NEW DELHI :
The Paytm IPO debacle notwithstanding, India’s burgeoning fintech sector is both a sunrise industry and an investor darling that mopped up investments worth $2 billion in the first half of 2021.
Gold rushes tend to spawn grey practices and this one is turning out to be no different. There were about 1,100 lending apps available to Indian Android users between 1 January and 28 February 2021. Of these, 600 were illegal, a recent report by a Reserve Bank of India (RBI)working group highlighted. The report underlined other concerns on the business conduct and customer protection issues arising from the spurt in digital lending. Aggressive lending and sharp recovery practices in the space have been problems that regulators have been concerned about.
The report was said to be prompted by an Enforcement Directorate probe on PC Financial Services, which runs a micro-loan mobile application called Cashbean. The company is being probed for alleged foreign exchange management act violation.
A Mint investigation has now revealed an egregious violation at a young and ambitious startup. The violation amounts to lending by an entity that doesn’t possess a licence to lend. Worryingly, some say the practice is not unheard of in the industry.
Bangalore-based Avail Finance was founded in 2016 by Ankush Agarwal, a former Ola executive. His brother Bhavish Agarwal, who is also a director on the board of Avail Finance, is the founder of Ola and Ola Electric, together valued at more than $10 billion, going by the last reported funding rounds and the reported valuation being sought by the cab-hailing app in an initial public offering of shares. Ola invested in Avail in 2019 and currently owns about 9% equity stake in the firm. Matrix Partners, which owns 29% in Avail, is also an investor in Ola.
The company is a so-called neo-bank aiming to serve credit products to blue collar workers such as maids, cooks and drivers.
Entities such as Avail Finance are fundamentally shiny digital storefronts to banks and shadow banks that possess a lending licence from the banking regulator, the Reserve Bank of India. Functioning like online sales agents, they can acquire customers, pass on the credentials to a real lender and facilitate a loan.
According to Mint’s investigation, Avail Finance, in some instances, has been using its own money to lend, circumventing a key RBI rule that allows only banks and licensed non-banking financial companies (NBFCs) to lend.
As part of the investigation, Mint spoke to officials who are directly aware of the matter and reviewed evidence of transactions that showed the company directly disbursing loans. Detailed queries sent to Avail Finance last week and subsequent reminders did not yield a response. The RBI did not respond to a query on whether they were aware of such practices.
Shades of grey
When it launched, lending was the first product Avail Finance brought to the market. It partnered with employers to offer loans to their employees. The firm also sourced its customers directly. This lending business took a hit during the pandemic, leading to the company laying off employees.
During the crisis, Avail stopped lending while focusing on products such as insurance and savings. But it is back to the lending business now—and pushing aggressively.
In 2019-20, the company reported ₹6.8 crore in revenues as compared to ₹73 lakh a year ago. The losses jumped to ₹37.5 crore in 2019-20 from ₹4.7 crore the previous year. Last year, Avail claimed that it had disbursed ₹200 crore across its different products. The latest number is not known. Avail has thus far raised $21.6 million in equity funding and is now in the process of raising another round of capital. The need to show rapid growth to investors is one of the drivers of suboptimal practices in the space.
Let’s first look at how lending works in the fintech world. A fintech platform ties up with NBFCs to offer loans to its customer base because as we saw already, only banks and NBFCs are allowed to lend from their books. In order to share the risk, as borrowers tend to be those who can’t get loans at better rates directly from established banks, the fintech platforms offer guarantees to lenders. All fintechs follow a so-called ‘first-loss default guarantee’ (FLDG) model, a way of protecting the interest of the lender in case of a default.
This means the fintech platform pays upfront to the NBFC a percentage of the total money the latter agrees to lend to the former’s customers. As the action has heated up, many in the industry are working on an 80-100% FLDG model, effectively underwriting the lending risk for the bank or NBFC.
Once a partnership between a fintech and NBFC is signed, two nodal/escrow accounts are set up by the NBFC partner and a payment gateway is deployed to facilitate transactions. One escrow is for disbursement; the second for collections.
“If the fintech player is not big enough, then there is just one escrow account. If the player is too small, then there is no escrow account at all. Both the disbursement and collection happen on the NBFC’s current account with its banking partner," explains a digital lending expert.
The ownership of the accounts remains with the NBFC partner. As per regulation, NBFCs are allowed to lend from its own books, which means they send the money to the nodal account (disbursement) to be disbursed to the customer of the fintech startup.
Avail Finance is not following, at least in some cases, this standard operating procedure. It is instead paying out loans from nodal accounts, opened by it for the purpose of disbursement, via payment gateways. Money from NBFC partners and Avail’s own funds are getting pooled in these accounts.
“Avail is transferring its own money directly into the account and using it for lending," said an executive with direct knowledge of the matter. He didn’t want to be identified.
There are two violations taking place here. Firstly, lending should be happening from the accounts of the NBFC partners and not from an account held by the fintech concerned. Secondly, the pooling of funds is a serious violation.
