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In the past decade, there has been a growing need for public policy and regulation to keep pace with the growth of technology and innovation. Policy and governance must evolve in parallel with this growth to avoid societal harm and regulatory uncertainty for businesses.

An example of this issue was the unchecked growth of mobile lending apps during the covid-19 pandemic. Although the apps delivered genuine innovation and eased financial transactions, vulnerable groups reportedly suffered significant stress. They faced exorbitant interest rates and struggled to make payments. In the absence of regulations for tech-based financing, some apps reportedly exploited these groups, ensnaring them in schemes such as buy now, pay later, which pushed them into debt spirals. The regulatory response to curb these practices involved multiple course corrections and clarifications. As a result, some startups shut down due to regulatory uncertainty. If properly regulated, such apps could have spurred further innovation and consumption. Instead, the episode became a cautionary tale that discouraged risk-taking and undermined the ethos of innovation.

Enhancing innovation through effective sandboxes

Regulatory sandboxes have become a vital tool allowing policymakers and regulators to protect consumers while fostering innovators who can drive the economy. They allow innovative products and systems to be tested in a controlled environment without fear of regulatory implications, while identifying possible harm, close regulatory gaps and adapt rules before products/services are released, minimising consumer risk. This also provides certainty to businesses to release innovative products without worrying about whether their business models will be affected.

The Reserve Bank of India (RBI), the Securities and Exchange Board of India, the Insurance Regulatory and Development Authority of India and the International Financial Services Centres Authority have separately used regulatory sandboxes to foster responsible innovation, with the RBI taking the lead.

The RBI’s sandbox framework grants some relaxations, on a case-by-case basis, from certain regulatory requirements such as liquidity, board composition, track records and financial soundness. However, no exemption/relaxation is offered for core compliance requirements, such as customer privacy, KYC and AML regulations and data protection.

Boosting RBI’s sandbox for innovation

Several business models have launched successfully after using this sandbox, including blockchain-based vendor financing for MSMEs and offline digital payment solutions using distributed ledger technology. To further strengthen the regulatory sandbox and make it more welcoming to innovation, additional support is needed.

Many sandbox applicants are startups with limited resources, that lack not only capital but also relevant datasets. Recognising such limitations, the UK’s financial regulator, the Financial Conduct Authority (FCA) offers technological support and access to synthetic, public, anonymised and pseudonymised datasets and APIs to facilitate testing in its digital sandbox. In contrast, the RBI does not provide such support, placing the responsibility for technical deployment solely on the applicant for live testing.

The sandbox applies strict eligibility criteria like minimum net worth, satisfactory conduct and credit history, demonstrable technological achievement and robust IT governance and protection. In comparison, the UK and Singapore are more flexible and place greater emphasis on whether products and services are innovative and beneficial to consumers.

Guidance gaps in RBI sandbox

Regulatory frameworks are complex and startups can benefit from informal guidance. In the UK, the FCA helps applicants understand and navigate regulatory requirements during their time in the sandbox. The RBI offers no such explicit assistance, requiring applicants to be aware of the law and regulations. Applicant must seek explicit approval for regulation relaxations.

The RBI encourages innovation by admitting numerous companies into its sandbox model. However, by adopting these additional measures, the RBI can further strengthen the innovation ecosystem, boost economic growth and encourage entrepreneurship.

Siddharth Suresh and Nakul Batra are partners, and Prateek Kumar Singh is a senior associate at DSK Legal.