Indian fintech ecosystem is the third largest in the world, with over 7,000 registered startups, and the market size expected to reach US$ 150 billion by 2025. RBI has continued to consistently frame regulations in an attempt to balance concerns relating to customer protection, grievance handling, internal governance, data protection, cyber security, and financial system integrity, without restricting the industry’s growth potential
The recent crackdown on Paytm Payments Bank, due to regulatory compliance issues has sent shockwaves through the sector. Fintech companies can expect increased scrutiny and enforcement of regulations, leading to stricter monitoring and compliance requirements. The crackdown on non-compliance may initially dampen innovation and investor confidence as companies prioritise regulatory adherence over disruptive technologies. Going forward, a more structured outline focusing on the powers and composition of self-regulatory organisations in the fintech sector may play a pivotal role to achieve harmonisation between innovation and regulatory compliance.
Source: PTI
The past few years have been eventful for the fintech industry. While the pandemic brought conventional businesses to a halt, it was truly an inflection point for the fintech industry, especially as it came quite close on the heels of the ramp up in digital payments post demonetisation and the launch of UPI. It is instructive to note that UPI transactions have grown at a CAGR of 147% since 2017-18 in volume terms to reach Rs 8,375 crore in 2022-23. In value terms, they have grown at an even more phenomenal CAGR of 168% to reach Rs 139 lakh crore during the same fiscal year.
Recognising the value and growth of the fintech industry, regulatory scrutiny is imminent, and the RBI has continued to consistently frame regulations in an attempt to balance concerns relating to customer protection, grievance handling, internal governance, data protection, cyber security, and financial system integrity, without restricting the industry’s growth potential. However, keeping pace with ever-evolving technology, nuanced business models, and intricate synthetic structures, while balancing the government’s mandate on financial inclusion and overall growth, has been somewhat challenging for the RBI, as it would be for other central banks throughout the world.
As a result, the RBI did not attempt to promulgate any unified legislation governing multi-faceted business models. Rather, a discussion was initiated around self-regulation in March 2023 at a conference organised by the Department of Payment and Settlement Systems. Soon after, the RBI published the ‘Draft Framework of Self Regulatory Organisations for the Fintech Sector’. acknowledging the need for self-regulation to complement existing formal regulations for effective sector-specific compliance. However, recent regulatory action against Paytm Payments Bank has brought the spotlight on compliance issues and raised concerns regarding the security of customers who have adopted digital banking so comprehensively.
In an announcement that sent shock waves across the industry, on January 31, 2024, the Reserve Bank of India, utilising its authority under Section 35A of the Banking Regulation Act, 1949, instructed Paytm Payments Bank Ltd (PPBL) to halt the onboarding of new customers immediately.
The regulator clarified that there were major irregularities in the KYC requirements by Paytm, which exposed customers, depositors and wallet holders to significant risks. It also added that the company had been earlier briefed and advised to address this issue and also been provided adequate time to ensure compliance. Following a thorough review, including the Comprehensive System Audit and subsequent compliance validation reports by external auditors, significant regulatory concerns persisted within the bank, necessitating further supervisory measures. Consequently, the RBI mandated the following actions for PPBL:
As of March 15, 2024, Paytm Payments Bank cannot receive further credits. To ensure uninterrupted UPI transactions via ‘@paytm’ handles and reduce UPI system risk, the RBI suggests several measures:
These steps aim to safeguard customers and the payment system, independent of any RBI actions against Paytm Payments Bank.
Early last week, Paytm assured that it was taking necessary steps to dissociate its offerings from Paytm Payments Bank. Paytm founder Vijay Shekhar Sharma announced his resignation from the board the latter. The board of Paytm Payments Bank has also seen a major overhaul with new inductees from the banking and bureucratic fraternity.
The Reserve Bank of India (RBI) delivered a hefty blow to Paytm, a massive player in the digital payments space with about 13% market share in India. It placed numerous restrictions on the Paytm Payments Bank, prohibiting it from providing additional banking services starting in March 2024, citing worries about non-compliance with regulatory standards.
The aftershocks caused a more than 80% drop in Paytm’s share price. This decision by the central bank has inevitably raised concerns among various industry players, especially fintech startups.
The Indian fintech ecosystem is the third largest in the world, with the market size expected to reach US$ 150 billion by 2025. Over 7,000 fintech startups have been registered in the country so far. Paytm has been a major player in the Indian fintech space for several years, particularly following the government’s demonetisation move in November 2016.
However, experts say the ongoing crisis extends beyond Paytm’s immediate operational and financial issues. Many critical areas of the fintech industry may be affected by these developments, including risk management, regulatory compliance, business model viability, client trust, innovation, and market adaptation.
According to Monica Jasuja, Ambassador, Emerging Payments Association of India, “Regulators might scrutinise fintech companies more closely and enforce stricter monitoring, potentially impacting innovation and growth due to a stronger focus on compliance instead. It is important for players to regularly monitor RBI guidelines and compliance requirements to ensure compliance to existing guidelines and watch out for evolving regulations,” adds Jasuja.
