Investors eye RBI move to regulate P2P lending

The online industry and e-commerce have acted as a game-changer, affecting the nature and dynamic of sectors including transportation, retail, hospitality, etc. It is now perhaps set to do the same to the financial sector. The Reserve Bank of India (RBI) in its Consultation Paper on Peer to Peer Lending released on 28 April (paper), while recognizing this potential, has proposed a framework with the goal of “developing an appropriate regulatory and supervisory toolkit that facilitates orderly growth of this sector so that its ability to provide an alternative avenue for credit for the right kind of borrowers is harnessed.” Facilitating (without participation) transactions between borrowers and lenders is the primary business of P2P platforms (platforms), though some offer credit assessment, payment monitoring services, etc.

RBI’s proposal: Many borrowers without access to traditional credit facilities due to the limited outreach and high transaction cost of credit institutions are forced to rely on the unorganized money-lending sector, which would change if this paper matures. The RBI proposes that platforms register as non-banking financial companies (NBFCs) and suggests a suitable leverage ratio to prevent platforms from expanding with indiscriminate leverage (which may fetter their business model, one that precludes taking liabilities onto their own balance sheets). While the requirements for a physical presence in India and fresh criteria for key managerial personnel of platforms seem positive, suggestions to limit a lender’s maximum contribution to borrowers/segments, minimum and maximum rates chargeable by lenders and KYC compliance (which will aid in preventing money-laundering) will help in stabilization.

Requiring a minimum of ₹20 million (US$295,000) capitalization and prohibiting guarantees on assured returns, etc., would alleviate the system in the long term, although in the short term, it may reduce the appeal of the sector for investors. Also, various state governments have enacted legislation to regulate the conduct of “money-lenders”, which would affect individual lenders registered on platforms. Since platforms will have users from different states, a balance on compliance with RBI regulations and different state laws is needed.

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FDI in P2P platforms: Although the RBI has proposed classifying platforms as NBFCs to bring them under its regulatory ambit (because the RBI views it as a form of financial services), most existing Indian platforms perform no business functions that fall within the scope of any of the 18 activities under clause 6.2.18.8 of the extant foreign direct investment (FDI) policy. There remains a lack of clarity as clause 6.2.18 provides that FDI in financial services other than those listed therein requires government approval.

In light of this uncertainty, the RBI/government could consider treating these platforms as a separate business (though still connected with the financial services sector as an ancillary business) without a sectoral cap and separate conditions attached to safeguard the interest of borrowers and lenders registered on the platforms. Alternatively, since the intent is regulation, these platforms may be treated as e-commerce companies operating under the marketplace model where 100% FDI is allowed under the automatic route since the current business models in India seem to fall under this category as per press note 3 of 2016. However, since this could conflict with the RBI’s proposal of having management and operational personnel stationed within India (which may not be the case in a 100% foreign owned and controlled company), specific guidance is needed.

Currently, existing platforms may not fall under any specific sector under the FDI policy and would be able to access 100% FDI under the automatic route. Since platforms are essentially aggregators, as they progress, they will want to access FDI to scale up operations and offer a wider range of services (such as assessment of transaction suitability, monitoring of borrower payments and soft-debt recovery). Therefore, clarity on the FDI norms applicable to platforms is required.

The RBI has done a commendable job in both identifying the risks and potential associated with India’s nascent P2P sector, and attempting to regulate a hitherto unorganized sector which has seen significant growth. However, other factors should be considered before the promulgation of the final regulations (expected by December) lest it smother this emerging sector. Industry reactions seem to be largely positive as this move will clear the air on compliance by platforms. Criticisms of the paper centre primarily on the redundancy of prescribed leverage ratios and high minimum capitalization requirements.

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Luthra & Luthra Law Offices is a full-service law firm with offices in Delhi, Mumbai, Bangalore and Hyderabad. Dipti Lavya Swain is a partner and Advait Nair is an associate at the firm. The views of the authors are personal. This article is intended for general information purposes only and is not a substitute for legal advice.