RBI Governor Shaktikanta Das recently gave a speech at the Financial Express Modern BFSI Summit in Mumbai. Das discussed the ongoing technological disruptions in the financial sector, and how the disruptions are creating new opportunities for the financial sector. The opportunities have led to emergence of new banking models which are posing challenges for regulators.
Historically, finance has always been influenced by technological developments. In finance, information is critical as it helps in screening lenders/borrowers and trading in financial assets. Technological developments that enable faster flow of information have always found early adoption in finance. Whether it is communication technology such as pigeons or telegraph, or travel technology such as railways, the financial sector has embraced them with open hands. Hence, it was not surprising to see the financial sector being an early adopter of the computer, the Internet, and advancements in mobile technology.
While it is not really new to see the financial sector applying the latest technology, what is new is how technology is shaping and changing finance and banking, perhaps forever.
Traditional banks are moving away from physical branch banking to digital banking. As per Das, “this paradigm shift has been possible due to innovations in information technology (IT), growth in mobile and internet connectivity, market-based financial intermediation, and the advent of Fintech”.The traditional banks competed over location and customer service in branches. Today the competition is moved to customer services over apps and other digital interfaces.
Technology has allowed fintechs to offer financial services. The fintechs are technology specialists such as mobile companies, software companies, and so on, which leverage their technical skills to offer superior financial services than traditional banks. In particular, fintechs have innovated significantly in the space of payments and small ticket loans to financially excluded populations.
There are few very large technological companies called BigTech, which offer fintech experience at a much larger scale. The major BigTech players are Amazon, Google, and Alibaba. While fintechs are mainly complementary to traditional banks, BigTechs threaten the traditional banks as they have the ability and capability to offer comprehensive banking services at a global level. Both fintechs and BigTechs use artificial intelligence (AI) and machine learning (ML) models to analyse data about potential borrowers from a wide range of traditional and non-traditional sources of data.
Technology has created another banking model named Decentralised Finance (DeFi). DeFi is a platform which brings together lenders and borrowers, and there are no intermediaries. Traditional banks and to an extent fintechs and BigTechs screen borrowers by capturing information about them. DeFi is based on blockchain where information about lenders and borrowers is not available as it is hidden behind cryptographic digital signatures. Thus, DeFi platforms rely on collateral to align the incentives of borrowers and lenders.
Das mentioned that there are three approaches to regulation. First is activity-based regulation, where all the entities are regulated irrespective of their legal status. For example, commercial banks and large cooperative banks/non-banking financial companies are regulated similarly irrespective of their legal status. Second is entity-based regulation, where regulations are applied to licensed entities or groups that engage in similar and specified activities. For example, commercial banks and co-operative banks will be regulated separately. Third, is outcome-based regulation, which sets some basic, common, and technology- or business model-neutral outcomes for the regulated entities.
He mentioned that for regulating fintechs, the RBI follows a hybrid approach of activity-based and entity-based regulations to ensure entities grow in an orderly fashion.
The RBI has not allowed BigTechs to offer banking services barring payment services. Having said that, there was a recent tie-up between Equitas Small Finance Bank and Google Pay wherein the latter’s subscribers could move their savings to the former and earn an interest. In a way Google Pay started to resemble a payment bank which also takes deposits and offers payment services. Technology has broken traditional boundaries and it is not clear for how long RBI can prohibit the BigTechs from offering financial services.
DeFi is still in nascent stages in India, but one has to still think about regulating these entities. Das says the DeFi model poses unique challenges as there is anonymity and lack of a centralised governance body. He suggests the need for a ‘globally co-ordinated regulatory approach and inter-regulatory co-ordination’ to enable comprehensive assessment of Defi activities and mitigation of their risks.
Early 20th century political economist Joseph Schumpeter famously wrote that creative destruction is an essential feature of capitalism where the new products and processes replace the old ways. We are seeing Schumpeterian creative destruction replacing the old ways of functioning in the world of business and finance. As the creative destruction process is underway, there is tremendous uncertainty for both the players and the regulators.
The core function of banking will remain, but the way we understand a bank in terms of branches and bank officers, is going to change forever. The changes will pose threats to financial stability, and regulators will be required to maintain a constant vigilance.