Neobanks are not banks. Why is RBI not clamping down?

Indian neobanks are redefining the way to manage their money, providing user-friendly interfaces, personalised financial insights, and a wide range of banking services without the need for traditional brick-and-mortar branches.

In recent years, the Indian financial landscape has witnessed the rise of “neobanks,” a term that, at first glance, seems to imply that it has been licensed by the Reserve Bank of India (RBI). They are not. The RBI's silence on this matter is widely perceived as tacit approval of these entities using the term “bank” in their names, even though they do not fit the conventional definition of banks.

Indian neobanks, popular with the youth, are redefining the way to manage their money, providing user-friendly interfaces, personalised financial insights, and a wide range of banking services without the need for traditional brick-and-mortar branches. As they continue to grow and evolve, as much as their strong engagement of Indian young demographics, neobanks will play a crucial role in democratising finance, making banking services more inclusive and convenient for a diverse population.

Neobanks, by their nature, operate as consumer-onboarding platforms, providing a range of financial services often accessible through mobile applications. Unlike traditional banks, they do not hold banking licenses, nor do they undertake core banking activities such as lending or risk management. Instead, they serve as intermediaries for licensed banks, facilitating transactions and aggregating various financial products. Neobanks have done well, where the banks have failed — consumer engagement with a good digital interface and ease of product sales. The traditional banks (including the private banks) still struggle to communicate with the younger audience. This is where partnerships with neobanks are helping the licensed banks.

Change The Nomenclature

To eliminate confusion and ensure fairness in the financial sector, it is about time that the RBI restricts such entities from using the term “bank” in their branding and nomenclature. A more suitable designation for these entities could be “digital correspondents”. This change in terminology would better reflect their role as intermediaries in the digital financial ecosystem and avoid misleading the public.

Why is it crucial to make this change? Primarily, it is about building and maintaining long-term consumer trust. The financial sector thrives on trust, and consumers should be able to differentiate between traditional banks and these emerging digital intermediaries. Using the term “bank” inaccurately can erode this trust, leading to misplaced confidence in the services offered by neobanks.

Delaying regulatory action risks exacerbating the situation. Neobanks are swiftly expanding their user base, and their market presence is becoming increasingly entrenched. Some of these neobanks may indeed possess specific licenses to operate within certain segments of the financial market, but it's important to clarify that these licenses do not imply the provision of traditional banking services, adding to the complexity and potential for misunderstanding in the financial landscape.

Allowing this trend to continue without clear guidelines only deepens the confusion among consumers. It creates a scenario where neobanks could potentially gain such a foothold in the market that rectifying their misleading nomenclature becomes far more challenging. Therefore, the RBI’s prompt intervention is not just about protecting consumer trust; it’s also about ensuring a level playing field in the financial sector and preventing potential disruptions down the road. Immediate action is essential to uphold the integrity of the financial industry and safeguard the interests of consumers and licensed banks alike.

Moreover, these neobanks are gaining traction, particularly among Gen Z and tech-savvy consumers. Gen Z, who are often early adopters of digital financial services, should not be lured into transacting with neobanks under the false assumption that they are dealing with established banks. Importantly, this consumer set is the large majority of our population and forms the core of the future of banking customers.

Secure Consumer Data

The RBI should be deeply concerned about how neobanks handle the sourcing and storage of consumer data, even when they are not regulated entities. Does the consumer data reside with them, or does it exclusively reside with the banks with whom they have partnered? Data privacy and security are paramount in today’s digital age, and neobanks, although not traditional banks, have access to sensitive consumer information. Unregulated practices in data management can pose significant risks to consumers, including potential breaches and misuse of their personal information.

If we envision a future where digital-only banks play a significant role, it is imperative to establish strong regulatory frameworks and robust licensing procedures for neobanks now — including clear regulations and fitness criteria that these entities must meet, along with a stringent code of conduct. Such measures are essential not only to maintain market equilibrium but also to protect consumers, fostering a financial environment where innovation thrives without compromising on safety and accountability.

The loose usage of the term “neobanks” should not be allowed to mislead consumers. It is crucial to act swiftly if we wish to prevent a generation of young Indians from growing up with the mistaken assumption that neobanks inherently possess regulatory approval for their services. Clarity in regulation and terminology is the foundation upon which trust and transparency in the financial sector must be built.

Srinath Sridharan is author, policy researcher and corporate advisor. Twitter: @ssmumbai. Views are personal, and do not represent the stand of this publication.