RBI AND THE PEER-TO-PEER (P2P) REGULATORY CONUNDRUM: WHY INDIA NEEDS A BETTER TAILORED LEGISLATION?: RAJ SHEKHAR & SANA RAGHUVANSHI (STUDENT, NATIONAL LAW UNIVERSITY OF STUDY AND RESEARCH IN LAW, RANCHI)

Peer-to-Peer Lending: The Changing Contours of Regulation

Financial Technologies better known as the Fintech have massively changed the way[1] money transactions and settlements are being carried out by the millennial. One of the most popular branches of fintech is something that we refer to as Peer-to-Peer (P2P) lending.[2] In simple terms, the P2P lending platforms play the role of an agent between two individuals, namely the lender and the borrower. The major reason behind the popularity of P2P in India is the fact that, though various digitalization oriented programmes have been implemented, yet almost half of Indians still lack a proper bank account,[3] leaving number of these incapable to get to conventional wellsprings of credit which these financial institutions offer. For these unbanked individuals, P2P lending platforms have emerged out as a viable alternative credit source for businesses and individuals alike,[4] for not only they make obtaining credit possible, but also with the minimum formalization of process.

However, with the up scaling growth rate of such platforms it has become a target for regulatory attention and the Reserve Bank of India (RBI) came up with regulation in the year 2017, vide the master direction bearing number DNBR (PD) 090/0.10.124/2017-18 (Master Direction) [5]which classified P2P as non-banking financial companies (NBFCs) and brought them under the radar of regulations. This move of RBI has been widely criticized as experts view it as a fundamental mischaracterization of P2P nature on grounds of the services being offered by them, and also the way in which such services are being rendered to the end user. Another issue that has plagues the P2P Sector is the RBI regulating framework which has provisions which on one hand under regulate certain aspects and on the other over regulate certain other facets. This article aims to clarify the need for an alternative credit lending system, which owing to the growing number of start-ups and innovation models in India, could help in streamlining of the establishment and tries to suggest ways to introduce better-tailored regulations, in order to avoid the existing regulatory crunch and ensure an effective legislation to boos future prospects for P2P in Indian Economy.

RBI Regulatory Conundrum: Understanding the Bone of Contention

The initial boom in unconventional financial methods began with the development of technology and the global financial crisis of 2008.[6] P2P emerged as one such unconventional financial method which witnessed its advent in the western markets towards the end of last decade. The growth in sources of credit beyond banks in the form of peer-to-peer lending began in the United Kingdom with the launch of Zopa in 2005.[7] A company born in the United Kingdom that introduced this idea of raising loans and funds from any common person or peer around the world that had money idly lying with him or her was revolutionary. Prosper and Lending Club, two US Companies soon joined the league[8] in the year 2006.

Though in India P2P lending is relatively a newer concept and is yet to create a strong position, RBI and its regulatory conundrum is already attracting concerns for enthusiasts and experts alike. Since its inception P2P lending has offered advantages which are winning over the archaic traditional banking structure, the major being its reliability, speed and hassle-free nature. However, the RBI and its guidelines have virtually crippled the benefits[9] and have been met with critical retaliation from players in the P2P field.

While the P2P sector is comparatively minuscule when put up against the gross value of Indian finance industry, yet the investors of such platforms have for themselves called for some type of regulation. The major contention is that with regulations comes trust, which is the major ingredient for setting up a flourishing venture. Rule makers aim to create credible practices for the sector, investors on the other hand look forward to regulatory clarity to safeguard their investment, and platforms want credibility and trust for future expansions. But the uncanny and unseen before nature of the P2P model categorized them under the regulatory grey space that exists.[10]

Therefore, the major issue before RBI was to first classify them under a proper subhead, and it indeed took the first step by categorizing such ventures under an umbrella term NBFC-P2Ps,[11] under Section 451 of the RBI Act,[12] which automatically brought them under its regulations. However, the move was widely criticized as there existed a popular counter-opinion which saw such classification as fundamentally erroneous. Such classification indeed helped them bring P2P into the mainframe, yet it also meant that P2Ps would now have to abide by the reporting, prudential, and governance requirements.

