Regulating India’s FinTech

[The
following guest post is contributed by Vaibhav
Parikh
, who is a business lawyer associated with the Aditya Birla Group]
“Disruption” is often used as a generic term to
describe situations where smaller and newer companies with fewer resources are
able to successfully challenge established incumbent businesses and upset
status quo. Although a case has been made that it brings visibility to an
enterprise, disruption is far more nuanced, and can result from a variety of
factors ranging from technological innovation and disintermediation to
regulatory arbitrage.
The distinction is, however, more than just
academic, as knowing the nature of disruption can help assess its regulatory
viability, sustainability and the ability of the underlying enterprise to
retain value.
The
Wave of FinTech Disruption
India’s resilient economy, along with a swelling
middle class and recent governmental policies, has certainly increased the
demand for financial services in the country. Traditional banks that were once
sheltered by regulations are now sailing in unchartered waters. And it is the
lack of innovation on their part that has resulted in the usage of FinTech as a
tool, which is growing leaps and bounds. It is creating significant
opportunities for innovators to take a leap of faith in the existing market.
Also, India’s FinTech firms are focusing more on
untapped customer segments and are certainly fulfilling the needs of the
customers. Businesses with unfavorable financing requirements from traditional
banks have turned to unconventional lenders for funding. This under-developed
consumer banking system has paved the way for FinTech firms to approach the
unbanked population who are seeking better offerings elsewhere.
Further, the developing technology
infrastructure in the country has also given FinTech firms an impetus to
flourish. Ubiquitous connectivity in major cities and unprecedented changes in
the government policies have translated to mature digital penetration in
payment methods. With payment cards to digital wallets, FinTech firms have led
the way in retail disruption.
Lastly, the readiness on the part of the
bankable population in adopting these products has offered disruptors an
opportunity to gain scale. India’s FinTech scenario is therefore at an
inflection point in reshaping the financial landscape.
Why is
there A Need for Regulating the Wave?
An emerging set of disruptors is seeking to
operate in sectors not usually amenable to disruption by reason of their being
heavily and actively regulated. Such regulation is often justifiable in the
light of the systemic importance of these sectors, and the risks associated
with them. This is proving to be a prominent disruption where FinTech firms are
seeking to facilitate direct small and medium ticket loans to individuals and small-and-medium
enterprises through third party lenders. They also seek to facilitate
disbursements, repayments and contracting in consideration for service fees.
Their objective is to render payment services
more efficiently and to drive loans which are not addressed by existing means.
This would require participation by non-traditional lenders, simplified
enrollments and lending procedures and unconventional lending and repayment
mechanisms and terms. These FinTech platforms may be subject to limitations on
interest rates chargeable, prudential and capital adequacy norms for
participation in risk, reporting requirements, regulations governing KYC
requirements and restrictions surrounding potential enforceability of
electronic documentation for recovery. Again, proactive compliance and
regulatory engagement will bring distinct advantages.
Also, investors investing into potentially
disruptive businesses need to be mindful of the nature of the disruption, its
long term sustainability, and how prepared their potential investee is for
regulatory interventions. An analysis of trends from legal issues affecting
investments into various sorts of disruptive businesses indicates that it is in
the interest of the investors to future-proof business models and operations
against emerging regulatory changes and trends.
One way this could be achieved is through
conducting thorough due diligence (financial, legal and technical) on potential
investees with special emphasis on the regulations governing their more
entrenched competitors and investee compliance with such regulations. Investors
must also analyze investee business operations and put in place suitable
processes and documentation to comply not only with best practices but also at
the very least with the spirit of applicable rules and regulations. Further,
analyzing, estimating and classifying risks, and structuring businesses in such
manner as to compartmentalize riskier, more regulated portions thereof from the
remainder of the their operations will also go a long way in ensuring that the
investment into a disruptive business is in the investors’ best interests.
Disruptive operations in highly regulated
sectors like financial services are subject to very substantial and proximate
regulatory risks. Last year, the Reserve Bank of India (RBI) set up
an inter-regulatory Working Group
to study the entire gamut of regulatory
issues relating to FinTech and Digital Banking in India. One of the terms of
reference of the working group is to chalk out appropriate regulatory response
with a view to re-align/ re-orient regulatory guidelines and statutory provisions
for enhancing FinTech associated opportunities while simultaneously managing
the evolving challenges and risk dimensions.
The focus on this nature of investment has moved
from risk mitigation to risk classification, with the intent being to mitigate
the most serious risks as much as possible. Given the recommendations
of Ratan Watal Panel
mooting an independent payment regulator, expect
disruptive behavior in the regulations for FinTech regulations in the form of
sandbox regulations. Some level of regulatory crystal ball gazing is also
called for by investors into these sectors.
Therefore, given the current strengths in terms
of government policies, talent resource pool and the current contribution of
the FinTech to the Indian economy, there is an opportunity to create
best-in-class standards, practices, resources, regulation and technology in
order to play a leading role in global as well as Indian development of
FinTech.
– Vaibhav Parikh

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

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