By Arvind Menon

Introduction 
Reserve Bank of India has recently provided guidelines to regulate Digital Lending infrastructure in India, more specifically the BNPL (Buy Now Pay Later) industry. The regulator through the Master Direction has banned Non-banking Institutions from loading Prepaid Payment Instruments (hereinafter referred to as ‘PPI’ ) with credit lines. This article aims to understand the growth, the need and the concept of the BNPL Model, and discusses the rationale behind the regulation and its consequences.

Buy Now and Pay Later (BNPL) Industry – the Need and the Concept and the Growth. 

1.1 The Need –
Credit Vacuum
Though mainstream financial institutions in India facilitated credit through various instruments, they had failed to provide any reliable credit instruments for lower-end transactions for populations below the average income requirement. BNPL model was brought in to primarily cater to this credit gap which was left uncatered by the mainstream financial institutions of India. To elaborate, Base level credit cards are provided to consumers with an average income of 1.44 lakhs per annum (12,000 per month) with a credit limit of 25 to 50 thousand rupees. Therefore, there was an absence of a reliable mechanism to cater credit for transactions below 10 thousand for a considerable population (majorly students and youngsters) with an income below 12000 per month. The rationale behind banks and NBFCs not catering to this sector is that such institutions are governed by RBI guidelines which severely restrict credit facilitation to high-risk consumers to ensure repayment. 

Credit Accessibility
Similarly, credit cards were issued to only  3% of the population as of 2017 and this was because the issuance of credit cards was based on several procedural criteria such as the decent CIBIL credit score, earnings and respective purchasing power which were put in place to ensure the repayment of the loans. This was ensued by rigour procedures and several levels of authentication.  

1.2 The Concept – Understanding BNPL Model (Win-Win Model)
Fin-tech companies recognising an untapped business potential brought out the BNPL model. This model facilitates short-term micro-credit for consumers with low purchasing power which can be repaid via instalments with 0% or subsidised interest. The said avenues of credit were made easily accessible by providing the same through a one-stop solution – E-wallets and other PPIs that are linked with the consumer’s phone number.

Further, this feature of easy credit accessibility, circumventing procedures imposed by the regulator was made possible by the fin-tech companies by issuing their own PPIs which are financed by Non-Banking Financial Institutions with credit lines which are loaded to these PPIs. Therefore, BNPL companies essentially act as a facilitator or an intermediary that connects end customers to financing partner.

The model made its earnings majorly via two avenues. Primarily via transaction rates charged on the sellers increasing the latter’s consumer base by providing credit. And secondarily via interest that is charged for defaults/delayed payment of instalments. This enables a win-win situation as it enables credit to customers while sellers’ consumer base increases and fintech companies make a profit. 

1.3 The Growth 
Catering for the said need, the BNPL industry had seen tremendous growth in the Indian market in the past few years. Until the recent RBI regulation, it was termed as credit card challengers and was contemplated to replace Credit cards at the lower and the mid-lower end of the spending spectrum. A report by Razor pay has observed the Indian BNPL market to have grown by 539 % in 2020 and 637% in 2021. Q4 2021 BNPL Survey had forecasted that BNPL payments in India to grow by 89.5% on an annual basis to reach USD 6927.4 million by 2022.  Now let’s examine why the central bank had to regulate the growth of the industry.

Regulator Intervention

2.1 Rationale behind the Intervention
The extensive and unnatural outgrowth of the BNPL industry has been based on several tangible and psychological factors. This unique combination of factors also forms the basis of pro-regulation arguments against the BNPL business model. To elaborate:

Target Demographic – A major chunk of the consumer base of the BNPL industry consists of GenZs and Millennials. Having been brought up and receiving their primary socialisation in the age of social media and digitalisation, the said populace is better placed to use the technology and is psychologically accustomed to instant gratification. 
Convenience with respect to easier credit facilitation, nearly 0% interest and alluring repayment schemes and one-stop application for purchasing, etc.
Deferred payments allow the populace to materialise the consumption in real-time while postponing the ‘pain of paying’. Psychologically our brains are hardwired to seek methods of easier or instant gratification.

