Can Regulatory Sandbox Nurture India's FinTech Innovation?

by Sohini Bagchi    Jul 31, 2017


The Indian financial services sector is undergoing major changes today. With more than 600 startups in the space of lending, payments, insurance and trading space, Fintech startups are not only spearheading innovation, but are also prompting traditional banks and financial institutions to explore new technologies and investing heavily in digital service delivery channels.

However, fintech startups unlike others face additional challenges of operating in a heavily regulated industry and have stiff competition as their key competitors are well established banking players. To overcome this challenge, experts believe, adopting a “Regulatory Sandbox” based approach where the regulator works closely with emerging Fintech firms make better sense.

Why adopt “Regulatory Sandbox”

According to them, regulatory sandboxes provide safe spaces for experimenting. In brief they constitute a program adopted by regulators which provide a new set of rules for those people looking to test their new products and business models in a live environment. They combine release from specific regulatory frameworks with strict regulatory supervision over a time limited period. They can help to minimize legal uncertainties for innovators, and help to improve access to investment.

What makes the sandbox model particularly interesting is that it is a more bespoke approach to dealing with innovation, and a more nimble approach to the needs of innovators, the role of regulation and the needs of consumers. As experts believe, it can be a great way to unlock innovations for mass public adoption, because a regulatory sandbox balances the twin objectives of nurturing financial innovation and safeguarding consumer interest.

“With more than $17 billion funding and over 1,400 deals in 2016, FinTech is one of the most promising sectors globally. With nearly $270 million funding in 2016, India is ranked amongst the top ten FinTech markets globally,” said a CII-Deloitte report. [Read the full report here]

Fintech firms have developed numerous technology solutions spanning across retail payments, lending, cryptocurrencies, financial products marketplace, credit scoring, etc. Specifically, there has been a huge upsurge in retail payments space driven by demonetization and increasing adoption of solutions offered by Fintech firms as well as NPCI (UPI, BHIIM, Aadhaar Pay, USSD, etc.). Similarly, P2P lending has seen significant growth with over 30+ firms operating in this space.

Although India, powered by Jan Dhan, Aadhaar and Mobile players, can support incumbent banks and financial service providers, but its true power is harnessed by FinTech companies in significantly reducing costs of acquisition and servicing. Aadhaar, which now extends to 1.1 billion people in India can be levied for effective biometric authentication of financial transactions. At the same time over 1 billion mobile subscribers and we would have about 500 million Internet users.

“The key challenge in the fintech sector is that often existing regulations are not able to keep pace with rapid technological developments. The purpose of this report is to take a brief look at the merits and gaps in existing regulations and provide suggestions for the way forward in ‘Making India a Global Fintech Hub,” said Chandrajit Banerjee Director General, Confederation of Indian Industry

Developing an ecosystem

Given the vast network of mobile phones and limited business viability of branch banking model across many areas of the country, it is essential to develop an ecosystem that facilitates growth of mobile banking and Fintech solutions.

“It is very important that we allow technology to move forward and the regulators don’t become restrictors, which very often they do, but become facilitators and creators,” Niti Aayog CEO Amitabh Kant said at a CII event on making India a global fintech hub, stressing that the role of India’s regulators needed to evolve as they often became restrictors of growth.

“The sandbox needs to be designed to adopt this unified consumer-centric lens through a single integrated sandbox, serving all four financial sector regulators… technology will always be ahead of regulation,” said Kant, referring to the Reserve Bank of India (RBI), the Securities Exchange Board of India (SEBI), the Insurance Regulatory and Development Authority of India (IRDAI) and the Pension Fund Regulatory and Development Authority (PFRDA).

Out of 600 startups, more than 30 of those start-ups are focused on the peer-to-peer lending space alone and their market potential is expected to reach $5 billion by 2020. Several start-ups are working in areas such as virtual currencies like Bitcoins, Blockchain-based settlements and so on. The total fintech market in India is estimated to be worth $8 billion and is expected to grow to about $14 billion by 2020.

 “As in many other fields, technology often runs ahead of the law, and new applications are constrained by regulations. Of course, in a sensitive and vital involving finance and money, caution is well advised. Therefore, ideas like a regulatory sandbox could be invaluable in testing new concepts in Fintech and digitization” said Kiran Karnik Chairman,CII National Committee on Telecom & Broadband.

Globally, regulatory sandboxes have been introduced in the U.K., Singapore, Australia, Malaysia and UAE. Each country has a certain “target group” for which sandboxing is done. All these countries have so far created a sandboxed environment to support financial institutions (FIs) and fintech firms, the report noted.

In India, for instance, since cryptocurrencies are not recognized officially, virtual currencies stored in e-wallets are exposed to hacking and users are exposed to a lack of recourse in case of any problems or disputes. The RBI has been cautioning users about the risks of dabbling in virtual currencies that it does not recognise over the past years.

“The sandbox approach is one encouraging signal that this message is beginning to take hold. Regulatory innovation can be difficult, it is about getting the balance right between ensuring consumer protections whilst making sure that it’s possible to try new things. The trial approach being adopted will offer useful insight, not only into how to regulate innovation but also into how we can experiment with new approaches, even in potentially high-risk environments,” said Banerjee.

He believes a robust regulatory framework, effective customer redressal framework, enhanced  security measures to enable confidence and trust, incentives for larger participation and benefits similar to cash transactions are some measures that can further help ensure long-term success for digital payments