Introduction
“It’s 7 AM. Your salary just hit your neobank account. By 9 AM, the app crashes. By noon, the company files for insolvency. Your rent is due tomorrow. Under Indian law, you are not a depositor you are a ‘digital platform user.’ The difference could cost you everything.”
At the hub of this digital revolution in banking is India, where the neo banking industry is experiencing explosive growth projected to reach over USD 150 billion by 2032 with The platform boasts hundreds of millions of account holders, with millennials and Gen Z dominating the number. They carry out transactions of thousands of rupees every month. Neo banks have gone beyond from mere convenience to mission-critical financial infrastructure for gig workers, rural communities, and India’s underbanked millions.
Yet Indian neobanks operate beyond the definitional limits of “banking” itself unshielded by deposit insurance, resolution frameworks, or insolvency safeguards. The wreckage of Wirecard’s multi-billion euro fraud, Silicon Valley Bank’s 48-hour collapse, and Synapse’s frozen accounts affecting millions, this provides an eerie preview.. With thousands of startups collapsing in India annually, the question isn’t if but when: What happens if a major neobank fails, and who protects the millions who depend on it?
What Exactly Is a Neobank and Its Legal Status?
Neo banking refers to the digital-only banking services that can operate your account entirely online, requiring no physical presence. It works through mobile applications, websites, or sometimes both. These banks usually lack any sort of physical infrastructure, but they provide all banking services as traditional banks. Under Indian law, there is no formal legal definition or status for a neobank.. The Banking Regulation Act, 1949 does not recognize “neobanks” as licensed banking entities, and the RBI has never issued a digital-only bank license. Legally, neobanks are technology platforms or fintech companies that provide banking-like services through partnerships with regulated entities typically licensed banks or NBFCs.
They operate under existing regulatory frameworks as:
- Banking Business Correspondents (BCs)
- Prepaid Payment Instrument (PPI) issuers
- Account Aggregators
- Digital lending intermediaries
The neobank itself cannot accept deposits, lend money, or perform core banking functions independently. Instead, it acts as a digital front-end or service layer, while the partner bank holds customer accounts, deposits, and legal liabilities. This is stipulated under Sections 5(b) and 6 of the Banking Regulation Act. The contractual relationship is tripartite: customer-partner bank-neobank. Customers have no direct deposit insurance claim against the neobank.
The Regulatory Patchwork: A Web of Laws With No Insolvency Answer
India’s neo-banking ecosystem operates under a fragmented legal regime where seven overlapping laws provide no clear insolvency framework. This patchwork regulation creates dangerous ambiguities in consumer protection and financial stability.
Banking Regulation Act, 1949
Section 5(b) of the Banking Regulation Act, 1949, defines banking as the accepting of deposits for lending or investment. Since neobanks themselves do not accept deposits, they completely fall outside the purview of this Act; it follows that RBI’s resolution powers under Section 45 are also inapplicable. They are not banks, so bank insolvency mechanisms are irrelevant.
Payment and Settlement Systems Act, 2007
The UPI rails and wallet licenses are governed by the Payment and Settlement Systems Act, 2007, wherein RBI is empowered to suspend operations under Section 23. However, it does not have provisions related to recovery of customer funds, creditor hierarchy, or liquidation waterfall in case of any collapse. This has resulted in a critical gap wherein operational regulation exists without accompanying consumer protection mechanisms.
DICGC Act, 1961
Only deposits with scheduled banks are guaranteed up to ₹5 lakh under the DICGC Act, 1961. The reason being: Neobank balances are not “deposits” legally, only digital account balance, and they remain fully uninsured. Millions of its consumers think that their money enjoys protection similar to traditional bank deposits.
Insolvency and Bankruptcy Code, 2016
While Section 3(7) of the Insolvency and Bankruptcy Code, 2016, excludes banks explicitly, section 227 carves out financial service providers separately. But are neo-banks ‘financial service providers’? Legally speaking, that’s murky. Most are organized as technology platforms, leaving uncertainty about which insolvency regime applies.
Consumer Protection Act, 2019
The Consumer Protection Act, 2019 identifies digital service users under Section 2(7), which provides redress for deficiency in service. However, it is inapplicable in cases of systemic failures of a platform or losses due to the insolvency of funds.
FRDI Bill, 2017 and Resolution Gaps
This vacuum is haunted by the ghost of the FRDI Bill, 2017, that was withdrawn after a “bail-in” controversy, and it did propose a Resolution Corporation. Most critically, India regulates payment rails and banks, but not the unregulated digital interface layer where customer trust actually resides: platforms face no capital adequacy norms, ring-fencing requirements, or mandatory resolution planning.
Seven Fragmented Laws: At a Glance
| Law |
|---|
| Banking Regulation Act, 1949 |
| Payment and Settlement Systems Act, 2007 |
| DICGC Act, 1961 |
| Insolvency and Bankruptcy Code, 2016 |
| Consumer Protection Act, 2019 |
| FRDI Bill, 2017 (Withdrawn) |
| RBI’s Payment & Digital Banking Regulations |
Seven fragmented laws govern different aspects but none address neobank platform failures, leaving digital banking users in regulatory limbo.
Five Failure Scenarios: Where Legal Theory Crumbles
| Scenario | Section ID |
|---|---|
| Partner Bank Moratorium | #partner-bank-moratorium |
| Neobank Failure | #neobank-failure |
| Dual Failures | #dual-failures |
| Fraud/AML Shutdown | #fraud-aml-shutdown |
| Cyber Incident | #cyber-incident |
Partner Bank Moratorium
When a partner bank of a neobank (e.g., Federal Bank partnering with Jupiter) enters moratorium, customer deposits remain protected under DICGC up to ₹5 lakh. However, customers may lose access through the neobank app due to breakdowns in API integration, with no clear regulatory clarity on managing the neobank’s digital interface during bank resolution. This gap risks service disruption despite deposit protection.
