What is Regulatory Sandbox by RBI? How RS help Banks, fintech?

What is Regulatory Sandbox by RBI? How RS help Banks, fintech?

Why In News?

The Reserve Bank of India (RBI) on September 18th, 2021 announced the opening of the third cohort of regulatory sandbox.
  • The theme for the 'Third Cohort' under the Regulatory Sandbox will be 'MSME Lending' and entities keen to participate in the exercise can submit their applications to the RBI from October 1, 2021 to November 14, 2021, it said.

In another News,

The Reserve Bank on 13th Sep 2021 said six entities have completed the test phase in the 'First Cohort' under the Regulatory Sandbox scheme with retail payments as theme and their products are found viable for adoption by the regulated entities.
  • Their products mainly deal with offline digital payments, prepaid cards, contactless payment and voice-based UPI.
The entities whose products have been found meeting the norms set by the RBI in the First Cohort are Nucleus Software Exports (PaySe), Tap Smart Data Information Services (Citycash), Natural Support Consultancy Services (IND-e-Cash), Naffa Innovations (ToneTag), Ubona Technologies (BHIM Voice) and Eroute Technologies (offline payment using SIM).
  • These entities, the RBI said, have now exited the First Cohort of the Regulatory Sandbox on 'Retail Payments'.

Under the 'Second Cohort' for cross-border payments, the RBI said that it has received 27 applications from 26 entities of which eight have been selected for the 'Test Phase'.
  • The selected entities are Book My Forex, Cashfree Payments, Fairex Solutions, Flyremit, Nearby Technologies, Open Financial Technologies, SoCash India and Wall Street Finance.
  • These entities will commence testing of their products from the third week of September 2021.

Lets' Consider a Case

Consider a firm that wants to launch a micro-insurance product, purchasable using mobile airtime. The firm will collaborate with telecom players for distribution, and with insurance providers for underwriting risk. It believes this product can be a game changer for India, which had near 100% tele density but less than 15% life-insurance penetration as of 2015. However, the firm will require regulatory clarity, since its product will attract the purview of multiple regulators (the Insurance Regulatory and Development Authority, the Telecom Regulatory Authority of India, and possibly the Reserve Bank of India) but regulators are unable to accurately assess the risks associated with such a new product, and regulatory coordination is limited. As a result, the firm will have to abort the launch due to regulatory ambiguity. Can we create an avenue that avoids such situations by helping regulators understand the risks and benefits associated with a new product, in a rigorous and streamlined way? 

A regulatory innovation that could help is that of a “regulatory sandbox"

What is Regulatory Sandbox

A regulatory sandbox is a framework set up by a regulator that allows FinTech startups and other innovators to conduct live experiments in a controlled environment under a regulator’s supervision.
As per RBI "Regulatory sandbox refers to live testing of new products or services in a controlled/test regulatory environment for which regulators may permit certain relaxations for the limited purpose of the testing"
The sandbox allows regulator, innovator, financial services providers and customers to conduct field tests to collect evidence on benefits and risks of new financial innovations while carefully monitoring and containing risks.

A regulatory sandbox is a useful tool for the regulator and fintech innovators for such situations where there is absence of governing regulations or where there may be a need to modify existing regulations because the proposed innovation shows the promise of ease to customers in a significant way
  • It is a safe space which allows regulators to facilitate small-scale tests by temporarily relaxing certain regulations to collect empirical evidence while containing risks.

For Example, RBI can allow the app to be launched with farmers within certain limits and for a specific period. At the end of the period, RBI will have the feedback on the utility of this innovation and the risks arising from it and If required certain regulatory changes could be made based on risk analysis.

Technology and business models are evolving rapidly and regulators may not have the opportunity or capacity to assess the true implications of many innovations unless they are tested. Such small-scale tests can provide the objective and time-bound evidence to the process of regulatory decision-making.

To encourage innovations RBI had rolled out regulatory sandbox framework on August 13, 2019.

