By G Padmanabhan and B Sambamurthy
Addressing a mammoth Global Fintech Festival (GEF) at Mumbai recently, the RBI Governor has urged and encouraged the fintech industry to form a self-regulatory body. Underscoring the urgency, he has even suggested a time frame of one year.
The regulation of fintech, or for that matter, big tech has been a challenge for the regulators across the globe. It needs walking the tightrope of balancing innovation and social good in the context of rapidly evolving technologies. RBI Deputy Governor Rabi Shankar, in his address at the same GEF, acknowledged this challenge and said that “rapid technology changes can outpace regulatory frameworks, and raise issues about market integrity, consumer protection, data privacy, and fair market practices. The agility of new age fintech firms can challenge traditional regulatory models, making it difficult to ensure compliance at all times and maintain stability.” He set the broad contours and context by saying, “as regulators continue to contemplate, implement, and refine regulations for the orderly development of the fintech sector, self-regulatory organisations (SROs) could play a pivotal role in the fintech industry by promoting responsible practices and maintaining ethical standards. ….”
Regulators need to deploy multiple tools that include adapted definitions, sandboxes, safe harbours, and SROs, and all these tools co-exist. We may repurpose technologies but not regulations.
SROs in the financial sector are not new to India. The outstanding examples are the Foreign Exchange Dealers Association of India (FEDAI) in the foreign exchange market, FIMMDA for fixed Income and Money Market Dealers Association of India, AMFI for the mutual funds industry, and of course the Indian Banks Association (IBA). FEDAI and IBA, in close collaboration with RBI, had played a stellar role in smooth transition from tightly regulated interest and forex markets to deregulated markets.
These SROs set and enforce standards, rules, regulations, and dispute resolution mechanisms. They also enforce the code of conduct. Winks and nods by RBI are enough to give teeth to these regulations. Breaching these would invite its displeasure. RBI’s licensing makes it incumbent to be a member and follow these rules.
Given their commitment to responsible practices and the public good principle, they could, at times influence the shape of official regulations and a healthy ecosystem. Their organisational structures, including the profile, both academic and conduct, of their CEOs /top management, contributed to the healthy development of ecosystem in respective sectors.
In the thesis The Dark side of Self-Regulation, Benjamin P Edwards highlights the main benefits of SROs. The economic incentive to self-police confers benefits on good behaviour. By lending regulatory experience and assistance, they may ease the burden on the regulator. It leads to a better compliance culture as rule making is a co-creation of self-regulation. The costs are also optimised by internalising some cost to players.
At times, fintechs complain of regulatory uncertainty, and SROs shall help mitigate this. Well governed SROs provide regulatory buffers on both the sides and leave ample scope to innovate.
These benefits notwithstanding, SROs need to be subject to periodic scrutiny so as to avoid pitfalls like regulatory capture, cartelisation, conflict of governance, and weak customer protection practices.
As progress is made in setting up an SRO, some issues need to be resolved through wider discussions and consultations. First, there is always this debate whether membership of SRO shall be voluntary or mandatory. Given the need to ensure a level playing field, fair practices and consumer protection, the membership, in the authors’ view, should be mandatory.
Second, given the range of activities, it is contentious to slice and dice fintechs into product-specific silos like payments, credit, e-commerce etc. At times, these products run parallel and even crisscross. They are too dynamic to box. There exist more than 3000 fintechs. It would be unwieldy to have a single SRO, and chaotic to have too many product-specific SROs. An optimum balance may be maintained.
Third, there are too many “form factors” in payment systems like cards, PPI, PA, BBPOU etc. But this form factor difference cannot take away the essential function of payment and all shall receive similar treatment.
Fourth, governance structure and practices are critical for the success of SROs and misgovernance is a knockout factor. To amplify, Benjamin Edward’s research found that independent directors associated with the SRO often served on the boards of corporate financial intermediaries and are often influenced by industry lobby groups. CEOs and the top management of SRO shall have no association with any player currently or in the immediate past. Decision-making rights shall be well defined. Further, fintechs, being a fast-evolving area, require continuous upskilling on the part of regulators. Otherwise, the outcome could be abdication rather than outsourcing.
Finally, no conversation on Indian fintech is complete without the mention of NPCI, the most significant institutional intervention by RBI. It has been playing a stellar role right from day one. It ignited global aspirations and thanks to the regulator, it laid a foundation for strong governance. Given its role, there is a debate whether NPCI should be a part of SROs or be given a special status. Authors suggest “duck logic” when in doubt. If it looks like duck, acts like duck, and sounds like duck, it is a duck.
It is important to appreciate that fintech risks are distinct from “too big to fail (TBTF)” risks. TBTF regulatory framework overlooks the distinct risks associated with small and decentralised (Defi) risks. These risks are no less significant and left unattended can destabilise financial markets and their integrity. These regulations cannot be repurposed to fintech. This needs altogether new regulatory responses, be it governmental or self. Be it SRO or a government regulator, the objectives are financial stability, consumer protection, and market integrity.
Padmanabhan is former ED, RBI, and senior consultant, AZB and Partners, and Sambamurthy is former director, IDRBT and NPCI