What is a Regulatory Sandbox?

"Regulatory Sandbox" (RS) based approach has been adopted by central banks in many countries, where the regulators work closely with emerging FinTech firms. The Reserve Bank of India has also adopted the concept of RS. It is necessary to make innovation grow. It ensures compliance with regulations in a controlled environment.

So what exactly is the Regulatory Sandbox?

Regulatory Sandbox (RS) is the live testing of new products/services in a controlled environment in which regulators may provide certain regulatory relaxations which are limited to testing purposes only. RS permits the regulators, innovators, financial service providers (as potential deployers of the technology) and the customers (as final users) to carry out field tests so that they can collect evidence on the benefits and risk factors of new financial innovations, while keeping an eye on them and controlling their risks. RS provides a structured route for the regulator’s engagement with the ecosystem and to create innovation-enabling or innovation-responsive regulations that help to deliver relevant, low-cost financial products. RS serves as an important tool which enables more dynamic, evidence-based regulatory environments which learn from emerging technologies and also evolve with them.

Product/Services/Technology Included under RS

At its core, RS is a formal regulatory programme meant for the market participants to try out new innovations, services or business models with the customers in a live environment. The proposed financial services launched under RS must make use of new or emerging technologies or existing ones in an innovative way to bring benefits to the customers.

A list of innovative products/services/technology which can be considered for testing under RS is given below.

Exclusion from Sandbox Testing

In case entities propose financial services similar to those which are already offered in India, they may not be suitable for RS unless the applicants can prove that either a different technology is being applied in a useful manner or the same technology is applied in a more efficient and effective way.

A negative list of products/services/technology which may not be accepted for Regular Sandbox testing is given below.

Relaxations by RBI

If RBI approves, some regulatory requirements can be relaxed for the applications during the period of the Regulatory Sandbox on a case-to-case basis. Regulatory relaxation has been given to the following things:

• Liquidity requirements 
• Board composition
• Financial soundness 
• Management experience 
• Track record
• Statutory restrictions

However, it is mandatory for the applicants to comply with the requirements mentioned below:

• Customer privacy and data protection
• Secure storage of payment data of stakeholders and access to it
• Local Data storage
• Security of transactions
• KYC/AML/CFT requirements
• Statutory requirements

Benefits of Regulatory Sandbox

Numerous benefits are linked to the Regulatory Sandbox such as ones mentioned below:

• RS encourages ‘learning by doing’ on all sides. Regulators obtain first-hand empirical evidence on the risks and benefits of the emerging technologies and their implications. This enables them to take a considered view on the regulatory changes or new regulations that may be required to support useful innovations while containing the risks.
• FinTech companies can improve their understanding of regulations that govern their offerings and shape their products accordingly. Feedback from customers educates the regulators as well as the innovators as to what benefits might be given to customers from such innovations. 
• RS users can test the viability of the product without the requirement of a larger and more expensive roll out in case the product seems to have the potential to become a success. In case any issues arise during the sandbox period, they can be fixed before the product’s launch in the broader market.
• FinTechs offer solutions that can further financial inclusion. RS can go a long way in improving the pace of innovation and technology absorption, financial inclusion and improving financial reach. Areas such as microfinance, innovative small savings, remittances, mobile banking and other digital payments can potentially get a thrust from the RS.
• The dependence of the regulator on industry/stakeholder consultations is correspondingly reduced due to the structured and institutionalized environment for evidence based regulatory decision-making.
• RS can lead to better outcomes for consumers due to an increased range of products and services, reduced costs and improved access to financial services.

Risks and Limitations of Regulatory Sandbox

• The innovators might lose some flexibility and time amid the sandbox phase. In order to reduce this risk, the RS can be run in a time-bound manner at each stage.
• Judgment calls and extra time may be required for customized authorizations and regulatory relaxations on a case-by-case basis. This risk may be addressed by managing applications in a transparent way and following well-defined principles in decision-making.
• The RBI or its RS cannot grant any legal waivers.
• A successful experimenter may still need regulatory approvals after the completion of the sandbox testing, before the product/services/technology can be authorized for wider application. 
• Legal difficulties may arise such as those relating to consumer losses in case of failed experimentation. There may not be much legal ground in such instances if the RS framework and processes have a clear criteria and transparency about the entry and exit. Clarity in advance about the fact that the liability for customer or business risks shall be on the entity entering the RS is important.

Eligibility Criteria of Regulatory Sandbox

Fintech companies including Start-ups, Banks, Financial Institutions, Limited Liability Partnership (LLP) and Partnership Firm which partner with or provide support to financial services businesses are the target applicants for entry to the RS.

The focus of RS is to encourage innovations meant for use in the Indian market in areas where:

• There is lack of governing regulations
• There is a need to temporarily ease regulations to enable the proposed innovation
• The proposed innovation promises to ease the delivery of financial services in a relevant way

Conclusion

Regulatory Sandbox (RS) is a formal regulatory programme which was launched for the market participants so that they can test new products, services and business models with customers in a live environment. The proposed financial services to be launched under the RS must make use of new or emerging technologies, or of the existing ones in an innovative way so that the consumers can be benefitted.

Author: Dushyant Sharma

Hey there, I'm Dushyant Sharma. With the extensive knowledge I've gained in past 8 years, I have been creating content on various subjects such as banking, insurance, telecom, and all the important registration and licensing processes for various companies. I'm here to help everyone with my expertise in these areas through my articles.