24
Apr

A Brief Comparison of Ombudsmen Frameworks – Part 2

By Madhu Srinivas, IFMR Finance Foundation

Following our initial post on a brief comparison of grievance redressal mechanisms existing in India for financial services, at first glance it can be seen that there is considerable variation in the process elements among the various sector ombudsmen. This is indicative of varying processes, approach and service levels of the redress mechanisms. Let us delve on some common observations we made from the comparisons.

Recognition of Misselling, or a lack thereof

The Report of the Governing Body of Insurance Council (GBIC)[1] has made the following observation in its analysis of the complaints received against Life Insurers – “In most cases of mis-selling the financial underwriting rules have been disregarded by the underwriter. So mis-selling which could have been arrested at the underwriting stage instead gets an impetus when the underwriter clears long premium paying term plans even though the proposer does not have the paying capacity to maintain the policy beyond the initial first payment.

Our cursory analysis in the previous blog post[2] reveals that there is no recognition of unsuitable sale as a separate category of complaints (beyond process-level complaints). Current supervisory mechanisms also have minimal efforts directed towards systematic detection of conduct violations on a regular manner, such as for violations of affordability assessments across all lending channels, and if such efforts exist, they are not placed proactively by the supervisor in the public domain. There is therefore a systematic under-representation of, and a lack of adequate evidence on the extent of unsuitable sale to households occurring in today’s context (products being unsuited to client needs, unfair contract terms, misleading conduct and market practices of intermediaries and so on). There is inadequate information about ‘misconduct’ practices feeding back to regulators and supervisors providing no respite for consumers even in the longer run. This would substantially underestimate the occurrence of, and the costs to customers on being mis-sold unsuitable products, and consequently reduce the impetus for regulatory action on the same.

Feedback Loops into Regulation and Supervision

The grievance redressal function can act as a powerful feedback loop to the regulator and can inform their regulatory and supervisory approaches as well as actions. We cannot definitively conclude whether regular feedback loops exist and if they do, whether regulators take these as inputs into supervisory processes, and further into updations in regulations (simply because these are not available in the public domain).

However, we looked at requirements placed in the respective Ombudsmen Schemes to see if such requirements are there on paper atleast. We found the following requirements which we think are inadequate for the purpose:

  • From the Banking Ombudsman Scheme[3]The Banking Ombudsman shall send to the Governor, Reserve Bank, a report, as on 30th June every year, containing a general review of the activities of his Office during the preceding financial year and shall furnish such other information as the Reserve Bank may direct and the Reserve Bank may, if it considers necessary in the public interest so to do, publish the report and the information received from the Banking Ombudsman in such consolidated form or otherwise as it deems fit.”
  • The Governing Body of Insurance Council (GBIC) has been established under Redressal of Public Grievances Rules 1998 (RPG), to set-up and facilitate the Institution of Insurance Ombudsman in India. From the RPG “The Ombudsman shall furnish a report every year containing a general review of the activities of the office of the Ombudsman during preceding financial year to the Central Government and such other information as may be considered necessary by it. In the Annual Report, the Ombudsman will make an annual review of the quality of services rendered by the insurer and make recommendations to improve these services.” [4]

The Report of the FRA Task Force[5] points out that “a large number of complaints on a particular issue (for example, misselling in Unit Linked Insurance Plans (ULIP) resulted in consumers losing more than a trillion rupees over the 2005-2012 period) reflect regulatory and supervisory gaps, creating a conflict of interest unless feedback from complaints flows to the regulator through an independent mechanism.” It has recommended the requirement for a research team under the proposed FRA to analyse complaints data and provide feedback to the regulator on areas for improvement in regulation or supervision[6]. We can therefore conclude that such feedback loops do not exist currently.

Powers of ombudsmen/regulators to take action against non-compliant providers

There seems to be a patchy framework around powers of ombudsmen and even the regulators to take action against financial services providers who do not comply with an award made by the Ombudsmen.

RBI / Banking Ombudsman

Section 35A(1) of Banking Regulation Act, 1949, empowers the RBI to give directions to the banking company, where it is satisfied that such directions

– are in the interests of public

– are in the interests of the banking policy

– are to prevent the affairs of any banking company being conducted in a manner detrimental to the interests of the depositors or in a manner prejudicial to the interests of the banking company;

The banking company is bound to comply with such directions.[7]

SEBI SCORES In case of non-redress of a grievance by an intermediary after having being called upon by the SEBI Board in writing to redress the grievances of investors, then such an intermediary shall be liable to a penalty which shall not be less than one lakh rupees but which may extend to one lakh rupees for each day during which such failure continues subject to a maximum of one crore rupees[8]
IRDAI / Insurance Ombudsman

The GBIC cannot penalise Insurance companies for not complying with the award given by it.

Currently, there are no penal provisions available in the RPG for the non-implementation of the award passed by Insurance Ombudsman. Section 16(2) of the RPG provides that the Ombudsman cannot award compensation for an amount exceeding twenty lakh rupees. The compensation cannot exceed the amount that covers the loss suffered by the complainant as a direct consequence of the insured peril. [9]

Unregulated, unlicensed or illegal services

The current redress mechanisms do not admit complaints arising from unregulated, unlicensed or illegal services. The only recourse left to victims in such cases is to approach the police and the courts. This is a big lacuna in the redressal mechanism and it needs addressing. One of the more recent attempts to fill this lacuna is RBI’s Sachet initiative.

To sum up, it is clear that there is significant variation among the grievance redressal mechanisms in place for the Banking, Insurance, Pensions and Capital Market sectors. There is a very strong case to be made for the creation of the Financial Redress Agency (FRA) as the single agency that can act on behalf of aggrieved customers – an idea that is not new and one that has been effectively set up and is running in many other jurisdictions.