RBI’s Powers and Classification Schemes: Can P2Ps be classified as NBFCs?

In India, the RBI has the legal authority conferred on it by banking law to regulate both ‘banks’ and ‘non-banks’.[13] Banks here would mean any financial institution indulged in lending and borrowing activities, and which has a license for the same from RBI, whereas non-banks would mean institutes that are into the business dealing with financial activities, and as per the existing rules will have to obtain a certificate of registration from the Reserve Bank of India, post the documentation and necessary formalities. Many times, it becomes very hard to demarcate such entities and for that RBI employs the ‘Principal Business’ (PB) test.[14] In such an examination, the benefits and income stream of an organization are analysed from the updated balance sheet, and if the income from the monetary administrations is more than 50% of its gross income, at that point the organization is assigned as a 'NBFC'.

However, as the P2Ps are not indulged in lending out their funds or accepting deposits from lenders or borrowers, but merely receive incentives in form of small brokerage fees, which are generally categorized as service charges that users have to pay for registering and operating on their platforms, coupled with the fact that they simply act as agents in the grant of loans and have no rights to collect any interest on such loans, makes them fail the PB test for being designated as an NBFC. This would mean that RBI is over-exercising its powers and trying to regulate a company which is more or less associated with technology and technical aspects, and which unfortunately happens to be indulged in affairs dealing with the financial sector, and such regulation can in no way be legally justified. This reason very well explains as to why P2P leaders are protesting against the existing classification and are demanding to be categorized as an independent and a separate technological entity, rather than as NBFCs. Therefore, if regulatory measure is to be maintained RBI needs to prove concretely as to how PB test applies to P2Ps.

US P2P Regulatory Norms: A Mirror to Indian ‘Flawed’ Approach?

Just like India, even P2P in the US began as largely self-regulated platforms and comprised of a very small fraction of the US Economy. Co-incidentally, just like India, the sudden spike in the net growth of P2P ventures made the gaze of the US government regulators turn towards these majorly unregulated P2P ventures. As a result, the government finally intervened in 2008 and the Securities and Exchange Commission (SEC) mandated the platforms to register their loans as securities under the Securities Act of 1933.[15] The public reaction was same too and such regulations were harshly criticized for their over-reaching regulatory mind-set. However, unlike India, the U.S. Government Accountability Office (GAO) understood the issue and as per a 2011 report noted that the regulations [16]“lacked flexibility and imposed inefficient burdens on firms.” But still P2P industry was aimed to not exclude financial experts as it was a volatile industry and needed efficient regulations.

Thus, to settle the conundrum at hand, the U.S. regulators decided to come up with a new classification altogether for the P2Ps, which even though novel would still fall within the SEC’s purview. This change in attitude led to the introduction of the Jumpstart Our Business Start-ups Act (JOBS Act),[17] which not only laid down regulatory provisions but also defined these new P2P platforms and referred to them as” emerging growth companies.” It meant that as long as annual revenue of such entities remained below $1 billion USD, and the amount that they lent out remained restricted to certain defined thresholds, they were to be exempted from SEC registration requirements. This meant an exemption from the existing limits on capital requirements, individual investment limits imposed on other companies, and an overall relaxation in provisions pertaining to eligibility. Such regulation allowed for promoting emerging growth companies yet still maintaining a regulatory stronghold.

At present, the SEC regulates the U.S. P2P industry and the RBI looks after and regulated the working of Indian P2P industry. Therefore, as the situations are more or less stable in the present scenario, the RBI should look forward to bringing in streamlining laws rather than drastic overhaul which can disrupt this fine balance. Thus, instead of opting for a fundamental regulatory restructuring, the RBI can still work on regulating the data security linked to the cross border transactions, which would fall under its ambit. Taking up a lenient approach would benefit both the RBI and they will have enough time to understand how P2P needs to evolve in Indian Financial Markets.

