The rise of FinTech sector

In its November 2020 Bulletin, the RBI published a paper titled FinTech: The Force of Creative Disruption, which said that while fintechs have helped enhance financial inclusion, a central bank’s interest in regulating the industry would be based on its impact on financial stability and monetary policy.

Financial regulators are facing unprecedented challenges with the emergence of FinTechs. These firms come in new shapes and forms, so fitting them into buckets for prudential or risk-based supervision is not easy. As the scope of activities widens from national to global, regulation too has to reach out across borders.

‚ÄĒ RBI Bulletin November 2020

In a¬†speech¬†delivered to the ‚ÄėNational E-Summit on Non-Banking Finance Companies‚Äô, organized by ASSOCHAM on November 6, RBI Deputy Governor M Rajeshwar Rao said that while the RBI will issue regulations for fintech in the future, the guiding principles will be based on orderly growth, customer protection, and data security. While the technological innovations have improved the delivery of financial services and products on the one hand, on the other hand the regulator has had to re-calibrate its interventions to safeguard consumer protection and financial stability.¬†

¬†‚ÄúThe regulatory challenges in marrying these diverse and sometimes conflicting objectives are many, but the clarity of purpose would help us make the right policy choices,‚Ä̬†

M Rajeshwar Rao, Deputy Governor, RBI

With the fast advancement of technology, undoubtedly the fintech companies have played a key role in developing improved access to financial services by solving several bottlenecks that existed within the Indian banking system. The growth of the sector has been powered by the Government of India (GOI) with the introduction of an innovation-supported startup landscape, friendly government regulations and policies, and a large market base. 

Source: India Fintech Report 2020

 Over 2000 fintech companies have set up operations in India since 2013, with the country ranking second globally in fintech adoption. However, this rise of fintechs has been accompanied by concerns surrounding the implications on financial stability as well as data privacy and security, all of which require regulatory guidance and oversight.

For instance, mobile wallets were developed in a regulatory grey space in the late 2000s in the aftermath of the telecom sector boom. In response, the Reserve Bank of India (RBI) issued guidelines for their operation, such as limiting the amount of money that can be stored in a wallet, thereby curtailing the larger systemic risks that wallets could have posed.

Which bodies regulate the provision of fintech products and services?

There is no universal regulatory body for fintech entities in India. Depending on the product or service offered by the entity, the regulatory body governing such vertical would regulate those specific entities. By and large fintech products and services can be considered to fall under the purview of the following regulators:

  • the RBI;
  • the Securities Exchange Board of India (SEBI);
  • the Ministry of Electronics and Information Technology (MEITY);
  • the Ministry of Corporate Affairs; and
  • the Insurance Regulatory and Development Authority of India (IRDAI).

However, the RBI currently regulates the majority of fintech companies dealing with account aggregation, peer-to-peer (P2P) lending, cryto­currencies, payments, etc

Regulatory framework in place

In a November 2017 report, an RBI working group on fintech and digital banking said that there was a need to regulate fintechs given concerns surrounding data protection, cybersecurity, ensuring healthy competition, encouraging new entrants, and protecting users and consumers.

At the present, the RBI has placed guidelines and regulations for various fintech players, whether it is Peer-2-Peer lenders, storage of payment data, Account Aggregators and payment aggregators and payment gateways. While these are direct regulations issued by the RBI to specific entities, much of the fintech industry in India is not directly regulated. Instead, the RBI relies on the banks and NBFCs to ensure that their fintech partners follow the same regulatory standards on Know-Your-Customer norms, Anti-Money Laundering, data privacy and protection, data storage in addition to guidelines on loans that banks and NBFCs have to follow.

There are plethora of financial services which have found its application in the human world

The recommendations laid down by the working group (RBI) are as follows:

  • Regulators should develop a detailed understanding of the inherent risks across fintech platforms
  • Identify specific fintech products and devise a regulatory approach
  • Create a dedicated organisational structure within each regulator for fintechs
  • Identify changes needed within the existing regulatory structure to respond to new innovations
  • Identify specific technologies and skill-sets required for regulating and supervising fintech innovations
  • Engage with fintech entities to create an appropriate regulatory response and re-align existing regulatory and supervisory framework

In January 2020, the RBI gave its nod to video-based KYC as an alternative to physical verification. The video-KYC process allows due diligence of the customer and identifying documents via video chat. Additionally, the RBI also authorized the use of digital lockers for paperless document management as part of the KYC process.

These steps will particularly help banks, NBFCs, prepaid wallet players, and Neobanks, all of whom have been pushing the edge of fully digitized onboarding for a while. Additionally, this should augment financial inclusion, with the cost of onboarding reducing significantly.

