Introduction
Fintech is the mix up of finance and technology, which essentially points out to the influence technology has over the years had on how the financial industry operates.[1] Thus fintech necessarily is the fusion of finance and technology which has evidently made our lives easier. When such a revolution comes in to effect, the necessity to regulate them also arises. There has been various attempt to tame the beast from governments around the world of which regulatory sandboxes remain to be the new and seemingly effective one. A regulatory sandbox allows fintech, especially start ups to test their products with fewer regulatory requirements, with less risk of regulatory enforcement action and proper guidance from regulators for improvement.[2]
When regulatory sandboxes, in principle would help fintech firms towards success, the effect it has on fintech firms and the financial market in general cannot be under stated. Regulatory sand boxes, although employed through out the world, must be structured as per the needs of the financial markets of the specific country in order to produce the intended result. Regulatory sandboxes and their working will always be a challenge to the regulators, especially for RBI in a country such as India.
Emergence of Regulatory Sandboxes
Before the happening of the global financial crisis, innovation in financial industry was most encouraged which eventually led to less regulatory requirements which in turn led to financial crisis of 2008.[3] Regulatory changes after the crisis along with the technological advancement boosted the rise of fintech firms.[4] This has posed the necessity to improve the existing regulatory framework by including technological innovations such as regulatory sandboxes.[5] In order to strive against innovatory challenges brought up by fintech firms, the regulator’s armoury should also be filled with innovatory shields. Regulatory sandboxes have often raised up to the occasion making regulator’s job easier and convenient.
Financial Conduct Authority of United Kingdom introduced regulatory sandbox in the year 2020 which influenced other countries to create their own version of regulatory sandboxes, in fact so much such that by the year 2020, as per World Bank, there were 73 unique regulatory sandboxes from 57 different countries across the globe which now would be more as the United Kingdom alone introduced the digital sandboxes in 2022 and the AI sandbox in 2024.
In India, Reserve Bank of India set up an inter-regulatory working group in 2016 which recommended the introduction of regulatory sandbox with a definite space and duration and the RBI introduced the first regulatory sandbox in India by 2019.[6] In 2024, five entities had been selected by RBI to enter test phase of 5th cohort of the sandbox.[7] Regulatory sandboxes in India has always been in the right direction, but there is always room for improvement. Regulatory sandboxes in a country such as India with a very volatile financial market is often necessary to boost the economy and for the rise of start-up fintechs.
Why Regulatory Sandboxes?
So regulatory sandboxes are often seen as a necessity in today’s world. The benefit it provides is actually two folds. How regulatory sandbox work is by the regulator allowing certain fintechs to function or test their products in an environment which is quite often different from the real-life scenario. Here, the firms are allowed to test their products to less complicated requirement to get an idea of how their products would work in the real-world. This way the fintech start-ups can experience an environment for better experimentation and growth while it would promote competition and growth of a nations economy at large which in turn would benefit the general public as well as to some extent the regulators itself.[8] Such a regulatory environment would make life easier for the fintech start-ups as well as the regulators.
From the perspective of the regulators, there exist a sort of compulsion to have an understanding regarding how to best apply the laws to fintech firms due to the significant increase in number of fintech companies along with the increase in the venture capital and corporate investment in the financial sector of the country.[9] Regulatory sandbox system helps the regulators to know more about fintech solutions which would in turn help them to adopt legislation as per the needs.[10]
Apart from testing facility provided by regulatory sandboxes, various studies have shown that regulatory sandboxes often help the start-up fintech firms in other ways too. Study conducted by Giulio Cornelli, Sebastian Doerr, Leonardo Gambacorta and Ouarda Merrouche in 2020 shows that regulatory sandbox in United Kingdom has helped firms in raising capital while at the same time reducing regulatory costs and information asymmetry.[11]
Further the research study conducted by Jayoung James Goo and Joo-Yeun Heo in 2020 itself has shown that regulatory sandboxes employed in any country helps fintech start-ups to adopt a flexible business model which would eliminate uncertainty that decreases institutional and legal risks for the firms as well as for the fintech industry in general.[12] Also, regulatory sandboxes would create such regulatory environment which would support innovation. The 2020 study by Jayoung James Goo and Joo-Yeun Heo also points out that regulatory sandboxes act as a positive catalyst for investment in the fintech sector. For instance, in the United Kingdom itself, 30% of the companies engaged in the first regulatory sandbox received venture investment and average investment amount reached to 6.6%.[13]
Fintech firms, especially in a country such as India faces lots of challenges in being operated in to a successful venture mainly in their initial stages. What regulatory sandboxes would do is not solve their entire problem in one go. Regulatory sandboxes are not a silver bullet that solves all the problem associated with the fintechs for the fintech start-up nor for the regulators. But what they can do is that it can be applied as a pre-approval regime for the fintech products.[14] The regulators can set up regulatory sandboxes with such standards that they seem fit and the fintech could be made to pass these tests to be given permission to release their products in to the market. This way, regulatory sandbox could be made into an entry barrier into the market. Further, the regulators could use regulatory sandbox as a testing ground where they could test proposed regulations also.[15] This way, regulatory sandboxes could be made into use just not as a testing ground but much more in purpose. Although not a complete solution for fintech problems, it could serve as an aid tool.