Conclusion

As of today, boosting the banking needs is a prime concern. P2P platforms are a unique combination of new FinTech and archaic banking services. RBI has tried to ensure that regulations cover P2Ps yet they require more elaborations in terms of the regulatory regime and the market dynamics of P2P lending structures. It has overregulated an industry which it needs to nurture. The restrictive norms have elevated the entry costs and unnecessarily pressurized the existing P2Ps with other costs, mandated by the RBI. Similarly, the unregulated areas like remittances and data security add to the dilemma of the current P2P operations. In a hurried approach to regulating P2P, the RBI has fundamentally misunderstood working of P2P lending. Thus, relaxation of norms, as discussed above by case analysis of US is needed, to allow for future P2P growth. However, this would not mean leaving the sector unregulated as we have seen in cases like China where without regulation, the P2P industry had faltered. An immediate reform is needed to ensure that it does not dampen and repress the industry which stands as a kept to solving India’s pressing credit access problems.

---

[1] Staff, How FinTech is Changing Banking?, Banking Circle (19^th September, 2020 03:52 PM), https://www.bankingcircle.com/how-fintech-is-changing-banking-117825.

[2] Michelle Black, Peer-to-peer lending lets you be the Borrower or the Investor, Investopedia (19^th September, 2020 03:54 PM), https://www.investopedia.com/articles/investing/092315/7-best-peertopeer-lending-websites.asp.

[3] Tis Sanghera, Banking in India: Why many people still don't use their accounts?, Aljazeera (19^th September, 2020 03:59 PM), https://www.aljazeera.com/ajimpact/banking-india-people-don-accounts-190621093947054.html.

[4] Staff, Peer-to-peer lending: Advantages and disadvantages for loan customers, Lending Works (19^th September, 2020 04:03 PM), https://www.lendingworks.co.uk/finance-guides/p2p-lending/peer-to-peer-lending-advantages-disadvantages-borrowers.

[5] RBI Guideline, RBI/DNBR/2017-18/57 Master Direction DNBR (PD) 090/ 03.10.124/2017-18.

[6] Kimberley Amadeo, 2008 Financial Crisis Causes, Costs, and Whether It Could Happen Again, The Balance (19^th September, 2020 04:04 PM), https://www.thebalance.com/2008-financial-crisis-3305679.

[7] Staff, About, Zopa, The Company (19^th September, 2020 04:08 PM),  https://www.zopa.com/about.

[8] Nav Athwal, The Disappearance Of Peer-To-Peer Lending, Forbes (19^th September, 2020 04:12 PM), https://www.forbes.com/sites/groupthink/2014/10/14/the-disappearance-of-peer-to-peer-lending/#2fbbd5a04c1d.

[9] Joydeep Sen, Things you should check before opting for P2P lending for higher returns, Live Mint (19^th September, 2020 04:18 PM), https://www.livemint.com/money/personal-finance/things-you-should-check-before-opting-for-p2p-lending-for-higher-returns-11578476660365.html.

[10] Ryan Litchenwald, P2P Lending and the Indian Market, LendITFinTech (19^th September, 2020 04:29 PM), https://www.lendacademy.com/p2p-lending-indian-market/.

[11] Rajat Gandhi, What makes NBFC-P2P sector a better choice for raising funds for an MSME these days?, The Economic Times (19^th September, 2020 04:34 PM), https://economictimes.indiatimes.com/small-biz/money/what-makes-nbfc-p2p-sector-a-better-choice-for-raising-funds-for-an-msme-these-days/articleshow/69054343.cms.

[12] Section 451, RBI Act, 1934.

[13] Provisions Relating To Non-Banking Institutions Receiving Deposits And Financial Institutions Reserve Bank of India Act, 1934, https://m.rbi.org.in/scripts/BS_NBFCNotificationView.aspx?Id=557 .

[14] Narendra Kumar, The Concept of Principal Business Criteria (PBC) of RBI for NBFC, EnterSlice (19^th September, 2020 04:42 PM), https://enterslice.com/learning/principal-business-criteria/.

[15] The Securities Act, 1933, USA https://www.sec.gov/answers/about-lawsshtml.html

[16] GAO report number GAO-11-613 entitled 'Person-To-Person Lending: New Regulatory Challenges Could

Emerge as the Industry Grows', https://www.gao.gov/assets/330/320698.html.

[17] The Jumpstart Our Business Startups (JOBS) Act, 2012 (USA). https://www.sec.gov/spotlight/jobs-act.shtml.