RBI's new fintech department has its work cut out
PremiumThe department must help RBI look beyond classic banking to a rapidly emerging global financial order
The Reserve Bank of India (RBI) created a new department to supervise and regulate fintech last week. It had previously hived off a division from within its Department of Payment Settlement Systems for this purpose. The creation of a dedicated department—the highest organizational unit within RBI for workflow allocation—is much needed in the light of rapid developments in fintech in recent years. Aside from the growth of pure-play fintech, this ecosystem has seen the entry of ‘Big Tech’ like Alibaba, as well as decentralized products and services based on blockchain technology. As the central bank should anticipate a vigorous contest for this emerging financial-services market, its new Fintech Department has its work cut out.
Through the department, RBI plans to “not only promote innovation in the sector, but also identify the challenges and opportunities associated with it". But an honest appraisal of innovative technologies and services would require the regulator to upend legacy thinking around the centrality of traditional banking. To wit, RBI has kept a relatively tight lid so far on banking-sector liberalization, despite our need to improve the provision of credit to spur investment. Nor has it nudged banks to think of digitization as value additive instead of as a cost centre. This is evident in the way banks act with impunity, refusing to upgrade digital payment infrastructure to meet RBI norms on things like e-mandates for subscription payments. The Fintech Department will need to shift this paradigm in three distinct ways.
First, the department must take a cue from climate-change discussions and adopt a ‘common but differentiated responsibilities’ ethos to regulate fintech. That is, rather than disallow new forms of financial intermediation for want of banking licences, RBI should apply differential rules in most cases where core policy objectives such as financial stability are secure. It already does so through entity-specific permissions, such as the on-tap authorization given to fintech companies to run payment systems. Conversely, banks want the regulator to ensure a ‘level playing field’ whenever fintech businesses stray into their territory. This is nothing but thinly veiled protectionism that seeks a kind of licence-raj, which should not find favour in any modern regulatory set-up.
Moreover, the Fintech Department can leverage ‘supervisory technologies’ to meet policy goals like consumer protection in fintech markets, while maintaining a light-touch regulatory approach. For instance, the Financial Conduct Authority (FCA) of the UK is experimenting with the use of ‘supervised learning’ techniques to predict the probability of mis-selling of financial products. The FCA uses complex machine learning models that enable it to visualize hotspots of risk. Similarly, today financial regulators are increasingly employing data analytics to identify risks linked to activities such as money laundering or terror financing. To its credit, RBI has tentatively embraced supervisory technologies, but needs to build real capacity, which can be done through this new department.
Second, the department should recognize the interconnected nature of digital markets, and widen RBI’s consultation perimeter beyond regulated entities like banks. Consider the progressive regulatory mandate for such entities to adopt card-on-file tokenization by December 2021: RBI had to extend its deadline to June 2022 at the last minute because most regulated entities were far from ready, despite claiming otherwise. Tokenization technology allows e-commerce providers or ‘merchants’ to process payments via payment services and banks, without storing debit or credit card data. Since merchants have service agreements with fintech firms, they are well placed to share market information with RBI to enable evidence-based decisions. Also, merchants have an incentive to build last-mile readiness, since they have a direct interface with consumers, unlike banks. Consumer awareness and digital financial literacy can be greatly magnified by leveraging this interconnected stakeholder.
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Third, the Fintech Department must grapple with new concepts of digital money, and must thus aim to define the contours of our future digital financial ecosystem. This will include decisions on the type of central bank digital currency (CBDC) to pilot, and on the inevitable need to supervise a decentralized crypto economy. RBI seems convinced of the utility of CBDCs to reduce cash in circulation and save on paper currency costs. It is likely to find it easier to experiment initially with ‘wholesale CBDCs’, which allow for instant settlements between financial institutions like banks, rather than with wider-application ‘retail CBDCs’. The regulator, however, appears less convinced about use cases for the crypto-economy.
Whether or not RBI sees innate value in the crypto economy, it is clear that people around the world do. Global crypto assets are valued at over $2 trillion now, and an estimated 15 million Indians have invested in them. Dozens of countries are developing their regulatory toolkits as a response, and those like the US and Singapore have provided certainty to traders by regulating crypto exchanges as a first step. The Fintech Department would do well to deepen international coordination with regulators and agencies, such as the Financial Action Task Force, to understand the implications of a world awash with crypto. The department must help RBI look beyond banking to a new and emerging global financial order.
Vivan Sharan is partner, Koan Advisory, New Delhi. These are the author’s personal views.
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