To promote digital banks, NITI Aayog proposes regulatory framework

NITI Aayog has released a paper titled "Digital Banks: A Proposal for Licensing & Regulatory Regime for India." It suggested establishing a framework for the licensing and regulation of Digital Banks.

What are key findings of the report?

• India has made rapid progress in financial inclusion (FI) in recent years thanks to the Pradhan Mantri Jan Dhan Yojana (PMJDY) and India Stack.
• However, credit penetration continues to be a policy issue, especially for the country's 63 million or for SMEs (micro, small and medium enterprises).
• The Unified Payments Interface (UPI), which has seen unprecedented adoption, has advanced FI.
• As of October 2021, UPI has recorded over 4.2 billion transactions totalling Rs.7.7 trillion.
• In addition, FI has led to direct benefit transfer (DBT) through applications like PM-KISAN and expansion of microcredit options for street vendors through PM-SVANIDHI.
• India is about to implement its own open banking architecture.
• By developing a model regulatory framework and policy for digital banking, India will have a chance to cement its place as a world leader in fintech while addressing many of the public policy challenges it faces.
  

Road map Proposed by the Report for digital banks:

• The report recommends a carefully calibrated three-step approach for a digital bank license by the Reserve Bank of India (RBI):
  • In the first phase, the applicant should be granted a limited digital bank license with restrictions in terms of volume/value of customers served and the like.
  • In the second phase, the licensee will be placed in a regulatory sandbox by the RBI.
  • Third stage, the issuance of a "complete" digital banking license will be granted based on the licensee's satisfactory performance in the regulatory sandbox, including significant, prudent and technological risk management.
• Capital Requirement: A digital bank may be required to bring a minimum of ? 20 crore of paid-up capital in the limited phase. A full-fledged digital merchant bank will need to bring in ?200 crore after moving out of the sandbox.
• Regulatory standards: Digital banks will be subject to prudential and liquidity standards at the same level as existing commercial banks.

Why digital banks are required?

• Despite the rapid progress India has made in advancing its financial inclusion agenda, the lack of financial deepening remains a challenge, particularly with regard to the small business lending agenda.
• According to the latest MSME Census (2015-2016), there are 63.88 million unregistered MSMEs in India.
• A significant portion of these 63.88 million people remain uninsured and continue to rely on informal money markets for funding, such as money lenders (quick disbursements without documentation) and money funds (delayed disbursements but lower interest rates than money lenders).

What are the potential challenges that digital banks will face?

• Revenue generation
• Viability
• High cost of capital
• Penetration

What are the recommendations of the report?

• A limited digital bank license would be issued, with limits on the number and value of customers it could serve, among other things.
• Adding the licensee to the regulatory sandbox framework created by the Reserve Bank of India.
• A "full-scale" digital bank license will only be granted if the licensee performs satisfactorily in a regulatory sandbox that includes operational, prudential and technological risk management.

Assessing the positives and negatives

• Bridging the digital gap
• Increasing the internet penetration
• Increasing the accessibility to the hinterlands
• Increasing digital literacy
• Infrastructural development