Neo-banking: future of fintech?

In this 5G era, with the digital India mission, the traditional banking system in India has not been able to go hand in hand with techno-geek customers. To list down a few here includes fixed working days/ hours, and long turnaround times.

As we say “fintech is the future of finance, and neo-banking is the future of fintech”. The fintech industry started working on a solution called neo-banks where neo means new. Presently, these are banks without any physical location and entirely digital (i.e online).  This is mobile-friendly and the first financial one-stop solution for payments, lending, deposit money, withdrawals, money transfer, issue debit/ credit cards, investments, and many more.

But the question is how to determine the scalability of the same. It is very evident that most of the neo-banks do not have a banking license and cannot function independently. Majorly, neo-banks partner with licensed banks to provide financial services with not-so-strict restrictions. Legally speaking, the challenges for neo-banks are regulatory ambiguity, technology, and security including data privacy. Let’s break down this further to understand the legal issues around neo-banks in India, unlike traditional banks, neo-banks are not directly authorized and regulated by the Reserve Bank of India (RBI). To render the services, neo-banks have to tie up with regulated banks. Therefore, banks adhere to and impose stringent outsourcing obligations (which include regular monitoring, audits, data security, and grievance redressal) when partnering with neo-banks. Further, RBI reserves the right to access neo-banks transaction and account records. In November 2021, RBI suggested that it is planning on regulating the digital banks and neo-banks and had released the Report on the “Working Group on Digital Lending including Lending through Online Platforms and Mobile Apps[1]” to substantiate the same. Also, RBI stated that neo-banks should be prohibited from using the suffix “bank” by their partner banks.

Subsequent to the RBI Report, NITI Aayog released a discussion paper titled “Digital Banks a Proposal for Licensing and Regulatory Regime for India[2]”, which proposed a framework should be created for neo-banks to convert into fully licensed and regulated digital banks, categorized into following models:

(a) [front-end only] neo-banks;

(b) [licensed] full-stack digital banks; and

(c) digital banking services by traditional banks.

Three most important challenges posed by neo-banks are “(a) obsolescence of the traditional banking ecosystem; (b) leading to failure in partnerships; (c) high capital cost that has no entry barrier; and (d) limited revenue potential including viability.”

The NITI Aayog paper proposes that for a neo-bank to apply for the restricted digital business bank license, it would need to have a minimum paid-up capital – suggesting INR 20 crores as the threshold. Further, drawing comparison to the capital requirements of small-finance banks, suggesting INR 200 crores as the minimum paid-up capital once the restricted license is converted to a full stack digital business bank license. Other considerations for applicants of the restricted license include track record, technological risk and neutrality, and business continuity planning.

Thus, it is very evident that the proposal of the regulatory framework within the fintech subsector is promising enough. However, we have to wait and watch if at all and to what extent this is going to be implemented in near future when several fintech subsectors are facing regulatory hiccups parallelly such as “open banking module” through the Account Aggregator (AA) regulatory framework, digital lending space. Recently, RBI has disallowed non-bank prepaid payment instruments (PPIs) to load credit lines.  

Then the next question to address is “are neo-banks better than traditional banking systems and is it okay to switch?” In my opinion, from a business perspective, yes, they are a big hit! Neo-banks have “lower fees and higher interest rates,” which also means they have more dedicated resources to make the banking experience better,  smooth, and hassle-free for their customers. To add the cherry on the cake, ease of use includes tasks like depositing a cheque which requires a visit to a physical bank branch and can be done on the customer’s handy gadgets. Generally, tech-savvy are fond of a smoother UI experience, and to take that into account “Neo-bank applications are built to improve the digital banking experience. Neo-apps are simple, powerful, and aesthetically pleasing.” On the other hand, traditional banks are held back by “glitches and lags.”

It is not wrong to say that neo-banks can bring in revolutionary change and it is for the techno-geek customers who love taking risks too, as it is still in the “nascent stage.” The opportunities in the neo-banking sector are scaling day by day with the Indian Government promoting UPI infrastructure and digital India.

As per International Data Corporation’s report “the annual average loss suffered by SMEs depending on legacy systems is INR 67 lakh per SME. Businesses that rely on traditional banking systems often have to carry out banking operations manually, running the risk of repetitions, errors, and unnecessary delays[3].” Thus, businesses, especially SMEs, would benefit immensely from switching to neo-banking with instant payouts, hassle free money management, smooth integrations, intelligent invoice generation and many more.

Why wait? Let’s join hands to upgrade your banking style for businesses!

Moreover, a framework from the RBI for regulatory and policy development around neo-banks in India is needed to subject such services to appropriate checks and balances in accordance with “Guidelines on Regulation of Payment Aggregators and Payment Gateways (“PA/PG Guidelines”), IT Act, 2000, 2006 RBI Guidelines on “Managing Risks and Code of Conduct in Outsourcing of Financial Services by banks” as well as the 2010 RBI Guidelines on “Financial Inclusion by Extension of Banking Services – Use of Business Correspondents (BCs).

Happy learning!!




About Sushmita Ray 18 Articles
Sushmita Ray is a Legal Counsel and works in the Fintech Industry. She is a graduate from KIIT School of Law, KIIT (Deemed to be) University, Bhubaneswar, Odisha and have successfully completed a 5-year Dual Degree Integrated Course, B.Sc.LL.B (Intellectual Property Laws Hons.). She has interned with various reputed IP firms in their Patents and TM Prosecution departments. She is also a participant and winner of various National, Regional and Cluster level competitions.

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