A group of start-up founders wrote to RBI Governor Shaktikanta Das and Finance Minister Nirmala Sitharaman after the RBI took regulatory action, requesting re-evaluation. They reportedly urged the RBI to reconsider the “proportionality of restrictions” imposed on Paytm, taking into account the potential impact on the payments bank, the fintech ecosystem, and the overall economy.
“The current directive against Paytm may cause a re-evaluation of investor confidence in the broader fintech sector. Investors are likely to scrutinise compliance practices and risk management frameworks more closely before committing funds,” says Manish Ashar, Principal Consultant at North Consulting.
Ashar further adds, “Fintech firms will need to demonstrate not only technological prowess but also a commitment to regulatory adherence to attract and retain investors.” While they are driving a digital payment revolution in India, adherence to regulations is mandatory to ensure that consumer confidence is retained and growth is sustainable.
Experts contend that fintech regulation should be completely reevaluated in light of this entire incident. Renuka Sane, research director at Third Bridge, writes, “We need to move away from the current one-size-fits-all framework to a risk-based approach. Until then, every fintech company will be saddled with some regulation it is potentially violating.”
Here are some more tips for industry stakeholders:
With self-regulation being considered as a key approach to governing disruptive technologies in the financial services landscape, the RBI kicked off 2024 by inviting comments on the ‘Draft Framework for recognising Self-Regulatory Organisations (SROs) for Fintech sector.’ In the rapidly evolving landscape of the fintech sector, the introduction of an SRO offers a unique approach. This initiative aims to provide a semi-hands-off and adaptable regulatory structure tailored to the dynamic nature of technological advancements and innovations within the fintech industry.
The draft framework consists of the characteristics, operations, eligibility criteria, functions, and governance standards for a fintech self-regulatory organisation (SRO-FT). It envisions SRO-FTs as representatives of the fintech sector, tasked with liaising with the RBI on behalf of its members. Additionally, SRO-FTs are expected to operate independently while serving as repositories of industry information for research and policy-making purposes.
Recognition of SRO-FTs hinges on various factors, including membership strength and diversity, technological capabilities, grievance handling processes, and overall fit-and-proper status. The RBI retains the discretion to impose additional conditions or guidelines during the recognition process.
The essence of this framework is to empower the fintech sector to establish its own standards and ethical practices collaboratively. SRO-FTs are envisioned to undertake pivotal roles in framing rules, monitoring implementation, standardising key documents, providing training, and arbitrating disputes among members.
While self-regulation presents an avenue for the fintech sector to demonstrate commitment to responsible conduct and innovation, it necessitates a well-defined structure based on consensus and cooperation among entities. Challenges such as maintaining objectivity, ensuring holistic representation, and establishing legal authority must be addressed to ensure the effectiveness of SRO-FTs in bridging industry-led innovation with regulatory compliance.
Ultimately, the success of SRO-FTs lies in their ability to operate objectively, maintain credibility, and foster sustainable development within the fintech sector under regulatory oversight. As the industry continues to evolve, SRO-FTs are expected to adapt and contribute to a conducive environment for organised and organic growth within the fintech ecosystem.
While the immediate impact of RBI’s action may seem daunting, the future outlook for the industry remains optimistic yet cautious. Fintech companies can expect increased scrutiny and enforcement of regulations, leading to stricter monitoring and compliance requirements. The crackdown on non-compliance may initially dampen innovation as companies prioritise regulatory adherence over disruptive technologies. However, the focus on self-regulation could also spur innovation by encouraging responsible conduct and ethical practices within the industry.
The Paytm incident may lead to a re-evaluation of investor confidence in the broader fintech sector in the near term, prompting investors to scrutinise compliance practices and risk management frameworks more closely. Fintech firms will need to demonstrate not only technological prowess but also a commitment to regulatory adherence to attract and retain investors.
According to Mohammed Riaz, Founder & CEO at Xtracap Fintech, “The RBI is a regulatory body and is not responsible for fostering innovation. The innovators need to build innovation within the regulatory environment and should apply for the RBI Sandbox in case of any regulatory forbearance. Customers interests and the stability of the financial system are of paramount importance. RBI should not be judged by the penal intervention of some players as unfair. I think RBI is doing a good job, but there is always scope for improvement. It comes with proper fintech capacity within RBI, which takes time to build.”
He further adds, RBI’s main mission should be to encourage access to financial services for all, and in the past, the RBI has made regulations to support the same. The Small Finance Bank is an example of regulatory support for the MFI sector, and OCEN 4.0 is an upcoming example for MSMEs. The RBI should be open to looking beyond banking and exploring licencing regimes for different segments in the coming future to fuel the growth of GDP from US$4 trillion to US$8 trillion and then to US$ 18 trillion in the next 10-15 years. Examples of this are digital banks and trade finance banks.”
The RBI’s framework-based approach to fintech regulation, coupled with the promotion of self-regulation, aims to balance innovation with regulatory compliance. Going forward, a more structured outline focusing on the powers and composition of self-regulatory organisations in the fintech sector may be necessary to achieve harmonisation between innovation and regulatory compliance.
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