Earlier this month, the Reserve Bank of India (RBI) expressed its desire for more private players to set up payment systems in the country. Citing lack of competition in the burgeoning industry, the RBI proposed a competitive open environment where multiple companies may operate payment systems in parallel.
However, creating such an ecosystem may be easier said than done. India’s complex legal regime and the absence of accessible regulatory guidance deter private players from entering the payments industry. While the RBI has announced plans to simplify entry norms and processes, this may not be enough. The RBI should complement these efforts by expediting its plans to set up a regulatory sandbox for payments.
A regulatory sandbox is a safe harbour, where businesses can test innovative products under relaxed regulatory conditions. Typically, participating companies release new products in a controlled environment to a limited number of customers for a limited period of time.
This allows companies to innovate and test, without the fear of regulatory action. It also gives regulators a chance to assess the implications of new products and business models and design practical regulations proactively instead of reactively. Such a hands-on approach would reduce legal uncertainty, thereby encouraging investment in the industry and attracting innovative fintech start-ups. A sandbox protects customers as well. It ensures that new products are tested in a controlled space, with some regulatory scrutiny, before being rolled-out to the public.
Several other countries have launched similar sandboxes to encourage fintech innovation. The structures and mandates of each of these sandboxes have varied significantly. In Hong Kong for example, entry to the Fintech Supervisory Sandbox (FSS) is only permitted to licensed banks and their partnering technology firms. Unlicensed fintech companies and start-ups are not eligible to participate in this scheme. In contrast, the Australian Securities and Investment Commission (ASIC) provides a ‘fintech licensing exemption’ and allows eligible fintech businesses to test services for up to 12 months without a financial services or credit license.
The RBI could consider a hybrid model for India, combining features of the various structures existing around the world. Keeping in mind the RBI’s goal of increasing participation in the payments industry, such a sandbox should be made available to both licensed banks and payment system providers as well as unlicensed fintech companies. This would allow complete collaboration between stakeholders and help achieve inter-operability in new products from the get go.
Once appropriate safeguards and conditions are framed, such a sandbox could also exempt participants from registration and reporting obligations under the Payment and Settlement Systems Act, 2007 (“PSSA”).
Alternatively, the RBI may grant individual participants specific waivers to particularly burdensome rules or requirements. For instance, the regulator may exempt start-up participants from the liquidity and net-worth requirements prescribed under the PSSA. These requirements act as significant entry barriers to start-ups and also increase the cost of doing business in the payments space. Where a specific waiver is not appropriate or practical, but the RBI believes that some leniency is justified in light of particular circumstances, it may issue ‘no enforcement action’ letters. In the UK, the financial regulator (the FCA) issues such letters and agrees not to take disciplinary action against a participant for any unexpected issues that may arise during the testing period. Such letters protect participants from regulatory fines or penalties as long as they adhere to prescribed parameters and treat customers fairly.
In addition, India’s payment sandbox should provide each participant a single point of contact within the RBI. This would allow companies to have proactive discussions with the regulator on a continuous basis, giving them access to customised regulatory guidance during product development. Such accessibility would also give participants a lot of comfort, particularly when operating in a sphere where regulations are unclear or ambiguous.
Regardless of their specific terms, structures or mandates, regulatory sandboxes clearly work. They act as an impetus to innovation, build trust among stakeholders, protect consumers and result in sensible and forward-looking regulations. By introducing a sandbox for payments, the RBI could achieve the much-needed balance between innovation and regulation and help the Indian fintech industry achieve its full potential.
Yajas Setlur is a member of the FinTech Practice at JSA.