In 1994, Bill Gates, then Chairman of Microsoft was quoted as saying that “Banking is necessary, but banks are not”. Gates’ words were not as well understood then, but they are becoming increasingly clear now.
Digitalisation of banking and payments is in full swing, especially after the COVID-19 pandemic. The significant surge in digitalisation has led to a rise in regulation. Thus, regulators are trying to not only keep up with the developments, but also issue laws to safeguard both the banking system and the consumer.
In April 7, the Reserve Bank of India (RBI) released the guidelines on digital banking units (DBU guidelines), and on September 2 it released the guidelines on digital lending. Both lay the foundation for enabling digital banking in India.
Defining Banking, Digital Banking
One can see Gates’ statement playing out when comparing the RBI’s traditional banking regulations with digital banking regulations.
The Banking Regulation Act, 1949, gave the RBI powers to licence and regulate banking activity across India. The Act defined many aspects around banking to give clear directions to the regulator.
For instance, what is banking? As per the Act, ‘banking means the accepting, for the purpose of lending or investment, of deposits of money from the public, repayable on demand or otherwise, and withdrawal by cheque, draft, order or other wise’. A ‘banking company’ means any company which transacts the business of banking. The Act states that banking means lending and investing of public deposits, and a ‘banking company’ is one which engages in this business of deposits and loans.
However, the digital banking guidelines do not redefine banking, but focuses on the digital delivery of banking services. Digital banking, in the guidelines released in April, is defined as ‘banking services provided by a licensed bank for the execution of financial, banking and other transactions and/or orders/instruments through electronic devices/equipment over web sites (i.e online banking), mobile phones (i.e mobile banking) or other digital channels.’ It further adds that digital banking involves a ‘significant level of process automation and cross-institutional service capabilities running under enhanced technical architecture and differentiated business model/strategy’.
The definition of digital banking simply says how digital banking can be provided via multiple channels.
Loans Vs Digital Lending
In such a scenario, what is a digital banking unit (DBU) doing when banking can be provided via apps? The April 7 guidelines specify that a DBU is a ‘specialised fixed point business unit/hub’ which has basic digital infrastructure for providing digital banking products and services. Hence, a DBU is an attempt to merge both the physical and digital, where digital banking services will be provided in a physical branch setup. These DBUs could be useful in places with limited Internet connectivity, and digital resources.
On analysing traditional lending vs digital lending, we again see working of Gates’ remark.
The Banking Regulation Act, 1949, defines loan as two types — secured loans, and unsecured loans. Secured loans or advances means a ‘loan or advance made on the security of assets the market value of which is not at anytime less than the amount of such loan or advance’. The unsecured loan means ‘a loan or advance not so secured’.
The September 2 guidelines on digital lending do not define digital loans; but they define digital lending. This is because there ‘digital loans’ do not exist. In digital banking, the way money is lent is different from how a traditional loan is given. Traditional banks give loans after assessing a person’s income and credentials via the branch system. Whereas banks providing digital banking give the loans after doing a person’s assessment in a completely digital and automated format. Therefore, guidelines define digital lending as ‘a remote and automated lending process, largely by use of seamless digital technologies for customer acquisition, credit assessment, loan approval, disbursement, recovery, and associated customer service’.
The guidelines on DBUs and digital lending are a step in a right direction, but they look at regulation through silos. These guidelines limit the opening of DBUs to commercial banks, but open digital lending to a wider pool of banks, cooperatives and NBFCs. Fintech companies are not even mentioned in both the guidelines. Bhargavi Zaveri and Harsh Vardhan in a recent article argue that technology has blurred the lines between different entities, and it is difficult to look at regulation in terms of entities.
We need to move towards activity-based regulation, where we look at the activity, and not the entity. Researchers at the Bank for International Settlements (BIS) recently released a research note arguing that regulators could apply both activity-based and entity-based regulation to overcome shortcomings of both the regulatory approaches.
It is a good idea for the government and the RBI to work towards a comprehensive digital banking regulation Act on the lines of the Banking Regulation Act. The new Act should bring all the entities on a common platform, and analyse how the different entities engage in digital banking and digital banking products. Accordingly, the new Act should be framed covering all aspects of digital banking, and encouraging competition in the sector.
The new Act will become a benchmark for other countries as India’s digital payments have become over the years.