The Reserve Bank of India (RBI) recently published a draft framework for a “regulatory sandbox”, a live, controlled environment to enable fintech companies to test their new products on a small group of users before scaling up. This can help lower time and costs in launching innovative products. The evidence generated in a sandbox enables regulators to take a view on whether these products should be deployed. It is a “safe zone” to facilitate small-scale rollouts of new products to real customers while mitigating serious risks to consumers or financial stability. It enables a “test and learn” approach where consequences of failure can be contained and the reasons for failure can be effectively analysed.
India is one of the fastest-growing fintech markets globally, attracting nearly $5.4 billion in investments between 2016 and 2018. Fintech companies drive inclusion and financial health of consumers by lowering transaction costs, personalising service and tailoring financial products. Recent years have seen rapidly growing digital payments, emergence of new digital credit players using alternative data for lending and robo-advisors for wealth management. The regulators have been supportive and have adopted a consultative approach to framing regulations. Notwithstanding this, there is massive untapped potential for fintech entrepreneurship. This calls for a new approach to regulation, making the regulatory sandbox timely and welcome.
Globally, regulatory sandboxes have seen increasing acceptance, with the UK’s Financial Conduct Authority launching the first regulatory sandbox in 2015 and at least 16 countries launching sandboxes thereafter. While most countries have principally followed the approach of a controlled environment to test new products and generate empirical evidence, each has made adaptations based on its own context. India’s approach, too, needs to be tailored to our market needs and regulatory architecture.
Fintech companies would expect the sandbox approach to address key challenges they currently face. The Household Finance Committee (constituted by the RBI in 2017) has pointed out some of these challenges: compliance with legacy regulations which are not designed for financial products delivered through technology, prolonged consultation processes, ambiguity in case of products that fall under multiple regulators’ jurisdictions and uncertainty regarding future regulations.
From the regulator’s perspective, the sandbox should generate rich data, enable deeper engagement with entrepreneurs and the industry to understand risks, and raise regulatory capacity. All these will improve the regulators’ ability to take better informed decisions (based on evidence) in developing regulations which are contemporary and contextual to our market. From the consumers’ perspective, the focus on customer privacy, data protection and security of transactions in the framework is laudable.
Ideally, the draft guidelines should consider two specific recommendations of the Household Finance Committee.
The first is that the sandbox be designed to go beyond testing new products. Globally, the principal focus of sandboxes has been to allow testing innovative business models in ‘safe’ regulatory spaces. In the Indian context, an additional use case would be particularly beneficial: enabling the sandbox to assess the pros and cons (costs and benefits) of proposed amendments to current regulations for existing products as well.
The second is that the sandbox enable the engagement of all financial regulators as an inter-regulatory unit. This is because technology is enabling innovations that result in hybrid products that fall under the ambit of multiple regulators. Entrepreneurs face the challenge of identifying the relevant regulations and fully understanding the implications for their business. Examples of such products can be payment plus pension products (potentially involving RBI and Pension Fund Regulatory and Development Authority) or savings cum insurance products (RBI and Insurance Regulatory Development Authority) delivered over the mobile phone. With the increasing availability of data and deep smartphone penetration, the number of products not restricted to regulatory silos will only increase.
It is very positive that RBI views the regulatory sandbox as a tool to promote financial inclusion. Our experience suggests that standardised financial products that fit into neat regulatory silos often fail to address middle- and low-income consumers’ complex financial lives. This creates major barriers for them in adoption of formal financial services. Bundled offerings which allow a flexible approach to savings, liquidity, investments and insurance are more relevant to the underserved segments of our population. A sandbox that enables multi-regulator engagement can provide an opportunity for industry to engage with different regulators for such products and enable them to plan for scaling up without the overhang of regulatory ambiguity.
A regulatory sandbox has the potential to encourage rapid innovation in a responsible manner and enable India to take its next big leap towards financial inclusion.
The article Let FinTech Play, Grow first appeared in The Economic Times, India on May 06, 2019.