Fintech regulations must be based on entity, not activity: RBI Dy Governor

If a fintech player is providing liquidity service (such as deposits and credit), it must be regulated as strictly as a bank, says T Rabi Sankar

The Reserve Bank of India’s (RBI's) regulation around financial technology (fintech) should be more entity-based than activity-based, Deputy Governor T Rabi Sankar said on Tuesday. 

This is the first time a senior RBI official spoke on regulations around Big Tech after Google and Amazon announced their association in facilitating deposit products - a key focus of the banking regulator. 

During his speech, he mentioned why fintechs are not allowed in deposit products, but only as payment service providers. If a fintech firm provides liquidity services, such as credit and deposit products, they should be regulated as strictly as other liquidity service providers, such as banks, he said. 

Big Tech and their regulations found mention several times in Sankar’s keynote address at the Global FinTech Fest 2021. 

As fintechs transform the financial landscape, the nature of regulation has to adjust, he said, adding the sheer diversity in the functioning of fintech firms necessitated 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 Big Tech firms,” said the deputy governor. 

While cybersecurity risks 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 Big Tech”.

With Big Tech in place, the differences between financial and non-financial firms are increasingly getting blurred and they no longer conform to boundaries. 

It is virtually impossible for legislation to catch up with the fast mutating fintech landscape, but in the interim, regulation must adapt, so 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,” said the deputy governor. 
 

There could be friction when a non-financial firm has to adhere to financial regulation, but slowing down the process of change “is often the best way to ensure customer protection”.

Fintechs cannot be banks 

The RBI deputy governor also harped on the importance of banks in the financial intermediation process. A bank provides liquidity services to the economy by taking deposits and lending it out after some time, thus creating money. This temporal gap can be filled only by banks, and not by fintech players who can bridge the spatial gap through their reach.  

"It is easier to see why fintech, 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," he said. 

“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," the RBI deputy governor said, without naming anyone. 

The ideal way is to identify fintech companies as enablers and partners. Competition to banks is not really from fintech firms but continues to be within banks that can leverage fintech, and those that cannot, he said. 

While India has one of the lowest digital frauds in the world, the focus should be on data storage, data safety and privacy, and customer protection from cybercrime. 

The RBI’s initiatives, such as two-factor authentication and tokenisation, are often resisted by fintech providers, as “resistance to change is couched in the guise of customer convenience”.

The deputy governor also said that cross-border payments remain a crucial area for the RBI, and here the central bank digital currency (CBDC) can play a role. 

Smooth cross-border payments remain stagnated, as issues like exchange rates, time zone differences, and varying regulations prevent such transfers. Fintechs and CBDCs can solve that problem. Particularly with CBDCs, payments can be almost instantaneous without needing any further settlements as they would be currencies maintained by central banks of two countries. 

The RBI recently tied up with the Monetary Authority of Singapore for one such cross-border payments service, on a reciprocal basis.