What Freud can tell us about FinTech regulation

Hi,

Imagine you’re taking riding lessons on a very spirited horse. Following the instructor's directions, you desperately attempt to stay on the rearing devil. The horse, however, has other ideas - and you end up in the dirt. 

In his 1923 study, The Ego and the Id, Sigmund Freud introduced many of the foundational principles of psychoanalysis. In the study, he presents a detailed depiction of the human psyche. The ego, superego, and id interrelate and shape a dynamic structure that responds to various aspects of the unconscious mind. According to Freud, the superego is a regulatory force that guides behaviour, while the id represents a reservoir of libidinal energy and impulsive desires. The ego, which operates at the level of conscious awareness, manages and reconciles these distinct facets of the unconscious to enable effective functioning.

In our story, you are the ego trying to control the wild horse, the id. The superego is the instructor who only knows the rules of riding.  

The id is impulsive, the ego is rational, and the superego is moral. 

Of course, Freud’s theory of the self was met with multiple conjunctions, objections and positions contributing to what can be described as ‘theoretical chaos’. 

However, this is my attempt at simplifying the theory to its core so I can contextualise it to lending (of course). 

The id 

Tales of malevolent lenders are as old as time. In Shakespeare’s classic, The Merchant of Venice, the notorious Shylock infamously demanded a pound of flesh from his debtor, who failed to pay on time. 

In post-pandemic India, digital lending was a saviour. Microloans, anywhere between Rs 200 to 3,000, were disbursed at the speed of light. They offered unparalleled ease and convenience. But some digital lenders, like the wild horse, turned rogue. They lured borrowers into signing up for loans with extortionary interest rates, and if borrowers failed to repay, they were hounded, shamed, and bullied. There were reports of lenders resorting to various forms of coercive tactics. Defaulters were publicly identified and humiliated on social media platforms, while their contact lists have been exploited to spam and intimidate their associates. Tragically, some individuals subjected to such harassment by lenders have taken their own lives.

Predatory lending is an extreme analogy for the id. What I mean here is that a nascent, burgeoning industry, like digital lending, is bound to excitedly jump like a spirited horse at the opportunity to compete and grow! 

The superego, i.e., regulation 

Several reasons exist for the proliferation of predatory digital lending platforms in India. Firstly, these platforms operate in a regulatory grey zone since they are not directly regulated by the Reserve Bank of India (RBI). Instead, they collaborate with regulated entities such as banks or Non-Banking Financial Companies to provide loans to borrowers. However, these regulated entities have somewhat failed to adequately monitor and regulate the activities of these digital lending platforms. 

And it’s only natural when there’s a new kid in town - in this case, the explosion of a new industry. 

Another factor contributing to the rise of these platforms is the absence of a dedicated data protection law in India. The Personal Data Protection Bill 2019 is still pending approval. Without this legislation, certain apps can obtain sweeping consent from users to access their personal data, including their phone book, SMS, photo gallery, and location. This data can then be used to harass and shame borrowers.

However, the superego, the apex regulator, and the RBI released the first set of rules on digital lending based on the working group (WG) recommendations in November 2021. These guidelines have limited impact on lenders, given that these partnerships with Loan Service Providers (LSPs) are still in the early stages of evolution. 

Regulation, like the superego, is a necessary act of morality. 

Among the recommendations from the WG, for instance, there’s one around thorough due diligence before partnering with an LSP - an excellent recommendation to facilitate more scrupulous lending. 

However, some of the regulatory directions in this instance seem harsher than they should be. Many companies and leaders have lamented behind closed doors that stricter guidelines on how, when and where to lend could reduce the industry's growth potential. Ultimately, the fight is between legacy institutions and their love for stability and FinTechs trying to build themselves a space beyond being digital distributors of regulated entities. 

How can regulators (the superego) and the new, burgeoning industry, sans the predators (the id), balance each other? 

Enter the ego

To demonise the entire industry because of a lack of a data protection bill or restrictive regulations/recommendations is an overkill. The industry has a significant role in financial inclusion, and the RBI has also recognised it with the working group on digital lending. So, the RBI’s role should be on quelling predatory lending and not on throttling innovation in the industry. 

It is crucial that the working group engages with industry players to develop a regulatory framework. 

A light touch of regulation which relies on the industry to self-regulate, is key. 

The self-regulation imperative 

Let’s look at Kenya and Indonesia - two other fast-growing, emerging fintech markets worldwide. 

