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

RBI Issues Draft Framework For Live-Testing Of Financial Services Products

The Reserve Bank of India has proposed to set up a regulatory sandbox for financial services providers and technology companies to live-test new products in segments such as retail payments, money transfer, data analytics and artificial intelligence, among others, before they are launched in the broader market.

Fintechs, traditional financial service providers and customers (end-users) can conduct field tests on a new product in a stable and controlled environment, while collecting evidence on its benefits and risks, according to the banking regulator’s draft framework.

This comes after a working group set up the RBI earlier this year recommended introduction of an appropriate framework for a regulatory sandbox within a well-defined space and duration where the financial sector regulator will provide the requisite regulatory guidance, so as to increase efficiency, manage risks and create new opportunities for consumers.

There are three objectives for setting-up a regulatory sandbox:

  1. Companies can address a relevant regulatory barrier that prevents their product/service from being deployed at scale.
  2. Participating entities can demonstrate that their “genuinely innovative and significant” product or service requires regulation, which may be absent at present.
  3. Entities can show that the proposed innovation will ease or effect the delivery of financial services in a significant way.

The RBI’s fintech unit will oversee the sandbox process, including the testing of products and services by eligible entities, the draft framework said.

RBI Issues Draft Framework For Live-Testing Of Financial Services Products
RBI Issues Draft Framework For Live-Testing Of Financial Services Products

Design And Eligibility

At the outset, the RBI’s draft framework proposed to create a few cohorts, or end-to-end sandbox process(s), with 10-12 selected entities in each cohort, during the stipulated time period.

Participating entities need to be incorporated in India, meet the criteria of a startup as per the government’s definition, have a minimum net worth of Rs 50 lakh, submit CIBIL score or equivalent of the promoter/directors and they must provide bank account details, including accounts belonging to promoters/directors of the entity, it said.

In its draft, the RBI said the participating entity must demonstrate that the product/service is technologically capable for deployment in the broader market, that the entity and its product/service complies with consumer data protection and privacy laws or regulations, and that they build adequate cybersecurity safeguards within their IT system.

Applicants, it said, would need to share the results of their proof of concept tests or the results from testing the product or service across different use-cases to be eligible for participation in the sandbox. Also, to limit any losses a customer may incur during the sandbox testing, all entities need to be upfront about the potential risks and limits of any compensation. They will also need to get explicit consent from customers prior to their participation.

Timeline And Conditions For Exit

Each cohort of the sandbox will have to complete five stages, which could last for a total of 26 weeks, the draft said.

These stages include: preliminary screening for four weeks, test design for three weeks wherein outcomes for the test are defined, application assessment under which the fintech unit will vet the test design and propose regulatory changes over three weeks, then testing for 12 weeks during which the fintech unit will collect empirical evidence and finally an evaluation stage for four weeks.

Companies can exit the sandbox when they desire, provided they inform the RBI one week in advance and as long as they fulfill any existing obligation to its customers of the financial service under experimentation.

On the other hand, the sandbox testing will be discontinued any time, by the RBI if the entity does not achieve its intended purpose, or if it is found not complying with the relevant regulatory requirements and other conditions specified at any stage during the sandbox process.

Benefits Of A Regulatory Sandbox

  • A sandbox will provide regulators, customers and companies first-hand empirical evidence of the benefits and risks of new technology solutions in the financial industry.
  • Incumbent financial service providers and new-age lenders, for instance, can improve their understanding on how new financial technologies work and how they can implement or build-on such technologies with their existing business.
  • If any concerns arise about a specific product or service, appropriate modifications can be made before the product is launched in the broader market.
  • For the regulator, a sandbox provides a “structured and institutionalised environment” to learn and understand how new financial technologies are developed, the technological nuances and the impact of the technology on other stakeholders.

Risks And Limitations

  • Regulatory relaxations on a case-by-case basis can involve a lot of time and the system may suffer from discretional judgments. This could lead to consumer losses in the case of failed experiments or losses by competing firms that were outside of the sandbox.
  • As is the standard practice, the central bank will provide the participating entity appropriate regulatory support it needs by relaxing specific regulatory requirements for the duration of sandbox test. But there is that a “successful experimenter” may still require approvals or relaxations even when it is being launched for the wider public.