Explained: Why India's Rapidly Growing 'Buy Now Pay Later (BNPL)' Sector Is In Crosshairs Of RBI Regulatory Action

The Indian Buy Now Pay Later (BNPL) sector has grown rapidly over the last few years as an increasingly large number of users adopted BNPL products for their purchases.

According to a report by Razorpay, the sector grew by 539 per cent in 2020 and 637 per cent in 2021. The target audience for some of these players has been students and young professionals who are completely new to credit.

Extending credit to customers whom banks and larger players wouldn't touch allowed these players to find a niche in the market. In addition, they effectively offered the same functionalities of credit cards without cumbersome documentation, lower fees on late payments, flexible payment structures, and multiple offers.

As the BNPL sector grew, several articles were written about the death of credit cards. But in a reversal of fortunes, the RBI may have rung the death knell for the BNPL sector through its new circular.

How did BNPL Companies Circumvent Regulations?

To understand why BNPL companies have landed in a soup, it is important to understand how these companies issue cards and credit and run operations.

Since banks are the only ones allowed to issue cards, these companies partnered with banks to issue these cards under the bank's name. But as highlighted earlier, these companies catered to markets that banks wouldn't touch with a pole.

Since they primarily catered to high-risk customers, these players soon turned to non-banking financial companies (NBFCs) that would lend to their accounts. Hence, the BNPL players managed to circumvent the Reserve Bank of India's regulations and reach out to customers that struggled with securing credit.

In fact, these companies became more successful than banks in terms of the volume of cards issued. According to reports, banks combined would issue around 15 lakh cards a month, in comparison to 20 lakh cards issued by BNPL players combined.

Why is the RBI Stepping In?

There has been a lot of speculation over the rationale behind the RBI's decision, but the RBI is yet to come up with a detailed clarification.

While some believe that non-bank pre-paid instruments (PPIs) wouldn't be allowed to be loaded with credit anymore, others believe that the move is only a means to bridge the regulatory gap between fin-techs and banks, where fin-techs enjoy greater freedom.

Pre-paid instruments include products such as digital wallets or cards that could have a credit line loaded onto them, making them pseudo-credit cards. These cards are also known as credit-card challengers.

The circumvention of rules and several other shady practices used by these companies is said to have attracted the regulators' attention. Recently, the RBI released a new letter asking "All Non-Bank Pre-Paid Instruments Issuers" to cease issuing cards.

"The PPI-MD does not permit loading of PPIs from credit lines. Such practice, if followed, should be stopped immediately. Any non-compliance in this regard may attract penal action under provisions contained in the Payment and Settlement Systems Act, 2007," said the clarification by the RBI.

The factor that allowed BNPL players to grow quite quickly – easy KYC processes, less documentation, quick approval, and no requirement of credit history, became the very factors that might've resulted in increased RBI scrutiny. Since it was quite easy for sub-prime borrowers to access these credit instruments, it also increased the risks faced by the lenders.

Some apps even allowed borrowers to borrow without submitting documents, which was clearly risky lending. According to Trans-Union CIBIL data, for loans that are 60 days past due date, non-BNPL loans show delinquencies of around 10 per cent, while BNPL loans show delinquencies of 18.69 per cent, which is almost double the non-BNPL rate.

Given that these delinquency rates are quite high, despite a relatively strong economy and high savings rates, it can get tougher in case the economy slows down.

Others would lend without making proper disclosures to credit bureaus about the loans and the repayments made by users. Further, they managed to charge exorbitant fees from customers in case of late payments, which are not regulated by the RBI.

Apart from circumvention of regulations, lending to sub-prime borrowers, and flouting of rules, some fin-techs have also come under the scanner for using shady means to recover money. For instance, several apps ask for permissions to contacts in case we wish to borrow from them.

Unsuspecting users allow these apps to have access to their contact list. However, the reviews show the real reason behind these permissions. Several reviews on prominent apps have highlighted that in case of delayed payments, the users' relatives and friends are called up and informed about the default. Then, the BNPL platform's recovery agents ask these contacts to pay up on the defaulter's behalf.

How would fin-tech players be affected?

The BNPL industry is still struggling to make sense of the new circular, as it threatens their very existence.

There have been debates over the new regulations' meaning, applicability, impact, etc. In case fin-techs cannot issue PPIs loaded with credit and lend, the entire business model would collapse.

For many fin-tech start-ups, BNPL products were the last option that could potentially save them. Many fin+tech businesses ultimately turned to BNPL to generate revenues when no other business yielded results.

For instance, Mobikwik, Paytm, Slice, Uni, LazyPay, OneCard and several other prominent start-ups heavily depended on the BNPL business to drive their revenues upwards. So far, in the absence of neo-banking regulations, they had been unable to find a better source of revenue.

On their part, BNPL players argue that such sudden regulations can cause confusion and panic within an industry that has been attempting to drive greater financial inclusion in India. They even see it as a move that allows banks to gain an edge in the credit card business while fin-tech players are forced to shut down due to regulatory pressure.