Note –
Dr Carey Morewedge put forth the infamous ‘Pain of Paying’ formula as

Cost of your item/pool of resources (cash/BNPL/others) = Pain of Paying

The size of the pool is inversely proportional to the pain of paying. That is when the pool of resources is larger, and a withdrawal from the same, psychological seems minuscule and negligible. BNPL companies by extending the credit limit increase the resource pool, and thus give a false belief of security.

Micro-credit vacuum as discussed above. 
And lastly, the Pandemic drove the nation to its knees and necessitated the restriction of mobility. This factor emanated a wave of online shopping and digital transactions even for the day to day needs. 

This unique combination of the above-said factors has been observed to have driven today’s young adults with (1) low purchasing power, (2)  volatile credit scores and (3) a reduced exposure to conscious spending; to purchase beyond their capabilities pushing them towards a debt trap. 

This phenomenon has been well documented in contemporary jurisdictions. For example, the Australian Securities and Investment Commission in November showed that 15% of Australian consumers using such pay-later schemes had to take out an additional loan in the previous year to pay off their BNPL plan on time.

Fitch rating commented 
“BNPL users may find themselves unable to afford the periodic repayments and may turn to
credit cards or other forms of high-interest debt to repay BNPL debts,”.

A study report by personal finance company ‘CreditKarma’ shows a third of U.S. consumers
who used “buy now, pay later” services have fallen behind on one or more payments, and
72% of those said their credit score declined.

In addition, these fintech companies had been involved in several unethical practices such as
the first loss default guarantee arrangement (FLDG).  FLDG is essentially an arrangement with
the financing partner to conceal the first instance of default from being considered as an NPA
to evade RBI regulations.

2.2 Legal Framework – Procedural Nuances 
Prepaid instruments initially materialised themselves in 2017 as an electronic wallet which could be loaded with money to make transfers and transactions. But in recent years, foreseeing the unexploited market here, fintech companies put forth loan-based PPIs with the model above explained. With a view to regulating the said market, the Reserve Bank of India issued Master Directions on Prepaid Payment Instruments (PPIs) on 27 th August 2021. Direction 7.5 therein defines the scope of the modes of storing/loading value into the PPI as follows 

“7.5 PPIs shall be permitted to be loaded/reloaded by cash, debit to a bank account, credit
and debit cards, PPIs (as permitted from time to time) and other payment instruments issued
by regulated entities in India and shall be in INR only.”

Clarifying the said direction, RBI on June 20, 2022, sent private letters to authorised non-bank PPI issuers explaining that the existing framework doesn’t allow the loading of PPIs with Credit Lines. The said letter was not made public but a copy has been published by certain news outlets.

Photo from Twitter 

Amidst the complaints of several fin-tech Companies critiquing the unanticipated and abrupt nature of the letter, RBI stated that the letter was merely clarificatory in nature as the existing framework clearly defines the scope of methods through which PPIs could be loaded. 

Conclusion

“With this RBI move, there will be more transparency in the system. The basic role of fintech is to provide the banks with a technology platform which enables them to deploy BNPL solutions”         Saurabh Puri of Zaggle 

The above-discussed rationale informs us of the requirement for transparency and regulation in the BNPL industry. It is to be understood that the primary intention of RBI is to regulate and not terminate the industry. Given that the business model of most BNPL players is not limited to the BNPL industry, they shall be able to survive the said regulation, until the central banks formulate appropriate regulation strategies to bring transparency within the industry. But it’s also to be noted that financial institutions while exploiting the markets are also burdened with the duty of creating awareness and attitudes of conscious expenditure among today’s young adults for a sustainable and stable economy.

Arvind Menon is a student of the B.B.A.-LL.B. 2019-24 batch of Jindal Global Law School.
His areas of interest surround Constitutional law, Contracts and Commercial Law  and Trial
Advocacy.