COMMENTARY ON THE RBI’S REGULATORY SANDBOX FOR FINTECH
This post is authored by Chinmayanand Chivukula, a fifth-year student of B.A. LL.B.(Hons.) at the Symbiosis Law School, Pune.
Increased interest in FinTech[i], which is reflected in the growing consumer adoption and funding, has caught the attention of sectoral regulators around the world. However, they are challenged with the task of creating an appropriate regulatory environment for FinTech for two reasons: firstly, FinTech’s rapidly evolving nature makes it difficult to address the issues of cybersecurity and data protection; secondly, without an appropriate regulatory environment, the goal of financial inclusion, for which Fintech is touted in India, may be hampered.
So, jurisdictions around the world have responded with regulatory tools, such as Regulatory Sandboxes (“RS”), Innovation Hubs, and “Test and Learn” approaches, which help financial regulators identify risks to both the financial system design and customers from innovations in finance. In 2019, the Reserve Bank of India (“RBI”) proposed the creation of an RS mechanism in India by releasing the Enabling Framework for Regulatory Sandbox (“the framework”).
2. REGULATORY SANDBOX FOR FINTECH IN INDIA
According to the RBI, RS “refers to the live testing of new products or services in a controlled/test regulatory environment for which regulators may (or may not) permit certain regulatory relaxations for the limited purpose of the testing”. Clear preliminary benefits such as streamlining the authorisation process of new FinTech products, addressing regulatory uncertainties, identifying risks, and ensuring the safety of customers, have been observed.
In an RS process, eligible entities[ii] are allowed to interact with real customers to conduct field tests to collect data on the benefits and risks of FinTech products. During this process, considerations such as the absence of appropriate regulations for innovation, effective delivery of financial services are also taken into account.
The process broadly involves four stages, Application (by entities to be part of the RS), Selection (of the entities that meet all the eligibility criteria), Testing and Evaluation (of the proposed innovation with real customers), and Exit (of the entity from the RS). Here, the innovation may be granted permission, based on the test results and risks assessed, to be deployed to the public at large. Alternatively, it may be rejected for not achieving intended purposes or for violating the terms under which it has been accepted into the RS or even at the discretion of the entity by prior notice of one month.
While the United States had set up the first sandbox-like framework, the U.K. coined the term 'regulatory sandbox' where it is run by the Financial Conduct Authority (“FCA”), an independent financial regulatory body and is operated in the form of group or cohort system similar to the RBI’s proposal. The first thematic cohort was announced in November 2019 on ‘Retail Payments’ with no tests conducted yet due to COVID-19.
3. ANALYSIS OF RBI’S REGULATORY SANDBOX
The official objectives of the RS according to the framework are threefold, fostering responsible innovation in financial services, promoting efficiency, and bringing benefit to consumers. The framework also provides a design for the RS. However, there are certain issues in the framework that make it difficult, to achieve these objectives and, to create an effective RS mechanism.
3.1.Rigid requirements prescribed in the framework
Usually, criteria for entry are common and necessary. However, the framework proposes certain restrictive and rigid criteria for entry into the cohort of the RS; moreover, it is not flexible enough to account for uncertainties.
3.1.1. Restrictive and rigid criteria for entry
The entities must have a minimum net worth of Rs. 25 Lakhs. Although this may be a micro-prudential regulatory measure for risk control especially since the RS process is expensive, such rationale has not been notified. So, this requirement may be challenged under Article 14 of the Constitution of India especially since smaller entities which otherwise meet all criteria and propose sound innovations are adversely affected by it. Applying the regulatory principle of proportionate approach - taking into account risks associated - is necessary to avoid excessive regulatory burden on smaller entities and to promote competition.
Moreover, having to clearly lay down all test scenarios and expected outcomes, concrete exit and transition strategy is too rigid, are not entity friendly, and may even be counterproductive to innovation and inclusion. Most other jurisdictions do not have such requirements. The FCA, in addition to not having such requirements, plays an active role in assisting the entities in creating an appropriate transition strategy considering its regulatory expertise.
Excluded technologies from the RS such as credit registry and credit information are concerning especially with an increased interest in the use of alternative data for credit information. Moreover, such exclusions prevent the RBI from identifying and mitigating risks involved with new technologies in FinTech.