The Reserve Bank of India (RBI) recently released a Draft Enabling Framework for [a] Regulatory Sandbox (DFRS), in a bid to foment innovation in the Indian financial sector.
By Meghna Bal
The Reserve Bank of India (RBI) recently released a Draft Enabling Framework for [a] Regulatory Sandbox (DFRS), in a bid to foment innovation in the Indian financial sector. There is a high degree of institutional risk that comes with technological experimentation in the financial industry — namely an error could vanquish large sums of money in a flash. A regulatory sandbox alleviates that risk by providing a framework that enables private firms to pilot innovations in real-world scenarios under the supervision of the regulator.
It is a regulatory strategy that has been deployed over the past few years by jurisdictions such as the UAE, Singapore, and the United Kingdom (UK) with a fair amount of success. A 2017 report released by the UK Financial Conduct Authority (FCA), the body overseeing the country’s sandbox initiative, revealed that the program enabled a decrease in the time and cost of getting innovations to market and facilitated increased access to capital for innovators.
While the outcomes of the UK sandbox are inspiring, there are elements of the DFRS that raise concerns about whether it will bring about similar results. First, the DFRS states that only start-ups that have been operational for seven years are eligible. Such a stipulation precludes the entry of established entities that desire an opportunity to test innovations in a controlled environment.
Though innovation is generally thought to be the dominion of newer firms, it is not beyond the realm of reason to expect meaningful inventions from larger firms or mature small and medium enterprises (SME) or even non-profit organisations working on financial inclusion. Illustratively, nearly a quarter of the firms inducted in the 2015 cohort of the FCA sandbox were SMEs and large firms.
Second, the DFRS indicates that the prospective applicant must have a net-worth of at least 50 lakhs as per its latest balance sheet. Such a condition may have been included in the DFRS to ensure that either the applicant has enough capital to test its product. It is, however, unclear how the RBI arrived at such an amount as a minimum threshold, and thus, its value as an evaluative criterion is questionable.
A firm’s net-worth alone is not a useful determinant of its ability to innovate and deliver products. The track record of the people running a company, its culture, its product proposition, and its plan for delivery all play an important part.
The minimum net-worth requirement essentially shuns smaller firms that may want to enter the market on the back of a new idea. A more practicable solution would have been to allow firms to such partner and apply for the sandbox. For instance, a smaller firm that may not have the means to test its product may partner with a larger one that is willing to bankroll it. Notably, the FCA explicitly allows for such an arrangement.
Regulatory sandboxes were originally conceptualised to create a safe space for path-breaking innovation that either fell afoul of regulation or into a regulatory grey area. At its heart, then, a regulatory sandbox centres around encouraging ideas with genuine ameliorative potential. The DFRS’ objectives include enabling regulation to evolve with innovation, greater efficiency and choice for consumers, encouraging financial inclusion – indicating that its goals broadly align with the original conception of a sandbox.
It is, however, uncertain whether the current eligibility criteria listed in the Draft Framework aligns with such a notion. The current formulation is overtly rigid and fails to deliver an evaluative mechanism that tests applicants on their merits and the innovative potential of their propositions. Instead, it creates a small catchment area drawn along arbitrary lines where only a niche set of firms may apply.
It would, then, behove the RBI to rethink the eligibility criteria for the DFRS and frame it in a way that, one, allows for a more diverse pool of applicants, and two, centres around testing the applicant’s idea and the applicant’s ability to deliver its conception of the idea. Such a template mirrors the eligibility criteria currently used by the FCA. The FCA tests whether an applicant’s proposition involves genuine innovation, the applicant’s readiness to test its proposition, whether there is a cognisable benefit to consumers, and if there is an actual requirement to test the proposition in a sandbox.
The FCA’s requirements focus on innovation and consumers, allow for a great deal of flexibility in evaluation, and enable a wide range of firms to partake in the initiative. As such, they are more consonant with the original conception of a sandbox and the objectives listed in the DFRS than the latter’s current requisites. And the companies successfully emerging from FCA’s sandbox serve as continuing proof of the utility of its template. Remarkably, 40 percent of them received investment either during the program or after they completed it.
The author is a lawyer and a technology policy expert. The views expressed are the author’s own.