T Rabi Sankar: Fintech innovation and approach to regulation
Keynote address by Mr T Rabi Sankar, Deputy Governor of the Reserve Bank of India,
at the Global Fintech Festival, Mumbai, 5 September 2023.
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Mr. Gopalakrishnan, Mr. Padmanabhan, organisers of the Global Fintech Festival,
delegates from both India and abroad, ladies and gentlemen. I am delighted to be
present in the fourth edition of the Global FinTech Festival (GFF) a platform which
provides space for a meaningful interaction and sharing of ideas amongst stakeholders
of the FinTech ecosystem. The deliberations help all participants in identifying common
objectives and also provide inputs for potential policy actions. The elements of the
theme of this year's GFF viz., inclusion, resilience, and sustainability, succinctly capture
the attributes of the sort of fintech ecosystem that one would like to see in India.
The role of innovation in increasing the productive capacity of the economy is well
understood. But where does innovation itself come from? Economists following the
tradition of Joseph Schumpeter concluded that innovations are overwhelmingly the
fruits of long-term investments that build on each other. Innovation rarely occurs in
isolation. It is by its very nature deeply cumulative: innovation today is often the result of
pre-existing ideas. Innovation is also collective, with long lead-times: what might appear
as a radical discovery today is actually the fruit of years of hard work by different
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researchers . In the Indian context, the theory certainly holds true. For example, UPI
which clocks more than 340 million transactions a day, is the outcome of cumulative
efforts and investments in institutions and technologies by the RBI and the government
over the past decade and a half. India's fintech players and the traditional financial
institutions have all seized the opportunities offered by these public-sector initiatives
and created the thriving ecosystem that we see today.
To be sure, innovation in the finance space is not a recent phenomenon. Wire transfers
or ATMs are also instances of technological innovation, as are modern stock
exchanges with their anonymous order matching systems, or algorithmic trading. All
these changes were gradual and enabled the financial system to adapt to the new
technologies in a by and large a non-disruptive manner. What is different about the
recent financial innovations is the speed and scope of such changes making them
potentially much more disruptive. So much so that they merited the status of a separate
industry and a new name 'Fintech'. It would be useful to remember that, apart from the
difference in speed and scope, neither the older innovations nor the current fintech
innovations change the basic nature and functions of the financial system.
The major transformation that characterises the FinTech ecosystem is the increased
efficiency with which financial products and services are delivered and consumed. This
efficiency is driven largely by (a) digitisation of information which can then be accessed,
processed and transmitted with ease, (b) more direct interface between buyers and
sellers, between borrowers and lenders and between payers and receivers, which
optimises transaction chains, and (c) democratisation of fast communication channels
that expands the reach of the financial system. Put together, these efficiencies lead to
lower cost, quicker transactions and better inclusion. This is clearly a desirable outcome
and one that should be actively encouraged and promoted, which is what the focus of
policy making and regulation currently is. But innovative developments raise different
issues, not undesirable in themselves, but which need to be addressed nonetheless.
One issue is the relative roles of traditional financial institutions, especially banks,
vis-àvis the fintech entities. Should their interaction be driven by motives of collaboration or
competition? The second issue is what should be the approach of financial regulators.
How is fintech ideally regulated, same as traditional finance or differently. I shall try and
talk about these two issues briefly in what follows.
Collaborate or Compete
Traditional financial players (let us use the term 'banks' for simplicity) have come to
acknowledge the impact of FinTechs on their functional roles and they are reacting in
one of two ways. The first way is by internalising innovations, thereby placing
themselves in competition to fintech entities. The second way is by collaborating with
FinTechs - either by engaging in one-to-one partnerships or by purchasing the services
of FinTech players. The latter kind of collaboration can be functional, in the sense that
fintech entities can perform functions where they have the competitive advantage and
banks focusing on areas of their expertise. While customers benefit from an improved
experience with curated products and services at competitive prices, regulators also
draw comfort in these arrangements as traditional financial entities like banks/ NBFCs
which are well regulated and continue to discharge the primary responsibility of risk
management through their balance-sheets.
