Digital Banks: A Proposal for Licensing & Regulatory Regime for India

Mains Marks Booster 5th August 2023

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"Digital Banks: A Proposal for Licensing & Regulatory Regime for India" by NITI Aayog emphasises the need for digital banks and a comprehensive regulatory framework. This proposal seeks to improve credit penetration among MSMEs and advance financial inclusion.

Digital Bank

The proposed definition of a digital bank within the Banking Regulation Act, 1949, emphasizes its unique characteristics:

Separate Legal Existence: A digital bank will possess its own balance sheet and legal identity.
Compliance with Prudential and Liquidity Norms: Digital banks must adhere to prudential and liquidity norms similar to those imposed on existing commercial banks.
Objective - To provide maximum services with minimum infrastructure, digitally without involving any paperwork.

Rationale for Digital Banks

The establishment of digital banks is driven by the following factors:

Credit Gap: Despite digital payments, India's micro, small, and medium businesses still need credit.
Reliance on Digital Channels: Digital banking channels empower under-banked small businesses and build retail consumer trust.
Challenges Faced by existing Neo-Bank Models like revenue generation and long-term viability.

Digital Banking Units (DBUs)

Overview of DBUs

Digital Banking Units (DBUs) are set up by the Scheduled commercial banks .
DBUs provide digital infrastructure for digital banking products and self-service financial products.
In DBU, the products and services are offered to customers in two modes:

Self-Service Mode (available on 24*7*365 basis)
Digital Assistance Mode
Objective - To ensure the benefits of digital banking reach every nook and corner of the country.

Benefits of DBUs

Improved Accessibility: DBUs enable individuals without Information and Communications Technology (ICT) infrastructure to access banking services digitally.
Assistance for Non-Tech Savvy: DBUs support individuals who are not technologically proficient in adopting digital banking.

Differentiating DBUs from Traditional Banks

24/7 Digital Banking Services: DBUs provide round-the-clock banking services, including cash deposits and withdrawals.
Digital Service Delivery: DBUs offer services exclusively through digital platforms.
Paperless Transactions: DBUs allow individuals without connectivity or computing devices to conduct banking transactions in a paperless manner.
Assisted Banking: Bank staff is available at DBUs to assist and guide users in their banking transactions.
Promoting Digital Literacy: DBUs contribute to digital financial literacy and raise awareness of digital banking adoption.

Difference between Digital Banks & Digital Banking Units (DBU)

Basis	Digital Banking Units (DBUs)	Digital Banks
Legal Status	DBUs do not have legal personality and are not licensed under the Banking Regulation Act, of 1949. These units are equivalent to banking outlets or branches legally.	Digital Banks have a balance sheet and legal personality and are proposed to be duly licensed banks under the Banking Regulation Act, of 1949.
Innovation and Competition	DBUs improve existing channel architecture by offering regulatory recognition to digital channels. The DBU guidelines expressly state that only existing commercial banks may establish DBUs.Thus, the competition and innovation are comparatively less.	The licensing and regulatory framework for Digital banks is more enabling along with competition and innovation dimensions.

Significance of Digital Banking

Enhanced Rural Credit Flow, Greater Access for the Poor, Cost-Effective Solution, Enhanced Technical Support, Reduced Manpower Requirement, Steady Profits for Banks, Enhancing Digital Literacy.

Challenges of Digital Banking

Low Awareness and Internet Penetration: Low internet penetration and awareness make digital banking difficult in lower-tier cities.
Vulnerabilities and Hacks: Phishing, pharming, identity theft, and keylogging can affect digital banking platforms.
Technological infrastructure: Ensuring uninterrupted availability, managing technological upgrades, limited internet connectivity, preventing system failures, and protection against cyber threats.
Lack of Financial Literacy: According to the National Centre for Financial Education (NCFE) survey of 2019 only 27 % of adults in India are financially literate.
Regulatory Compliance: Adhering to know-your-customer (KYC) requirements, anti-money laundering (AML) regulations, and data privacy laws.

Way Forward

Infrastructure Development: Improving internet connectivity, digital infrastructure in both urban & rural areas,
Enhance Customer Experience: Prioritize seamless and user-friendly interfaces, personalized services, and efficient customer support.
Embrace Technological Advancements: Forge partnerships and collaborations with fintech companies, payment processors, e-commerce platforms, and other ecosystem players, conduct workshops, training sessions, and awareness campaigns.
Financial Inclusion: Collaborate with governments, NGOs, and other stakeholders to address the digital divide, expand access to affordable digital devices, developing user-friendly interfaces, simplifying processes.
Ensure Regulatory Compliance: Adhere to RBI guidelines, maintain strong relationships with regulatory bodies, and stay updated on evolving regulations.
Prioritize Cybersecurity: To build trust and reduce cyber risks, implement strong security, audit regularly, and protect customer data.

Conclusion

Digital banks and units can revolutionise Indian banking. These banks serve underserved rural and remote populations. India can lead the fintech industry and empower all with the right strategies and partnerships.