Introduction
Reserve Bank of India (“RBI”) operates as one of the Indian regulators in relation to fintech. Over the years, RBI has approached various developments, innovations and disruptions in fintech in a balanced and forward-looking manner. This may be in accordance with the publication of discussion papers, press notes, frequently asked questions, draft regulations and main instructions.
This is a unique, discussion-based approach to fintech regulation and provides an insight into the regulatory approach taken by the RBI. In this article, we attempt to shed light on the earlier steps taken by the RBI and the quasi-jurisprudence created.
RBI’s internal approach to Fintech
It should be noted that RBI has not defined fintech in an Indian context. While the term is a contraction of the words “finance” and “technology”, it is an umbrella term coined in recent times to denote technological innovation that has implications for financial services.
The Financial Stability Board (FSB) of the Bank of International Settlements (BIS) has given the following definition of fintech: “fintech is technologically enabled financial innovation that can result in new business models, applications, processes or products with an associated significant effect on financial markets and institutions and the provision of financial services“. While regulators are trying to have a formal definition of fintech, the description above as used by the FSB is preferred by the RBI and has been used in several RBI reports.
Regarding the internal allocation of resources from the RBI to fintech, in June 2018 a fintech unit was established in the Department of Regulation to act as a central point of contact within the RBI for all activities related to fintech.
The RBI had a separate fintech division, which has been operating within the Department of Payment and Settlement Systems (DPSS) since July 2020. This was made a full-fledged department with effect from 4 January 2022 (“Fintech department”), with the aim of giving further focus to the area and facilitating innovation in the fintech sector.
This Fintech department has been created to promote innovation in the sector, identify the challenges and opportunities associated with it and address them in a timely manner. The fintech division will also provide a framework for further research on the subject that can help RBI’s policy interventions. Accordingly, all matters relating to the facilitation of constructive innovations and incubations in the fintech sector, which may have wider implications for the financial sector/markets and fall under the purview of the RBI, will now be examined by this Fintech department. Issues related to inter-regulatory coordination and international coordination on fintech will also fall under its domain.
Regulatory Jurisprudence followed by RBI
Regulations prescribed by the RBI are primarily of two types – supervisory regulation and conduct regulation. While the supervisory regulation focuses on the solvency, safety and soundness of financial entities and the financial system, the conduct regulation focuses on how the financial entities should relate to their customers and includes information disclosure by the entities, their competence, their continuity, and fair business practices.
The RBI does not follow a one-size-fits-all approach to regulating financial innovation. To that extent, representatives of the RBI have spoken in detail about the requirement to regulate financial innovations, including the arguments against regulations.
The argument against regulating financial innovation is that it serves the interests of financial service providers and is mostly to the detriment of consumers. This is primarily due to reduced competition and subsequent cost increases. However, it should also be noted that the absence of financial regulation, which leads to unregulated financial systems, may force the establishment of external regulation. With the increasing reliance on fintech, the scale of financial transactions is growing and an unregulated sector can lead to unforeseen problems that can be detrimental to the interest of customers and may seek intervention from the authorities/regulators. Therefore, regulations can to some extent prevent such future events.
The RBI has used several approaches while examining whether a financial innovation should be regulated. They include:
- To ignore
- To look after
- To regulate passively
- To regulate actively, and
- To prohibit
RBI’s approach can be roughly categorized into the following regulatory principles:
- Can the innovation cause harm on a large scale; so ban it.
- Is the size or size very small; then ignore it.
- Can an informed decision be made by consumers; so warn them.
- Can it be beneficial to many consumers; regulate it passively with light touch control.
- It may be beneficial for many consumers, but consumer protection issues loom large; then actively regulate it.
Regulatory forecasting and public discussion approach
RBI has consistently followed an approach of forecasting the challenges and resulting changes proposed.
Forecast
RBI has released payment vision documents every couple of years. The first Payment Vision document was released in 2001 and sets out the goals for the period 2001 – 2003. The latest Payment Vision document was released in 2022 and sets out a vision up to 2025. In the current vision, RBI has chosen the core theme of ‘E-payments for everyone, everywhere, every time’ (4Es). Across the 5 (five) anchor goals of Integrity, Inclusion, Innovation, Institutionalization and Innovation, RBI proposes to take up 47 initiatives to achieve its vision for 2025.
