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The IBA’s response to the situation in Ukraine
Akil Hirani
Majmudar & Partners, Mumbai
akil@majmudarindia.com
Swati Agrawal
Majmudar & Partners, Mumbai
swati@majmudarindia.co
Neobanks (commonly known as online banks, internet-only banks, virtual banks or digital banks) are fintech entities that exclusively operate online without traditional physical branch networks. They offer services like online cards, corporate credit cards, digital savings accounts, cash management and other ancillary services.
Neobanks have gained significant traction in India since the onset of the Covid-19 pandemic. There are many players, including Novo, Yelo, SaveIn and Jupiter, who have all raised significant funding this year. Large Indian private banks like ICICI Bank are also partnering with neobanks to offer services to their clients. Additionally, some traditional banks have set up their own digital-only banks. For example, DBS has launched its platform, called digibank, which offers all kinds of banking services online.
The reason for the success and growing popularity of neobanks is simple – customer convenience. Neobanks are making cumbersome banking processes like opening a bank account, funds transfers, expense tracking and invoice management easier for the end user. For example, Novo has integrated its technology into various platforms like Slack, Shopify and others, and provides easy funds transfers, virtual cards and other banking services.
A neobank’s business model differs from that of a traditional bank. Some of the key features of neobanks are as follows.
The Indian regulatory regime for neobanks is in a nascent stage. Neobanks are not as yet allowed to obtain a banking licence, unlike in other Asian countries, and are not directly regulated by the Reserve Bank of India (RBI). The collaboration model discussed above categorises neobanks as third-party technology service providers. These service providers are indirectly governed by the outsourcing guidelines[1] applicable to regulated entities like banks, payment system operators and non-banking financial companies (the Guidelines).
The Guidelines mandate partner banks to have an outsourcing policy and contract in place to monitor the activities of technology service providers, as well as to evaluate their risk mitigation mechanisms. A robust IT infrastructure and business recovery plan is a must for service providers. Neobanks are also obliged to comply with the data protection and security regime for financial and payment data in India.
Neobanks have expanded their scope of services; entering the lending, MSME[2] and healthcare financing space, among others. However, they have their own set of challenges, as follows.
Despite the challenges, neobanks have tremendous growth prospects in the Indian market. The ‘online only’ approach of neobanks bridges the gap between rural and urban India, and helps in promoting financial inclusion. Digital banks are also playing a significant role in developing India’s fast-growing start-up sector. For example, neobanks like Mahila Money, Niyo and Tide focus only on specific segments of the population and provide lending support to that segment. This segmented approach can go a long way in changing the banking system.
Neobanks abound in many countries around the world. In the US and the UK, this industry is growing exponentially, with an estimated growth value of $47.1bn in 2021 and $722bn in this decade. In the US, these digital banks are more commonly referred to as ‘challenger banks’.
Two approaches have been adopted by neobanks globally. One, a phased approach where neobanks first operate on a limited scale and gradually convert into fully-fledged banks (as has been the case in Singapore and Australia). Two, they directly apply for a banking licence and comply with all regulatory requirements applicable to traditional banks from the get-go. This approach has been followed in the US and the UK.
In other jurisdictions, the regulators have implemented a separate framework and licence regime for digital-only banks. Hong Kong, Malaysia and South Korea are some of the jurisdictions which follow this approach.
This industry has immense potential. The RBI has so far given neobanks a relaxed environment (regulatory sandbox) to develop and launch new products. The need of the hour is to create a level playing field for these entities and provide them enough space for technological and product innovation.
The growth of the neobank space in India depends on customer acceptance and risk management of the digital platforms. The retail customer base in India is diverse. Many people are still apprehensive of the digital-only model, finding traditional banks a safer option. Customer trust and regulatory support will help neobanks align with traditional banks.
It is imperative to strike a balance between regulation, product offering, and consumer benefits and safety. Universal licensing of neobanks may not be the right approach; all stakeholders will have to caucus and come up with a nuanced approach so as not to kill this industry.
[1] RBI Guidelines on Managing Risks and Code of Conduct in Outsourcing of Financial Services by Banks (RBI, 3 November 2006); Framework for Outsourcing of Payment and Settlement-related Activities by Payment System Operators (RBI, 3 August 2021); RBI Guidelines on Managing Risks and Code of Conduct in Outsourcing of Financial Services by NBFCs (RBI, 9 November 2017). See www.rbi.org.in.
[2] Micro, small and medium enterprises.