The Indian financial ecosystem maintained a guarded position for several decades primarily depending on traditional technology systems. Fast forward to 2024, the outlook has changed drastically, paving the way for new financial products and services backed by cutting-edge tech and innovative solutions including Application Programming Interface (API).
API banking or banking-as-a-service (BaaS) is primarily driven by the seamless data exchange between third parties and banks to provide personalised financial products and services that align with evolving customer requirements.
Financial institutions must understand the regulatory framework and overcome the challenges in API banking to ensure compliance and consistently obey local regulations.
Let’s take a look.
What is API in Banking?
API in banking can be described as a set of rules or protocols that allow third parties to access a bank’s services. This creates a seamless channel for customers to make transactions, manage finances, and reap the benefits of numerous digital banking products.
Simply put, APIs secure a digital connection between a bank and a company to integrate banking services, exchange customer data, and automate different banking processes.
Understanding API Compliance
As the name suggests, API compliance is a regulatory framework that ensures that all APIs comply with the government and security protocols and adhere to the industry regulations.
While the Payment Services Directive 2 (PSD2) and Payment Services Directive 3 (PSD3) laid down a clear open banking framework in Europe, the Reserve Bank of India (RBI) is the main regulatory body in India that oversees open banking proceedings.
Regulatory Framework for Open Banking in India
Now, let’s go through the regulatory framework and other guidelines that aim to strengthen data security, safeguard sensitive financial data exchange and information, and provide a solid platform for open banking to thrive:
1. Account Aggregator Framework
The RBI rolled out the account aggregator (AA) framework, a robust data exchange system in 2016 as a measure to safeguard sensitive customer financial information and how non-banking finance companies (NBFC) retrieve and handle customer data.
The rules state that NBFCs operating within the AA framework cannot share, retrieve, or transfer financial information without customer consent. The guidelines suggest that account aggregators can exchange data only if the customer has given their consent. As of 2024, the AA framework has more than 77.25 million users in India.
2. Digital Personal Data Protection Act, 2023
The Digital Personal Data Protection (DPDP) Act, 2023 overlooks how personal data is shared and processed in India. Many experts argue that the DPDP Act is inspired by privacy laws worldwide, including GDPR in the European Union and has borrowed several concepts from GDPR. The law prohibits AA from unlawful processing of personal data and lays down rules under which, data can be legally processed.
Additionally, the DPDP also includes different data principles rights including the right to erasure, object, and access along with strict obligations, where non-compliance can result in heavy fines and punishment.
3. Master Direction on Digital Payment Security Controls
As the financial sector in India embraces new technologies and heralds into the era where digital transactions are growing exponentially, there is an urgent need for clear and strict digital payment security regulations.
There were around 5 billion cyberattacks on Indian businesses, government agencies, and other entities in 2023.
The Master Direction provides a clear governance structure and security standards for API banking systems, card payments, internet banking, and other forms of digital transactions.
Some of the key areas under the purview of the Master Direction on Digital Payment Security Controls include Application Security Life Cycle (ASLC), Fraud Risk Management, Mobile Payments Application Security Controls, etc.
Key Regulatory Challenges in API Banking Lenders Must Know
Here are some glaring regulatory challenges in the current API banking landscape in India.
1. Inadequate Standardisation
Despite RBI’s proactive measures to encourage and regulate open banking, it is safe to say that we do not have a comprehensive framework like Europe’s PSD2 and PSD3.
The lack of a standardised open banking framework affects how APIs are deployed across third-party providers and banks.
2. Data Security and Privacy
Data security and privacy are arguably some of the biggest challenges in the digital banking realm. APIs interact with several data points, which are often vulnerable to cybercrimes if they are not secured correctly.
Additionally, data localisation guidelines suggest consumer data can only be stored within Indian soil, putting forward several roadblocks for efficient data management.
3. Maintaining Regulatory Compliance
Players in the API banking space need to stay afloat with the latest amendments and ever-evolving regulatory requirements to ensure compliance. The dynamic regulatory landscape requires companies to monitor changes consistently and adapt to the situation.
4. Curbed Innovation
Striking a balance between releasing innovative solutions while complying with the regulations can be an uphill task. While stringent API banking laws can slow innovation, the lack of regulations can lead to data privacy and security issues.
Parting Notes
At present, account aggregators, Fintech companies, banks, and other third parties are standing at the crossroads of tech advancements and the evolving regulatory landscape. Despite the success of the Unified Payment Interface (UPI) and other initiatives including Aadhaar authentication and e-KYC to name a few, there is a certain degree of uncertainty in open banking.
This reinforces the need for a collaborative approach between Fintech companies, banks, account aggregators, and regulators to ensure an efficient and compliant banking ecosystem.
Finezza’s cutting-edge loan management and loan origination solutions have empowered lenders to streamline their financial services and deliver top-notch customer experiences. You can seamlessly deploy these solutions with our safe and secure APIs that can be easily integrated with your existing tech stack.
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