Fintech Regulations: A No Man’s Land?

Indian fintech rooms are designated as one of the most disruptive, innovative and mature in the world. Despite the bleeding bottom line, the valuations for Indian fintech players were sky high, primarily due to the enormous potential the market has to offer. UPI has catapulted the wave of digital adoption into payments and the PPI framework provided fintechs and non-banks with much-needed fund holding capabilities.

As the new forms of credit lines such as Buy Now Pay Later (BNPL) began to penetrate the market for lending to private customers, fintech players had to improvise the use of the PPI framework and optimize the experience for customers. Now RBI has told fintechs “Enough of these improvisations, work with banks and stay within bounds.”

The development of Fintech products in India

Internet-based banking was the first consumer-focused fintech product in India. While online banking developed over time to become an older fintech product, it was not until 2016 that demonetization acted as a catalyst to accelerate customer adoption of fintech products in India. This disruption enabled the growth of fintech startups, which through innovation and flexible ways of working, gave customers digital first financial products such as Digital Lending, Digital Insurance, Discount Broking, Wallets, Payments, etc. India stack and pandemic also played crucial roles i increase customer adoption for these digital first models.

This type of new age fintechs was not and still is not licensed by India’s central bank and serves their customers through strategic alliances with banks, NBFCs, insurance companies. Their only hope of eventually becoming a fully digital bank under a separate licensing regime is also waning, and the RBI governor rules out the need for such a licensing framework.

The Fintech sector in India has created a lot of changes in how the general population acts and in the ways of working for financial institutions. Armed with advanced technology and fresh talent, fintechs were able to alleviate the inherent friction present in the India Financial Services ecosystem. Fintech companies operating in digital lending have partnered with banks, NBFCs to increase credit distribution across the various teams’ populations by leveraging technology to create smoother customer journeys and shorter processing times.

Although there has been no direct intervention by the Reserve Bank of India (RBI) to regulate fintech companies and reduce the risk they pose to the financial ecosystem, there have been a few initiatives to embrace them. One such example is RBI’s Fintech Regulatory Sandbox – established in 2018 with the main goal of being a controlled regulatory environment for testing fintech products. Due to its selective onboarding process and closely monitored scope for testing, large fintech companies have been discouraged from participating. Another initiative by RBI to bring some of fintechs under their area of ​​responsibility was the introduction of the license for payment system operators. This initiative was a step in the right direction and led to a much-needed scrutiny of the ever-growing payment landscape in India.

What has led to ambiguity in Fintech Space?

The absence of an overarching set of rules for fintechs has created several ambiguities in the system for both companies, investors and consumers. From a fintech company perspective, the ad hoc and whimsical nature of regulatory guidelines creates uncertainty in their overall product roadmap and makes them less innovative than what their capabilities offer. The product development limbo imposed by regulatory ambiguities results in making fintech business models unsustainable.

One must be aware of the fact that the much-vaunted digital payment penetration was originally funded and built on the toil of early Fintechs such as Paytm and Bhrathpe. The burning of capital to provide QR codes and mobile apps across the country to create an acceptance framework was possible only because these unicorns had a viable business model that received investor support.

Why Activation Regulations Are Important for India’s Fintech Ecosystem?

As the regulator intervenes and enforces new obstacles on the road to fintech with targets for consumer protection and market correction, it is equally important to introduce enabling regulations to support the fintech ecosystem as well. The recent RBI circular on prepaid payment instruments (PPIs) is worth analyzing in this context – the absence of specific regulations banning the use of credit lines to load PPI instruments gave birth to several innovative digital financial products such as Buy Now Pay Later (BNPL), EMI- cards, payday loans, etc.

These products have been hugely successful in the Indian market and have seen aggressive adoption by consumers; for example, the BNPL market in India was valued at over INR 22,000 Cr (USD 3 billion). The success of these products is primarily due to the two basic measures – partnerships with financial institutions for credit collection, the ability to pay off the credit obtained through prepaid instruments. The RBI directive to ban such schemes will cause both fintech companies and their partners to use valuable resources that could otherwise have been focused on innovation to re-evaluate and redesign their operating models, at enormous cost.

In 2021, the Indian fintech companies raised $ 6.9 billion in capital from investors, mainly driven by the innovations generated by the companies and large-scale customer adoption. The stifling innovation and product development as a result of regulatory ambiguity can lead to a twofold effect on existing fintechs – stagnation in customer adoption and lower investment levels from the PE / VC sector. This bilateral effect of reduced customer base and liquidity will leave fintech in a Catch-22 situation, exacerbating their problems further. For new players, regulatory uncertainty will act as an establishment barrier, thus further stifling growth.

To quote the report from RBI’s working group for FinTech and Digital Banking, “FinTech-driven activities should ideally only be carried out by regulated entities, such as banks and regulated payment system providers”. This statement represents a rather dilapidated view that does not fully understand the role of the unlicensed and unregulated fintech player in helping the growth of digital adoption across the country. A more constructive approach from RBI would be to recognize the role of fintechs in India’s financial inclusion agenda and establish a regulatory framework that will remove current ambiguities while giving fintechs sufficient flexibility to think and innovate new proposals.

(By Jaikrishnan G, Partner and Head of Financial Services Consulting, Grant Thornton Bharat)