Zeta founder Bhavin Turakhia has long held a unique view on fintech in India. He believes that startups need to separate fin and tech because these two sides of the fintech coin are vastly different from each other.
In March this year, Turakhia tweeted, “Banking is fundamentally about “risk management” above anything else. What is (incorrectly) perceived as the RBI’s heavy handedness against fintechs is infact [SIC] an opportunity for founders to leverage tech to reduce risks, improve governance, and enhance compliance.”
This week, the RBI’s action against heavyweights in the non-banking financial companies (NBFC) space has once again turned the focus on how fintech startups need to deal with regulators and vice versa. The Reserve Bank of India directed Sachin Bansal’s Navi Finserv, DMI Finance, Arohan Financial Services and Asirvad Micro Finance to immediately stop sanctioning and disbursing loans due to supervisory concerns.
The four NBFCs have up to close of business on October 21, 2024 to manage the fallout from this RBI action, but essentially, this has thrown a huge spanner in the digital lending ecosystem. Among fintech founders, there’s a defeated feeling, with many claiming that startups have to continuously play catch up with regulators.
Why The RBI Acted Against NBFCs
As per the RBI, the pricing policy of these NBFCs for the Weighted Average Lending Rate (WALR) and the interest spread charged over the cost of funds were found to be excessive and not in adherence with the regulations.
WALR is calculated by multiplying the interest rate for all individual loans with the loan balance and dividing this figure by the total loan balance.
Besides this, the central bank claimed their lending operations were “not in conformity with the provisions laid down under Fair Practices Code”. The central bank added that the four NBFCs were involved in unfair and usurious practices, which were noticed during onsite examinations as well as from the data collected and analysed by the RBI.
The RBI also said, “Deviations were observed in Income Recognition & Asset Classification (IR&AC) norms, resulting in evergreening of loans, conduct of gold loan portfolio, mandated disclosure requirements on interest rates and fees, outsourcing of core financial services, etc.”
While most commenters have picked up on RBI’s usage of usurious practices in relation to the interest rates, those in the fintech and lending ecosystem believe that there are several other compliance hurdles that may not be publicly discussed by the RBI.
Many founders have lashed out against the so-called opacity in RBI’s actions. A similar sentiment was heard during the January 2024 action against Paytm Payments Bank, which disrupted Paytm’s UPI and lending business for months.
Will Digital Lending Feel The Heat?
Ever since the troubles for Paytm in the past year, there has been an industry-wide transition in the digital lending space. Across the board, digital lenders have looked to diversify their lending partnerships with multiple NBFCs and registered lenders furnishing the funds. With four NBFCs being asked to stop lending operations, many fintech companies would be left scrambling for partners.
In particular, RBI’s claims that such platforms have been charging usurious interest rates means that other lenders would feel compelled to reevaluate their lending partnerships in the short and medium term.
One side effect of these changes is that lending platforms are finding it harder to raise funds. Take MSME lender Lendingkart, for instance, where existing investor Fullerton Financial Holdings acquired a controlling stake after a cash crunch forced the company to look for investors at a lower valuation, due to challenges in the unsecured loans market.
Indeed, DMI Finance is one of the biggest lending partners in the digital distribution and co-lending space, having partnerships with the likes of Google Pay, Samsung for their distribution businesses, as well as lenders such as Moneyview.
It also operates its own DMI Finance app for personal loans, MSME business loans as well as consumption loans on purchases of durables and large appliances from a host of partners. DMI Finance also acquired ZestMoney earlier this year, and got exclusive right to use ZestMoney’s brands. DMI Finance became a preferred lender on ZestMoney’s BNPL platform after the transaction.
Then there’s Navi Finserv, which offers personal and home loans through the Navi app. Navi’s AUM increased 44.6% YoY to INR 11,366 Cr in FY24, and then to INR 11,724 Cr in Q1FY25. According to India Ratings, the NBFC’s personal loan portfolio accounted for INR 10,439 Cr of this loan book, with the home loan portfolio at INR 1,285 Cr growing 3X from Q1FY23, two fiscals ago. About 50% of the personal loans disbursed by Navi are pre-approved, which means it is primarily targeting customers with a good credit score.
For the home loans business, Navi has adopted a co-lending strategy, with five separate partners as of June 2024.
Incidentally, the RBI’s action against Navi came a few days after the NBFC announced the completion of a $24.5 Mn loan securitisation transaction with Goldman Sachs (India) Finance Private Limited, the NBFC arm of Goldman Sachs in India. Goldman Sachs is the seventh multinational bank to lend to Navi Finserv and the securitisation deal covers unsecured personal loans, originated and serviced by Navi Finserv.
