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In the rapidly evolving fintech ecosystem, the integration of fintech companies with traditional banks has revolutionized financial services, offering seamless digital lending, payment solutions, and customer-centric innovations. However, this collaboration introduces significant risks, particularly from shadow data—data that is collected, stored, or processed by fintech companies outside the oversight of formal governance frameworks. Shadow data, often unmanaged or unknown to organizations, poses unique challenges to banks, especially in the context of India’s robust data protection laws, including the Digital Personal Data Protection Act, 2023 (DPDPA), its accompanying rules, the Information Technology Act, 2000 (IT Act), and regulations from the Reserve Bank of India (RBI) and the Securities and Exchange Board of India (SEBI). This blog explores how shadow data in fintech operations can expose banks to compliance, security, and operational risks and offers strategies to mitigate them.

What is Shadow Data in the Fintech Context?

Shadow data refers to personal or sensitive data that fintech companies collect, process, or store without proper documentation, governance, or oversight. This can include customer data gathered through third-party APIs, user interactions on unregulated platforms, or data stored in unmonitored cloud environments. Examples include:

• Untracked Customer Data: Data collected through customer-facing apps or third-party integrations (e.g., payment gateways, credit scoring tools) without clear audit trails.
• Legacy Systems: Data stored in outdated systems or databases that lack modern security protocols.
• Third-Party Vendor Data: Information shared with or processed by unregulated vendors or sub-processors, such as marketing agencies or analytics firms.
• Employee-Generated Data: Spreadsheets, local storage, or personal devices used by employees to handle customer data without centralized oversight.

In the fintech-bank ecosystem, where fintechs often act as data processors or, in some cases, data fiduciaries under the DPDPA, shadow data becomes a critical concern for banks, which are typically classified as data fiduciaries responsible for ensuring compliance with data protection laws.

Key Risks Posed by Shadow Data to Banks

Shadow data introduces multifaceted risks to banks, amplified by the stringent regulatory landscape in India. Below are the primary risks and their implications under the DPDPA, IT Act, RBI, and SEBI regulations.

1. Compliance Risks

India’s data protection framework imposes strict obligations on banks and fintechs to ensure lawful data processing, transparency, and accountability. Shadow data undermines these requirements, leading to significant compliance risks.

• DPDPA Non-Compliance: The DPDPA, enacted in August 2023, mandates that data fiduciaries (e.g., banks) ensure lawful processing, obtain explicit consent, and maintain data accuracy, minimization, and purpose limitation. Shadow data, by its nature, evades these controls, as it may be processed without proper consent or for unspecified purposes. For instance, if a fintech partner collects customer data through an unregulated app feature, the bank, as the data fiduciary, could face penalties of up to INR 250 crore for failing to implement security safeguards or notify data breaches.
• RBI Regulations: The RBI’s Master Directions on Outsourcing and Guidelines on Digital Lending (2022) hold banks accountable for the actions of their fintech partners, including sub-agents. Shadow data processed by fintechs without proper oversight could violate RBI’s data localization requirements (e.g., storing payment data within India) or breach reporting mandates (e.g., reporting cyber incidents within 6 hours). Non-compliance could result in regulatory sanctions or reputational damage.
• IT Act Violations: Until the DPDPA is fully enforced, the IT Act, 2000, and its Information Technology (Reasonable Security Practices and Procedures and Sensitive Personal Data or Information) Rules, 2011 (SPDI Rules) govern data protection. Shadow data that lacks “reasonable security practices” (e.g., encryption or access controls) could lead to penalties of INR 100,000 to 1,000,000 for contraventions, alongside liability for compensation to affected individuals.
• SEBI Regulations: For banks involved in capital markets or working with SEBI-regulated entities (e.g., stock brokers or mutual funds), the SEBI Framework for Adoption of Cloud Services (2023) mandates robust data security and breach reporting. Shadow data in cloud environments managed by fintechs could violate these standards, exposing banks to penalties or loss of trust.

2. Cybersecurity Risks

Shadow data is often stored in unsecured or unmonitored systems, making it a prime target for cyberattacks.

• Data Breaches: Untracked data in fintech systems (e.g., customer KYC details or transaction records) may lack encryption or access controls, increasing the risk of breaches. Under the DPDPA, banks must notify the Data Protection Board of India and affected customers of any breach, with potential fines of INR 200 crore for failure to report.
• RBI and SEBI Cybersecurity Mandates: The RBI’s cybersecurity guidelines and SEBI’s Cybersecurity and Cyber Resilience Framework (CSCRF) require financial institutions to implement state-of-the-art security measures, such as ISO 27001-compliant systems and real-time monitoring. Shadow data in fintech systems that do not meet these standards could expose banks to cyber risks, such as ransomware or data theft.
• Third-Party Vulnerabilities: Fintechs often rely on third-party vendors for analytics, cloud storage, or marketing, creating additional entry points for cyber threats. Banks, as data fiduciaries, remain liable for breaches caused by these vendors, as stipulated under the DPDPA and RBI outsourcing norms.

3. Operational Risks

Shadow data can disrupt banks’ operational efficiency and data governance processes.

• Consent Management Challenges: The DPDPA requires explicit, informed, and revocable consent for data processing. Shadow data collected by fintechs without proper consent mechanisms (e.g., through embedded trackers or unverified APIs) could lead to non-compliance, forcing banks to halt operations or erase data upon customer withdrawal of consent. This is particularly challenging given RBI’s KYC Directions (2016), which mandate retaining customer records for at least 5 years, creating a potential conflict with DPDPA’s erasure requirements.
• Vendor Oversight Gaps: Banks’ reliance on fintechs for outsourcing services (e.g., payment processing or credit scoring) means shadow data may reside with vendors lacking robust governance. The DPDPA holds banks accountable for ensuring their data processors comply with regulations, but shadow data evades such oversight, increasing operational risks.

