How two RBI circulars could impact fundraising in fintech space going ahead

Fintechs have to read the regulator better even as the sector improves the quality of data on offer

Ask Vinayak Burman, founder and managing partner of Vertices Partners, a law firm, how deep the cut will be for Indian fintech’ fund-raising, and he says: “They will be compelled to revisit their business models. Higher scrutiny prior to deal closures is expected.” Fintechs have had a bull run. According to Bain & Company (India Fintech Report 2022: Sailing Through Turbulent Tides), they have guzzled $35 billion since 2000. An estimated $8.4 billion will flow in 2022 — healthy, but lower from the $10 billion in 2021.

This fall of $1.6 billion may have otherwise been viewed as a blip, but for two key Reserve Bank of India (RBI) circulars in play now — pre-paid instruments (PPIs) are not to be funded from credit lines from shadow banks (issued on June 20) and tighter digital lending norms (August 10).

Few will go on record that the funding tap will not flow as before; and private equity (PE) investors have started to ask hard questions of fintechs on their level of compliance with the RBI guidelines. An internal survey by the Fintech Association for Consumer Empowerment (FACE) in collaboration with the Center for Financial Inclusion (CIF), an independent global think-tank, reflects the sombre mood. 

Respondents (that is, fintechs which are in the lending business) ranked funding third in their list of risks; compliance came in fourth, with regulation in the sixth spot. Basically, capital and what the RBI does or doesn’t do from hereon, will be a big variable. (The yet-undisclosed FACE-CIF survey — Risk barometer: Understanding the perception of risks in the fintech lending sector, November 2022 — has been reviewed by Business Standard.)

Worse still, there’s no clarity on the amount of capital riding on fintechs; or an official aggregate of their assets. All data-tracking is proprietary — as consultancies or PE firms do it, but this can’t   substitute what is to be captured by the regulators; it’s basically a compilation. Again, a host of fintechs play off only equity capital and are also not regulated by the RBI even though raw data may have been reported to the Securities and Exchange Board of India (Sebi).

“The opacity of startup investment data is a challenge,” says Naveen Surya, founder of the FinTech Convergence Council, and chairman emeritus, Payment Council of India. Investments flows in from PEs, venture capital, angel networks, family offices, friends and family network besides debt from legacy regulated entities. “Granular data is not available like in the case of bank credit, and there’s no agency tracking this in a consolidated manner like we do for foreign direct investment, or trade,” he adds.

Legal definition

Nor do we have a legal definition of what a fintech is in the first place! Even the RBI’s Report of the Working Group on Digital Lending including Lending through Online Platforms and Mobile Apps (November 18, 2021) is silent on this aspect. It merely says fintechs are “a broad category of software applications and different digital technologies deployed by the intermediaries that provide automated and improved financial services competing with traditional financial services.”

The definitional issue had figured in discussions with the RBI’s newly-minted Department of Fintech. The saving grace is that no legal definition exists in any financial jurisdiction in the world.

“I would like to put it slightly differently (not blind spots). The risk appetite of promoters matters. If you believe that as a digital lender, you can aspire for a digital banking licence, then you are positioned on a certain trajectory, and will act accordingly. Now, if it doesn’t turn out that way, you have to rework it,” explains Alok Mittal, co-founder and chief executive officer of Indifi Technologies, a full-stack platform that finances small businesses.

He adds: “To date, commercials are decided between regulated entities (REs) and fintechs. Now, if the regulator has a view on the risk aspects of it, then naturally, the commercials will have to be rethought of. And it will have an effect on funding.”

Ajay Garg, founder and managing director of Equirus Capital reckons that “fintechs which were offering a quasi-credit card proposition, will be most impacted; and digital lenders will be affected on the commission and charges they get from REs, as the latter have more bargaining power.” He is categorical that “there seems to be a concern at the regulators’ end that digital intermediation can come in the way of the understanding of the end-use of funds, and gaps in the data with the credit bureaus.”

Regulatory blind spots

It’s turning out to be messy. The ambiguity around the applicability of the RBI circular which prohibits the loading of PPIs with credit lines is seen as a one of the key regulatory blind-spots affecting fintech promoters. “It’s not clear if the intent of the RBI is to keep open credit lines as a source of funding for PPIs when they are issued by approved or authorised by banks, or whether it applies to all entities,” notes Burman.

All of this means that fintechs and PE firms have to read the RBI’s moves better, even if it does not directly concern them. They should have taken their cue from RBI’s cutting of the regulatory arbitrage between banks and non-banking financial companies, and the tightening of the governance code at both private banks and urban co-operative banks.

Or, the fact that marquee names such as HDFC Bank, MasterCard International, American Express and Diners Club International had over the past two years been at the receiving end of the RBI’s displeasure. (However, it’s back to business now for the aforementioned players.) Had fintechs paid heed, it would have been evident that it was only a question of when the central bank would move in on them, partying as they were on regulatory arbitrage.

And just two months before the working group’s report had made clear the emerging regulatory landscape, RBI deputy governor T Rabi Shankar had been equally explicit (September 28, 2021): “It’s virtually impossible for legislation to keep in step with the fast-mutating fintech landscape. Until legislation catches up, regulation has to adapt to ensure that the financial system absorbs digital innovation in a non-disruptive manner.”

That speed-breakers will be in play was also made explicit: “Regulation is sometimes defined as the process of slowing down change to give time for a system to adapt and evolve. The job of the regulator is not easy when a given financial service, performed by well-regulated financial firms, changes to include non-financial firms in a constantly reconfiguring financial value chain.”

As things stand, a few billion dollars which are riding on select fintechs will be stuck given that Sebi is weighing fresh pricing regulations for their initial floats. Both fintech promoters and PE firms will have to grin and bear it in the interim, even though they may turn wistful while looking at the private market valuations that have been bandied about so far.