[1] Pg 33 Consolidated Annual Report of the office of the Governing Body of Insurance Council (GBIC), 2015-16
[2] http://www.ifmr.co.in/blog/2017/04/10/a-brief-comparison-of-ombudsmen-frameworks-part-1/; https://ajayshahblog.blogspot.in/2017/01/establishing-financial-redress-agency.html
[3] https://rbidocs.rbi.org.in/rdocs/Content/PDFs/67933.pdf
[4] http://www.gbic.co.in/notification/Redressal%20of%20Public%20Grievances%20Rules,%201998%20-%20copy.pdf
[5] Pg 10, Report of the Task Force on Financial Redress Agency, Government of India, June 2016
[6] Pg 15, Report of the Task Force on Financial Redress Agency, Government of India June 2016
[7] Pg 142 Report of the Task Force on Financial Redress Agency, Government of India June 2016
[8] See Section 15C of Securities and Exchange Board of India Act, 1992
[9] See Page 32 of the GBIC, Consolidated Annual Report of the Governing Body of Insurance Council & Offices of the Insurance Ombudsmen for the year 2014-15. Also, See Pg 143, Report of the Task Force on Financial Redress Agency, Government of India, June 2016

10
Apr

A Brief Comparison of Ombudsmen Frameworks – Part 1

By Madhu Srinivas, IFMR Finance Foundation

This is the first of a two-part blog series on the state of Grievance Redress in the Indian Financial System.

An independent grievance redress function that financial services consumers have access to, in the event of less than satisfactory resolution of one’s grievances by the internal grievance redressal processes of financial services providers, is an important piece of the larger customer protection frameworks in place for India (albeit one that is limited to being ex post in nature). Such an external grievance redressal mechanism has an important role to play in market conduct supervision. The redress function can potentially serve two important purposes:

  1. Misconduct by firms imposes costs on society and may damage the confidence in the financial system. This could fuel a retreat of users of financial services from the formal system. An effective and quick redress mechanism would mitigate this problem to a large extent[1]
  2. The analysis of complaints received through the redress mechanism, in particular, for their impact on institutional and systemic stability, could inform future regulation/regulatory action on micro-prudential and market conduct aspects.

While much has been written about prudential regulations and systemic stability, especially in today’s scenario of stressed banking balance sheets, regulations for ensuring market conduct have received relatively little attention, with a significant part of the focus being limited to the possible creation of a Financial Redress Agency (FRA), as envisaged by the Financial Sector Legislative Reform Commission (FSLRC). More recently, in June 2016, the Task Force set up by the Government of India for establishing the FRA submitted its report that covered an implementation plan to operationalise such a statutory FRA (the report was made available for public comment in December 2016).

Taking a step back, in this post, we carry out a short comparative assessment of the nature of redress systems in the Indian financial sector, along specific metrics, to give a more nuanced sense of differences in approach and effectiveness (without necessarily concluding whether one system is more successful than the other). For the sake of simplicity we take into account only the external grievance redress mechanism in the Banking, Insurance, Pensions[2] and Capital Markets sectors and contrast these with the Financial Ombudsman Service of Australia as a benchmark for comparison[3]. The below table[4] summarises, along certain metrics, the existence or otherwise of certain elements of the redress mechanisms, and a more detailed analysis follows it. It is to be noted that large categories of institutions remain left out of current systems – a case in point is a complaint against an non-banking financial company (NBFC) or a non-bank Prepaid Payment Instrument Provider (PPI). There are also jurisdictional uncertainties such as for annuities and pension products provided by insurance companies for instance.

Financial Ombudsman Service, Australia RBI Banking Ombudsman SEBI SCORES Insurance Ombudsman[5]
Channel for Complaint Submission
Online lodging, toll-free calling lines, E-mail, letter, fax and in person Offices in 18 locations in India, online lodging Online lodging, toll-free calling lines Offices in 17 locations in India, online lodging, toll-free calling lines
Classification of disputes
Disputes are classified under various dimensions such as – complexity of dispute, demographic characteristics of disputants, nature of financial service, issue involved and so on. Disputes are classified under various dimensions such as – product type, demographic characteristics of disputants, legal status of the disputant, FSP against which the dispute has been raised, nature of dispute. Disputes are classified under two main dimensions –

1. Entity against which dispute has been raised and

2. Nature of dispute raised.

However, the second dimension did not have any further categorisation.

