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RBI Cancels Registration of Two Entities for Regulatory Lapses

The Reserve Bank of India has recently stepped up its monitoring of NBFC compliance with outsourcing regulations and regulatory lapses. The same is clear from most of its recent orders, where it has not only criticised NBFCs for non-compliance with outsourcing regulations and prohibited them from outsourcing the activities in return for regulatory lapses. The increase in the usage of technology in the financial sector to provide hassle-free services like lending, account opening, credit analysis etc., has encouraged organisations like banks and non-banking financial companies to collaborate with Digital Lending Platforms (DLP) to connect with their customers. The increased usage of these DLPs has altered how loans are distributed and raised questions about their transparency, recovery mechanism, grievance redressal etc. Regardless of whether banks and NBFCs lend through their internal digital lending platform or through an outsourced digital lending platform, the Reserve Bank of India has imposed regulations to guarantee that the DLPs and the banks/NBFCs properly comply with the fair practices code and outsourcing guidelines.

Recently, the RBI has cancelled the registration of two non-banking financial companies for their regulatory lapses in their lending operations. In this blog, we will discuss the outsourcing norms for NBFCs, guidelines given by the Reserve Bank of India, and the Notification regarding the cancellation of registration for regulatory lapses.

Outsourcing norms for NBFCs

NBFCs have outsourced a variety of activities which exposes them to a variety of risks. To safeguard NBFC customer interest and to ensure that the NBFC concerned and the Reserve Bank of India have access to any relevant books, documents, and information held by the service provider, the outsourced activities must be brought under the regulatory jurisdiction of the regulator. The specific guidelines for managing the risks connected with NBFCs’ outsourcing of financial services, as well as a code of conduct that must be followed by both service providers and NBFCs, have been released by the RBI.

What is Outsourcing in the context of NBFCs?

Let’s first define what “outsourcing” means in the context of NBFCs. The Reserve Bank of India defines “outsourcing” as the NBFC’s employment of a third party (either an associated entity within a corporate group or an entity that is external to the corporate group) to do activities that the NBFC itself would typically carry out, now or in the future. The apex bank has expressed concern about outsourcing various financial and non-financial activities by NBFCs in traditional and digital lending-recovery processes. This issue gained more attention during the COVID-19 pandemic when the market was flooded with various money-lending apps to entice people to borrow money at low-interest rates with zero or very minimum collateral. Since these outsourced companies were not directly under RBI’s supervision or control, they felt free to engage in unethical behaviour. In contrast to the rules established by the Reserve Bank of India for NBFCs and lenders engaged in the business of providing credit, this put the borrowers in an unfair hardship and violated other directives. So the Reserve Bank of India issued specific guidelines to supervise these unfair practices and regulatory lapses in the industry.

Activities that are allowed to outsource: According to these regulations, NBFCs may only contract out for material financial services, such as those involved in loan or credit card application processing, document processing, marketing, loan supervision, including debt recovery, data processing, and back office-related tasks. Such directions do not apply to the following:

• Technology related issues
• Activities that are not related to financial services
• Non-material outsourcing agreements

Material outsourcing agreements are ones with the potential to significantly affect a company’s operation, reputation, profitability, or level of customer service. The Reserve Bank of India clearance is not necessary for advance for NBFC to outsource. However, such arrangements are still subject to inspection and supervision of regulatory lapses by RBI both on and off-site.

Activities that are not allowed to outsource: NBFCs outsourcing financial services shall not outsource the following while outsourcing financial services:

• The company’s core management functions include internal audits.
• Strategic and compliance functions.
• Decision-making functions include approving loans, managing investments in a portfolio, and determining whether KYC requirements were met when opening accounts.

Outsourcing guidelines for NBFCs

The specific guidelines for outsourcing financial services by NBFC should follow these procedures issued by the Reserve Bank of India.

• The mere act of outsourcing shall not ease NBFC, its Board of Directors, or its senior management of their legal obligations.
• NBFC shall be responsible for the actions of their service providers, such as direct sales agents, recovery agents, etc.
• The customer’s rights against the NBFC, and the right to seek redress, shall not be affected by this activity outsourcing.
• The NBFC must have a grievance redress mechanism, which outsourcing must never compromise.
• NBFCs must include a clause indicating they use or may utilise agents for sales, marketing, recovery, etc., in the relevant product literature/brochure.

Digital Lending Platforms 

The platform known as digital lending gives financial institutions a chance to raise productivity and loan revenue in order to provide speedier services. Where sensitive information is kept private, digital lending makes the best use of available technology. Borrowers can apply for any consumer or corporate loan product using Digital Lending from any internet-capable device and from any place. Everything that happens is done digitally and quickly.

