(REGULATORY SANDBOXING AND ITS POTENTIAL TO HELP IN REGULATING FINTECH)

Over the last decade financial industry, globally, has seen fast growing adoption of financial technology, or fintech. Banks and venture capital funds have made sizeable investments in fintech, reflecting their expectations for substantial change in the industry. Innovation is often ahead of the regulation mechanism existing in the country. Financial technology (Fintech) is one such arena which has seen lot of development in the recent years and financial regulators around the world had been struggling to regulate and make these services risk[1] free without distorting the market. Evaluating whether the current regulatory frameworks may present unintended barriers to fintech innovations. These barriers could inadvertently result in the development of innovations outside the regulated financial industry, creating an unlevel playing field for competitors and potentially exposing financial consumers to unwarranted risk . To bridge the gap between regulation and innovation, many supervisors (regulators) have put in place the initiatives to improve the interaction with innovative financial players with them, one such initiative is setting up a regulatory sandbox.

Regulatory Sandbox provides the testing grounds for new business models that are not protected by regulation or supervised by regulatory authority[2]. The purpose of the sandbox is to match compliance of financial regulations with the pace of the innovation. This has to be achieved in a way that it does not smother the fintech sector with rules but at the same time takes care of consumer protection. For instance, with the aim of becoming the global capital for financial markets United Kingdom came with a report ‘Project innovate’ in 2015 where it explained why a regulatory sandbox was needed. After its implementation in mid-2016, fintech companies around the world from various financial sectors such as insurance, retail banking, retail lending., wholesale etc, presented applications to the FCA. The report sets out the potential benefits of the sandbox such as[3] –

1. reducing the time and cost of getting innovative ideas to market

2. enabling greater access to finance for innovators, by reducing regulatory uncertainty

3. enabling more products to be tested and be introduced in the market

4. allowing the FCA to work with innovators to ensure that appropriate consumer protection safeguards are built into new products and services

The sandbox provides access to regulatory expertise and a set of regulatory tools to facilitate testing. The firm under testing is assigned a dedicated case officer who supports in design and implementation of the test. This helps firms to understand how their innovative business models fit within the regulatory framework and at the same time ensures appropriate safeguards are built into services or products during and after testing. Regulatory agencies provides support, such as, systems penetration testing, or secondary review of robo-advice by qualified financial advisers etc to mitigate potential harm during and after testing.

In order to share their experience, FCA also came out with a lesson learnt report after its first year of operations. According to the report 75 percent of the firms accepted into the first cohort have successfully completed testing, and around 90 percent of firms that completed testing in the first cohort are continuing towards a wider market launch following their test[4]. Most of the firms which got restricted authorization for their test have gone on to secure a full authorization following the successful completion of the test. Obtaining authorization helps firms access funding, hence sandboxing has been beneficial in reducing the constraints to growth and funding.

Similarly, Australian Securities and Investments Commission (ASIC) released a detailed regulatory framework during May 2016 on innovation hub/sandbox which allowed eligible fintech businesses to test certain specified services without holding an Australian financial services (AFS) or credit licence. This allows eligible businesses to notify the regulator and then commence testing without an individual application process[5]. Other countries which have already set upped or announced sandboxes include Singapore, Canada, Republic of Korea, Indonesia, Hong Kong, UAE etc.

FINTECH AND ITS IMPACT ON INDIAN FINANCIAL MARKET

In India, fintech has the potential to provide workable solutions to the problems faced by the traditional financial institutions in terms of low penetration, scarce credit history and cash driven transaction economy. If a collaborative participation from all the stakeholders, viz., regulators, market players and investors can be harnessed, Indian banking and financial services sector could be changed dramatically. Fintech service firms are currently redefining the way companies and consumers conduct transactions on a daily basis.

Some of the major fintech products and services currently used in the market place are Peer to Peer (P2P) lending platforms, crowd funding, block chain technology, distributed ledgers technology, Big Data, smart contracts, Robo advisors, E-aggregators, etc. These fintech products bring together the lenders and borrowers, seekers and providers of information, with or without a nodal intermediation agency.

Financial institutions are seeking to increase their knowledge in relation to technological innovation, both through partnerships with tech companies and by investing in or acquiring such companies. Despite this, there are wide differences in the preparedness of market participants for these changes in practice.

RBI in their report has expressed their concern with respect to fintech development in country. The multiplicity of firms and a mosaic of business models complicate the classification of the various types of activities, products and transactions covered under the fintech spectrum[6]. Currently in India right now fintech risks are being looked at more in terms of its association with the traditional IT systems, such as cyber-security risks. While the IT related risks are no doubt multiplying manifold under fintech, the whole gamut of issues under the fintech umbrella, particularly those of regulatory concern, have to be responded to on priority. It is, therefore, necessary to examine these issues and outline the contours of an appropriate regulatory strategy. RBI in its report on fintech and digital banking has recognized the potential benefit of using regulatory sandbox

With cryptocurrency, and blockchain technology like innovations knocking the door of the Indian market, India should be ready to adapt its regulatory framework according to the changing global financial market. Setting up a regulatory sandbox will enable to tap into the immense potential of fintech in India and also help in reaching the goal of financial inclusion.

Recently RBI has announced the setting up of regulatory sandbox for financial technology and setting up data science labs to keep pace with innovation in the digital lending space. It has set up an inter-regulatory working group to study regulatory issues relating to fintech and digital banking in India which recommended Institute for development and research in banking technology to be given responsibility of setting up such labs[7]. Some of the issues which RBI might have to deal with before and after setting up the regulatory sandbox are –

1. The selection criteria for firms which will be taken into sandbox testing

2. The kind of competition issues (like abuse of dominant position, advantage of being first in market, monopolies etc) which can arise when firms are given authorization to operate in market after successful completion of the test.

RBI should come with a guideline and ensure enough safeguards are provided through regulations in order to prevent any distortions in the market due to these innovations.

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[1] https://www.bis.org/bcbs/publ/d431.pdf

[2] https://www.bbva.com/en/what-is-regulatory-sandbox/

[3] https://www.fca.org.uk/publication/research-and-data/regulatory-sandbox-lessons-learned-report.pdf

[4] https://www.fca.org.uk/publication/research-and-data/regulatory-sandbox-lessons-learned-report.pdf

[5] https://rbi.org.in/scripts/PublicationReportDetails.aspx?ID=892#4.2

[6] https://rbi.org.in/scripts/PublicationReportDetails.aspx?ID=892#5.1

[7] https://economictimes.indiatimes.com/industry/banking/finance/banking/rbi-to-form-regulatory-sandbox-for-fintech-set-up-data-science-lab/articleshow/65894188.cms