Disputes are first separated as being related to either Life Insurance or General Insurance and then further classified by – Geographical origin of dispute, FSP against which the dispute has been raised, Nature of dispute. The categories under Nature of dispute are along operational lines, for instance partial or total repudiation of claim, delay in settlement of claims.
Whether ‘mis-selling’ is captured as a separate category
‘Mis-selling’ is not an explicit category under which disputes are classified, but disputes are classified under categories that have further broken down mis-selling, such as – Failure to act in client’s best interest, Inappropriate advice, Incorrect advice and so on. No such categorisation. However, there is a section on mis-selling of third party products (insurance and pension) in rural areas in Annual Report 2015-16 – it is therefore not capturing misselling of pure banking products such as loans, FDs. No recognition of mis-selling, either implicitly or explicitly. Though there is no explicit or implicit mention of mis-selling, there is a separate classification of complaints against (only) life insurers, which includes a category “Unfair Business Practice”[6].
Classification based on the Financial Services Provider (FSP) against whom grievance has been raised
No. The Terms of Reference of the FOS mandate it to keep confidential all information pertaining to a dispute, subject to certain conditions. However, the FOS is required to report information about the disputes to the Australian Securities and Investments Commission (ASIC). Yes Yes Yes
Classification based on the complexity/ severity
Yes, complaints are categorised into Fast-track, Standard and Complex – along increasing complexity and increasing time spent to close. No No No
Satisfaction level of the complainants
Yes, a yearly survey is conducted by FOS to ascertain the satisfaction level of the complainants There is no systematic process of doing surveys to ascertain the satisfaction level of the complainants. However a sample survey was conducted last year, in the New Delhi Region, to ascertain the reason for the high spurt in complaints in that region. This survey also included questions on the satisfaction level of the complainant with the Ombudsman[7] Yes, SEBI is currently conducting an independent survey to gauge the efficacy of the redressal mechanism. It is unclear if this will be a regular feature or a one-off occurrence. No
Disclosure of names of erring financial institutions, agents
No. The Annual Review Report 2015-16 contains no names of any FSP or its agents. Yes. The annual report, 2015-16, has a table which lists the number and type of dispute raised against each bank. For instance State Bank of India had 1172 complaints raised against it pertaining to deposit accounts in the year 2015-16. It should also be noted that the annual report carries sample case studies of exemplary complaints received by the banking ombudsman. Though these case studies are anonymised and the name of the bank is not revealed. Yes. The SCORES website has entity wise numbers on Pending complaints against them. This information is updated regularly. Yes . The Annual Report 2015-16 of the Governing Body of Insurance Council (GBIC) has various tables which list the number of complaints, nature of complaints, time taken to dispose the complaint for each entity against which complaints were received.[8]
Feedback loops to regulators
As mentioned in their 2015-16 report, the FOS is required, as per the ASIC regulatory guide 139, to report on systemic issues and notify Australian Securities and Investment Commission (ASIC) of cases of serious misconduct. In connection with this, FOS reported 58 cases of definite systemic issue in 2015-16 There is no explicit mention of any feedback being given to the regulator. However, the latest annual report of the banking ombudsman mentions as one of its goals – “To provide policy feedback/suggestions to Reserve Bank of India towards framing appropriate and timely guidelines for banks to improve the level of customer service and to strengthen their internal grievance redress systems” No such mention anywhere. The annual report of the GBIC gives a brief analysis of the complaints received and makes certain suggestions based on this analysis. However, it is unclear if the audience is only the regulator or if it includes insurers and other market participants.
The Body or Authority to make appeal to
The Australian courts are the appellate authority The Deputy Governor-in-Charge of the department of RBI administering the Banking Ombudsman Scheme (Consumer Education and Protection Department) is the designated Appellate Authority Securities Appellate Tribunal (SAT) Consumer/High courts of India
Details about number of cases that went to appeal
Not Given 34 awards went to appeal for the year 2015-16 Not Given Not Given
Disclosure of Total Disputes Received, Total Closed
Yes Yes Yes Yes
Disclosure of average number of days to close a dispute
Yes, 62 days No Yes, 36 days No
Age Profile of closed disputes
Yes No but the age profile of open disputes is given Yes[9]. It is given as the number of disputes closed in buckets of – 0-30 days; 31-160 days; 61-90 days and so on till More than 360 days. Yes. It is given as the number of disputes closed in three buckets – Less than 3 months; 3 months to 1 year; Greater than 1 year.

The colour coding is provided to indicate a rudimentary comparative picture, moving from green through yellow to amber, to indicate good (existence of adequate practice for a metric) to bad (no evidence for existence of any practice for the metric).

Overall, we see that there exists a set of external grievance redress forums available today, albeit ones that are varied in completeness and effectiveness and provide a fragmented set of protections for aggrieved consumers. In the next post we take a deeper look at the observations made above and briefly analyse them.

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In case you have difficultly in viewing the table please click here.


[1] https://www.esrb.europa.eu/pub/pdf/other/150625_report_misconduct_risk.en.pdf

[2] We have excluded the grievance redressal mechanism of the Pension Fund Regulatory and Development Authority of India as they currently regulate only 2 products and also score adversely on almost all the metrics.

[3] The colour coding is provided to indicate a rudimentary comparative picture, moving from green through yellow to amber, to indicate good (existence of adequate practice for a metric) to bad (no evidence for existence of any practice for the metric).

[4] All the data used to populate the below table came from the following sources –
Report of the Task Force on Financial Redress Agency, Government of India June 2016
The Banking Ombudsman Scheme 2006, Reserve Bank of India(RBI), Annual Report 2015-16
Securities and Exchange Board of India(SEBI) Annual Report 2015-16
SEBI Complaints Redress System website – http://scores.gov.in/Reports.aspx?Tab=0
Consolidated Annual Report of the office of the Governing Body of Insurance Council (GBIC), 2015-16
Pension Fund Regulatory and Development Authority(PFRDA) Annual report, 2013-14
Insurance Regulatory and Development Authority of India (IRDAI) , Annual report 2015-16
Financial Ombudsman Service, Australia. Annual review 2015-16
[5] The Insurance Ombudsman is provided with a Secretarial Staff by the Governing Body of Insurance Council and such staff is drawn from Insurance Companies. http://www.policyholder.gov.in/FAQ_on_Ombudsman_Scheme.aspx
[6] http://www.policyholder.gov.in/uploads/CEDocuments/Classification%20of%20Complaint%20Life%2015-16.png
[7] The Banking Ombudsman Scheme 2006, Reserve Bank of India(RBI), Annual Report 2015-16
[8] http://www.policyholder.gov.in/Life_Grievances_Analysis.aspx
[9] This information is not available publicly, and/or periodically. It was obtained from the Report of the Task Force to set up Financial Redress Agency (FRA), 2016

27
Mar

Comments on the Ministry of Electronics & Information Technology’s Draft Rules for Security of Prepaid Payment Instruments

By Malavika Raghavan, IFMR Finance Foundation

On 8 March 2017, the Ministry of Electronics & Information Technology (MeitY) released a set of draft rules for security of prepaid payment instruments (Draft Rules), inviting comments by 20 March 2017.[1] The IFMR Finance Foundation’s Future of Finance Initiative has provided its response to the Draft Rules.

