India’s banking regulator wants the fintech sector to form self-regulatory organisations, but diverse interests in the industry aren’t the only challenges in making this happen. Freny Patel reports

India is home to one of the world’s fastest growing financial technology industries, with the fintech market estimated to reach USD2.1 trillion by 2030 according to Invest India, the country’s investment promotion agency.

The phenomenal growth of the fintech industry involves leading players in payments, digital lending, insurance and personal finance such as Google Pay, Paytm, Razorpay, Lendingkart, Shiksha Finance, MoneyTap, Instamojo, Pine Labs, ZestMoney, Policybazaar, InCred and a host of others.

Fitch Ratings said in a report last year that Indian regulators remain generally keen to encourage innovation in digital financial services. However, the rapid pace of fintech innovation complicates efforts to match regulation to the sector’s evolving risks.

India is not alone in facing the challenge of regulating fintech. While the sector promotes financial inclusion, regulators across the Asia-Pacific (APAC) region, especially post covid-19, increasingly face risks related to cybersecurity, consumer protection and other operational risks associated with fintech.Prashanth Ramdas, Partner, Khaitan & Co

The pandemic exacerbated existing challenges in regulating the fintech space and introduced new ones. The majority of regulators in APAC identified access to timely data as a key challenge, while the lockdown made co-ordination between domestic regulators and agencies equally challenging, and impacted their ability to perform their core functions while working remotely.

“Enforcement is likely to be a major challenge in light of the proliferation of unlicensed lenders and limited resources among regulators,” said the Fitch Ratings report.

However, the sustainability of any financial system is about balancing the needs of the future against the wants of today, observed the Reserve Bank of India (RBI) executive director Ajay Kumar Choudhary at a fintech conclave earlier this year. He said it was always challenging for regulators to strike the right balance between innovation and managing risks.

RBI calls for self-regulation

India’s central bank has opted for the fintech industry to determine how to go about this, with Choudhary explaining that “it is desirable that this balance should come from within the fintech sector”.

Vinu Peter Immanuel, a New Delhi-based associate partner at Dentons Link Legal and member of the venture capital, technology and emerging growth companies practice group, points out that existing regulations governing fintech companies were made more from the perspective of traditional banking practices. As a result, he says, they are not suitably watertight to regulate practices related to the online collection of know-your-customer documents, security and the execution of loan contracts.

Jyotsna Jayaram, a Bengaluru-based partner in TMT practice at Trilegal, says: “Innovative regulatory methods are the need of the hour to ensure that innovation and commercial needs are protected while also ensuring consumer interests are secured.”

A self regulatory organisation (SRO) can take into account specific evolving business models and practical issues while coming up with governance processes and self-regulation for the industry, says Jayaram.

The RBI is adopting policies to monitor the thriving fintech sector more closely, while ensuring that innovation is balanced with risk management. The authority has called on fintech companies to establish their own SROs.

The SRO model would monitor the misconduct of entities and protect consumer rights and high governance standards, RBI deputy governor MK Jain said in March this year. “The role of such an SRO can include setting the standards for conduct, as well as acting as a bridge between the sector and regulators,” said Jain.

The idea behind fintech companies organising themselves under an SRO model was to keep a check on the misconduct of entities while protecting consumer rights and governance standards, said Jain.

The RBI had first come out with the SRO model in the payments space in 2020. However, its remit was limited to regulated payment system operators, which includes banks, card networks and wallet operators, among others, says Prashanth Ramdas, a Bengaluru-based partner in the banking, finance and fintech practice at Khaitan & Co.

Big, broad sector

SROs would be best placed to address critical gaps in the regulatory fintech landscape and establish codes of conduct and behavioural standards for market players, without overburdening the existing fintech players and upcoming market entrants with increasing compliance, says Jayaram.

While the RBI is keen to adopt a self-regulatory approach to sustain industry growth, it has been difficult for the industry to come together and establish an SRO.

Fintech is a big and broad sector with multiple specialised areas including digital payments, digital lending and account aggregation,” says Ramdas.

The digital payments industry also consists of other multiple stakeholders who are not directly regulated by the RBI, such as UPI [unified payments interface] service providers, and business correspondents, which are partner organisations that provide financial and banking services to customers in areas where banking services are sparse.

Hence, there is a need to ensure that industry bodies adequately represent all the regulated and unregulated stakeholders and ensure that they meet the basic ethical and professional standards,” says Ramdas.

