Opinion: Influence, not just regulate
Regulation must have a bias towards financial innovations for general prosperity
By B Sambamurthy
Hyderabad: Thanks to homegrown innovations by fintech and Big Tech, hundreds of millions of underserved and unserved people are provided access to the formal financial system. Over 260 million users on the UPI platform, over 400 million Jan Dhan Accounts, and over 110 million demat users are some of the outstanding successes of our digital journey in the financial sector. We just leap-frogged.
This exponential growth is achieved on the back of superior customer experience and customer empowerment. Super convenience, speed, lower costs, ease of access are the hallmarks of customer experience.
Technology is democratising and decentralising finance and inclusive growth faster than ever. We are now in an era of banking as a service. You are just an app away from access to an array of financial services. The fintech in India has created a number of Unicorns/Decacorns and attracted a lot of FDI.
Why Regulate
This begs the question “Why then regulate fintech and Big Tech in financial services?” Financial stability is top of the mind for regulators. It is also important to remember that the direct or indirect outcome of fintech innovation is a financial service/product and no amount of fintech washing would take away this essential characteristic and the need for similar regulation.
Prof Knut Blind, Chair of Innovation Economics at Berlin University, and several others, present evidence on how technological innovations have an economic, social and institutional impact and argue that regulation will influence innovation.
Mitigating Monopolies
There is a concentration issue in the UPI ecosystem. The top three players control over 90% of the UPI market share squeezing out small but nimble players. It is instructive to note that the UPI software is actually built by a small company, not any Big Tech. There is a need for more new players with new innovations so that the active user base can be enhanced from the current 300 million to at least 800 million.
Winner takes it all is a phenomenon of the tech economy which leads to monopolies. This needs to be mitigated. The network effect is a double-edged sword – helps blitz scale and also creates monopolies. We need new monopoly laws for the digital world.
Social, institutional Impact
On the social impact side, there are issues concerning harm to consumers like lack of transparency, coercive practices, debt trap, increasing frauds (over 2 lakh frauds per month in payments only), mis-selling of products and services abd data thefts that make out a strong case for regulation. Buyer beware will not work in the midst of high digital and financial illiteracy, especially among vulnerable sections. The regulator needs to identify vulnerable drivers and protect them from harm. Another challenge is to regulate the impact of AI/ML tools to ensure they are free from biases and data poisoning.
Innovations also impact institutional structures. RBI Deputy Governor Rabi Shanker has flagged this issue: “We cannot afford to let loose DeFi technologies on financial institutions with virtually no understanding of how a bank-less system would operate.”
Bank Runs, Digital Finance
The collapse of Silicon Valley Bank and a few others demonstrates how digital finance and de-regulation are a deadly cocktail. Thanks to the digital channels, SVB depositors withdrew nearly 40% of its deposits in a matter of few hours leading to the fastest bank collapse. Globally, there is a serious revaluation of digital banks/finance.
Given these varied, if not contesting demands on regulation, what are the options before the regulators and the government without constraining purposeful, responsible and beneficial innovation? Let us look at various regulatory models to achieve these objectives.
* FEDAI/IBA: Self-regulation, co-regulation and statutory regulation frameworks evolve and co-exist. Self and co-regulation help promote good conduct by the players and supplement statutory regulation. Co-regulation promotes competition. FEDAI (Foreign Exchange Dealers Association of India), a self-regulatory/co-regulatory body, working closely with the RBI, played an important role in the design and delivery of reforms of forex markets during 1990. It was also a good sounding board for regulators. IBA (Indian Banks’ Association) too is playing a similar role. In fact, the guidelines of these self-regulatory organisations (SRO) are as good as statutory rules. These offer useful lessons. The NPCI, though an operating agency, provides another model of self and co-regulation.
* Rule Vs Principle: Regulations cannot evolve at the speed of technology and as such highly prescriptive rules stymie innovation. Principles-based regulation gives space for innovation, especially for early-stage startups and also helps regulators come to grips with the fast-evolving system. Close engagement with SRO and regular feedback/guidelines will help. It will be more outcome-based rather than activity-based.
*Proportional regulation: Given the fact that over 2,000 fintechs are in various sizes, stages, scales and scope, a proportionate regulation may address the issue and help mitigate regulatory and compliance burden on early-stage and smaller fintech. The fintech universe may be put into three-four buckets for differential regulation. Another debate is entity Vs activity-based regulation. It needs a blend of both. It is essential to capture macro-prudential risks like governance and operational resilience.
In this fast-evolving technological progress, it is not easy for a regulator to always take timely and right calls. They should not be shy of experimentation with sufficient guardrails, especially in unknown space. Maybe the RBI and other regulators have to reassess their (mix) resources to navigate the digital economy for faster growth and general prosperity.
Data Economy
The enactment of the Data Privacy and Protection Act will support a sound regulatory environment. We need a policy on data economy and data markets that helps both big and small to innovate. The policy must not be defensive and inward-looking. Runaway success of the UPI is as much about the regulatory principle of interoperability, public good as technology. The ecosystem is brilliantly orchestrated by the not-for-profit NPCI. This is a unique feature of India. Europe and the UK are now mooting international interoperability.
There is no global consensus yet on tech regulations. It is laissez-faire in the US, robust (restrictive?) frameworks in Europe, government vagaries in China. In all three jurisdictions, digital financial services are flourishing. Each country must develop a regulatory system in light of its own objectives.
Ring-fence Social Media
Social media platforms pose, at times, social, cultural and political stability risks. These platforms are now active in financial services. The financial and social stability risks only get amplified. Regulators need a playbook to ring-fence and mitigate these risks. Locally created sector-specific subsidiaries may mitigate these risks. Regulation and development are two sides of the innovation coin. Regulation must have an innovation bias and provide buffer zones for open experimentation.
Digital players need to recognise that regulation enhances much-needed citizen trust and bestows legitimacy on businesses. This avoids surprises both for investors and consumers. Our digital financial services are at a tipping point. Regulatory and development policies must be aimed at creating a new Digital Financial Architecture. Technology innovations create both utopian and dystopian narratives and ChatGPT is the latest example. A smart regulator stands between the two by influencing innovations.
To say the least, regulation must facilitate and influence innovation for general prosperity.
We are well-placed to take forward the Bali Fintech Agenda 2018 and present India Digital Finance Architecture-2023. This may be India’s contribution to G20 Presidency.
