For nearly all fintech startups, lending has long been the end game. A notice from India’s central bank this week has thrown a wrench into the ecosystem, scrutinizing just who all can lend.
The Reserve Bank of India has informed dozens of fintech startups that it is barring the practice of loading non-bank prepaid payment instruments (PPIs) — prepaid cards, for instance — using credit lines, in a move that has prompted panic among — and existential threat to — many fintech startups and caused some to compare the decision to China’s crackdown on financial services firm last year.
Several startups including Slice, Jupiter, Uni and KreditBee have long used the PPI licenses to issue cards and then equip them with credit lines. Fintechs typically partner with banks to issue cards and then tie up with non-banking financial institutions or use their own NBFC unit to offer credit lines to consumers.
The central bank’s notice, which doesn’t identify any startup by name, is widely thought to be impacting just about everyone including buy now, pay later firms that also use a similar mechanic to offer loans to customers. Amazon Pay, Paytm Postpaid and Ola Money are cautious, too, because many believe that they might be impacted as well.
"The rule is very confusing and strange," said a fintech founder on condition of anonymity to avoid upsetting RBI officials. "What the RBI is essentially saying here is don't load credit line on PPI. The way things work with PPI currently is that the money finally goes to merchants. You're saying now that NBFCs can't give credit lines to merchants and their money should only be routed to bank accounts of customers."
The founder added that this new stance risks erasing all the innovation that has happened in the past five years in the fintech industry, which has attracted over $15 billion in investments in the last two years from scores of high-profile backers including Sequoia India and Southeast Asia, Tiger Global, Insight Partners, Accel and Lightspeed Venture Partners.
"The way everyone works right now in the fintech space, with maybe one degree of separation where money first goes to a payments gateway, the money is routed to merchants. Some banks have been employing the same strategy for like a decade!" the founder added.
Fintech startups are convinced that banks have lobbied the RBI to reach this decision, employing the age-old tactic where incumbents cry foul and rely on the regulator to rescue the day.
Not allowing loading of pre paid instruments through credit is aimed at protecting bank’s lazy credit card business from Fintech’s potent BNPL business. It’s a flex move by banks - rent seeking. But market is market and regulation will eventually come around to what market needs.
— Ashneer Grover (@Ashneer_Grover) June 23, 2022
The central bank, which didn't offer an explanation in the notice this week, has long expressed concerns about lenders who are charging exorbitant interest rate and requiring minimum know-your-customer details to onboard and coerce customers. Some of these firms, the government agencies have claimed over the past two years, may be engaging in money laundering schemes.
"Some people are speculating that when the PPI licenses were given, RBI was clear that they are not given as credit instruments. With the PPI + BNPL combo, the PPI route is now being used as an alternative to credit cards or offer seamless BNPL, which RBI may not be okay with as of today," said an industry player, who also requested anonymity.
The new rule is said to be impacting not just such shark lenders and sketchy players, but everyone.
“We believe this regulation could significantly impact the fintechs involved in this business and would be advantageous to banks, as they can further accelerate card acquisition with less competition,” analysts at brokerage house Macquarie wrote earlier this week.
The fintech startups exist, many argue, because they found a way to bring financial inclusion to millions of users, something the RBI has long welcomed and a fact that banks would appreciate if you didn’t bring up. The PPI model, which brings together two regulated entities, enables lenders to offer credit to customers at lower cost, dramatically increasing the reach of who can receive credit.
"In the traditional personal loan model, the lender deposits money directly into a bank account. So, the lender doesn't earn any money when the consumer spends that money," explained Himanshu Gupta, a fintech veteran. "But in the PPI instruments backed by the credit line model, fintech startups earn interchange revenue on every payment, which can be as high as 1.8%. This means they can potentially offer credit at lower cost to consumers as compared to a pure 'personal loan into bank' model," he added.
India’s credit bureau data book is thin, making most individuals in the South Asian market unworthy of credit. As a result, banks don’t offer credit cards or loans to most Indians. Fintechs use modern-age underwriting systems to lend to customers and a maze of regulatory arbitrage — all considered OK until now — to operate.
The central bank might just be too late to make a decision now, some argue. The fintechs serve over 8 million customers in India, and without clarity, most of those customers are under no obligation to meet their current payback deadlines, which would create significant stress on firms.
Additionally, the NBFCs run by different startups are regulated entities. Some fintech veterans argue that if RBI really wants to crack down on the use of PPI as a credit instrument, then they should really consider giving credit card license to startups, something the RBI hasn’t done to date.
In the meantime, investors are getting spooked and many startups that are in the middle of raising new funding rounds are beginning to see some VCs back out, according to people familiar with the matter. Some industry players believe that India's central bank is taking a similar approach as China in cracking down on lenders and fintechs at large. (Shares of SBI Bank, the government-owned bank in India, on the other hand, have surged over 14% since the central bank sent the circular.)
"We do not believe RBI is very keen on issuing digital banking licenses, as reflected by the recent statements of the RBI Governor. RBI has been coming down heavily on fintechs and has been advocating tighter regulations over the past several months. It is our view that the message is clear that fintechs will increasingly be regulated more," wrote Macquarie.
"RBI’s payments vision 2025 document also talks about looking at the various charges for payments made in India in such a way that it further encourages digital adoption, which we believe means there is a possibility that various payment charges can come down to encourage more adoption. It is clear to us that the risks are increasing for the fintech sector, for which regulations have been a light touch so far."
Entrepreneurs are scrambling to relay their concerns to the RBI. At least three entities including Digital Lenders Association of India and Payments Council of India (PCI), part of lobby group Internet and Mobile Association of India, are in the process of writing letters to the RBI and various ministries to allay their concerns.
On a Zoom call on Thursday, dozens of fintech officials discussed the common grounds for what they should inform the RBI. Some of their pressing requests include extending the timeline for the new rule by six months and establishing to the central bank that fintech industry at large is “responsible and trying to do the right thing,” according to people who attended the call.
The fintechs also seek to explain in detail their business models and make a case for why those who operate with full know-your-customer mandates should be permitted to continue.
But until some change or clarity arrives, large disruptions are expected. Tiger Global-backed Jupiter and Azim Premji’s PremjiInvest-backed KreditBee have already temporarily stopped customers from making any transactions on their prepaid cards.