INTRODUCTION
The banking business has shifted towards a transformational path, with the conduct of banks evolving with a focus on providing superior customer experience. Technological advancements and inculcating innovative models have helped Neo Banks deliver high-end online financial services. The ease of opening and running accounts, streamlined transfers, deposit, remittance processes, and innovative forms of creditworthiness evaluation attributable to Neo Banks have appealed to Micro and Small businesses, under-banked or unbanked customers such a freelancers and gig economy workers.
Recently, Neo Banking has become a highlighted topic in the FinTech sector. The term can be defined as “a type of direct bank that operates exclusively online without traditional physical branch networks”. Neo Banks are a completely digital, cloud-based concern which is enabled by mobile applications and web mechanisms.
Neo Banks rely on banking partners to provide licensed banking services to their customers, as the Reserve Bank of India (“RBI”) has yet not allowed banks to be entirely digitized. The RBI has often highlighted the importance of digital banks having some physical presence.
Most often, Neo Banks and digital banks are used synonymously. However, it is pertinent to note that though both types of Banks offer digital financial services, digital bank usually refers to an online subsidiary of a regulated bank.
EVOLUTION OF NEO BANKS IN INDIA
The term Neo Bank was first used in 2017 to define FinTech-based finance companies that were challenging conventional banks. There were two major categories of businesses offering digital financial services: businesses applying for their banking license and companies working with conventional banks to offer such financial services.
Neo Banking firms originated around five years ago, mainly in the United Kingdom by FinTech players such as Monzo and Atom Bank. Neo Banks also grew in Australia, with not just the implementation of crowdfunding money, but legislation that removes constraints on the company being brought forward.
In India, start-up Neo Banks are evolving and gaining widespread recognition in terms of the digital banking marketspace. Indian Neo Banks are yet to receive certain regulatory approvals from the governing bodies. Indian Neo Banks are not regulated by the RBI since they have no substantial physical branch roots. They are partnered up with Non-Banking Financial Companies (“NBFCs”), licensed banks and other financial institutions to impart their services.
Due to the absence of any licensing regime, Neo Banks are not subject to many burdensome compliances. Although, in regards to the partnership with the regulatory financial institutions, Neo Banks are typically regulated through RBI’s Outsourcing Regulations and the Master Directions on Digital Payments Security Control.
SERVICES OFFERED BY NEOBANKS
In the present era, Neo Banks are becoming the new banking device to provide financial services with each passing day. With the high-end technologies, Neo Banks offer a wide range of services, which include:
- Loan and credit facilities
- Deposit accounts
- Investment advisory services
- Money transfers
- Forex trade
- Prepaid card services
- Opening of bank account
- Insurance services
ADVANTAGES OF NEOBANKS
One of the most heavily regulated sectors in the country is that of a banking community. They employ substantial resources including manpower, time, and money to ensure compliance with the regulatory frameworks. Over the past few decades, there have been cut-throat technological developments, providing tech-enabled banking solutions. Neo Banks have brought in the latest technology to the community of financial services, eventually leading to enriched customer services.
The definition of Neo Banks has taken a shift as differentiating themselves from just the online banking services and not just merely revolving around the digital banking, but diving straight into the high-ranking customer services.
With the rise in innovative technology inventions, banks are struggling to keep up. An important aspect to consider is whether Neo Banks and traditional banks are in collaboration or competition.
The need of the hour is that both forms of banking join hands with each other for customer satisfaction and provision of transparent financial services.
A few more highlighted advantages of Neo Banks are as follows:
- Automated accounting and taxation services
- Transparency and real-time alert
- Easy-to-use Application-Programming Interface (“API”)
- Dashboard solutions with greatly improved interfaces
REGULATORY FRAMEWORK
1. RBI Master Circular No. RBI/2016-17/17 on Mobile Banking transactions in India – Operative Guidelines for Banks dated 01.07.2016 (“Master Circular on Mobile Banking Transactions”)
Clause 6.1 of the Master Circular on Mobile Banking Transactions prohibits the provision of mobile banking services by those entities which are not licensed, supervised and without a physical presence in India.
Hence, Neo Banks cannot provide mobile banking services independently as they do not possess a physical presence in India, and are not yet supervised or required to be licensed by the RBI.