Every month, Avail has been transferring a few crores of its own money, the executive added. “Since it offers short-term loans, about 80% of the money comes back every month, which the company rolls over," he said. A majority of the loans at Avail Finance is processed via Liquiloans, a peer-to-peer NBFC.
“Ideally, Avail should transfer money to the NBFC partner in the form of a bank guarantee or cash directly into the NBFC’s bank account. The NBFC would then transfer the money to the nodal account (disbursement) managed by the payment gateway partner," an NBFC head, who lends to fintechs, said. He didn’t want to be identified.
This operating model is the source of the problem, said the founder of another fintech, who also owns an NBFC. “Many players do not operate NBFC nodal accounts. Fintechs open a Razorpay/Cashfree account in their own name and start disbursing," he said.
A payment gateway executive who didn’t want to be named clarified that the gateways only act as a technology service provider and manage the escrow account of the NBFC lender. Detailed queries sent to Liquiloans and payment gateways such as Razorpay and Cashfree did not elicit any response at the time of filing this story.
New moves
Avail has made other aggressive moves. It is in the process of acquiring a Delhi-based NBFC, Art Climate Finance (India), which is run by Rakhee Kapoor Tandon and Payal Sanghavi Bharat. Rakhee is the daughter of former Yes Bank managing director and CEO Rana Kapoor.
But this is not the first time Avail has made an attempt at acquiring the NBFC tag. Earlier, the company had applied for a licence through its subsidiary, AF Capital Pvt Ltd. However, the application didn’t go through. Over the last two years, many fintech firms have applied for NBFC licences to save costs, cut the dependency on traditional lenders, and for better control over customers.
Meanwhile, Avail has added new products on the lending side. For instance, it recently launched ‘Credit ATM’, where it gives ₹1,000-5,000 as credit line to blue-collar workers.
Just like a credit card, a borrower can withdraw cash from the account with an initial limit of ₹1,000. A bill is generated at the end of every month for the user to pay back. A borrower using this product can end up paying a substantial amount in fees annually. Avail charges ₹250 as annual servicing fee and 7.5% as processing fee. The 7.5% fee is recurring. For a month’s credit line, if a customer borrows ₹1,000, then he pays ₹1,325 ( ₹1,000+ ₹250+ ₹75). On an annualized basis, a borrower will pay ₹1,150 in fees alone.
Many fintech platforms today focus on the short-term loan segment. In fact, the RBI’s Working Group report states that around 87% of loans amounting to ₹0.98 trillion disbursed by banks have tenure of more than one year, while for NBFCs, only 23% of the loans amounting to ₹0.05 trillion fall under this bucket. On the contrary, loans with tenure of less than 30 days have maximum share in the case of NBFCs—37.5% amounting to ₹0.9 trillion.
The aggressive strategies adopted by fintech platforms can lead to a high-pressure work environment. And it can lead to senior executives quitting. Avail has witnessed senior exits over the last few months across functions. Mint’s research on professional networking site LinkedIn revealed that Karan Punjabi (CFO), Ankita Sen (head HR), Vikalp Jambhulkar (head of marketing), Gyan Chaudhary (finance controller), Ketan Anand (growth product manager) and Rajesh Pandey (compliance officer) have moved out of the company.
Most of these exits came within six-seven months of their joining.
A larger phenomenon
Some of the circumvention of norms appears to be widespread. NBFC industry officials Mint spoke to did confirm that fintech companies transferring their own money into the disbursement account is a clear violation of the regulation but is not surprising either.
“We have received such requests from new fintechs coming to us for partnerships," a chief executive at an NBFC said. He, too, didn’t want to be identified. They admit that many fintechs are pushed into doing this since they want to raise bigger venture rounds to survive and thrive in a competitive space.
“FLDG is still a grey area and is not allowed by the regulator. But it is widely prevalent in the industry. An unregulated company directly transferring money into the disbursement account is against the regulation," he said.
In the report, ‘Working Group on Digital Lending including Lending through Online Platforms and Mobile Apps’, the RBI highlighted its concerns over the FLDG model. It recommended: “In order to avoid creation of operational grey areas in the process and for the sake of better transparency, all loan servicing, repayment, etc., should be executed directly in a bank account of the balance sheet lenders without any pass-through account/pool account of any third party. The disbursements should always be made into the bank account of the borrower. Any fees, etc., payable to lending service providers as per agreement with the lender, should be paid by the lenders, and not received by them directly from the borrower."
Meanwhile, the founder of a fintech platform quoted earlier said that the regulation is not stringent for the older and smaller NBFCs and they do get away with several audit and reporting requirements that the new-age and bigger NBFCs are required to follow.
The bottom line is that despite regulatory warnings on malpractices by digital lending platforms, the operating models employed by several startups raise many questions. But it also points to the need for rules that keep pace with new digital realities.
“A fintech just can’t operate and scale if it goes by the books," the founder of a startup warily said.
