For the times they are a-changin’
– Bob Dylan

Paul Volcker, the former head of the Federal Reserve once told American financial services executives that the ATM was the peak of innovation in the financial industry. While reasonable folks may disagree with Volcker, it is certain that the pace of innovation in the financial sector space is slow, in part, as an unintended consequence of entry-barriers and maze of regulations governing the sector. In the aftermath of the great financial crisis of 2008, regulatory caution is perhaps expected. Nonetheless, the absence of innovation in the financial sector may have consequential impact in terms of inhibiting the rate of financial inclusion for the poor. (There are structural/legal reasons for according stability a “first among equals” treatment among the several regulatory goals. For example, the constituent statutes of most central banks make stability and controlling inflation as their main goals. Thus there is an Institutional bias in favor of preserving stability).

In recent years, starting with the Financial Conduct Authority (UK), regulators have attempted to intermediate the tension between innovation and stability through the construct of a regulatory sandbox.

Simply put, a regulatory sandbox is a “safe space” in which businesses can test innovative products, services, business models and delivery mechanisms without incurring regulatory consequences of engaging in the activity in question.

A controlled environment ensures that the businesses operate without any risk of enforcement actions from the regulators. (The actionable instrument here is in the form of a “No-action letter” that issues from the regulator to the entity experimenting for the duration of the experiment). Regulators from Australia, HK, Malaysia and Singapore have followed the template laid down by FCA and set up their own sandboxes. In fact, as a CGAP paper on the issue tells us, more than 20 countries from Abu Dhabi to Sierra Leone have adopted the concept. Closer home, an internal working group at the RBI also appears to be convinced of the potential of a sandbox to promote innovation and has recommended that it be housed at the IDRBT. 2

But why am I telling you all this? Because at Catalyst, continuing with our commitment to financial inclusion, we have embarked on a project that compliments the idea of regulatory sandbox. Jumping ahead of the regulatory sandbox curve if you will, we are presently documenting use-cases that remain constrained owing to regulatory, infrastructural or operational reasons. We have put together the first tranche of 7 such areas and propose to document a total of 15 scalable use-cases that are also relevant from a financial inclusion stand-point by the end of this exercise. We will disseminate the paper through a symposium and engage in concerted advocacy with the regulators along the way.

I am going to walk you through the first tranche in a bit but before that, recall the scene from Moneyball when Billy Beane (Pitt) meets John Henry of the Boston Red Sox. Beane’s unorthodox approach to Baseball and reliance on statistics instead of scouts to source players had the Oakland A’s on a 19 match unbeaten streak (that regrettably ended against Kansas in the playoffs). As John Henry told Beane:

“I know you’ve taken it in the teeth out there, but the first guy through the wall — he always gets bloody. Always. It’s the threat of not just the way of doing business, but in their minds, it’s threatening the game. But really what it’s threatening is their livelihoods. It’s threatening their jobs. It’s threatening the way that they do things. And every time that happens, whether it’s the government or a way of doing business or whatever it is, the people who are holding the reins — have their hands on the switch — they go batshit crazy.”

Fintech start-ups are the Billy Beane of our ecosystem. They invest capital and intellectual labor in a business idea motivated to solve for apparently difficult problems that society faces. As with Baseball the incumbents and the hard-coded legal rules and processes don’t make their task any easier.

It is important therefore to create facilitative Institutional framework where they can test business cases with potentially consequential benefits for the society; like the use-case on enabling customized wealth management for the informal sector consumers that we have covered. It is common knowledge that they experience high cash-flow volatility and are often under/uninsured. Yet, we do not have a regulatory framework for offering customized portfolio management, based on their unique needs. We suggest some testable solutions.

Aadhaar-Pay is another use-case rich with potential given India’s poorly developed general card acquiring infrastructure. Aadhaar Pay can be used by merchants as an alternative to cost-intensive PoS infrastructure in areas where PoS penetration is poor. However, the current unit economics does not support banks to acquire merchants on Aadhaar Pay rails.

We propose, among other things, a change in the pricing model that compensates the acquiring bank that can proliferate the Aadhaar-Pay solution.

Finally, there is the emergent form of lending on a non-recourse basis; a platform matches borrower to a group of lenders discovering the coupon on the loan through bidding on the platform. At present, RBI’s regulatory framework has restricted the use-case by capping both the lender-side and borrower-side exposure. However, there is case for experimenting the use of these platforms for micro and small business credit. Equally, there is a case for experimenting scenarios where Institutional capital invests in these businesses and not merely natural persons. Likewise, these platforms can facilitate deepening of secondary market for loans on balance sheet of conventional originators. At present, the secondary market participants only include banks and ARCs. Testing if these platforms can buy, spread and manage that risk among their Institutional investors if successful can unlock another buyer group and move importantly, clean up the formal financial system of NPAs faster. More on this later!

I will leave you all with a quote from Money Ball, (the book this time): “If you challenge conventional wisdom, you will find ways to do things much better than they are currently done.”


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