Reserve Bank bolsters oversight of fintech firms with more inspections

Mumbai, Feb 21, 2024 

From hiring analysts to scrutinise customer data to holding frequent meetings with executives, India's financial regulator is bolstering oversight of fintech firms in a signal of an end to years of light-handed regulation of a key business sector.

Those steps from the Reserve Bank of India (RBI) come after regular inspections over the past year found a number of fintech firms have been lax in following, for example, customer due diligence, five sources with knowledge of the matter said.

Fintech firms and their investors were given a foretaste of that stricter approach last month when the central bank ordered sector giant Paytm to wind down its banking unit due to, what it termed, persistent non-compliance with regulations.

That directive, which stirred disquiet in the sector, was followed by a separate order this month to Visa asking it to stop business-to-business card payments through third party fintech firms.

The RBI's moves come as financial regulators in other major markets, including in China, crack down on rule violations and frame new regulations for the fintech sector after having taken a laissez-faire approach for a long time.

Globally, fintech firms provide a range of services - from payments to small credit and deposits -- and as their economic influence increases, regulators are sharpening scrutiny of their linkages with the broader financial system.

Like in India, nimble-footed fintech firms' customer due diligence and data handling processes have also raised concerns for the central banks and regulators globally as they try to tamp down on monopoly, data privacy, money laundering and spillover risk.

"The RBI is very clear, whether you are "fin(ancial) or tech or fintech", basic rules governing customer identification and a clear footprint of fund flows have to be followed," said one of the sources familiar with the central bank's thinking.

All the sources declined to be named as they were not authorised to speak to the media.

A spokesperson for the RBI did not respond to an email seeking details of its interactions with fintech firms.

Customer due diligence

In particular, the central bank is uneasy with the digital customer identification process used by fintech firms, which relies on a government identity proof, called Aadhaar, and a linked mobile number to verify a person's identity.

This method is widely used by fintech firms as a faster and cheaper way to do due diligence, but it is also prone to manipulation, which raises fraud or money laundering concerns, said the second source.

While the RBI has not prohibited the use of this method of verification, it has asked that digitally verified accounts be tagged as 'high risk' till the time physical or video-call based identification is completed, according to central bank's regulations on customer due diligence.

As part of its sharpened oversight, RBI officials have been picking out random samples of a fintech firm's user base during frequent onsite inspections to check for authenticity, founders at two fintech firms said.

Frequency of such meetings has increased from once a quarter last year to once a month now, one of the founders said.

Separately, the RBI is also investing in better technology to catch regulatory violations and hiring analysts to study millions of customers' personal data held by the fintech firms, the second source said.

India's finance ministry will hold meetings with the home-grown fintech startups, some of them backed by marquee global investors, next week to urge them to comply with regulations and hear their concerns, Reuters reported on Tuesday.

Heightened regulatory scrutiny and evolving regulations will drive up the cost of compliance and also capital requirements, which in turn could trigger a consolidation round in the sector, said Ashish Fafadia, partner at Blume Ventures.

The scrutiny, however, will "force people to be compliant and do deeper diligence and back companies which have complied, rather than steer them away from it," said Fafadia, whose firm has invested in 20 Indian fintech firms.

[Reuters]