Besides these two majors that work primarily with fintech players and on the digital lending front, there will be some systemic impact from the action on Arohan Financial Services and Asirvad Micro Finance as well.
But does RBI’s mention of usurious lending mean that these platforms are charging interest rates much higher than allowed?
As per analysts and lending startup founders, interest rates on digital loans can climb up to 35%-40% per year, depending on the borrower’s credit profile. Banks and NBFCs typically partnered with fintech startups because of their strengths in digital distribution. But such arrangements might be put on hold for the time being.
“Co-lending, where multiple NBFCs are used to distribute loans, has been a key business growth driver for fintech startups and one of the ways that these startups are hedging their risks. Larger NBFCs will potentially look to revisit deals and special tie-ups with startups after the recent RBI action,” the founder of a Delhi NCR-based lending platform told Inc42.
In fact, a lot of these interest rates are decided based on the borrower profile as well as these special arrangements between NBFCs and lending apps.
Regulatory Disruption Is A Way Of Life
Those in the industry believe that the signs were there for everyone to read. It’s not the first time that the RBI has come down hard on digital platforms. For well over two years, public pressure has been mounting on the central bank to act on complaints related to predatory lending, aggressive recovery and collection tactics and poor underwriting models for digital lending platforms.
In March this year, brokerage Bernstein said that while the broader household credit has largely grown in line with the system credit growth, consumer loans have grown at a much more rapid pace, which foreshadows heavier regulatory scrutiny. The share of personal loans to banking credit has almost doubled from 16% in 2014 to around 32% in 2024.
This surge in unsecured loans during and after the pandemic had led to such unscrupulous practices and unauthorised lending platforms.
“The RBI has never shied away from regulating. There was the disruption for SBM and its fintech partners in April 2023, then in November, the RBI increased the risk weight for consumer credit. Then came Paytm in January 2024, followed by the crackdown on NBFC-P2P lending in August this year,”a Bengaluru-based VC fund manager told Inc42.
Founders and investors believe that these were all signs of things to come, and no startup can claim to be unaware of what would happen if regulations are not followed. “It all depends on how you view compliance and how you balance it with fintech innovation. They go hand-in-hand, founders need to realise that compliance is not an option, but a necessity,” a Pune-based digital lending platform’s CEO said.
On the other hand, critics of RBI’s move believe that it’s not the action itself but the lack of clarity on the rationale or the principles behind the action. Many pointed out that the RBI has not clearly stipulated what interest rates are usurious, for instance.
But Gautam Sinha, CEO of Loantap, said the regulator is continuously engaging with stakeholders and is training them on various aspects related to compliance. “The RBI has always been more concerned about systemic risks, and the interest of the majority i.e the consumers and businesses using banking and financial services. In the RBI’s view, it cannot allow exceptions for startups just because they are innovating.”
Sanjay Swamy, managing partner at Prime Venture Partners, which has backed fintech startups such as Freo, Niyo, kredX and FinAgg said it’s not easy to build a fintech business, and that’s by design. “There are no get rich fast schemes. But there are huge problems to solve in fintech, and if one takes the long-term view, there will always be meaningful and large companies to be built,” he added
Will Secured Loans Rescue Digital Lenders?
So where does the lending ecosystem go from here? For one, many startups are eyeing a move towards secured lending as a way to move forward.
Paytm CEO Vijay Shekhar Sharma said in May this year that the fintech giant will focus on secured lending business as a growth vertical. “We are trying secured loans also, as a part of our experiments. We are integrating a couple of secured credit lines, especially for small merchants, micro LAP (loan against property) makes a lot of sense,” Sharma said at the time.
On the same lines, PhonePe, listed giant Paisabazaar, CRED, Volt Money and others are also eyeing secured loans as a way to hedge against regulatory risks. But secured loans are easily the biggest opportunity for those with an existing base of borrowers. However, it might require a review of the risk profile of these borrowers.
The likes of PhonePe, Paisabazaar, CRED and Paytm are banking on the growing mutual funds market for loans against securities. But the pace that startups typically take up for new products or features is sometimes at odds with regulators. Even when it comes to secured loans, as the market grows and as more players come in, there are likely to be several regulatory hurdles.
Investors insisted that startups cannot choose to interpret regulations in their own way and then cry foul about the regulator taking action. Unfortunately for Navi and DMI Finance, the RBI’s action could very well set them back several quarters.
“Compliance is not a moat, it’s actually oxygen. Non-compliance is the death knell,” Prime VP’s Swamy told Inc42.
