RBI’s role in financial innovation

The recent clampdown by RBI on a well-known payments bank has stirred up, among other things, a debate on the proportionality of regulatory action. There is no shortage of critics particularly from Fintech. Some dub the regulatory action as anti-innovative and detrimental to risk taking. A few others even vented that 60-something regulators are dousing the innovation flame and risk taking by 40-somethings. So how did India become a prime of place for innovation in financial inclusion and digital payments? It is also the world’s largest ecosystem in this space comprising 600 million Jan Dhan bank accounts, over two million business correspondent (BC)-served banking outlets covering six lakh villages, over half a billion mobile phones mapped to these and over 100 billion UPI transactions. Here are some of this writer’s experiences with RBI on facilitating innovations. KYC and BC In the past when someone wanted to open a bank all she needed was an introduction by an existing account holder. To curb money laundering a new set of globally compliant norms were issued in 2002. Post this, bank accounts are subject to scrutiny not just by banks but also law enforcement agencies and tax authorities for any potential violations of KYC guidelines. Around 2005, the RBI (under Dr YV Reddy) pushed for financial inclusion to provide banking access to all citizens. This was a huge pivot for regulators as well as banks. This programme was the most ambitious and needed lot of innovation and risk taking. On boarding and facilitating transactions with customers scattered over six lakh villages was beyond HR/IT resources of banks. BCs were an innovation. But initially RBI stipulated only retired bankers, teachers, postal employees etc settled in those villages were eligible to be BCs, but it was hard to find them. In a review meeting with then Governor YV Reddy and his team, this issue was flagged. After some debate, RBI relaxed the rule and permitted banks to appoint any fit and proper citizens living in the village as BCs after due diligence and banks put in place necessary risk management. Thanks to this over two million BCs (certified) are now driving financial inclusion. Aadhaar and innovation Complying with identity proof requirement of KYC was a major constraint. Initially RBI took a stand that Aadhaar (launched in 2010) was not enough identity proof for providing banking access. Again then Governor D Subbarao convened a meeting of bank CEOs, UIDAI officials led by then Aadhaar chief Nandan Nilekani. After this meeting RBI agreed that Aadhaar is enough identity for providing banking access and this accelerated the financial inclusion process. Today, the banking system boasts of over 600 million of these accounts and is globally the largest financial inclusion project. This happened due to calculated risk taking and facilitation of innovation by the regulators. Similar is the case with the launch of Aadhaar Enabled Payment System (AEPS). The creation of NPCI, conceived, designed and promoted by RBI, is the most impactful institutional innovation, a one of its kind globally. So also, the globally popular UPI innovation, which was facilitated by the RBI during Raghuram Rajan’s tenure. The vision for product design of UPI and AEPS was a gift by Nandan Nilekani brilliantly executed by NPCI and facilitated by RBI. Fintech was in its infancy during these initiatives. But they fully leveraged these innovations and helped create a large digital ecosystem. Regulations are prescriptions but not descriptions or suggestions. Innovation and risk taking needs to be in this space if bank has to retain the authorisation to continue to do business. Customer focus is vital for a sustainable business model. Customer protection is central to RBI regulation. Customer-focus and protection need not be at odds with each other as they appear to be now and they need to be aligned. Well, it helps not only to know the letter and spirit of law but also the language of the regulators. It would be useful if inter-regulator forum comes out with Do’s and Don’ts for Fintech. There are several grey areas in implementation and RBI would do a great a service in promoting innovation if they come out with FAQ on clarifications sought by several fintechs without bouncing them to earlier circulars. May be once in two months if not earlier. RBI should kick off Fintech SRO without further delay. Today’s discussion should be more about resolving the friction between public good and private desire. If government mandates that public good shall be delivered by private enterprise for free, the latter should be compensated. Otherwise, innovation gets discouraged and this has more economic costs. The writer is a former chairman of a PSU bank and NPCI