Disruptions & Opportunities in the Financial Sector
Address by Shri Shaktikanta Das, Governor, Reserve Bank of
India - June 17, 2022 - Delivered at the Financial Express Modern
BFSI Summit in Mumbai
It is my pleasure to be here amongst such a distinguished gathering to
deliver the inaugural address at the Financial Express Modern BFSI
Summit. The theme of my address "Disruptions & Opportunities in the
Financial Sector' will resonate in the current context of technological
innovations and fast evolving business models in the financial sector.
2. The impact of Covid-19 pandemic, the recent geo-political crisis and
the all-pervasive technological innovations sweeping across
economies are challenging the traditional financial intermediation
processes. In my address today, I would like to focus more on the
banking and the financial services space. I propose to share my
thoughts on possible implications of technology on the financial
services industry.
The Changing Paradigm of Banking
3. The edifice of growth and development in modern economies is built
on the foundation of a vibrant, resilient and well-functioning financial
sector. The core functions of the financial sector in an economy, viz.
intermediation, asset price discovery, risk transfer and payments are
globally undergoing a process of transformation. This is primarily driven
by technological advancements. The Indian financial sector has also
been a part of this churning and is adopting and propelling these
transformations.
4. Over the past few years, the business of banking has witnessed a
shift from traditional branch banking to digital banking. This paradigm
shift has been possible due to innovations in information technology
(IT), growth in mobile and internet connectivity, market-based financial
intermediation, and the advent of Fintech. Financial service providers
are now devising new products and services and are adopting new
business models for reaching out to the target customers.
5. Improvements in technology have also enhanced the cause of
financial inclusion and tech-enabled public goods delivery. Direct
Benefit Transfer (DBT) through the digital mode is among the best
examples of tech-enabled public goods delivery. Digital-mobile-
anywhere-anytime banking is becoming the order of the day. The
indigenously developed Unified Payments Interface (UPI) and Aadhaar
Enabled Payment Service (AePS) have become the backbone of our
retail payments system.
6. Alongside these advancements, the Reserve Bank's regulatory
approach has been realigned to support and foster such innovations.
The regulatory guidelines for account aggregators and peer-to-peer
lending operators are indicative of a proactive regulatory approach. An
enabling framework for Regulatory Sandbox has been in place for last
three years. The Reserve Bank Innovation Hub (RBIH) has also been
set up by the RBI to catalyse innovations in the Fintech sector. We are
now moving towards the introduction of a central bank digital currency
(CBDC).
Technology as a Disruptor - Opportunities and challenges
7. With the advent of new technologies, we are witnessing a new era of
disruption. Given the growing role of technology, data and network
effects, there is a feeling among the banks that having an ethos of a
technology company, while offering banking services, is the need of the
hour. This is an area of opportunity for the banks; but there are
associated challenges which need to be mitigated. Greater attention
needs to be given to building customers' trust by (i) offering products
and services appropriate and fit for customer's needs and
circumstances; (ii) ensuring robust security controls, reliable and
efficient delivery of services, transparency of terms and conditions to
customers; and (iii) by handling customer grievances satisfactorily and
building necessary awareness among customers. All of these aspects
need to be factored in when financial institutions introduce or enhance
technology driven products and services.
8. Talking about opportunities, it would be relevant to note that what we
have seen until now could be just the tip of the iceberg. The use of
artificial intelligence (AI) and machine learning (ML) to determine the
creditworthiness of clients for small ticket loans by analyzing data from
a wide range of traditional and non-traditional data sources, has the
potential to enhance access to credit for marginalized customers. Here
also it would be necessary to understand the associated risks and
mitigate them suitably through various safeguards and precautions.
Risks relating to cyber security, software development, limitations in
transaction capacity, privacy of customer data, and data security need
to be factored in. The methodology of algorithms underpinning digital
financial services has to be clear, transparent, explainable and free
from exclusionary biases. The credit scoring models using innovative
techniques can be useful but they should be subject to a robust model
governance framework. Comprehensive assessment of risks has also
to be undertaken while planning to move to cloud with customer
sensitive data.
