Opinion
Is the fintech sector in India under a regulatory siege?
Summary
- Evidence of RBI’s enforcement action does not support that view. The regulator’s actions were a result of loose interpretations of rules by fintech platforms and outright violations in some cases. Self-regulation is needed so that we gain from transparency without stifling innovation.
The regulatory developments and the actions of the Reserve Bank of India (RBI) on fintech entities in 2024 received widespread coverage. The unease felt by the sector was expressed in various forums.
Consequently, fintech companies got an audience with the finance minister. RBI initiated monthly meetings to increase engagement. It also issued a licence for a self-regulatory organization for fintech (SRO-FT).
So, is the narrative of the fintech sector facing regulatory headwinds really true?
Also read: Armed with RBI sanction, first fintech self regulator to ramp up enforcement
In 2024, out of nearly 340 cases of enforcement action by RBI, 75% pertained to cooperative banks. Eighteen private banks and seven state-run banks also faced monetary penalties. In comparison, less than 10 fintech entities were penalized.
These numbers do not seem to support the view that the fintech sector is under increased regulatory scrutiny.
Aggregate data often overshadows nuances. So, we analyze a few instances to understand if they qualify as ‘regulatory overreach’.
The aggressive interpretation of regulations on First Loss Default Guarantee (FLDG) resulted in RBI instituting prescriptive guidelines. A fintech firm with an innovative product idea or capability to identify potential borrowers using alternate data would want to tie up with a non-banking financial company (NBFC) or bank to lend.
At the same time, the lender would like to reduce the risk of non-repayment by this new segment of borrowers. By providing an FLDG, the fintech company agrees to bear these losses up to an agreed percentage.
In the absence of any regulatory restriction, such tie-ups were often concluded at high FLDG rates, sometimes even up to 100%.
In effect, the fintech partner was operating like a lender without a licence. The consequent regulatory action of capping the FLDG at 5% was much debated for its impact on innovative lending models.
In the case of Peer-to-Peer (P2P) lending platforms, the regulations were violated. These platforms are licensed to play the role of matchmaker and facilitate lending/borrowing transactions between individuals.
P2P platforms cannot entice lenders by offering a cap on the possible losses due to non-repayment of loans.
The mixing of funds in disbursal and collection streams is not allowed. In practice, a few P2P platforms started behaving like banks by offering assured minimum returns and liquidity options to lenders. This led to enforcement action from RBI and more prescriptive guidelines.
In contrast, inferences from the notification asking Navi FinServe to desist from disbursing fresh loans in October can be called ambiguous. A key reason for the regulatory clamp seems to be high interest rates charged. In response, Navi reduced its interest rates on personal loans, leading to a reversal of its ban in less than 45 days.
Also read: Why do we need regulation for fintech firms?
For customer protection, RBI must guard against ‘interest rate gouging’ by lenders. But the answer to what qualifies as a ‘high’ rate and whether a cap should be prescribed is not clear.
Aggregate data and these instances indicate heightened media interest instead of a regulatory siege. In this context, it is important to appreciate that the financial sector is unlike other industries. The regulator is tasked with developing the sector while ensuring overall stability of the financial system and customer protection.
Encouraging innovation is important for the sector’s evolution. The list of innovations facilitated by RBI and institutions it has been instrumental in founding (NPCI, RBIH) is impressive.
Think of 24X7 fund transfers (IMPS/ NEFT/ RTGS), the Unified Payments Interface, Rupay, Aadhaar-enabled Payment System, Bharat Bill Payment System, Account Aggregator system, United Lending Interface (ULI), etc.
Fintech startups have leveraged these innovations, the assimilation of which in a non-disruptive manner is equally important for the stability of the financial system. Currently, some distance needs to be travelled to bridge the gap between regulatory expectations and industry standards.
A November survey by Grant Thornton opines that a lot more needs to be done in this area. The regulator has been reiterating that governance, risk management and customer grievance redressal are key themes for the sector to focus on. However, fintech lenders do not see these as major risks for their business operations.
These findings seem to support the views expressed by T. Rabi Shankar, deputy governor of RBI, in his speech on ‘Fintech and Regulation’. He discussed “an unexpected regulatory challenge which one might characterise as compliance-aversion.
Financial entities traditionally subject to regulation understand that regulation serves the larger objective of systemic stability and development.
Entities outside the financial space are still learning to adapt to a regulated environment. Consequently, their initial reaction to regulation is objection."
One way to reconcile this supposed regulatory misalignment is through self-regulation. The SRO-FT licence provides an RBI recognized platform to evolve a consensus on contentious issues. It should be used to curb attempts at gaining from regulatory arbitrage.
Transparency can be increased by prominently displaying interest rates and charges on fintech apps and websites.
The SRO-FT could take a lead and publish the interest rates of its members on its website. Collaboration with the regulator to identify and call out rogue fintech players/illegal apps should be strengthened.
Fintech has an important role to play in making financial services in India future-ready and these steps will help it achieve its promise faster.
The author is an economist and researcher.
