Along with the deepening of technology and digital services, there’s been a rise in digital fraud and consumer dissatisfaction. This has triggered the regulator to take a closer look at the operation of the fintechs, resulting in the introduction of certain supervisory steps to address the risks emanating from their activities.

The zero-MDR (merchant discount rate) guidelines of January 1, 2020, for promoting small ticket debit card merchant transactions, is the first of these regulations. While these have adversely affected certain fintech players, including banks, realising the potential in distributing loan products, several fintechs have ventured to act as direct selling agents of banks.

Being away from the radar of the regulator, a number of unethical practices in lending have been reported. Increasing instances of brutal collection methods, opaque lending practices, mis-selling of products, customer harassment, etc., forced the RBI to enhance its supervision on fintechs.

While predatory lending is regulated by the Usurious Loan Act (1918), restricting private moneylenders from charging excessively high rates of interest, payday loans by fintechs — at annual rates of 360-500 per cent — that serve during short term financial emergencies, remain least regulated.

The most recent move by the RBI in barring prepaid instruments with credit lines in connection to Buy Now Pay Later (BNPL) is criticised as a deterrent to fintech growth and innovation in India. Razorpay report, ‘The (Covid) Era of Rising Fintech’, shows that the Indian BNPL industry has grown by a whopping 569 per cent in 2020 and 637 per cent in 2021 to achieve the market size of $3.7 billion.However, recently, Harvard Professor Marshall Lux claims that BNPL is a bubble, not a boom.

Similarly, the tough stance of the RBI regarding cryptocurrency transactions is also criticised among participating fintechs.

Fintechs operating as P2P lenders, alternative credit scoring platforms and crowd sourcing platforms are being slowly brought under the regulatory ambit.

Importance of fintech

Fintechs are an essential part of Indian financial ecosystem, which comprise start-ups, technological businesses, and existing financial institutions operating in payments, lending technology, wealth technology (WealthTech), personal finance management, insurance technology (InsurTech), regulation technology (RegTech), cryptocurrency, and other sub-segments.

Though fintechs have been around for decades, their importance is pronounced post demonetisation, with the pandemic further intensifying their significance. India is the global fintech superpower with the highest fintech adoption rate in the world.

India is also one of the fastest growing fintech marketplaces in the world, with 6,636 fintech start-ups, 24 of those are ‘Unicorns’ with a valuation of over $1 billion. Most notably, fintech accounts for one out of every five start-up Unicorns in the country. As per government of India estimates, the Indian fintech ecosystem is expected to reach $150 billion by 2025 from its present level of $50 billion.

The most important question is whether fintech regulation is bad or how much regulation is optimal for financial stability. Fintech regulation is essential due to the challenges they pose to the financial ecosystem and the new risks they introduce. Hence, while promoting innovation is necessary, managing risks to financial stability is more important. Worldwide, fintech firms are subject to three types of regulations. Activity-based regulation, in which identical actions are regulated equally regardless of the legal status or type of the entity doing the activity.

Entity-based regulation, which requires laws to be applied to licenced firms engaged in comparable and specified activities, such as deposit taking, payment facilitation, lending, and securities underwriting, among others.

The third category, outcome-based regulation, where firms are required to ensure certain fundamental, common, and technology related aspects.

The new challengers

As fintech firms grow in size, they may encounter increased regulatory scrutiny. A sensible regulation with transparency will strengthen the sector in the long run and facilitate the Indian economy in growing at its potential rate by allowing its growth drivers to fuel the engine of economic advancement.

When fintechs ventured into the Indian financial landscape, they were treated as competitors to the existing large financial entities including banks and NBFCs. However, with the evolution in the financial ecosystem and realising that competition is not the solution, Indian banks now collaborate with at least one fintech.

The majority of public and private sector banks have established their own fintech incubation centres. Banks no longer see fintech as a threat, but as a valuable partner in increasing their reach and connecting with consumers.

However, the true challenge to fintech comes from Bigtechs, which have enormous customer networks and primary businesses in social media, telecommunications, Internet search and e-commerce, with significant global presence. Bigtechs use the new technologies that enabled fintech start-ups to unbundle financial services to ‘reverse’ the unbundling.

They benefit from cross-subsidisation and economies of scale because of their worldwide user base of non-financial products. As a result, they are well-positioned to acquire a major part of the financial services sector and take control over the market.

Both Bigtech and fintech pose different regulatory challenges and need to be regulated accordingly. Bigtechs’ penetration may pose new and complex trade-offs between financial stability, competition, and data protection. It is time that the regulator focuses on Bigtechs as well and ensures a level-playing field between Bigtechs and banks, considering the former’s wide customer base, access to information and broad-ranging business models.

The network effects and concentration of Bigtech in supplying some financial services such as cloud computing highlight the financial sector’s reliance on Bigtech services and their systemic significance. Breakdown of any one of these firms, or failure of a service, would lead to severe consequences for markets, customers and financial stability.

The writer is Economist, State Bank of India. Views are personal