Reserve Bank of India Centra Office Building, Shahid Bhagat Singh Marg, Mumbai.(Photographer: Prashanth Vishwanathan/Bloomberg)

Are RBI’s Regulatory Sandbox Proposals Too Restrictive?

The Reserve Bank of India’s proposals to spur innovation in financial technologies may end up excluding smaller startups and discourage those who cannot take on legal or customer liabilities that may emerge during early testing of a product.

The draft guidelines for a ‘regulatory sandbox’ were released by RBI on Friday after consultations which have lasted more than two years. A ‘regulatory sandbox’ is a commonly used framework which allows innovators to test products and services without regulatory restrictions for a period of time.

While experts and executives at fintech firms welcomed the setting up of a sandbox in India, they pointed to certain proposals as being restrictive. Among them are the entry barriers, the lack of legal protection and the RBI’s decision to discourage innovation in certain areas like credit information and crypto currency.

Entry Barriers

According to the draft proposals, entities that meet the Government of India’s definition of a startup will be eligible for entry into the sandbox. The government defines a startup as an entity which is upto 10 years old and whose turnover has not crossed Rs 100 crore.

A minimum net worth criteria of Rs 50 lakh has been set. In addition, “applicants should demonstrate that their products/services are technologically ready for deployment in the broader market,” the proposals said.

Raj Chowdhury, managing director of HashCash Consultants, a blockchain consultancy told BloombergQuint that the criteria may exclude smaller innovators.

For any sandbox the entry criteria should be on the merits of the product or solution, after which conditions like net worth should be looked at. Individual entrepreneurs, that maybe have 2 to 10 employees, who are drivers for innovation in the fintech space may be excluded.
Raj Chowdhury, Managing Director, HashCash Consultants

While excluding small firms, the proposals will also limit the ability of incumbents, which fall beyond the definition of startups, to participate in live-testing of innovative financial products.

Mandar Kagade, a fintech policy consultant, cites the example of Hong Kong, where banks and their partnering technology firms are allowed to operate within the sandbox. Limiting the participating firms based on the government’s definition of startups could exclude payment firms like Visa and Mastercard or even major fintech players like PayTm and Freecharge.

The RBI’s proposals go on to say that cohorts, or groups of entities working in a similar area, would be created. Vivek Belgavi, partner and fintech leader at PwC said that additional clarity may be needed on the selection process for each cohort, beyond just the net-worth and ‘fit and proper’ criteria.

No Legal Support?

Another significant concern is the limited legal support suggested in the RBI’s draft circular.

“The RBI or its regulatory sandbox cannot provide any legal waivers,” said the draft. It further added that liability for customer or business risks shall devolve on the entity entering the RS.

This is antithetical to the spirit of a sandbox environment, said Tarun Ramadorai, Professor of Financial Economics at Imperial College London. “The question is whether the RBI Act permits legal waivers. This may be a jurisdictional issue. So securing the necessary powers or clarifying the limits of regulatory waivers that RBI can issue seems important,” Ramadorai said.

A committee on household finance, headed by Ramadorai, had suggested a sandbox to encourage financial innovation that will benefit households as part of its report in 2017.

Ramadora said the draft seems conflicted on the issue of any liabilities that may arise from customer losses during the testing process. The ‘boundary conditions’ listed for the regulatory sandbox suggests limited liability with a cap on customer losses, Ramadorai pointed out. “The document seems internally conflicted on this issue.”

Should the issue of liabilities emerging from testing not be resolved, startups may be reluctant to take on risk, said Ajit Kumar, chief executive officer of RupeeCircle, a peer-to-peer lending platform. “No startups would want a situation where they find themselves in a legal soup because of the experiments they do under the sandbox especially when the RBI will not protect them,” Kumar said. He added that the RBI needs to provide more details on how entities must deal with financial losses for customers’ or data protection issues.

Belgavi, however, felt that consumer rights would need to be protected even under a regulatory sandbox. It would be difficult for regulators to underwrite that risk, he said.

Protection Of Intellectual Property Right

Kumar also noted that there is no intellectual property protection under the draft guidelines, which will make startups reluctant to participate. This may be particularly true for those who don’t have patents on their product.

“Without this protection the sandbox can end up revealing a lot about a startups’ technology solution, which they have worked on for a long time. Hopefully the RBI will include this in the final guideline,” he said.

Ramadorai shared this concern and said that the issue of intellectual property rights and business risk needs to be addressed.

One of the key risks for businesses when entering a sandbox is the leakage of its intellectual property into the public domain. So some safeguards need to be provided out discussed to make this appealing for businesses.
Tarun Ramadorai, Professor of Financial Economics, Imperial College London

Positive And Negative List

The RBI, in its draft, put out a negative and positive list of areas where startups would be encouraged to join the sandbox.

Areas in the negative list include credit registry, credit information and cryptocurrency, crypto asset services, among others.

“One cannot innovate on blockchain in a vacuum. Jurisdictions like Singapore are thinking of blockchain and crypto as an integrated ecosystem. So, RBI is a bit confused to have blockchain in positive list and crypto in negative list,” said Gautam Chhugani, senior analyst at Bernstein.

Ramadorai believed that excluding ‘credit information’ from the innovation list may not be appropriate. “This is one of the key areas (lending using digital footprints) that holds the potential for innovation for financial inclusion. Our report highlights the importance of this area, and it is one of the reasons we propose a sandbox,” he said.

Eventually Chhugani believes that while the sandbox will support innovation, it may not make a substantial difference.

The concept of sandbox has been implemented in many international jurisdictions but we have not seen anything scalable emerge. Usually the best fintech ideas and entrepreneurs get funded commercially by venture capital regardless when they push the regulatory barriers and open new markets and usually regulators respond with a lag. However, the fintech players can help educate RBI better in breaking some regulatory barriers to innovation, KYC etc.
Gautam Chhugani, Analyst, Bernstein