Abstract:
With the Indian Buy Now Pay Later (“BNPL”) market expected to grow at a CAGR of 12.2% from 2023 to 2028, it has become a popular alternative to traditional credit for small-ticket items. However, regulatory and systemic challenges persist as the Reserve Bank of India (RBI) has imposed restrictions on credit-based BNPL models, mandating a shift toward Prepaid Payment Instrument (PPI)-based systems. The author aims to review India’s regulatory journey, from the RBI’s 2021 guidelines on prepaid payments to the 2023 Default Loss Guarantee guidelines, discussing how these regulations impact BNPL providers’ operations and consumer transparency. The article also aims to underscore the benefits, such as increased transparency and redressal mechanisms, but also criticize them on the constraints on innovation caused by the PPI-based approach. Lastly, the author contrasts India’s regulatory framework with international practices from financially advanced nations, including the UK, Australia, and the US, to suggest measures that could help India strike a better balance between consumer protection and credit access.
Keywords: Buy Now Pay Later, RBI, Financial Regulation, PPI, International Comparisons
Introduction:
As the markets evolve to accommodate newer forms of payment, the introduction of innovative credit creation systems has become more frequent. The rise of Buy Now, Pay Later (“BNPL”) systems has revolutionized the spending habits of the average consumer while providing the convenience of deferring payments for small everyday spending via a systematic repayment plan. The industry while having a projected growth rate of CAGR 12.2% from 2023 to 2028, has captured the interests of consumers, merchants and policymakers alike.
In this article, the author endeavours to examine the rationale behind BNPL systems, a detailed outline of the regulatory landscape, current applicable regulations and gather insights from existing mature markets internationally to provide recommendations to mitigate issues.
Understanding BNPL Systems
BNPL systems are based on an alternative payment model that enables individuals to make purchases and pay for them in credit to the BNPL service provider. Transactions are completed at the Point of Sale (POS) without the need for immediate payment. Companies such as Slice or Lazy Pay, allow users to buy a certain commodity at its full price from the goods/service provider repaid in instalments without accrual of interest as opposed to conventional credit card systems. BNPL providers generate revenue through merchant fees, late payment charges, and partnerships with financial institutions.
Regulatory History in India:
The BNPL space is mostly unregulated, with most companies registered under the Companies Act, 2013, while others being registered with the RBI under the Master Directions for Non-Banking Financial Companies, 2016.
The RBI first became aware of the situation after receiving numerous complaints against service providers and apps, which led to the creation of a working group. On the recommendations of such group, the RBI released the Report on Digital Lending.
In August 2021, the RBI issued the Master Directions on Prepaid Payment Instruments (PPIs) outlining the scope and requirements for entities offering Prepaid Payment Instruments (“PPI”) services, including BNPL arrangements. Direction 7.5 of the Master Directions stipulates permissible modes of loading/reloading value into PPIs, emphasizing compliance with Indian currency (INR) and prohibiting the loading of PPIs with credit lines.
In June 2022, the RBI clarified that the existing framework does not permit the loading of PPIs with credit lines, signalling a regulatory stance against credit-based BNPL models. This move compelled BNPL providers to pivot a user prepaid instrument model as opposed to the true BNPL model and led to the halting of operation of market giants such as Slice Pay for a brief period. The RBI also addressed the First Loss Default Guarantee (“FLDG”) partnership model via the September 2022 guidelines, wherein only regulated entities such as Banks, Non-Banking Financial Companies, and Credit Information Companies (“RE”) are allowed to underwrite loans and not the BNPL provider themselves.
Currently Applicable Regulations
In June 2023, the RBI released the Guidelines on Default Loss Guarantee (“DLG”) in Digital lending. At present, DLG providers are mandated to be bodies incorporated under the Companies Act, 2013 while also limiting the permissible form of DLGs to Cash Deposits, Fixed Deposits and Bank Guarantees. The DLG cover imposed is also capped at 5% of the entire loan portfolio.
Initially, while BNPL providers operated in a grey area, there have been major business model overhauls due to the changing stances of the RBI. The BNPL providers who traditionally offered short-term credits are now forced to shift to a Pre-Paid Instrument (PPI) system, requiring customers to load funds into their accounts prior to making purchases. This transition demands an overhaul of operational processes, including payment processing, risk assessment, and consumer engagement strategies essentially diminishing the USP of such payment system.
Alongside these regulations, the Lending Service Providers (“LSPs”) are required to publicly disclose their DLG portfolios. While the regulations are playing a safe game, the RBI should consider implementing these regulations in a phased manner, providing a more relaxed timeline for compliance based on the nascent nature of the industry. A collaborative approach between regulators and industry players can lead to balanced regulations that support both consumer protection and industry innovation. Industry associations can negotiate with the RBI to permit consumer innovation within the regulatory framework.
