Amid the ongoing pandemic crisis, there has been a surge in demand for online forms of services wherever possible. Unfortunately, the greater dependence on digital platforms has seen a rise in financial fraud as well. This may be partly attributed to Indian consumers’ digital illiteracy and inability to identify dubious digital features of user interfaces (UI) as deployed by clever service providers to entrap consumers. This calls for the government to introduce regulatory safeguards in the digital finance ecosystem to prevent service providers from leveraging the cognitive limitations of vulnerable consumers through in-app tricks.
Until recently it was common for online travel booking portals to bundle travel insurance with bookings. They used pre-checked consent boxes at the payment stage to default the users into buying insurance cover, even when the user had no active interest in purchasing the product. To the surprise of many, the Insurance and Regulatory Development Authority of India (IRDAI) reacted against this practice and directed insurance companies to “ensure that any portal or App providing the travel insurance coverage shall not pre-select the option of buying the travel cover as a default option”. IRDAI raised concerns that such clever in-app defaults impede consumers’ “informed choice”. This regulatory intervention was the first of its kind in India where a regulator objected to the use of dark patterns in UI and brought to light several concerns such practice entails with regards to consumer protection in the digital economy.
Background
The pre-checked buttons in digital interfaces is a classic example of a dark pattern. The term ‘dark pattern’ was coined by Harry Brignull, who defines them as interface designs that “trick users into doing things that they might not want to do, but which benefit the business in question”. In the example above, the use of ‘pre-checked boxes’ assume the user’s default preference as to purchase an add-on financial service even when it is not the case. Here the users are expected to be attentive to uncheck the box and opt-out. But as the UK’s Financial Conduct Authority has submitted, often consumers use digital services under time constraints and are less likely to opt-out or be aware of existing defaults. Therefore, beset by their cognitive vulnerabilities, limited rationality and the constraints on time and attention, a sizeable proportion of consumers end up buying services without informed consent.
More worryingly, research suggests that individuals with lower levels of education and in urgent need of money make for easy targets for financial service providers. This has significant implications for India, which is characterised by low income, low levels of digital literacy and a sizeable proportion of first-time users of the internet. Such consumers having subscribed for financial services unintentionally and unknowingly get severely exploited. For instance, the Reserve Bank of India (“RBI”) recently mentioned the reports where individuals have fallen prey to dubious digital lending platforms which promised easy credit but trickily charged excessive interest rates and adopted high-handed and inappropriate recovery methods. RBI highlighted that digital platforms are ‘misusing’ in-app digital agreements to access data on the mobile phones of vulnerable consumers and sending messages to their contacts, categorising them as delinquents and using social shaming to recover credit. It is these tactics of digital lending apps that has now resulted in harassed consumers committing suicide, which eventually has prompted RBI to scrutinize lending platforms closely.
Solution
Dark patterns based interfaces are manipulative in sharp contrast to persuasive marketing efforts. The distinction between personalisation and manipulation has been at the heart of policy issues that stem from the use of personal information during the supply of financial services. It is crucial that a legal framework must be incorporated to identify manipulative dark patterns in the context of consumer’s choice, value-system, and socio-economic background.
Regulators with direct jurisdiction over dark patterns include data protection authority, consumer protection authority and the sectoral regulator(s) that has jurisdiction over the provider using dark patterns. Simultaneous jurisdiction can lead to duplication of regulation or regulatory arbitrage. In the US, Federal Trade Commission (“FTC”) is the federal body in charge of consumer protection and regulates dark patterns by using its power to punish “unfair and deceptive practices” under section 5 of the Federal Trade Commission Act.FTC v AMG Capital Management is an important ruling on dark patterns where AMG, a payday lender, deployed dark patterns in its digital loan agreement to auto-renew (instead of close) expensive payday loans as a default option. The FTC found AMG Capital Management guilty of unfair and deceptive practices.
In India, dark patterns such as hidden costs could fall under the remit of section 11(ii) of the Consumer Protection Act 2019 (“CPA”) and the Central Consumer Protection Authority (“CCPA”) to redress such issues. But the absence of broad terms like “unfair and deceptive practices” in the CPA could significantly constrain the regulator’s effectiveness in regulating other kinds of dark patterns. Therefore, consumer protection legislation could be amended to allow CCPA to regulate dark patterns comprehensively. Further, as significant as regulation is, it is important to design appropriate regulatory tools that regulators could use.
Implementation
CCPA shall issue guidelines clarifying which market practices could be considered manipulation or personalization. To achieve this, the regulator must crowd-in opinions from the community, engage in inclusive public consultations, conduct primary studies to gauge users’ privacy preferences and be transparent about their decision-making processes.
The success of regulators in regulating dark patterns will depend on the language of the existing statute and its ability to include dark patterns as the ‘cause of action’. To overcome dark patterns, existing consumer protection framework could be amended to equip them to deal with them.
Amended legislative framework should enable regulators to undertake audits looking for digital interfaces that foster deceptive and unsuitable selling or nudge users to share excessive personal information. Regulators could also lay out model interfaces or guidelines to help providers design user-friendly interfaces.
For cases in which intervention by more than one regulator is needed, a comprehensive legislation defining a mechanism for inter-regulatory coordination should be enacted.
The significant advancements in Fintech are directly impacting on the traditional financial sector. The regulators had to be cautious in order to not miss the train and should jump on the wagon of promoting financial innovation and stiff competition in the sector. The newcomers in the sector should be provided certain leniency in form of exemptions from a number of strict compliances which are used to curb the malpractices of the big corporations, for the sake of promoting competition in the market. This post is dealing with key takeaways from reports of different regulators’ committees in India. This is the last post in the series of ‘Simplifying FinTech and FinTech Laws’.
Fintech charged firms and businesses must work in tandem with the regulated entities, e.g. banks and regulated finance providers. The businesses that a bank can undertake are provided under Section 6 of the Banking Regulation Act, 1949 and there is no business outside Section 6 that can operate as the bank. Such provisions, therefore, incentivize banking companies to make fintech innovations in a narrower scope relevant to their operations. The archaic laws make it difficult for banks to undertake fintech innovations that can be of significant utility but are beyond the scope of financial regulation.