Background of Regulatory Sandbox

The Reserve Bank of India (RBI) set up an inter-regulatory Working Group (WG) in July 2016 to look into and report on the granular aspects of FinTech and its implications so as to review the regulatory framework and respond to the dynamics of the rapidly evolving FinTech scenario.
  • One of the key recommendations of the WG was to introduce an appropriate framework for a Regulatory Sandbox (RS) within a well-defined space and duration where the financial sector regulator will provide the requisite regulatory guidance, so as to increase efficiency, manage risks and create new opportunities for consumers.

Regulatory Sandbox: Entry criteria

Entities applying for the RBI’s regulatory sandbox must have a net worth of INR 25 lakh and be incorporated and registered in India or licensed to operate in India.
  • On December 16, 2020, the RBI had eased the eligibility norms for applications under sandbox. ''To encourage innovation and broad base the eligibility criteria, the enabling framework has been modified by reducing net worth requirement from the existing ₹25 lakh to ₹10 lakh, as also including Partnership firms and Limited Liability Partnership (LLPs) to participate in the RS," RBI said in a release on December 16, 2020.

Regulatory Sandbox: Objective
  • The objective of the RS is to foster responsible innovation in financial services, promote efficiency and bring benefit to consumers.
  • The RS is, at its core, a formal regulatory programme for market participants to test new products, services or business models with customers in a live environment, subject to certain safeguards and oversight.

Regulatory Sandbox: Benefits

First and foremost, the RS fosters ‘learning by doing’ on all sides. Regulators obtain first-hand empirical evidence on the benefits and risks of emerging technologies and their implications, enabling them to take a considered view on the regulatory changes or new regulations that may be needed to support useful innovation, while containing the attendant risks.
  • Incumbent financial service providers, including banks, also improve their understanding of how new financial technologies might work, which helps them to appropriately integrate such new technologies with their business plans.
  • Innovators and FinTech companies can improve their understanding of regulations that govern their offerings and shape their products accordingly.
  • Finally, feedback from customers, as end users, educates both the regulator and the innovator as to what costs and benefits might accrue to customers from these innovations.

Second, users of an RS can test the product’s viability without the need for a larger and more expensive roll-out, if the product appears to have the potential to be successful. If any concerns arise, during the sandbox period, appropriate modifications can be made before the product is launched in the broader market.

Third, FinTechs provide solutions that can further financial inclusion in a significant way. The RS can go a long way in not only improving the pace of innovation and technology absorption but also in financial inclusion and in improving financial reach. Areas that can potentially get a thrust from the RS include microfinance, innovative small savings, remittances, mobile banking and other digital payments.

Fourth, by providing a structured and institutionalized environment for evidence-based regulatory decision-making, the dependence of the regulator on industry/stakeholder consultations only is correspondingly reduced.

Fifth, the RS could lead to better outcomes for consumers through an increased range of products and services, reduced costs and improved access to financial services.

Regulatory Sandbox: What will and won’t be considered

The RBI has said it will accept “innovative products/services” in the domains of money transfer services, marketplace lending, digital KYC, financial advisory services, wealth management services, digital identification services, smart contracts, financial inclusion products and cybersecurity products.

It will also accept “innovative technologies” such as mobile applications, data analytics, API services, applications under blockchain technology, artificial intelligence and machine learning.

The RBI has explicitly stated that it will not accept startups engaged in the creation of credit registry; credit information services; cryptocurrency or crypto assets; trading, investing and settling in crypto assets; initial coin offerings (ICOs); chain marketing services; and any product or service that has been banned by other regulators and the Indian government.

Regulatory Sandboxes in India

In addition to the RBI, two other financial regulators have announced plans for regulatory sandboxes—the Securities Exchange Board of India (SEBI), which regulates India’s securities markets, and the Insurance Regulatory and Development Authority of India (IRDAI), which oversees the insurance and reinsurance sectors.