The Draft Rules propose new requirements for pre-paid payment instrument (PPI) issuers, requiring them to:

  • put in place information security policy and privacy policies, and undertake risk assessments to assess risks associated with the security of their payment systems, and
  • institute a range of measures on customer identification, authentication, awareness, and education, and separately, a set of security practices.

The Draft Rules seek to broaden the category of customer information that is considered “personal information” for the purposes of the Information Technology Act, 2000 (IT Act), improper disclosure of which can be penalised by a fine up to Rs. 5 lakhs or imprisonment up to 3 years (or both). It also seeks to give transaction history data held by PPI issuers a higher degree of protection as “sensitive personal data and information” under the IT Act.[2]

The Draft Rules are an important and progressive step towards highlighting customer data protection and privacy concerns of customers using PPIs. However, MeitY has taken the interesting position of making rules for a particular institution type (PPIs here), which makes it akin to a sectoral regulator. It is also interesting to note that the Draft Rules traverse areas in which Reserve Bank of India (RBI) regulation already exists. In this regard we note that on 20 March 2017, the RBI released its updated “Master Directions on Issuance and Operation of Pre-paid Payment Instruments (PPIs) in India”, inviting comments by 31 March 2017.

In our comments to MeitY we have sought to highlight that the Draft Rules:

  • dealing with privacy and data protection, while incorporating some of the key (and internationally recognised) data protection principles can benefit from a more complete coverage of these principles,
  • while certainly taking the lead in customer data protection, should, keeping in tune with several other jurisdictions, go a step further and consider a broadening of the scope of Sensitive Personal Data and Information (SPDI) by covering any “personally identifiable financial information that any institution collects about an individual in connection with providing a financial product or service (unless that information is otherwise publicly available) – We characterise this as “Non-Public Personal Information (NPI), and make a case for treating NPI as SPDI for the purposes of the Information Technology Act, 2000
  • should attempt consistency with the existing framework of the Information Technology Act, 2000 (particularly the Reasonable Security Practices and Procedures and Sensitive Personal Data or Information Rules, 2011) so as to avoid multiplicity of legal standards.

We consider MeitY to be best placed to continue its role as the overarching standards setting body for issues relating to security and integrity of electronic transactions, and we see the actual monitoring and enforcement of such standards to be delegated to sector specific and specialised regulators (such as RBI, SEBI, IRDA, PFRDA, TRAI, Airports Authority of India, Registrar of Companies, All India Council for Technical Education, others. Therefore, in the context of PPIs, it would be wise to take note of existing regulations and monitoring systems already present within the RBI, as further described in our response document.

Our response to MeitY’s public consultation is available here.

About the Future of Finance Initiative:

The Future of Finance Initiative (FFI) is housed within IFMR Finance Foundation and aims to promote policy and regulatory strategies that protect citizens accessing finance given the sweeping changes that are reshaping retail financial services in India – including those driven by Indiastack, Payments Banks, mobile usage and the growing P2P market.


[1] The deadline has since been extended to 5 April 2017.

[2] For an explanation of these categories, see our blog on Electronic Financial Data and Privacy in India (published December 2016).

21
Mar

The P2P Lending Market in China: A Parable for Indian Policymakers – Part 2

By Varun Aggarwal, IFMR Finance Foundation

In the first post of this two-part series, we tracked the explosive rise of the P2P lending market in China, which took place in the absence of any regulations. In this post we look at the series of regulatory measures introduced by the Chinese authorities in the wake of high profile platform failures and mounting outstanding debt levels.

Changes in the Regulatory Environment  

The China Banking Regulatory Commission (CBRC) first began addressing the issue of P2P regulation in official speeches in 2014. The speeches marked “red lines” lenders should not cross and outlined principles for the industry.[1] However, it was not until July 2015, with outstanding P2P loans at 200 billion RMB that the first intentions to regulate the industry were articulated. The People’s Bank of China (PBOC) (the Central Bank) along with the China’s State Council and other key financial regulators such as the China Securities Regulatory Commission and China Insurance Regulatory Commission jointly issued the Guiding Opinions on Promoting the Healthy Development of Internet Finance [2] to encourage financial innovation, promote the healthy development of Internet finance, clarify the regulatory responsibilities, and regulate market order. The CBRC was officially made responsible for formulating and administering policies on the behavioural supervision of P2P lending platforms. Some of the key proposals included the following:

  • P2P platforms were to become “information intermediaries” and not financial intermediaries as was the prevalent industry practice.
  • In order to put a stop to fraudulent platform operators stealing funds, all client accounts were to be parked at custodian banks.
  • Platforms were also precluded from offering “credit enhancement” or guaranteed returns by covering losses themselves.