The Watal Committee Report noted this, that:
“The current law does not impose any obligation on authorised payment systems to provide open access to all PSPs. This has led to a situation where access to payment systems by new non-bank payments service providers, including FinTech firms, is restricted. Most of them can access payment systems only through the banks, which are also their competitors in the payments service industry. This, according to the Committee, has restricted the fast-paced expansion of digital payments in India by hindering competition from technology firms.”
Forming a comprehensive and non-discriminatory regulatory approach
Regulators and legislators are required to realign their legal approach to the Fintech services. There is a requirement of developing a deeper understanding of various Fintech services and their interaction in a financial environment with other fintech services. To provide the fintech space to work utmost to its potential, it is needed that it gets a level playing field in relation to the traditional banking and non-banking players. The practise of restricting the access of non-bank institutions to payment infrastructure, such as AEPS, has to be reevaluated and the proper steps to be taken. It is required from the end of Government and Regulatory bodies that they should adopt necessary measures in order to provide accessibility to national payment infrastructure and facilities to all fintech firms without any discrimination.
Providing Standards for Data Protection and Privacy
All the fintech companies are required to invest significantly in self-regulating policies to prevent privacy risks. Fintech companies should be provided with the standards of data protection as soon as possible by government and regulators. It is evident that the provisions of the Personal Data Protection Bill, 2019 can significantly affect the growth of Fintech companies. Therefore, the standards adopted for fintech companies by regulators should be reviewed with respect to data protection and privacy concerns. The government and regulators specific to finance of the country should start focusing on the valuation of data that is processed by banking companies and recommend practices to safeguard consumer interests.
Open Data principles should govern the financial sector in order to enhance Competition
The regulators should pay heed to the open data policy among participants of a fintech sector. The regulators should begin with the mandatory norms directing financial service companies to encourage banking institutions to enable participants to access the databases of their rejected credit applications on a specific platform on a consensual basis. The practice of the UK with respect to Open Data Regulations in Banking can be adopted, where banking institutions on the basis of consent framework allow data to be available to banking partners in order to foster competition. Even the RBI Steering Committee on Fintech recommended:
“It also recommends that all financial sector regulators study the potential of open data access among their respective regulated entities, for enhancing competition in the provision of financial services.”
The KYC process should be reformed with respect to the Supreme Court’s Judgment on Aadhaar’s validity
Fintech businesses are the most affected entities due to the striking down of Section 57 of the Aadhaar Act as it invalidated the online KYC process. The online KYC and authentication provided the required efficiency and convenience to fintech firms with respect to their endeavours of on-boarding as many as consumers on their digital platform. It is recommended that alternatives to the mandatory linking to Aadhaar should be adopted in the form of possible video-based KYC, such that the documents as verified must be protected and processed with the prior consent of the consumer.
Other key recommendations
1. It is recommended that the adequate cybersecurity, anti-money laundering and fraud control measures should be adopted by investing in technologies and guidelines that can prevent fraud.
2. Technical innovations should be monitored with respect to the potential risk that innovation carries in operation under the contemporaneous legal landscape of the country.
3. A self-regulatory body to facilitate the needs of fintech is much needed as for the RBI it is still turning out to be difficult to replace the existing regulatory structure. A regulatory mechanism allowing the broader participative consultation approach should be adopted.
4. Regulators should invest in Reg-Tech (“Reg Tech is a sub-set of FinTech that focuses on technologies that facilitate the delivery of regulatory requirements more efficiently and effectively than existing capabilities. In July 2015 the FCA issued a call for input entitled ‘Supporting the development and adoption of Reg Tech’.”)
5. The majority of economies have adopted the practice of setting up of the regulatory sandboxes catalyzing the fintech innovations. It is recommended that RBI should continue with the introduction of the mechanisms, like regulatory sandboxes, enabling the adaptation of regulatory initiatives which will play a key role in maintaining India’s competitive edge.
No industry in the economy can boom unless it is supported by the Government in the country it wishes to further expand in. A fine line exists between regulation and obstacles for the industry to boom. In light of this, the Government of India has begun to take initiatives and steps toward the stronger building of fintech in the country, paving the path for this industry to a brighter future. This post will give you a brief overview of all the regulatory initiatives that the Government and Regulators have taken to promote the FinTech in India. This is the fourth post in the series of ‘Simplifying FinTech and FinTech Laws’.
Fintech in the past decade has expanded rapidly. What once emerged as merely as an intersection point of financial services and technology, has now become an important aspect of India’s economy. With the vision of the country towards a digitized and less dependent economy with ‘make in India’, fintech has gained a larger space to expand in and function smoothly. According to the NASSCOM Report ‘Fintech Landing- Unlocking Untapped Potential’, it is because of initiatives in India that have led India to emerge as a leader for the fintech industry worldwide. According to this research by NASSCOM, India alone harbours 2% of the largest start-up base for fintech in the world and also leads in the rate of adoption of fintech at 87% adoption rate.
Not only the initiatives by the Government adversely affect the success of the fintech industry in the country, but the allied regulators of financial institutions play a role as well. These include regulators such as SEBI, RBI, Insurance Sector, etc. Such an encouraging atmosphere for the development of fintech in the country has increased faith in fintech among the consumers in the country, for easier and grass-root adoption and acceptance of fintech.
Initiatives by the Central Government
Encouragement for the Start-Ups
With the policies such as that of make in India and to boost the Indian economy, the start-ups are increasingly supported by the Government. In 2015 itself, over 12,000 start-ups in the area of fintech emerged across the world. In India, the initiative to support the start-ups was launched by the Central Government in 2016, reserving USD 1.5 billion funds to support the start-ups. Under the increased support, he start-ups began to receive in the country, there are more than 600 startups in fintech at present in India. It is in light of such an initiative begun by the Government and supported by the allied stakeholders that India progresses towards the vision of a completely digitalised economy, promoted innovation and leading economy with sustainable growth.
In further aid of this initiative that the Government has now introduced tax reliefs such as 3-year exemption from paying tax for the start-ups along with other exemptions, credit guarantee, etc.
