Banking the Unbanked: BNPL as a Tool for Financial Inclusion in India and the Barriers in Achieving it

Introduction

Consumer credit is a concept that has existed in various forms since the genesis of the monetary system and is nothing new. While it started formally through instalment sales in the 19th century,¹ in 2023, the Buy Now Pay Later (BNPL) system is one of the new and novel ways of extending credit to consumers.

BNPL is a form of payment mechanism through which an individual can purchase goods and services at the moment but pay for the same later through small instalments, often with no interest.² There are two types of BNPL services, offline and online. Offline BNPL has existed for long and includes traditional EMI systems with lengthy paperwork and interest payments. On the other hand, online BNPL is relatively new and combines the features of digital lending and payment mechanisms to offer seamless credit to consumers and is the one relevant to this essay.

BNPL has grown to prominence lately backed by the fact that India’s credit market is extremely unserved with about 400 million people, or 50% of the total eligible population of the country not having access to formalised credit.³ Additionally, a mere 77 million people,⁴ with a credit card penetration rate of 0.02 per capita against 2.01 per capita in the US,⁵ own and use credit cards.

However, Reserve Bank of India (RBI) believes that easy access to credit in a world where ecommerce is extremely popular — will lead consumers into debt traps. Adding to that, there have been various reports of online scams and harassment by digital lenders recently.⁶ This has caused RBI to look at the practices being employed by BNPL companies and on 20-6-2022, Central Bank came out with a notification that has sent shockwaves to the whole fintech industry.⁷

There have been speculations that the future of the BNPL industry is at risk in India.⁸ In light of the same, this paper aims to examine the economic structures of online BNPL and their significance, the legal implications of RBI notification, and the way forward in regulating BNPL industry in a way that benefits the consumer economy and at the same time mitigates the risks posed by an unregulated BNPL industry.

The role of BNPL in promoting financial inclusivity

BNPL arrangements have become increasingly popular despite the existence of a range of consumer credit and payment options. This is primarily due to the BNPL system’s promise of financial inclusion.

It must be understood that credit cards have very high eligibility criteria, and only serve individuals who have an existing and acceptable credit score/history or generally those who have a great relationship with the few banks that are authorised to issue these cards.⁹ Credit scores can only be built by being a part of the formalised credit industry and therefore it becomes a vicious cycle.

BNPL lenders, contrary to the conventional credit card and unsecured loan providers, use alternative data sources to assess the creditworthiness and underwrite customers who are new to credit.¹⁰ This enables a large segment of the country’s salaried and self-employed population to obtain point of sale credit and finally be brought under the formalised credit system.

Thus, by lowering the entry barriers for formal credit, BNPL has become a really popular mode of payment in India and worldwide. Many believe that it is the future of payments in India and research estimates that the BNPL industry has the potential to grow 15x from USD 3-3.5 billion in 2021 to USD 45-50 billion in 2026 with the individuals using BNPL slated to grow from 10-15 million to 80-100 million in the same period.¹¹

The other crucial driving force of the popularity of BNPL is the specific benefit that accrues to the various demographic of consumers and merchants particularly in India.

First and foremost, BNPL arrangements are made to accommodate the spending habits of younger generations, who are just entering their prime spending years.¹² Due to their propensity for being early adopters of new technologies and greater comfort with online shopping, people between the ages of 18 and 24 are more likely to use BNPL services.¹³ This age group also has a tendency to have less disposable income, so it is possible that they are seeking more flexible payment alternatives that let them spread out their purchases over time.

Younger customers are also drawn to BNPL services because they frequently do not need a credit check or a credit card, making it simpler for people with bad or no credit history to make purchases.¹⁴ Young customers who want to make purchases but may not have the money to do so all at once may find them to be an appealing option due to the convenience and simplicity of BNPL services.

Second, BNPL can help in serving Indian workers in the unorganised sector. In India, the unorganised sector employs 93% of the workforce, many of whom are not eligible for formal credit.¹⁵ This gap can be filled by BNPL. BNPL services can aid unorganised sector workers in India by enabling them with more flexible payment choices for their purchases. It may be challenging for many workers in the unorganised sector to make larger purchases or obtain credit when they need it since they may have inconsistent incomes and limited access to typical credit lines and credit cards.

