Tough sandbox criteria could kill fintech innovation
Dialling back a few years when financial technology companies or ‘fintechs’ had surfaced and disrupted the financial services space in India, many were of the view that the role of banks was becoming peripheral and would eventually become irrelevant.
Facing stringent regulations from the financial sector along with stiff competition, fintech companies required a unique ecosystem to seamlessly test their products in consonance with banks/financial institutions before going public. The position today is starkly different with all major financial service providers engaging with fintech companies to streamline their financial products and services for customers.
On April 18, 2019, the Reserve Bank of India issued the draft “Enabling Framework for Regulatory Sandbox” inviting comments from all stakeholders.
A regulatory sandbox is an enabling interface/infrastructure set up by a regulator to conduct live tests on new financial innovations and technologies, for which, the regulator may or may not permit certain regulatory relaxations for the limited purpose of testing. The regulatory sandbox allows the regulator, the innovators, the financial service providers and the customers to gauge the benefits and risks of the new technology along the course of the live testing.
From the perspective of a regulator, the sandbox provides a structured avenue for the regulator to engage with developing ecosystems and equips it to formulate regulations that can help deliver relevant, low-cost financial products and services.
For the fintech company, the sandbox provides a platform for limited-scale testing of innovations and new technologies in an evidence-based environment.
It further provides some regulatory relaxations, accommodates room for failure and a final viability-check of the service or product before its actual market launch.
The regulatory sandbox will be beneficial for financial service providers, too, as it will isolate the core banking solution (CBS) of a bank from exposure to the testing and protect it from the risks.
The draft was open for public comments till May 8, 2019, and clarifies that only start-ups recognised by the department for industrial policy and promotion (DIPP) will be eligible for entry into the regulatory sandbox.
Who are eligible
To be eligible, a start-up must have a minimum net worth of Rs 50 lakh, according to its latest audited balance sheet, and should have a satisfactory Cibil or equivalent credit score of the promoters, directors or entities.
While some of the criteria are objective, additional requirements such as “satisfactory” conduct of the fintech’s promoters/directors do not provide any definitive benchmark. These conditions may manifest as a serious gating issue, hampering the hopes of start-ups that have developed products suitable for the regulatory sandbox but do not have the means to meet the conditions stipulated.
Further, in terms of structuring, too, the draft seems to be more beneficial for a fintech starting afresh rather than an incumbent. Adding to this uncertainty are requirements to ensure compliance with existing regulations/laws on consumer data protection, privacy and safeguards for IT systems, considering there is no robust data protection framework in India at the moment.
According to the draft, the testing shall begin on 10-12 entities selected through a comprehensive process.
An indicative list of the innovative products/services/ technologies which may be considered for testing include retail payments, money transfer, digital KYC and financial advisory services. Wealth management, financial inclusion products, cyber security, mobile technology applications, data analytics, applications under blockchain technologies and artificial intelligence are among the other products on the list.
The sandbox testing will typically be a six-month-long process and divided into five phases: preliminary screening, test design, application assessment, testing and evaluation. Though the proposed product may undergo several rounds of tweaking and checks with consumer feedback, industry experts feel it may not be easy to evaluate whether a pilot will be successful or not in real time and that sandboxes are typically employed by companies that do not have a conclusive exit strategy for a product.
The focus of the regulatory sandbox will be to encourage innovations where there is an absence of regulations, or when there is a need to temporarily ease regulations to enable the proposed innovation, or where the proposed innovation shows promise of effecting or easing delivery of financial services in a significant way.
The fintech should highlight an existing gap in the financial ecosystem and demonstrate how the proposed innovation would address the problem or deliver the benefits to the consumers.
An indicative list of products/services/technologies that may not be accepted for the regulatory sandbox includes credit registry, credit information, crypto-currency or crypto-assets services, initial coin offerings, chain marketing services and any product or service which may have been banned by the Indian government. The FinTech Unit of the RBI would oversee the comprehensive testing of the products during the sandbox process.
Across all stakeholders, the RBI embracing a regulatory sandbox system is seen as a welcome move. Particularly, the acceptance of innovations using blockchain technologies is well received.
Globally, regulatory sandbox is used in over 20 countries today, including Singapore, Australia, Hong Kong, Malaysia, Netherlands, Denmark and Canada. The regulatory sandbox can go a long way in not only improving the pace of innovation and technology absorption, but also in financial inclusion. The fintech sector will have to keep a close eye on further developments in the form and manner in which the draft will finally be implemented.
Archana Tewary is partner and Arjun David Alexander is an associate at J. Sagar Associates