Navigating Innovation and Compliance: Analysing RBI’s New Draft Regulations for Fintech’s

[By Siddh Sanghavi]

The author is a student of National Law University Odisha.

 

Introduction

On January 15, 2024, the Reserve Bank of India released the draft regulation outlining a framework for self-regulatory organisations in the fintech industry. These self-regulatory organisations have been named SRO-FT. As per the RBI’s outlined framework, a Self-Regulatory Organization for Fintech (SRO-FT) will be a non-profit entity established under section 8 of the Companies Act of 2013 and will have to fulfil certain requirements and comply with governance standards to gain recognition by the RBI.  

This idea of having a self-regulatory organisation for the Fintech industry is not something that is new and can be traced back to the Report of the Working Group on Fintech and Digital Banking released by the RBI in 2018, where the idea of a self-regulatory organisation for the Fintech industry was first proposed.  

This blog analyses the Reserve Bank of India’s (RBI) draft regulations on establishing Self-Regulatory Organizations (SROs) for the Fintech industry in India. It discusses the need for regulation, why self-regulation is currently the best approach, and how the RBI’s steps will bridge the gap between regulators and the industry. It also highlights potential issues with the draft regulations and suggests improvements. 

Need for regulation 

As per the Report of the Working Group on Digital Lending including Lending through Online Platforms and Mobile Apps fintech lending entities in India are of two types:  

1) Those which the RBI regulates by granting them NBFC licenses. And 2) those that are currently unregulated. The new draft framework is aimed at regulating the second category of Fintechs.  

One of the main functions of the Fintech sector is that it provides solutions to the already regulated entities in the form of an outsourced information technology provider as well as providing lending services such as KYC (Know Your Customer) tasks. This involves fintechs amassing a large amount of sensitive financial data, and therefore ensuring robust cyber security measures becomes extremely important.  

By the nature of its functions itself, it is understandable why it is important to regulate this sector. If not regulated, it may pose significant risks towards consumers’ data privacy and cyber-security in the banking system. It is proposed that these SRO-FTs will help develop codes of conduct, ensuring all the members follow the basic industry standards and meet the expectations of the RBI.  

Why self-regulation will be the best route. 

Section 45I(f)(iii) of the RBI Act 1934, allows the RBI with the approval of the Central Government to notify any class of companies as an NBFC (Non-banking financial company). Through this section, RBI has the power to notify fintech entities that are involved in the process of lending as NBFCs. Since NBFCs are already regulated by the RBI, this notification of classifying Fintech companies as NBFCs would have allowed RBI to bring them under the same regulation.   

However, RBI has in its press release stated that it prefers the approach of self-regulation as it will help get a balanced approach between innovation and meeting regulatory requirements.  

Further, the RBI in its draft omnibus stated that Self-Regulatory Organisations (SROs) enhance the effectiveness of regulations by drawing upon the technical expertise of practitioners and also aid in framing/fine-tuning regulatory policies by providing inputs on technical & practical aspects, nuances and trade-offs involved. 

As stated by the RBI in its draft omnibus it may not be prudent to bring Fintechs under the same regulation as an NBFC, there has to be industry-specific regulation and till the time RBI doesnt come up with regulations specifically dealing with Fintech self-regulation will be the best route.   

Further, this approach of self-regulation taken by the RBI is appropriate since the Fintech industry in India is poised for growth, innovation and investments and burdening it with mandatory and excessive regulations may not be the right move currently and is something that can be considered in the future.  

Success of Self-Regulatory Organisations across sectors. 

The concept of a self-regulatory body is not new in India; it has also been effectively used in the past to close the gap between the regulated and the regulators without requiring excessive regulation.  

The most famous example is the Association of Mutual Funds India (AMFI). The AMFI has acted as a link between SEBI/ RBI and the Mutual fund ecosystem. AMFI has also worked to set standards for best practiceswhich then become the status quo of the industry and is followed by all in the eco-system. The AMFI has also been recognised by the SEBI and now also acts as the licensing body for all Mutual funds in the industry.  

Other examples of successful self-regulatory organisations include the Indian Banks Association (IBA), and the Foreign Exchange Dealers Association of India (FEDAI), they have also been successful in collaborating with regulators in the past and ensuring compliance and upholding ethical standards. 

The RBI by providing a framework for Self- Regulatory organisations for the Fintech Industry aims to achieve a similar purpose. An SRO-FT will act as an interface between the industry and the RBI.  

The Key ingredients of success: Recognition by the RBI and active participation.  

According to the new draft guidelines for an entity to be recognised by the RBI it must receive a letter of recognition from the RBI. From the examples mentioned above, the system of self-regulatory organisations can only work smoothly and truly act as a representative of the industry it needs to gain recognition from the regulator. Since the SRO acts as a representative of the entire industry, recognition from the RBI will grant them legitimacy.  

Further, recognition by the RBI will automatically increase participation and membership of an SRO. As mentioned above Fintech entities are usually service providers to the already regulated entities, therefore accreditation by an RBI recognised entity (SRO) will increase trust and marketability of the fintech entity. This is also one of the important reasons why a Fintech entity would be motivated to voluntarily subject itself to regulations and supervision by an SRO-FT. Therefore recognition by the RBI is likely to automatically boost participation. 

Issues and Suggestions with the draft regulation. 

The draft framework issued by the RBI is comprehensive and a step forward in regulating Fintechs. However, there are certain issues which can crop up and require clarification. For instance, there is no specific provision in the draft regulations that clarifies the number of SROs that the RBI will recognise in each sector. As mentioned above the main function of an SRO is to act as a bridge between the RBI and the industry and act as a facilitator and also the representative of the industry, a large number of SROs in the same sector may lead to confusion and undermine the effectiveness of the regulation.  It would be important that the RBI clarify the number of SRO’s it seeks to recognize in each sector.  

Further, the RBI in its draft regulation also specified that one-third of the members on the board of the SRO-FT including the chairperson have to be independent and not have any “active association” with a fintech entity. However the term “active association” has not been defined in the draft regulation. This may lead to confusion regarding the membership requirements of the board of an SRO-FT.  

Furthermore, to increase participation and membership of SRO-FTs, the RBI  can also introduce a system of accreditation that can be given by the SROs to Fintech entities. This will be beneficial in ensuring that all players follow the best industry practices and also incentivise new companies to join the SRO. Similar licensing and accreditation powers have already been given to organisations like the AMFI.  

It would also be beneficial if the RBI specified a timeline in which it seeks to decide on applications that have been received for recognition. This will help speed the process of recognition of SRO- FT’s.   

Conclusion 

India is currently emerging as a frontrunner in financial technology and establishing a reputable and accountable SRO would help elevate the nations status as a leader in setting global fintech standards. It would be beneficial to both the regulator as well as the industry to promptly create a reputable and accountable SRO, which will help enhance trust within the sector.  

There are already industry associations like the FACE (Fintech Association for Consumer Empowerment) and DLAI (Digital Lenders Association of India) which have a large membership and may be poised to be recognised by the RBI as an SRO-FT since they are already in compliance with the new draft regulation. It will also be interesting to see how many SROs are given recognition by the RBI.  

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