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WHAT FUTURE HOLDS FOR NEO-BANKS IN INDIA?

1. BACKGROUND & INTRODUCTION

1.1. It is rightly said that this era is an era of technological evolutions. With digital innovation and intrusion of information technology (IT), yet another sector (read: banking sector) is reforming with the emergence of neo-banks. As per the report of Statista, neo-banks are growing with the annual average rate of 50% and are expected to reach the market size of over two (2) US$ by 2030[1].

1.2. Neo-bank means “new bank”. The term ‘neo’ has originated from the Greek word “neos” which means ‘new’. Unlike traditional banks, neo-banks are new kind of technology-driven banks which do not have any corporeal presence. Neo-banks are, generally, fintech firms which offer banking services, virtually, by using IT and artificial intelligence. Mobile applications or website platforms are used to provide end-to-end banking services such as opening bank accounts, loan/credit facilities, prepaid card services, money transfer and remittance solutions etc. Tech-savvy customers find neo-banks more transparent, customer-friendly, convenient, cheap, and less time consuming.

2. HOW DO NEO BANKS WORK?  

The neo-banks work on the “business as a service” model. There are mainly three models on which neo-banks provide services to their customers:

S.NO.

MODELS OF NEO-BANKS

 

1.       

 

 

 

 

 

LICENSED (FULL-STACK) NEO-BANKS

•      Neo-banks operate as an independent bank after obtaining banking license from the regulatory bodies to render banking services on digital platform.  

•      This model is followed where licensing of neo-bank is permitted and regulated by the government and regulatory authorities.  

•      For instance, Prudential Regulation Authority and the Financial Conduct Authority of United Kingdom has granted full- banking license within the existing regulatory framework to neo-bank, Monzo.[2]

 

2.       

 

 

 

UNIT OF TRADITIONAL BANKS

•   Neo-banks act as a digital unit for traditional bank to provide digital banking services to banks’ customers.

•   For instance, in March 2017 Kotak Mahindra Bank introduced its digital initiate “811 by Kotak” to provide swift banking business services to its customer[3]. In this type of model is largely followed by Banks in India.

•   YONO by SBI is also an example of neo-banking service provided by traditional bank.

3.       

 

 

 

(FRONT-END) NON-LICENSED NEO-BANKS

•   Non-licensed neo banks enter into a strategic partnership with the licensed banks to provide banking services.

•   For instance, InstantPay, an Indian neo-bank entered into strategic  partnership with banks such as Axis Bank, Induslnd Bank to offer financial services to its customers.

•   This model is being followed in India by fintech companies to provide neo-banking services to its customers.

3. INDIAN REGULATORY FRAMEWORK FOR NEO-BANKS

  3.1. In India, banking services are regulated by the Reserve Bank of India (RBI) under the Banking Regulation Act 1949 (Act). As per section 22 of Act, no one can carry the banking business unless it has obtained license from the RBI. On 01.07.2016, RBI via Master Circular-Mobile Banking transaction in India-Operative Guidelines for Banks laid down that “banks which are licensed, supervised and having physical presence in India, are permitted to offer mobile banking services”[4]. Consequently, since it is mandatory for an entity to have physical presence in India for providing banking services, neo-banks are not governed and licensed in India. That’s why neo-banks such Jupiter, Niyo, RazorpayX have collaborated with the traditional banks for providing their services in India.

  3.2. In absence of regulatory framework in India, neo-banks or fintech companies enter into the strategic partnership with the banks licensed by the RBI under the Act. The strategic partnership between the licensed banks and neo-banks (or fintech companies) is governed by the RBI inter alia under:

      i. ‘Financial Inclusion by Extension of Banking Services–Use of Business Correspondents (BCs)’[5] dated 28.09.2010;

          ii.‘ Master Direction on Digital Payment Security Controls’[1] dated 18.02.2021;

         iii. ‘Guidelines for Managing Risks and Code of Conduct in Outsourcing of Financial Services by Banks’[7] dated 03.11.2021.

  3.3. On 24.11.2021, NITI Aayog has released a discussion paper namely “Digital Banks: A Proposal for Licensing & Regulatory Regime for India”[8] (“Discussion Paper”) which lays down a road-map for licensing and regulating the digital banks (including neo-banks) in India.  After considering the four facts i.e., entry barriers, competition, business restrictions, technological neutrality within digital bank global regulatory index, Discussion Paper recommends the following:

      i.The introduction of a restricted digital business bank license wherein the restrictions could be imposed on minimum paid-up capital, asset, deposits, etc.;

  ii. The entities acquiring license (“Licensee”) would be subject to regulatory sandbox framework and monitoring of RBI;

       iii. Basis on the performance of Licensee within the regulatory sandbox framework, the initial set of restrictions imposed on Licensee could be progressively relaxed to a Full Stack Business bank license (as issued by the UK).

4.           DALAW COMMENTS

Considering the present regulatory framework for banking in India, it seems quite challenging for neo-banks to carry their business operations on stand-alone basis. However, if the necessary regulatory and legal support is provided, neo-banks can become a promising option for the customers. It can’t be denied that neo-banks are cheaper, convenient, transparent in comparison to traditional banks and, with progressive regulatory backing, neo-banks can become the future of banking in India. NITI Aayog has also recommended in favor of bringing the neo-banks within the regulatory sandbox. Therefore, if the steps are taken in the recommended direction, neo-banks may transform the prevalent banking systems in India.