Indian Fintech Players’ Guide to Navigating ‘The Fintech Enforcement Summer’

The seasonal shift in the fintech startup funding environment is well-known. Compared to 2021, Indian fintech startups received 47% less funding in 2022. But the onset of the funding winter is matched by an equally important seasonal change – the enforcement summer.

Over the past few years, the Reserve Bank of India (RBI) has proposed, debated, and enacted several regulations which impact the fintech industry. In 2020, the RBI made payment aggregation a licensed activity, setting off a race among fintech players to secure a payment aggregator license. In 2021, an RBI Working Group released its much-awaited report on the regulation of the burgeoning digital lending ecosystem. This report became the basis of RBI’s ‘Digital Lending Guidelines’ released in 2022.

The rule-making phase of the regulatory cycle can leave businesses frozen in limbo, hoping for the best and preparing for the worst. But once new rules are designed and implemented, the ice begins to thaw under the heat of enforcement. During the rule-making winter, the focus is on convincing the regulator that a product benefits society and shouldn’t be banned or restricted. But during enforcement summer, it is more about looking inward and getting your house in order.

The RBI has taken several actions in the last few months which suggest that enforcement will be a priority going forward. For instance,  the RBI asked banks to share information about their agreements with fintech service providers. The RBI reportedly wants to understand who’s deciding the creditworthiness of customers and bearing the risk of default in bank-fintech partnerships. To be clear, the RBI’s outsourcing guidelines place the onus of determining customers’ creditworthiness squarely on the regulated entity. 

The RBI’s Digital Lending Guidelines have also raised doubts about the permissibility of existing credit-risk sharing arrangements between regulated entities and their fintech partners. So, after laying down the rules of the game, the RBI is now verifying if the rules are actually being followed.

If there’s material non-compliance, the RBI won’t shy away from imposing penalties. In 2023, the RBI has already penalised or cancelled licenses of at least four Non-Banking Financial Companies (NBFCs) for borrower harassment.

Besides information-gathering, regulators have been taking more drastic steps. Last month, the Ministry of Electronics and Information Technology (MeitY) banned 94 digital lending apps from app stores including several prominent apps. The reasons behind the app bans were reportedly wide-ranging: borrower harassment, data misuse, cybersecurity, predatory pricing, money laundering and Chinese links. The app bans were implemented hastily with the government adopting a ban-first-ask-questions-later approach. Several apps were later unblocked after they submitted proof of their legality. While enforcement of rules is surely needed, the app bans showcased how legitimate businesses can become collateral damage.

The regulator’s gaze hasn’t been limited to lending either. In the payments space, prominent companies like PayU and Paytm have faced hurdles in securing a payment aggregation license. Even companies that have in-principle approval to operate as a payment aggregator haven’t had a smooth ride. For instance, the RBI asked multiple players including Razorpay to halt the onboarding of new merchants, a move that allowed competitors to gain market share.

So, what can fintech players do to prepare for the enforcement summer?

Accept The Fundamental Nature Of Finance

The business of holding, moving, lending, and investing public money is a fundamentally regulated business. It’s not a business in which you can move fast and break things. It’s always possible to find regulatory loopholes. But products which rely on clever legal engineering are short-lived and rarely allowed to scale. Many fintech players understand this, and as a result, have developed license FOMO. They know that if they want to be more than a pretty low-margin wrapper around a regulated financial product, they must secure a license themselves. Securing a license isn’t easy but it can be an unparalleled competitive edge and path to profitability. 

Bat For Self-Regulation

Ideally, enforcement actions should be a surgical strike, not a carpet-bombing operation. But with limited capacity and pressure to act, regulators may forgo accuracy for speed. To prevent such a scenario, the fintech industry must push for a co-regulatory approach. Self-regulatory bodies which have the regulator’s stamp of approval can go a long way in boosting the capacity to implement rules without causing harm to legitimate players.

Encourage Cross-Functional Coordination

In many companies, the legal team’s role is limited to providing abstract guidance and ensuring the paperwork is correct. This isn’t enough anymore. A lot can get lost in translating legal advice into user flow, visual design and operational practices. Close cross-functional coordination is necessary to ensure that on-ground implementation matches the letter and spirit of the law. Saying the right things in your contracts and manuals is no longer enough because regulatory audits and inspections focus on what you’re doing, not just what you’re saying.

Meet Your Promises

Regulators care about the industry following the rules. But they mostly care about it when someone overpromises and underdelivers. The difference in the quality of loans sourced by digital lenders seems to have sparked off the recent RBI investigation into bank-fintech partnerships. This is a problem that the industry is aware of and trying to solve. For instance, fintech players are reportedly improving their underwriting and collections processes because the average default rates for their loans are higher than traditional loans. Continued focus on building high-performing products is the best way to ensure the regulator doesn’t find a reason to intervene.

The funding winter and enforcement summer is a double whammy for the fintech industry. But these challenges will separate the wheat from the chaff and set the stage for long-lasting and transformative businesses.