T Rabi Sankar: Responsible digital innovation
Address by Mr T Rabi Sankar, Deputy Governor of the Reserve Bank of India, at the Global
Fintech Festival, 28 September 2021.
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Good morning.
1. Fintech, or technology that provides digital financial services is transforming the provision and
delivery of financial services. At its most basic level digital technology enables speed - speed in
processing information and speed in communication. Processing speed has reduced cost and
time for transactions while communication speed has enhanced connectivity of systems
expanding the reach of transactions. Taken together, digital technology is changing the way
financial services are organised and financial products are delivered.
2. Digital innovation has, for example, enabled fast payments systems like UPI and IMPS.
Instantaneous communication and the ability to process large databases has enabled use of
Aadhar for transaction authentication which in turn has made it possible to effect large scale
Government transfers instantaneously and directly into the bank accounts of beneficiaries. eKYC
has contributed to safety of on-line payments. P2P Lending or Crowdfunding platforms are
gaining popularity in substituting for bank credit. Technology such as AI/ML has been used in
such diverse areas as investment advice, fraud detection, HelpDesks etc. High Frequency
Trading has changed the way financial markets function.
3. Notwithstanding these benefits, it is important to appreciate the limitations of technology. To
understand this, let us break down the essence of financial intermediation - between savers in
an economy (basically households) and borrowers. The core part of this financial intermediation
is done by banks - through accepting deposits, extending credit and enabling payments. Since
virtually all money (other than currency) is held as bank deposits, banks are at the centre of the
payments system. This basic intermediation structure is overlaid by other institutions. Financial
markets enable direct transfer of funds from savers to borrowers, bypassing banks to that extent.
Entities like insurance companies, pension funds and asset management companies assume
varied degrees of importance in financial markets as alternatives to intermediation by banks. In all
these cases, funds eventually are held in a bank account.
4. Now that we understand how banks intermediate funds, we can identify the defining character
of intermediation - banks bridge gaps in space and time between savers and borrowers. The
spatial gap occurs when a saver and a borrower do not know each other, or are in different
locations. The temporal gap occurs when the needs of the borrower and the lender arise at
different points in time - borrower needs money after a month but the saver has money now.
This later gap is bridged by banks through provision of liquidity services - a bank would take a
deposit from the saver now and lend to the borrower after one month. Banks are uniquely placed
to provide this service because they can create money and credit and thereby act as liquidity
providers to the economy.
5. Similarly, in the field of payments, the area in finance where fintech is the most impactful,
banks are uniquely placed since all digital payments transactions are transfer of money from one
bank account to another. All other payment service providers facilitate transfer of money from
one bank account to another, and in that sense play a supporting role.
6. Now it is easier to see why financial technology, while it can improve the efficiency of
intermediation, cannot replace the core nature of financial intermediation. It can bridge the spatial
gap but not the temporal gap, in our terminology. For instance, one would still need a bank to
warehouse the liquidity risk as no other entity can create credit and money. Put another way, any
fintech entity that provides such liquidity services is effectively functioning as a bank and
therefore should be subjected to the same legal/regulatory/supervisory regime that a bank is
subjected to. This is one reason why in almost all countries, entities other than banks are not
allowed to directly deal in deposit or deposit-like money.
7. This understanding of the limitations of technology prepares us better to manage the change
that fintech is causing in banking and finance. It would also enable an effective approach to
regulating fintech and the fast-mutating financial system.
8. The benefits of technology in improving efficiency and reach of the financial system, as well as
the concomitant benefits for economic growth and financial inclusion call for a systematic
nondisruptive adoption and encouragement of such technology in the financial system. Because
FinTech can improve the efficiency of intermediation by driving down costs, sachetising of
products and services, improving customer service and expanding the reach of financial
services, it poses a challenge to the incumbents and forces them to adapt or change the way
financial intermediation takes place. The ideal approach is for FinTech companies to be
considered as enablers and partners by banks or other financial institutions. Competition for
banks comes not from FinTech firms but from other banks which leverage FinTech better.
Regulation of Fintech
9. As fintech is transforming the financial landscape, the nature of regulation has to adjust. The
sheer diversity in the functions performed by fintech firms, necessitates a widening of the
regulatory perimeter. The approach to regulation also needs to adapt to the type of entity being
regulated. While similar activities should attract uniform regulation in most cases, such activity
based regulation might be less effective than entity-based regulation when one is dealing with
financial activities by bigtech firms. Cybersecurity risks are likely to overshadow financial risks for
all. Systemic risks, operational risks and risks affecting competition are of prime importance
when dealing with large financial market infrastructure entities or bigtech. Countries need to
overcome the legislative and regulatory deficits in dealing with concerns surrounding privacy,
safety and monetisation of data. Regulations pertaining to data issues needs to adapt to a world
where boundaries between financial and non-financial firms is getting increasingly blurred or
geographical boundaries are no longer a constraint. (BIS Papers No 117 33)
10. It is virtually impossible for legislation to keep in step with the fast mutating fintech landscape.
Until legislation catches up, regulation has to adapt to ensure that the financial system absorbs
digital innovation in a non-disruptive manner. Regulation is sometimes defined as the process of
slowing down change to give time for a system to adapt and evolve. The job of the regulator is
not easy when a given financial service, performed by well-regulated financial firms, changes to
include non-financial firms in a constantly reconfiguring financial value chain. Similarly, there are
frictions for a non-financial firm to get used to financial regulation. The social benefits of a new
technology or its impact on customer needs to be well understood by all stakeholders -
regulators, existing financial firms as well as innovating fintech entities. Slowing down the
process of change, which attracts the criticism of stifling innovation - is often the best way to
ensure customer protection.
