Recent events, such as the Reserve Bank of India’s ban on a leading bank from onboarding new customers on its app, due to various governance violations, have thrown a stark light on the urgent need for financial regulators to think digital, not just finance. By the way, the particular trouble in that bank incident was human-centric and not digitally-emanated. But it shows the haste in which banking sector is wanting to go-digital? But at what cost?
Traditionally seen as bastions of financial security, banks of today, are vulnerable and yet accountable to the public; for they handle monies, and are also institutions that the public has trust on.
Their vast data treasures, once a source of strength, are now potential Achilles heels in the face of cyber threats and unauthorised activities —including human risky-actions, emanating from within.
Do they get away with money and mockery, simply because their regulatory-parentage affords them to, while their fintech-frenemies get the stick?
Money is no longer confined to physical currency but has transformed into bytes, and the management of this, faces threats from both within and outside the system. We can no longer view “digital finance” through the narrow lens of fintech; the harsh reality is that digital permeates all corners of the financial world.
Rephrasing with creativity, the Peter Drucker’s famous quote, the reality is that ‘Digital eats banking for breakfast’. Regulators must recognise that fintech is no longer a fringe element but an integral part of digital finance. Regulators must think digital, not simply finance, because the financial world now operates within an intricate digital ecosystem where all entities are interconnected through technical pipelines managed by humans.
Money flows through servers via digital means with a simple act of linking a phone number and punching in an OTP, and this process, when manipulated by humans, creates systemic vulnerabilities that exist beyond the traditional audit framework. Banking regulations have historically centred on technical pipelines and physical entities, but this approach is now conceptually naive.
It is time for regulators to adopt a digital-native framework. Digital finance is not about translating physical structures into digital; it is about exporting digital structures into the physical world. A bank account is now an entry in a database residing on a server, and a ledger is nothing more than two database tables. A phone number serves as the conduit to connect two bank accounts via UPI.
By ignoring this conduit approach and solely focusing on physical entities, regulators cannot effectively oversee finance. In India, fintech is often seen as a venture capital success story, but it has yet to establish a robust regulatory model that can straighten out and detect egregious bad behaviour by regulated entities.
To bridge this gap, regulators must shift their perspective and embrace the digital transformation that has reshaped the financial landscape. The RBI has encountered challenges in its pursuit of regulating digital lending apps, especially those outside of its authority, a predicament emblematic of the broader challenges financial regulators worldwide will inevitably confront.
Beyond this specific issue, a pivotal transformation is required within the regulatory framework: the shift from entity-based supervision to real-time, digital-first activity-based supervision.
Traditional regulatory models that predominantly focus on the legal entity have become increasingly inadequate. The reliance on entities alone no longer suffices in monitoring the intricate and instantaneous transactions that define modern financial systems. The call for a transition towards activity-based supervision has become a necessity.
This shift implies a more proactive and responsive approach, whereby regulators delve into the actual activities taking place in the digital financial landscape in real time. It encompasses the monitoring of transactions, risk assessment, and the ability to swiftly identify and address potential issues as they emerge.
While this transition represents a formidable challenge, it is essential to ensure the integrity and stability of digital finance. Regulators must harness technology to their advantage, working in tandem with industry players to create a regulatory environment that adapts to the ever-evolving landscape of digital financial services. It is a transformative journey that, when executed effectively, promises to enhance the regulatory ecosystem and uphold the financial well-being of consumers in the digital age.
The Reserve Bank of India (RBI) must wield its regulatory power with a heavy hand and penalise its supervised entities, such as banks and NBFCs, with substantial fines for significant transgressions. It has to start thinking of stopping the CEO / concerned CXOs’ next employment renewal or reducing the contractual-duration with the financial institution, or asking the entities to table its concerns on its Board records with specific ask of additional ‘capital provisioning to cover those risks’.
It's preposterous to believe that the RBI can reform the behaviour of these financial giants by imposing paltry fines that barely scrape the surface of what an entry-level to mid-level job in the very same institution pays. For too long, these institutions have gotten away with minor slaps on the wrist, which do nothing to deter reckless practices or misconduct.
If the RBI is to be a true guardian of financial stability and integrity, it must send a clear and unequivocal message — negligence, misconduct, and transgressions will not be tolerated, and the price to pay will be substantial. The time has come for fines that sting and leave an indelible mark, ensuring that the financial sector operates with the highest standards of responsibility and accountability.
—The authors, Dr. Srinath Sridharan, is a Policy Researcher & Corporate advisor, and Anand V, is a Cyber-Security Researcher & Co-Founder at DeepStrat. The views expressed are their personal.
(Edited by : C H Unnikrishnan)
First Published: Oct 25, 2023 8:42 AM IST
