India’s central bank cracks down on fintech startups

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For almost everyone For fintech start-ups, lending has long been a destination. A notice from India’s central bank this week disrupted the ecosystem by scrutinizing who can lend.

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The Reserve Bank of India has informed dozens of fintech startups that it is banning the practice of loading non-bank prepaid payment instruments (PPIs) – such as prepaid cards – using credit lines, causing panic among – and an existential threat to many fintech startups, causing some compare this decision to China’s crackdown on financial services companies last year.

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Several startups, including Slice, Jupiter, Uni and KreditBee, have been using PPI licenses to issue cards for a long time and then equip them with credit lines. Fintechs typically partner with banks to issue cards and then link up with non-bank financial institutions or use their own NBFC unit to offer lines of credit to consumers.

It is widely believed that the central bank notice, which does not identify any startup by name, affects just about everyone, including buy-now-pay-later firms like ZestMoney, which also use a similar mechanism to lend to customers. Amazon Pay, Paytm Postpaid, and Ola Money are also being cautious as many believe they may also be affected.

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“The rule is very confusing and weird,” the fintech founder said, speaking on condition of anonymity so as not to upset RBI officials. “What the RBI is basically saying is don’t load the credit line on PPI. The way things are with PPI right now is that the money is finally going to sellers. Now you’re saying that NBFCs can’t provide lines of credit to merchants and their money should only go into customers’ bank accounts.”

The founder added that this new stance risks erasing all the innovation that has taken place over the past five years in the fintech industry, which has attracted more than $15 billion in investment over the past two years from a host of high-profile backers including Sequoia India and Southeast Asia. , Tiger Global, Insight Partners, Accel and Lightspeed Venture Partners.

“The way everyone works in the fintech space right now is perhaps with one degree of separation where the money first enters the payment gateway and then goes to the merchants. Some banks have been using the same strategy for ten years!” added the founder.

Fintech startups are convinced that the banks lobbied the RBI to make this decision, using the age-old tactic of having the actors resent and relying on the regulator to save the day.

The central bank, which did not provide an explanation in this week’s notice, has long expressed concern about lenders charging exorbitant interest rates and requiring minimal customer details to attract and coerce customers. Some of these firms have been alleged by government authorities over the past two years to be involved in money laundering schemes.

“Some people have suggested that when the PPI licenses were issued, the RBI made it clear that they were not issued as lending instruments. With the combination of PPI + BNPL, the PPI route is now being used as an alternative to credit cards or offering seamless BNPL, which the RBI may not agree on to date,” said an industry player who also wished to remain anonymous.

The new rule is said to affect not only such shark creditors and sketchy gamblers, but everyone.

“We believe this regulation could significantly impact fintechs involved in this business and will benefit banks as they can further accelerate the acquisition of less competitive cards,” analysts at brokerage Macquarie wrote earlier this week.

Many argue that fintech startups exist because they have found a way to bring financial inclusion to millions of users, which has long been hailed by the RBI and which banks would appreciate if you didn’t mention it. The PPI model, which combines two regulated entities, allows lenders to offer loans to customers at a lower cost, greatly increasing the reach of those who can get a loan.

“In the traditional personal loan model, the lender deposits money directly into a bank account. So the lender does not make money when the consumer spends that money,” explained Himanshu Gupta, a fintech veteran. “But in PPI instruments backed by a credit line model, as fintech startups earn exchange income on every payment, which can be as high as 1.8%. This means they can potentially offer credit to consumers at a lower cost than a pure “personal bank loan” model, he added.

India’s credit bureau directory is small, making most individuals in the South Asian market unworthy of a loan. As a result, banks do not offer credit cards or loans to most Indians. Fintechs use modern underwriting systems to lend to clients and the maze of regulatory arbitrage that has been considered normal until now to work.

Some argue that the central bank may simply be too late to make a decision now. Fintech companies serve over 8 million clients in India, and without clarity, most of these clients are not required to meet their current payback periods, which could put a significant strain on firms.

In addition, NBFCs, run by various start-ups, are regulated entities. Some fintech veterans argue that if the RBI really wants to stop the use of PPI as a lending tool, then they should really consider licensing credit cards to startups, which the RBI hasn’t done so far.

Meanwhile, investors are spooked, and many startups that are in the process of raising new rounds of funding are starting to see some VCs back off, according to people familiar with the matter. Some industry players believe that India’s central bank is taking the same approach as China in its fight against lenders and fintech companies in general.

“We do not believe that RBI is very interested in issuing licenses for digital banking, as evidenced by recent statements by the RBI governor. The RBI has hit fintech hard and has been advocating tougher regulations in the past few months. We think the message is clear that fintech will be increasingly regulated,” Macquarie wrote.

“The RBI Paper on Payments 2025 also talks about looking at different fees for payments made in India in a way that further encourages digital adoption, which we think means there is a possibility that different payment fees may be lowered to encourage wider adoption. We are clear that the risks for the fintech sector are increasing, for which regulation has been a light touch so far.”

Entrepreneurs are struggling to convey their concerns to the RBI. At least three organizations, including the Digital Creditors Association of India and the Payments Council of India (PCI), part of the Internet and Mobile Association of India lobby group, are in the process of writing letters to the RBI and various ministries to allay their concerns.

During a Zoom call on Thursday, dozens of fintech representatives discussed common grounds for keeping the RBI informed. Some of their urgent requests include extending the new rule by six months and telling the central bank that the fintech industry as a whole is “responsible and trying to do the right thing,” according to people on the call.

Fintech companies are also keen to explain their business models in detail and justify why those operating under a full “know your customer” mandate should be allowed to continue operating.

But until there is some change or clarity, big disruptions are expected. KreditBee, backed by Tiger Global, and PremjiInvest, backed by KreditBee, have already temporarily banned customers from making any transactions with their prepaid cards.

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