Self-regulation useful tool for setting rules for fintechs: RBI's M K Jain

The central bank's deputy governor says RBI has endeavoured to find a middle ground trying to balance between the innovation brought by fintechs and the unique risk they introduce

The country's fintech sector should attempt to organise itself under a self-regulatory organisation (SRO) that monitors the conduct of member fintech entities. This approach can help protect consumer interest and improve governance standards in fintech entities, said M K Jain, Deputy Governor, Reserve Bank of India, on Friday.

“From the fintech sector perspective, self-regulation can be a useful tool for setting and enforcing rules.” he said at the International Research Conference on FinTech: Innovation, Inclusion, and Regulation at IIM Ahmedabad. “The role of an SRO can include setting the standards for conduct as well as acting as a bridge between the sector and the regulators. Regulation is merely a guard rail to keep the sector on the right path,” Jain said.

The RBI had, in its digital lending guidelines, mooted the idea of setting up an SRO covering regulated entities and digital lending applications (DLAs)/loan service providers (LSPs) in framing a code of conduct for recovery and a model standardised LSP agreement for balance sheet lenders, among other things. Currently, there are two bodies – Digital Lenders Association of India (DLAI) and Fintech Association for Consumer Empowerment (FACE) – that are eyeing the SRO tag in this segment.

India has the world's third largest fintech ecosystem. So far, RBI has taken a balanced approach on regulating the fintech sector. It has endeavoured to find a middle ground trying to balance between the innovation brought by fintechs while addressing the unique risk they introduce.

Any approach to regulate the fintech sector will invariably be based on five fundamental objectives – financial stability, consumer protection, financial system integrity, competition, and orderly development, Jain said.

According to Jain, at one end of the spectrum, there is the hands-off approach that advocates allowing the sector to develop freely and develop without any regulatory intervention. While this harnesses innovation, it risks the possibility of failing to protect the financial system and customers from adverse outcomes.

At the other end of the spectrum, there is a status quo approach that aims to maintain the existing framework, without any relaxations to cater for new developments. Under this approach, fintech products and services are regulated in the same way as traditional financial products or services. From the perspective of controlling risks, it may appear to be the best approach as it applies tried and tested regulation. However, the benefits of innovation may be lost.

Jain said, from a regulatory perspective for fintechs, there are risks associated with financial stability, market integrity, and customer protection. For example, fintechs operating on the lending side have spurred the availability of unsecured loans globally. Such loans are often driven by machine learning models. However, effectiveness of these models for delinquencies has not been fully established, especially during an economic downturn. Any significant failure of these models will not only be limited to new entrants but will also impact regulated entities with exposure to them, he said.

According to Jain, use of models also brings the question of fair treatment in the extension of credit. It is necessary that highly aggravated fintech business models for decision making take care of the requirement of fairness through additional procedures, controls, and safeguards both in the development and deployment of models and also in the final decision making.

Jain said that fintechs need to be conscious with customer protection and that is where RBI is finding gaps in the Indian operating space. Mis-selling, frauds, or misconduct by fintechs may harm the very consumers they wish to serve. The careful management of this risk is crucial for the sustainable development of the fintech sector.

While regulators are always worried about customer protection, fintechs should even be more aware, vigilant, and proactive in ensuring that the bedrock of their business remains protected, he said.