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]

 —

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

9
Mar

District-level Assessment of Credit Depth in Uttar Pradesh

By Nishanth K, IFMR Finance Foundation

In this post we assess the state of bank credit depth for the state of Uttar Pradesh (UP) and the variation in credit depth across the 75 districts of UP during the 2004-12 period. We define ‘credit-depth’ as the ratio of total bank credit outstanding to gross domestic product (CGDP) of a particular sub-economy. This is a commonly used measure for the adequacy of credit relative to GDP.

At an all-India level, CGDP went from 38% in 2004-05 to 88% in 2011-12. During this same period, CGDP in UP went from 37% to 68%. It will be observed that despite a similar starting point, UP grew below the national average during this seven year period and ended with a significantly lower level of credit depth.

In addition, this growth in credit depth seems to be largely driven by a substantial increase in concentration of bank credit within a few districts of the state. This is evident from the graph below: among the districts1 in UP considered, the top seven districts ranked on the basis of credit depth in 2004-05 witnessed a significant increase in credit depth (the median CGDP of these seven districts increased from 40% in 2004-05 to 72% in 2011-12). In comparison, although the median credit depth of bottom seven districts also increases significantly, it is still a mere 24% in 2011-12. This is low when compared to both the median of district level credit depth (68%) and the median credit depth of the top seven districts (72%).

The highest district CGDP in 2004-05 was only 54% whereas in 2011-12 this had risen dramatically to almost 200% for Lucknow. In comparison, districts such as Kaushambi (5% in 2004-05 and 9% in 2011-12) and Auraiyya (7% in 2004-05 and 10% in 2011-12) have seen their credit depth levels remain low in this time period. In some districts such as Chitrakoot, Sant Ravi Das Nagar and Etah, there has worryingly been a decrease in credit depth of about 2-4%.

In 2004-05, the bank credit outstanding in the district of Lucknow alone accounted for about 11% of total outstanding in the state. As of 2011-12, bank credit in Lucknow accounted for 19% of the state’s total outstanding credit. Therefore, although there has been increase in the overall credit depth of the state, it is evident that this increase is skewed by the increase in credit supplied to certain districts. This potentially has significant growth consequences for the state.

In the next post, we provide a more detailed discussion of the working paper that evaluates the Tamil Nadu data in detail with respect to the growth dynamics of credit depth.



1 – For the sake of continuity we have omitted the districts that were created post 2004-05. This does understate values for parent districts following the separation of the new district. We have also omitted districts for which GDP data was not available. Hence, our analysis considers only 69 districts.

28
Feb

Monetary Policy Transmission in India – Part 2

By Madhu Srinivas, IFMR Finance Foundation

In the second post of our two-part series on Monetary Policy Transmission, we take a closer look at the impediments to policy transmission in India and also list the recent measures taken by RBI/Government to overcome these impediments. In addition we look at what recent empirical evidence has to say on effectiveness of policy transmission in India 

Impediments to Transmission in India

  1. Sustained fiscal dominance – RBI, being the merchant banker for the Government, has the responsibility to raise money, in this case through Government bonds, as and when needed by the Government. These Government borrowings tend to crowd out non-food credit in bank finance[1] and thereby reduce policy transmission. Though it is to be noted that steps have been taken to separate RBI from its public debt management responsibilities.[2] How effective these measures are and when they will reach their logical conclusion, however, remain uncertain. In contrast, many Emerging Market Economies (EME) such as Brazil, Poland, Hungary and South Africa have a separate debt management office to management government debt. Also, even among those EMEs where the central bank is involved in public debt management, their role is quite limited and they only act as a facilitator[3].
  2. Statutory pre-emption through Statutory Liquidity Ratio (SLR) – The SLR prescription provides a captive market for government securities and helps to artificially suppress the cost of borrowing for the Government, dampening the transmission of interest rate changes across the term structure. It was also observed that till 2014, the Government was borrowing at a negative real interest rate[4]. This was because the estimated average cost of public debt was above the average CPI inflation.
  3. Small savings scheme – Besides market borrowings, the other main source of funding government deficits in India is small savings mobilised through, inter alia, post office deposits, saving certificates and the public provident fund, such channels are characterised by administered interest rates and tax concessions. The substitution from bank deposits (both time and demand deposits) to small savings erodes the effectiveness of the monetary transmission mechanism, especially through the bank lending channel.


Source: Indian Budget 2017-18 and RBI’s Statistical tables relating to Banks of India : Table No. 10

As can be seen from the above graph, the funds in the small savings scheme are substantial compared to the bank deposits in the Scheduled Commercial Banks (SCB).

  1. Subventions – The Government also influences monetary transmission through its directives to banks. Keeping some economically and socially important objectives in mind, both the Central and State Governments offer interest rate subventions to certain sectors including agriculture[5] instead of considering direct subsidies, distorting the transmission mechanism.
  2. Informal Economy – India has a large informal sector workforce[6] and significant presence of informal finance as a significant source of credit for the real economy[7]. These are outside the influence of transmission measures.
  3. Liability Profile – The policy repo rate does not directly affect the determination of base rate of banks. The pass-through mainly hinges on the policy rate influencing the interbank rate, which in turn, influences the deposit and lending rates[8]. This pass-through is greatly diminished, since wholesale borrowings (including borrowing from the RBI and interbank borrowings) constitute barely 10 per cent of the total funds raised by banks[9].


