Reserve Bank of India's (RBI) clarification that prepaid payment instruments (PPIs) like e-wallets and prepaid cards may not be allowed to extend credit through these instruments, forms part of an overall tightening of digital financial services regulation. While the regulatory changes will challenge the operations of some financial technology start-ups, it would result in a more stable and robust fintech industry over time, says Fitch Ratings.
In a report, the rating agency says, "The clarification may hit the business plans of a number of fintech firms offering prepaid payment instruments (PPIs), including mainstream operators. However, more established and sophisticated companies will benefit in the longer term if tighter regulation encourages the exit of less scrupulous firms from the sector."
An RBI working group on digital lending estimated that there were about 1,100 apps offering loan products in the country in 2021, with close to 600 illegal loan apps—although Fitch believes digital lending remains small relative to total system credit at present.
Mobile wallets accounted for 25% of all point-of-sale (POS) payments in India in 2021, according to estimates by WorldPay (part of FIS), from only 5% in 2019.
According to Fitch, increasing product penetration per customer is a key strategy for many fintech start-ups to raise their profitability. "The RBI's clarification that PPI - a licensing category that includes e-wallet operators in India - can only be loaded via cash, bank accounts and credit cards issued by regulated entities does not prevent digital finance platforms from offering loans backed by banks and other non-bank financial companies."
RBI's clarification, however, restricts certain business models under which PPI operators had taken on customer credit risk by effectively extending unsecured personal credit, for example through buy-now-pay-later (BNPL) schemes and 'quasi-credit cards'.
Fitch-rated financial institutions that lend through digital platforms are unlikely to be affected by the recent clarification since their digital lending tie-ups remain small in scale, although future regulation may prompt shifts in their budding digital strategies.
According to the rating agency, greater fin-tech regulation is likely in the next 12-24 months, reflecting the sector's growing presence in the financial system.
It says, "Indian regulators remain generally keen to encourage innovation in digital financial services. Even so, their focus is shifting towards safeguards to prevent risks from migrating to more lightly regulated segments of the financial system. This follows regulatory measures to strengthen risk and governance practices among non-bank financial companies after a crisis of confidence in the sector in 2018-2019."
The RBI working group produced several recommendations for a digital-lending regulatory framework in late 2021. Regulatory issues highlighted by the working group include licensing and oversight, customer suitability and education, data protection, consumer leverage, and credit and enterprise risk management - which mirror regulatory priorities identified in other jurisdictions.
In most cases, Fitch says it expects the RBI's strategy for regulating fintech to be for similar financial products and services—entailing broadly similar risks - to be governed by consistent regulatory principles, including any prudential requirements. "This approach should narrow the potential for regulatory arbitrage between firms, and enable appropriate oversight by the relevant financial regulators."
"Nonetheless, the rapid pace of fintech innovation complicates efforts to match regulation to the sector's evolving risks. Enforcement is likely to be a major challenge, in light of the proliferation of unlicensed lenders and limited resources among regulators," it added.
According to Fitch, the large number of fin-tech enterprises and the sector's short record may also make it harder for consumers to distinguish legitimate and disreputable operators, regardless of the licensing regime in place.
Without appropriate regulation, it says, there is a risk that a major mishap could blunt consumer confidence in the fin-tech sector and undermine its potential to advance financial inclusion and efficiency.