Regulators must balance innovation and stability, says RBI deputy governor M. Rajeshwar
'While it is necessary to minimise systemic risks and protect consumers, it should not discourage creativity, innovation, or healthy market dynamics,' Rao said at the inaugural session of the Department of Personnel and Training and Management Development Programme (DoPT MDP) on Financial Market Regulations at the Indian Institute of Management Kozhikode (IIMK) on Tuesday. The speech was uploaded on the Reserve Bank of India (RBI) website on Wednesday.
Rao said while innovation has transformed the financial sector, it has also created regulatory grey areas, often through new business models and partnerships with unregulated third parties. Regulators must ensure that such gaps are addressed by creating guardrails that allow innovation to flourish without undermining systemic stability, he said. To this end, the regulators are adopting more agile approaches, including the use of regulatory sandboxes and deeper engagement with stakeholders, to integrate emerging players into the financial system.
New technologies, Rao said, have improved ease of doing business and lowered operational costs, but they also bring complex regulatory challenges. These include the unpredictable nature of tech-driven business models, questions around data privacy and control, and what he called 'the artificial intelligence (AI) conundrum'.
Rao cited the example of the banking-as-a-service model, which expands the distribution of financial products but could also give rise to business conduct risks. 'Regulators face a dilemma: whether to come out with a framework before such financial innovations happen or allow markets to develop, risking unanticipated systemic risks and exploitative consumer practices,' said Rao, adding that regulators must navigate capacity constraints and legal complexities in crafting effective regulations.
The RBI has set up a committee to develop a Framework for Responsible and Ethical Enablement of Artificial Intelligence (FREE-AI) in the financial sector. It has come out with a principle-based approach to AI adoption in the financial sector.
Rao pointed out the challenge of the lack of precise data, which makes it difficult for regulators to craft effective policies. The rapid growth of financial technologies has created a flood of information, but questions remain over its credibility and accuracy. 'Though regulators are equipping themselves with the latest tools and skills, the pace at which requirements are evolving is breathtaking,' he said, adding that continued capacity building was needed.
He highlighted the growing importance of Regulatory Impact Assessments (RIA) as a way to design evidence-based rules that are both effective and proportionate. Two key elements of RIA, Rao said, are cost-benefit analysis and broad-spectrum stakeholder consultations. 'While the latter leads to enhanced transparency, fostering trust, and improvement in the quality and effectiveness of the regulations, the former helps determine the optimal solution for addressing the problem,' he said, adding that such approaches ensure efficient allocation of resources.
Rao said the regulators must also focus on improving compliance by simplifying regulations and removing redundancies. The RBI, he said, has been working to enhance clarity in its regulations by including examples and FAQs, and is in the process of consolidating over 8,000 regulatory instructions into 30-35 thematic categories. Such initiatives, according to him, are intended to make it easier for regulated entities (RE) to respond effectively while supporting the broader development of the financial sector.
He emphasised the need for stronger coordination among India's multiple financial sector regulators (FSR). 'The Financial Stability and Development Council (FSDC) headed by the finance minister, provides a platform for combined assessment of risks from the financial stability perspective and plays a pivotal role in inter-regulatory co-ordination on the matters where there is overlap among FSRs.'
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