Financial technology innovation has revolutionized the Indian banking system and financial inclusion. Digital Banking Units (DBUs) which are set to be launched to mark 75 years of Indian Independence are a significant step forward to leverage technology to provide banking services in a paperless and connected environment. The Reserve Bank of India's (RBI's) rejection of NITI Aayog's suggestions for opening Digital Banks signalled a cautious and calibrated approach of the central bank.
The RBI Guidelines for Establishment of DBUs state that Digital Banking refers to present and future electronic banking services provided by a licensed bank for the execution of financial, banking and other transactions through online banking, mobile banking or other digital channels. The DBUs will be specialised fixed point business units or hubs housing certain minimum digital infrastructure for delivering digital banking products and services as well as servicing existing financial products and services digitally, in both self-service and assisted mode, to enable customers to have cost-effective and convenient access. A template and roadmap for a Digital Bank released by the NITI Aayog last month indicate that these DBUs are expected to create the ecosystem for laying the foundation for licensed digital banks.
The NITI Aayog in its report titled, "Digital Banks- A proposal for Licensing & Regulatory Regime for India" insists that "traditional banks (with their legacy technology stack with limited product codes) may lack the ability to serve an emerging class of "digital-native" businesses" and "a regulatory innovation in the form of Digital Bank license may be a potential solution so that these businesses located downstream of banks may thrive and become engines of employment. " The report highlights that the Digital India revolution catalysed by Prime Minister Jan Dhan Yojana (PMJDY), India Stack, e-Know Your Customer and Unified Payments Interface (UPI) led to the opening of 42 crore bank accounts under PMJDY since its launching in 2014 while UP has clocked 4 trillion rupee transactions since it was launched in 2016. The lack of financial deepening, especially on the small business financing agenda despite the rapid progress in financial inclusion, forms the core basis of NITI Aayog's push for licensing and regulatory regime for digital banks.
The think tank argues that even though the share of gross value added in the national GDP of 63. 88 million unincorporated MSMEs was to the tune of 30% in 2019-20, a significant fraction of them remains outside the ambit of formal finance and rely on informal market money markets for funding. The Non-Banking Financial Companies (NBFCs), which have a greater market share than banks in MSME funding, are also constrained by the lack of authority to collect deposits and have to rely on funding from bank loans and debt capital markets, which, the report points out, translates into the higher capital cost for NBFCs and higher borrowing cost for MSMEs despite the fact modern NBFCs digitized all elements of their value chain.
Referring to a recent report of the Credit Information Bureau India Limited, the report points out that out of a total of 220 million credit-eligible retail customers, banks are servicing about 70 million customers and about 150 million customers will have credit needs but are yet to be serviced which shows that there is significant room to promote credit usage. About 66 million outstanding credit cards compared to 892 million outstanding debit cards amplify this gap. The RBI, on the other hand, sounded the word of caution that while innovative methods of designing and delivery of credit products and their servicing through digital lending routes have acquired prominence, certain concerns have also emerged which, if not mitigated, may erode the confidence of customers in digital lending ecosystem.
The RBI Working Group on 'digital lending including lending through online platforms and mobile apps' recommended a regulatory framework that is based on the principle that lending business can be carried out only by entities that are either regulated by the Reserve Bank or entities permitted to do so under any other law. For digital lending entities lending outside the purview of any statutory/ regulatory provisions, the working group suggested specific legislative and institutional interventions for consideration by the Central Government to curb the illegitimate lending activity being carried out by such entities. Recommendations of the Working Group accepted by the RBI for immediate implementation mandated to be followed by RBI regulated entities, their Lending Service Providers and Digital Lending Apps include customer protection and conduct issues, technology and data requirements and regulatory framework.
The RBI's cautious approach towards the NITI Aayog's suggestion for a digital bank licensing regime is explained by the apprehension of associated risks without a sound regulatory framework needed to retain the confidence of customers. The NITI Aayog coming up with a new template with more clarity on issues flagged by RBI may clear the decks for a licensed digital bank in India. .