In year 2018, Maharashtra govt unveils ‘sandbox’ to boost fintech innovation. Maharashtra, the first State to have a dedicated fintech policy, is also planning to have a dedicated ‘Fintech Officer’ in the Department of Information Technology

Later in 2019, Karnataka government announced to set up regulatory sandbox for supporting tech innovation. Karnataka is also planning to set up a Technology Development Board that will fund ventures in the new technology domains like artificial intelligence, machine learning, big data and biotechnology among others.

SEBI’s regulatory sandbox

According to SEBI’s guidelines, all entities registered under the SEBI Act 1992 are eligible for testing in their sandbox even if they use the services of a fintech firm.

Initially, all Sebi-registered entities will be eligible to participate in such a 'regulatory sandbox', a live testing environment where new products processes, services and business models can be deployed on a limited set of eligible customers for a specified period of time with certain relaxations in rules and guidelines

IRDAI’s regulatory sandbox
  • The IRDAI’s sandbox exclusively looks at products and services in the insurance sector and has set up a panel to review applications.
  • Any applicant who wants to promote and implement innovation in insurance in India is eligible to enter the programme
  • However, the applicant must demonstrate the invention to the regulator and not merely apply to get a regulatory waiver. There is no specific period of testing, but the testing period ends when the number of customers crosses 10,000 or when the premium collected exceeds INR 50 lakh or by any other parameter decided by IRDAI

Comparison of basic features of various RS frameworks : RBI, SEBI and NABARD

Frequency of application: 
  • RBI Framework: Based on the cohort framework i.e. end-to-end sandbox. The RBI rolls out a theme-based cohort, say digital payments, under which fintech intending to provide services relating to the theme shall apply. Applications can be made only when a cohort is live.
  • SEBI Framework: This is an on-tap framework. Hence, an application may be made anytime Based on the cohort approach. 
  • IRDAI Framework: Based on the cohort approach. Applications can be made only when a cohort is live.

Applicability/Eligibility to apply
  • RBI Framework: Fintech companies including stratus, banks, financial institutions and any other company partnering with or providing support to financial services businesses which satisfies the detailed eligibility criteria laid down
  • SEBI Framework: Entities registered with SEBI under section 12 of SEBI Act, 1992.
  • IRDAI Framework: Insurers, Insurance intermediaries, any person (other than individual) having net worth of Rs. 10 lakhs or more in the previous financial year, Any other person recognized by IRDAI

Testing duration
  • RBI Framework: Maximum 12 weeks, extendable on request
  • SEBI Framework: Maximum 12 months, extendable upon request
  • IRDAI Framework: Maximum 6 months, extendable on request

  • RBI Framework: As motioned Above in the Article
  • SEBI Framework: No such exclusions
  • IRDAI Framework: No such exclusions

Way Forward

Regulatory sandbox should prioritize businesses that innovate to address the needs of under-served customers such as rural households, women, blue-collared workers, self-employed and senior citizens. This would help achieve one of its stated benefits of improving financial inclusion.

Regulators must harmonize the jurisdiction for sandboxes. Currently, RBI, SEBI, IRDAI and several individual states are running separate sandboxes, and there is a need to build communication channels between these.

The regulator’s internal capacity must be boosted. The RBI has indicated that three full-time officers will oversee the regulatory sandbox. With fintech developing at a rapid rate, there is a need to understand these innovations and the impact they would have on consumers, which would require more people to work closely with the firms.

Indian regulators must institute a formal office/mechanism to reach out to innovators and actively look at developments in the fintech space. Additionally, this mechanism should help address the innovators’ doubts and provide guidance on regulatory compliance.

Indian regulators must be part of global networks for knowledge sharing. As India’s fintech ecosystem starts expanding to other countries, it is necessary to ensure these firms do not contravene international norms. It will also help India take on a leadership role for unique innovations. For instance, Google wrote to the US Federal Reserve to urge the regulator to build a real-time payments architecture on the lines of India’s UPI.

As financial systems digitize, financial regulators must keep abreast of data governance and privacy issues and the evolving data-specific laws. 

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