Source: RBI’s Statistical tables relating to Banks of India : Table No. 2 ; As of March 2016

As can be seen from the above graph, the non-deposit borrowings of banks (which include borrowings from RBI and other wholesale funding) though significant, are quite small when compared to deposit liabilities. Thus their power to influence the lending rates is low. Added to this is the limited ability of banks to reduce their deposit rates in response to lowering of the policy rate. It is quite hard for banks to lower their term deposit rates (term deposits form almost 60% of all funds) in response to lowering of the policy rate by RBI. This constraint in lowering of deposit rates imparts rigidity to the liability term structure and to that extent impedes policy transmission.

Recent measures taken by RBI/Government that helps to overcome impediments to transmission 

  1. The Government, through an executive order, has set up a Public Debt Management Cell (PDMC) under the Ministry of Finance. The PDMC takes over the front office and the middle office functions of public debt management from RBI, while RBI will continue to handle the back office operations. The PDMC is to become a full-fledged body and completely take over the debt management functions from RBI in about 2 years[10].
  2. Effective from 1st April 2016, RBI has mandated all banks to move to a Marginal Cost of Lending Rate (MCLR) based regime. This rate is to be calculated taking into account –
    1. Marginal cost of funds
    2. Negative carry on account of Cash Reserve Ratio CRR
    3. Operating Costs
    4. Tenor Premium

This is set to improve the monetary policy transmission on the lending side. While early signals from the market suggest that this move would indeed increase the effectiveness of policy transmission[11], it is still too early (less than 4 quarters since the measure came into effect) to comment on the impact of this change with any certainty. Most empirical studies suggest that monetary policy transmission happens with a lag, and depending on the variable to influence, of about 2-3 quarters.

  1. With the Government resetting the interest rates for Small Saving Schemes every quarter[12], there is some scope for these interest rates to be aligned with the policy rate and thereby help transmission.
  2. There is some indication from the Finance Ministry (April 2016)[13] that it may consider replacing interest rate subvention schemes with interest subsidies paid directly into borrower accounts. However action on this is still awaited.

Effectiveness of Policy Transmission

Recent empirical research in the Indian context suggests that the bank lending rates respond asymmetrically to monetary policy, i.e lending rates respond more quickly and positively to monetary tightening than to monetary loosening[14][15][16]. Also there seems to be some evidence of pass-through in the first leg of policy transmission – Policy rates to Bank Lending rates. However, with regard to the second leg of policy transmission – Bank Lending/Financial Market rates to economic output/demand, the evidence seems to suggest little or no pass-through[17]. One reason for this could be the low level of penetration of formal financial intermediation in our economy. Put differently what it means is that the interest rate decided by RBI seems to significantly influence the bank lending rates in the right direction, especially when RBI raises the rate. But this does not seem to impact the output or price of goods and services in any substantial way. One reason for this is that large sections of our population still do not save in or borrow from banks or other formal financial institutions. However, with the current thrust on financial inclusion and the consequent spread of the formal financial system, the transmission in this leg is likely to get strengthened over time.

[1] Urjit Patel Committee Report (2014), Chart IV.2

[2] The Hindu Businessline – Debt management office to gradually-end; Oct 2016

[3] Report of the Expert Committee to Revise and Strengthen the Monetary Policy Framework (Chair: Dr. Urijit Patel, 2014)

[4] Ibid, Chart IV.3

[5] https://rbi.org.in/Scripts/NotificationUser.aspx?Id=10540&Mode=0

[6] http://www.ilo.org/wcmsp5/groups/public/—asia/—ro-bangkok/—sro-new_delhi/documents/publication/wcms_496510.pdf

[7] http://www.mospi.gov.in/sites/default/files/publication_reports/KI_70_18.2_19dec14.pdf

[8]Sonali Das , IMF working paper WP/15/129 – Monetary Policy in India : Transmission to Bank Interest Rates

[9] Urjit Patel Committee Report (2014)

[10] The Hindu Businessline – Debt management office to gradually-end ; Oct 2016

[11] Indian Express – Private Sector capex ; Oct 2016

[12] Press Information Bureau release ; March 2016

[13] The Hindu Businessline – Govt. to pay interest subsidy directly to borrowers ; April 2016

[14] Mishra, Montiel and Sengupta (2016) , “Monetary Transmission in Developing Countries – Evidence from India”

[15]Bhupal Singh (RBI 2011) , “ How asymmetric is the monetary policy transmission to Financial markets in India”

[16]Sonali Das , IMF working paper WP/15/129 – Monetary Policy in India : Transmission to Bank Interest Rates

[17]Mishra, Montiel and Sengupta (2016), “Monetary Transmission in Developing Countries – Evidence from India”