By enabling customers to pay for their purchases over time, frequently without the need for a credit check or a credit history, BNPL services can help address this issue. Because they would not have to pay for them all at once, this may make it simpler for unorganised sector workers to make larger purchases like appliances or electronics. Unorganised sector employees may be able to better manage their finances by delaying their payments over time and avoiding debt or other financial hardship.

Finally, merchants and e-commerce platforms have a huge incentive for incorporating the BNPL service under the payment ecosystem. Due to the fact that purchases made through BNPL do not require the consumers to pay anything or only a nominal amount at the time of the purchase, the consumer is encouraged to make more spontaneous buys. Additionally, the BNPL providers pay the merchants immediately (after the deduction of a merchant fee),¹⁶ and the complete credit risk is borne by the BNPL providers. Therefore, the merchants enjoy increased sales without having to bear any of the credit risks which is highly beneficial for them.

Economic structure of BNPL

Instruments that facilitate purchase of goods and services, financial services, remittance facilities, etc., against the value stored therein are known as prepaid instruments (PPI) in India.¹⁷ A PPI can be issued by any company holding a PPI licence and their popular forms include gift cards, travel cards, coupon cards, etc.¹⁸ However, due to the lack of clear guidelines over the same, major fintech companies have now started loading PPIs with third-party backed credit lines instead of the consumer’s own money.

A BNPL in India typically involves three parties, (1) the entity providing credit (generally banks and NBFCs); (2) the PPI issuer (BNPL provider holding PPI licence); and (3) the consumer. There are various alternative BNPL structures but the functioning of the most common one is as follows:¹⁹

1. The BNPL provider holding the PPI licence ties up with a bank or a NBFC authorised to issue credit.

2. The BNPL cards/wallets in the form of PPI are issued to consumers who are allowed to make payments or withdraw cash through these PPIs.

3. Although a utilisation limit is provided for the PPI, it does not come with any preloaded cash. It, however, is backed by a credit line by the third-party bank or NBFC.

4. When the consumer utilises the PPI, the credit line would be activated on demand and the payment would be effectuated.

Decoding the regulatory concerns

On 20-6-2022, RBI issued a directive to the “Non-Bank PPI issuers”. The directive stated that “The PPI-MD does not permit loading of PPIs from credit lines. Such practices, if followed, should be stopped immediately.”²⁰

While PPIs can be loaded with cash, debits from a bank account, credit cards, and debit cards, according to the RBI, the legal structure that controls their issuance and use prohibits them from being loaded with credit lines. The ban is a close follow-up to RBI’s previous clarification from December 2020, which stated that only banks, registered NBFCs, and other State Government regulated statutory bodies can engage in public lending activities.²¹

(a) BNPL services as credit cards

One of the primary concerns of RBI in banning PPIs loaded with credit lines seems to be the fact that companies not authorised to offer credit cards are offering these PPIs that have similar characteristics to credit cards but do not conform with the Master Directions on Credit Card and Debit Cards (MD-Credit and Debit Card).²² The concern of RBI is more focused towards non-bank entities issuing PPIs and the recent directive is addressed to them because non-bank entities are not allowed to issue credit cards.

Clause (a)(xii) of Para 3 of the Master Direction on Credit and Debit Card states that—

Credit card is a physical or virtual payment instrument containing a means of identification, issued with a pre-approved revolving credit limit, that can be used to purchase goods and services or draw cash advances, subject to prescribed terms and conditions.²³

BNPL cards and wallets, issued as PPIs with credit lines, have a close resemblance in characteristics to qualify as a credit card in pursuance to the above definition. BNPL instruments are issued in both physical and virtual forms. BNPL instruments are also used to withdraw cash and purchase goods and services. Finally, while there are BNPL instruments that do not have revolving credit lines and simply function as term loans, the general outlay of BNPL is remarkably similar to credit cards.

Therefore, it appears that the BNPL companies have structured their products in this way to bypass the regulatory framework. Permitting PPIs to operate like credit cards would create an opportunity for regulatory circumvention which is particularly dangerous in a critical industry such as payments.

