FinTech: To Regulate Or Not To Regulate? Former RBI Deputy Governor R Gandhi Explains

The traditional banking sector has had a new irritant to deal with in recent years. Smaller, nimbler, unregulated financial technology or fintech firms, which claim they can do some parts of banking even better than banks.

While still small, fintech firms have made their presence felt in a number of areas. In lending, peer-to-peer lenders and online SME (small and medium enterprises) lenders are targeting clients considered too risky by banks. They claim to use technologies that can assess credit worthiness in smarter ways than the traditional income statements used by banks. In payments, wallet companies have taken the lead in retail payments forcing banks to up their game.

One gripe that banks have is that these fintech firms are getting away unregulated, which gives them a lot more flexibility in how they do business.

That’s true for now, said R Gandhi, former deputy governor of the Reserve Bank of India (RBI) who retired after a 37-year stint at the central bank earlier this month. The dilemma for the regulator is to decide when to regulate and how to regulate so as to ensure that innovative business models get a fair chance, Gandhi explained in an interview with BloombergQuint on Tuesday.

Gandhi draws a parallel to the development of the microfinance industry.

In the early years of the emergence of the industry, the RBI allowed it to grow unregulated. That was a conscious choice made by YV Reddy, then governor of the RBI. However, as the industry grew in scale and certain malpractices started to come to light, the regulator raised concerns. Finally in 2012, microfinance was officially brought under the RBI’s purview but only after a massive crisis had erupted in the sector.

Could segments of fintech, like peer-to-peer lending, go the same way? Gandhi doesn’t give a clear answer except to say that the regulator can choose between five different regulatory philosophies – totally ignore, totally block, active regulation, passive regulation and catalytic regulation.

“We are at that stage where we need to make that call,” Gandhi says.

During Gandhi’s tenure, in April 2016, the RBI issued a discussion paper suggesting some checks and balances for peer-to-peer lenders who essentially connect borrowers with lenders. The RBI suggested a minimum capital requirement of Rs 2 crore for these companies and said that a leverage ratio may be prescribed. No cap on rates or lending amounts was proposed. The regulator, however, said that prudential limits may be considered.

A final set of regulations is still awaited.

Bitcoin: Ripe For Regulation?

One area where authorities seem to be closing in on some form of regulation is virtual currencies. The RBI first cautioned users against Bitcoins in December 2013. The central bank put out a simple advisory saying that Bitcoins are not authorized by any monetary authority and that users should deal in these virtual currency units at their own risk.

Since then a number of similar advisories have followed but no regulation has been put in place. On Wednesday, a statement from the Finance Ministry said that a committee is being set up to “examine the existing framework with regards to virtual currencies.” The committee will look into issues related to consumer protection and money laundering among other things.

When asked whether there was growing concern around the use of Bitcoins, Gandhi said that there have been an increasing number of reports of Bitcoins being used for illegal activities.

While the regulatory discomfort with Bitcoins is growing, there is a recognition that the underlying technology of blockchain can be put to use in other areas of banking.

“Blockchain as a technology can be utilized for a lot of purposes,” says Gandhi while adding that trials have been underway at the Institute for Development and Research in Banking Technology (IDRBT). The idea is to identify areas where blockchain can be used.

But even that will take time, says Gandhi, countering the surge in optimism around the use of blockchain in banking services.

“It’s a new technology so you cannot expect it to come tomorrow itself. Banks’ existing systems should become obsolete before new systems are brought in. It’s a cost-heavy operation to replace these systems.”

Innovation vs Experimentation

While Gandhi is open to allowing innovative business models to grow before they are regulated, he is not in favor of unfettered experimentation.

When asked about the globally popular ‘Sandbox’ concept under which fintech firms are allowed to test innovative technologies, Gandhi questioned whether this is appropriate for an industry where money is involved.