From employing analysts to scrutinize client data to holding frequent meetings with executives, India's financial regulator is stepping up monitoring of fintech businesses.
The Reserve Bank of India (RBI) took these steps after routine inspections over the past year revealed that a number of fintech businesses had been negligent in implementing client due diligence, according to five persons familiar with the subject.
Fintech firms and their investors got a taste of that tighter approach last month when the central bank ordered industry behemoth Paytm to suspend its banking unit due to what it called "persistent noncompliance with regulations."
That direction, which sparked concern in the industry, was followed by a separate order to Visa this month, instructing it to halt processing business-to-business card payments through third-party fintech firms.
The RBI's actions come as financial regulators in other key economies, like China, crack down on rule infractions and develop new regulations for the fintech sector after adopting a laissez-faire policy for many years.
Fintech firms provide a wide range of services worldwide, from payments to modest credit and deposits, and as their economic importance grows, regulators are tightening their scrutiny of their relationships with the rest of the financial system.
Like in India, nimble fintech firms' customer due diligence and data handling practices have sparked worry among central banks and regulators throughout the world as they seek to reduce monopoly, data privacy, money laundering, and spillover risk.
"The RBI is very clear, whether you are "fin(ancial) or tech or fintech", basic rules governing customer identification and a clear footprint of fund flows have to be followed," said one of the persons familiar with the central bank's views.
All of the sources declined to be named since they were not authorized to speak to the media. A spokesman for the RBI did not respond to an email requesting information about its interactions with fintech firms.
Customer Due Diligence The central bank is particularly concerned about fintech firms' digital client identification method, which uses a government identity proof known as Aadhaar and a linked mobile number to verify a person's identity.
This strategy is extensively employed by fintech organizations as a speedier and less expensive means to conduct due diligence, but it is also susceptible to manipulation, raising fraud or money laundering issues, according to the second source.
While the RBI has not forbidden the use of this kind of verification, it has requested that digitally verified accounts be marked as 'high risk' until physical or video-call-based identification is accomplished, in accordance with the central bank's standards on customer due diligence.
As part of its increased control, RBI officials have started randomly sampling a fintech firm's user base during periodic onsite inspections to ensure legitimacy, according to founders of two fintech firms.
According to one of the founders, such sessions are now held once a month, up from once a quarter last year.
Separately, the RBI is investing in better technology to detect regulatory infractions and recruiting analysts to investigate millions of consumers' personal information kept by fintech firms, according to the second source.
According to Reuters, India's finance ministry will meet with home-grown fintech businesses, some of which are backed by big global investors, next week to push them to comply with regulations and listen to their concerns.
Heightened regulatory scrutiny and increasing laws would increase the cost of compliance as well as capital requirements, potentially leading to a consolidation round in the sector, according to Ashish Fafadia, partner at Blume Ventures.
However, the scrutiny will "force people to be compliant and do deeper diligence and back companies which have complied, rather than steer them away from it," said Fafadia, whose firm has invested in 20 Indian fintech firms.
