Decoding India’s Regulatory Sandbox Program for Innovations in Financial Technology

[Anirban Roy Choudhury is a banking and finance lawyer, currently pursuing Master of Laws in Finance at the Institute for Law and Finance, Goethe University Frankfurt]

Regulatory sandboxes are designed to provide a controlled environment for testing innovative financial or other products and services on a real-time basis, subject to certain regulatory safeguards and supervision. Its primary objective is to promote innovations by providing a controlled environment with reduced regulatory barriers and costs, while ensuring that risks associated with the innovation are not transferred to the customers.

The Inter-Regulatory Working Group on FinTech and Digital Banking in India (Working Group) set up by the Reserve Bank of India (RBI) in 2016, in its report dated 8 February 2018, first recommended the introduction of regulatory sandbox in India in order to foster innovations in the highly regulated financial sector. In line with the recommendations of the Working Group, the RBI issued the ‘Enabling Framework for Regulatory Sandbox’ (Framework) on 13 August 2019 after a consultation procedure that began earlier this year. 

Key Elements of the Regulatory Sandbox Program

Scope

The Framework aims to promote financial innovations in areas where either governing regulations are missing, or temporary relaxation of regulations is imperative for facilitating the proposed innovation, or where the proposed innovation aims to significantly ease the delivery of financial services. Further, to be eligible to take advantage of the regulatory sandbox program, the proposed financial innovation must be novel and different from products and services already being offered in the Indian market, unless it can be demonstrated that a different technology is used or the existing technology is used more efficiently for the offering.        

The regulatory sandbox program can be used for pilot-testing financial innovations in areas like retail payments and lending, digital know your customer, financial inclusion products, financial advisory and wealth management services, cybersecurity, etc.; and innovative technologies including data analytics, artificial intelligence and machine learning, blockchain technologies, application program interface services can be used to deliver these products and services. The program initially aims to run thematic cohorts focussing on different areas with limited number of participants in each cohort testing their financial innovation within a stipulated time period.  

The Framework has, however, kept various ‘new-age’ products/ services including crypto-currencies, crypto-assets, credit registry and credit information, chain marketing and any other product or service otherwise banned by the government outside the ambits of the regulatory sandbox program.

Eligibility Criteria

The Framework stipulates stringent eligibility criteria for participation in the regulatory sandbox program. Only companies incorporated in India, banks licensed to operate in India, and financial institutions constituted under a statute in India, having a minimum net worth of INR 2.5 million, are eligible to apply for participating in the regulatory sandbox program. It also mandates the entity and its promoters/ directors to be ‘fit and proper’ and requires strict scrutiny of their bank accounts including loan accounts, credit score, and credit history. 

Further, as the regulatory sandbox is a platform for pilot testing financial innovations, the proposed offering should be technologically ready for testing in a live environment and the applicant should have robust IT infrastructure to handle the operations, including means to ensure compliance with cybersecurity, data protection and privacy regulations.

Regulatory Relaxations 

The goal of the regulatory sandbox program is to foster financial innovation by lowering administrative and regulatory barriers. Unlike under the regulatory sandbox program in many other jurisdiction, the RBI does not provide any blanket regulatory relaxation to all participants. However, pursuant to the Framework, the RBI may relax some of the regulatory requirements otherwise applicable for the proposed innovation, on a case-to-case basis.

The RBI may, where necessary, provide regulatory relaxation in the areas of liquidity requirement, board composition, financial soundness, etc. However, consumer protection and consumer welfare remains cardinal and accordingly all regulations regarding customer privacy and data protection, transaction security, know your customer and anti-money laundering compliances, etc. must be mandatorily complied with.

The regulatory relaxations are designed only for the duration of the sandbox period.  The regulatory sandbox program is not a route for circumventing regulatory requirements and participation in the regulatory sandbox program does not provide immunity from any regulatory requirements. The financial innovations will have to comply with all regulatory requirements including obtaining requisite approvals and permits upon expiry of the regulatory sandbox period and prior to being commercially launched in the market.

The Regulatory Sandbox Process

The regulatory sandbox process will be supervised by the FinTech Unit (FTU) under overall guidance of the Inter Departmental Group of the RBI and the FTU shall serve as the point of contact for the applicants and participants of the regulatory sandbox program. 

The FTU will receive applications for participation in the regulatory sandbox program from eligible entities, and, after evaluation and preliminary screening, will shortlist applications. The FTU will, thereafter, evaluate the benefits and risks involved in the proposed financial offering and will finalise the test designs for the shortlisted applicants. The pilot testing of the financial innovation can thereafter be conducted in the controlled environment of the regulatory sandbox for a maximum period of twelve weeks which may be extended, upon application from the participant, at the sole discretion of the RBI. During this period the FTU will closely monitor the tests and generate empirical evidences from the tests which will enable the RBI to review the regulatory landscape in light of the emerging technologies and take decisions on the regulatory changes or new regulations that may be vital for supporting new innovations. Upon completion of the regulatory sandbox period, the final outcome of the testing of the financial offering will be evaluated and its suitability for the larger market will be determined.

At the end of the regulatory sandbox period, the participant must exit the regulatory sandbox and all regulations applicable for the financial innovation including obtaining specific permits and approvals must be complied with. The participant can also exit from the regulatory sandbox at an earlier time by duly intimating the RBI. Testing under a regulatory sandbox may also be stopped by the RBI if the intended purpose of the financial innovation is not achieved, or upon any failure to comply with the applicable regulatory requirements, or if the consumers’ best interest is disregarded. 

It must be noted that the regulatory sandbox program in no way limits the liabilities towards customers and in no way provide any legal waivers. All potential risks associated with the regulatory sandbox and the proposed financial innovation will have to be borne by the innovator and must be notified to the customers upfront and their explicit consent for participation must be obtained. Additionally, risks arising out of the regulatory sandbox must be adequately insured to further safeguard the customers. 

The FTU has not started taking applications for participation in the regulatory sandbox program yet. The RBI is expected to notify the dates during which applications can be made shortly.

The Way Forward

Although a considerably new concept, regulatory sandbox has created the positive stir in the market and is now seen as the optimal regulatory impetus for fostering financial innovations. Regulatory sandbox has been successful globally and more and more jurisdictions are taking the initiative to set up regulatory sandboxes for supporting innovations in financial technology and boosting the financial market. 

The Framework and the regulatory sandbox program thereunder, which has largely received positive response in India, aims to catapult India to the forefront of the evolving financial ecosystem. The regulatory sandbox can indeed be a highly effective tool for financial innovation and most entities involved in financial technologies see this as a propitious opportunity to experiment with and test their financial innovations in limited cost and consequence prior to commercial launch. 

However, transparency with respect to the selection process for participating in the regulatory sandbox program will be exceptionally critical for the success of the program and the RBI should ensure that its discretionary selection process remains transparent and based on identified parameters. Further, although not addressed in the Framework, the RBI should ensure that the intellectual properties attached to the financial innovations of the applicants and the underlying technologies are duly protected during the application process and during the regulatory sandbox period if inducted. This will give the necessary confidence to the innovators and their investors to participate in the regulatory sandbox program and make it a success.   

Anirban Roy Choudhury

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