He says certain industry organisations already exist, including the Payments Council of India, the Digital Lenders Association of India, the Fintech Association for Consumer Empowerment and Sahamati.

Immanuel adds: “The recognition of a self-regulatory body by the RBI would ensure that there would be standardisation of certain rules applicable to companies that carry on fintech business such as security practices, pricing guidelines and customer grievance redressal mechanisms.” As a member of an SRO, a fintech company would be recognised and have the legal backing of the organisation.

Allowing for discipline

As any law is likely to impede the growth of the dynamic and evolving technology that primarily governs the fintech industry, the SROs would provide an ecosystem for the disciplined growth of the fintech sector, compelling organisations of unregulated bodies to adhere to and comply with the regulations, says Immanuel.

Jayaram adds that SROs will provide a platform for members to test their evolving business models against self-built frameworks that balance the regulator’s concerns and evolving consumer needs. “Creating an SRO could reduce excessive regulation and thereby promote innovation in the market,” she says.Ambuj Sonal, Dentons Link Legal

Ambuj Sonal, a Mumbai-based associate partner Dentons Link Legal, agrees, and says that an SRO will act as a conduit between regulators and fintech players and thereby benefit both sides by providing a protocol that can address issues related to increasing cyberattacks, technical glitches and other operational challenges. “The formation of the SRO will create a check and balance on such entities and ensure that the members of the SRO comply with the regulatory policies set out by the authorities and, in turn, help ensure the security of customers using the services rendered by the fintech entities,” Sonal explains.

Ramdas says the SRO model in the fintech space is unique to India because of its demographic dividend and the sheer number of businesses that would be included, given that the financial services sector is witnessing rapid growth after digitisation and tech adoption.

However, despite the huge upside, the fintech industry has not been able to organise itself to create SROs for various reasons. The RBI has specified that one-third of the board of an SRO should comprise independent members and that all members should meet the central bank’s fit and proper criteria.

Prevailing challenges

Jayaram cites three major impediments to the formation of SROs. The existing diversity among various stakeholders in the fintech market and the competitive need for an SRO to represent the interests of all stakeholders is the key roadblock, she says.

The varying degrees of RBI scrutiny over different sections of fintech players is another roadblock and further complicates matters.”

Jayaram adds that payment gateways do not attract the same level of regulatory scrutiny as digital lenders, and so forming an SRO can be challenging.

The disparity is not surprising given that India’s digital lending industry has been subject to a clampdown by the RBI following complaints about consumers being lured into debt traps through quick loans, as India Business Law Journal reported last November.

Lending apps under RBI scrutiny

India’s digital lending industry, which is expected to grow in worth to USD1.3 trillion by the end of the decade, has been subject to a clampdown by the central bank.

Jayaram says the exclusion of unregulated entities from forming the SROs is a third roadblock because most business models are intrinsically linked to the technologies that unregulated entities offer.

The working group set up by the RBI had recommended recognition of SROs to cater to both licensed lenders as well as unregulated fintech companies in the digital lending space.

Jayaram explains that SROs should strike a balance between RBI-regulated entities and key stakeholders from the private unregulated sector. This would ensure that “the interests of all parties and influences are sufficiently taken into account”.

She says that ensuring transparency and emphasising independence and accountability within the SRO systems can reduce the risk of conflicts of interest to a great extent.

Sonal says that to avoid conflicts of interest that can arise within the governing body of an SRO, it is critical that this governing body is “truly independent and represents the interests of all categories of its members, including the startups and big giants in the fintech sector”.

Ramdas adds: “The real intent of setting up SROs is to insure against predatory lending practices and maintain a playlist of service providers and tech companies that are a right fit for the industry and follow the best practices.”Vinu Peter Immanuel, Dentons Link Legal

Elements for success

Immanuel suggests that the governing bodies of SROs should comprise independent individuals with backgrounds in law, technology, policymaking and academia to ward off conflict.

Many lawyers are optimistic and say the success of self-regulation depends on the scope of an SRO, the membership criteria, and adequate oversight to ward off any conflicts of interest.

Outlining the membership criteria, both Sonal and Immanuel say that SROs should admit members based on the nature of the business conducted, the statutory compliance the fintech company is bound by, and the customers or target group using the services of the fintech company.

While SROs should be independent and represent members’ interests, they have to be accountable to authorities, especially the RBI. A self-regulatory approach can build trust among customers and promote the growth of the fintech sector.

An SRO can help develop uniform rules and standards of operation for the industry, ensuring a level playing field for all fintech companies while promoting healthy competition.