NITI Aayog moots licensing, regulatory framework for digital banks

The Centre’s policy think-tank NITI Aayog has made a case for setting up digital banks, which would accept deposits and advance loans through digital means, and suggested a licensing and regulatory framework for such lenders.

A digital bank would be a bank defined in the Banking Regulation Act, 1949, and shall have its own balance sheet and legal existence. Such a bank would be different from the 75 Digital Banking Units (DBUs) -- announced by Finance Minister Nirmala Sitharaman in Union Budget 2022-23 -- which are being set up to push digital payments, banking and fintech innovations in underserved areas.

The success India has witnessed on the payments front is yet to be replicated in meeting the credit needs of its micro, small and medium businesses, said a NITI Aayog report titled ‘A proposal for Digital Banks in India: Licensing and Regulatory Regime’. “The current credit gap and the business and policy constraints reveal a need for leveraging technology effectively to cater to these needs and bring the underserved further within the formal financial fold,” the report said.

Banks and fintech businesses that offer digital banking services rely primarily on digital channels that organically have high-efficiency metrics relative to incumbent commercial banks, the report said. This structural feature makes them a potentially effective channel through which policymakers can achieve social goals like empowering the under-banked small businesses, and enhancing trust among retail consumers, the think tank said.

Digital banks will be subject to prudential and liquidity norms on a par with existing commercial banks. Creating a new licensing and regulatory framework has been proposed as regulatory innovation and not as regulatory arbitrage, the report said.

The report said existing partnership-based neo-bank models face several challenges, such as revenue generation and viability. They have limited revenue potential, high cost of capital, and offer products of only partner banks.

Making a case for digital banks, the NITI Aayog said initially “restricted” licences should be issued for such banks to applicants. The restricted nature of the licence would limit the volumes and value of customers serviced. The applicant would then be required to commence operations as a digital business bank/digital consumer bank in a regulatory sandbox. A full-scale licence would be issued based on satisfactory performance in the sandbox.

The report states that the applicant for a licence may require one or more controlling persons to have an established track record in e-commerce, payments, or technology space. Applicants may have the option to apply in the form of a consortium. Existing neo-banks seeking to upgrade or small finance banks that see the opportunity in digital business bank licence are potential eligible candidates. Fintech businesses may also be allowed to procure such a licence, the report said.

The report by the NITI Aayog states that while the RBI has the authority to issue a licence to a banking company under Section 22 of the Banking Regulation Act, an additional step is needed for creating a licensing regime for digital business banks and digital consumer banks that permits them to offer value-added-services that are complementary to their core financial business, on the same balance sheet as banking services.

Legal engineering for respective licences would be done in two steps: A digital business bank licence or a digital consumer bank license. The licence may also lay down the path to a “full-scale” digital business bank/digital consumer bank licence.

The Centre will have to notify that a non-financial business is complementary to the core financial business of digital business banks/digital consumer banks as an additional line of business they can engage in. The Centre, in consultation with the RBI, may create a permissible list of NFBs for digital business banks and digital consumer banks, respectively, and a list of non-permissible NFBs to ensure prudential decorum.