2. RBI Master Circular No. RBI/2006/167 on Guidelines for Managing Risks and Code of Conduct in Outsourcing of Financial Services by Banks dated 03.11.2006 (“Outsourcing Guidelines”)
The Outsourcing Guidelines lay down a framework for managing the attendant risks in outsourcing of banking services by another entity, including Neo Banks. They address few of the risks associated with banks outsourcing their financial services to Neo Banks, to ensure that such banks maintain compliance with the requirements of RBI including maintenance of books, records and information by the bank.
The Guidelines also direct such banks to adopt sound and responsive risk management practices for effective oversight, due diligence, and management of risks arising from such outsourcing to Neo Banks.
3. RBI Notification No. RBI/2010-11/217 on Guidelines for engaging of Business Correspondents dated 28.09.2010 (“Guidelines for Business Correspondents”)
The Guidelines for Business Correspondents enables banks to engage companies registered under the Companies Act, 1956/2013, excluding NBFCs, as business correspondents. Thus, the Guidelines for Business Correspondents enables Neo Banks registered as a company to act as Business Correspondent for banks.
Various scope of activities of a Business Correspondent are identified by the Guidelines, including identification of borrowers, collection and preliminary processing of loan applications, processing and submission of applications to banks, post-sanction monitoring, follow-up for recovery, disbursal of small value credit, etc. Neo Banks are predominantly engaged in such activities, and thus, would be governed by the requirements of the Guidelines for Business Correspondents.
4. RBI Notification No. RBI/2021-22/64 on Guidelines for Managing Risk in Outsourcing of Financial Services by Co-operative Banks dated 28.06.2021 (“Outsourcing Guidelines for Co-op Banks”)
The Outsourcing Guidelines for Co-op Banks stipulate the compliances to be followed by co-operative banks for outsourcing their financial activities to Neo Banks in accordance with the banks’ obligation to its customers and RBI. The Guidelines have imposed restrictions on co-operative banks from outsourcing to Neo Banks certain core management functions such as policy formulation, internal audit and compliance, compliance with KYC norms, credit sanction and management of investment portfolio.
6. Information Technology Act, 2000 (“IT Act”) and the Information Technology (Reasonable Security Practices and Procedures and Sensitive Personal Data or Information) Rules, 2011 (“IT Rules”)
As Neo Banks obtain, utilize and communicate financial information of customers being sensitive personal data through online platforms to the banks, they are subject to the data protection compliances stipulated for Intermediaries under the IT Act.
Neo Banks are further required to maintain certain security standards as laid down by the IT Rules, and ensure compliance with other mandates including implementing a privacy policy; mandatorily informing the user that their data is being collected and obtaining their explicit consent for collection of sensitive personal data; appointment of grievance officer; enabling users to access, update and delete their information; and ensuring that the data collected is as per the applicable law.
CHALLENGES FOR NEO-BANKS
1. Lack of direct regulation: As the major financial regulators of India including the RBI, the Securities Exchange Board of India (“SEBI”), and the Insurance Regulatory and Development Authority (“IRDAI”) have not yet issued express provisions for the regulation of Neo Banks, the reliability and security of such Neo Banks continue to remain uncertain.
2. Data privacy: A major concern for Neo Banks across India are the data privacy implications as they operate entirely on a digital platform, without any physical presence. In the absence of any laws stipulating data protection requirements for Neo Banks in particular, such Neo Banks are highly susceptible to data breaches which can significantly impact the country’s economic standing.
AMLEGALS REMARKS
With the successful advent of Neo Banks in India, these entities have paved the way for provision of accessible financial services to each individual situated in different corners of the country. At present, Neo Banks are either gathering impetus or declaring high profits, a clear indication of its successful implementation.
Despite Neo Banks not being accepted by the RBI as a “bank” in its true sense, through outsourcing arrangements and Business Correspondent contracts with traditional banks, they provide seamless online financial services to the customers.
However, the need of the hour is for the regulatory authorities, including the RBI, to step forward and issue regulatory framework and safeguards to be followed by a Neo Bank for the provision of internet-based financial services in a legally-compliant and secure manner.
For any query or feedback, please feel free to get in touch with arushi.vyas@amlegals.com or riddhi.dutta@amlegals.com.
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