The wrong regulator for fintech

The Reserve Bank of India (RBI) is determined to maintain control of the emerging digital lending ecosystem. But has it demonstrated the ability to understand how technological innovation has upended and can continue to transform consumer finance?

Last month there were two major relevant publications on the subject of digital banking. First, the RBI released the report of its working group on digital lending “including lending through online platforms and mobile apps”. The central bank states its concern about “digital innovations along with possible entry of BigTech companies [altering] the institutional role played by existing financial service providers and regulated entities”. The working group’s aims may be uncontroversial: Imposing technology neutrality, so as to ensure innovation is not stifled; principle-based regulation rather than rule-based regulation; and the prevention of regulatory arbitrage. But the final recommendations of the working group are problematic on several counts. One such suggestion is the creation of a new “framework” within the RBI that it wants to call “Agency Financial Service Regulation”, which would control “customer-facing” outsourced aspects of lending. Why a new framework but with the same personnel? Why not an independent, and hopefully better equipped, regulator? The group also called for banning “first loan default guarantees”, in which fintech players offer a guarantee to their partner banks or NBFCs in order to get the latter to expand into lending to sectors and individuals that were excluded from the formal finance ecosystem. The RBI is concerned by this as it sees it as shifting credit risk to entities with weaker balance sheets. Yet it tips its hand later in the section where it says that tech companies providing their data, “either raw or processed, to established financial services firms” and their size and trust give them an “unfair competitive advantage over regulated entities”. Here the RBI sounds like the chief stakeholder for India’s legacy banks, rather than the protector of India’s consumers.
 

The working group’s recommendations include many suggestions from the Union government. Yet it is likely that the government, as usual, is divided on the subject; for at the same time, the NITI Aayog has released a working paper on “digital banking” that seeks to create a regulatory sandbox that would allow digital-only banks to scale up lending. The RBI, of course, is not a fan of digital-only banks. It also wants to suggest that the paid-up capital for a digital bank be “proportionate” rather than the same as regular banks; and that essentially a separate licensing mechanism for digital banks is necessary.

The evolution of the banking sector is too important to be left to the RBI, which has a history of failing to understand technological innovation, the heterogeneity of India’s consumer base, and an inability to properly balance the risks and returns of regulation. It has also consistently failed to explain its regulatory action in this field with data or models, and has not been held accountable for failures in the past.

On this occasion, for example, the RBI working group relied for two crucial parts of its argument on “media reports”. The RBI report claims that “certain ill-reputed foreign investors” are “circumventing Indian laws for digital lending”, but without details of its own investigation or of the scale of the problem. Even when it comes to macro-financial stability — which after all is the real reason why we should be concerned about balance sheet risk — the RBI merely quotes a Bloomberg op-ed by a Texas law professor. (Who, incidentally, has gone on to argue for a “regulation lite” model for fintech, which incentivises information disclosure rather than enforces it, and who also suggests the object of fintech regulation should not be uniformity but the prevention of contagion.) At the very least, if the RBI fears increased systemic risk, it should explain and calibrate its model.

These are important questions to ask of the RBI precisely because so few ask them. The RBI constantly claims it is protecting consumers from financial innovation, with zero evidence. Who asked, precisely, for the recent limits on card usage that prevent Indians from buying services abroad? That forces small enterprises and charities onto a complex system for tiny recurring payments? Where is the data on consumer welfare that informed this awful decision?

There has to be accountability for the central bank’s errors in the past. In 2007, new legislation gave the RBI the authority to regulate payment systems; and, promptly, in 2008, the RBI limited mobile payments to regular banks with a physical presence in India. “M-banking” had already taken off in a limited way in early 2008, and was clearly convenient and transparent. The RBI first warned banks to stay away from partners in the telecom industry and finally effectively shut mobile banking down. Not for years was this policy reversed; in the meantime, other developing countries developed strong and effective mobile payments systems that helped all consumers, particularly those ignored by legacy banks. A much-cited 2016 article in Science used large-scale panel data to argue that “since 2008, access to mobile-money services — which allow users to store and exchange monetary values via mobile phone — increased daily per capita consumption levels of 194,000, or roughly 2 percent, of Kenyan households, lifting them out of extreme poverty”. The RBI bears responsibility for not allowing this to happen in India, for keeping tens of millions of Indians in poverty as a consequence of its 2008 decision. Who will hold it accountable? Can it be trusted to regulate the next revolutions in fintech?