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Neobanks could become full-stack digital banks; here’s how

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Currently a clutch of neobanks, like Razorpay, function as tech partners for traditional banks. Niti Aayog's paper highlights the challenges posed by this 'partnership model' and proposes a two-stage approach for licensing.

Neobanks could become full-stack digital banks; here’s how
Following the recommendation of an RBI working group to regulate digital banking, government think tank Niti Aayog has proposed setting up ‘full-stack digital banks’ in India.
The proposal will cover a host of neobank fintechs which partner with traditional banks to provide technology support for customer acquisition and banking activities.
In a discussion paper titled ‘Digital Banks: A Proposal for Licensing & Regulatory Regime for India,’ Niti Aayog highlights the challenges posed by the “partnership model” in neobanking.
Niti Aayog chalks out a possible action plan for neobanks to acquire a full-stack digital banking licence and eventually provide lending, deposits and other banking services to medium, small and micro enterprises (MSMEs).
What are digital banks and neobanks?
According to the paper, the terms ‘challenger banks,’ ‘neobanks’ and ‘digital banks’ are used interchangeably among fintechs even though they may not actually function as banks.
Digital banks are defined by the Banking Regulation Act, 1949 (B R Act) as entities that issue deposits, make loans and offer the full suite of services. As the name suggests, these banks rely on the internet and other proximate channels to offer their services instead of physical branches.
Digital banks offer speed and superior user experience as compared to a traditional bank. They also offer low and transparent cost structures to their consumers. They also have a high efficiency metric when compared to commercial banks as they rely on digital channels. The government can use the channel effectively to reach the under-banked small businesses, Niti Aayog proposed.
Neobanks in India include startups like Open, RazorpayX, Freo, Jupiter, Fi and Niyo.
Licensing framework
In the absence of a licensing regime for ‘full-stack’ digital banks, neobanks have partnered with traditional banks, providing tech support in the customer engagement layer.
The paper recommends a two-stage approach for licensing -- a digital business bank licence to be issued first, followed by a digital (universal) bank licence.
Licences will be restricted in terms of volume and value of customers serviced. The licensee will then be allowed to operate in a regulatory sandbox framework. In a sandbox, companies can innovate, operate and experiment in a monitored environment. Upon satisfactory performance in the framework, these licensees will be issued a ‘full-stack’ digital business bank licence.
“As per the illustration, upon progression from the sandbox into the final stage, a full-stack digital business bank will be required to bring in Rs 200 crore (equivalent to that required of the small finance bank),” the paper said.
Welcome move
Welcoming the recommendations, Harshil Mathur, Co-Founder and CEO of Razorpay, told Moneycontrol: “Today neobanks operate as technology layers. What this paper is proposing is that over time we can foray into full-stack banking.”
Meanwhile, neobanks hope to urge Niti Aayog to include the provision for retail banking in the recommendations. Most neobanks are focused on retail (individual) customers.
“We will write to them requesting that retail banking should also be included in the services that licensed neobanks will be able to provide. We will also add any recommendations on what more can be included,” Jitendra Gupta, Founder of neobank Jupiter, told Moneycontrol.
The Niti Aayog will accept comments on the discussion paper till December 31.
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