This article is written by Kalpita Krushnakant Pandit pursuing a Diploma in Advanced Contract Drafting, Negotiation, and Dispute resolution from Lawsikho.
This article has been published by Sneha Mahawar.
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Shaktikanta Das – “There are two broad areas that merit attention in the Indian context: the first is regarding improving the accessibility of financial platforms using fintech, and the second is about analyzing potential risks that may arise out of fintech adoption.”
The word fintech is a union of the words finance and technology. India ranks second in the adoption of fintech, with a growth rate of 87%, according to market reports. Technology in finance is making our everyday lives easier and creating a rapidly growing and strong union between the two. It made things not only easier but also more efficient and relatively safer. It is not a 100% secure way of managing financial matters, but it is much better than the traditional ways. Fintech is changing every moment with new advanced technologies introduced swiftly. It is a wonderful combination of software, codes, and digital systems installed on computers and smartphones to conduct financial activities smoothly. It is used by big companies as well as by individuals. Nowadays, with the Digital India initiative and widely used cheap internet services, digital payment apps are used from street vendors to multimillion corporations.
What we know about fintech
At first, fintech was traditionally used by banks or financial institutions for their back-end operations. When fintech emerged in the 21st century, the term was initially applied to the technology employed at the back-end systems of established financial institutions. Technology is now used by almost every industry that exists in the world for various purposes. Many of the functions are automated in our lives, such as financial matters by way of fintech. A person can now transfer money in seconds just sitting at home, can apply for credit cards without approaching any bank physically and many people prefer to carry a digital wallet instead of a leather one. Fintech has replaced traditional methods almost completely. The positive side of this is that many brick-and-mortar banks are in favour of using technologies and therefore, associate with many fintech start-ups by supporting them e.g., recently HDFC Bank and Bank of Baroda tied up with fintech firms to offer efficient and better services to their customers. One of the reasons being that setting up and managing a physical bank branch is a costly affair, and this is where the fintech firms come into the picture.
The history of financial technology can be traced back to the earliest credit cards that were adopted by the general public in the late 1950s. After the use of ATMs and online trading platforms, PayPal entered the market, making financial transactions easier and quicker across borders. These technologies started to reach the masses very fast, and they became an inevitable part of the everyday lives of many people. The more the human race progressed in terms of wealth and luxuries, the more they wanted to ease payments and financial matters in day-to-day life. People were hesitant to rely on traditional banks, especially after the 2008 financial crisis.
How does fintech function
Fintech has eliminated many unnecessary steps that come with traditional banking, such as writing a cheque, then going to a bank to deposit it, depositing and withdrawing cash, opening an account, updating passbooks or bank statements, getting insurance by approaching insurance company offices, trading on stocks in crowded trading markets, etc. It has changed traditional trading by introducing automation on trading platforms, e.g., Zerodha. From opening an account to placing an order and selling stocks is all possible on your computer or smartphone. There is no longer any need to store share certificates or visit crowded trading institutions.
Even purchasing groceries at a supermarket or buying food or other items from street vendors has been digitalized, thanks to fintech. You don’t have to carry a large amount of cash or feel flustered while counting it at the payment counter while others await behind you patiently. Just swipe or tap, and payment is done. These transactions include minimal human interference, making them free from fraud to some extent. Fintech does have its share of problems, such as technical or security issues, but they can be easily resolved.
Fintech includes various models to help financial institutions function seamlessly. Fintech has been around for quite some time now, and it is not just popular technologies such as blockchains, cryptocurrencies, and bitcoins but also the back-office mechanisms that have existed for decades.
The technologies that underpin fintech business models vary considerably. They include blockchain technology, artificial intelligence (AI), machine learning, and other big data functions like Robotic Processing Automation (RPA). Each case is unique, but the underlying theme is a collective effort to disaggregate the financial services sector, which, historically, has enjoyed a highly protected status due to high levels of regulation.
There are peer-to-peer lending platforms that eliminate the role of brick-and-mortar banks or lending institutions. These platforms need to comply with guidelines introduced in India in 2017. Neo-banks have been on the path of replacing traditional banks. In India, in 2016, the Unified Payments Interface (hereinafter referred to as UPI) developed by the National Payments Corporation of India (NPCI) came into existence, and it has gained popularity and wide usage in just 4-5 years. Countries like Nepal and Bhutan have also adopted the UPI system for easy transactions. Bharat Interface for Money (hereinafter referred to as BHIM) is one similar example. There are crowdfunding and crowdlending platforms too.
Globally known technologies such as the Society for Worldwide Interbank Financial Telecommunications (hereinafter referred to as SWIFT) also exist. SWIFT was founded by 239 banks from 15 countries in 1973. The technology facilitated interbank communications across borders in the safest possible way. This communication is in an encrypted messaging format and is protected by high standards. As of 2022, SWIFT has been expanded to 200 countries with 11,000 banks.