(b) PPI – Master Directions and the directive

(i) Understanding the PPI — Master Directions

The RBI Master Directions on PPIs (PPI-MD) govern all the affairs concerning PPIs in India.²⁴ Para 7.5 of the aforementioned directions provide that the loading and reloading of PPI should be done through debit to bank account, cash, debit card and credit card of the PPI holder.²⁵ Additionally, Para 7.9 of the same directions provide that the PPI issuers may also load or reload the PPIs issued but it must only be done through the authorised outlets or authorised/designated agents of the PPI issuer and subject to conditions including due diligence, confidentiality, adherence to KYC, etc.²⁶

Although it is clear from Para 7.5 of the PPI-MD that the objective purpose of PPIs is loading the consumer’s own money and using it for making payments, BNPL companies have been using Para 7.9 and regulatory arbitrage in the fact that there was no direct prohibition on loading PPIs with credit, to facilitate their business models and now RBI has found objection to the same.²⁷

(ii) Applicability of the directive

The fact that the directive has been addressed specifically to “Non-Bank PPIs” has caused a lot of ambiguity on which entities it actually applies to.²⁸ However, Para 7.5 of the PPI-MD itself states the permitted ways of loading a PPI are through cash, bank transfer, credit and debit cards.²⁹ The recent directive simply clarifies the existing regulation with regards to the same. Additionally, it can also be seen that Para 1.3 of the PPI-MD states that the PPI-MD applies to all PPI issuers.³⁰

Therefore, the language of the directive which states “PPI-MD does not permit loading of PPIs with credit lines” cannot be reasonably understood to be inapplicable to bank-based PPIs. Pursuant to the same interpretation, multiple BNPL companies, including ones based on both bank and non-bank PPIs, have shut down their BNPL operations and have chosen to pivot to co-branding of credit cards.³¹

Suggested framework

India intends to become the hub for Fintech in Asia, utilising technology to boost productivity, open up new opportunities, and more effectively control risks.³² The country has revolutionised the global payments industry with the introduction of UPI.³³ However, the complete ban on BNPL which is gaining widespread prominence around the world would hinder India’s hopes of becoming a fintech hub.

However, BNPL is a form of unsecured consumer credit and it has an elevated risk component as compared to a secured loan, where the creditor or the consumer can sell the collateral to recover the debt. Therefore, the suggestions for regulation are made to preserve the novelty of BNPL while mitigating its attendant risks and in reference to the existing unsecured credit regulations in the country.

Licence requirements

BNPL arrangements involve an inherent credit risk and their stable management is imperative. They may have systemic implications if not managed properly. By requiring licences, the BNPL providers will be required to adhere to all prudential supervisory rules, including those pertaining to capital adequacy, liquidity management, and stress testing. Additionally, having a licensing requirement will help the regulator ensure that fair lending practices are being followed by BNPL providers such as providing consumers with clear information on their rights and duties, not using aggressive and harmful debt collection techniques, etc.

Para 2.2 of the Master Circular on Credit Card, Debit Card and Rupee Denominated Co-branded Prepaid Card Operations of Banks and Credit Card issuing NBFCs (MC-CC) which is the authority on credit cards in India provides that only banks and NBFCs with a net worth of Rs 100 crores and above may be allowed to issue credit cards.³⁴ Such a stipulation would ensure that only credible companies with adequate financial backing are allowed to offer BNPL services to consumers.

Compliance with KYC norms

Know Your Customers (KYC) are certain standards designed to protect banking institutions against fraud, money laundering, corruption, terrorist financing, etc.³⁵ Most financial services in the country are subject to the KYC norms issued through the Master Direction —Know Your Customer (KYC) Direction, 2016.³⁶

Para 6 of the MD-PPI already makes PPI issuers and in furtherance all BNPL providers subject the KYC norms, but Para 2.8 provides for small PPIs which can be issued without KYC of the consumer.³⁷ Various BNPL providers have been making use of this provision to issue BNPL services without proper KYC.

KYC is a critical feature of protecting the security of financial transactions and avoiding fraud and money laundering. Additionally, BNPL providers can determine their customers’ creditworthiness and confirm their identities by doing KYC checks on them. Therefore, BNPL services should be subject to KYC norms like all other financial services in the country.

Income requirements and credit limits

The primary purpose of BNPL is providing a vast majority of Indians who were previously excluded, access to affordable and on demand credit. Most BNPL providers do not charge interest on credit as long as it is being repaid in the requisite time period. This feature of BNPL services helps prevent customers from being led into a debt trap by credit fees or interest and smooths out any cash flow issues the customer may experience. Thus, BNPL services should not be subject to any minimum income requirement as such a requirement would again lead to the exclusion of certain groups of the population.

