Dawn Of Unfettered Fintech Innovations? Assessing Need To Review Hurdles In RBI Regulatory Sandbox

The Theme Neutral's illustrative list of items includes digital financial literacy, financial inclusion, digital lending and alternate credit scoring, e-KYC and, most importantly, emerging technologies like artificial intelligence, blockchain, machine learning, smart contracts, tokenisation, in the financial services space. This pivotal development begs a significant question — with the introduction and explicit recognition of innovation across neutrally-themed technologies, has RBI initiated a relook of its sandbox testing model?

The Fit and Proper Criteria for selection of participants in RS effectively excludes non-resident entities from testing their product, which they may want to deploy in India, within the RS. This restriction, however, overlooks the potential of foreign expertise in areas that are nascent to the Indian market. Further, this exclusion isolates India from global best practices in areas of emerging technology and artificial intelligence. Financial technology landscape thrives on engagement and understanding of perspectives rather than siloed development and implementation of ideas.

The RBI, through the RS, has the keys to potentially unlock a more collaborative approach between domestic as well as international players in areas of emerging tech, such as tokenisation and smart contracts, where expertise and learning are needed from around the world. This approach could potentially transform India's financial technology landscape and boost innovation, economic growth, regulatory learning and consumer protection.

For instance, a foreign fintech firm testing their product in the Indian market has the potential to attract foreign investments in the fintech sector in India. Further, products which have already been tested in RS of other jurisdictions, when tested under the RBI's purview, will allow the RBI as well as domestic players to gain insights from the global best practices.

The RBI understands that groundbreaking innovation can emerge in areas not explicitly foreseeable by them. However, the maintenance of a negative list creates regulatory blind spots. The existence of a negative list results in premature exclusion of innovation, even though the same can be safely managed within the RS model and yield results later.

The inclusion of crypto-based services in the negative list, followed by blockchain, smart contracts and tokenisation in the illustrative list of potential test-able products, presents a conceptual fallacy. This approach is flawed as crypto-based entities have the most hands-on expertise on deployment of smart contracts and navigation of complexities surrounding blockchain in volatile markets.

The RBI, by shutting the door for crypto-based entities/services, is barring key market players to provide valuable insights on the implementation of blockchain and smart contracts in the financial markets.

The RBI may consider taking the approach where the products which are currently a part of the negative list, may be tested in the RS environment on a case-by-case basis, subject to a more stringent eligibility criteria demonstrating adequate risk mitigation, protection of consumer rights and higher capital requirement, if need be. For example, a stablecoin project could be permitted if it is able to demonstrate full backing by a fiat currency held in regulated bank accounts, followed by stringent implementation of anti-money laundering and counter-terrorism financing measures exceeding the standard requirements.

Moreover, designing a thematic cohort specifically concerning the products in the negative list, but with a clear focus on exploring specific use cases with strong potential benefits and manageable risks, could shape the future of fintech innovations in the economy. A case in point being BRICS nations, which are exploring an alternative to the SWIFT system to reduce the dependency on the US dollar, may serve as the perfect opportunity for the RBI to consider allowing international fintech players/banks to test their products pioneering blockchain and smart contract-based solutions to payments, which can serve as the future, and potentially replace dependency on SWIFT.

As the RBI stands at a pivotal moment to reshape its approach to RS, by moving away from the restrictive components; a meticulous, case-by-case evaluation of risks and potential benefits — reinforced by strong safeguards and tiered access — is required to unlock the true potential of RS.

A case in point is the successful implementation of the business-friendly sandbox model of South Korea's Financial Services Commission. The model not only yielded job growth in the fintech sector in South Korea, but also attracted foreign investments and enabled domestic firms to expand internationally. This exemplifies how collaborative and well-structured sandbox models are favourable for innovation, economy as well as business.