As India’s Fintech Reaches Inflection Point, Is There a Need to Regulate?

Proactive compliance and regulatory engagement will bring distinct advantages and not hamper the growth of financial technology platforms.

India's fintech revolution is only getting started. Credit: Reuters

India’s fintech revolution is only getting started. Credit: Reuters

“Disruption” is often used as a generic term to describe cases where smaller companies with fewer resources are able to successfully challenge established incumbent businesses and upset the status quo. A case has been made that it brings visibility to an enterprise, but in my experience, disruption is far more nuanced and can result from a variety of factors ranging from technological innovation to disintermediation to regulatory arbitrage.

The distinction however, is more than just academic, as knowing the nature of disruption can help in assessing its regulatory viability, sustainability and the ability of the underlying enterprise to retain value.

Fintech disruption

India has a resilient economy that is thriving at the moment with remarkable changes. Combine the economy with the swelling middle class and recent governmental policies, it has certainly increased the demand for financial services in India. Traditional banks that were once sheltered by regulations are now treading in unpredictable waters. And it is the lack of innovation on their part that we see the usage of financial technology growing leaps and bounds. It is given that it is creating significant opportunities for innovators to take a leap of faith in the existing market of the present economy. The comparisons of impact on social behaviour and communication due to fintech can be drawn with the usage of internet and online social networks.

Also, India’s fintech firms are focusing more on untapped customer segments and are certainly fulfilling the needs of the customers. Traditional banks have neglected the SME and retail customer segments. Businesses with unfavourable financing requirements from traditional banks have turned to not-so-traditional lenders for funding. This under-developed consumer banking system has paved the way for the fintech firms to approach unbanked populations who are seeking better offerings.

Although there is a certain lack on the investing front for the fintech firms to thrive but these fintech hubs are strategically located near top universities to give them an edge when sourcing for talent. And the developing technology infrastructure in the country has also given fintech firms an impetus to flourish. Ubiquitous connectivity in major cities and unprecedented changes in the government policies has translated to mature digital penetration where cash is preferred. Now we are on the verge of potentially frog-leaping the era of cash and payment cards to digital wallets like Paytm, Freecharge and Ola Money, fintech firms have led the way in retail disruption.

Last but not least, the readiness on the part of Indians in adopting these products have offered disruptors an opportunity to gain scale. India’s fintech scenario is, therefore, on the inflection point in reshaping the financial landscape.

These are the emerging set of disruptors who are seeking to operate in sectors not usually amenable to disruption by reason of their being heavily and actively regulated. Such regulation is often justifiable in the light of the systemic importance of these sectors and the risks associated with them. This is proving to be a prominent disruption where fintech firms are seeking to facilitate direct small and medium ticket loans to individuals and SMEs through third party lenders. They also seek to facilitate disbursements, repayments and contracting in consideration for service fees.

While their objective is to render payment services more efficiently and to drive loans which are not addressed by existing means, this would require participation by non-traditional lenders, simplified enrollments and lending procedures, and unconventional lending and repayment mechanisms and terms. These fintech platforms may be subject to limitations on interest rates chargeable, prudential and capital adequacy norms for participation in risk, reporting requirements, regulations governing KYC requirements and restrictions surrounding potential enforceability of electronic documentation for recovery. Again, proactive compliance and regulatory engagement will bring distinct advantages.

Also, from a perspective of investors, those investing into potentially disruptive businesses need to be mindful of the nature of the disruption, its long term sustainability and how prepared their potential investee is for regulatory interventions. An analysis of trends from legal issues affecting investments into various sorts of disruptive businesses indicate that it is in the interest of the investors to future proof business models and operations against emerging regulatory changes and trends.

One way this could be achieved is through conducting thorough due diligence (financial, legal and technical) on potential investees with special emphasis on the regulations governing their more entrenched competitors and investee compliance with such regulations. Investors must also analyse investee business operations and put in place suitable processes and documentation to comply not only with best practices but also at the very least with the spirit of applicable rules and regulations. Further, analysing, estimating and classifying risks, and structuring businesses in such manner as to compartmentalise riskier, more regulated portions thereof from the remainder of the their operations will also go a long way in ensuring that the investment into a disruptive business is in the investor’s best interests.

Disruptive operations in highly regulated sectors like financial services are subject to very substantial and proximate regulatory risks. The focus in this nature of investment moves from risk mitigation to risk classification, with the intent being to mitigate the most serious risks first as much as possible. Given the recommendations of Ratan Watal panel mooting an independent payment regulator, expect disruptive behavior in the regulations for fintech in the form of sandbox regulations. It is because some level of regulatory crystal ball gazing is also called for by investors into these sectors.

Therefore given the current Indian strengths in terms of government policies, talent resource pool and the current contribution of the fintech to the economy, there is an opportunity to create best-in-class standards, practices, resources, regulation and technology in order to play a leading role in global as well as Indian development of fintech.

Vaibhav Parikh is part of the corporate-legal team at the Aditya Birla Group.