Future Of Buy Now Pay Later In India: The Regulatory Road Ahead
What is the Buy Now Pay Later scheme?
The E-commerce sector has grown exponentially in the past decade. The customer base of these platforms sees year-on-year growth. However, not all consumers possess the same purchasing power. Therefore, in order to move small consumer goods, Fintech companies have introduced Buy Now Pay Later schemes. This is also called “Point of sale credit.” These loans are short-term and often interest-free. They allow the user to make a purchase with a minimum down payment and pay the remainder in equal monthly installments.
How does BNPL work?
Before moving any further, we must understand that different Fintech companies have different BNPL models, and all of these models are only applicable to online purchases. The only thing common in all these models is the “point of sale credit.” Here is how a typical BNPL model works:
- To avail of the BNPL facility, you must complete the KYC by selecting the BNPL option in your profile.
- Once you complete the profile, you will receive a credit balance based on your credit score. You can use this credit to buy products online.
- You go to the retailer’s website and select the product within the credit range and click on checkout.
- On the checkout page, you will see an option of Buy Now Pay Later. By clicking on this option, you will agree to pay the amount in agreed-upon installments interest-free.
- You can then redeem your credit limit by paying the amount via UPI or Debit Cards.
Important terms associated with BNPL
Buy Now Pay Later has a fairly complex backend mechanism. For consumers, it is a blessing because there are no hidden charges, no interest, and no complicated paperwork. But it is crucial to understand the arrangement operating in the background. Here are some important terms associated with BNPL that we often come across:
Prepaid Payment Instruments
Prepaid Payment Instruments are defined by RBI in the guidelines provided under Payment and Settlement Systems Act, 2005. According to this definition, PPIs are such payments of instruments that can be used to purchase goods and services. The value reflected in these instruments is equivalent to the value paid by the holder using debit cards, credit cards, cash, or other PPIs. Additionally, PPIs can also be used for fund transfers and financial services. In August 2021, RBI issued a master direction to regulate the Prepaid Payment Instruments. In terms of para 7.5 of RBI Master Directions on Prepaid Payment Instruments (PPIs), PPIs can only be loaded or reloaded by cash, debit to a bank account, or debit/credit cards. Recently, RBI issued a statement where it directed the Fintech companies (non-bank PPI issuers) to not load their wallets via credit lines. These Fintech companies provided BNPL services by loading the credit in the consumer wallet.
Currently, three BNPL models where wallets are loaded via credit lines are under the RBI scanner.
- Where wallets are loaded in the same manner as that of credit cards.
- Where the operator obtains the loan and provides it to the PPI issuer.
- Where the PPI holder gets the loan.
The term “shadow bank” was first coined in 2007 preceding the great crisis of 2008. It refers to the non-banking financial institutions that engage in the activities of commercial banks, such as maturity transformation but are not covered under traditional regulations. Shadow banks raise funds from the money market and inject them into long-term mortgages. Since they are not regulated as commercial banks in the country, they provide attractive partnership opportunities to the Fintech companies. Fintech companies are merely intermediaries that are termed as non-banks by the RBI. Therefore, these companies act as a third party that facilitates the lending between an NBFC and the PPI holder. The larger issue at hand here is that, unlike commercial banks, an NBFC cannot borrow money from the RBI. Hence, there is a risk of no money recovery in case a large volume of PPI holders becomes an NPA. To mitigate this risk, NBFCs enter a First Loss Default Guarantee with the Fintech companies providing BNPL services. Under these agreements, the Fintech companies agree to cover a certain percentage of the default amount. Currently, the financial risk at the national level is not alarming because loans under BNPL are for very short amounts. Still, the ease of procuring BNPL loans has started a borrowing trend among consumers (especially in the age group of 18-24) and increased the purchasing power, which has sparked concerns within the RBI.
Overview of RBI Working Group Report On Digital Lending
On 18th November 2021, RBI released the Report of the Working Group on Digital Lending including Lending through Online Platforms and Mobile Apps. Let’s take a brief look at some of the key issues addressed by RBI relating to digital lending, which also provides a picture of the regulatory road ahead for new-age Fintech companies:
- Buy Now Pay Later: In the said report, RBI finally provided the definition of BNPL services as deferred payment services at the time of purchase in predetermined installments.
- Legal and Regulatory Recommendations:
- Short-Term: For the short term, RBI recommended that balance sheet lending should only be done by entities that are regulated and authorized by RBI or any such entity authorized to undertake lending business. This is crucial to bring clarity as to who assumes the risk in digital lending. In case of the balance sheet lending, the platform disburses the loan directly to the consumer and assumes complete credit risk.
- Medium-Term: The working group also recommended that the government should bring an effective legislative framework to protect consumers’ interests and protect them against fraudulent or illegal lending activities.
- Technological recommendations:
- Standard baseline technology should be a precondition before signing an agreement with lending service providers.
- The server location of the Fintech companies offering BNPL or digital lending services should be in India.