11. As digitisation is promoted by public policy, the industry is often characterized by the rise of
dominating entities, whether bigtech or infrastructural entities. This raises competition and
concentration risks. There is no clear answer to how such issues are to be resolved - limits on
market share, for example, might open up the market to new players but it could also stifle
incentives to innovators. Regulators also need to improvise to address single-point-of-failure
risks arising from market concentration, as much as they need to be alert to new points of failure
arising from shifting value chains.
The Indian Experience
12. The approach to regulation taken by the Reserve Bank has been to create the environment
where digital innovation can thrive. This involved, to begin with, taking the initiative to set up the
basic infrastructural entities which provided the rails on which innovative products can run -
IDRBT and NPCI, to name two. Regulation sought actively to facilitate wider participation to
include non-banks (e.g. mobile wallets issued by non-banks) and increase interoperability among
different payment systems. Popular participation is created through making transactions simple
and convenient, keeping costs low and minimising risks to customer (2FA or AFA, positive
confirmation, user-friendly switch-on-switch-off facility on card-not-present or on-line
transactions etc). Data storage requirements aim to promote data safety and privacy. Customer
data protection from cybercrime is being ensured through minimizing vulnerable access points in
the system through encouraging tokenisation.
13. As the digital payments landscape is maturing, RBI's regulatory attention is shifting to the
next level of reforms. Upscaling of supporting infrastructure like RTGS and NEFT to be available
round-the-clock not only improves choices for customers and businesses alike, they enhance
the availability to non-banks and reduce settlement risk of satellite payments systems.
14. A customer protection framework with limited liability for customers, online dispute resolution,
digital ombudsman scheme, etc., are unique developmental initiatives. We have also
benchmarked our payment systems with global best practices. These efforts have led to India
reporting one of the lowest digital payment fraud rates across the globe.
15. To foster innovation, the Reserve Bank has come out with enabling framework for Regulatory
Sandbox with the objective of fostering orderly and responsible innovation in financial services,
promoting efficiency and bringing benefit to consumers. A Reserve Bank Innovation Hub (RBIH)
has been set up to promote innovation across the financial sector by creating an enabling
ecosystem where academics, technology, finance and regulators are brought together.
16. Rapid technological transformation of the financial sector has led to some peculiar
challenges. One can witness a degree of friction in compliance, not characteristic of a typically
well-regulated financial system. Regulatory initiatives, especially those intended for customer
convenience or safety, often face opposition. Resistance to change is couched under the excuse
of customer convenience. There was a strong push-back when the Reserve Bank introduced
2FA, about a decade back, although everyone cites it today as a unique success story in India's
payment evolution. Nonetheless, one can see a persistent tendency to oppose customer friendly
reforms - e.g., the introduction of tokenisation to limit storage points of card credentials for
customer safety, or to ensure 2FA for recurring transactions. We would only be able to reach a
thriving and mature payments system if, over time, all stakeholders attach due importance to
long-term improvements over short-term gains and internalise mature practices like informed
consent and transparency of data usage.
17. Notwithstanding these niggles, we have come a long way in promoting digital innovations.
The JAM trinity has achieved levels of financial inclusion unimaginable for a country the size of
India. Small businesses and vendors have started adapting to digital payments. Yet digital
penetration is limited largely to urban and metro areas. We need technological solutions to
increase penetration to the vast sections of the population which is unbanked and lacks a
smartphone. Promising options have been identified through the sandbox mechanism and efforts
are on to mainstream those technologies.
18. While digital payments have become instantaneous within the country, the environment for
cross-border payments has pretty much stagnated for decades. The factors cited are usually the
following - need for exchange rates, time-zone differences, varying regulatory and legal
requirements across different jurisdictions etc. Fintech can surely solve these frictions -
platform-based solutions can make real time price discovery possible even for retail sized
transactions. CBDCs, if both countries have it, can make time zone differences disappear by
replacing bank settlements with currency delivery which can take place even if the payment
systems are closed.
19. Another area where fintech holds promise is to prevent digital frauds, which has become
apparent as the pace of digital penetration has outstripped development of awareness. Digital
Frauds1: Incidents of digital frauds risen during the pandemic. Data from American consumer
credit reporting agency TransUnion has found that fraudsters are ramping up their efforts in the
financial services industry. When comparing the last four months of 2020 (Sep 1 - Dec 31) and
the first four months of 2021 (Jan 1 - May 1), the company found that the share of suspected
digital fraud attempts originating from India against financial services businesses had increased
by 89 per cent. Globally, financial services fraud attempts increased 149 per cent. Clearly, both
regulators and other stakeholders have to play their respective roles effectively to ensure that
innovation in the fintech space continues to support India's economic growth.
20. To sum up, the fintech landscape can be described in Dickensian terms - we are in the best
of times, with the promise of technological innovation in finance and hope of substantial efficiency
gains, better customer experience and greater social welfare. But we also need to deal with
threats of online frauds, compromise of customer credentials and data privacy and safety for the
1
spring of hope not to turn into the winter of despair.
1
www.transunion.in/blog/fraud-trends-Q2-2021