Digitization of the Economy
The current Government fiercely promotes the digitization of the economy. Whether intended or not, the unprecedented demonetization has acted nothing less than a catalyst in increasing the digital payments in the country. Having scaled the benefits of digital payments, it is now increasingly used by the country than retreating back to the physical currency. Such an environment is an ideal environment for the fintech ecosystem to thrive in.
Taxation Reliefs
Apart from the policies of the Government to support the fintech, taxing regime plays a major role in the growth of the fintech industry in the country. The 2016 Budget introduced tax rebates for those traders who transacted more than 50% of their bill digitally. The Ministry of Finance further proposed withdrawal of surcharge on digital payments of cards and online used to avail government services. The surcharges as of now stay relaxed.
Protection of Intellectual Property
The fintech start-ups are supported with ease in the procurement of intellectual property (IP) acquirement. The facilitation in the acquirement of trademarks, patents, designs, etc. has led to an increase in the start-ups under the fintech industry in the country. Moreover, under the start-ups initiative, the Government offers 80% rebates for the patent costs required for the start-ups.
Infrastructural Plans
The Government’s plans to accelerate the economy of the country with digital India and Smart Cities have led to an increase in reliance upon fintech in the country more than ever. Not only the local fintech industry is expected to benefit out of his but the outsourcing and foreign investment are also expected to be increased to further the advancement of the fintech industry in the country.
National Payments Council of India
It is the umbrella organisation for all retail payments in India, under the guidance of RBI and Indian Banks Association. With the increase of multiple usages of mobiles in India and increased acceptance of Unified Payment Interface (UPI), there was a paved way for the National Payments Council in India (NPCI). The expected userbase of smartphones is by 2020 is 500 million. Thus, the digital footprint is expected to rise as well. Initiatives by the NPCI such as that of Rupay Cards have led to fintech adopting such technologies, penetrating further into the traditional banking system in the country.
India Stack
India Stack is a set of Application Program Interfaces that allow entities such as businesses, start-ups, governments and developers to engage in the utilisation of the digital infrastructure. This unique feature of India Stack helps to solve problems in ground level in India and promote the paperless, cashless and presence-less delivery system in India. India Stack mirrors the support system offered to the telecom industry back in the 1990s for the fintech industry in the country. This has enabled the manifold increase in fintech in the country and has facilitated easy adoption of fintech by the innovators, entrepreneurs, other industries and companies. However, after the Aadhaar judgment, the India Stack programme has stopped.
Initiatives by Financial Market Regulators
The financial market regulators (FMRs) role has gravely impacted the fate of the fintech industry in the country. Some of the primary FMRs are discussed herein:
Reserve Bank of India (RBI)
One of the most recent initiative by RBI for the adoption of fintech in the financial market is allowance to set up the regulatory sandbox. This refers to the controlled environment in which live testing of digitally innovative techniques may be conducted in the arenas of e-KYC, retail payments, management of wealth, etc. RBI has also acknowledged the possibility of fintech disruptions in the financial market, in light of which certain regulatory norms have been introduced. However, it is to be noted that these are purely regulatory in nature in benefit of the consumers and fintech industries, without creating a hurdle for the boom of the fintech industry. Moreover, to better understand the nitty-gritty of fintech in influencing the traditional financial market, RBI set up an inter regulatory working group to come up with an appropriate framework for fintech without disrupting its functions. RBI in 2017 released a ‘Report on Working Group on Fintech and Digital Banking’ acknowledging fintech to be a point of attention in today’s era and uncertain regulatory regime to stunt its growth. Thus, RBI persuades other sectors to be better apprised with fintech to come up with better and definable regulatory regime so as to not cause unprecedented or unforeseen loss to this industry and continue with its growth.
However, with no uniform set of guidelines and no particular authority to govern fintech, fintech at present faces loss in this area. The aforementioned market regulators have their own policies for fintech which often overlap and defeat the purpose of facilitating policies to obstacles fintech needs to overpower to ensure its smooth functioning. The grey areas of fintech require to be urgently addressed so that the booming growth does not reduce to stunted growth of the industry India expected to lead in future. It is expected with RBI’s report and acknowledged lacuna in the current fintech ecosystem, changes are soon to begun to take place across all sectors in the financial market to ease the functioning of fintech for greater benefits.
The RBI has also introduced several small fintech spaces in order to invite comments from general stakeholders before issuing any regulation governing new technologically innovative financial products. The RBI has released a ‘Draft enabling Framework for Regulatory Sandboxes’ which proposes guidelines on governing regulatory sandboxes to be established by RBI to check on the R&D of new fintech products and services.
The RBI, as well, has recognized the need for confidentiality and data protection. The RBI’s “Master Circular on Mobile Banking Transactions in India” states that “technology used for mobile banking must be secure and should ensure confidentiality”.
Below is the table that represents how well are such fin-tech regulatory sandboxes faring. This is an independent research initiative by the author.
