The Reserve Bank of India has recently released draft guidelines on setting up a ‘regulatory sandbox’ for testing financial products and has invited comments and feedback on it from stakeholders. The guidelines, when introduced, could have a significant impact on fintech innovations and the financial ecosystem.
The genesis of this can be traced to July 2016 when RBI set up a Working Group (WG) to look into granular aspects of financial technology (fintech) and its implications to review the regulatory framework and respond to dynamics of the rapidly evolving fintech scenario.
One of the key recommendations of the WG was to introduce an appropriate framework for a regulatory sandbox (RS) within a well-defined space and duration where the financial sector regulator would provide the necessary regulatory guidance to increase efficiency, manage risks and create new opportunities for consumers.
A sandbox, as we remember from our childhood memories, is a box filled with sand to play. This could have been the backyard either of our house or our school. However, in the world of computing, a sandbox is a virtual space in which untested software or a new programme is tested securely without harming the entire system.
Started in the UK in 2015, regulatory sandboxes normally involve temporary relaxations or adjustments of regulatory requirements to provide a “safe space” for start-ups or fintech companies to test new technology-based financial services in a live environment for a limited time, without having to undergo a full authorisation and licensing process.
Regulatory sandboxes are in different stages of development and implementation in many countries. Businesses that want to try out their unique products or services have to demonstrate that their innovations offer solutions for an “existing gap” and serve the public interest, improve access to financial products and services, and do not pose risks to consumers or burden the financial system.
As per the draft guidelines, “a regulatory sandbox refers to live testing of new products or services in a controlled regulatory environment for which regulators may (or may not) permit certain regulatory relaxations for the limited purpose of testing.” The regulatory sandbox allows the regulator, innovators, financial service providers (as potential deployers of the technology) and customers (as final users) to conduct field tests to collect evidence on the benefits and risks of new financial innovations, while carefully monitoring and containing their risks.
The sandbox can provide a structured avenue for the regulator to engage with the ecosystem and to develop innovation-enabling or innovation-responsive regulations that facilitate delivery of relevant, low-cost financial products. It is stipulated that the proposed financial service to be launched should include new or emerging technology, or use of existing technology in an innovative way and should address a problem, or bring benefits to consumers. The objective of allowing such innovations to be tested is to promote financial inclusion and benefit customers.
For the innovator, the biggest benefit is that unlike simulation, they can test the product’s viability in the real world, without the need for a larger and more expensive rollout. If the product is not successful, the innovator can either make modifications or discard it at the sandbox stage itself, thus minimising the loss. If it has the potential to be successful, the product can be authorised and brought to the broader market more quickly.
The sandbox approach also encourages “learning by doing” by all stakeholders like regulators, financial service providers, banks, innovators and fintech companies. Feedback from customers can also help innovators tweak the product to suit their needs. While regulatory sandbox can go a long way in improving the pace of innovation and technology absorption, it can also help in financial inclusion and improving financial reach.
Some areas that can get a fillip include remittances, digital payments, microfinance, micro-insurance products, mobile banking and digital payments. That said, a product or service may not be suitable for RS if the proposed service is similar to those that are already being offered. Also, startups trying to test products or technology related to credit registry, services related to crypto currency trading or settlement, initial coin offering, chain-marketing services, etc., will not be considered.
The guidelines also have stipulated “fit and proper criteria“ for participants, which says that the entity should be a company incorporated and registered in India and should meet the criteria of a start-up as per government notification, have a minimum net worth of Rs 50 lakh, a satisfactory CIBIL score and a robust IT infrastructure with adequate safeguards.
The flipside is that regulators may potentially face legal issues — those relating to consumer losses in case of failures or from competitors who are outside the RS, especially those whose applications have been rejected. This may not have any legal ground if the RS framework and processes are transparent and have clear entry and exit criteria.
(The writer is with Manipal Academy of Banking, Bengaluru)