Neobank Failure (Partner Bank Intact)
In case of a neobank failure where the partner bank remains intact, customers suffer from operational collapse:
- loss of app access
- UPI transaction failure
- disturbance in standing instructions
- vanished card data
- customer service blackouts
Legal ambiguity remains: customers are unaware of claims under IBC as operational creditors or remedies under the Consumer Protection Act; rules of contract and data inheritance are not defined.
Dual Failures (Neobank and Partner Bank)
In the case of dual failures, when both a neobank and a partner bank fail, the RBI has placed bank resolution as the priority, thus leaving the neobank platform “orphaned” in terms of coordinated frameworks, with very high customer exposure.
Shutdown Due to Fraud or AML
A shutdown due to fraud or AML, as in the case of Wirecard, triggers an immediate liquidity crisis:
- platforms freeze
- there is no mechanism of emergency withdrawal, unlike traditional bank protections.
Cyber Incidents
Cyber incidents compound risks: ransomware leads to data loss, shutdowns of operations, and account inaccessibility. Insurance typically excludes cyberattack-induced bankruptcy, leaving neobanks unable to recover while customers lose access and data.
Proposed Framework: A Digital Banking Resolution Code for India
India is in a pressing need of a comprehensive Digital Banking Resolution Code supported by newly enacted Digital Banking Entities Act, to fill in the regulatory spaces created by the withdrawal of the FRDI Bill. The framework outlines three digital banking entity categories based on functions:
Category 1 — Digital Banks
Digital Banks (Category 1) accept deposits and lend and would be governed by the full Banking Regulation Act with specialized resolution mechanisms that will both protect depositors and protect for systemic stability, similar to traditional banks.
Category 2 — Neobanking Platforms
Neobanking Platforms (Category 2) operate as intermediaries but do not hold deposits. They would be eligible for intermediate regulation on a minimum net worth of ₹100 crores, customer funding escalation requirements including placing customer funds in escrow accounts with partner banks, fidelity insurance for technology cost and fraud risk, and Recovery & Resolution Plans (RRP) with a subsection specific to runoff plans.
Category 3 — Payment Service Providers
Payment Service Providers (Category 3) enable payment transactions, operate and do not hold funds, and are regulated under the Payment and Settlement Systems Act, 2007, with appropriate compliance requirements the same regulatory compliance and other regulatory obligations, but as in category 1 or 2 or Regulation, similar to whatever the required compliance is, compliance should not become an unfair burden.
Resolution Architecture and Safeguards
| Institution / Tool | Purpose | Funding Mechanism |
|---|---|---|
| Resolution Authority | Use of moratoriums, forced sales, bridge neobanks, and bail-in-lite tools | 0.05% transaction levy |
| Digital Deposit Guarantee Fund | Guarantees deposits up to ₹1 lakh per customer | 0.1% revenue levy |
A resolution authority, which could be either an expanded IBBI or the newly-established Digital Banking Resolution Corporation funded by means of a 0.05% transaction levy, would use moratoriums, forced sales, bridge neobanks, and bail-in-lite tools. A Digital Deposit Guarantee Fund, with regulatory capital provided by a 0.1% revenue levy, would guarantee deposits of up to ₹1 lakh per customer.
Implementation Roadmap
- There are specific guidelines for effective disclosure, real-time deposit tracking, and any required cybersecurity audits.
- There is an 18-month compliance period.
- Licenses are grandfathered.
- There are proposed sandbox pilots.
- There will be an MOU with international regulatory jurisdictions.
This resolves the paradox of ‘too small to regulate, too big to fail’ while creating the right balance between innovation and consumer protection.
Conclusion
Digital banking is a present reality, rather than a future prospect, to transform savings and credit in India. But without safety, innovation is building a house on sand. Today’s legal vacuum poses a silent systemic threat: when a neo bank fails, neither law nor regulator gives clarity on who bears the loss.
India urgently needs an all comprehensive Digital Resolution Code that defines clear failure protocols, enhancement in consumer protection mechanisms, deposits insurance coverage, and distinct RBI licensing frameworks which differentiate neobanks from payment aggregators.
We must make a choice: design these frameworks proactively now, or wait for the next crisis to dictate rushed, innovation-strangling regulations. A pro-innovation, pro-stability approach calls for prevention, not reaction. Digital banking needs guardrails fit for the digital age before the next collapse teaches us why. End Notes:
- https://www.transparently.ai/blog/how-the-wirecard-scandal-happened?utm_source=chatgpt.com
- https://www.federalreserve.gov/publications/files/svb-review-20230428.pdf?utm_source=chatgpt.com
- https://www.pymnts.com/legal/2025/frozen-funds-still-unresolved-as-synapse-bankruptcy-nears-conclusion/?utm_source=chatgpt.com
- https://www.indiacode.nic.in/bitstream/123456789/1885/1/A194910.pdf
- https://www.rbi.org.in/commonman/English/scripts/Notification.aspx?Id=773
- https://www.indiacode.nic.in/handle/123456789/1885?utm_source=chatgpt.com
- https://www.indiacode.nic.in/bitstream/123456789/2082/4/a2007-51.pdf?utm_source=chatgpt.com
- https://www.dicgc.org.in/sites/default/files/2024-10/DICGC_Act1961.pdf?utm_source=chatgpt.com
- https://www.indiacode.nic.in/bitstream/123456789/15479/1/the_insolvency_and_bankruptcy_code,_2016.pdf?utm_source=chatgpt.com
- https://www.indiacode.nic.in/bitstream/123456789/16939/1/a2019-35.pdf?utm_source=chatgpt.com
