Mandar Kagade
The Reserve Bank of India (RBI) released the “Draft Enabling Framework for Regulatory Sandbox” last week. The concept of a sandbox, first put in place by the Financial Conduct Authority and since replicated in some jurisdictions to promote innovation, means a “safe space” in which businesses can test innovative products, services, business models and delivery mechanisms without immediately incurring all the normal regulatory consequences of engaging in the activity in question. In the Indian context, an RBI working group and the Household Finance Committee chaired by Professor Tarun Ramadorai had recommended the establishment of a sandbox to promote innovation. The framework marks the first formal proposal of how a sandbox might operate in the Indian context and with respect to the activities within the RBI’s remit.
At the outset, RBI’s initiative in promoting innovation is welcome. However, the framework, as it stands, appears to have room for further reform and facilitation. Since the framework is in the draft phase, there is time to improve it in several areas so that it can truly facilitate market-moving innovation.
Critical areas excluded: The framework has proposed a positive list (for activities that can be sandboxed) and a negative list (for activities that may not be sandboxed). One of the salient exclusions is "credit information." It potentially inhibits innovation around leveraging alternative data (like utility/telecom payments) as “credit information” (for discerning creditworthiness). Given that credit remains under-penetrated in our economy, (a recent study released by Omidyar-BCG estimates that 40 percent of the MSME lending is through informal money markets), this exclusion will foreclose innovation where we need it the most.
Eligibility thresholds need to be inclusive: As drafted, the eligibility to be included in a sandbox is restricted to start-ups per Department of Industrial Policy and Promotion definition. This excludes innovation of a collaborative nature between incumbents and start-ups. A huge swathe of work today happens through strategic partnerships. The first wave of fintech brought out the “disruptive innovation” narrative. As the sector matured, it became apparent that at a steady state, innovation would require partnerships between incumbents and start-up fintech companies. Unbundling has given way to an ecosystem approach with “bank-as-a-platform” thinking where banks facilitated specialist services to plug in through APIs. The framework ought to reflect that reality.
No legal waivers: The framework highlights that one of the limitations of the sandbox may be the inability of RBI to offer any legal waivers. Since regulatory relaxation appears to be a necessary condition for a sandbox experiment and it is a form of (limited) waiver, it is not clear what is intended to be covered by the expression, “legal waiver”. It is important that RBI clarifies what is the legal relaxation fintechs would be offered during the sandbox period. The Consumer Finance Protection Bureau issues a “No Action Letter” to an entity in a sandbox that offers the latter protection against any adverse regulatory action during the period of the sandbox. Remarkably, the framework has not adopted the “No Action Letter” language. Certainty a ring-fence would be of critical importance if the regulatory sandbox framework is to facilitate innovation.
Fit and proper criteria: The applicant is required to demonstrate that the product is technologically ready to be deployed in the broader market. The stipulation that the applicant demonstrates the product is ready to be deployed at scale is akin to putting the cart before the horse. Notice that an applicant would only seek registration in a regulatory sandbox because a current regulation is inhibiting a given product/service from being produced/supplied; (or in a scenario where the regulatory framework is absent altogether given the novelty). Absent regulatory relaxation/ clarity, a start-up would find it very difficult to find venture capital investment. And absent the investment, it would be virtually impossible for a start-up to develop the technology to a stage where it is readily deployable. Thus, this condition appears to impose a significant and unfair burden on start-ups and ought to be removed.
Furthermore, one of the requirements seeks a “satisfactory” CIBIL or equivalent score of the applicant's promoters/ directors. To the extent truly market-moving innovation (disruptive innovation) is likely to come out of Indian Institutes of Technology hostel rooms whose founders may not have a credit history, this stipulation is unduly restrictive. There are other ways in which an entity's (applicant's) risk towards its counterparties and consumers can be secured. One is already hard-wired through net-worth Rs 5 million requirement.
Confidentiality: The framework has proposed that the RBI may require the applicant to share PoC results and through the Fintech Technology Unit monitor the empirical results during the testing. The draft offers no clarity about the confidentiality of this data. Alarmingly, the framework proposes that RBI: “reserves the ‘right to publish any relevant information...including for the purposes of knowledge transfer…” Start-ups invest resources to come up with their secret sauce and there are good social reasons for letting them retain confidentiality around their secret sauce. Language, as occurs in the disclosure section, is too wide including especially the knowledge transfer wording. A sandbox is not a mechanism for "socializing" business know-how. The aforementioned language may, therefore, ex-ante chill the incentives of a start-up to register in the sandbox. For that reason, it ought to be watered down / removed altogether.
(Mandar Kagade is Head, Public Policy & Outreach at RupeePower. Views are personal)
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