify whether it will allow existing funding arrangements availed through P2P platforms to continue. These may have to be modified to bring them in line with the prescribed mechanism. Alternatively, these arrangements may have to be wound down. That said, the regulatory position on acceleration of repayments is also not set out in the Master Directions.
  • Separately, existing players who are currently not operating under a company structure, may require longer than the prescribed three-month window to restructure and transition their existing businesses prior to making an application.
  • Also, unlike other NBFCs, an NBFC-P2P will be required to seek approval of the RBI in case of 'any change' in shareholding coupled with the right to nominate a director. To this extent, acquisition of stakes in an NBFC-P2P appears to be more stringent in comparison to the legal framework dealing with cases of acquisition and transfer of control of NBFCs in general. Given that NBFC-P2Ps will have no access to funds and cannot undertake lending activities, the rationale for stricter regulation is unclear.

Conclusion

In other jurisdictions, stricter supervision of such platforms may be necessary given their significance and systemic risks. However, given that this sector in India is still nascent and requires a flexibility to further evolve, on balance, the industry was anticipating a more "light touch" regime. Notwithstanding, the Master Directions are a well-intended move by the RBI as P2P lending platforms can no longer exist in a state of lawlessness.

Legal recognition of this sector will encourage setting up of more platforms and consequently enable lending at competitive rates. It may also enable start-ups to raise capital from investors who previously steered clear from investing in this sector. Relaxations, for instance caps on lender and borrower exposure etc., may give further impetus. However, it remains to be seen how market practices will evolve within the contours of the prescribed requirements.

* This piece was co-authored by Gazal Rawal, Principal Associate, with assistance from Rishi Ray, Associate

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