Opinion

The latest norms, however, disrupt the fintech ecosystem

With a neobank being the 100th entrant to India’s unicorn club, it poses further creative disruption in the Indian fintech ecosystem. However, the introduction of Digital Banking Units (DBUs) in the 2022 Budget and the RBI guidelines regarding the same have created an upheaval in the market.

The DBU rules allow only scheduled commercial banks with past digital banking experience to expand into digital units as separate banking outlets. It could also be perceived as a precursor to digital bank licences. Thus, fintechs with no physical branches and banking licences, such as neobanks, are outrightly precluded.

Neobanks are digital banking facilitators serving their customers via online platforms rather than conventional physical branches. Such fintech companies do not have their own banking licences, relying on their banking partners via corporate collaborations to provide licensed core banking services and over-the-top financial services.

The poster boy of neobanks is ‘Nubank’ that initially offered credit cards in Brazil. It did not have a banking licence until 2017, much like the present Indian players. Once it acquired the licence, it became a full-stack digital bank offering a plethora of services. It is established that neobanks are a viable business model providing core banking services rather than collaborating with regulated entities.

Two key models

These digital banking facilitators are preferred largely for seamless on-boarding, intuitive and user-friendly platforms, one-tap availability, and transparency. They offer a convergence of financial and non-financial services into a blended ecosystem.

Neobanks in India presently work on two prominent models — payment gateways, and payment banks. They also serve non-retail customers like MSMEs with white-label solutions. It entails mobile-first financial services such as money transfers, lending, invoicing software, cash management, payment processing, etc.

In light of this, it is pertinent to understand the policy landscape that governs these entities. Neobanks provide products that come under the regulatory framework of the three financial regulators — the Reserve Bank of India, the Securities & Exchange Board of India, and the Insurance and Regulatory Development Authority of India. One may note that while there is no specific restriction on operations of neobanks, they are not directly subjected to compliances under RBI’s licensing regime.

NITI Aayog’s 2021 proposal to set up full-stack digital banks lays down the roadmap for a licensing and regulatory mechanism for neobanks, so direly needed. Initially, the RBI too conceptualised in its Report by Working Group on Digital Lending to enlist such neobanks in a regulatory sandbox.

The RBI regulates the banking services, credit facilities, loans, domestic money transfers, utility bill payments, and prepaid card services provided by neobanks. SEBI governs the investment advisory products offered by neobanks. Similarly, IRDAI regulates the corporate agents, insurance web aggregator, and insurance policy services offered by neobanks.

The partnership with regulated entities model is broadly governed by three RBI regulations: RBI Outsourcing Regulations (2021), Business Correspondent (BCs) Guidelines (2014), and Master Direction on Digital Payment Security Controls (2021). The applicability of the guidelines is based on the nature of services offered by the neobanks.

However, the BCs’ standards are relatively outdated and do not take into account the changes in relationships between financial institutions and their BCs. The notion of a BC has evolved from one of a physical entity delivering financial products to one of a digital entity. In addition, the range of products offered has exceeded the ambit covered under the extant regime.

The increasing traction of neobanks and their interaction with financial entities warrant that the extant regime be revisited. The Indian framework needs to fulfil the needs of regulated entities to perform services like settlements and fund management while fintech and neobanking partners handle the technological interface and user experience.

The UK had a headstart in neobanking owing to the early introduction of uniform banking guidelines across Europe. The US offers separate fintech licences. It is regulatorily permissible in Canada. Many Asian economies like Singapore, China, Malaysia, Hong Kong, etc., have also adopted digital banking licensing regimes and internet-only bank guidelines.

The present situation of legal ambiguity and room for speculation decrease the confidence of retail consumers who account for a major chunk of the Indian market. It also deprives the country of tapping into vast opportunities tech-backed neobanks may have to offer. The 2022 DBU guidelines seem to have furthered the uncertainty, leaving neobanking and fintech as a grey area. It is imperative that the law acts as an enabler and not a disruptor.

The writer is a lawyer and columnist

Published on June 09, 2022