Rajeshwar Rao: Regulatory insights into 2024
Special address by Mr Rajeshwar Rao, Deputy Governor of the Reserve Bank of India,
at the India Investment Summit & Awards, organised by Mint, Mumbai, 30 March 2024.
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Good Evening,
It is indeed a pleasure to be here amidst this distinguished gathering. The theme of the
summit, 'Rise of the Indian Spring', is both contextual and inspiring, reflecting not just
the rising trajectory and profile of the Indian economy, but also the sentiments
prevailing within the country and across the world.
As a Regulator, our endeavour always is to promote a robust and resilient financial
intermediation system with an appropriate regulatory and supervisory framework.
During my address today, I therefore intend to share some perspectives on how are we
building the enabling regulatory frameworks to prepare Indian financial system and
entities to support the nation's growth aspirations as well as building guardrails for
ensuring financial stability.
The technological developments and innovations, which we are currently witnessing
hold great promise for the financial sector. They have immense potential to increase the
reach of financial firms, enhance the range of product offerings and conveniences for
customers, expand the ambit of finance to hitherto excluded segments with the added
benefit of lower costs for delivering them. At the same time, we need to be alert to the
possibilities that the new entrants into the financial services space, including FinTech
firms, could significantly alter the universe of financial services providers. This could
affect the degree of market concentration and competition and may give rise to new
challenges.
Regulatory Principles
Regulations can be thought of as cornerstones for building trust, enabling integrity and
ensuring stability in the financial sector. Regulations define the boundaries of industry
conduct, while ensuring a fine balance between fostering innovation and safeguarding
public interest.
Before I touch upon the specific areas of our potential focus going forward, I would like
to outline a few guiding principles that usually guides us in deciding our regulatory
approach. While each policy formulation focusses on addressing a specific set of
requirements, having its own schema and flavour, policy makers should be guided by
three broad guiding principles namely - Prudence, Proportionality and Proactiveness.
Given the dynamics of the Indian financial landscape and the institutional set-up, one
more principle relevant for us at the Reserve Bank is a "harmonised approach to
regulations".
Prudence in Regulations
Prudence in financial regulations refers to being cautious and sensible in managing
risks within the financial system. It involves ensuring that financial institutions maintain
adequate capital, hold sufficient provisions and make sound financial decisions to
prevent excessive risk-taking that could lead to instability or systemic failures in the
financial system.
Time and again, episodes of crisis have demonstrated that lack of prudent behaviour by
one or a few entities can impact not just the entity concerned but can potentially
snowball into a systemic crises. Therefore, when risk management and prudence takes
a back seat vis-à-vis growth ambitions, there is an onus on the regulator to ensure
effective functioning of safety nets in the form of prudential regulations to preserve
financial stability and protect larger interests.
A key aspect of the RBI's prudential approach to regulation is having strong processes
for supervision and monitoring of banks and other regulated entities. Through this, RBI
endeavours to have a thorough assessment of the entities' financial health, risk
management practices, as well as compliance with regulatory requirements. This
proactive approach is intended to help the RBI to identify potential vulnerabilities and
address them promptly, thereby enhance the resilience of the financial system.
Proportionality in Regulations
The principle of proportionality is a concept we have flagged previously and
implemented in some of our recent regulations. It has to be recognized that
overregulation in any sector could lead to increased compliance costs affecting
efficiency and innovation among the market players. Accordingly, the focus is on
achieving a delicate equilibrium that addresses the critical concerns without imposing
undue burden on the regulated entities.
The principle of proportionality is synonymous with a nuanced strategy to ensure that
the intensity of regulations correspond with identified risks. Our policy measures such
as the scale-based regulations for NBFCs, tiered regulations for UCBs and tailored
regulations for differentiated banks, i.e., small finance banks and payments banks are
reflective of this approach.
Proactiveness in Regulations
Adopting a pro-active approach to regulations is a necessity in current times. A
forwardlooking approach in regulation entails identifying and analysing emerging trends so as
to proactively pre-empt any build-up of risks. Additionally, it facilitates the recognition of
the evolving landscape and provides valuable inputs for regulators to accommodate
new developments amid evolving challenges and uncertainties.
Being proactive also means remaining attuned to market innovations and global trends.
Reserve Bank has always supported and encouraged responsible innovations.
However, there is always the possibility of a trade-off between regulation and
innovation. As regulators of an evolving financial landscape, we need to remain alert to
the spawning of new ideas/ trends in the markets, try and understand their scale,
assess their potential to disrupt the market and consider interventions where and if
necessary. For example, Regulatory Sandbox is one such initiative where pilot
programs can be tested in a controlled environment without any fallouts. This ensures
that regulations evolve concomitantly with new products/ services rather than being
preemptive or reactive to innovations.