Perhaps the sweet spot lies in fintechs acting as both competitors as well as
collaborators. The existence of competition is necessary to create incentives for
fintechs to invest in innovations as well as pushing traditional entities to stay on their
toes. At the same time, collaboration is essential for innovations to be absorbed into the
financial systems. Traditional players with their robust balance sheets, capital base and
risk management practices can provide the strength and stability while Fintechs with
their agility and innovative capabilities can deliver on customer experience, drive down
costs and expand access. What should be the areas of collaboration and what should
be the fields of competition will eventually be determined by market forces. But this is
also an area that regulators need to focus on creating a regulatory framework that
continues to spur innovation.
Regulatory perspective of FinTech Innovation
The Reserve Bank of India is deeply engaged in this process of technological
transformation of the financial system. It's role has largely been to create an enabling
environment for innovation to thrive by creating mechanisms such as Regulatory
Sandbox, Hackathons, creation of Fintech Department within the RBI and setting up of
our own Reserve Bank Innovation Hub (RBIH). Recently, we announced the
development of a Public Tech Platform for Frictionless Credit. The Platform is being
developed by Reserve Bank Innovation Hub (RBIH), to enable delivery of frictionless
credit by facilitating seamless flow of required digital information to lenders from
multiple sources of information. The platform will serve as a public good and
exemplifies RBI's approach to fostering innovation. This is the developmental role that
RBI plays.
At the same time, RBI also plays the role of regulating the evolving financial system to
maintain financial stability. Rapid technology changes can outpace regulatory
frameworks, and raise issues about market integrity, consumer protection, data privacy,
and fair market practices. The agility of new age fintech firms can challenge traditional
regulatory models, making it difficult to ensure compliance at all times and maintain
stability. The reliance on digital platforms also amplifies vulnerabilities to cyber threats
and data breaches. As FinTechs amass sensitive financial data, ensuring robust
cybersecurity measures and maintaining data privacy becomes paramount to
safeguarding consumer information and financial systems. The rush to roll out new
products and services could potentially undermine market integrity and compromise
customer protection. Therefore, while fintech innovation holds immense promise, a
balanced evolution, where innovation is responsible and inclusive, is essential for the
sustained positive impact of Fintechs on financial services.
The regulations for P2P in 2017, the guidelines for Account Aggregator (AA) in 2016,
are examples RBI's proactive developmental role. The focus of the Digital Lending
Guidelines (DLG) on fair treatment of customers demonstrate the prioritisation of
innovation with suitable guardrails. It is important to recognize that regulation plays a
crucial role in managing the pace of change and allows the financial system to adapt to
new innovations without threatening the stability of the system.
Self-Regulation
As regulators continue to contemplate, implement, and refine regulations for the orderly
development of the FinTech sector, self-regulatory organizations (SROs) could play a
pivotal role in the fintech industry by promoting responsible practices and maintaining
ethical standards. These industry-led bodies establish guidelines and codes of conduct
that foster transparency, fair competition, and consumer protection. SROs can facilitate
collaboration between fintech firms, regulators, and stakeholders, creating a framework
for innovation with guardrails. By proactively addressing issues like market integrity,
conduct, data privacy, cybersecurity, and risk management, SROs help build trust
among consumers, investors, and regulators. Their voluntary compliance mechanisms
contribute to a more sustainable and reputable fintech ecosystem, ensuring growth
while minimizing potential risks and negative outcomes. In the context of a new and
evolving sector like FinTech, it is the industry participants who possess the deepest
understanding of the processes and practices within the trade. Therefore, they are
bestsuited to establish common rules, enforce them, and effectively handle disputes that
may arise from non-compliance with these rules.
Conclusion
In conclusion, it is crucial for FinTechs to continue collaborating and innovating to
enhance the effectiveness of the financial sector. Collaborating and competing with
FinTechs is essential for traditional financial entities too, in order to adapt. While
innovation is vital, it should also support social and economic goals. Regulation should
play the role of guiding the sector to those goals. Self-regulation needs to play a far
more active role too. Together, industry participants - fintech and banks alike-,
regulators, and self-regulatory organizations can work harmoniously to shape a vibrant
and resilient financial landscape that promotes inclusivity and progress for all.
Thank you for your attention and wish you all the best.
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Chapter 7: Extracting Value Through the Innovation Economy in The Value of
Everything by Mariana Mazzucato (2018)