Importance and challenges
Fintech regulations are very complicated, as the fintech sector is a rapidly developing industry. In India, currently, fintech is regulated based on its prime business. Reserve Bank of India (hereinafter referred to as RBI) is the regulator for financial institutions involving banking, lending, deposits, and withdrawal operations. There are crowdfunding and crowdlending platforms that do not come under any specific regulations and have been under the scanner of SEBI. SEBI has been scrutinizing ways to regulate these platforms. Fintech partnerships with the insurance sector are regulated by the Insurance Regulatory and Development Authority of India (IRDA).
Almost all financial institutions are associated with fintech startups for large-scale operations such as back-office work, digital services, etc. These fintech startups are very poorly regulated due to various reasons. Mostly because the technologies behind blockchain and cryptocurrencies are complex and it is difficult to determine their governing structure. It is very difficult to control blockchain by third parties and government because of the blockchain design which is self-governing and decentralized in nature.
One other reason is that fintech is evolving rapidly, and it’s hard to keep up with the developments and changes. Much harder to establish is a concrete regulatory framework. In other words, it is really challenging to come up with a singular and concrete structure to apply to every known and unknown technological development and change in the finance sector.
Fintech, though a blessing, is also creating complex problems with almost no solutions. The safety of a person and his/her data is very much at risk. Regulations, such as General Data Protection Regulation (GDPR), were created to deal with those risks, but are they enough? India is also coming up with its own Personal Data Protection Bill.
For every use of digital and electronic transactions, private data and sensitive information are being compromised. These pieces of information are used by the companies in lieu of free services and sold out or misused for profits.
Efforts made by the government to regulate fintech
On August 13, 2019, the RBI launched a framework for a regulatory sandbox. “A regulatory sandbox is a hub that enables live or virtual testing of new products and services in a controlled testing environment.” The regulator provides the appropriate support by relaxing specific legal and regulatory requirements for the duration of the sandbox. There are defined entry criteria to these sandboxes as well as an exit strategy in case the participant fails. These sandboxes help filter out the most beneficial, law-abiding, consumer-centric fintech. They encourage fintech startups to research and develop innovative technologies while keeping consumer-focused technology safe, transparent, and efficient.
India has created a potent environment for fintech startups to enter and bloom in the industry, and it is quite welcoming to fintech startups and new technology. In the 2022 budget, the government expressed its intention to launch digital currency in regulated space. It levied a tax on the transaction of cryptocurrencies (It did not confer legal status on the cryptocurrency). RBI, on a national level, restricts lending businesses that are not licensed under its regulations or any other laws in the country. It has introduced the Payment System Operators license under the Payment and Settlement Systems Act, 2007. There is Information Technologies Act, 2000, and Information Technology (Reasonable Security Practices and Procedures and Sensitive Personal Data or Information) Rules, 2011 to protect data and safeguard against fraudulent cyber activities to an extent. RBI recently set up an Internal Fintech Department on January 04, 2022, to overlook growth and innovations, identify challenges, and regulate widely used UPIs, and mobile bank applications.
The financial institutions, fintech, regulators, consumers, and government need to join forces to have a fair and comprehensive regulation benefitting every stakeholder. With the Digital India movement, the government has created a favorable environment to establish a digital infrastructure. There are significant examples as to why fintech startups need to be regulated; one such example is a data breach at a tech-based company like Uber, which caused a multitude of threats to the private data of its consumers.
The strong regulation will include assessing the initial risk of potential data breaches and security threats and working on mitigating or resolving them. For this, financial institutions need to keep dedicated departments, and these departments should be very alert in their work. This will help self-regulate the fintech industry and financial institutions to avoid big blunders. There should be proper reporting channels for the same. There has to be a check on the internal threats as well. The Uber data breach is one such example of faulty internal systems in the company itself. It has been noted that corporate governance in fintech startups is one of the most neglected functions. RBI has come up with two recent developments in the fintech industry:
- The zero-MDR (Merchant Discount Rate) guidelines for promoting small ticket debit card merchant transactions.
- The most recent move by the RBI is barring prepaid instruments with credit lines in connection to Buy Now Pay Later (BNPL). Recently, Harvard Professor Marshall Lux claimed that BNPL is a bubble, not a boom.
Fintech has helped strengthen the reach of financial institutions in rural areas and among the economically backward population. It has helped create resilient financial infrastructure in the country and globally. It is pertinent to come up with regulations that increase the advantages and diminish the disadvantages or risks posed by fintech. There is a need for regulations to minimize the collection and storage of the financial data of a consumer without consent, whether it is shared with a third party or misused. There should be strict regulations to instill accountability on fintech institutions in case of data breaches or the discovery of possession of users’ private data by a third party without user consent. The regulations should facilitate easy and secure transactions. There should be a separate, specialized, and dedicated grievance redressal mechanism for consumers to log any complaints against these institutions, like an ombudsman, as is the case of brick-and-mortar banks. Fintech is definitely challenging to regulate due to its speed of growth but it is not impossible.
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