Harmonised approach to Regulations
Indian financial system is characterised by different types of financial institutions. Many
of these entities are niche players with varying risk profiles. Therefore, they require
differentiated regulatory treatment. While recognising the need to allow for differentiated
regulatory treatment, we are increasingly looking to adopt the approach of "same
activity", "same risk", and "same regulations".
This approach enhances our oversight capabilities by providing a holistic view of the
activity across the financial system. It allows for identification of systemic risks,
monitoring of cross-sectoral linkages, and initiation of pre-emptive measures to address
1
potential vulnerabilities. However, let me reiterate a point I had made earlier that
harmonisation does not mean prescribing uniform set of regulations. In fact
harmonisation entails a risk-based perspective, wherein regulatory requirements are
tailored to the specific risks associated with each type of financial entity and activity.
The idea is that regulatory arbitrage can not be an option exercisable by the regulated
entity.
While we remain guided by these principles in framing regulations, it needs to be
emphasized that in any maturing economy, the regulations must eventually graduate
from a rule-based approach to a principle-based approach. The Reserve Bank too has
been endeavouring to adopt principle-based regulations which means regulator would
focus on setting broad principles, thereby allowing for a nuanced approach to risk
management by the regulated entities. It helps in balancing flexibility with achieving
regulatory objectives. However, an essential pre-requisite for the success of such an
approach is a financial landscape which values discipline and compliance in both - letter
and spirit. Else, the flexibility available under a principle-based mechanism might be
misused. Therefore, in their own interest, the market players should support such
regulatory endeavours through suitably strengthening their compliance culture and
governance frameworks.
Emerging areas of Regulatory Focus
Now, let me focus on the emerging areas which are engaging our attention at present.
These are not just limited to the growth of FinTechs but traverse across the spectrum of
the financial services sector.
A few areas of the focus going forward would include issues of how to go about
harnessing the benefits of technology, ensuring good customer service and conduct,
enabling a strong governance and compliance framework within the regulated entities,
reinforcing and fine-tuning existing prudential regulations and contain the risks from
procyclicality in lending.
Harnessing the benefits of technology
The key area where a lot of work is underway is evaluating the use of technology in
financial services and assessing how RBI as a regulator can harness the benefits of
technology for greater public good. The foundation of the digital revolution of today has
been built on the digitalisation push of Government of India and enabling regulations by
the Reserve Bank. To give an example, the Financial Stability and Development
Council - Sub Committee (FSDC-SC) had set up a Working Group in April 2016 to look
into the granular aspects of FinTech and its implications so as to review and reorient
the regulatory framework. Sequel that on the framework for peer to peer (P2P) lending
was issued in April 2016. Further, guidelines for Account Aggregators were also
introduced in September 2016. Moreover, the RBI established its Regulatory Sandbox
in August 2019. All of us here are well aware about the transformation of payments
space in India where we can be proud of the country's progress and prowess.
Post covid, digital economy had got a push and adaptation rates have increased
multifold. This has brought up newer challenges, especially in digital lending products such
as issues pertaining to coercive practices, dark patterns and excessive interest and
other financial charges. To address some of these issues RBI issued digital lending
guidelines in 2022 to regulate such practices. Further, when industry innovated through
structures like loss default guarantees, RBI supported such initiatives by issuing
suitable regulations in June 2023. Reserve Bank has thus strived to remain ahead of
many of its global peers in nurturing fintech innovations by way of regulations to support
them from time to time.
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As I have alluded to previously that with newer players entering the financial services
space and disrupting the rules of the game, banks may become but one amongst host
of entities competing to win customer's business. Therefore, the focus of the banks as
well as regulators has to pivot from intermediation paradigm to marketplace paradigm.
As the consumer preferences change, banking and financial services industry would
have to reorient their business models, processes and products. To cater to this
change, the RBI has started its groundwork on enhanced use of technology in banking
such as use cases of artificial intelligence, digital ledgers, and so on. Let me also add
here that technology brings its own set of challenges in the form of data protection,
cyber security, and technology-induced frauds. These are in fact areas which are
increasingly engaging the attention of regulators not just in India, but also at a global
level.
Strengthening Customer Service and Conduct
You all may have noticed that there has been a renewed focus on strengthening the
conduct related aspects of our regulated entities. Over the last one year we have issued
instructions on the responsibilities of regulated entities employing recovery agents,
strengthening of conduct regulations relating to pricing for loan related products, return
of loan related security documents, addressing customer grievances related to reporting
of credit scoring, among others. The recent announcement for lenders to provide their
borrowers a Key Fact Statement (KFS), which will be issued shortly, is also an
endeavour in this direction. These regulatory initiatives are expected to foster more
responsible lending conduct in lending by REs.
These efforts on regulatory front are being complemented by suitable supervisory
examination of the conduct of regulated entities to ensure fair, sound, efficient and
transparent delivery of banking products and services.