RBI Guidelines For Outsourcing over Digital Lending Platforms

The Reserve Bank of India’s Notification requiring all institutions using digital platforms for transactions to abide by the Fair Practices Code requires immediate attention in light of these developments. The letter was sent out as a result of numerous occurrences that exposed some financial firms’ highly unethical behaviour, which led to regulatory lapses. These included exorbitant interest rates on borrowings, non-transparent interest calculation, cruel practices to recover loans, and unauthorised usage of consumer data. The following instructions are a part of the Fair Practices Code by RBI, which are binding for banks and NBFCs engaging digital lending platforms as their agents to source borrowers and to recover dues:

• On the websites of banks and NBFCs, the names of digital lending platforms that have been hired as agents must be disclosed.
• The name of the bank or NBFC on whose behalf they are interacting with the customer must be disclosed upfront by digital lending platforms acting as agents.
• The sanction letter must be sent to the borrower on the letterhead of the bank or NBFC as soon as it has been approved but before the loan agreement is actually executed.
• At the time of their loan sanction or disbursement, the borrowers must be given a copy of the loan agreement and the various fee structure elements and enclosures listed in the loan agreement.
• The bank and NBFCs’ digital lending platforms must be effectively supervised and monitored. 
• Sufficient efforts must be made to raise public understanding of the system of grievance redressal mechanism.
• Digital Lending Platforms, banks, and NBFCs that source loans using digital platforms are required to abide by the fair practices code and outsourcing guidelines, which the RBI periodically amends.

The rising number of service providers and alliances offering simple loans to people working as retailers, small-scale traders, and others required the presence of rules that streamline the entire process to stop any inconsistencies. Additionally, it was discovered that several digital lending platforms were presenting themselves as lenders without naming the banks or NBFCs with which they had partnered. These instances of non-closure added to a great deal of uncertainty in the lending process. Also, it was stated that a lack of a clear structure and transparent system made it extremely difficult for customers to file complaints.

RBIs Notification for Regulatory Lapses

The Notification was issued in response to specific observations regarding the non-disclosure by online lending platforms of the names of actual lending banks/NBFCs, non-transparent methods to calculate interest, exorbitant interest rates being charged to borrowers, harsh recovery practises, and unauthorised use of personal data in relation to the outsourcing of financial services provided to banks and NBFCs.

The Reserve Bank of India has highlighted in its Notification that banks and NBFCs have the primary duty of adhering to regulatory requirements when outsourcing activities, including those to digital lending platforms, in light of the growth of such platforms in India.

If the RBI cancelled the registration of NBFCs for their regulatory lapses, they shouldn’t conduct business as Non-Banking Financial Institutions (NBFI) because their Certificate of Registration (CoR) has been revoked. The Certificate of Registration (COR) of the NBFCs will be cancelled because of violation of the Reserve Bank of India Guidelines on Fair Practices Code and outsourcing in their digital lending operations undertaken through third-party applications. Also, the organisations engaged in excessive consumer harassment as a means of loan recovery while failing to adhere to current standards regarding the charging of excessive interest will face the consequence.

Benefits of RBI Guidelines

The Reserve Bank of India has reiterated in its Notification that banks and NBFCs have the primary duty to adhere to regulatory requirements when outsourcing activities, including those to digital lending platforms, in light of the growth of such platforms in India. 

• The Notification’s adoption will increase responsibility and transparency for customers regarding borrowing through DLPs. The rights and interests of the borrowers will always be safeguarded if the necessary documentation is in place.
• This action will encourage digital lending platforms to adjust their operational and strategic approaches if they do not conform to the applicable regulatory framework.
• While this change will help to increase trust between DLPs and their borrowers, which is in the interest of the banks/NBFCs, it also imposes additional disclosure requirements concerning the names of the lending partners, computation of the interest rates charged by the DLPs, and the method by which it is calculated.

Redress Grievances related to outsourced Services

According to the RBI’s circular on the grievance redressal mechanism, NBFCs must form the grievance redressal machinery. At their branches or other places where business is conducted, all NBFCs must clearly display the name and contact information of the grievance redressal officer. The assigned officer must see to it that customers’ legitimate complaints are resolved quickly and without delay. The fact that the NBFCs’ Grievance Redressal Mechanism would also handle problems relating to services rendered by the outsourced agency must be clearly stated.

Customers are typically allowed 30 days to file complaints or issues with the company. The NBFC’s website must include information about its grievance resolution process and the deadline for responding to complaints.

Conclusion

The nation’s regulatory bank has always had the protection of consumer interest as its top priority. It was discovered that several digital lending platforms were presenting themselves as lenders without naming the banks or NBFCs with which they had partnered. Also, a lack of a clear structure and transparent system made it extremely difficult for customers to file complaints. The recent order of the Reserve Bank of India cancelling the registration of non-banking financial companies shows that RBI is supervising the regulation procedures seriously for regulatory lapses in lending operations. It mandates the NBFCs to adhere to its regulatory requirements in outsourcing services.

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