Country
Name of the Regulator
Date of Starting
Sandbox Name/ Project Name
Number of Participants
Remarks
The United Kingdom
Financial Conduct Authority (FCA)
Launched in October 2014- First cohort of applications opened on May 2016
The regulatory sandbox is a part of the project called Innovate by FCA
There are two kinds of Sandboxes that have been proposed under the MAS supervision: ‘Sandbox’ and ‘Sandbox Xpress’
Nearly 50 Formal Applications have been considered; Half were withdrawn; 1/3rd proceeded without the need of Sandbox; remaining being approved or under review. (till 2019) Source: NUS CBFL working paper 19/04 https://law.nus.edu.sg/cbfl/pdfs/working_papers/CBFL-WPS-1904.pdf
The Treasury Laws Amendment (2018 Measures No. 2) Bill 2019 (Bill) could provide an example of ideal specific legislative framework related to Fintech Sandboxes given the number of benefits it proposes. The Bill aims to enhance the existing regime by enabling more businesses to test a wider range of financial products and services, for a longer period of time. The Federal Government anticipates that this will help drive competition in the financial services industry, incentivising financial providers to be more responsive to the needs of consumers. While the Bill broadens the types of credit products and services which are eligible for the regime, it simultaneously imposes stricter requirements on credit services which are already subject to the regime. Sources referred: ASIC expands Sandbox Regime https://www.lexology.com/library/detail.aspx?g=825aafdb-0cf4-4dfd-b6b0-be411bb5f957;
Malaysia
Bank Negara Malaysia (BNM) through its cross-functional group the Financial Technology Enabler Group (FTEG)
Since the launch of Insurtech Sandbox until end February 2019, IA received eight sandbox applications and two were completed and rolled out to the market. Source: Discussion Paper, Legislative Council Panel on Financial Affairs, LC Paper No. CB(1) 70/18-19(04), Pg.6, https://www.legco.gov.hk/yr18-19/english/panels/fa/papers/fa20190401cb1-760-4-e.pdf
De Nederlandsche Bank (DNB) Aand Dutch Authority for the Financial Markets (AFM) as per their MoC (Memorandum of Cooperation)
Launched in January 2017
Regulatory Sandbox’ under the Innovation Hub
There is no specifc register or data that is available for the number of entities that are strictly part of the Regulatory Sandbox (Even in their guiding paper released in December 2016, they specifically stated in Section 4, at Pg.5, that “such requests are confidential and will be treated as such”.) Although, the regulators have shared that total 650 queries has been received by the Innovation Hub and Sandbox together till 28th August 2019 (Source: Report DNB-AFM, Continuing Dialogue, InnHub and RegSandbox: lessons learned after three years, https://www.dnb.nl/en/binaries/Continuing%20dialogue_tcm47-385301.pdf)
The presence of SEBI has largely affected the financial market for over two and a half decades now. The interface of technology in the financial market has only led to a rise in the financial sector. It has led to efficiency in the system of trading, reduced costs of transactions and an increase in consumer base. Not only this, technology has played a significant role in democratising the financial market. While these remain the immediate effect felt of technology as it entered the financial market, more recent are the machine-based and algorithmic trading. SEBI has warmly welcomed technology in the market with screen-based trading, dematerialisation of shares and using it as a platform to offer nationwide trading. The capital market in India with such innovations backed by SEBI has witnessed the transformation in recent years.
Insurance Sector
The innovation in the insurance sector has always been thought about twice, such that its adoption has remained the slowest in this sector in the financial market. However, the past decade with the rise of fintech has seen the regime of insurance sector change, especially with the digital channels and process automation. Technology has further led to the addition of personal touch and customised services for consumers. The fintech had led to increasing common conscience of the society to repose faith in the insurance sector due to customised services and cost-effective functions. Fintech has ensured that the start-ups in the insurance sector do not act as a tool of disruption in the insurance sector and spread a sense of insecurity amongst the existing companies but act as a collaborator, collate the efforts of all and direct services for the benefit of the consumers.
Over the years, the financial services industry has become increasingly regulated in terms of adoption of technologies for facilitation and disintermediation of transactions. The extensively fragmented laws and regulations certainly make it difficult for any person and entity to objectively find the mandatory requirements that a law imposes upon them. This post will give you a brief overview of fintech laws and the various ways in which they govern our digital transactions. This post is the third one in the series of ‘Simplifying FinTech and FinTech Laws’.
The legal topography that regulates the Fintech services in India is majorly distributed, and there is not a single comprehensive regulation or legislation that governs the Fintech industry in the country. The lack of a complete and comprehensive single set of guidelines or regulations makes it hard to refer to actual authorities that are supposed to govern the Fintech in India. The legislative or regulatory, whichever it is, primarily comprises of:
The Payment and Settlements Act, 2007
The sources of law that actually governs payment in Indian jurisdiction are the Payment and Settlement Systems Act, 2007 (PSS Act) and the Payment and Settlement Systems Regulations, 2008 and rules as issued thereunder. Basically, these are the statutes from which India’s central bank, the Reserve Bank of India, derives power to function and regulate payment and settlement system in India. In accordance with the PSS Act, the RBI has wide discretionary powers to issue orders, directions and rules to financial systems established in India. There are several recommendations (pending), to change the PSS Act and form a new regulatory board named as the Payments Regulatory Board (PRB), while the necessary amendments to the PSS Act still await.
As per the PSS Act, any person inclusive of the non-banking financial companies (NBFCs) which want to undertake the operation of a payment system, may do so as upon taking the authorization by the RBI. The Act provides several eligibility criteria that are required to be fulfilled by that person or company wishing to operate as a payment system. Further, technology facilitators between merchants and banking institutions (that process and settle the transactions), are known as ‘Gateway Service Providers’, doesn’t have to acquire any authorization from RBI. For instance, common gateway service providers are BillDesk, RazorPay, InstaMojo etc.
The PSS Act is the primary legislation that governs the regulation pf [ayments in India. The PSS Act provides the definition of the “payment system” such that:
“a system that enables payment to be effected between a payer and a beneficiary, involving clearing, payment or settlement service of all of them, but does not include a stock exchange”.
Master Direction on Issuance and Operation of Prepaid Payment Instruments
Prepaid Payment Instruments (PPIs) that are pre-loaded values (basically your PayTM or Freecharge wallets) and in some cases that value can be utilized for a specified purpose only as payment (basically Ola Money). PPIs provide the value to existing in a specified form which facilitates the payment for goods and services also in certain cases person to person remittance transactions of money for eg. sending money to your friends or family members. As defined in Rule 2.3 of the Master Directions:
“PPIs are payment instruments that facilitate purchase of goods and services, including financial services, remittance facilities, etc., against the value stored on such instruments. PPIs that can be issued in the country are classified under three types viz. (i) Closed System PPIs, (ii) Semi-closed System PPIs, and (iii) Open System PPIs.”
The Master Directions were issued by the RBI on October 11, 2017, and amended from time to time. It provides the eligibility criteria that is required to be followed by the PPI issuers, provides the thresholds for debits and credits that can be done using PPIs, and also provides the other operational obligations that are required to be fulfilled by a PPI issuer at the time of issuing such instruments to its customers in India. PPIs come into the ambit of the term ‘payment system’ as provided under the PSS Act and henceforth have to comply with the PSS Act and the Master Directions, both. PPIs include brand-specific gift cards, e-wallets like PayTM wallet, Freecharge, Mobikwik, shopping or travelling cards as issued by the Banks themselves, etc.
