Will RBI’s Regulatory Sandbox framework catalyze innovation in financial sector?

The Reserve Bank of India (RBI) has released a draft approach paper to roll out Regulatory Sandboxes (RS), a mechanism to facilitate technology-leveraged innovation in the financial sector in a controlled environment so as to contain any potential systemic risk arising out of the experimentation. The paper, titled Enabling Framework for Regulatory Sandbox, specifies the contours of India’s RS program.

The products/services that find a place in RBI’s indicative list eligible for testing under the RS model include retail payments, money transfer services, marketplace lending, digital KYC, financial advisory services, wealth management services, digital identification services, smart contracts, financial inclusion products and cyber security products.

Mobile technology applications, Data Analytics, Application Program Interface (APIs) services, applications under block chain technologies, Artificial Intelligence and Machine Learning applications are the specific technologies mentioned for testing out through the RS mechanism in the RBI draft.

The advantages

A regulatory sandbox (RS) is an approach followed by financial regulators worldwide to facilitate innovations in the financial sector leveraging rapidly changing technology while avoiding risks that these new technologies and applications may bring in by trying it out in controlled environment. 

Globally, countries have adopted multiple approaches of introducing new technologies and innovations while avoiding large-scale systemic risk. The two approaches that have been used mostly are innovation hubs and regulatory sandboxes. While the former is a way of continuous communication between the regulator and the innovators, the latter is an actual live testing on the ground, albeit in controlled environment. In the EU, for example, both the models have been tried though only a limited number of nations have tried the regulatory sandbox model. That could be because it is a high commitment, high involvement model. 

The US Consumer Financial Protection Bureau (CFPB) was the first to set up a sandbox-like framework way back in 2012. However, it is UK’s Financial Conduct Authority (FCA) that is credited for coining the term regulatory sandbox in 2015.

A working group set up by RBI in 2016 to look into the granular aspects of FinTech and its implications for regulation purpose had recommended introduction of an appropriate framework for a regulatory sandbox (RS).

RBI draft says that the RS may run a few cohorts (end-to-end sandbox process), with a limited number of entities in each cohort testing their products during a stipulated period. The RS shall be based on thematic cohorts focussing on financial inclusion, payments and lending, digital KYC, etc. The cohorts may run for varying time periods but should ordinarily be completed within six months.

It says RBI may consider relaxing, if warranted, some of the regulatory requirements for sandbox applicants for the duration of the RS on a case-to-case basis. However, it specifically mentions that certain regulatory requirements have to be maintained mandatorily. They are: Customer privacy and data protection, secure storage of and access to payment data of stakeholders, security of transactions, KYC/AML/CFT requirement, statutory restrictions.

To ensure that the RS provisions are not misused, RBI clearly specifies a list of services already being provided or not welcome by the regulator that are excluded from RS. The list includes credit registry, credit information, crypto currency/crypto assets services, trading/investing/settling in crypto assets, Initial Coin Offerings, etc, chain marketing services or any product/services which have been banned by the regulators/Government of India.

RBI is seeking comments on the draft guidelines by May 08, 2019. 

Can it really drive innovation in India?

A regulatory sandbox has many inherent benefits.

By definition, it provides learning and feedback for all stakeholders—the regulators, newer fintechs, incumbents as well as the end users. Users get to experience what is possible and the costs and benefits. Their reaction is feedback for all the other three stakeholders.

Two, it provides a low investment (and hence low-risk) way to try out their products in live scenarios and based on the experience can decide to introduce in market or go back to the lab to improve.

A slower but far-reaching impact of regulatory sandbox is for the economy. They help regulators move from assumption-based regulation to evidence-based regulation, avoiding costly mistakes and delays.

So, the benefit that RS provides to all stakeholders is now not in question.

But does that mean that it automatically drives innovation.

It is only in some cases that it stretches the boundary of what is possible – either in terms of empowering customers or in terms of achieving a socio-economic objective – as in case of financial inclusion. 

Will the RBI RS framework be able to achieve that?

That depends on what broader regulatory stance RBI takes overall in respect to certain technologies and not only on regulatory sandbox framework. While it is theoretically possible that RS experiments may—in the long run—impact overall policy stance, normally it would be the other way around. For example, there will be no crypto-currency and related technologies regulatory sandboxes. This is in sync with the long-term regulatory stance that RBI has taken in regard to these technologies.

Also, the overall rollout of the framework will determine how popular it becomes. Many have already expressed the concern that the numbers mentioned in RBI draft are too limited. We hope those numbers are not cast in stone. The regulator may well be starting with a number to create a ‘missing the bus’ situation to stimulate and speed up the rollout.

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