A Raft of Reforms in India’s fintech sector

Reforms in the Air

At the ET World Leaders Forum (WLF) last week, Prime Minister Narendra Modi vowed to unleash an “arsenal of reforms” — a continuation of his Independence Day promise to reshape India’s economic landscape. Among the many sectors awaiting attention, fintech stands out as the first port of call.

India today boasts one of the highest fintech adoption rates globally — 87%, far outpacing many developed economies. The JAM trinity (Jan Dhan, Aadhaar, Mobile) has played a defining role in pushing digital finance into the mainstream. The most visible marker of this revolution is the Unified Payments Interface (UPI), which handled 1,868 crore transactions worth over ₹24 lakh crore in April 2024.

While adoption is soaring, the framework supporting fintech remains overly complex and, in parts, outdated. For India to maintain its global lead, it must transition from a regulation-heavy approach to one that fosters innovation, competition, and resilience.

Simplifying Regulations: A Clear First Step

Finance Secretary Sanjay Malhotra recently pointed out that India has close to 8,000 financial regulations, of which nearly 5,000 are redundant. This dense regulatory web creates inefficiencies and compliance costs that are ultimately passed on to consumers.

Take KYC requirements for payment aggregators. These intermediaries collect payments on behalf of merchants but do not maintain customer accounts. Yet, they are forced to conduct full KYC checks under the RBI’s 2016 guidelines — even though banks already perform identity verification while onboarding merchants. This duplication results in higher compliance costs that disproportionately affect small businesses.

If simplification is to succeed, the guiding principle must be:

• Redundant regulations must be repealed, not repackaged.

• Every new rule should demonstrate that it is the least-cost method to achieve its objective.

By cutting clutter, the regulatory system can support both ease of business and ease of living, aligning with the government’s broader reform agenda.

Unlocking UPI’s Wider Potential

India’s retail credit market, despite recent growth, remains underpenetrated. Household credit-to-GDP ratio is just 42%, compared to China’s 60% and the United States’ 69%. Closing this gap is essential to strengthening consumption and boosting small businesses.

One bold yet calibrated step would be to allow NBFCs to issue UPI-linked credit lines. At present, this facility is limited to commercial and small finance banks. However, banks continue to treat UPI credit as a narrow, channel-based product. In contrast, NBFCs have deeper reach into underserved markets and could extend credit to segments that banks often overlook.

By opening UPI credit to NBFCs, India could:

• Expand access to affordable credit.

• Strengthen UPI’s role beyond payments.

• Drive digital inclusion further up the financial pyramid.

Revisiting the NUE Framework

While UPI has been a transformative success, its dominance also creates vulnerabilities. A system heavily dependent on a single infrastructure risks becoming a single point of failure.

To address this, the RBI proposed the New Umbrella Entity (NUE) framework in 2018, designed to create alternate retail payment systems. Although shelved, the idea is worth revisiting.

The benefits of NUEs include:

• Systemic resilience by reducing concentration risk.

• Alternative channels for smaller fintechs to scale.

• Dilution of TPAP dominance, since UPI today is dominated by a handful of third-party app providers.

Even if NUEs don’t radically disrupt existing platforms like IMPS or UPI, they will add much-needed redundancy and competition, safeguarding India’s digital payments ecosystem.

Encouraging Innovation with No-Action Letters

Globally, fintechs are experimenting with Generative AI (GenAI) and other advanced technologies to reimagine financial services. India’s fintech ecosystem is no different. Yet, a lack of regulatory flexibility often hinders innovation.

One solution is the introduction of No-Action Letters (NALs). These are formal assurances from regulators stating they will not enforce certain rules against a business or activity for a specified period, under defined conditions. NALs create a safe space for startups to innovate, test, and refine their solutions before wider rollout.

While India has a regulatory sandbox, it does not include an NAL provision. Adding this feature would give fintechs the confidence to experiment responsibly, without fear of premature enforcement action.

Digital Bank Licensing: A Missing Link

Financial inclusion remains a challenge despite UPI’s wide reach. Household credit as a share of GDP and small business lending remain well below global benchmarks. Traditional banks often avoid lending to smaller borrowers, citing profitability and risk concerns.

This is where digital-only banks could make a difference. NITI Aayog’s Digital Banks report recommends a proportionate roadmap for licensing such entities. By operating without the cost structures of traditional banks, digital banks could:

• Provide credit to underserved households.

• Offer tailored products for small businesses.

• Leverage technology to minimize operational costs.

With regulatory oversight through sandboxes and tiered licensing, digital banks can become a critical pillar of inclusive growth.

Why These Reforms Matter

India’s fintech sector is at a pivotal moment. Its success so far has been built on strong adoption and digital-first innovation. However, sustaining this momentum requires systemic reforms that address inefficiencies, reduce risks, and expand opportunities.

Together, these steps can:

• Simplify compliance and reduce costs for businesses.

• Unlock UPI’s full potential as both a payments and credit platform.

• Strengthen resilience against systemic risks.

• Foster a culture of innovation through regulatory flexibility.

• Expand financial inclusion via digital banks.

Conclusion: Seizing the Moment

India’s fintech story has captured global attention. With UPI already setting international benchmarks, the next phase must focus on making the ecosystem leaner, more inclusive, and more resilient to shocks.

The government’s reform push presents a timely opportunity. If regulators and policymakers act decisively, India could not only sustain its fintech momentum but also emerge as a global leader in financial innovation and stability.

The fintech sector does not just need reforms — it needs the right kind of reforms. The time to act is now.

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