In the current scenario, RBI does not prescribe a minimum income requirement for issuing credit cards but credit companies may, according to their policies, come up with income requirements that they deem suitable. For example, HDFC which is one of the largest banks in India, prescribes minimum income requirements ranging from Rs 2 lakhs per annum to Rs 21 lakhs per annum for its credit card products.³⁸

However, RBI may prescribe a maximum credit limit, based on income levels, to protect the interests of the consumers. This would ensure that while everyone will have access to credit, they would not be able to borrow beyond their means. Currently, RBI allows banks and NBFCs to decide the credit limit by themselves, under Para 2.3 of the (MC-CC).³⁹ In contrast, an aggregate credit limit prescribed by RBI, based on the income level of consumers will allow fair competition between BNPL providers and also ensure that affordable credit is accessible.

Disclosure requirements

Given the sensitive nature of BNPL services, the providers must be mandated to provide their consumers uniform information disclosures. If the information regarding interest rates, penalties, administrative fees, etc. is not clear to the consumers, it may lead to information asymmetry and consumers may not be able gauge the potential costs of using the BNPL service.

Para 5.1 of the MC-CC stipulates that any levy of interest, late fee or penalties on credit cards must be done in a transparent manner and the methodology and calculation of these charges must be clearly indicated to the consumers.⁴⁰ Additionally, in the UK, the FCA instructed BNPL providers that they must comply with financial promotion rules and that information with regards repayment, additional charges, etc. must be made clear to the consumers while providing the service.⁴¹

Therefore, it is imperative for the protection of consumer interests that uniform information disclosures be made available to the consumers. The RBI may draft new rules or extend the credit card disclosure requirements for the purpose.

Confidentiality

BNPL providers deal with highly sensitive information such as the name, address, and income details of its consumers. Absence of adequate confidentiality safeguards could lead to unauthorised access of this information and have dangerous ramifications such as identity theft, fraud, misuse, etc.

Thus, BNPL providers must put in place sufficient security measures, to safeguard the privacy and confidentiality of consumer data and prevent unauthorised access to information. Para 9 of the MC-CC provides that no information of a consumer shall be divulged to any individual or organisation without the specific consent of the consumer.⁴² Additionally, BNPL providers in Singapore⁴³ are required to comply with Info-Communications Media Development Authority Data Protection Trustmark and the providers in the UK⁴⁴ are required to comply with GDPR.

In the absence of data protection legislation in India, RBI may provide specific rules for the use of data or extend the rules available for credit card providers to BNPL services.

Grievance redressal mechanism

The complete BNPL industry is very new and therefore, the possibility of delinquencies is very high. BNPL providers must be required to establish a robust grievance redressal mechanism to address consumer grievances. This would give customers a way to avail relief if they have concerns with the services offered.

Para 12 of the MC-CC provides that consumers may be given a time period of 60 days for referring their complaints/grievances and that designated grievance redressal officers should be mentioned on the credit card bills.⁴⁵ Such a system can also be implemented for BNPL services to ensure that consumer grievances do not go unaddressed.

To sum it all up, it is suggested that regulation of BNPL services in India should focus on maintaining the benefits of the BNPL mechanism but at the same time ensuring transparency, consumer protection, and responsible lending practices. This would encourage the creation of a healthy and sustainable BNPL business in India and assist in preventing consumer debt accumulation that is excessive.

Conclusion

The BNPL market has seen rapid expansion in recent years, both locally and internationally. BNPL services have the potential to benefit India significantly. BNPL arrangements provide cheap and less risky credit to consumers, catering to the demands of risk averse younger generations, allowing access to credit to the underbanked, and improving the sales of merchants.

However, as has been noted in this essay, BNPL arrangements are not governed by consumer credit laws and may provide potential consumer issues that require immediate attention. To guarantee that the BNPL market grows in a way that benefits customers, regulatory control is required.

To this end, this paper proposes adopting an approach that protects the interests of the consumer but at the same time preserves the unique characteristics of the BNPL mechanism. With respect to BNPL arrangements, an attempt has been made to outline in broad brushes six key reforms that could be undertaken in India including licensing criteria, KYC standards, credit limit rules, standardised information disclosure, confidentiality requirements, and a grievance redressal.

This approach will foster a culture of consumer priority, transparency and accountability in the BNPL industry and promote a healthy and responsible credit ecosystem, allowing BNPL to grow while endowing substantial benefits to consumers.