In 2016, a PBOC-led group of regulators began a rectification campaign for the Internet finance sector. Local governments were given orders to survey the online lenders, crowdfunding platforms, private equity funds, and more complex financial firms operating in their jurisdiction to get a clearer picture of what regulation is needed. Major cities stopped registering new firms in this field, stricter rules on advertisements came out, and reports even circulated of internet finance firms being ordered to vacate office buildings in busy districts due to fear that they would become targets for protests staged by defrauded investors if the platforms failed.[3]

Based on the 2015 Principles, on 24 August 2016, the CBRC, the Central Ministry of Industry and Information Technology (MIIT) and the Cyber Administration of China (CAC) jointly released the Interim Measures on Administration of the Business Activities of Peer-to-Peer Lending Information Intermediaries (the “Interim Measures”).[4] The Interim Measures comprise the first comprehensive legal framework specifically regulating peer-to-peer lending activities in China.[5]

Under the new rules, an “internet lending information intermediary” – namely a P2P lending platform – means a validly established company that specialises in acting as an intermediary provider of online lending information – “online lending” means direct lending made amongst individuals through an Internet platform. Individuals include natural persons, legal persons, and other organisations.[6] [7]

Some of the key requirements of the Interim Measures included:

  1. The capping of the total amount that an individual can borrow on a single platform at RMB200,000 (~29,000 USD), and RMB1 million (~143,000 USD) on multiple platforms. The respective caps for a corporate entity are RMB1 million and RMB5 million (~718,000 USD).
  2. P2P lending platforms must now hold borrower and lender funds in custodian accounts with ‘registered financial institutions’ instead of in the platform itself. The custodian account acts as the fund transfer mechanism between lenders and borrowers, and serves as an escrow account for all transactions between both sides.[8]
  3. Other operational obligations on platforms included filing with local financial supervisory authorities[9], obtaining permits from relevant telecommunications authorities and releasing of, for public record, information on direct lending and borrowing transactions.
  4. The scope of operations was demarcated — prohibiting P2P lending platforms from selling asset-backed securities or financial instruments such as insurance, trust products and wealth-management products and the prohibition of conducting offline promotion of financing projects.
  5. Standards for data management were put in place — focusing on proper KYC and data protection.[10]

The Interim Measures provide a 12-month transitional period for existing P2P lending platforms to achieve compliance.

The new rules also set out authority among Chinese regulatory agencies — financial regulators at the provincial and city level will be primarily responsible for registering and overseeing P2P lending platforms. This offers the benefit of more direct supervision; however China experts[11] highlight graft and fraud among mid-level bureaucrats as being still relatively common at the local level.

Other major criticisms of the measures centered on the absence of reporting requirements to a centralised database which records all P2P lending information (or an equivalent credit bureau).[12] This makes enforcing the borrowing cap impractical, as platforms cannot ascertain the aggregate outstanding debt of a borrower across multiple platforms.[13] [14]

Nonetheless, in the long run, regulators believe that the ‘Interim Measures’ should help to ensure a healthier and a more sustainable market. These measures may likely bring about a reshuffling and consolidation of market players.

Lessons for Indian Policymakers

The P2P lending industry in India is tiny compared to China. At the end of 2015, for instance, there were 38 P2P lending platforms operating in India — compared to 2200 in China. But 20 of the new online P2P lending platforms were launched in 2015, suggesting that the market is starting to take off in India. In fact, projections expect India’s P2P lending market to swell to USD 4-5 billion in the next 5-6 years.[15]

On April 28, 2016, The Reserve Bank of India (RBI) issued a public consultation paper on P2P lending regulations in India. Though the paper only states the proposed rules and solicits feedback/comments, it does give an idea about the RBI’s stance towards P2P lending — IFMR Finance Foundation conducted a detailed analysis in their response to the RBI’s consultation paper.

Nonetheless, the risk-ridden rise of the Chinese P2P lending market — characterised by explosive growth and spectacular platform failures — and the consequent attempts to regulate it, are relevant and timely parables for Indian regulators. Some of the key lessons from the Chinese experience are:

  1. Clarifying the definition of a P2P lending platform and demarcating the scope of its business activities. For instance, the China regulations clarify internet finance to include incorporated businesses as lenders, besides individuals. Furthermore, P2P lending platforms were prohibited from taking deposits from members of the public or creating asset pools, selling wealth management products and transferring debts by issuing asset – backed securities.
  2. P2P platforms should not be allowed to promise guaranteed returns to its lenders (as envisaged already in the RBI consultation paper). Chinese regulators have prohibited platform guarantees for borrowers (unless facilitated through a third party, such as a bank).
  3. Proactive supervision of platforms’ lending activities and practices — by utilising mystery shopping and periodic filings with relevant authorities.
  4. Need for implementing public disclosure of characteristics of the assets under management (AUM) such as number of loans, outstanding amounts, NPA ratios. In China, platforms are required to publically disclose information on direct lending and borrowing transactions; although it is unclear whether there is a requirement to disclose asset quality numbers.
  5. Need for prudential requirements (in some form of a backstop) for systemically important platforms proportional to the total volume of lending activity being conducted. Chinese regulations have not incorporated such a requirement while UK has this for its loan-based crowd-funding platforms.[16] The RBI consultation paper considers a leverage ratio but it is unclear how the ratio will be applied since neither liabilities nor assets reside on the platform’s balance sheet.
  6. Retail borrowers and retail lenders need to be provided with additional protections against being missold unsuitable products (loans and debt investments respectively). While the Chinese authorities require platforms to offer financial consulting services, it is unclear what these services involve. The UK’s FCA has taken steps to ensure suitability requirements on P2P platforms:
    • For Borrowers: The FCA’s Handbook on Responsible Lending specifies that “a firm, with respect to operating an electronic system in relation to lending in relation to a prospective borrower under a P2P agreement”, “must undertake an assessment of the credit-worthiness of the prospective borrower[17]. Furthermore, providers have to highlight[18] key risks to the borrower such as the consequences of missing payments or under-paying.
    • For Lenders: FCA specifies that where lenders have the choice to invest in specific P2P agreements, platform providers should provide information regarding the details of the creditworthiness assessment of the borrower carried out.[19] Moreover the FCA has mandated platforms to disclose[20] all relevant information to enable potential investors to make informed decisions on whether or not to invest.
  7. Ensuring that all loan disbursements and loan performance details are reported mandatorily to credit bureaus. This requirement is currently absent in China.
  8. Allowing P2P platforms to have access to credit bureaus records. Chinese P2P platforms have access to records of existing personal or business credit from traditional and non-bank financial institutions, including credit information from the central bank’s national credit-registry system.
  9. In order to facilitate secured lending on platforms, there is a need to provide access to platforms to the CERSAI asset registry, potentially include them under the ambit of SARFAESI Act; Chinese P2P platforms have access to the central bank’s national ‘movable assets’ registry information for accounts receivables.[21]
  10. As Platforms store and handle sensitive datasets there is an urgent need for proper data protection and security standards. Currently China’s regulations are focused solely on the accuracy of data being collected; however more detailed implementing rules are expected to be issued on data privacy and technological standards.[22]
  11. Platforms should be stopped from using misleading promotions of services — UK[23] authorities, for instance, actively monitor financial promotions on platform websites and take action where firms do not meet their standards. The FCA has also released a guide on financial promotions in social media.[24] Chinese regulators have prohibited the offline publicising or recommending of projects that need funding (only electronic channels such as internet, fixed-line telephones, and mobile phones or via entrusting or authorizing a third party, are permitted), although the rationale behind this prohibition is ambiguous.[25]

