Fintech regulation: India seeks to balance innovation with risk management

Fintech regulation
After RBI nudge, fintech industry looks to establish self-regulatory organisations to formulate rules and standards.

Fintech regulation in India: With rapidly evolving technology and the ever-changing regulatory landscape, digital payment players are seeking to establish a self-regulatory organisation (SRO) that can develop uniform rules and standards of operation for the fintech industry. This is a welcome move, but it is just the beginning of the arduous journey of fintech regulation.

While RBI Governor Shaktikanta Das had earlier proposed the creation of an SRO, the corporations have not made significant progress in forming a partnership. RBI wants all regulated payment companies to come together and form a single SRO instead of allowing other companies, such as the Payments Council of India (PCI), which also includes a number of unregulated firms, to become the head.

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RBI believes that an SRO can be tasked with setting ground rules and enforcing them. The organization can also help with developing surveillance methods for effective monitoring of the space. The only criteria that RBI suggests for setting up an SRO is that no organisation which operates for profit can participate and only regulated entities can become SRO members.

Need for fintech regulation

In recent years, financial technology, or fintech, has emerged as a disruptive force in the financial industry, with technology like UPI seeping into day-to-day transactions with ease. The rise of fintech platforms has followed. However, as fintech becomes more mainstream and complex, there are concerns about its potential risks to consumers, markets, and stability. This has led to calls for regulating the fintech space to ensure that innovation is balanced with risk management.

In India, the fintech industry is presently diverse with various UPI apps, mobile wallet businesses, ATM service providers, clearance corporations, business correspondents, and others, which poses a major challenge to the formation of a self-regulatory body. These diverse players rarely exchange conversations, making it difficult to bring them all under a single umbrella. Various organisations, including PCI, Confederation of ATM Industry, and the Business Correspondents Federation of India, are currently in the race to become SRO.

The need for fintech regulation arises because, while fintech has democratised finance by reaching underserved and unbanked populations, especially in emerging markets, it also poses risks to consumers, such as data breaches, fraud, cyberattacks, and unfair practices. Analysts and industry watchers are also concerned that fintech firms often collect sensitive personal and financial data from consumers, who can be vulnerable to unauthorised access, misuse, or theft.

At times, fintech firms have also been found using algorithms and automated decision-making processes that lack transparency, accountability, and human oversight. There are also chances that these companies may be operating in regulatory grey areas or evade regulatory requirements, which can create arbitrage and regulatory gaps. Since fintech is largely based on technology, it is also vulnerable to technological failures, cyber incidents, or financial shocks, which can propagate across the financial system and affect its stability. Therefore, there is an ever-growing need to regulate the space.

To address these risks, regulators around the world are exploring ways to better manage the fintech space. Fintech is an industry that is constantly changing, with new products and services being introduced all the time. This makes it difficult for regulators to keep up with the latest developments and ensure that they are appropriately regulated. A flexible and proportionate regulatory approach that balances innovation with risk management is the need of the hour. Regulation of the space also requires a collaborative and coordinated effort among regulators, industry players, and stakeholders to ensure that objectives are met without stifling innovation or competition.

One approach to regulating the fintech space is to adopt a regulatory sandbox. RBI had established a regulatory sandbox in 2018 with the primary objective of being a controlled regulatory environment for testing fintech products. This controlled environment allows fintech firms to test their products and services under regulatory supervision and experiment with new ideas and technologies without facing regulatory barriers or compliance costs. Regulators can also monitor and evaluate the risks and benefits of fintech innovations and adjust their regulatory requirements accordingly.

Fintech firms are transforming the financial industry with their innovative products and services. However, these firms also pose risks to consumers, markets, and stability. Therefore, regulators around the world are exploring ways to better manage the fintech space. In India, the fintech industry is rapidly growing, and the government estimates that it will reach $150 billion by 2025. To ensure that innovation is balanced with risk management, regulators need to adopt flexible and proportionate regulatory approaches.

Another approach is to enhance regulatory cooperation and coordination. Fintech firms often operate across multiple jurisdictions and face inconsistent or conflicting regulatory requirements. Regulators can enhance cooperation by sharing information, best practices, and standards on fintech regulation. They can also establish cross-border frameworks or agreements that enable fintech firms to operate in multiple jurisdictions while complying with consistent and harmonized regulatory requirements.

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Regulators must also set standards and requirements for fintech firms’ conduct to ensure consumer protection and market integrity. These standards and requirements should include data protection, transparency, and fairness. Regulators can enforce these standards through inspections, investigations, and sanctions. Fintech firms should also adopt self-regulatory measures, such as codes of conduct, certification schemes, or dispute resolution mechanisms.

However, regulating fintech space can create challenges because traditional financial institutions may view it as a threat to their business models. Regulators must balance the interests of both traditional and fintech players.

The Indian fintech industry is thriving, and regulators need to ensure that it remains innovative, competitive, and safe. Adopting flexible and proportionate regulatory approaches, establishing regulatory sandboxes, enhancing regulatory cooperation, and setting standards and requirements for fintech firms’ conduct can help achieve these goals.