NPCI Guidelines governing the UPI Payments
UPI payments are governed through the Procedural Guidelines related to UPI and Operating and Settlement Guidelines related to UPI, as issued by the NPCI. As per the contemporary governing framework, the Banks only have the scope to provide UPI payment services to consumers. Banks are authorized to integrate the UPI platform into their payment systems. They operate over the UPI platforms by engaging the services of a technology provider, in such circumstances the Guidelines subject such technology providers and the Banks to strict compliance with certain norms as prescribed by the NPCI.
“The Unified Payment Interface enables architecture and a set of standard Application Programming Interface (API) specifications to facilitate digital payments using a mobile phone.”
Regulations related to Non-Banking Financial Companies (NBFCs)
The primary document of legislation that governs the NBFCs is the Reserve Bank of India Act, 1934 and subsequent to other secondary master directions and rules and guidelines and circulars which regulates the licensing and operation of such companies in India. The RBI has formed a set of thresholds that are required to be fulfilled in order to determine whether a business entity is to classified as a “financial services company” which also requires a license. Majority of lenders that operate digitally fall under the ambit of the term ‘NBFCs’. The most important regulation that holistically governs NBFCs is the Master Direction – Non-Banking Financial Company – Systemically Important Non-Deposit taking Company and Deposit taking Company (Reserve Bank) Directions, 2016, Master Direction – Non-Banking Financial Company –Non-Systemically Important Non-Deposit taking Company (Reserve Bank) Directions, 2016, and Master Direction – NBFC – Acceptance of Public Deposits (Reserve Bank) Directions, 2016.
Master Directions related to P2P lending platforms
The Master Directions- NBFC- Peer to Peer Lending Platform Directions 2017 incentivized a whole lot of activities for P2P platforms. It provided the P2P platforms to act as an intermediary, such that it has to comply with certain strict legal requirements and has to conduct proper due diligence of participants that are using the platform to finance or borrow. The Master Directions make it mandatory for P2P portals to check the creditworthiness in a form of an assessment and perform risk profiling of the borrower’s business or project, and actively share the disclosures with the potential investors or lenders. Further, RBI regulations bar the P2P platforms from lending or raising deposits or cross-sell any product over the portal. They are not required to facilitate any credit guarantee or secured loans. Cross-jurisdictional flows of funds are barred as per the Master Directions. Therefore, in toto, the Directions prescribe the norms that govern lender exposure and aggregate borrowing thresholds in the context of workings of P2P lending platforms in the country.
Guidelines to govern Payment Aggregators/Intermediaries
The RBI’s circular related to“Directions on opening and operation of Accounts and Settlement of Payments for Electronic Payment Transactions involving Intermediaries” as on November 24, 2009, (“Payment Intermediary Circular”), which lays down the legal framework that applies to the operation of payment gateways and intermediaries in India. Such intermediaries are strictly subjected to be in compliance with guidelines related to the operation of intermediary systems in Inda as provided under the Payment Intermediary Circular.
According to the RB I’s recent discussion papers, it has been suggested that the payment gateways and aggregators form a significantly critical link in the transaction flow, and henceforth it is required to regulate the activities as fall under the ambit of the PSS Act, 2007. The RBI has provided that the established contemporary guidelines governing payment intermediaries and gateway providers have to be reviewed in its Monetary Policy Statement for 2018-19.
RBI Guidelines on Payment Banks
The Guidelines on operation of Payment Banks and Guidelines for Licensing of Payment Banks as provided under the RBI’s governing framework elucidates that the governing regulations and measures related to licensing and operation of payments banks in India. The guidelines, among others, lays down the criteria for eligibility for registration or permissible operation and further other such guidelines that govern the working of payment banks. The Reserve Bank of India provides the purpose of setting-up Payment Banks such that:
“Reserve Bank of India says ―The objectives of setting up of payments banks will be to further financial inclusion by providing (i) small savings accounts and (ii) payments/remittance services to migrant labour workforce, low income households, small businesses, other unorganised sector entities and other users.”
Anti-Money Laundering (AML) Regulations and Know Your Customer (KYC) Regulations
Know Your Customer (“KYC”) is a term that indicates the customer identification process. The KYC norms include the prudential efforts made to ascertain the identity and ownership source of accounts, source of funds, the nature of customer’s business, and accountability of operations in the account in connection to the customer’s businesses etc which further assists banking institutions to manage the risks reasonably. The purpose of the KYC guidelines is to avoid and prohibit banks from being used, specifically as criminal essential of money laundering.
The Reserve Bank of India issued the guidelines to banks under Section 35A of the Banking Regulation Act 1949 and Rule 7 of Prevention of Money-Laundering (Maintenance of Records of the Nature and Value of Transactions, the Procedure and Manner of Maintaining and Time for Furnishing Information and Verification and Maintenance of Records of the Identity of the Clients of the Banking Companies, Financial Institutions and Intermediaries) Rules, 2005.
The key takeaway regulatory guidelines that prescribe anti-money laundering (AML) norms for fintech services in India are part of the PMLA, the PML Rule and the KYC norms included in the Master Directions.
Data Protection Regulations and Rules
Fintech is a data-driven industry due to which it faces a challenge or risk related to the data ownership and its security. Such a risk can be superseded by taking certain legal and technical measures only. There are choices of cybersecurity measures that data labelling, optional information sharing and identified data shareholding, which can be the response to various data-driven challenges that the fintech space is facing.
Unauthorized access to customers’ data is a threat to data privacy, which actually violates the fundamental right to privacy, and therefore a significant challenge to the Fintech platforms engage in gathering and storing several forms of financial and behavioural data. India, right now, doesn’t have any comprehensive legislative or regulatory framework that governs data protection. The Information Technology Act 2000 and the IT (Reasonable Security Practices and Procedures and Sensitive Personal Data or Information) Rules, 2011, contemporarily provide for the obligations of corporations or businesses to take reasonable measure in order to protect the personal data of consumers.
