Digital lenders wary of RBI scrutiny of new-age underwriting algorithms


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RBI said such algorithms should be available for regular audits to eliminate discriminatory practices.

By Salman SH

Several digital lenders have raised concerns about the banking regulator’s proposal to regulate the proprietary underwriting algorithms they use.

The Reserve Bank of India (RBI) recently issued recommendations to introduce a new set of regulations for digital lenders. Primarily, the banking regulator has sought to differentiate between balance sheet lenders (BSLs) and loan service providers (LSPs).

BSLs include authorized digital lenders who own an NBFC and therefore take direct risk by lending money from their own balance sheets. LSPs include digital lenders who act as loan outsourcing partners by partnering with regulated banks and NBFCs. However, since language service providers do not necessarily take risks and do not lend from their own balance sheet, they are not subject to more stringent regulatory oversight.

Lately, several dishonest app-based lenders that operate on the outsourced LSP model have been subjected to the regulator’s scanner for lending money at outrageous interest rates of 60-70% and more. After the Covid-19 pandemic wreaked havoc in the country, several borrowers reportedly turned to these lenders for quick cash.

But many borrowers who couldn’t repay on time were subjected to predatory tactics from dishonest lenders who had unrestricted access to the borrower’s phone contacts, call logs and through the mobile app. . Debt collectors allegedly used these common contacts to shame the borrower and get him to pay back. Several news reports in early 2021 pointed out that such tactics led to suicides and that state police, including Telangana, Haryana and Kerala, hammered down dishonest lenders. The RBI has already identified over 600 of these digital lenders who have been able to tap into demand from Android and iPhone app stores.

Akshay Mehrotra, co-founder and managing director of consumer loan app EarlySalary, told FE dishonest lenders charge exorbitant interest rates to absorb risk as many of them lend to consumers with low or no credit scores.

“This is the wrong way to run a loan business. You cannot give loans to 100 people and expect to get money back only from 50 of them and charge high interest rates. This is something that RBI is trying to solve by trying to protect the end consumer from borrowing money from institutions that don’t care about consumer safety, ”Mehrotra added.

One of the main recommendations made by the RBI last month was to end this threat by regulating loan cash flow from lender to borrower. The regulator said all loans must be repaid directly to a bank account owned and maintained by the balance sheet lender. Additionally, RBI said that loan disbursements should always be made to the borrower’s bank account. The other suggestion also included setting up a public registry of verified lenders maintained by a hub body.

“Clear specifications on the flow of money ensure any intermediary business that managing cash money for a client does not also arise as a lender. Loans require both short and long term management of funds, and miscalculations carry high systematic risks. The rules on the flow of money ensure the safety of customers and the company in the long term, ”said Anurag Jain, founder of KredX and executive committee member of the Digital Lenders Association of India.

In addition, the RBI also sought transparency on the proprietary algorithms used by digital lenders to secure the risk of a potential borrower. Traditionally, banks underwrite loans using tangible collateral, but lately the new generation of digital lenders have developed underwriting algorithms that use sensitive user data and other online fingerprints left by borrowers. RBI said such algorithms should be available for regular audits to eliminate discriminatory practices.

“RBI wants to ensure that new age underwriting algorithms are fair and non-discriminatory, as lenders should not discriminate against certain segments or types of consumers, especially on the basis of gender, etc. This is in fact a fair request, but such algorithms are in fact confidential company information and may include proprietary technology that lenders may not want to publicly disclose, ”said Adhil Shetty, CEO of the company. Bankbazaar online loan marketplace.

EarlySalary’s Mehrotra, which processes over Rs 250 crore in monthly loans using such proprietary algorithms, said new-age underwriting can help digital lenders not only underwrite risk, but also predict capacity. repayment of borrowers who are new to credit.

“One of our variables used in the algorithm includes how a user interacts within our application itself… If a user quickly moves around the touchscreen with multiple clicks during a loan request, we assign a negative score to the borrower. So we understood that users who are too agitated when applying for loans do not necessarily repay on time, ”added Mehrotra.

Buy Now Pay Later (BNPL) lenders rely heavily on these algorithms, and the RBI has also taken an in-depth look at this new category of digital lenders. Currently, BNPL service providers like LazyPay, Simpl, ePayLater, and others are not legally classified as credit products because they charge zero interest rates with a 15-30 day repayment period.

RBI estimates show that around 0.73% of scheduled commercial banks and 2.07% of NBFCs are exposed to BNPL loans in terms of the amount disbursed in fiscal 2021. The regulator seeks to change this by seeking potentially creating a new framework for BNPL products and classifying them as credit services.

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