- Digital lending definition: The working group report did not provide a comprehensive definition of digital lending. The report cited its concerns about the evolving nature of digital lending vis-a-vis financial services technology. However, for the immediate purpose, reliance has been placed on the “FinTech Credit” definition put forth by the Financial Stability Board. FinTech credit means “credit activity facilitated by electronic platforms whereby borrowers are matched directly with lenders.” This is the closest definition of digital lending according to the working group report.
- Key Regulatory Recommendations vis-a-vis BNPL:
- i) Impose restrictions on Balance Sheet Lending through Digital Lending Applications by entities entitled under the law to carry out the lending business.
- ii) Loan servicing should be entered directly into the account of the balance sheet lender. Similarly, disbursement of the loan amount should be made directly into the bank account of the borrower.
- iii) Borrowers who are the holders of fully KYC PPIs shall be eligible for loan disbursement.
- iv) Setting up of an independent authority, Digital India Trust Agency, which will verify the Digital Lending Applications.
- v) GOI should bring legislation regarding the storage of consumer data.
- vi) Data collected by Digital Lending Applications to be stored on servers located in India.
Effect on BNPL market players
RBI’s working group report acknowledges the feasibility of the Buy Now Pay Later models. According to the report, digital lending will lead the way in the future because of untethered consumer inclination. However, RBI has also issued directions to a few FinTech companies that load their consumer’s PPI wallets using credit lines from NBFCs. RBI, in the instant case, noted that FinTech companies are non-banks and there is strict regulation regarding the loading source of PPI wallets.
FinTech companies are not entitled under the RBI Master Directions on Prepaid Payment Instruments (PPIs) to load their PPI wallets using credit lines. RBI in its communication to these companies stated that NBFCs that lend their arms for such credit transactions cannot track the end-use of the credit they are disbursing using Digital Lending Applications. This move from the RBI will adversely affect some FinTech companies that use the credit line business model for BNPL.
The working group report recognizes different lending models and has tried to understand their functioning in the report. The report has recommended the government of India bring legislation so the digital lending scenario can be regulated in the country with ease and clarity. As of now, the start-up FinTechs are in a tough position because the legality of their business model is constantly under RBI’s scanner.
The future, however, of BNPL in India is bright because it increases the purchasing power of online consumers, thereby, helping in the development of the e-commerce industry in India. Currently, the FinTech companies should ensure strict adherence to the provisions under the Payment And Settlements Systems Act, 2005 along with the regulations provided under RBI Master Directions on Prepaid Payment Instruments to avoid any penalties.
BNPL’s impact on the economy
BNPL business models and FinTech companies promoting them are here to stay. The pandemic period brought significant changes in consumer behavior and technological exposure. Before the pandemic, consumers had little faith in online payment mechanisms via UPI. However, due to the distancing protocol, UPI soon became a standard mode of payment in the country. This also brought a revolution in the realm of financial inclusion.
Similarly, jobs became uncertain during the pandemic, which helped in the rise of BNPL models. People wanted an inexpensive way to defer payments while purchasing goods.
BNPL is a line of credit that does not charge any hefty interest to its consumers. There is only a penalty that is levied when the consumer misses a payment. Moreover, there is no complex paperwork to apply for BNPL. We just have to complete our online KYC and we are good to go. These are the primary reasons that have contributed to the exponential growth of BNPL FinTech companies.
However, BNPL still remains a double-edged sword. While BNPL is a good way to ensure financial inclusion and boost businesses, there is still a risk of delinquent payments that reflects on the balance sheet of the lenders. Currently, FinTech companies offering BNPL services have caused market disruption for traditional players.
The automation technology that manages risk, assesses credit and verifies consumer information has ensured greater market penetration. However, as the reach of these companies will grow, the volume of delinquent payments will grow, which can have a snowball effect on the Indian economy.
Therefore, this is high time to regulate the digital lending sector to protect the interest of young consumers who are unaware of the liabilities under the line of credit. Once the regulatory framework is in place, BNPL models will help boost the Indian economy.
The digital lending sector saw rapid growth in 2020 globally, which piqued the interest of Governments. The primary concern with BNPL that has been cited is the increasing debt tendencies in the consumers. Additionally, the majority of BNPL users are young and do not understand the financial risk associated with the line of credit. Therefore, government interference has started to ensure that there are no fraudulent activities going on under the garb of digital lending.
In India, non-banks cannot provide digital lending services on their own so they partner with NBFCs. The NBFCs provide a line of credit to the consumers that are deemed fit for BNPL services. However, easy access to credit means that there will be an increase in delinquent payments, which will put the NBFCs under pressure. Now, unlike traditional banks, NBFCs cannot approach the central bank in case of a deficit. Therefore, the government and the RBI must step in and lay down a proper legal framework regarding digital lending in India.
This will also help new FinTech start-ups in devising a sustainable business model vis-a-vis Buy Now Pay Later Services. Additionally, there is also a need to educate consumers about the financial repercussions of these services so they can make an informed decision. The onus is on the RBI to lay down regulations to prevent predatory lending in India. These are nervous times for FinTech companies in India because the regulatory framework has started to take shape, and we may soon have a robust legal framework regarding digital lending in India.
Author: Pushpam Raj,
Dr. Ram Manohar Lohia National Law University, 2022