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The $584 Bn-sized fintech ecosystem has been a hot topic of late. Now, with the NITI Aayog recommendations to regulate the ecosystem, neobanks have finally come under the licencing scanner.

The Government Think Tank NITI Aayog has, in its report titled ‘Digital Banks: A Proposal for Licensing & Regulatory Regime for India’ stated that it intends to offer a level playing field to incumbents as well as competitors. 

It has proposed that to regulate the ecosystem, the government can issue a restricted or a ‘full-scale’ digital bank licence and enlist the licenced neobank in a regulatory sandbox framework.

For the restricted license, the limitations would be imposed in terms of volume of customers and the like while a full-scale licence can be issued upon contingents on satisfactory performance such as salient, prudential and technological risk management.

For the same, the methodology for the licensing and regulatory template is based on an equally weighted ‘digital bank regulatory index’. It comprises four factors, viz., entry barriers, competition, business restrictions and technological neutrality. 

“Given the need for leveraging technology effectively to cater to the needs of banking in India, this report studies the prevailing gaps, the niches that remain underserved, and the global regulatory best practices in licensing digital banks,” NITI Aayog CEO Parameswaran Iyer stated.

Challenged Posed By Neobanks, As Stated By NITI Aayog

NITI Aayog, in the report, outlined that the prevalent neobank business model in India functions in a ‘regulatory vacuum’. It stated that current neobanking fintechs offer expense management products (like employee prepaid cards), payroll management, accounts receivables management platform and a business loan/credit line facility through the banking partner.

“In the absence of a licensing regime for ‘full-stack’ digital banks, fintechs offering the neobank propositions have improvised and adopted the ‘front-end neobanks’ model. But this model presents several challenges including with respect to revenue and viability,” it said.

It posed three most important challenges including the obsolescence of the traditional banking ecosystem, leading to failure in partnerships that neobanks have today, a high capital cost that has no entry barrier and limited revenue potential.

The idea to propose a regulatory framework within the fintech subsector comes at a time when several fintech subsectors are facing regulatory hiccups. 

For instance, RBI has enacted an open banking module through the Account Aggregator (AA) regulatory framework. Digital lending has been another hot topic and RBI has disallowed non-bank prepaid payment instruments (PPIs) to load credit lines. 

Further, RBI is also looking to unveil the guidelines for the digital lending ecosystem soon to deal with the rising cases of harassment by online loan sharks. Only yesterday, Inc42 exclusively reported that the fintech ecosystem is seeking clarifications over neobanking offerings on PPI wallets and the issuance of co-branded credit cards in partnership with banks. 

While NITI Aayog’s report offers mere suggestions, it remains to be seen how and if the regulators will work on these remarks.