As we further strengthen our approach towards addressing the concerns in framing and
enforcing conduct-based regulations, the guiding philosophy would be to set out
minimum regulatory expectations, with the option for entities to adopt higher standards
depending upon their size, proportionality and customer focus. The regulations should
ensure that customers are not misled by false promises and /or do not fall prey to unfair
practices.
Improving Governance and Compliance & Risk Management
Another area of focus is on improving governance in the regulated entities. If one were
to choose a single expression that epitomizes banking business, it has to be 'risk
management'. This arises from multiple factors including bank's fiduciary role in respect
of depositors, their critical interaction with real economy and their role in ensuring
financial stability. A strong governance framework and a robust risk management
system coupled with effective oversight by the Board and the senior management
provides a greater degree of complementarity to the objectives of the Regulator.
Recognising that governance is the bedrock of a sound banking system, guidelines
have been issued to address several operative aspects with regard to the composition
of the Board and certain committees of the Board; age, tenure and remuneration of
directors, etc. The Reserve Bank has also issued guidelines on supervisory
expectations and for providing sufficient authority, resources and independence to three
critical assurance functions of risk management, compliance and internal audit. The
Boards are expected to take an active role in identifying/ approving the head of control
and assurance functions and to establish clear lines of communication between the
Board and these assurance functions. Continuous assurance vetted by an independent
process should give succour to the institutions managements and not just the
Regulators.
Reinforcing prudential regulations
RBI will continue to rationalise and wherever required, reinforce prudential regulations
to ensure that banks recognise risks in their balance sheets and proactively manage
them. For example given that our financial system is largely bank driven, to make it
more resilient, RBI is introducing the expected credit loss (ECL) based framework for
loan loss provisioning in banks which is a forwarding looking measure and leading
identifier of stress. When issued, it is expected to transform assessment of credit risk
and ensure that banks build sufficient buffers through the business cycle to be able to
withstand any impacts of the cyclical downturns.
Further, to facilitate the diversification of credit risk and ensure market-based credit
products, enabling regulatory frameworks have been put in place. The Directions on
'Securitisation of Standard Assets' issued on September 24, 2021, focusing on
traditional securitisation structures. Further, with a view to develop a robust secondary
market in stressed loans segment, a framework for securitization of stressed assets is
on the unveil.
These reforms combined with the planned rollout of revised Basel III guidelines would
provide a fillip to individual institution's capacity to support the credit needs of a growing
economy and aid stability of the financial system.
Containing risks from pro-cyclical lending
Unbridled credit growth and any laxity in credit discipline or underwriting standards can
be deleterious to the health of the financial entity concerned and if widespread, could
give rise to systemic concerns.
From this perspective, in recent times, credit-offtake towards the consumer credit
segment, especially the unsecured portfolio was observed to be quite substantial. Also,
increasing dependency of NBFCs on bank borrowings was leading to regulatory
concerns. Although asset quality at broader portfolio level was not exhibiting any major
signs of stress, the consistent high credit growth reported in the above segments
warranted regulatory intervention. Accordingly, certain quantitative and qualitative
measures were undertaken from a macro-prudential perspective.
As regulators, we would want to ensure continuous vigil to mitigate risks emerging from
both within and the periphery of the financial eco-system. For example, the digital
lending guidelines issued by the Reserve Bank envisage that regulated entity
undertakes the due diligence required for lending decisions even when the loan is being
sourced through a lending service provider (LSP). The increased reliance of banks
/NBFCs to identify and onboard borrowers through fintech partners should not mean
lowering of underwriting standards and improper pricing of risks.
As a regulator and supervisor, we are examining the prevailing models and practices to
see how best they could be leveraged for effective credit delivery, without
compromising on risk management and prudential credit underwriting standards.
Concluding thoughts
I would like to stress here that what has been shared so far is an illustration of some of
the key areas of regulatory focus. At the same time, there are several other aspects
which continue to be on the regulatory radar. I am sure, through a collective,
consultative and collaborative approach, it would be possible to frame appropriate set of
policy measures to address the current and emerging challenges. Through this process,
we should be able to build a stable and resilient financial system which shall meet the
emerging needs of our country in an effective manner.
To conclude, let me emphasize once again that even as the financial landscape evolves
and transforms, the underlying principles of good governance, robust risk management,
effective compliance, customer protection and responsible business conduct will be
increasingly relevant. A robust culture within the organisation which delivers financial
services while embracing these principles will stand the system and the Institutions in
good stead in the long run.
Namaskaar!!
The inputs provided by Pradeep Kumar, Peshimam Khabeer Ahmed and Pramanshu
Rajput are gratefully acknowledged.
1
RBI Speech: No More a Shadow (of a) Bank - available at https://rbi.org.in/Scripts
/BS_SpeechesView.aspx?Id=1416
2
Changing Paradigms in the Financial Landscape - available at https://rbi.org.in/Scripts
/BS_SpeechesView.aspx?Id=1397