Leapfrogging India’s fintech evolution with a regulatory sandbox
In this age of the Fourth Industrial Revolution, by accident or design, India is excelling at being a fast follower. Whether it is ecommerce, ride-hailing, online grocery, payments or fintech, we may have come late to the party, but sector after sector we are consistently leapfrogging peers in other countries.
Given India’s relatively low financial access, the great inclusion opportunity, and the scope to expand consumer debt-to-GDP ratios, fintech represents the next big opportunity. We have made the argument before that, unlike in most western countries, where the appeal of fintech is in disrupting the status quo among established players – in what amounts to, de facto, a zero-sum game – in India, the fintech thesis is one of market expansion and increasing the size of the pie. And, in this context, the role of a regulator becomes mission-critical. The regulator has to strike the fine balance between consumer protection and organised market development. In this context, the Reserve Bank of India (RBI’s) recently released draft guidelines for a regulatory sandbox hold a lot of potential.
Digital payments represent a significant leap for a country that, till a few years back, had but a handful of participants. The demonetisation was a shot in the arm to digital payments, which tripled to seven percent of GDP in just three years. Revolutionary technologies like machine learning, robotics, and the IoT (Internet of Things) are expected to transform the way people interact, shop and pay. As a fast follower, we should learn from others’ mistakes to make a better mousetrap. In fintech, there are a few interesting examples from around the world that could help catapult India’s fintech ecosystem to pole position.
The UK and 15 other countries have taken the initiative to set up regulatory sandboxes in the past few years, allowing different players in the financial ecosystem to test new solutions. Many incremental, as well as radical innovations, have been tested here thoroughly before a full-scale rollout. India can take a leaf or two out of their books, without having to undergo the same learning curve.
Around the world in regulatory sandboxes
The UK FCA (Financial Conduct Authority) allows traditional and new players, as well as technology businesses, to use the regulatory sandbox and its capabilities. In India, ‘fintech’ companies could either be startups or well-heeled organisations that have even shaped the industry. Recognising this and encouraging collaboration between the two could help launch robust products with better consumer acceptance.
The Hong Kong Monetary Authority (HKMA) too lets banks and their technology partners conduct pilot trials with its sandbox. In India, a significant number of banks and startups are developing new financial initiatives and trying to solve for the country’s complex financial needs. Such an approach will provide a level playing field to both. Other markets like Australia, Malaysia, and Singapore, where regulatory sandboxes have emerged, also encourage multiple players to participate.
Innovation in any field requires a flexible regulatory framework. Players and their products operate within existing regulations and their limitations. To address such hurdles, the Australian Securities and Investment Commission (ASIC) specifies exemptions for participants. Eligible fintech companies can test certain products or services in the sandbox for up to 12 months without an Australian financial services (AFS) licence or credit licence. Participants can also use existing legal or fintech licensing exemptions in that duration. This provides leeway for new solutions that may not have seen the light of day within existing regulations. Emerging players in the UAE too can apply to the authorities for specific exemptions while operating through the sandbox, provided appropriate consumer protection measures are in place.
While the digital payments regulations in India are indeed progressive, it will augur well to provide a degree of flexibility without fear of legal sanction. It may also shorten the time to market and help India vault ahead in digital evolution.
The Monetary Authority of Singapore (MAS) provides guidelines for fintech innovation with the caveat that once the experiment is successful and the entity exits the sandbox, it must comply with the relevant legal and regulatory requirements. A regulatory sandbox is meant to provide new solutions with a wider perimeter for testing, within a controlled environment and with limited consumers. Adhering to all existing regulations may be counterproductive as some innovations could necessitate regulatory amendments in the future. A smarter way to ensure risk mitigation is to check for the intent to deploy to a broader market and an appropriate exit strategy.
The UK FCA appoints a dedicated case officer who acts as counsel for sandbox participants. The officer guides how the innovation fits into the sandbox and advises on safeguards to be built into the product. In India too, having a dedicated guide, either from the regulator or an industry expert, could help new players and innovators understand and navigate legalities. In addition, the player could have a mandatory, documented exit strategy that can be put in motion if the product faces failure. This practice is followed in Bahrain, Singapore, and Eswatini (erstwhile Swaziland).
One of the objectives of a regulatory sandbox is to allow the testing of a wide range of products and services, some of which may not fall within the current regulatory ambit. Many countries today like Singapore and the UK have sandboxes and the frameworks do not explicitly debar any technology from using the sandbox. They encourage its use for new solutions as long as participants conduct due diligence and adhere to the law.
What lies ahead
In India, 40 percent of MSME lending happens through informal money markets. Specifying products like credit information, credit registry, etc. in a negative list, though indicative, may hinder the growth of credit solutions further, in an already underpenetrated credit market. The sandbox could give rise to novelties that solve niche problems but at a slight premium. Mandating low-cost products would deter the development of solutions that are not targeted at the masses. The majority of sandboxes world over provide maneuvering room for such innovation instead of categorically disallowing product types.
An ideal regulatory sandbox framework would be an enabler for the industry. Homegrown fintechs could have instant access to global proprietary technology and platforms of larger participants such as banks and payment networks; tweak their products, test it for scale within the confines of the sandbox and have a ‘ready for market’ product within a short span of time, significantly cutting down their learning curve.
Let’s look at fintechs that specialise in transaction authentication solutions for mobile devices, making second-factor authentication smoother and friction-free. Commerce in India is increasingly going mobile, and with around 200 million smartphone users, cybersecurity is a permanent focus area. Authentication through SMS OTPs have their own challenges but need to become more convenient. What if a fintech solution allowed devices to generate their own OTPs and authenticate transactions, reducing the risk of MITM and other attacks? Using the sandbox, the fintech could test this solution with limited risk, a simulated environment, and select consumer segments. This could help the fintech enhance the proposition, incorporate feedback, scale the solution, and build in necessary controls, moving to effective risk-based authentication.
The RBI’s proposal for setting up a regulatory sandbox is a welcome approach and would catapult India to the forefront of payment innovation alongside countries like Singapore, Australia, and the UK. Allowing players to participate in a regulatory sandbox can introduce avant-garde digital payment products ably steered by the regulator. It will also build trust in traditional and non-traditional players for open collaboration. The regulatory sandbox can indeed be a highly effective tool that demonstrates to the payments ecosystem that novelty in digital payments is required, encouraged, and fostered.
(Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the views of YourStory.)