Further, the draft Personal Data Protection Bill, 2018, that is in pipeline can be best described such that:
“The draft Personal Data Protection Bill (2018) contains provisions that go beyond just the requirements of the IT Rules. The Bill specifies a notice and consent framework with explicit consent in the case of sensitive personal data. Explicit consent is understood as consent that is informed, clear, and specific along with being free and capable of being withdrawn.”
In the second quarter of 2019, Indian mobile payment leader PayTM surpassed China in the number of deals. Such a feat has been achieved while India is still an evolving fintech market in comparison to the developed fintech market like China. Red-tapism and the immense number of laws are the reasons of slow down for the FinTech market in India, but strict regulations are inevitable when it comes to a financial or technological company. The Steering Committee on FinTech related issues constituted by the Ministry of Finance, Department of Economic Affairs, submitted in September 2019 its report indicating various trends and challenges related to FinTech in India. This post discusses the same in brief. This post is the second one in the series of ‘Simplifying FinTech and FinTech Laws’.
Suggestions by the Steering Committee on Issues related to FinTech. Source: Economic Times
Trends related to Fintech in India
The FinTech sector in India is thriving and growing expansively, enabled by a large consumer base, innovatively boosted startups and balanced regulatory policies in the form of ‘Digital India’ programme. The Indian Fintech industry has grown by 282% in the last decade and has reached the valuation of USD 450 million in 2015. Currently, there are more than 400 fintech companies that are working in India and the investments are to be fueled with 170% by 2020. The Indian fintech market is expected to grow by USD 2.4 million by 2020 from the present USD 1.2 billion, as per NASSCOM report. The transactional value of Indian fintech sector is evaluated to be USD 33 billion in approx in 2016 and is further forecasted to reach the point of USD 73 billion by 2020.
Source: Bloomberg
FinTech facilities in India
The primary facilities offered by companies operating in the space of fintech are:
Pre-paid Payment Instruments
Also known as PPIs, this instrument enables the user to engage in the purchase of products that include products relating to financial services as well. To be able to purchase the products, a value entered into the e-wallets in the PPIs so as to make purchases against that value. There are 3 types of PPIs: Closed, semi-closed and open systems. Depending on the type, one may also have the facility to withdraw cash from the PPIs. Other than the banks, they can only be issued by institutions authorized to function in the arena of e-wallets or pre-paid card services.
UPI Payments
Managed by the National Payments Corporation of India, the UPI (Unified Payment Interface) provides a platform for quicker real time-based transactions, facilitating ease for the smartphone users to enter into multiple transactions with a lower cost than what the traditional method demands. Constituting a major part of the consumer behaviour in the market, the UPIs enable universality to the transactions they wish to enter in and engage in the greater number with the traders.
Digital Transactions
In the traditional financial market, it was only the banks that could lend money. However, with the convergence of technology and financial market, loans nowadays are even dispersed by non-banking financial companies, also known as NBFCs. The NBFCs with their interactive and user-friendly applications have attracted wide userbase in the digital arena to enter into credit purchasing, loan system after verification.
Lending Platforms
These lending platforms offered are Peer to Peer based. Such platforms bring together willing lenders and borrowers to enter into regulated transactions. As per the guidelines issued by RBI in this regard, the lending platforms can only be offered by the registered non- banking companies in India.
Online Sale and Purchase
The recent trends amongst many have also been that of online sale and purchase. To facilitate the same there requires to be a system whereby an entity collects payments form the purchases and send it across to the sellers. The entities involved in this function are known as payment aggregators or intermediaries. These entities electronically consolidate the payments done and transfer the same to the sellers.
Banking Services
Once begun as a measure to penetrate into the grassroots level of society the banking system and provide ease to the customers, digital banking services by the payment banks have now become a feature of the payment banks. The RBI has allowed payment banks to offer basic services involved in smooth banking by the customers online. This includes facilities such as accepting deposits (though RBI has placed a limit on it), view transactions, transfer funds, etc. However, this arena remains strictly regulated for not all facilities remain digitally available such as issuing credit cards.
Source: Bloomberg
Regulatory Challenges to Fin-Tech in India
While in India, digital finance firms are thriving as the government is continuing to issue pro-startup regulations and policies, the central regulatory body for Fintech i.e. the Reserve Bank of India, still suffers due to a traditionally rooted and established infrastructure which cannot be easily replaced with the updated regulatory framework that matches the advancements of technology.
Indian market is already recognized as the conservative and restrictive market and henceforth makes it difficult for Fintech firms to further instil the confidence in adopting the Fintech services in the absence of any concrete regulatory framework.
The commendable steps have been taken by the Indian government and regulatory institutions in a prompt manner, however, policies and regulations have to match the pace with which technological advancements in the finance sector taking place. This is much needed to ensure secure a transparent growth of Fintech in India.
Regulatory Uncertainty in the Fintech Sector
The foremost challenge that the regulator for the fintech sector has to dealt with by it the lack of regulations. Moreover, if there are regulations then to consolidate them is another major challenge. There is a requirement to “to support the formulation of policies that foster the benefits of fintech and mitigate potential risks”. Henceforth, a regulator or policy-maker has to work in the directions of “the modification and adaptation of regulatory frameworks to contain risks of arbitrage, while recognizing that regulation should remain proportionate to the risks.”
Digital On-boarding and Financial Inclusion
The two significant challenges that one can see as the huge mountainous tasks in the Indian context are: firstly, making the fintech platforms accessible to every Indian and secondly, analyzing the risks that are potentially present in trying out a scheme to provide digital onboarding. The Supreme Court recently decided upon the constitutionality of the Aadhaar, the ambitious government project to provide a unified identity. Aadhaar has been held constitutional but Section 57 of the Aadhaar Act was struck off. Section 57 provided the mandatory verification and linking procedure for consumers to avail a company’s service. The judgment is having serious implications on the government’s efforts to provide frictionless onboarding of consumers.
“The judgement impacted the delivery of financial services across verticals including bank account opening, loans, mutual funds and insurance. Though the judgement allows voluntary use of Aadhaar by consumers, there are multiple interpretations of it and the Unique Identification Authority of India (UIDAI) has resorted to safer approaches to avoid any more legal battles and stopped services to private entities altogether.”