4. Reputational Risks

Data breaches or non-compliance incidents involving shadow data can erode customer trust and damage a bank’s reputation. In a highly competitive financial market, reputational damage can lead to loss of customers and market share, particularly if shadow data mishandling by a fintech partner results in public exposure of customer data.

5. Cross-Border Data Transfer Risks

The DPDPA allows cross-border data transfers unless restricted by the government or stricter sectoral laws, such as RBI’s data localization requirements for payment data. Shadow data transferred abroad by fintechs without proper controls could violate these restrictions, exposing banks to legal and regulatory consequences.

Regulatory Context: DPDPA, IT Act, RBI, and SEBI

The interplay of India’s data protection laws and financial regulations creates a complex compliance landscape for banks and fintechs:

• DPDPA 2023: The DPDPA establishes a principle-based framework for processing digital personal data, emphasizing consent, purpose limitation, data minimization, and breach notifications. It applies to banks as data fiduciaries and fintechs as data processors or fiduciaries, depending on their roles. The DPDPA’s extraterritorial scope means offshore fintechs serving Indian customers must comply, amplifying the challenge of managing shadow data across borders.
• DPDPA Rules (2025): The draft rules, published on January 3, 2025, detail operational compliance frameworks, including consent management and data breach reporting. Shadow data undermines these requirements, as it often lacks proper consent or audit trails.
• IT Act, 2000, and SPDI Rules: Until the DPDPA is fully enforced, the IT Act and SPDI Rules require “reasonable security practices” for sensitive personal data. Shadow data, often unsecured, violates these standards, exposing banks to penalties and compensation liabilities.
• RBI Regulations: RBI’s outsourcing norms, KYC Directions, and digital lending guidelines hold banks accountable for fintech partners’ data practices. Shadow data in fintech systems could breach localization or retention mandates, leading to regulatory action.
• SEBI Regulations: SEBI’s Cloud Framework (2023) and CSCRF mandate secure data handling and breach reporting for regulated entities. Shadow data in fintech-managed cloud environments could violate these standards, impacting banks’ compliance.

Case Study: Shadow Data in Action

Consider a fintech providing a digital lending platform for a bank. The fintech collects customer data (e.g., KYC details, transaction history) via an app but stores it in an unmonitored third-party cloud server. This shadow data lacks encryption and audit trails, violating DPDPA’s security safeguards and RBI’s localization requirements. A data breach occurs, exposing sensitive customer information. The bank, as the data fiduciary, faces:

• DPDPA Penalties: Up to INR 250 crore for failing to secure data or INR 200 crore for not reporting the breach.
• RBI Sanctions: Penalties for non-compliance with outsourcing or localization norms.
• Reputational Damage: Loss of customer trust due to publicized data exposure.
• Operational Disruption: Halting services to comply with DPDPA’s data erasure requirements upon customer consent withdrawal.

This scenario underscores the cascading impact of shadow data on banks’ compliance and operations.

Mitigation Strategies for Banks

To address the risks of shadow data from fintech partners, banks can adopt the following strategies:

1. Robust Vendor Due Diligence:
   • Conduct thorough assessments of fintech partners’ data governance practices, ensuring compliance with DPDPA, RBI, and SEBI regulations.
   • Mandate ISO 27001 certifications and regular audits of third-party systems to identify and eliminate shadow data.
2. Contractual Safeguards:
   • Include stringent data protection clauses in contracts with fintechs, specifying compliance with DPDPA, RBI, and SEBI requirements.
   • Require fintechs to report shadow data incidents within 6 hours, aligning with RBI and CERT-In breach reporting timelines.
3. Data Mapping and Audits:
   • Implement comprehensive data mapping to identify all data flows between banks and fintechs, ensuring no shadow data exists.
   • Conduct regular audits to detect unmanaged data in fintech systems, focusing on cloud storage, APIs, and third-party vendors.
4. Consent Management Systems:
   • Deploy centralized consent management platforms, potentially via Account Aggregators, to ensure explicit, revocable consent for all data processing, as required by DPDPA.
   • Ensure fintechs align with DPDPA’s consent notice requirements, specifying data collection purposes and customer rights.
5. Cybersecurity Enhancements:
   • Enforce state-of-the-art cybersecurity measures, such as AES encryption and real-time monitoring, across fintech systems to secure shadow data.
   • Designate dedicated teams within banks to monitor fintech data breaches, as recommended by RBI and DPDPA guidelines.
6. Training and Awareness:
   • Train fintech partners and bank staff on DPDPA, IT Act, RBI, and SEBI compliance requirements to prevent shadow data creation.
   • Foster a culture of transparency and accountability in data handling practices.
7. Data Localization Compliance:
   • Ensure fintechs adhere to RBI’s data localization requirements for payment data, preventing shadow data from being transferred abroad without authorization.

Conclusion

Shadow data in fintech companies presents significant risks to banks, including compliance violations, cybersecurity breaches, operational disruptions, and reputational damage. The DPDPA 2023, IT Act, 2000, RBI regulations, and SEBI rules collectively impose stringent obligations on banks to oversee their fintech partners’ data practices, making shadow data a critical liability. By implementing robust vendor oversight, contractual safeguards, data mapping, and cybersecurity measures, banks can mitigate these risks and ensure compliance with India’s evolving data protection landscape. As the DPDPA’s enforcement approaches, proactive management of shadow data will be essential for banks to maintain trust, compliance, and operational resilience in the fintech-driven financial ecosystem.

Disclaimer: This blog is for informational purposes only and does not constitute legal advice. Banks and fintechs should consult qualified legal professionals to ensure compliance with applicable laws.