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About the Future of Finance Initiative:

The Future of Finance Initiative (FFI) is housed within IFMR Finance Foundation and aims to promote policy and regulatory strategies that protect individuals accessing finance given the sweeping changes that are reshaping retail financial services in India – including those driven by Indiastack, Payments Banks, mobile usage and the growing P2P market.



[1] See:https://piie.com/blogs/china-economic-watch/p2p-series-part-2-regulating-chinas-plethora-p2p-players
[2] See:http://hkmb.hktdc.com/en/1X0A34J5/hktdc-research/China-Issues-Guidelines-on-Development-of-Internet-Finance
[3] See:https://piie.com/blogs/china-economic-watch/p2p-series-part-2-regulating-chinas-plethora-p2p-players
[4] For an English translation of the measures see: http://en.pkulaw.cn/display.aspx?cgid=278756&lib=law
[5] See:www.linklaters.com/pdfs/mkt/shanghai/A32461989.pdf
[6] See: www.linklaters.com/pdfs/mkt/shanghai/A32461989.pdf
[7] See: https://hk.lexiscn.com/law/law-english-1-2917482-T.html
[8] The CBRC recently issued the Guidelines for Online Lending Fund Depository Business; for more see: http://hkmb.hktdc.com/en/1X0A99GT/hktdc-research/CBRC-Issues-Guidelines-for-Online-Lending-Fund-Depository-Business
[9] For the purpose of these Measures, “local financial regulatory authorities” means the departments of all provincial people’s governments which undertake the functions of local financial regulation. See more: http://en.pkulaw.cn/display.aspx?cgid=278756&lib=law
[10] See: https://hk.lexiscn.com/law/law-english-1-2917482-T.html
[11]See: http://www.nasdaq.com/article/new-rules-for-chinese-p2p-lenders-designed-to-minimize-fraud-slow-industry-growth-cm719480
[12] Although there have been suggestions that the CBRC will build a centralised database on the online lending industry. See more: https://www.nri.com/~/media/PDF/global/opinion/lakyara/2016/lkr2016235.pdf
[13] See: www.linklaters.com/pdfs/mkt/shanghai/A32461989.pdf
[14] See: http://www.globaltimes.cn/content/1003315.shtml
[15] See: http://www.business-standard.com/article/pti-stories/startup-sees-peer-to-peer-lending-market-growing-big-in-india-116020700125_1.html
[16] See: https://www.fca.org.uk/publication/policy/ps14-04.pdf
The volume- based financial resources requirement calibration placed by FCA on P2P platforms is the sum of:

  1. 0.2% of the first £50 million of the total value of the total loaned funds outstanding
  2. 0.15% of the next £200 million of the total value of the total loaned funds outstanding
  3. 0.1% of the next £250 million of the total value of the total loaned funds outstanding
  4. 0.05% of any remaining balance of the total value of the total loaned funds outstanding above £500m

[17] See: 5.5, https://www.handbook.fca.org.uk/handbook/CONC/5.pdf
[18] See: https://www.handbook.fca.org.uk/handbook/CONC/4/3.html?date=2016-07-01
[19] See COBS14.3.7A (4) in: https://www.handbook.fca.org.uk/handbook/COBS/14/3.html
[20] See: https://www.fca.org.uk/publication/thematic-reviews/crowdfunding-review.pdf
[21] See: http://www.accaglobal.com/content/dam/ACCA_Global/Technical/manage/ea-china-p2p-lending.pdf
[22] See: www.linklaters.com/pdfs/mkt/shanghai/A32461989.pdf
[23] The FCA highlights concerns regarding promotions that compare P2P lending in equivalence to holding money on deposit –as investors should understand that there are greater risks involved and they may lose some or all of their money. For more see: https://www.fca.org.uk/publication/thematic-reviews/crowdfunding-review.pdf
[24] See: https://www.fca.org.uk/publication/finalised-guidance/fg15-04.pdf
[25]A plausible reason could be the prevalence of offline-online business models in China, where providers would promote their online services to customers through offline means.