The Reserve Bank of India (RBI) has also announced the operationalisation of the payment infrastructure development fund (PIDF) scheme, which is intended to subsidise deployment of payment acceptance infrastructure in tier-3 to tier-6 centres, with a special focus on the north-eastern states of the country. The regulator prescribed details of contribution to the fund and sought to incentivise the usage of payment devices.

Along with this, the RBI has constituted a Working Group (in Jan 2021) on digital lending including lending through online platforms and mobile apps. While penetration of digital methods in the financial sector is a welcome development, the benefits and certain downside risks are often interwoven in such endeavours.

A balanced approach needs to be followed so that the regulatory framework supports innovation while ensuring data security, privacy, confidentiality and consumer protection. The Group has been advised to submit its report within three months.

On 01st January 2021, the Reserve Bank of India has constructed a composite Digital Payments Index (DPI) to capture the extent of digitisation of payments across the country.

The RBI-DPI comprises 5 broad parameters that enable the measurement of deepening and penetration of digital payments in the country over different time periods. These parameters are ‚Äď (i) Payment Enablers (weight 25%), (ii) Payment Infrastructure ‚Äď Demand-side factors (10%), (iii) Payment Infrastructure ‚Äď Supply-side factors (15%), (iv) Payment Performance (45%) and (v) Consumer Centricity (5%). Each of these parameters has sub-parameters which, in turn, consist of various measurable indicators. The major sub-parameters under each parameter are available here.

The RBI-Digital Payments Index- Parameters and Sub-paramaters

In 2016, the RBI set up an inter-regulatory working group to “look into and report on the granular aspects of fintech and its implications to review the regulatory framework. With this in August 2019, the central bank brought in a framework for a regulatory sandbox, and in June 2020, it issued a guideline for digital lending platforms.

Under the first cohort of Regulatory Sandbox (RS), two entities commenced testing of their products from November 16, 2020. The regulatory sandbox has been considered as one of the enabling factors for the growth of the Fintech sector.

In addition to the RBI, two other financial regulators have announced plans for regulatory sandboxes‚ÄĒthe Securities Exchange Board of India (SEBI), which regulates India‚Äôs securities markets,¬†and the Insurance Regulatory and Development Authority of India (IRDAI), which oversees the insurance and reinsurance sectors.

Along with the regulatory sandbox, one also needs to know about the Industry sandbox where fintech firms can test their solutions isolated from the live market.

The purpose of the industry sandbox is to provide a collaborative space accessible to all the fintech participants including the regulators. The Industry Sandbox Framework is a platform of shared knowledge and data developed, operated, and maintained by the industry wherein fintech firms can test their innovations before rolling out into the live market or approach regulatory sandbox.

Challenges for regulation of the sector

The RBI paper highlights five major regulatory challenges that fintechs pose to an economy and consumers:

  1. Innovative cross-border payment companies pose a regulatory challenge as it requires oversight across jurisdictions
  2. The use of data by fintechs raises concerns over data protection and data privacy, especially when rights and obligations of service providers are not clearly defined. Further, bias within machine learning algorithms could reproduce and perpetuate existing patterns of discrimination and exclude vulnerable sections, the paper says.
  3. If fintech lenders weaken credit standards across the board in order to deliver more loans and compete with other lenders, there could be potential for system-wide risks.
  4. There is a need for protecting consumers, integrating digital literacy within financial literacy, and ensure there are adequate safeguards and redressal mechanisms that are simple to understand and accessible to all sections of the population
  5. The paper says that with large banks and multinational corporations entering the payments and lending space, there could be a trade-off between ‚Äúdata-fueled oligopoly for cheap services they need for re-aligning incentives to foster smaller, more innovative firms for a competitive ecosystem.‚ÄĚ Regulators therefore should be¬†neutral between incumbent companies and newcomers.
Source: National Financial Inclusion strategies conference (World Bank)

Need of a more enabling environment for the FinTech sector

The rise of India’s dynamic FinTech sector can be a much-needed breakthrough, connecting the dots and bridging the gap between banks and the Indian public. India’s FinTech sector is rapidly evolving, but it trails behind some of its counterparts in South East Asia. South East Asia is a mixed bowl of banking technology readiness. While countries, like Singapore, are advanced and boast of exceptional success, others are still playing catch-up

Over the last two years, the government and regulators have adopted a supportive approach towards the FinTech industry. However, as India is on the cusp of adopting digital technology in areas such as payments, lending, and customer onboarding on a larger scale, it is necessary to create an even more favourable environment for the industry.

The Indian technology ecosystem does not lend itself naturally to innovation. This is unlike the Silicon Valley, and whose products stem from co-innovation between the corporates and the academia. What the Indian FinTech industry needs is for all its stakeholders ‚Äď from the academia to regulators to innovators to venture capitalists‚Äď to come together and innovate. Only then one can predict the right future for the sector.

Vedprakash Singh

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