RBI’s regulation of interest rates and penal charges: Next financial regulatory hot topic in India? [Part II]

For the assistance of banks, NBFCs and fintech companies who may be apprehensive about action under this notification, we list down the key reasons on the basis of which the bans and show-cause notices are issued:

• If the application/website communicates to servers located in hostile countries. (The IP/domains where the application is connecting are reportedly involved in suspicious and malicious activities)

• The application/website is functioning in a non-transparent method, collecting exorbitant interest rates, threatening.

• Collections malpractice: harassing, threatening, and putting down late-paying customers.

• Data security concerns include contentions that data may be sold, transferred, or disclosed to fraudulent parties.

• User complaints: harassing using their unauthorised personal information.

• Applications that are not on RBI's whitelist may be prohibited because they are regarded to be illegal.

• Contentions of some loan operations being carried out using shell firms.

• Authorization: without RBI's direct oversight, numerous applications may function in legal limbo.

• Applications using/renting licences from inactive NBFCs to conduct lending operations are known as "licence mulling."

RBI has made the computation of annualized interest rates mandatory for not just banks but also for NBFCs. This is a method of expressing the effective interest rate on a loan or deposit over a year, accounting for the effect of compounding.

Banks and NBFCs are also required to disclose pricing information to prospective borrowers in a standardised and simplified factsheet, which must explicitly mention any fees charged. There should be no pre-payment penalty on microfinance loans and any changes in interest rates or charges must be informed to the borrower well in advance and be effective only prospectively.

The lending institutions are required to prominently display the minimum, maximum, and average interest rates charged on microfinance loans and the information must also be included in supervisory returns and subjected to supervisory scrutiny by RBI. Industry associations may publish the range of interest rates charged by their members and RBI may also offer information regarding the interest charged by lending institutions on microfinance loans.

RBI has deregulated interest rates to be charged to borrowers by financial institutions (other than NBFC- Micro Finance Institution). The chargeable interest rate by the company is governed by the terms and conditions of the loan agreement entered into between the borrower and NBFCs. However, NBFCs have to be transparent and the rate of interest and manner of arriving at the rate of interest to different categories of borrowers should be disclosed to the borrower or customer in the application form and communicated explicitly in the sanction letter etc.

RBI on February 8th, 2023 released a statement on developmental and regulatory policies through which it proposed that only penal charges and not penal interest are allowed as a penalty for delay or default in servicing of loans or non-compliance of material terms and conditions of loan contract by the borrower. Furthermore, this shall be collected separately and not added to the principal outstanding.

We don't think so. There are presently NBFCs whose annualised interest rate is in the bracket of 300-500%. The rationalisation of interest rates is probably another signal from the regulator that they are looking for players who are serious about India and are in it for the long haul. Just like McDonald's redesigned its entire menu for India and now India is one of its biggest markets, market players shall have to create a customised business model that aligns with their group or global philosophy to capitalize on the opportunity of Invest India.

India, despite the potential impact of interest rate rationalisation on the NBFC sector, would certainly remain an attractive destination for foreign investment due to its large and growing consumer market, its favourable demographic profile, and its rapidly expanding middle class. The Indian government has taken several steps in recent years to improve the investment climate in the country, including steps to reduce red tape, improve infrastructure and promote foreign investments.

The personal loan market in India is more mature and sophisticated due to financial measures, resulting in a growing pool of eligible borrowers with good credit scores and healthy borrowing habits. This presents an opportunity for lenders, including NBFCs, to cater to this segment of the market, but it is important for lenders to be responsible and lend in a sustainable manner to protect both borrowers and the long-term stability of the market. Adding to this, India's high digital penetration and growing online loan market make it an attractive destination for foreign investment in the financial services sector. The growth of digital technologies and online lending has made it easier for borrowers to access affordable loans and has reduced the cost of lending. This presents a significant opportunity for foreign companies to tap into the growing market in India and meet the needs of an increasing number of borrowers.

The rationalisation of interest rates by RBI can be seen as a positive sign for foreign investors, as it suggests that the market is maturing and regulated. There are multiple use cases of foreign investors in India who are successfully running NBFC and other regulated entities bearing a clean slate as they have been able to toe the line. They use market leverage to up their game instead of trying to use interest rate arbitrage that was available in India to make an easy profit.

The presence of foreign investors running successful NBFCs and regulated entities in India without getting into trouble is a positive sign for the financial services market. These investors have been able to build their businesses by adhering to regulations and following best practices, gaining a reputation of trust and credibility. This strongly conveys that it is possible to succeed in the Indian market by operating responsibly, and sets a positive example for other foreign investors to follow in the coming times.

By attracting financial institutions that are committed to the long-term success of the country, India is laying the foundation for a more stable and sustainable financial services sector. These institutions want to adopt the long-term Indian narrative and be a part of the country's growth story.

This reminds us of the legendary Warren Buffet's investment advice - “If you aren’t willing to own a stock for 10 years, don’t even think about owning it for 10 minutes”.

Anuroop Omkar and Kritika Krishnamurthy are Partners at AK & Partners.