In the evolving landscape of fintech or financial technology, India stands at the crossroads of innovation and regulation. What began as a quest for stability and oversight has devolved into a dystopian odyssey, where good intentions pave the road to chaos, and unintended consequences lurk around every corner.
Our story today commences with a modest trigger — the cautious instructions of the RBI to Kotak Bank, halting new digital customer onboarding and suspending credit card issuances. The regulatory zeal, ostensibly aimed at preempting potential outages, lacks a tangible basis for outage events. It’s reminiscent of the regulatory crackdowns of the past, where rigid checks were imposed without a clear understanding of the underlying issues, like the one on HDFC a few years ago or on Paytm recently. This knee-jerk reaction to largely hypothetical scenarios reflects a systemic failure to distinguish between proactive risk management and reactive overreach.
Now, cast your gaze on the recent renewal of permissions for onboarding new merchants for payment aggregators like PayU and Razorpay — a belated glimmer of hope in a sea of uncertainty. Even these restrictions were imposed earlier due to concerns about their KYC processes, which have their own nuances. Yet, this ray of light is swiftly extinguished by the heavy hand of the RBI in other cases, wielding mandates on data localisation and card storage with reckless abandon.
Is fintech regulation effective or disruptive?
The stated intention behind data localisation is privacy and security. The question that needs to be asked is: Was this the most effective and least disruptive option?
Card storage guidelines were also poorly thought out — card data could be stored only at the network level or by banks, not by other entities including payment aggregators and merchants. No banks have provided that facility. This caused a lot of disruption because merchants used to store these card numbers, as stored card transactions are preferred for the reduced friction in the transaction flow. The cumbersome protocols for subscription services, necessitating one-day prior notifications and convoluted cancellation procedures, have only exacerbated the disruption, particularly in international payments. What was needed was just to mandate more transparency, not added mandatory steps.
Merchants and users accustomed to seamless transactions via mandates and stored cards are wary of these changes. These are complex integrations between different entities, which require proper systems thinking to evolve good policies. We are introducing multiple friction points into the system without measuring how they could impact various transactional flows.
How OTPs complicate the picture
Stock broking and mutual fund businesses, too, find themselves tangled in a regulatory quagmire, with onerous OTP requirements for selling mutual fund units adding layers of friction to an already complex process. Also, this obsession with OTP-based two-factor authentication without considering OTP delivery rates is sure to cause drop-offs. Also, nobody thought about the discrepancy in email and mobile data between the various participants in the ecosystem — brokers, RTAs, mutual fund houses, etc. This required a lot of frantic work behind the scenes to smoothen out the system.
The prohibition on using wallets or pooled money for mutual fund purchases only serves to compound the problem, needlessly complicating settlement processes without due consideration for the downstream impact on consumers and market liquidity. The settlement processes became a bureaucratic nightmare, refunds languished in limbo, and customers were left stranded in a maze of red tape.
Why not simplify the process?
The regulatory maze extends beyond this to even Aadhaar-PAN linkages and nominee declaration guidelines for mutual funds. While these measures may appear sound in theory and aim at customer protection, what about backend systems readiness and customer discomfort? Wouldn’t it have been better to simplify the process of checking nominees only for those in need rather than mandating this for all redemptions and purchases?
Unintended consequences abound in this regulatory quagmire. Take, for instance, the stringent Know Your Customer (KYC) norms imposed on fintech companies. Ostensibly aimed at curbing money laundering and terrorist financing, these regulations have unwittingly erected barriers to financial inclusion, especially for those in rural and remote areas. The imposition of arbitrary lending caps on peer-to-peer lending platforms, ostensibly to protect consumers from excessive debt, has effectively kneecapped a vital source of credit for small businesses and individuals and smothered innovation, choice and opportunity. Moreover, bureaucratic inertia and lack of regulatory clarity have created a climate of uncertainty, deterring investors and stifling startups and innovation.
Consumer pays the price
But perhaps the most egregious consequence of haphazard regulation is the disruption and inconvenience it inflicts on customers. Take the recent debacle surrounding digital lending apps, where unsuspecting borrowers were subjected to harassment and exploitation due to lax regulatory oversight.
The lack of stakeholder consultation and cost-benefit analysis raises troubling questions about the regulatory decision-making process, highlighting a pervasive culture of “act first, think later” that prioritises compliance over innovation and consumer welfare. Moreover, the definition of cost in a cost-benefit analysis must be expanded to include customer discomfort, transaction drop-offs, friction points added, increased work for different stakeholders, impact on innovation, etc.
Whenever regulators consider any intervention, they should ask the question: What is the least disruptive, optimal option? Not doing anything and letting markets play out are also options because every intervention has a significant opportunity cost—both for businesses and customers.
Behind the facade of regulatory vigilance lies a stark reality: The ossified legacy systems of traditional banks, which have long resisted innovation, adaptation and competition. By imposing stifling regulations on fintech disruptors, regulators risk entrenching this status quo.
What effective regulation looks like
So, where do we go from here? Separation of regulatory powers, transparency, consultative processes, greater proactiveness and responsiveness in responding to consumer feedback – all noble ideals, in fact, necessary conditions, yet mere band-aids on a gaping wound. For example, RBI’s mandate is not really fintech regulation – along with the separation of powers, it is also a question of capability and expertise. So, the calls for a separate fintech regulator are sound in logic but ignore the fact that despite having a separate regulator, SEBI, for stock markets and mutual funds, we haven’t seen less of a disruption in this sector. What we need is a fundamental rethink of our approach to fintech regulation. It’s time to embrace innovation, develop expertise, build guardrails, not roadblocks and think outside the box.
For instance, OTPs are not the only method of two-factor authentication. Recognising this opens up the field for a lot of innovation. Could we also please modernise the settlement and reconciliation processes, which are still file-based mechanisms, and not api-based in today’s world? We need more private, agile entities running the backbones of our fintech system to drive scale and innovation. In a recent Bank for International Settlements (BIS) working paper, Nandan Nilekani and others propose the “concept of the ‘Finternet’ as a vision for the future financial system: multiple financial ecosystems interconnected with each other – much like the internet”.
If this is our vision, it cannot be accompanied by a regulatory system which is archaic in its rules and functioning.
In conclusion, the journey through the regulatory minefield is fraught with peril, yet it is not without hope. By embracing transparency, collaboration, and innovation, India can chart a course towards a brighter future.
(The writer is research scholar at the Takshashila Institution, Bangalore)