Low Credit for Startups
Investors in the market are now hesitant to invest in fintech startups. The investors are baulking as there have been quite a number of bad loan incidents. The big setback to the fintech industry as well as the financial sector came into the form of IL&FS breakdown. The company defaulted against the inter-corporate deposits and commercial papers or borrowings. The incident has affected the whole fintech industry as the crisis included lending businesses that were key to a number of NBFCs as a funding source.
e-NACH crisis
The Apex Court’s judgment brought down to stoppage, another popular mode of financing which is also the foremost mode of debit for lenders, MFs and insurance, as in pulling money from customer’s account. This is yet another judgment that has slowed down the advancement and has promoted the traditional manner of physical registrations.
Data Protection
Both the traditional banking system and the fintech services gather a large number of data records from various of their clients, which contains a profile of behavioural and financial information. Though the utility of such data is positive when it is used for a specific purpose of improving the services, it leads to giving way to a heap of privacy issues as well, especially when the financial service provider engages a third party’s technology services.
The judiciary recognized the risk of data privacy to the banking sector’s consumer in the case of Punjab National Bank v Rupa Mahajan Pahwa, “in which Punjab National Bank had issued a duplicate passbook of a joint savings bank account, held between the petitioner and her husband, to an unauthorized person”.
Other Challenges to the Fintech system in India
In terms of regulatory standards, India lacks in providing a comprehensive cybersecurity framework to reduce the cyber-crime issues. The competition law has also, in some sort of stages, have failed to control the domination of certain advance fintech NBFCs.
Note from Author: This post is the first one in the series of ‘Simplifying FinTech and FinTech Laws’. The evolution of finance started almost a century decades ago when the world saw the establishment of Fedwire in the US in 1918. The actual FinTech application was the first mobile payment in 1997 to buy a Coca-Cola from the vending machine. In India, as well, the FinTech has completed almost one and a half-decade, but still, there seems to be little awareness about what the term ‘FinTech’ actually means and what law governs it. The fact that people are not aware of what ‘FinTech’ is and what daily financing applications constitute it is the inspiration of the series of posts. The author is hopeful that these posts will help in simplifying the understanding of FinTech and related laws.
An individual can realize that something has changed when, in the current scenario, he sees that everyone around him is transacting amounts with a click on their mobile phones. Since the time civilization has seen the increasing use of the mobile payment apps like PaytTM, Google Pay etc., financial technology (hereinafter referred to as “fin-tech”) companies, the financial services industry has been turned on its head. Whether you are doing online shopping or just buying groceries from your local grocers, fintech is surrounding us from all sides in 2019.
Financial technology, basically, means the technology that seeks to assist, improve and automate the facilitation, processing and delivery of transactional and financial services. At the core, fintech is being utilized to facilitate corporations, businessmen and customers process their financial operations by operating through curated software and algorithms as used on computers and significantly on computers, eliminating the manual intermediation in the financial industry. Broadly, as stated, the ‘fin-tech’ term can be applied to the number of technological innovations in the processes of transaction business, such as the invention of digital money to double-entry bookkeeping.
Since the digital boom and the incoming of the recent smartphone generation, financial technology has grown exponentially and expansively, in both the manner. Therefore, the fintechs are attracting the attention of various sectors especially customers of banking facilities and investment funds, which have the impression of fintech as the future of the financial services industry. The offline retailers and telcos are also considerably looking fintech as a better alternative to traditional financial services, as financial technology provides them with the speedier and decentralized mode of handling transactions. The extensively large number of activities are raising a flurry of questions regarding the emerging financial topography.
Some several major fin-tech products and services are currently being utilized in the market, some of them are Peer to Peer lending platforms, crowdfunding platforms, distributed ledger technology, Big Data, Mobile Banking Services etc. These fintech options are in operation to facilitate the services of international finance, bringing together the large lenders and borrowers, “seekers and providers” of data and information, providing the centralized or decentralized mode of transactions.
Traditional financing institutions have understood the need to upgrade their services. In pursuance of this, financial institutions are modifying the services by adding the technological innovation, by the way of both retaining the services technology companies or by themselves investing in technological research and development (“R&D”). However, there still exist wide disparities in the practices of traditional banking facilities in India.
Further, according to the Financial Stability Board (FSB), of the BIS, “FinTech is technologically enabled financial innovation that could result in new business models, applications, processes, or products with an associated material effect on financial markets and institutions and the provision of financial services”.
These definitions focus on encompassing the broader categories of innovations in the financial sector as facilitated by technologies, irrespective of the kind, business scale and regulatory status of the technologically innovative firm. The width of the FSB’s definition can be gauged while “assessing and anticipating” the expansive development of the financial system, and “the associated risks and opportunities”. Therefore, the key take away from the definition is that FinTech refers to “the integration of technology into offerings by financial services companies in order to improve their use and delivery to consumers”.
FinTech developments or innovations have the potential to facilitate a range of beneficial services, specifically efficient processing and cost-minimizing. Technological advancements are also substantially transforming how people have access to financial services. The investments in the Fintech sector is largely increasing through venture capital funds. The same is estimated at around USD 20 billion.
FinTech products and services
There is no defined scope of FinTech innovations, products and services. The broad nature of the technological advancements in the area of financial services includes some of the most prominent fintech innovations that have produced quite a significant effect on financial markets. Mobile and web-based payments are being used in Payments, Clearing and Settlement as an advancement. Similarly, crowdfunding and peer to peer lending have made deposits, lending, and capital raising more advanced than before. E-trading has made Investment management better. It is worth noting that, Data Analytics and Risk Management in delivering financial services are flexible now as the automation of the process is being carried out by using Big Data and Artificial Intelligence.
Thanks to Ionixxtech.com
Payments, Clearing and Settlement
Fintech products and services in this category are the innovations that focus on the expediency and efficiency of the ‘payments, clearing and settlement’. The innovation in terms of improving the speed of transaction, minimizing the cost and flexing the mode of financial transaction, will bring positive changes to the whole financial services system.
