Understanding Direct Lending: A Guide to Funds, Institutions and Legal Framework in India

Law, Legislation & Guidelines

Laws and guidelines are formulated and implemented by the government to regulate and control various activities in society. Legislation includes all laws made by legislative bodies while guidelines are general rules, principles, or pieces of advice.

In the context of direct lending in India, the primary legislation is The Reserve Bank of India Act, 1934, which governs all banking activities. Additionally, the Securities and Exchange Board of India (SEBI) regulations are also applicable to direct lending firms. Specific guidelines for direct lending have also been issued by RBI in the form of Non-Banking Financial Company – Peer to Peer Lending Platform (Reserve Bank) Directions, 2017.

Understanding Direct Lending: A Guide to Funds, Institutions and Legal Framework in India

Direct lending refers to the practice of non-bank entities providing loans to borrowers without intermediaries like brokers or investment banks. In India, direct lending mostly happens through Non-Banking Financial Companies (NBFCs) and Peer-to-Peer (P2P) lending platforms.

1. Funds: Direct lenders raise funds from various sources like individual investors, institutional investors, or via securitization. The funds are then lent out to borrowers at an agreed interest rate.

2. Institutions: The main institutions involved in direct lending are NBFCs and P2P lending platforms. NBFCs are regulated by RBI under the RBI Act, while P2P platforms are governed by the NBFC-P2P guidelines issued by the RBI.

3. Legal Framework: The primary legislations governing direct lending activities include The Reserve Bank of India Act, 1934, and SEBI guidelines. RBI regulates the operations of NBFCs and has issued specific directions for P2P lending platforms.

For instance, according to the NBFC-P2P guidelines, every company intending to undertake P2P lending will have to obtain a certificate of registration. Additionally, they also provide directives on fund transfer mechanism, participant eligibility criteria, lending limits, and operational requirements.

Direct lending in India is attracting a growing number of investors due to its potential for high returns. However, it’s essential for all parties involved to be aware of the legal framework that governs these transactions to ensure compliance and avoid potential legal problems.

From a legal perspective, all agreements between lenders and borrowers must adhere to the Indian Contract Act, 1872. It is also important for lenders to understand the implications under the Income Tax Act, 1961, for income earned from direct lending. Therefore, it’s recommended that participants seek legal advice before getting involved in direct lending activities.