India pilots self-regulation for fintechs

India has announced plans to regulate its sprawling fintech industry through a series of standards and a surveillance mechanism governed by the country's central bank, which it hopes will be sufficiently flexible to facilitate innovation.  

Currently, the fintech sector in India is regulated by a number of authorities, including the RBI, the Insurance Regulatory and Development Authority and the Securities and Exchange Board of India. However, as the market experiences a steep growth in the number of new fintech companies, authorities are concerned about a lack of a comprehensive regulation.

In January, the RBI launched a framework to create a self-regulatory organisation (SRO) to set stronger governance standards and address other challenges. Fintechs are expected to benefit from the SRO’s role as an intermediary, facilitating communication between its members and supervisors like the RBI. The framework targets financial companies that are not captured by existing financial regulation and tackles issues around customer protection, cyber security and grievance handling, among other concerns. It says that a fintech adhering to the SRO “that has formal recognition from the regulator will acquire legitimacy and provide regulatory comfort”.

Pratik Dattani, founder of UK-based think-tank Bridge India, said that the new SRO framework will help provide clearer guardrails for fintechs to follow when doing business, while helping implement more robust measures for consumer protection.

“Following recent demonetisation efforts in India, fintechs have helped a whole generation of unbanked masses to access banking services, generating exponential growth within the market and bringing the necessity for new types of regulations,” said Dattani.

According to a 2021 report from PwC, of the more than 1.3bn people living in India, roughly 850mn reside in rural areas with limited or no access to financial services. Significant developments within the digital payments industry, like the introduction of the United Payments Interface, have helped foster innovative payment methods in India. 

Launched in 2016, UPI is a real-time payment system used on mobile devices to instantly transfer funds between two bank accounts. In January, the payment system recorded more than 12bn transactions through its platform.

“There is a huge amount of potential for fintechs to operate now in India,” said Tarun Ramadorai, professor of financial economics at Imperial College London, who cited digital payments and mobile penetration as the primary causes of this trend. “Now, one of the main issues for this framework is to come up with a regulatory regime that allows innovation to flourish.”

By 2025, the market size of the country’s fintech industry is expected to reach $150bn, while the volume of digital payments is forecast to grow to approximately $100tn by 2030, according to data from Invest India.

China, a neighbouring fintech hub, has recently taken a tougher approach to regulating the market, with rules aimed at supervising non-bank payment institutions. But India’s self-regulatory system takes a different route, by appointing representatives from the fintech industry to craft sustainable compliance norms and promote responsible innovation within the industry.

The SRO framework aims to allow the sector to keep its innovation flow while ensuring that the rules are clear and widely understood by firms. 

“At this stage of fintech growth in India, a self-governance framework is a welcomed move in that it will enable regulation to be agile, recognising [that fintech] is different from the legacy banking sector,” said Dattani. He added that its success will depend on how effectively self-regulators can attract new members, set industry benchmarks and represent the market as a whole.

“The introduction of the new framework highlights the confidence the regulator has in the entire financial ecosystem in India… [It] will improve regulatory compliance standards across the board; not just in fintechs but in traditional banks as well,” he said. 

As emphasised in RBI’s draft, a chosen SRO that fulfils all the necessary requirements will have to maintain an objective outlook and operate responsibly under the supervision of the regulator as it works on a strategy to ensure phased regulatory compliance within the industry. 

According to Ramadorai, the success of this approach will depend to a certain extent on the incentives given to SRO applicants, as well as how RBI assesses the best candidates for the role. “I view this as an opening gambit rather than the final word,” he said. “I think the story is yet to be told.”

As the market draws closer to peak maturity, stricter regulations might become the natural next step to ensure its sustainability. According to Siddharth Goel, director, Apac non-bank financial institutions at Fitch Ratings, unchallenged growth can easily lead to poor governance practices within fintech firms.

The latest fintech provider to fall prey to the regulators is Paytm Payments Bank, the banking subsidiary of India’s Paytm mobile payments services, which is currently under investigation for its failure to provide appropriate know-your-customer verification on thousands of its accounts. Paytm is a major player in the local fintech scene.

“Putting restrictions on Paytm will be very disruptive for its business, but ultimately, it gives a huge signal that RBI doesn’t want entities to get off the hook and do business as usual, and that they need to follow the rules to remain operational,” said Goel. 

Goel added that this new system will ultimately bring more transparency to the digital lending space, enhance data privacy measures and reinforce policies around credit limits, among other things. “The RBI framework makes financial services providers more accountable while reducing risks of systemic failure, and I think that in the medium to long run, this will help improve the conduct of the sector,” he said.