Niti Aayog’s discussion paper on digital banks

Ikigai Law
3 min readMay 23, 2022

This post explores Niti Aayog’s proposal to create a licensing framework for fully digital banks. It examines the impact of this proposal on neo-banks and explains the roadmap for implementation.

If I had a rupee for every time I heard the word ‘neobank’, I’d deposit all those rupees in a neobank. Despite being a fintech buzzword, neobanks have not made remarkable strides in India. As they operate in a regulatory vacuum. So, in November 2021, Niti Aayog stepped-up as the bellwether for neobank regulations. And published a discussion paper on full-stack digital banks. Niti Aayog’s proposed regulatory model would enable neobanks to operate as the utility layer as well as the engagement layer of financial services.

The discussion paper explains the value proposition of neobanks, and lays down an implementation plan to put the bank in ‘neobank’. Here is all you need to know about the proposal and our take on it.

An idea whose time has come

An end-to-end digital bank model has not been green lit under Indian law. Which means neo-banks must partner with banks or other licensed entities to launch their platforms. As a result, most neo-banks end up acting as front-end technology layers. Traditional banks act as utility layer, and perform the core functions. So, neo-banks are not equipped with regulatory freedom to create ground-up innovative products. The Niti Aayog report highlights that neobanks have limited revenue potential (under current regulatory framework). They either earn fee-based revenue as partners or a fraction of interchange for processing payments. So, neobanks rely on equity capital to meet their operational costs, because unlike banks, they can’t accept deposits. Low entry barriers (in absence of regulations) also aid entry of rogue players in the market.

As for financial inclusion, the report mentions that it is questionable how far traditional banks have been able to enable financial inclusion and bank the underbanked. India’s small businesses continue to suffer from the same old malaise — lack of access to credit. As small businesses opt for informal credit, traditional banks find it difficult to assess their creditworthiness. And in cases where underwriting is simpler, the financial rewards (for banks) are not worth the risk.

Neobanks, armed with technological tools, offer high-cost efficiency. Operational costs for traditional players may be 10–20 times higher than that of neobanks. Neobanks with lower customer acquisition cost and cost-to-serve have the headroom to offer cheaper financial services at a faster pace. And they can be the be-all end-all for financial inclusion.

Blueprint for licensing

Niti Aayog’s paper proposes implementation of full stack digital banks in three stages — (i) introduction of a digital business bank license with restrictions on asset sizes and deposits; (ii) enlistment and assessment of the licensee under the RBI’s regulatory sandbox; and (iii) grant of a full-stack digital business bank license based on the performance of the licensee in the sandbox.

Niti Aayog’s paper also proposes that RBI must allow digital banks to provide complementary non-financial services. Like payroll management, account receivables management and tax management. This can create seamless user experience and offer digital banks additional monetisation avenues. For this, the RBI will need to increase the remit of banking companies under the banking regulation law.

A utopian dream or an impending reality

A full stack digital bank in the hands of new age disruptors sounds utopian. A proof of concept is available in UPI, which enabled mass adoption of instant retail payments through participation of start-ups and tech giants. With their deep pockets to market and technical expertise, full stack digital banks could make banking as ubiquitous as UPI. Niti Aayog’s proposal is tacit approval of the necessity of digital first neobanks.

(This post has been authored by the fintech team at Ikigai Law.)

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Ikigai Law

An award-winning law firm helping innovation-led companies find efficient solutions to their legal and business challenges