RBI: Self-Regulation – A Panacea for NBFC and Fintech Disease, Legal News, ET LegalWorld

This year has seen a major regulatory shake-up in the banking and finance sector, including the issuance of a detailed self-regulatory framework by the Reserve Bank of India (RBI). With the growth in the number, scale and operations of various categories of regulated and unregulated entities, the increased adoption of innovative technologies and the expanded reach of customers, the RBI has limited ability to directly monitor everything. To counter this situation and to take cues from other jurisdictions, the RBI has been promoting self-regulation both as an indirect mechanism for overseeing such entities and as a way to foster a culture of compliance, innovation, transparency and consumer protection.

The RBI mandates that a self-regulatory organization (SRO) must be registered as a Section 8 company under the Companies Act, 2013 to work with the regulator as well as the industry on policy and regulatory reforms. While industry bodies (such as PCI, IBA) have been around for some time, the detailed RBI regulations are likely to formalize the governance and operations of SROs and may address some of the issues faced by such bodies.

After public consultation, the RBI has issued an omnibus framework which will serve as its main framework and has separately prescribed additional sector-specific conditions. Based on this omnibus framework, the RBI has issued a call for invitations for setting up of SROs in the NBFC sector, particularly for investment and credit companies, housing finance companies and factors. Apart from these three, other types of NBFCs (such as infrastructure companies) can also join as members. One of the narratives in the industry is that NBFCs need to be viewed from a different perspective than banks in aspects that affect their functioning (such as debt recovery) to live up to their special status. Arguably, an NBFC-SRO can help bridge this gap.

In addition, the RBI has also published an enhanced SRO framework for the fintech sector. By encouraging unregulated entities (including those based outside India) to join the SRO, this reform is a significant achievement in promoting innovation while ensuring consumer protection. Notably, the term ‘fintechs’ has also been defined for the first time.

Given the vastness and diversity of the fintech sector, the RBI has not currently specified a maximum number of SROs that will be recognised. This is in sharp contrast to the NBFC sector, which is restricted to a maximum of two SROs. This will allow multiple Fintech-SROs (potentially engaging in different activities within the fintech sector) to co-exist simultaneously. There appears to be a derogation under the fintech framework as compared to the omnibus framework in terms of the power to impose monetary penalties. While this is not permitted under the latter, the RBI has permitted Fintech-SROs to impose monetary penalties on their members, provided that they are reasonable and not prohibitive. The RBI has also included provisions to ensure that the SRO is a diverse body, without any one member(s) being influenced or dominated by it. For example, a limit of 10% of the share capital and rotation of directors for important board positions. Membership in an SRO is voluntary, however, it is recommended that companies participate in at least one SRO.
A recognized SRO could bridge the gap by providing sectoral insights to both the regulator and the participants. By maintaining a unified voice of the industry, the SRO could play a key role in policy formulation and promoting overall growth. Once recognized, the RBI can consult with the SRO from time to time, which can inform the industry about upcoming policy changes and help prepare it for timely compliances.