Kenya’s Mutiso’s Digital Lenders Association of Kenya (DLAK) became a primary force during the pandemic to reform some of the industry’s worst actors.

Mutiso’s DLAK, reformed rogue actors in Kenya's digital lending industry during the pandemic. DLAK's code of conduct standardises the industry, with violators risking ostracisation and action from authorities. DLAK's public awareness campaign brought rogue actors to the negotiating table with promises to end unethical practices. DLAK oversees almost 75% of the Kenyan digital lending market, with plans to bring up to 90% of the industry under its self-regulatory umbrella.

Indonesia's fintech industry relies heavily on peer-to-peer lending, but the regulatory regime has been inadequate. The country's regulatory authority, OJK, has only a basic law from 2016, which doesn't account for the industry's nuances. OJK has made AFPI, the local digital lending association, mandatory for all legally operating digital lenders to address this. OJK has deputised AFPI as co-regulators to create policies and standards for local operators.

With AFPI's oversight, OJK shut down thousands of illegal lenders, improving Indonesia's digital lending market conditions. However, despite AFPI's policies, predatory and illegal operators still exist, with daily interest rates capped at 0.8%.

Indonesia's digital lending market has been flooded with lenders to the extent that OJK put a moratorium on new licences. Chinese lenders have also contributed to the market's predatory practices, as they have in Kenya and India. China's crackdown on P2P lending in 2017 pushed these lenders to operate abroad, often under different names. Kenya's DLA publicly shamed and brought to heel two Chinese-owned rogue actors, Okash and Opesa. 

India has also made progress in stopping predatory digital lenders, with over 200 lending apps removed from Google's store and India’s Fintech Association for Consumer Empowerment (FACE)’s increasing efforts to create public awareness and establish industry standards.

Despite progress made by private sector efforts in self-regulating digital markets, there is still a need for robust regulatory frameworks to establish industry standards and build consumer trust. The RBI oversees India's banks and non-banking financial companies, creating a regulated environment for digital lenders. However, observers have pointed out blind spots in regulating fintechs' proprietary platforms, which the RBI only indirectly regulates.

What I’m trying to say is..

Digital lending is growing faster than we can say the word. And self-regulatory organisations are best positioned to understand the nuances of the market and maintain the speed, agility, and convenience that digital lending companies are built on. 

The AFPI, for instance, sets industry standards for P2P lenders and reports any misconduct to the regulator. To start their business, P2P lenders in Indonesia must receive a recommendation from AFPI. As a self-regulatory body, AFPI is well-suited to establish guidelines for underwriting, interest rates, KYC, and loan terms for borrowers and prevent misuse of customer data while the personal data protection framework is being finalised. 

The RBI's digital lending guidelines propose a Self Regulatory Organisation (SRO) to oversee regulated entities and Digital Lending Applications (DLAs)/Loan Service Providers (LSPs), establish a code of conduct for recovery and a standardised LSP agreement for balance sheet lenders. 

India has the world's third largest fintech ecosystem, and RBI has taken a balanced approach to fintech regulation, striving to balance innovation with risk management. 

As the Former Deputy Governor of the RBI, R Gandhi, has rightly questioned - 

“In regulation, we always have this trade-off to be resolved. When to step in and how? Do we regulate? If we regulate, where should we stop? Should it be a light touch or a hard kill? It’s a policy decision.”

Industries that pursue self-regulation to meet regulatory requirements may face criticism for being self-serving or lacking awareness. To counter these perceptions, self-regulatory efforts should incorporate transparent and impartial processes. Industry players can share their proposed frameworks for public feedback or ask relevant stakeholders, including regulators, to review and suggest changes before adopting them. This approach can help build credibility and promote the implementation of meaningful measures to tackle specific issues.

What I’m also trying to say is..

Despite being one of the most controversial figures in psychology, Freud got some ideas right. His theory of the id, the ego and the superego radically changed human beings’ understanding of themselves. It explained the nuances of human behaviour, precisely why we are so often at war with ourselves. 

Freud posited that a person with a strong ego, despite the compelling forces of the id and the superego, can effectively manage the pressures of life. 

So when it comes to regulating digital lending, think of it like parenting a child. New to the world, digital lending needs an authority figure (like the RBI) to guide them to do the right thing so it doesn’t indulge in excesses - like you’d tell your child not to smoke, drink or do drugs. 

However, you’d want the child to have a mind and personality of her own. That’s the self-regulating bit - guide them, ensure they understand that there are consequences to bad actions, but let them make the right choices. 

That’s all from me this week!

Written by Rajat Deshpande