Internet-based payment apps
In general terms, payments services work such that there is a user who gets an account opened in a bank and receive “a payment instrument” (Credit Card, Debit Card, etc.), which is, in consequence, is” linked to the account from the issuing bank to pay merchants online or offline”. Bank merchants are intermediaries that request payment and are obliged to reciprocally share the information of payment with the bank i.e. the financial institution. Banks receive funds while facilitating the transactions for various other financial institutions. Today, all the series of aforementioned processes are being assisted by the Internet. In such transactions, the payments are directly made to the service provider through the fintech services and “integrated payment agency”.
There are two kinds of internet-based payment services, such that the services that are based on mobile applications which merely assist the existing payment infrastructure. For eg. Apple Pay, mPay, GPay etc. which operate over the “existing card payment infrastructure” providing the consumer of services with an ability to use their mobile as their credit cards or debit cards. Then there are other mobile applications or internet websites that provide payment facilities through the “new payment infrastructure”, for eg. “Mobile phone money services such as M-Pesa in Kenya and IMPS in India”.
Digital Currency
A digital form of currencies, basically “digital representations of value”, is “value stored electronically in a device such as a chip card or a hard drive in a personal computer”. Innovative technology in combination with the proliferation of AI and automation, internet availability, and upgrading consumer choices, has expanded the scope of the need for alternative forms of hard currencies or traditional instruments of payment. Digital currency can be defined, in a broad sense only, as something that represents value such that firstly it is an electronic or digital form of money or “government-issued flat currency”. Then subsequently it also covers the virtual currency- an electronic form of the currency that is not a legal tender. These currencies are the tokens or tenders which are developed, controlled and created by certain private developers, with the value being trusted and appreciated in a specific community.
Distributed ledger technology
Distributed ledger technology (“DLT”) is the innovation that provides a wholly secure and safe transaction record, which connects various users in a network duly updated and verified. Each and every transaction is accessible to all the users and hence allow users to have the track record of a transaction, eliminating the chances of fraud and centralization in the transaction. These transactions following the DLT are, in actual sense, peer-to-peer transactions, offering advantages of efficiency and security. As per the World Bank’s report,
“Distributed Ledger Technology refers to a novel and fast-evolving approach to recording and sharing data across multiple data stores (or ledgers). This technology allows for transactions and data to be recorded, shared, and synchronized across a distributed network of different network participants.”
Blockchain technology
Blockchain technology is a form of distributed ledger technology which is constituted of transactions (e.g. cryptographed tokens or securities) stored in units of blocks. Blockchain system works on the model of a distributed ledger to record time-stamped digital transactions that are irreversible and may not be unilaterally altered. The process of recording transactions over the ledger is called mining. A blockchain network has as many nodes as much there are participants in the network. The recorded transaction is broadcasted to all the participating nodes and requires consensus over the authenticity of the transaction from each and every node that is part of the distributed ledger. As per the report of the steering committee on fintech related issues:
“Blockchain is a type of DLT which enables a community of users to record transactions in a distributed (without a central repository) and a decentralized (without a central authority) manner. The transaction records are visible to all the participants of the blockchain network, while being immutable at the same time. Blockchains rely heavily on cryptographic primitives”
Deposits, lending and capital raising avenues
As the currency flow has transformed around us, other kinds of the transaction are also transforming to become expedient and flexible and disintermediating the financial transactions. Alternative finance is becoming a prominent mode of capital raising and financing. As the Medium and Small Scale Enterprises are mushrooming across India, the inability to access adequate finance still exists in our lives as one of the major reasons for the constraint to the growth of SMEs. There is lack of access to the adequate sums as the traditional banks don’t provide finance till the time they satisfy their creditworthiness requirements which require strong collaterals, good asset size and perfect credit history on part of the SMEs and businesses.
The new avenues of financing which exempt the lending from being vitiated by the financial intermediation, are data-driven and facilitated by technology. Popular alternative financing avenues are Crowdfunding and Peer to Peer lending.
Crowdfunding
Crowdfunding is an innovative technology portal which allows its users to connect such that forming the relationship constituting three parties: the entrepreneur or SME firm seeking funds, the contributors looking for investing the project or cause, and the moderator organization that facilitates the engagement between the contributors and initiators. The moderators make it flexible for the contributors to acquire data about the several initiatives at a platform that are seeking the funding opportunities for the development and production of their products and services. Foremost and prominent business models of crowdfunding are rewards-based crowdfunding, donation-based crowdfunding, and equity-based crowdfunding.
Peer-to-Peer (“P2P”) Lending platforms allow individual businesses and, especially, SMEs to finance and borrow amongst themselves. As the credit goes to the updated and developed IT infrastructure, P2P portals provide the options of interest rates lower than the traditional banking institutions. Further, the thin line of distinction between banks and P2P platform providers is that the P2P fintechs are basically “matchmakers”, as the P2P platforms facilitate the networking between lenders and borrowers and in exchange of such a function they charge a fee. As the P2P lenders provide services on a fee based mechanism, they basically doesn’t have to meet the mandatory “capital adequacy requirements”.
In the case of P2P platforms, one cannot expect investor protection through compensation against default as one expects under deposit guarantee schemes in traditional bank deposits. The rising trend of application of P2P platforms in order to secure finance can be gauged from the fact that most of the jurisdictions like Germany and Italy, have already classified P2P portals as banks (as they undertake the task of credit intermediation) and are being regulated as banks.
All these aforementioned technological innovations potentially can bring many opportunities and challenges. Fintech has the capability to substantially improve the efficiency and diversity of the financial market. The load concentration in traditional banking for minor payments will get minimized and may lead to expedient delivery of services to consumers. As technology advances, it finds a way to make a service or product more user-friendly. Similarly, as Fintech advancing, it is providing an incentive for traditional financing institutions to be competitive and focused on their customers.
Jungho Kang, Mobile payment in Fintech environment: trends, security challenges and service, Human-centric Computing and Information Sciences 8:32, at https://link.springer.com/article/10.1186/s13673-018-0155-4 (last accessed on 12/10/2019)
Law for Innovative Technologies 