[Daksh Kasliwal and Shubham Sehgal are 3rd year law students at Gujarat National Law University, Gandhinagar]
Over the past decade, India’s fintech industry has been experiencing a remarkable growth trajectory and has emerged as the third largest fintech economy in the world. WEF, in its study, has placed India alongside the United Kingdom, the United States, and Singapore as “the most significant operating countries” for fintech. According to another report, India’s fintech industry is poised to achieve a staggering $70 billion in annual revenue by 2030. However, this exponential growth brings forth critical challenges in terms of regulatory oversight. The urgency is further underscored by the RBI’s Financial Year 2023 report, which shows that digital frauds using cards and internet-based payment methods nearly doubled in the last financial year.
Recognizing the imperative need for regulatory measures, the Reserve Bank of India (RBI) took a pivotal step on 15 January 2024 by unveiling a draft framework for Self-Regulatory Organizations (SROs) dedicated to the fintech sector. This initiative, aimed at revolutionizing the fintech landscape, envisions streamlining processes, enhancing accessibility, and reducing costs. The genesis of this idea traces back to the Global Fintech Festival 2023, where RBI Governor Shaktikanta Das urged the fintech industry to proactively self-regulate.
This post delves into the nuances of the RBI’s proposed SRO framework for the fintech sector, exploring its potential implications and the opportunities it presents for stakeholders in the industry.
Overview of the Proposed Framework
According to the proposed framework, applicants seeking recognition as Fintech Self-Regulatory Organizations (SRO-FT) shall be established as a company under section 8 of the Companies Act, 2013. The memorandum and articles of association of such entities aspiring to be recognized as SRO-FTs should explicitly state that operating as an SRO-FT is one of its primary functions. Additionally, to attain recognition as an SRO-FT, the concerned entity must possess the requisite infrastructure and capital to undertake the functions of an SRO effectively. While SRO-FTs should be domiciled in India, they can have members from any jurisdiction.
The SRO-FT is expected to be the representative of the fintech sector, with the power not only to frame but also to enforce rules. Under the framework, the primary functions of an SRO-FT would entail making contributions to the overall development of the sector, acting as a platform to arbiter industry disputes, setting standards and enforce a code of conduct, encouraging and monitoring regulatory compliance, analysing and aggregating industry data, and acting as a conduit between the regulator and market players. It is expected to regulate the conduct of entities in the fintech sector, ranging from placing a code of conduct for a responsible advertisement to the consequences that would entail a violation of any provision.
In addition, the SRO-FT will have to work in tandem with the RBI, complementing and supplementing its regulatory and supervisory efforts. In this regard, its tasks involve, among other things, regularly apprising RBI of the developments in the sector, sharing relevant data and sectoral information with it, submitting an annual report, and performing any such function as may be prescribed by the regulator.
SRO-FT vs. SRO-RE: Tailoring Regulation to Fintech’s Unique Challenges
Before the introduction of SRO-FT, the RBI also released the framework for Self-Regulated Organizations for Regulated Entities (SRO-RE), which has already been discussed in another post. Although both frameworks share the common goal of promoting ethical practices and professionalism, there exist some differences, primarily stemming from the unique characteristics and challenges of the fintech sector.
The SRO-FT framework adopts a more targeted approach to address the specific needs and challenges of the fintech sector. Its focus lies on fostering innovation while simultaneously ensuring consumer protection and risk containment. In contrast, the SRO-RE framework adopts a broad-based approach applicable to all regulated entities. It allows for sector-specific additional conditionalities and encourages SROs to develop their best practices.
For instance, given the rapid growth in the fintech sector, the SRO-FT framework empowers the RBI to appoint observers to the board of SRO-FT. This measure aims to enhance the RBI’s understanding of the unique challenges and opportunities in the fintech sector, ensuring that its development aligns with broader objectives such as financial stability and consumer protection. Significantly, the SRO-FT is anticipated to frame standardized documents for the fintech sector, addressing specific requirements such as agreements between lending service providers and regulated entities.
Advantages
The introduction of Self-Regulatory Organizations for Fintech (SRO-FT) brings a multitude of advantages that could revolutionize the fintech sector. Firstly, SRO-FTs can function as the frontline defenders in risk management. Their capability to identify and address potential risks at an early stage, before they reach a level requiring direct regulatory intervention, is a proactive approach that enhances the sector’s stability and integrity. This early mitigation of issues underscores the significance of SRO-FTs in upholding the sector’s robustness.
Secondly, they can be instrumental in promoting responsible practices and ethics within the sector. By setting and enforcing standards, they can help prevent unethical behaviours such as charging excessive interest rates and harassment of borrowers. This proactive stance will likely contribute to the establishment of a more responsible and trustworthy financial ecosystem.
Thirdly, SRO-FTs bring invaluable industry expertise and insights to their members. Armed with a profound understanding of the distinctive challenges and opportunities inherent in the fintech sector, these organizations are strategically positioned to offer regulation that is not only relevant but also effective. Their industry-specific knowledge can empower them to craft regulations that are practical and mutually beneficial, fostering a regulatory framework tailored to the sector’s needs.
The Way Forward
The introduction of SRO-FTs by the RBI is a significant milestone in the evolution of the Indian fintech sector. However, the journey ahead is filled with opportunities and challenges. As a result, there are several areas that need further clarification and attention. For instance, the RBI mandates that at least one-third of members on the board, including the chairperson, should be independent and without any active association with a fintech entity. However, the term “active association” is not clearly defined, which could lead to confusion. Additionally, the framework does not mention the minimum net worth or the threshold for necessary infrastructure. Clear guidelines on these aspects will be crucial for the effective functioning of the SRO-FT.
Apart from this, the RBI should stipulate a timeline for taking action on any application it receives. In 2020 as well, a similar proposal was mooted by the RBI for establishing a payments SRO. Even though a few entities applied for the licence, approval is still awaited from the regulator, even after over three years. While the introduction of SRO-FT is a welcome step, they should not become mechanisms for regulators to abdicate regulatory responsibility and create regulatory ambiguity.
Conclusion
The RBI’s proposal to introduce SRO-FT marks a significant milestone in the evolution of the Indian fintech sector, heralding a new era of self-regulation within the industry. It underscores the recognition of the growing importance of the fintech industry by RBI. At the same time, it also highlights the RBI’s understanding that it cannot directly control every sector.
This transformative initiative has the potential to revolutionize the sector by fostering innovation, promoting ethical practices, and ensuring regulatory compliance. However, the journey ahead is not without challenges. The success of this initiative will depend on clear guidelines, effective implementation strategies, and active engagement with stakeholders. As the sector continues to evolve, the SRO-FT framework will need to adapt and respond to emerging trends and challenges.
– Daksh Kasliwal & Shubham Sehgal