The onset of the pandemic has caused an unpredicted increase in the demand among consumers for digital banking, including instant access to banking services, products, and information. In such circumstances, there can be no better time than the present to welcome the future of banking with digital bank, particularly when the world is stricken by the ever-increasing variants of the covid-19 virus and its ensuant plague that requires the restriction of free movement and avoidance of public spaces.
The growing use of technology has also led to tremendous changes in conventional ways of finance and keeping its eye on the advancement of digital technology around the globe. India has kept its pace with the rest of the world in technology innovation for digital inclusion in the financial sector.
The Reserve Bank of India (RBI), the primary regulator of the financial sector in India, has been conscious of the importance of technology-based innovations and its growing use in India. In 2019, the RBI issued its “Enabling framework for regulatory sandbox” guidelines. Under this, fintech companies – including startups, banks, financial institutions and any other company partnering with or providing support to financial services businesses – which also satisfy the eligibility criteria, are selected to test their products in the regulatory sandbox. This allows for the testing of new products, innovations and technologies in a live environment within specified parameters and timeframes under the aegis of the RBI.
Digitisation has become a prominent theme, which has transformed the way in which public services are delivered. The unified payment interface (UPI), a payment platform in India that enables real time, instantaneous, mobile-based bank-to-bank payment, has witnessed extraordinary adoption. As a result, payments can now be made with a click on mobile phones, not just at retail outlets but also peer to peer.
Although this success was witnessed in the retail payments and peer to peer transfers, the same success could not be replicated in the context of payment and credit needs of small businesses. Therefore, keeping in view this gap and to enable small businesses to have quicker access to finance from the formal sector, the NITI Aayog, an apex public policy think tank of the government of India, while examining the global scenario, has recommended a full-stack digital bank in its discussion paper titled “Digital banks – a proposal for licensing and regulatory regime for India” published in November 2021.
The NITI Aayog, in its discussion paper, has highlighted the need for licensed entities to leverage technology to mitigate the costs of acquisition and cost-to-serve and have the benefit of low-cost deposits to supply credit to small businesses sustainably. And therefore, it has recommended a two-stage approach with the introduction of a full-stack “digital business bank” licence in stage 1 and full-stack “digital universal bank” licence in stage 2. The RBI is to consider introducing the digital universal bank licence based on the regulatory experience gathered from the introduction of the digital business bank.
Taking a cue from policymakers globally, especially in Southeast Asia, the discussion paper has recommended a three-step licence process for the digital business bank, which are:
Step 1: Introduction of a restricted digital business bank licence. In this step, the RBI will vet all applicants and select ones to get a restricted licence to operate in a regulatory sandbox.
Step 2: The applicant acquiring the restricted licence (licensee) enlists in the regulatory sandbox and commences operations as a digital business bank in the sandbox. The relaxations applicable in the regulatory sandbox are to be decided by the RBI, in line with its guidelines. This process is expected to identify a set of metrics for which the licensee will be progressively monitored by the RBI.
Step 3: Based on the satisfactory performance of the licensee in the sandbox, the initial set of restrictions will be relaxed to advance the licensee to a full-stack digital business bank licence. The duration for which the licensee will operate in a regulatory sandbox will vary from case to case. The discretion is with the RBI to determine the licensee’s progress.
In case the metrics agreed on ex ante are not met over a defined period, the licensee will be given a window to unwind the liabilities created, including any term deposits, and exit the sandbox.
The discussion paper further describes other features and conditions of the digital business bank licence where the minimum paid-up capital for a company to qualify for a sandbox framework is specified at INR200 million (USD2.6 million) and upon progression from the sandbox into the final stage it is specified at INR2 billion for a full-stack digital business bank.
This is one of the major relaxations, in comparison to incumbent banks, for digital banks, and is equivalent to that of small finance banks (SFBs), maybe because digital banks are not expected to have any physical branches.
The discussion paper also suggests that the branch mandates are to be interpreted in a progressive manner to allow banks to decide on the channel of delivery of services.
It is further proposed that digital banks have the same level of access to infrastructure enablers in India, like Aadhar electronic-know your customer (e-KYC), national electronic funds transfer (NEFT) or real-time gross settlement (RTGS), the ATM network, the deposit insurance and credit guarantee corporation, as the incumbent banks.
Further, since the operation of digital banks will be almost entirely dependent on technology, the regulatory requirements include additional regulations on digital banks. Given the digital native nature of banks, the licensee is also required to have an established track record in industries such as e-commerce, payments, and technology.
Following the above-mentioned foundational phases and requirements, the licensed digital bank, will also be required to fully comply with all the regulations touching upon banks’ conduct that is issued by the RBI from time to time under the Banking Regulation Act, 1949.
The introduction of digital banks in India is at a very nascent stage, with the aforesaid discussion paper now in public upon which comments are sought from various stakeholders and the public at large. The potential of the digital banks to leverage data and platforms to lend remotely can definitely play a positive role in supporting small businesses amid the pandemic and is expected to have a direct correlation with their performance.
Nonetheless, right now, it will be premature to observe and analyse how successful digital banking in the country will be, but given the approach of policymakers, as well as the advancement of technology and advent of digitisation, one thing is sure that India, too, is ready to embrace brick-and-mortarless banks, i.e. digital banks very soon in the near future.
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