This post is a response to the YourStory article - Is RBI over-regulating by allotting online platforms additional responsibilities?

The gist of the article is that the RBI is overreaching by imposing capital and regulatory requirements to a nascent and developing P2P lending industry. Since my startup is related to the same space, I have some perspectives on the same.

Harini makes a good point that it is generally a good idea to not overregulate certain segments. For example, the Monetary Authority of Singapore not only provides financial support to fintech startups, but it has also committed to not interfere until startups reach a certain size.

However, I also feel that RBI is not being unfair when it is imposing certain regulations on this sector. For example, requirement for P2P lending startups to be NBFCs. It is easy to call these requirements “absurd”, but if we look at the worldwide standard around lending platforms - there is precedent to imposition of volume based financial resources requirement. For example the UK based FCA imposed the following constraints for any crowdfunding platform (including P2P)

  • 0.2% of the first 50 million pounds of total loans issued and outstanding;

  • 0.15% of the next 200 million pounds of total loans issued and outstanding;

  • 0.1% of the next 250 million pounds of total loans issued and outstanding; and

  • 0.05% an any remaining balance of loans issued and outstanding.

Interestingly, these constraints came as a consequence of several rounds of back and forth between startups and the FCA. Now, the NBFC rules in India impose a static 2 crore holding requirement.. which I would argue is much more lenient than the volume based approach of the UK government. The financial watchdogs of the UK have a much more stringent  corporate governance code than in India. Perhaps most people are not aware that NBFCs are still available for sale in India for black money (just like you would sell real estate) as a way to escape scrutiny by the people who eventually end up controlling the NBFC.

The objection to the “no assured returns” clause is a little puzzling to me - the RBI has rightfully mandated that just like stocks or mutual funds, nobody should claim a certain assured return. The reason that P2P platforms may stoop to promise assured returns because of investor pressure or the need to make quarterly numbers. It would not be surprising for a platform to run TV ads asking to “give a loan on Platform-Z and get guaranteed interest rates of 100%”. It is precisely the reason that ULIPs were regulated - because their promise of returns never accounted for “management fees”.

Now both the above points, combine to form a logic to see why the third point makes sense: The objection to word “expansion” - the logic is exactly what the FCA in Britain put across. That, you need to maintain a certain leverage ratio for the cash on hand and cash lent out. This is direct consequence to the behavior in China where uncontrolled expansion and leverage led to P2P platforms wiping out billions of dollars of capital. The way this worked was very simple - it was effectively Ponzi borrowing because of “assured returns”. Ezubao promised unrealistically high “guaranteed returns” (seven times the bank rate). To fund these returns which it had to pay its early investors, it went and promised even higher returns to new investors… that it used to pay back older investors. This is why the RBI is rightfully mandating a leverage ratio to prevent Ponzi mechanisms.

As far as clarifications on related party transactions are concerned - these are not banned by the government. The govt only says that related party transactions must not be at terms that are not normally offered. What everyone may not be aware of is that, by making the NBFC requirement as mandatory, the RBI has already taken care of that - via notification RBI/2013 - 14/57. This notification makes it amply clear that Net Owned Funds of NBFC are reduced by giving them out to

  • subsidiaries

  • companies in same group

  • other NBFC

An online platform does not evolve transparency in a vacuum - lending companies are risk centres and the central bank has a duty to not let one become a chain reaction meltdown. These regulations make a whole lot of sense for the overall health of the new age lending ecosystem in India and will catastrophic events like the Ezubao event.

What I do support Harini over is that the govt of India needs to take the same approach as the Monetary Authority of Singapore - treat fintech companies as a sort of “SEZ” and let them grow unhindered until they reach a scale when it becomes mandatory to regulate them.

And regulate them we should.