Steering Committee Report on Digital Lending: Issues and Solutions

[Richa Saraf is a Legal Advisor at Vinod Kothari Consultants Pvt. Ltd.]

The Department of Economic Affairs has recently released the Report of the Steering Committee on Fintech Related Issues, which discusses the various issues faced by fintech companies. This post seeks to focus on the issues pertaining to online lending, and the recommendations offer by the Steering Committee to address the same.

Verifying the Authenticity of User

The Reserve Bank of India (RBI) already provides for guidelines on Know Your Customer (KYC), specifies Originally Seen and Verified (OSV) norms, and lays down conditions for non-face to face KYC. In fact the e-KYC process was simplified with the advent of Aadhaar. However, the Aadhaar verdict of the Supreme Court has adversely affected the fintech industry, and the Steering Committee has observed that there is a need to explore alternatives for physical KYC. The Committee has made key recommendations in this regard, as discussed below.

Offline Authentication Process

Lately, smartphones are equipped with biometric enabled multi-factor authentication; therefore, technology may deployed for the purpose of KYC and authentication of the user. Some fintech companies have already come up with various unconventional modes of KYC, such as video-based KYC and obtaining validated electronic versions of KYC-related documents through DigiLocker. As an additional layer of protection, authentication of the user can also be carried out by sending a one-time password (OTP) at the registered mobile number of the user, or by using geo location, which indicates the IP address of the user. The Committee has also recognised some of these options in its discussion paper, provided the same is subject to prior customer consent.

Central Data Registry

In light of the representations made by various stakeholders, the Committee has expressed that e-KYC has the potential to reduce customer on-boarding and servicing costs significantly, and it has, therefore, recommended that all financial sector regulators fix deadlines for on boarding existing KYC data to the Central KYC registry, thereby transforming KYC into a completely digital and paperless process.

Other Non-traditional Ways of Data Exchange

The discussion paper also mentions the usage of the Application Programme Interface (API), for facilitating real time information sharing. India Stack is one such API, where digital records move with an individual’s digital identity, eliminating the need for massive amount of paper collection and storage.

Determination of Borrower’s Creditworthiness

The Steering Committee has noted how the unbanked are often unable to access credit due to the lack of formal credit history or non-availability of significant information or documents. The following are the key recommendations in this regard:

Data Sharing in the Finance Industry

The Committee believes that APIs must be used for cloud storing of data, and the same should be open in order to ensure equal access to all those who wish to build upon or rely on this data. For instance, an India Agri Stack can be built such that lenders can evaluate the creditworthiness of agricultural borrowers. This stack can include a farmer’s borrowing history, land ownership data, income data, among other information. Additional APIs to facilitate research and the creation of applications may include: government departments and local government bodies’ unified stack; land registry and state land records; ownership, fitness, loan, or mortgage enforcement records to provide transparency to transactions; and so on. Further, the India MSME Stack may be built for MSME financing related data.

Digitisation of Land Records

The Digital India – Land Records Modernisation Program is aimed at national integration of all land related data across the country in order to provide conclusive titles, including details such as characteristics of the land, mortgages, encumbrances, ownership and other rights, etc., enabling financial services companies to make informed decisions about lending.

Reliance on Informal Modes

Fintech companies are using a variety of sources for collecting customer information and advanced data analytics to access customer credibility, for instance obtaining data from social media usage, web browser history, financial transaction behaviour, product purchase behaviour, etc. from the mobile phones of prospective borrowers. Some companies are also resorting to psychometric tests to build the customer’s profile.

For agri-loans specifically, to access the credit score of a borrower, it is suggested that companies use a permutation and combination of the alternate data which may be available, such as weather forecasts and records, agronomic surveys, accessing the demographic, geographic, financial and social information of the customer, farmer progressiveness and such like. Referring to a Chinese agricultural fintech company Nongfenqi, which generates credit scores on the basis of interaction with customers’ business partners, fellow customers and villagers, the Committee has observed that the default rate in such model is merely 0.1%. In order to increase access to credit and to stabilise the growth of such practices, the Committee has recommended that Ministry of Economics and Information Technology (MEITY) and the Telecom Regulatory Authority of India (TRAI) formulate a policy to enable such practices through a formal, consent-based mechanism.

Usage of Artificial Intelligence (AI)

AI affords an opportunity to gain insight into customer behaviour pattern, thereby aiding in determination of their creditworthiness. Equifax is one credit information agency, which gives potential lenders an overall insight on the borrower’s credit health through neuro decision technology. It claims to predict the likelihood of a business incurring severe delinquency, charge-off or bankruptcy on financial accounts within the next 12 months. Vantage Score Solution, which claims to predict the likelihood of the borrower repaying the borrowed money, also used AI to develop a model for people with thinner credit profiles. The Steering Committee has also recognised AI for modernising the credit scoring methodology and approach.

Execution of Agreements Online

Fintech entities have been vigorously using the e-mode for entering into transactions; for instance, providing app-based loan, on a click. While one may contend that click-wrap agreements are prone to fraud, since the user is not known and, thus, cannot be relied upon, such may the case in any mode of execution. Quite often in litigation it is not uncommon for parties to challenge the authenticity of agreement, claiming that the acceptance by mail was not sent by them, or that the signature is forged. While physical signatures may be examined by way of forensics, it is difficult to verify whether a click- wrap agreement was actually entered into by the parties or was a mere mistake on the part of either of the parties.

While e-agreements are generally held as valid and enforceable in the courts, for high stake transactions, parties have apprehensions on the enforceability in case of default of loan or non- compliance of any of the terms and, therefore, they still insist on wet signatures on physical agreements. The Steering Committee has discussed the re-engineering of legal processes for the digital world. The Committee suggests that insistence on wet signatures on physical loan agreements be replaced by paperless legal alternatives, as these can enable cutting costs and time in access to finance, repayment, recovery, etc., for businesses and financial service companies. To achieve the goal of paperless economy, the requirement of physical loan agreements are unwanted. The Committee has, therefore, recommended that the Department of Legal Affairs should review all such legal processes that have a bearing on financial services and consider amendments permitting digital alternatives in cases such as power-of-attorney, trust deeds, wills, negotiable instrument, other than a cheque, any other testamentary disposition, any contract for the sale or conveyance of immovable property or any interest in such property, etc., (where Information Technology Act is not applicable), compatible with electronic service delivery by financial service providers.

Other Recommendations on the Lending Industry

Enhancing Competition by way of Referral Pool

The Committee recommends that all financial sector regulators may study the potential of open data access among their respective regulated entities, for enabling competition in the provision of financial services. The RBI may encourage banks to make available databases of rejected credit applications available on a consent-basis to a neutral marketplace of alternate lenders. In line with the Open Data Regulations in the UK banking sector, the Committee further recommends that RBI may consider making available bank data (such as transaction and account history data) to fintech firms through APIs.

Data Privacy Risks

The Committee notes that the data sharing between entities is also subject to privacy laws, and while the Ministry of Science and Technology has already formulated the National Data Sharing and Accessibility Policy, and MEITY is the nodal Ministry to implement the policy, the same needs wider acceptance and implementation. The Committee has further recommended that a taskforce in the Ministry of Finance may be set up with the participation of the regulators and suitable recommendations may be made to safeguard the interests of consumers.

The Committee has expressed its view that the provisions of the Data Protection Bill, 2018 may have far-reaching implications on the growth of fintech sector and it has, therefore, recommended that regulators should urgently review the existing regulatory framework with respect to data protection and privacy concerns, in keeping with emerging data privacy legislation in India.

Richa Saraf

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