CONCLUSION
Regulatory sandboxes have been applied in various countries globally in order to successfully regulate fintech start-ups. Fintech start-ups with the advancement of technology has grown in innovation and prosperity which necessitates the evolvement of regulation as well which regulatory sandboxes have successfully achieved over the years. Initiating in the United Kingdom, several countries have successfully adopted their own version of regulatory sandboxes which also has been successful. Reserve Bank of India has also taken step towards a regulatory sandbox with recent advancement in this regard being in 2024.
Regulatory sandboxes, although not being a complete medicine to cure every problem associated with fintechs, is surely a pain killer which would serve as an immediate relief. While being an aid to boost innovation in the industry, it also increases the amount of investment boosting overall well being of the sector as well as the country as a whole.
[1] Itay Goldstein, Wei Jiang, and G Andrew Karolyi, ‘To FinTech and Beyond’ (2019) 32(5) The Review of Financial Studies 1647 https://doi.org/10.1093/rfs/hhz025 accessed 12 January 2025.
[2] Hilary J. Allen, ‘Regulatory Sandboxes’ (2019) 87 Geo Wash L Rev 579
[3] Edward J Schoen, ‘The 2007–2009 Financial Crisis: An Erosion of Ethics: A Case Study’ (2017) 146 Journal of Business Ethics 805 https://doi.org/10.1007/s10551-016-3052-7 accessed 12 January 2025.
[4] Douglas W Amer and others, ‘The Evolution of FinTech: A New Post-Crisis Paradigm?’ (2016) 47 Georgetown Journal of International Law 1271.
[5] Dirk A. Zetzsche , Ross P. Buckley, Janos N. Barberis & Douglas W. Arner, ‘Regulating a Revolution: From Regulatory Sandboxes to Smart Regulation’ (2017) 23 Fordham J Corp & Fin L 31
[6] Comprehensive Framework for a Regulatory Sandbox’ Drishti IAS (30 October 2021) https://www.drishtiias.com/daily-updates/daily-news-analysis/comprehensive-framework-for-a-regulatory-sandbox accessed 12 January 2025.
[7] Five Entities Enter Test Phase for Fifth Cohort of RBI’s Regulatory Sandbox’ Business Standard (26 July 2024) https://www.business-standard.com/finance/news/five-entities-enter-test-phase-for-fifth-cohort-of-rbi-s-regulatory-sandbox-124072601046_1.html accessed 12 January 2025.
[8] Thomas Hellmann, Alexander Montag, and Nir Vulkan, ‘The Impact of the Regulatory Sandbox on the FinTech Industry’ (November 2024).
[9] Jonathan R Everhart, ‘The Fintech Sandbox: An Overview of Regulatory Sandbox Regimes’ (2020) 12 S J Bus & Ethics.
[10] Ibid.
[11] Giulio Cornelli, Sebastian Doerr, Leonardo Gambacorta, and Ouarda Merrouche, Inside the Regulatory Sandbox: Effects on Fintech Funding (Discussion Paper DP15502, Centre for Economic Policy Research, 29 November 2020).
[12] Jayoung James Goo and Joo-Yeun Heo, ‘The Impact of the Regulatory Sandbox on the Fintech Industry, with a Discussion on the Relation between Regulatory Sandboxes and Open Innovation’ (2020) 6(2) Journal of Open Innovation: Technology, Market, and Complexity 43.
[13] Ibid.
[14] Hilary J. Allen, ‘Regulatory Sandboxes’ (2019) 87 Geo Wash L Rev 579.
[15] Ibid.
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