Given the rapid pace of innovation, regulators need to adopt such a 'test and learn' approach to stay ahead of the curve
Fintech has massive potential to serve financially underserved populations by providing customization at scale and reducing cost-to-serve, as argued in the first part of this series. Yet fintech offerings remain primarily accessible only to “elite India", i.e. the relatively well-off consumers in tier I and II cities. If fintech has the potential to be a game changer for inclusion, why are we not seeing more innovation for the mass market and the so-called “base of pyramid" (BoP) consumer?
While there are several demand and supply side factors explaining this—the inherent aversion to formal financial services, the lack of financial and digital literacy, challenging business economics—we believe that there are also some regulatory issues. But first, let us acknowledge the exemplary role regulators have played in catalyzing the momentum in the fintech sector, such as paving the way for new service models (differentiated banking licences), taking a more consultative approach to rule-making, supporting public good investments like the unified payments interface (UPI), etc. While this has set the stage, our extensive recent consultations with over 50 Indian fintech institutions suggest that some regulatory barriers still persist.
Consider a firm that wants to launch a micro-insurance product, purchasable using mobile airtime. The firm will collaborate with telecom players for distribution, and with insurance providers for underwriting risk. It believes this product can be a game changer for India, which had near 100% teledensity but less than 15% life-insurance penetration as of 2015. However, the firm will require regulatory clarity, since its product will attract the purview of multiple regulators (the Insurance Regulatory and Development Authority, the Telecom Regulatory Authority of India, and possibly the Reserve Bank of India) but regulators are unable to accurately assess the risks associated with such a new product, and regulatory coordination is limited. As a result, the firm will have to abort the launch due to regulatory ambiguity. Can we create an avenue that avoids such situations by helping regulators understand the risks and benefits associated with a new product, in a rigorous and streamlined way?
A regulatory innovation that could help is that of a “regulatory sandbox". A regulatory sandbox is an entity, hosted or endorsed by the regulators, that enables temporary, limited-scale testing of a new product that may involve some regulatory ambiguity, or temporarily relax a regulatory requirement to enable such a product to launch, to assess the potential benefits and risks posed by such a move to consumers or the market. This provides a solid evidence base for making a regulatory decision. In the micro-insurance case, the regulators could ask the firm to test their product in a sandbox setting for a limited period (say, three months) and on a restricted scale (say, 10,000 consumers), while laying out metrics for evaluation. This would generate the evidence required to help regulators decide on benefits (say, the potential to increase insurance coverage) vis-à-vis risks (say, misselling), and how best to regulate it.
The sandbox approach marks a shift to a more forward-oriented yet evidence-driven regulatory framework. Given the rapid pace of innovation, regulators need to adopt such a “test and learn" approach to stay ahead of the curve, and make rapid data-driven decisions.
To help develop the blueprint of an Indian regulatory sandbox, we recently consulted with fintech institutions and with regulators in five different countries, many of whom have set up their own sandboxes. Although the former are excited about this approach, its success will be contingent on seamless and efficient execution. We believe that the Indian sandbox should have five key features.
First, much as consumers (and increasingly, fintech start-ups) do not view financial products in regulatory silos, the sandbox should be designed to adopt this unified consumer-centric lens by being a single integrated sandbox serving all four financial sector regulators. Second, it should strike the balance of being autonomous, yet be embedded in the regulators. This will help in hiring market professionals for technical roles and foster a culture of innovation, while remaining within the regulatory purview to effectively inform regulatory decision making.
Third, the role of the sandbox should only be to assist the regulator by providing evidence for decision making, not replace it. The sandbox should not have any direct powers to relax, amend or draft new regulations. Fourth, the sandbox should have robust systems to identify, quantify and monitor risks emerging from the new product during the testing. Finally, the engagement process for industry should be business-friendly. For this, the sandbox should offer a single point of contact, have a charter promising timebound action, and rely on objective metrics-driven assessment.
We believe a sandbox approach can be a powerful tool in the Indian regulator’s arsenal. It’s an idea whose time has come; in the last two years, regulators globally have announced at least eight sandboxes, testament to the changing role of financial regulators from “restrictors" to “enablers" of innovation. A regulatory sandbox, rooted in India’s realities, and custom-made for India, can become the flag-bearer of the nation’s next-generation financial inclusion imperatives.
Varad Pande, Nehal Garg and Vineet Bhandari work at Dalberg, a strategic advisory firm.