Financial inclusion has been improving rapidly in the country as evidenced by the Reserve Bank of India’s financial inclusion index which has grown from 43.4 in March 2017 to 60.1 in March 2023. A confluence of factors has contributed to this, such as Aadhaar, Jan Dhan and UPI payments, proliferation of smartphones and an increasing number of internet connections. Non-banking finance companies (NBFCs) and fintech lenders (who procure clients for banks and NBFCs and act as third party loan service providers) have played an important role, especially since the pandemic.

The first report by the Centre for Advanced Financial Research and Learning (CAFRAL) on NBFCs highlights the critical part played by them and fintech companies in improving last mile connectivity in bank credit, while highlighting the potential risks in this space. Digital lending by fintech companies has democratised access to credit greatly over the last few years. This growth should be nurtured, while addressing regulatory gaps. There have been several unsuccessful attempts over the years to wean borrowers away from usurious moneylenders and move them towards the formal banking system. Now, the role of the government in the ongoing transition is restricted to providing the digital infrastructure; the shift is occurring primarily due to changing habits of the population. The CAFRAL report shows that fintech NBFCs lending to young borrowers has increased 100 times since 2015, due to the increased digital usage by the youth. There has been a spurt in NBFC credit to rural areas. The growing outreach of fintech lenders is also driving consumption, with the market share of NBFCs growing 1.8 times in retail loans, between 2015 and 2022. Only 2 per cent of bank lending takes place through digital channels whereas around 12 per cent of NBFC lending is through the digital route.

While the report talks about systemic risk due to increased linkage between NBFCs and banks, the regulatory tightening after the IL&FS episode in 2018 has reduced such risks. The RBI’s scale based regulations, dividing NBFCs based on size, activity and risk, have ensured that the largest NBFCs, falling in the top and upper layer, are subject to regulations that are as stringent as on banks, including the application of the PCA (prompt corrective action) framework. Also, despite the rapid growth, digital lending is still quite small in comparison with conventional lending.

It’s good that the central bank has used light-touch regulation of digital lenders so far. Stipulating that the loan repayments should be done only in the accounts of the regulated entity such as banks or NBFCs ensures that client funds are not handled by digital lenders. The RBI has also laid down disclosures to be made to borrowers regarding the terms of the loan contract to deter hidden charges. As the usage of such digital channels grows, the RBI should consider creating a regulatory framework for fintech lenders, while giving them room to grow.

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