India: Digital Lending Guidelines: Fund Flow And Pass-through Accounts

Pass-through accounts are common in digital lending arrangements. Buy-now-pay-later (BNPL) products typically involve five parties: (1) a Regulated Entity (RE) like a bank or NBFC lending off its own books; (2) a Lending Service Provider (LSP) which owns the distribution channel and helps service borrowers through its Digital Lending App (DLA); (3) a payment service provider like a Payment Aggregator (PA) which facilitates the movement of funds; (4) a borrower who avails a loan from the RE through the DLA; and (5) a merchant who the borrower wants to buy products or services from, on credit.

When a loan is sanctioned, the RE transfers the loan amount to the PA. When the borrower buys a product from the merchant, the PA in turn transfers a portion of the loan amount (the sale price) to the merchant. When the due date for the loan arrives, the borrower transfers the loan amount utilized to the PA. And the PA transfers the repayment collected from the borrower to the RE. But the RBI'sDigital Lending Guidelines(Guidelines) have cast doubts on the permissibility of this fund flow. Let's understand why.

The Guidelines govern two key aspects of the fund flow. The first is where money can go to. The second is where money can go through.

Where money can go to

The Guidelines state that the RE must disburse the loan amount directly into the borrower's account. Further, the RE must ensure that repayments by the borrower are directly transferred to the RE's account. So, the money can only go to the borrower's account (in case of disbursal) or the RE's account (in case of repayment). However, the Guidelines also recognize exceptions to this general rule. For e.g., the RE can disburse the loan amount into an end-beneficiary's account if the disbursal is for a 'specific end-use'. This suggests the RE can transfer the loan amount to the merchant's account in certain cases.

But what does specific end-use mean? It could cover loans which can only be used to pay a single merchant. But could it also cover loans which can be used to pay many but not all merchants? For e.g., if you can use the loan amount to buy groceries, electronics or jewelry but not lottery tickets, is the loan intended for a specific end-use? Does the RE have to white-list specific end-uses or is it enough if the RE black-lists specific end-uses? Does it matter if the RE's LSP has acquired merchants on its own or if a PA's merchant network is used? All these factors may impact whether the RBI believes a loan disbursal is for a specific end-use.

Where money can go through

The Guidelines state that disbursals and repayments must be made directly between the RE and the borrower without involving the pass-through account of any third-party. However, an exception to this rule is disbursals covered exclusively under statutory or regulatory mandate. It's unclear whether this exception will cover disbursals made to a PA's regulated escrow account. PAs have alsosoughtthe RBI's permission to continue acting as intermediaries in digital lending transactions.

Time for a road-trip

To understand the impact of these requirements and the best way forward, imagine the digital lending transaction as an arrangement which requires physical movement of cash in a car. Can the RE hire a professional driver (the PA) to drive the car and drop off the cash? And can the car drop off the cash at the merchant's address instead of the borrower's address?

Scenario 1:If disbursals must be made without any pass-through accounts and only to the borrower's account, the RE must drive the car to the borrower's address and drop off the cash. But the borrowers may live in a different neighbourhood and the RE isn't familiar with the roads in these areas. So, it must spend a lot of time and energy traveling to each borrower's address. The borrower must also then travel to the merchant's address when it wants to buy a product using the loan amount.

Scenario 2:If pass-through accounts of PAs are allowed, the RE can hire a driver to drive the car to the borrower's address and drop off the cash. The driver is familiar with most roads in the city and it can locate the addresses of borrowers more easily than the RE.But even in this scenario, the borrower must travel to the merchant's address to buy a product using the loan amount.

Scenario 3: If disbursals to merchants are allowed, the RE can drive the car to the merchant's address and drop off the cash. This saves the borrower the hassle of travelling to the merchant's address herself. But the RE doesn't have a relationship with the merchant. So, the RE again has to spend a lot of time and energy traveling to each merchant's address.

Scenario 4:If both pass-through accounts of PAs and disbursals to merchants are allowed, the RE can hire a driver to drive the car to the merchant's address and drop off the cash. This is the optimal solution. The driver can easily locate the merchant's address because she has tied-up with the merchant and regularly makes deliveries to the merchant. In this scenario, the borrower also doesn't have to travel to the merchant's address herself.

We hope the RBI clearly greenlights use of pass-through accounts of PAs and disbursals to merchants to preserve the efficiency of digital lending transactions.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.