16
Mar

The P2P Lending Market in China: A Parable for Indian Policymakers – Part 1

By Varun Aggarwal, IFMR Finance Foundation

Since 2011, China’s P2P lending market has witnessed unprecedented growth. However, numerous high profile platform failures prompted the Chinese authorities to come out with a host of regulations at the end of 2016. This post is the first in a two-part series and takes a brief look at the explosive rise and the subsequent failures in the Chinese P2P lending industry.

China’s peer-to-peer (P2P) lending sector has emerged as the largest digital alternative finance sector in the world. In China, digital financial services, such as P2P lending, are generally referred to within the broad category of Internet Finance. This taxonomy includes both traditional financial institutions that have moved online and non-traditional financial platforms offering online financial products and/or services.

Box 1: Disaggregation of P2P Lending in China[1]

The Initial Boom

The first online P2P lending platform, ppdai.com, was established in China in August 2007. However, 2013 is widely seen as the watershed year for marketplace/peer-to-peer lending[2] in China.[3] Between 2013 and 2014, the market grew, in terms of lending volume, at a rate of 337% per annum, peer-to-peer (P2P) lending topped USD 100bn in China in 2015, soaring 248.3% versus the previous year. The number of active users of P2P also surpassed 9 million in 2016[4].

Box 2: Annual Outstanding Through P2P Platforms

Box 3: Lending Volume of P2P Industry

The number of platforms trading between 2013 and 2016 also increased rapidly: 800 platforms were trading at the end of 2013, 1575 by the end of 2014, and 2,364 as of March 2016.[5] [6] In comparison the P2P Lending market has developed much more slowly in UK and US, despite the first platforms in these countries predating China.

The Subsequent Busts and Consolidation  

However this explosive growth led to a large number of “incidents” and platform collapses involving cash shortages, defaults, fraud and closures. These incidents have inflicted huge financial losses on lenders and the wider public, and led to instances of social unrest in certain areas of China. For instance Anhui province-based Ezubao, which until January 2016 was one of the top 10 largest P2P lending platforms in China, was shut down in early 2016 and 21 of its executives arrested for scamming 900,000 individual investors out of USD 6.7 billion. An estimated 95% of all borrower listings on Ezubao were fraudulent and the top executives used investor money to enrich themselves.[7] Other cases of fraud saw company bosses launching P2P platforms to fund their own businesses.

Box 4: Number of Operational Platforms vs ‘In Trouble’ Platforms[8]

During the first half of 2016, 515 P2P platforms were shut down.[9] By the end June 2016, there were 1,778 troubled P2P platforms, accounting for 43.1% of the total, according to the China Banking Regulatory Commission (CBRC).[10] Furthermore the number of newly created P2P lending platforms in China had declined at a rate of over 50% in April, compared to a growth rate of nearly 80% back in May 2015.[11] The number of platforms experienced a year-on-year decrease for the first time in the short history of P2P lending in China.

China’s financial authorities had initially enabled the P2P Lending Industry’s growth, and were content to let things develop without any government intervention. However, the increasing number of platform failures forced their hand and 2016 saw the introduction of a whole host of measures to regulate and guide the market. These measures — called the ‘Interim Measures’ — put a stop to some of the predatory and cavalier practices of P2P platforms and introduced provisions to control risks.

Some Determinants of the Chinese P2P Market: 2007 -2016

Four factors were instrumental in driving the growth of China’s Online P2P Lending Industry at an unparalleled speed: an open and supportive regulatory environment, enormous demands for inclusive finance from under-served segments, innovative business models and the entry of mainstream financial institutions in the market. But many of these factors also contributed to the building of customer and systemic risk in the sector which culminated in the series of platform failures.

  1. The regulatory environment

The Chinese government has been extremely forthcoming in its support for P2P platforms and internet finance in general. In recent years Chinese Premier Li Keqiang made multiple calls of support in the Report on the Work of the Government over 2014/15, stating that “Internet-based finance has swiftly risen to prominence”, with the imperative “to encourage the healthy development of … Internet banking”.[12]

Chinese platforms operated in a regulatory vacuum until 2016. They registered themselves as some variant of “information services” companies with the local Industry and Commerce office, then opened up their websites soliciting borrowers and investors with no official standards for disclosure and no formal regulation from the central bank or banking regulator.[13] It was unclear which watchdog agency should regulate the industry. Consequently, due to the fact that P2P platforms are not subject to any market entry rules, industrial criteria or regulatory monitoring, they had grown extremely fast.

But this loose environment was a double edged sword. While it created room for companies to build new financial products in traditionally underserved areas like consumer finance and small business loans despite the lack of reporting to credit reporting agencies, it made it easy for bad actors to defraud unwary investors. Interest rates were higher than those offered by banks, and returns to retail investors were high too — averaging around 13.29% in 2015.

  1. Limited financial services available for low income customers

Since the start of the policy era of market ‘reform and opening’ in the 1980s, a few massive State-Owned Commercial Banks (SOCBs) have dominated China’s financial system. These large banks have predominately financed large state-owned enterprises and government-related borrowers. Furthermore, the traditional credit market in China is subject to various restrictions such as interest rate caps and exchange rate caps.[14]

In order to increase the supply of credit SOCBs had initiated many schemes, however there remains a large ‘institutional gap’ when funding smaller enterprises, poorer individuals and household. According to data from People’s Bank of China, only 25.1% of individuals have got personal loan approvals from traditional banking institutions in 2014.[15] This has been largely attributed to the difficulty in accessing traditional banking institutions, complex and cumbersome application process and overtly strict eligibility criteria for wealth management products.

