RBI’s sandbox rules need more clarity

May 03, 2019 1:59 AM

The draft guidelines do not say anything about the evaluation criteria for sandboxes in India.

The Australian model on the other hand uses a white list approach, where companies meeting the criteria are allowed to test their concepts without the requirement of a licence.

By Saon Ray

The Reserve Bank of India has come up with draft guidelines on “Enabling Framework for Regulatory Sandbox” for the financial sector. The sandbox approach is currently the most favoured mechanism globally to promote and facilitate fintech innovation. This article discusses the joining criteria, boundary condition and evaluation criteria for sandboxes in India with respect to the draft by RBI.

Regulatory sandbox refers to live-testing of new products and services in a controlled environment with active cooperation of the supervisor. This allows companies to experiment with their products and improve their viability in the existing market. The handholding by the supervisor can help the fresh entrants better address barriers to entry and information asymmetries in the market that would have otherwise limited their growth and development. From the regulator’s perspective, the sandbox allows it to gain insights into potential risks and benefits arising out of innovative products and business models, and facilitate innovation.

In a sandbox setup, generally, there is a prior application process and selection by supervisor before it engages with the firm which may or may not be currently regulated. A sandbox would also have a given eligibility criteria, a well-defined space and duration for testing of the product and appropriate boundary conditions to ensure protection of interests of all parties involved, including consumers and rest of the industry.

Prior application is necessary in case of a sandbox, unlike innovation hubs that provide regulatory advice on request. Hence, the joining criteria become important in the case of a regulatory sandbox. RBI, in its draft guidelines, has listed the eligibility criteria for participating in the sandbox. It has listed certain innovative products, services and technologies that could be tested in the sandbox. It has also listed what may be excluded from the sandbox. It has also spelled out the criteria for selection of participants in the sandbox.

The criteria suggested by the Bank for International Settlements (BIS) include ‘genuine innovation, with a consumer benefit, not fitting easily into an existing regulatory framework and being ready for market.’ The idea of the regulatory sandbox is to encourage innovation in financial products and is similar to the requirements of a patent-filing: novelty, non-obviousness and capable of industrial application. How do the RBI guidelines compare with the BIS criteria? While the draft guidelines seem to be emphasising the first and third point, there seems to be less emphasis on the second: not fitting easily into a regulatory framework. Most novel innovations should fit into this category, and the list of exclusion in the draft guidelines does mention a few. Does this mean barring these, all innovations could potentially be tested in the sandbox?

With respect to the joining criteria, there is a difference between the UK and Australia models. The Australian model does not require companies to obtain individual approval where as the UK model, which has an application process where applicants are tested against a set of criteria, including the ingenuity of the innovation, benefit to consumers, readiness of the product to be tested, and need of guidance for the testing process, does. In the UK, the Financial Conduct Authority (FCA) operates on a cohort basis with two six-month test periods per year, where the selected firms are provided with ‘sandbox tools’ to conduct the test within a regulatory framework. The Australian model on the other hand uses a white list approach, where companies meeting the criteria are allowed to test their concepts without the requirement of a licence.

The Indian approach spelt out in the draft guidelines, is silent on this aspect, too, though some media articles have pointed out that the UK approach may be adopted.
Boundary conditions for the regulatory sandbox refer to the space and duration of the proposed financial services to be tested in the sandbox. The draft guidelines have specified the start and end date of the regulatory sandbox, target customer type, limit on the number of customers involved, the transaction ceiling and cash-holding limits, and cap on customer losses.

The draft guidelines do not say anything about the evaluation criteria for sandboxes in India. To conclude, while the draft guidelines are indeed a logical step forward in the process of setting up a sandbox in India, clarity on some of the aspects outlined above is needed.

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