The increasing role of fintechs in the financial sector has led to a noticeable increase in scrutiny of arrangements between regulated entities of the Reserve Bank of India (RBI) and such fintechs. (Representative image)
To effectively meet the diverse financial needs of Indian consumers, achieve rapid stability for necessary cost efficiencies, and share risks, there has been a noticeable increase in the number of financial institutions and banks tying up with financial technology companies (fintechs). They have jointly introduced a range of products and solutions, enabling the rapid growth of fintechs in India.
A case in point is SBM Bank, which had been working with fintechs. It has emerged as a leading bank in providing products and services in partnerships with fintechs. Almost 90 percent of the total credit cards issued (by it) have been through co-branding partnerships with fintechs.
However, as fintechs’ role in the financial sector has grown, there has been a noticeable increase in scrutiny of arrangements between regulated entities of the Reserve Bank of India (RBI) and such fintechs. The RBI has been working to bring fintech activities under its jurisdiction through regulations such as the Guidelines on Digital Lending and Master Direction on Credit Cards. The RBI has asked banks to provide it with reports on their contractual arrangements with fintechs in order to assess the risks associated with such arrangements.
Specifically, the RBI has been stressing on compliance with know your customer (KYC) regulations, due to the increased anti-money laundering and combating the financing of terrorism (AML/CFT) concerns arising from the use of digital means by fintechs. The RBI has been imposing monetary penalties on regulated entities found to be non-compliant with KYC regulations. Amazon Pay, Bank of India and Axis Bank are some of the entities that have been fined recently for such non-compliance.
In March, the RBI directed SBM Bank to update KYC information pertaining to its corporate credit cardholders. In order to ensure that it was fully compliant with the central bank’s mandate, SBM Bank conveyed to its partner fintechs the decision to pause customer transactions through co-branded corporate credit cards, effective April 01, 2023.
Reports suggest that the partner fintechs were informed of the decision only 10 days prior to the effective date of the decision, while customers were given barely a few hours to update their KYC information before the complete pause. This short notice made it difficult to maintain business continuity and provide corporate credit card services to clients, many of whom are start-ups. Such start-ups now find themselves without access to corporate credit cards, as large banks are unwilling to provide credit cards to them.
Given that the RBI had directed SBM Bank to stop cross-border remittances under the Liberalised Remittance Scheme, citing material supervisory concerns, it would be fair to assume that the decision to pause transactions through corporate credit cards, may have been taken to avoid any adverse action by the RBI. If found in violation, regulated entities such as SBM Bank face the risk of adverse decisions, involving:
(a) Directing regulated entities to not onboard any new corporate credit card customers, as seen in the case of non-compliance with data localisation norms by HDFC, Mastercard, Diners Club and American Express; and
(b) The possibility of a monetary penalty for non-compliance with KYC regulations.
Such developments can cause a confidence crisis among all stakeholders. The customer could lose confidence in the financial products (co-branded corporate credit cards in this case), leading to financial losses for the regulated entities, especially banks and other financial institutions, working closely with fintech companies. The businesses of fintechs would be most affected, especially for entities like Volopay and Karbon that only provide services related to co-branded corporate credit cards, and SBM Bank’s decision will bring their businesses to a complete halt.
The above developments can have far-reaching implications for an otherwise flourishing start-up ecosystem, with significant ripple effects under the current tight liquidity scenario.
Increasing Financial Penetration
The fintech-led financial transition has rested on the agility provided by regulatory flexibility that enabled innovation in financial services. The emergence of fintech companies and solutions provided by them for customer acquisition and servicing through digital means has vastly increased financial penetration. Catering to the divergent requirements of Indian consumers, including the underserved and unserved, who had historically struggled with access to the financial system, prior to India’s digital transformation, has been made possible with the prolific growth of the fintech sector.
RBI’s increased scrutiny of banks servicing start-ups and tech-based companies may be a fallout of the recent global trends affecting certain banks dealing with start-ups, in particular or possibly a natural extension of the central bank’s KYC compliance scrutiny. Whatever may be the reason, the decision has largely impacted the business continuity of partner fintechs, with their customers being left in a lurch.
While the RBI’s mandates and norms are to serve the larger economic interests of all, it is important that due alternatives and options are provided to a flourishing start-up ecosystem, which through continuous innovation, has made India a fintech leader, while also enabling inclusive economic growth in the country.