These under-served customers had an eager appetite for online P2P lending to fulfil their needs. Many P2P lending providers had also moved into consumer financing by offering a diversified range of lending services in areas where traditional banks have been too slow to operate – such as car financing, education and training, as well as mortgage financing.[16]

  1. Entry of mainstream financial institutions and other large enterprises in the market

Since 2014, state owned enterprises, private equity and mainstream financial institutions such as SOCBs gradually became involved in the P2P lending sector by buying equity stakes in the platforms. This swelled the average registered capital of P2P platforms to RMB 27.84 million (~ USD 4 million) in 2014, almost double the 2013 average. This enabled many platforms to take a trial and error approach to expand their customer base by offering low-price or even free services.[17]

  1. Innovative Business Models

In order to attract enough investors, P2P companies offered various investor-protection plans, and security schemes to guarantee the repayment of the principal and interest. And thus, platforms in China devoted a large pool of money and resources to building up offline risk control teams, thereby forming a so-called online to offline (O2O) business model.

While the Internet was used to obtain funding, offline processes were used to educate and consult with individual investors. Due to the relative lack of comprehensive credit information about borrowers, providers relied on offline modes for soliciting them and for carrying out credit investigations. However, many P2P platforms did not have specialised risk controls and credit check teams.[18]

A survey done by the Association of Chartered Certified Accountants (ACCA) captures the following distinctions amongst P2P lending provider business models in China, explained below[19] :

Box 5: Different P2P Lending Provider Models in China

These measures drastically increase the operational costs of P2P lending, contributing to the relatively higher interest rates compared to the commercial lenders in China.[20]

Box 6: P2P Loans for Home Mortgage Down Payments[21]

The P2P lending industry has been a source for loans for down payments on homes. These P2P loans typically mature in 90 days and carry interest rates of up to 12%. Speculators applied for multiple mortgages from banks, increasing the overall systemic risks to the Chinese financial system. Many experts are worried that property speculation in China’s four biggest cities — Beijing, Shanghai, Guangzhou and Shenzhen — has reached new highs, largely due to unregulated P2P financing.[21] For instance, Lianjia.com, a Beijing-based real estate company and P2P lender which shut down in mid 2016, had lent up to RMB 3 billion (USD 430 million) alone.


In the aftermath of these developments, the “Interim Measures” from Chinese authorities were aimed at the controlling the damage from platform failures. In the next post, we will analyse these measures and look at the subsequent lessons for Indian policymakers.

About the Future of Finance Initiative:

The Future of Finance Initiative (FFI) is housed within IFMR Finance Foundation and aims to promote policy and regulatory strategies that protect individuals accessing finance given the sweeping changes that are reshaping retail financial services in India – including those driven by Indiastack, Payments Banks, mobile usage and the growing P2P market.



[1] Source: https://home.kpmg.com/au/en/home/insights/2016/03/harnessing-potential-asia-pacific-alternative-finance-benchmarking-report.html
[2] Debt crowdfunding is more commonly known as peer-to-peer lending (P2P lending). It is the practice of matching borrowers and lenders through online platforms. The online lending company provides the platform for lending transactions. The borrower’s need for funding is published on the platform after a vetting process, and lenders provide funding. Another commonly used term for debt crowdfunding is market place lending, this is to allay confusion caused due to the increasing presence of institutional lenders on peer-to-peer lending platforms.
[3] See: https://www.jbs.cam.ac.uk/fileadmin/user_upload/research/centres/alternative-finance/downloads/harnessing-potential.pdf
[4] See: http://www.iresearchchina.com/content/details7_26454.html
[5] See:http://www.globaltimes.cn/content/1003315.shtml
[6] As until recently there was no explicit requirement for P2P lending platforms to make regulatory filings or register with a regulator, the numbers and scale of P2P lending companies in China can only be calculated on the basis of some incomplete data.
[7] See: http://www.lendacademy.com/massive-7-6-billion-fraud-large-chinese-p2p-lending-platform/
[8] Source: WDZJ.com
[9] See: http://www.globaltimes.cn/content/1003315.shtml
[10] See: http://www.globaltimes.cn/content/1003315.shtml
[11] See: https://www.chinamoneynetwork.com/2016/05/26/chinas-p2p-lending-market-is-a-scammers-paradise
[12] See: http://www.mckinsey.com/industries/financial-services/our-insights/whats-next-for-chinas-booming-fintech-sector
[13] See: https://piie.com/blogs/china-economic-watch/p2p-series-part-1-peering-chinas-growing-peer-peer-lending-market#_ftn1
[14] See: https://www.brookings.edu/wp-content/uploads/2016/06/shadow_banking_china_elliott_kroeber_yu.pdf
[15] See: http://www.iresearchchina.com/content/details7_26454.html
[16] See: http://www.accaglobal.com/content/dam/ACCA_Global/Technical/manage/ea-china-p2p-lending.pdf
[17] See: http://www.mckinsey.com/industries/financial-services/our-insights/whats-next-for-chinas-booming-fintech-sector
[18] See: http://blog.lendit.com/wp-content/uploads/2015/04/Lufax-white-paper-Chinese-P2P-Market.pdf
[19] See: http://www.accaglobal.com/content/dam/ACCA_Global/Technical/manage/ea-china-p2p-lending.pdf
[20] See: https://ssrn.com/abstract=2827356
[21] See: https://www.ft.com/content/2cd149d0-e999-11e5-bb79-2303682345c8