A Proposal on a Licensing and Regulatory Regime for Digital Banks Mooted: NITI Aayog
NITI Aayog has releaseda Discussion Paper titled “Digital Banks:A Proposal for Licensing & Regulatory Regime for India” seeking comments till 31.12.2021. The Discussion Paper can be accessed on the NITI Aayog website.
The Discussion Paper has been prepared by NITI Aayog, in consultation with eminent experts in the field of finance, technology and law and based on inter-ministerial consultations.
Context for the Case of Digital Banks in India: Financial Inclusion
India has made rapid strides towards enabling financial inclusion catalyzed by PMJDY and India stack. However, credit penetration remains a public policy challenge, especially for the nation’s 63 million odd MSMEs that contribute approx. 30 % to the Gross Domestic Product,about 45% to manufacturing output, more than 40% of exports, while creating employment for a significant section of the population, which in terms of volume stands next to agricultural sector. This is hindering the development of a conducive business environment for expansion of the MSME sector.
Over the past few years, with the help of unprecedented level of technology-led digitization and digital disruption heralded by Jan Dan-Aadhar-Mobile (JAM) trinity, biometric Aadhar systemetc., financial inclusion has become a viable reality for the citizens of India. This has been furthered by the Unified Payments Interface (UPI) which has witnessed extraordinary adoption. UPI recorded over 4.2 billion transactions worth over ₹ 7.7 trillion in just October 2021. The platform approach taken by the government in conceptualizing UPI has resulted in valuable payments products being developed on top of it, as a result of which payments can be made with the click of a mobile phone not just at retail outlets but also peer to peer, completely redefining the way in which money is transferred between individuals. A “whole of India approach” towards financial inclusion has also resulted in Direct Benefit Transfer (DBT) through apps such as PM-KISAN and extending microcredit facility to street vendors through PM-SVANIDHI apps. In parallel, India has also taken steps towards operationalizing its own version of “Open banking” through the Account Aggregator (“AA”) regulatory framework enacted by the RBI. Once commercially deployed, the AA framework is envisaged to catalyse credit deepening among groups that have hitherto been under-served.
The success that India has witnessed on the retail payments and credit front, has failed to replicate when it comes to payments and credit needs of its micro small and medium businesses. The current credit gap and the business and policy constraints reveal a need for leveraging technology effectively to cater to the needs of this segment and bring them further within the formal financial fold.
Summary of Reforms Proposed – Digital Banks:
The Discussion Paper makes a case, and offers a template and roadmap for a Digital Bank licensing and regulatory regime for India.
The Discussion Paper alsorecommends regulatory innovations such as Digital Bank license that hold the promise of solving for as well as mitigating the financial deepening challenges faced. The Paper starts by defining the concept of “Digital Bank” and points out the promise it holds while mapping the prevalent business models. It goes on to highlight the challenges presented by the “partnership model” of neo-banking that has emerged in India as a function of regulatory vacuum and absence of a Digital Bank license.
In terms of the methodology for licensing and regulatory template offered by NITI Aayog, the Paper constructs an equal-weighted “Digital Bank Regulatory Index” comprising of 4 factors: Entry barriers; Competition; Business Restrictions and Technological Neutrality and maps the elements of these indices against the 5 benchmark jurisdictions of Singapore, Hong Kong, United Kingdom, Malaysia, Australia and South Korea.
The Paper also recommends a two-stage approach with a Digital Business Bank license to begin with a suggestion for Digital (Universal) Bank license after policymakers and regulators have gained experience from the former. Focus on avoiding any regulatory or policy arbitrage and giving a level playing field is an important recommendation.
Moreover, even with the Digital Business Bank license, it recommends a carefully calibrated approach comprising of following steps:
- Issue of a restricted Digital Business Bank license (to a given applicant) (the license will be restricted in terms of volume/ value of customers serviced and the like).
- Enlistment (of the licensee) in a regulatory sandbox framework enacted by the RBI.
- Issue of a “full-stack” Digital Business Bank license (contingent on satisfactory performance of the licensee in the regulatory sandbox including saliently, prudential and technological risk management).