9. In all these digital initiatives, the plan should also factor in those sets
of customers who may not be digitally savvy and who may want to
engage physically with the bank. It is, therefore, crucial that while
driving various tech-enabled initiatives, the existing systems and
processes do not see frequent disruptions and non-availability. We
have already seen instances of the damage that disruptions in
technology systems can bring and the reputation risk they carry for
financial entities. A casual approach to handling technology issues
even as basic as wrongful deletion of a single system file or inadequate
care in patch updating often lead to financial and operational losses.
10. The IT systems and platforms are also exposed to obsolescence
and require frequent upgradation. This calls for adequate investment in
IT infrastructure by all financial sector entities. This is one of the
important focus areas of RBI's supervision of its regulated entities,
especially the Banks and the NBFCs.
11. It has also to be recognised that human resource can turn out to be
the weakest link in technology enabled financial services. There is thus
a vital need for ongoing training and skill building programmes.
12. At end of the day, the bottomline is how technology improves the
financial system in terms of efficiency, effectiveness, resolving
bottlenecks in economic functions and provide value addition to the
customers.
Collaboration between Finance and Technology Firms
13. Large technology companies (BigTech) which have entered into
provision of financial services could potentially be another source of
disruption to the financial system. As you would be aware, such
companies, whether from e-commerce, social media and search
engine platforms, ride hailing and similar businesses have started to
offer financial services in a big way on their own or on behalf of others.
These companies have an enormous amount of customer data which
has helped them to offer tailored financial services to entities and
individuals lacking credit history or collateral. Even the banks and other
lenders are sometimes utilising platforms provided by fintech
companies in their internal processes for credit risk assessment. Such
large scale use of new methodologies in credit risk assessment can
create systemic concerns like over-leverage, inadequate credit
assessment, etc. Authorities and regulators have to strike a fine
balance between enabling innovation and preventing systemic risks.
14. The big techs also pose concerns related to competition, data
protection, data sharing and operational resilience of critical services in
situations where Banks and NBFCs utilise the services of big tech
companies. These concerns can also materialise in sectors other than
financial services. The provision of financial services through the digital
channel, including lending through online platforms and mobile apps,
have brought in issues relating to unfair practices, data privacy,
documentation, transparency, conduct, breach of licensing conditions,
etc. The Reserve Bank will soon issue suitable guidelines and
measures to make the digital lending ecosystem safe and sound while
enhancing customer protection and encouraging innovation.
What kind of Regulation and Supervision?
15. The need for FinTech regulation emanates from the challenges they
pose to the financial system and the new risks they carry. These risks
have a bearing on overall financial stability and market integrity.
16. The approach to regulation of FinTech could be by way of Activity
Based Regulation wherein similar activities are treated similarly,
regardless of the legal status or nature of the entity undertaking the
activity. It could also be Entity Based Regulation which requires that
regulations are applied to licensed entities or groups that engage in
similar and specified activities, such as deposit taking, payment
facilitation, lending, and securities underwriting, etc. The approach
could also be an Outcome Based Regulation by setting out some basic,
common and technology or business model-neutral outcomes that
entities must ensure.
17. India has traditionally followed a hybrid form of regulation that
combines Activity and Entity Based regulation. As a principle, the RBI
has been applying comprehensive regulatory, supervisory and
oversight requirements to various segments of financial sector in its
domain to create an enabling ecosystem for such activities to grow in
an orderly fashion. The underlying theme has always been to maintain
financial stability. Going forward, the RBI will continue to finetune its
regulatory and supervisory measures keeping in mind the evolving
dynamics of the financial sector.
Does Regulation require collaboration with different Regulators?
