Developing best practices

SRO for fintechs will be a first step

The suggestion by the Reserve Bank of India (RBI) that fintechs set up a self-regulatory organisation (SRO) is a step in the right direction. These new-age digital startups provide a buffet of vital services to consumers. They have empowered tens of millions of lower-income people by giving them easy access to the formal economy. At the same time, they exist in a regulatory grey area and an SRO would be the first step to setting ethical standards. There are literally hundreds of fintechs, all of which leverage digit­isation and data analysis to provide financial services. Apart from merchant payment services and person-to-person cash transfers built around the Unified Pay­ments Interface (UPI) platform, they offer digital wallets and loan-distribution services.

Fintechs have also replaced traditional moneylenders in many cases. They provide low-ticket, low-duration loans to low-income borrowers who are typically not worth servicing for a bank or a credit-card company. The fintechs can leverage access to detailed transaction data to accurately assess the credit risks of small tradespersons, vegetable vendors, subsistence farmers, fishermen, and the like. So fintechs identify the need for loans and distribute them, passing them on to more traditional non-banking financial companies (NBFCs) and banks for a “take rate”. Thus far, their default rates appear to be well within acceptable limits in comparison to NBFCs and banks. By servicing high volumes of customers at the bottom of the income pyramid, many fintechs have already built impressive revenue streams. But while the provision of these services has helped India to leapfrog decades in terms of quickly bringing the unbanked within the ambit of the formal economy, fintech processes and practices have to conform to acceptable regulatory and ethical standards.

Their services otherwise could easily spiral into creating several kinds of risks. It would be easy for fintechs to attempt to charge very high interest rates, for instance, since many of their borrowers don’t have access to any other form of formal credit. This might in turn lead to default. Mis-selling of loans is another area where there are inevitable issues, given the incentive structure. It would also be easy for fintechs to misuse personal data since this flows to them in huge quantities. This is an especially high-risk possibility. A fintech can accurately tie transaction data to locations, bank accounts, personal habits, medical conditions, etc and there may be a temptation to misuse this. Lax data privacy standards on their part could also lead to major issues.

The central bank ultimately has the responsibility to ensure the safety and security of the financial system. While it might welcome the advent of fintechs in terms of the resulting financial inclusivity, it is also right to worry about the potential for negative disruption that may result from poor fintech industry practices. The RBI has thus done the pragmatic thing by setting a basic framework for an SRO and asking fintechs to regulate themselves, while keeping a light hand on the reins. It can always consider the possibility of imposing tighter regulations if this doesn’t work. But right now, an SRO gives an industry that is built on innovation a chance to define its own best practices.