With all the focus on new banking licences and their potential impact on financial inclusion, some crucial points in the inclusion mission are slipping off the radar. The aim of inclusion is to expand the coverage of the formal financial system in the country, and over the past decade, this has also become a key objective for emerging economies.
India has chosen a bank-led model, primarily due to concerns of risk mitigation and supervision. Yet after eight years, it is clear that banks are labouring under the mandate, progress is slow and the cost of continuing exclusion is growing. Meanwhile, internationally, it is now well accepted that non-banking institutions also play a significant role in leading the unbanked onto the digital financial pathway. Given the current scenario, where monitoring and supervision of banks clearly needs to be reviewed, it is high time the discussion in India moved away from the standard bank/non-bank debate and dealt with addressing the core principles of risk mitigation as enunciated globally, i.e., provide an enabling environment for inclusion that deals with the risks in the specific services being provided, rather than focus on the provider.
How does this work?
The prime concerns of regulators revolve around ensuring financial stability and consumer protection, while addressing risks of fraud and money laundering. While the Bank for International Settlements (BIS) has recognized the linkages of inclusion to financial stability, the Financial Action Task Force (FATF) has explicitly stated that “the prevalence of a large informal, unregulated and undocumented economy negatively affects AML/CFT (Anti-Money Laundering/Combating the Financing of Terrorism) efforts and the integrity of the financial system”. The emphasis now is on setting international standards and guidelines for mitigating these risks while expanding coverage of the formal financial system and regulators aim for an environment that allows for innovation as technology evolves new models and modes.
To begin with, a key aspect of BIS and FATF guidelines is that regulators focus on addressing the specific risks of the business, irrespective of who provides the service. So the European Union 2009 Payment Services Directive applies to all payment service providers, stating clearly that funds accepted for e-money do not qualify for deposits because of e-money’s “specific character as an electronic surrogate for coins and bank notes, which is to be used for making payments, usually of limited amount and not as means of saving”. Regulation aimed at payment services alone, therefore, provides for a level playing field for all participants in the payments business, banks or non-banks: funds collected for the specific purpose of payments are isolated from the other funds of the institution, credit disbursal is disallowed from these funds, there are strict capital requirements, etc.
The Reserve Bank of India (RBI) does this as well in a limited way, so the principle is understood here—this model of letting non-banks lead is not quite anathema to RBI. So what holds RBI back from wholeheartedly accepting non-banks in the payments system? It has to be the concern of the risk of fraud and money laundering, especially given the propensity of market players to bend rules, lax supervision of know your customer norms, etc. The recent guidelines on the risk-based approach to new products and payments services issued by the FATF makes the point that AML/CFT safeguards can end up deterring legitimate consumers from the financial system, pushing them into the informal sector that is not subject to regulatory and supervisory oversight. Thus, the recommendation for proportional regulation, i.e., lower levels of regulation for lower levels of risks. For instance, limits on transaction levels can mitigate the risk of fraud, as long as it is combined with other measures such as account and transaction monitoring and filing of suspicious transaction reports.
What remains key is record keeping, transaction monitoring and reporting; one of the biggest concerns in India today is putting these systems in place. This needs more support from all stakeholders, not just RBI. For instance, from RBI’s point of view, a unique national identity number will make a lot of difference for it to effectively monitor transactions, whether by banks or non-banks. Here, of course, Aadhaar can play a big role, but not only are there concerns about the legal validity of this, there are also many practical issues that remain.
When it comes to financial inclusion in India, the crux, therefore, is that we need to address the basic risks while allowing more players and modes into the mission, and for this, we need to have much more coordination and collaboration, not just between industry participants but also between the various arms of policymakers. The international practices and guidelines are there for us to use, new banks will barely dent the surface of exclusion unless we change the way we transact.
Sumita Kale is with the Indicus Centre for Financial Inclusion.