Consumer Standpoint:
As it currently stands, the consumer is in a far better position now as opposed to the situation prior to the 2022 Directions. While shifting the BNPL system to a PPI-based system may not fully align with the consumer’s best interest, there are improvements.
The mandatory publication of details such as the Annual Percentage Rate (APR), recovery mechanisms, Grievance Redressal Officers designated by the REs (who can resolve disputes with LSPs) including the cooling off period are key measures.
These changes, explained in the Master Directions for Microfinance Loans, enhance transparency. This ensures that users are aware of the applicable yearly interest rates charged. The display of redressal details also helps build consumer confidence while protecting them from unfair practices. Such clarity leads to informed financial decisions and reduced over-indebtedness, owing to certain hidden fees and unclear payment terms.
Comparison with International Market Practices:
The key difference between Indian and Foreign systems, is that India has adopted a PPI-based BNPL system as opposed to the Authentic BNPL system engaged by the likes of UK, Australia and the USA.
In mature BNPL markets such as the United Kingdom and Australia, the regulations have focused heavily on consumer protection and transparency. The Financial Conduct Authority (FCA) in the UK has proposed rules to ensure lenders provide clear communications with respect to the BNPL products being categorised as loans, which can have an impact on a consumer’s credit file.
Similarly, the Australian Finance Industry Association (AFIA) has also introduced a self-regulatory practice code which restricts access of such marketing to minors and people of financial vulnerability in the society. Such practices are lacking in the Indian BNPL space.
The United States of America (USA) has a comprehensive framework for lending practices. Regulations such as the Federal Trade Commission Act (FTCA) and Unfair Deceptive Acts and Practices (UDAP) preventing predatory lending practices. The US regulations ensure the consumer’s ability to repay before issuing a line of credit, and mandates strict reporting standards to maintain a clear view of repayment history and capability supported by a refund system.
Additionally, it is worth noting that international regulations have had a positive impact on consumer behaviour and market dynamics. In the UK for instance, the FCA’s regulation secured consumer protection and modifying contract terms to be fairer and more transparent. The cap on fees collected by BNPL providers in Australia is also expected to play a significant role in the reduction of surmounting debt traps. The Consumer Financial Protection Bureau (CFPB) of the USA also positively connected all credit card related rights towards the usage of BNPL services, providing users with a well-established information and dispute resolution mechanism.
Recommendations
It is imperative to consider international best practices to improve our regulatory framework further. Markets like the UK and Australia have incorporated various practices with respect to consumer communications, ethical marketing practices, as well as regulations on terms and penalties. The BNPL provider can help the user understand the potential impacts of each credit transaction with respect to the period and penalties levied, and enable providers to adopt self-regulatory codes akin to the ones used by the AFIA. This will be a welcome move in an economy which sees roughly 60% of users falling into debt trap after using a BNPL service.
While the RBI has adopted the PPI-based BNPL system in view of emphasizing financial prudence, the market is now limited in terms of innovation and growth in the industry. The RBI ideally should have taken the route of stringent regulation as opposed to a change in the core working of the system in order to less diminish the USP of the product market in the country. Imbibing a few of the above-mentioned regulations in connection to screening, credit checks and repayment history prior to enabling such services for consumers in the Indian system can help boost regulatory and consumer outlook.
Further, the largest competitors in the market such as Slice Pay have faced major data leak issues which needs to be curbed in order to instil a better financial environment for the consumer. With the Digital Personal Data Protection Act, 2023 (DPDP) being passed, REs can immensely contribute to the safety of data by designing privacy compliance programs which will mandate all BNPL service providers to adhere to them, due to the lack of an alternative option. Routine checks can determine breaches and establish clear protocols in carrying out other functions using such user data.
Lastly, the inclusion of Integrated Ombudsman Service (RB-IOS) as an intermediate step between the GRO and Consumer Courts comes as a relief for all BNPL related issues, as it provides free-of-cost redressal mechanism to those consumers that do not receive a response or satisfactory resolution within a period of thirty (30) days from the date of complaint to the RE. Moving forward, it is essential to have a balance struck between regulation and ease of access in order to keep afloat this relatively easy method of credit-based payment.
Conclusion
The RBI has started to fully regulate BNPL systems by acknowledging complaints, setting up working groups, and issuing guidelines. While these directives explicitly prohibited loading of PPIs with cash, they allowed a more secure and trustworthy method of carrying out the BNPL model over time. Such moves come to show the willingness of the RBI and the Government to encourage financial inclusivity. The shift from a credit-line based BNPL system to a PPI based BNPL system however, seems to be a negative move for the market and innovation. By adopting the above-mentioned recommendations, it is possible to shift back to the original payment system which can benefit both consumers and the market alike.
This article is a part of the DNLU-SLJ (Online) series, for submissions click here.
Practitioner, Kristu Jayanti College of Law, Bengaluru
