Financial Inclusion in India and Its Challenges

[op-ed snap] The promise of fintech revolution


Mains Paper 3: Science & Technology | developments & their applications & effects in everyday life

From the UPSC perspective, the following things are important:

Prelims level: Bali Fintech agenda

Mains level: Issues being faced by fintech sector and future prospects


Bali Fintech Agenda

  1. The recent International Monetary Fund/World Bank annual meetings marked the launch of the Bali Fintech Agenda
  2. It is a set of 12 policy recommendations aimed at better harnessing the benefits and opportunities of rapid advances in financial technology
  3. The Bali Agenda sets out a roadmap to be used by national authorities as a reference point for policy design and implementation
  4. It also highlights the importance of managing risks

Digital banking a boon

  1. The innovations spurred by digital breakthroughs are starting to revolutionize the availability of financial services, which is sorely needed, with 1.7 billion worldwide unbanked
  2. The spread of formal banking has been constrained by the cost of physically reaching people in rural and remote areas, as well as the economics of servicing low-income populations, informal sectors and small- and medium-sized enterprises
  3. In this regard, fintech has the potential to broaden the reach of formal financial services, sharply lower costs and spur efficiency gains
  4. The resulting income and employment gains and poverty reduction should help bring more inclusive growth in support of the UN’s 2030 Agenda for Sustainable Development

Developments in the fintech sector

  1. The technology drivers of the fintech revolution are multifaceted
  2. The private sector-led development of telecom infrastructure and falling costs are facilitating the greater use of smartphones as well as broadband internet services
  3. Advances in cryptography and biometrics bolstering security and customer-identification are also powerful drivers, as are distributed computing and the use of big data and machine learning
  4. The promise of fintech is epitomized in the wave of innovation in payments, clearing and settlement, offering both the banked and unbanked cheaper and faster services, besides powering e-commerce

Impact of these developments

  1. As a result, financial inclusion can fundamentally reshape the lives of people and have a hugely positive economic and social impact
  2. Another positive spillover comes from governments benefitting from reduced leakages and better targeting of public services, while an expanding tax base through improved compliance allows greater resource-generation for public investment

Associated risks of fintech

  1. Fintech tends to be lightly regulated or unregulated in some jurisdictions and soundness and stability are concerns
  2. Payments and e-money operators use essentially private money, which carries credit and settlement risks
  3. Broader financial stability questions arise as fintech expands from a low base and linkages with banks grow
  4. There are increasing concerns associated with data privacy, data security and money laundering
  5. Cryptocurrencies raise issues related to excessive price volatility, lack of investor, illicit activities, and regulatory arbitrage and contagion
  6. Other fintech risks relate to monetary policy transmission, financial safety nets, lender-of-last-resort and questions regarding financial crisis management and resolution

Required interventions in the sector

  1. The risks call for an appropriate supervisory and regulatory approach at the country level, backed by international cooperation to address cross-border concerns
  2. Policy needs to strike the right balance between not stifling innovation while guarding against financial stability risks
  3. Regulatory sandboxes, incubators and accelerators can be used to test new products and technologies, but bringing fintech under strengthened, effective and unified supervisory oversight is a priority
  4. Regulation/licensing and risk management should be based on activity rather than the type of institution for a level playing field for financial service providers
  5. Appropriate rules also need to be set for data protection, privacy and technology, along with cybersecurity protection and reporting standards

Bali agenda a guiding light

  1. The promise and concerns are set out in the Bali Agenda, which strikes the right balance and provides a useful framework for policymakers
  2. The Bali Agenda also correctly sees a role for central banks to issue digital currency, and expanding access to and improving the resilience of payments services
  3. The issue of digital fiat currencies by central banks would help preserve their control and relevance as well as trust, interoperability, openness and security of payments and settlements systems, besides addressing concentration and competition concerns

Way forward for India

  1. In India, planned reforms include overhauling payments system laws to foster competition, consumer protection, stability and resilience
  2. Another reform is a digital fiat currency, under consideration by the RBI. Besides regulation, bridging the digital divide is a pressing issue for India
  3. Whether to establish a separate regulator or keep the Reserve Bank of India (RBI) in charge, in line with usual global practice, is still under debate which should be resolved at the earliest
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