RBI’s crackdown on NBFCs sparks debate over fairness

If the critics are to be believed, the Reserve Bank of India (RBI) is once again playing favorites, with young fintechs and innovations potentially at risk.

Several founders and experts spoke Your story that the RBI’s recent action against four NBFCs smacks of arbitrariness and the reasoning behind it is not logical.

The four NBFCs – DMI Finance, Navi Finserv, Asirvad Micro Finance and Arohan Financial Services – were penalized for allegedly charging high interest rates, but they are not alone.

“If NBFCs are penalized with fees of 30-40%, why don’t credit card companies, which sometimes charge up to 40% or more, adhere to the same standard?” said a founder of a lending startup, requesting anonymity.

In its order last week, the RBI noted that some NBFCs were charging excessively high interest rates, particularly on small loans. In asking companies to stop lending, the central bank stressed that the difference between what it charges borrowers and their borrowing costs (their profit margin) is excessive. The companies were also found to be violating provisions of the Fair Practices Code.

The RBI does not directly regulate the interest rate margin that NBFCs can charge. However, NBFCs are expected to establish internal policies and procedures for setting interest rates, thereby ensuring that any spread between the interest rates they charge and their borrowing costs is reasonable and justified by the risk.

Several voices from the lending startup ecosystem have raised concerns over the RBI’s actions and questioned what “appropriate interest rates” mean for the central bank.

“The regulator has already made it clear that all interest rates and fees charged to customers must be disclosed [at the time of disbursing the loan]. Only when the customer reads it and gives their consent does it continue,” says another founder Your storyand also requests anonymity.

In February this year, the RBI made it mandatory for all lending institutions, including banks, NBFCs and digital lenders, to disclose all charges related to loans to increase transparency.

“So I don’t think anyone can do business today without disclosing interest rates and fees. But the real question is: Why are NBFCs being singled out when credit card fees are higher? If there are concerns that an interest rate of 30% is too high, shouldn’t the RBI also take action against interest rates on credit cards of 40%?” argues the fintech founder.

According to lending marketplace Paisabazaar, DMI Finance and Navi charge interest rates of up to 45% per annum. DMI Finance and Navi Finserv offer loans of up to Rs 4 lakh and Rs 20 lakh respectively.

According to a report by ICRA, DMI Finance’s credit spreads increased to 14.6% in FY2024 from 14.1% a year ago. For Navi, the report states: “Any past collection deficits have been offset by the subordination and/or excess interest margin available in the structure.”

Other executives expressed concerns about the regulatory environment in India’s financial sector.

Anand Lunia, founding partner of IndiaQuotient and investor in loan startups LendingKart and LoanTap, criticized the current approach in a post on X.

The founder of a digital lending startup, who also requested anonymity, highlighted the challenges NBFCs face in pricing their products. Non-banks must consider future securitization prospects, which are critical to maintaining liquidity, as well as fraud that could render a loan unviable. “It costs a lot to set up a modern NBFC with modernized underwriting systems, branch networks, etc,” he notes.

He warned that financial inclusion, a goal championed by the government itself, could be undermined if lending rates were cut without taking into account the risks involved.

“I am not sure if some of these products will even work if NBFCs are not allowed to charge reasonable tariffs,” he reflects. “Of course costs have to come down, but there has to be a natural progression for that to happen. Taking unsecured loans is a very difficult task.”

Credit cards vs NBFCs

Banks charge various fees on credit cards, the most significant being interest on unpaid amounts. This interest is expressed as the annual percentage rate (APR), which represents the credit card’s annual cost of borrowing.

Credit card APRs in India can include special rates, sometimes as low as 0% before switching to regular rates. For example, Axis Bank’s APR can go up to 52.86%, while Yes Bank’s APR can go up to 28.8%. These can be equal to or even higher than those offered by regulated microfinance institutions (MFIs), which typically charge between 20 and 30% per year.

Some argue that it’s not just because of the high interest rates, but also how transparently they are calculated.

Credit card companies provide clear information about APRs and all associated fees, notes Anirudh A Damani, managing partner at Artha Venture Fund, which has invested in digital credit startups such as KarmaLife and LenDenClub.

“After testing the situation myself, I found cases where an NBFC was charging an interest rate of 24%, but once processing fees and hidden costs were added, the effective interest rate climbed to over 36%. This lack of clarity is problematic, particularly when it comes to lending to SMEs or individuals who may not have the financial knowledge to recognize such discrepancies,” he explains.

While some in the industry argue that high interest rates are necessary to cover the risk of unsecured loans, there is an urgent need for better transparency and protection for borrowers.

Ritesh Srivastava, founder of FREED, a debt resolution platform that helps overburdened borrowers manage repayments and avoid harassment, challenges the notion that borrowers faced with high-interest loans have no alternatives.

“You don’t give a man the loan because he’s needy. They give a man a loan because he is creditworthy,” claims Srivastava, dismissing the notion that NBFCs are the only option for those desperate for loans.

However, Srivastava also points out that borrowing at higher interest rates does not mean borrowers are being misled or “screwed” by lenders.

“Even when NBFCs fully disclose their fees, interest rates and EMIs, borrowers tend to focus only on whether they can afford the EMI without considering the overall cost of the loan. As a result, they may end up paying double the amount borrowed over time.”

In the meantime, the market regulator appears ready to intensify its control. More lending companies could come under regulators’ scrutiny, according to a report from Morgan Stanley.

“The role of the regulator is not only to support innovation, but also to ensure that it is carried out responsibly,” notes Damani.