Fintech Regulations: A No Man’s Land?

Indian fintech space is touted as one of the most disruptive, innovative and mature in the world. Despite the bleeding bottomline, valuations for Indian fintech players were skyrocketing primarily due to the immense potential the market has to offer. UPI has catapulted the surge of digital adoption in payments and PPI framework provided the much-needed fund holding capabilities to fintech’s and non-bank’s.

As the new forms of credit lines like Buy Now Pay Later (BNPL) started penetrating the retail lending market, fintech players had to improvise usage of PPI framework and optimize experience for customers. Now RBI has told fintechs “Enough of these improvisations, work with banks and stay within the limits.”

The Evolution of Fintech Products in India

Internet-based banking was the first consumer focused fintech product in India. While Internet banking evolved over time to become a legacy fintech product, it wasn’t until 2016 when demonetization acted as a catalyst in accelerating the customer adoption for fintech products in India. This disruption enabled growth of fintech startups, who through innovation and agile ways of working, brought to customers digital first financial products such as Digital Lending, Digital Insurance, Discount Broking, Wallets, Payments, etc. India stack and pandemic also played crucial roles in increasing customer adoption for these digital first models.

This breed of new age fintechs weren’t and still are not licensed by India’s Central Bank and services their customers through strategic alliances with banks, NBFCs, Insurance companies. Their only hope of eventually becoming a fully digital bank under a separate license regime is also diminishing with the RBI Governor ruling out the need for such a license framework.

The fintech sector in India has created a plethora of changes in how the general population transacts and in the ways of working of financial service institutions. Armed with advanced technology and fresh talent, fintechs were able to soothe the inherent friction present within the India Financial Services ecosystem. Fintech companies operating in the areas of Digital lending have partnered with Banks, NBFCs to increase credit distribution across the various strata’s population by leveraging technology to create smoother customer journeys and shorter turnaround times.

While there has not been any direct intervention by the Reserve Bank of India (RBI) to regulate fintech companies and mitigate the risks they pose to the financial ecosystem, there have been a few initiatives to embrace them. One such example is the RBI’s Fintech Regulatory Sandbox – established in 2018 with the primary objective of being a controlled regulatory environment for testing fintech products. Due to its selective onboarding process and tightly monitored scope for testing, large fintech companies have been dissuaded from participation. Another initiative by the RBI to bring a section of fintechs under their purview was the introduction of the Payment System Operators license. This initiative was a step in the right direction and brought in a much needed scrutiny to the ever expanding payments landscape in India.

What has led to Ambiguity in Fintech Space?

The absence of an overarching regulatory framework for fintechs have created multiple points of ambiguity in the system for companies, investors and consumers alike. From a fintech company perspective, the ad hoc and capricious nature of regulatory guidelines creates an uncertainty in their overall product roadmap and renders them less innovative than what their capabilities offer. The product developmental limbo enforced by regulatory ambiguities result in rendering fintech business models unviable.

One must be cognizant of the fact that the much-boasted digital payment penetration was originally funded and built on the toil of early Fintech’s such as Paytm and Bhrathpe. The capital burn for providing 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 got the investor backing.

Why Enabling Regulations are Important for India’s Fintech Ecosystem?

As the regulator intervenes and enforces new hurdles on the path of fintech’s with the objective of consumer protection and market correction, it is equally important to bring in enabling regulations for supporting the fintech ecosystem as well. The recent RBI circular concerning Prepaid Payment Instruments (PPI) is worth analyzing this context– the absence of specific regulations prohibiting the use of credit lines to load PPI instruments, gave birth to several innovative digital finance products such as Buy Now Pay Later (BNPL), EMI Cards, Pay Day Loans etc.

These products have been hugely successful in the Indian market and have seen aggressive adoption by the consumers; for example, the BNPL market in India was valued in excess of INR 22,000 Cr (USD 3 Billion). The success of these products is primarily due to its two foundational levers – partnerships with financial institutions for credit sourcing, ability to disburse the sourced credit via prepaid instruments. The RBI directive to forbid such arrangements will cause both fintech companies and their partners to spend valuable resources that could otherwise be focused on innovation to reevaluate and redesign their operating models, at huge costs.

The year 2021 saw the Indian fintech companies raise ~$6.9 billion in capital from Investors, driven primarily by the innovations generated by the companies and the large-scale customer adoption. The stifled innovation and product development as a result of the regulatory ambiguity could lead to a two pronged effect for incumbent fintechs – stagnation in customer adoption and lower levels of investments from the PE/VC sector. This two pronged effect of diminishing customer base and liquidity will leave fintech in a Catch-22 situation, further exacerbating their woes. For new entrants, the regulatory uncertainty will serve as a barrier for entry, thus further stifling growth.

To quote the report of RBI’s Working Group on FinTech and Digital Banking, “FinTech powered business should ideally be undertaken by only regulated entities, e.g. banks and regulated payment system providers”. This statement represents a rather parochial view that does not fully appreciate the role that unlicensed and unregulated fintech’s play in aiding the growth of digital adoption across the country. A more constructive approach from RBI will be to recognize the part fintechs play in India’s financial inclusion agenda and establish a regulatory framework that will remove the current ambiguities while giving fintech’s sufficient flexibility to ideate and innovate new propositions.

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

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