Public discussion
In 2016, the RBI decided to set up an inter-regulatory task force to examine and report on the detailed aspects of fintech (“Fintech working group”) and its implications for the financial sector to appropriately review and reorient the regulatory framework and respond to the dynamics of the rapidly evolving fintech scenario. The Fintech Working Group included representatives from RBI, SEBI, IRDA and PFRDA, from selected financial entities regulated by these agencies, rating agencies such as CRISIL and fintech consultants/companies.
This Fintech Working Group issued a report on fintech in November 2017 which made several recommendations in relation to fintech. The report mentioned that regulatory uncertainty around fintech could potentially inhibit development. One of the recommendations was that regulatory actions could vary from “Disclosure” to “Light-Touch Regulation & Supervision” to a “Tight Regulations and Full-Fledged Supervision”, depending on the risk implication.
On 10 August 2022, the RBI issued a press release in relation to digital lending, implementing in a staggered approach certain recommendations, previously given in a report dated 18 November 2021, on digital lending by a task force constituted by the RBI. (“WG report on digital lending“). Certain recommendations from the Digital Lending WG report have been implemented on an immediate basis in this press release. Certain additional recommendations in the Digital Lending WG report were classified as: (i) accepted in principle but requiring further investigation; and (ii) requires broader engagement with the Government of India and other stakeholders in light of the technical complexities. Subsequently, on September 2, 2022, the RBI issued certain guidelines for digital lending.
This approach of a working group making recommendations to the RBI is a highly inclusive method of determining the requirement and scope of regulation in relation to financial innovation.
Other regulatory steps taken by RBI
RBI has also set up a regulatory sandbox mechanism to allow fintech companies to test their products and system in a controlled regulatory environment. The regulatory sandbox enables the regulator, innovators, financial service providers (as potential deployers of the technology) and customers (as end users) to conduct field tests to gather evidence on the benefits and risks of new financial innovations, while closely monitoring. and limit their risk.
On 20 June 2022, the RBI banned all non-bank issuers of prepaid instruments from loading prepaid instruments with lines of credit. This will affect the growing buy-now-pay-later lending model, where non-bank lenders used lines of credit to finance “prepaid instruments”.
On 17 August 2022, the RBI released a discussion paper on “Fees in payment systems” for public feedback. In this discussion paper, the existing mechanism and rules for levying charges on payment systems have been detailed along with other alternative options. RBI proposes to seek feedback on the proposed and existing charges on payment systems.
Recently, on October 7, 2022, the RBI released a concept note on “central bank digital currency”. The intention of RBI behind this concept note is to create awareness about digital currencies and possible use cases of the same. In this note, the RBI clarifies the approach it may take for the launch of the ‘digital rupee’.
Challenges faced by RBI
With the increasing number of fintech products, the incidence of fraud and cheating through certain fintech platforms has also increased. The RBI has regularly addressed this issue by regulating for more information to be provided to customers. From June 2020, every fintech lending platform is required to provide the name of the lender providing the credit facility. Similarly, RBI has implemented an ombudsman scheme for digital transactions to ensure a complaint forum for customers.
Another challenge faced is unregulated digital lenders operating in the market charging exorbitant interest rates and high service charges.
The RBI is also constantly required to understand and evaluate the innovative steps taken by the fintech players. A constant rules-based approach will not be beneficial for regulating financial innovation. A regulatory requirement that may be suitable for one product may be restrictive for another.
Conclusion
RBI has always encouraged innovation in the financial system, products and credit delivery methods. Sometimes the most important first step a regulator can take in this regard is to take no action at all. In the event that every new product is regulated, it will lead to the stifling of innovation and may result in giving legitimacy to certain products which may be harmful to the economy and the public in the long run.
In this light, RBI’s initial approach of “ignore” and “wait and see” has been beneficial to the development of initial innovation in the financial sector in India. However, this has also led to some additional challenges. Over time and depending on risk and the extent of public impact, the RBI may step in to regulate products with “light touch” or “active” regulations.
We are at a very interesting stage in the journey of ‘Indian fintech regulation’. It is expected that over the next few years, along with the development of the Indian fintech sector, the RBI will slowly move towards implementing more “active” regulations.
