Performing well in sandbox won’t be enough
RBI recently came up with a Draft Enabling Framework for Regulatory Sandbox in financial technology. For context, a sandbox is a framework that allows testing of innovations by private firms in a controlled environment. As far as developments in the fintech regulation space go, this is a good one.
A sandbox allows players to run a pilot test on new products and services at a smaller scale with less capital than usually required.
According to the draft, RBI will consider testing for innovative products and services in the following areas, Retail payments, Money transfer services, Marketplace lending, Digital KYC, Financial advisory services, Wealth management services, Digital identification services, Smart contracts, Financial inclusion products, Cybersecurity products. Some of these, especially the digital KYC and financial inclusion, are more front-facing than others. There is also a separate clause for innovative technologies that include, Mobile technology applications (payments, digital identity, etc.), Data Analytics, Application Program Interface (APIs) services, Applications under blockchain technologies, AI and Machine Learning applications.
A notable exemption from the sandbox is cryptocurrencies. This is keeping in line with the report of the inter-ministerial group that recommended banning private cryptocurrencies and proposed a fine of up to `25 crore as well as up to 10 years imprisonment. It echoes the stance of the report that encourages developments in blockchain and the distributed ledger technology in general. This is likely due to concerns that private cryptocurrencies can lead to macroeconomic instability and finance terror groups, both of which are fair concerns.
There have been claims that the sandbox is available for a limited set of customers, only 10-12 companies. It is unclear whether that hypothesis is true. The eligibility criteria as specified in the draft states that the focus of the sandbox will be to encourage innovations where there is an absence of governing regulations; there is a need to temporarily ease regulations for enabling the proposed innovation; the proposed innovation shows promise of easing/effecting delivery of financial services in a significant way. This does not directly translate into having only 10-12 players.
This should also act as a win for Facebook, and in all probability, WhatsApp. It is an open secret that WhatsApp has been keen to launch a payments service in India, dubbed ‘WhatsApp Pay’. However, over recent times, the regulatory climate has proved to be unfavourable to bring those efforts to fruition. The regulatory sandbox may serve as the ideal testing ground for the service before its release.
A successful stint in the sandbox is not a guarantee to achieve regulatory approvals however, as the draft states. Companies and their services can perform well and still be denied clearance to launch at a national level. That is something firms like WhatsApp and Facebook will have to deal with. Any financial services that pass the sandbox will need to clear regulatory hurdles such as data localisation guidelines laid out by RBI and the data protection bill (if and when it becomes law).
There are two key things to keep in mind here. Firstly, the sandbox is likely to be of help to both newcomers into the market as well as incumbents who plan to try out new ideas in fintech. This includes innovative efforts to increase financial inclusion through services that rely on machine learning and AI. Thus, it is a boost to the fintech landscape overall and also on India’s AI front. The latter of which could use an injection in homegrown talent, applications, and infrastructure. Secondly, returns from the sandbox have the potential to pay off dividends in the short to long term, depending on how long the program lasts.
The RBI, also to their credit has provided a set of risks and limitations in the draft. It includes the possibility of innovators losing time and flexibility because of due process. The need for regulatory approvals after sandbox testing and legal issues leading to consumer losses is also included. None of these risks is an argument for not having the sandbox.
The sandbox proposed is an objectively good idea. Countries around the world, including Thailand, Singapore, and the US have tried it. In a fintech space that is growing and needs new innovation to foster better development in areas such as financial inclusion and creditworthiness, this is a welcome step.
It is too early to say whether the idea will be successful, or whether it will face implementation challenges or end up leading to unintended consequences, such as favouring the incumbents over startups or making participation exclusive to a limited set of players. The idea is still in the draft stage and it could be a while before it is successfully carried out. The bottom line here is that despite all these considerations, it is better to have a sandbox than not have one.
The sandbox is likely to be of help to both newcomers into the market as well as incumbents who plan to try out new ideas in fintech.