Increased scrutiny of the bank-fintech alliance puts the start-up ecosystem at risk

RBI’s increased scrutiny of banks servicing start-ups and technology-based companies has greatly affected the business continuity of partner fintechs, leaving their customers in the lurch.

To effectively meet the diverse financial needs of Indian consumers, achieve rapid stability for necessary cost-effectiveness and share risk, there has been a noticeable increase in the number of financial institutions and banks tying up with financial technology companies (fintechs). They have jointly introduced a number of products and solutions, enabling the rapid growth of fintechs in India.

An example is SBM Bank, which had been working with fintechs. It has emerged as a leading bank in offering products and services in partnership with fintechs. Almost 90 percent of the total credit cards issued (by it) have been through co-branding partnerships with fintechs.

However, the growing role of fintechs in the financial sector has led to a noticeable increase in scrutiny of arrangements between regulated entities of the Reserve Bank of India (RBI) and such fintechs. RBI has been working to bring the activities of fintech under its purview, know regulations such as Guidelines for digital lending and Master Direction on credit cards. To assess the risks arising from such arrangements with fintechs, the RBI has asked banks to provide it with reports on their contractual arrangements with fintechs.

Compliance with KYC norms

Specifically, the RBI has emphasized compliance with know your customer (KYC) regulations, due to increased anti-money laundering and countering the financing of terrorism (AML/CFT) concerns arising from fintechs’ use of digital funds. RBI has imposed monetary penalties on regulated entities that do not comply with KYC regulations. AmazonPay, Bank of India and Axis Bank are some of the entities that have recently been fined for such non-compliance.

In March, RBI directed SBM Bank to update KYC information relating to corporate credit card holders. To ensure it was fully compliant with the central bank’s mandate, SBM Bank communicated to its partner fintechs the decision to pause customer transactions through co-branded corporate credit cards, effective April 1, 2023.

Reports suggest that partner fintechs were informed of the decision only 10 days before the effective date of the decision, while customers were given barely a few hours to update their KYC information before the complete pause. This short notice made it difficult to maintain business continuity and offer credit card services to customers, many of whom are startups. Such start-ups now find themselves without access to business credit cards, as large banks are unwilling to give them credit cards.

Regulatory measures

Given that the RBI had asked SBM Bank to stop cross-border remittances under the Liberalized Remittance Scheme, citing significant supervisory concerns, it would be reasonable to assume that the decision to pause transactions through corporate credit cards may have been taken to avoid adverse action by the RBI. If found in violation, regulated entities such as SBM Bank face the risk of adverse decisions, involving:

(a) Instruct regulated entities not to bring new corporate credit card customers, as seen in the case of non-compliance with data localization norms by HDFC, Mastercard, Diners Club and American Express; and

(b) The possibility of a monetary penalty for non-compliance with KYC regulations.

Such a development could cause a crisis of confidence among all stakeholders. The customer may lose confidence in the financial products (co-branded corporate credit cards in this case), which may lead to financial losses for the regulated entities, especially banks and other financial institutions, which work closely with fintech companies. The businesses of fintechs will be most affected, especially for entities like Volopay and Karbon that only offer services related to co-branded corporate credit cards, and SBM Bank’s decision will bring their businesses to a complete halt.

The above development could have far-reaching implications for an otherwise thriving startup ecosystem, with significant knock-on effects under today’s tight liquidity scenario.

Increasing economic penetration

The fintech-led economic transition has rested on the agility provided by regulatory flexibility that enabled innovation in financial services. The emergence of fintech companies and solutions provided by them for customer acquisition and service through digital means has significantly increased financial penetration. Catering to the diverse demands of Indian consumers, including the underserved and unserved, who had historically struggled to access the financial system, prior to India’s digital transformation, has become possible with the prolific growth of the fintech sector.

RBI’s increased scrutiny of banks serving start-ups and technology-based companies may be a result of recent global trends affecting certain banks dealing with start-ups, particularly or possibly a natural extension of the central bank’s control of compliance with KYC. Whatever the reason may be, the decision has greatly affected the business continuity of partner fintechs, leaving their customers in the lurch.

While RBI’s mandates and norms are meant to serve the greater economic interests of all, it is important that appropriate options and alternatives are provided to a thriving startup ecosystem, which through continuous innovation has made India a fintech leader, while enabling inclusive economic growth in the country .

(Naman Lodha, associate at Cyril Amarchand Mangaldas also contributed to the article.)

Anu Tiwari and Pallavi Singh Rao are partners at Cyril Amarchand Mangaldas. The views are personal and do not represent the position of this publication.