Regulating AI in Finance: India’s Balancing Act Between Innovation and Risk
Artificial Intelligence (AI) has quietly become the invisible hand steering India’s financial ecosystem. From fraud detection at banks to robo-advisory in wealth management, and AI-driven credit scoring at fintech startups — algorithms are increasingly making decisions that were once left to seasoned bankers and financial advisors.
The Promise of AI in Finance
Banks and fintechs argue that AI is not just about efficiency but inclusion. For instance, BharatPe and ZestMoney have experimented with AI-based alternative credit scoring models to bring first-time borrowers into the formal credit system — a move critical for a country where nearly 190 million adults remain unbanked (World Bank data).
Similarly, Paytm’s lending arm and Cred’s BNPL offerings rely heavily on machine learning algorithms to underwrite loans faster and with fewer defaults. In the stock markets, AI is at work in algorithmic trading, where bots can analyze data patterns in milliseconds to make investment decisions.
The upside is clear: faster decisions, lower costs, and greater reach.
The Perils of Algorithmic Finance
Yet, the same technology poses risks. AI models, often treated as “black boxes,” can be biased or inaccurate. An AI credit scoring system may inadvertently discriminate against borrowers from certain geographies or economic backgrounds if the training data is skewed.
Globally, regulators are already grappling with this. The US Federal Reserve has raised concerns about AI-driven lending reinforcing inequalities, while the European Union’s AI Act is categorizing credit scoring as “high-risk” AI, subjecting it to stricter rules.
In India, the Reserve Bank of India (RBI) has flagged concerns over “dark patterns” in digital lending apps and the Securities and Exchange Board of India (SEBI) has tightened rules around algo-trading to ensure transparency and prevent market manipulation.
India’s Regulatory Dilemma
The challenge for Indian regulators is unique: the country is both a playground for fintech innovation and a fragile financial ecosystem where missteps can affect millions of first-time digital users.
- RBI has already issued guidelines on digital lending, mandating that loan disbursals must happen only through regulated entities and not via third-party wallets. This was in response to several app-based lenders misusing algorithms to charge predatory interest rates.
- SEBI, meanwhile, has been tightening its scrutiny on algo-trading platforms, ensuring retail investors don’t fall prey to untested AI-driven strategies promising unrealistic returns.
- The Ministry of Electronics and IT (MeitY) is reportedly studying the EU AI Act to draft India’s own AI governance framework, which could directly impact fintech players.
The balancing act is clear: too little regulation risks financial misuse; too much could stifle innovation and hurt India’s ambition of becoming a global fintech hub.
Real-World Flashpoints
- In 2022, several Indian borrowers raised complaints that digital lending apps were using AI-based models to harass defaulters with aggressive recovery tactics. This led RBI to ban unregulated players from accessing credit bureau data.
- Globally, Apple Card’s AI-based credit line allocation came under fire in the US after allegations of gender bias, showing how even big tech can stumble in financial AI.
- In the Indian stock market, SEBI had to issue warnings to brokers offering “AI-powered guaranteed return” tools, calling them misleading and dangerous for retail investors.
The Road Ahead: Co-Regulation?
Experts believe India may move towards a co-regulation model — where regulators set the guardrails, but fintech companies also self-regulate by ensuring algorithmic transparency and bias testing.
Some startups are already moving in this direction. Lendingkart claims to regularly audit its AI models to prevent biases, while Groww has adopted stricter internal compliance to stay on the right side of SEBI norms.
With G20 discussions putting AI governance on the global agenda, India — as both a leading fintech market and the world’s fastest-growing digital economy — is in a position to shape norms that balance innovation and consumer protection.
AI in finance is no longer futuristic; it’s here, powering decisions that impact millions of Indians every day. But with great power comes great responsibility. For India’s regulators, the balancing act will be ensuring AI serves as a tool for financial empowerment, not exploitation.
The coming years will likely define whether India becomes a global leader in responsible AI-driven finance — or a cautionary tale of unchecked algorithms.