18. When it comes to technology, it may transcend regulatory or
national boundaries. The most relevant example in this case would be
the blockchain technology. Different blockchain platforms cannot be
limited to a regulator or a nation. Another example can be the case of
De-centralised Finance (DeFi) in which financial applications are
processed on a blockchain with limited or no involvement of centralised
intermediaries. DeFi poses unique challenges to regulators as its
anonymity, lack of a centralised governance body, and legal
uncertainties can make the traditional approach to regulation
ineffective. There is, therefore, a case for a globally coordinated
regulatory approach and inter-regulatory co-ordination to enable
comprehensive assessment of such activities and mitigation of their
risks.
Some recent initiatives of the RBI
19. I would now like to focus on certain supervisory steps taken by the
RBI recently to deal with the emerging challenges from fintech. In the
specific area of cyber security, the RBI has recently conducted Phishing
Simulation exercises for select Supervised Entities (SEs) to assess
their email security standards and cyber security preparedness. We
have also initiated the process of conducting Cyber Reconnaissance
exercises this year. This will provide pre-emptive information on the
cybersecurity risk vectors of SEs. Besides, Cyber Drills which are
conducted periodically are being further enhanced in terms of coverage
and periodicity.
20. The increasing use of technology and digital services has led to
more incidents of digital frauds and customer dissatisfaction. The
recommendations of the RBI Working Group on digital lending in this
area are under examination for issuance of guidelines.
21. In the context of customer service, another area which is engaging
the attention of the RBI is the harsh recovery methods used by certain
lenders, without having adequate checks and controls over their
recovery agents. We have received complaints of customers being
contacted by recovery agents at odd hours, even past midnight. There
are also complaints of recovery agents using foul language. Such kind
of actions by recovery agents are unacceptable and pose reputational
risk for the financial entities themselves. We have taken serious note
of such instances and will not hesitate to take stringent action in cases
where regulated entities are involved. Such complaints against
unregulated entities will have to be taken up with appropriate law
enforcement agencies.
22. We have recently set up of a Committee for Review of Customer
Service Standards in the RBI Regulated Entities (REs) which would
inter alia review the emerging and evolving needs of the customer
service landscape, especially in the context of evolving digital financial
products and their distribution, and suggest measures for strengthening
the overall consumer protection framework.
Governance and Risk Management
23. I have often spoken about the importance of good corporate
governance in banks and financial institutions. A good governance
structure will have to be supported by effective risk management and
compliance functions. The cost of compliance to rules and regulations
should be perceived as an investment, as inadequacy in this regard can
prove to be highly costly. Compliance culture should ensure adherence
to not only laws, rules and regulations, but also integrity, ethics and
codes of conduct.
24. The Global Financial Crisis was preceded by a wave of financial
innovations related to securitisation and other innovative financial
instruments. These allowed the financial system to grow at a pace that
was beyond its capacity to manage, especially from the point of view of
the connected risks. Given such past experience, prudence demands
that introduction of innovations in the financial system should be done
responsibly and in a calibrated manner, taking into account the capacity
of financial entities to manage potential risks. It goes without saying that
innovations which provide opportunities through high risk taking need
to be managed by sound corporate governance and risk management
practices within the financial institutions. The senior management and
internal control mechanisms in financial institutions should also ensure
that their IT systems are robust and transparent, and not open to
manipulation that may camouflage the true state of affairs in the
organisation.
Conclusion
25. Let me conclude by saying that we are in the midst of a
technological revolution in the sphere of financial services. Technology
and Innovation per se are neither destructive nor constructive. It is the
use cases that present the responsible or irresponsible sides of any
particular innovation or technology. Reserve Bank shall continue with
its approach where innovations which provide benefits to society are
encouraged without compromising the stability of the financial system.
26. The trend of technology driven changes in the financial services
sector will continue in the future. Participants and players in this sector
will have to strive hard to remain relevant in the ever changing
economic environment by continuously improving the quality of their
governance; reworking their business strategies and business models;
designing products and services with the customer in mind; ensuring
operational resilience and risk management; and focussing on more
efficient products and services by leveraging on technology. The
possibilities are immense only if we are ready to embrace them while
meeting the challenges!
Thank you.