With the Reserve Bank of India (RBI) issuing operational guidelines for digital banking units earlier this month, it seems to be shutters down on Niti Aayog’s proposal to issue exclusive digital bank licenses, an idea that the government’s think-tank had floated in November 2021.

This means that, neo-banks such as RazorpyX, Jupiter, Niyo, Fi, and Open, which had pinned hopes on becoming digital banks based on the Niti Aayog’s recommendations may have to continue with the partnership model with banks.

According to a highly placed sources, RBI wasn’t comfortable handing out fresh digital licenses as it could lead to further fragmentation of the market. It may also have been difficult for the candidates to clear RBI’s bar on ‘fit-and-proper’ criteria for bank promoters.

“There is already a strong feeling within sections of the central bank that perhaps way too many small finance bank licenses have been handed out. Barring one or two names, not many have even reached a critical mass that would be expected of a bank,” said a person aware of the matter. In this context, issuing more licenses may result in further fragmentation of the pie.

Whether this would really help in achieving financial inclusion was the concern expressed by the regulator. Small Finance Banks or SFBs, which were flagged off for financial inclusion, now have nearly 50 per cent of their branches concentrated in urban and semi-urban areas. The regulator feels that the experience with digital banks, if permitted, may not be any different.

Tighter regulations

Post the BharatPe saga, the quality of promoters who run financial entities and the ability of private equity investors to ensure unexceptionable corporate governance has also come under the spotlight. With fintech firms yet to establish themselves in the governance aspect, the regulatory thought process is that these firms must first accustom themselves to tighter regulations, and then aspire to become a bank.

The consensus seems to be that, it is okay to lag countries such as Australia, Korea, Taiwan, and Singapore which have been in a rush to issue digital bank licenses, rather than realising that the model isn’t working as intended in hindsight.

The regulator’s concern is that the licensing process should not turn into an exit vehicle for large private equity investors who’ve invested in the fintechs, said a person with direct knowledge of the matter. To end speculation around digital bank licenses, the RBI has put out guidelines for existing banks to set up exclusive digital banking units, to interact with customers in the digital-first mode.

Why RBI isn’t enthused about digital banks
Fears fragmentation of market
Doubts on fintechs making the cut on ‘fit and proper’
SFB experience suggests urban focus
Ability of fintechs to survive regulated environment
Bank licenses shouldn’t be an exit route for investors