Analyzing the Fintech Implications of RBI’s Mandate for Interoperability

[Akshay Luhadia and Rohit Gupta are 3rd year B.A., LL.B. (Hons.) students at West Bengal National University of Juridical Sciences, Kolkata]

On April 7, 2021, the Governor of the Reserve Bank of India (‘RBI’) announced significant changes in the policies regulating the operation of prepaid payment instruments (‘PPIs’) in India. According to the guidelines under the Payment and Settlement Systems Act, 2007, PPIs are “instruments of payment that facilitate buying of goods and services, including the transfer of funds, financial service and remittances, against the value stored within or on the instrument.” PPIs are available in various formats: wallets, smart cards, magnetic chips, vouchers, etc. In essence, any instrument which allows access to a prepaid amount can be termed as a PPI.

The Governor first announced the RBI’s decision to mandate PPIs to adopt interoperability amongst themselves. Interoperability refers to the ability of computer systems or software to exchange and make use of information. This would imply the exchange of information and the seamless transfer of funds between PPIs.  

Second, the RBI proposed to gradually allow the payment system operators to obtain direct membership in the Central Payment System (‘CPS’). This would enable them to additionally transact through Real-Time Gross Settlement (‘RTGS’) and National Electronic Funds Transfer (‘NEFT’) without the need for traditional bank interference. Beneficiaries would not only include issuers of payment wallets, but also other platforms regulated by the RBI, such as walled-garden payment options, white-label ATM operators, card networks, and the Trade Receivable Discounting System (‘TReDS’).

Third, while operating these systems, payment banks (‘PBs’) will be allowed to settle accounts with a maximum balance at the end of the day of two lakh rupees, as opposed to the previous one lakh rupees per customer. Lastly, the RBI also expressed plans to enable users of non-bank PPIs which are fully subject to know-your-customer (‘KYC’) requirements to withdraw cash from any ATMs in operation. This comes as a concerted effort with mandating interoperability, mimicking the results of the same for offline transactions as well.

This post analyses the implications of the aforesaid significant reforms in terms of recent industry demands to minimize settlement risks and to introduce a level-playing field in the payments market to enable PPIs to compete with traditional banks.

RBI’s Trajectory for Dealing with PPIs and PBs

In the past, the RBI’s policies have inadvertently affected the popularity of PPIs. With the rollout of the United Payments Interface (‘UPI’) and the imposition of strict obligations to ensure KYC compliance in 2017, PPIs witnessed a loss of appeal in providing wallet services. The customer base began migrating towards the use of UPI, which provided zero-cost transfers directly from bank accounts, bypassing the service fee which was charged on such transactions by PPIs. In the next three years alone, 22 digital wallet providers became inactive, as their licenses were rendered infructuous. Others, such as PayU, relied upon their gateway and lending wing to sustain the impact.

For the majority of its existence, the RBI has remained risk-averse by only trusting traditional banks with the utilization of the CPS to facilitate digital transactions. The inclusion and ease provided by UPI interoperability, however, has shifted the burden, wherein PPIs and payments banks have taken a bulk of new digital transactions, which are high in volume but low in value.

Payment banks are akin to other traditional banks, but operate on a smaller and restricted scale. They cannot associate with credit risk, nor advance loans, or issue credit cards. To meet their operational costs, they predominantly rely on transactions and income from investments. However, minimal receipt of deposits and a bar from lending has effectively curbed any potential growth for payment banks.

Naturally, interoperability, and the facility to withdraw cash from ATMs, addresses the isolation created by operators, which only allow transactions to occur within their payment networks. Additionally, the increase in the end-of-day balance proposed by the RBI provides consumers with further assurance that they can withdraw their cash from full-KYC PPIs and payment banks.

As a result, PPI holders are more likely to engage in digitalized transactions and less likely to operate with cash. This increase, coupled with escalated online transfers, also provides non-banking entities with the opportunity to complete their KYC conformity in addition to the mandate of interoperability. The RBI has previously observed that interoperability was not partaken by many due to inertia against migrating towards full-KYC PPIs. The increase, thus, has killed two birds with one stone; interoperability and abating traditional banks’ monopoly in India. 

However, these benefits may be disproportionately experienced among large-capital operators, such as PayTM or Mobikwik, rather than medium or small capital businesses, since the ability to transfer funds inter-network would reduce the onboarding of customers. Now, customers would not need to operate accounts on multiple payment platforms to interact with others not on their network. This may eventually lead to monopolization by certain PPI operators.

The Payment Settlement Crisis and the CPS

Notwithstanding UPI’s popularity and effective functionality, its operation has been subject to various technical failures and an emerging trend of cybersecurity attacks. In September 2020 alone, the overwhelming volume of UPI transactions led the United Bank of India server infrastructure to fail 12.4% of 9.28 million UPI transactions. Similarly, State Bank of India and Canara Bank witnessed technical declines of 5.3% of 510 million and 5.9% of 58 million UPI transactions, respectively. Unfortunately, notification of such failures is often in the form of a ‘payment is processing’ message which leaves users in a state of flux regarding their settlements. Banks and gateways have also failed to establish a speedy redressal mechanism which can handle customer complaints. In response, the National Payments Corporation of India, in November 2020, announced that each third-party UPI operator would not be allowed to process more than 30% of the total volume of UPI transactions, calculated on a rolling three-month basis. The announcement to allow PPIs and PBs to directly gain membership of CPS, too, allows for diversification of payment channels to distribute incoming volume to prevent clogging.

Conclusion

Banks currently operate with limited legacy technology, which has curtailed their expansion to Tier III to Tier VI centres. The boosted migration to full-KYC PPIs has the ability to complement the banking infrastructure, especially in these unbanked regions. These measures also allow fintech companies to penetrate such areas and offer services traditionally offered by banks. This may include a wide variety of operations, such as co-branding prepaid cards with PPIs for promotion as well as online stockbroking, which requires the reliability and end-to-end security of legacy systems such as RTGS and NEFT. Since large credit transactions are almost exclusively conducted through the CPS, it would now open the field for fintech companies to function as neo-banking facilities, on par with traditional banks.

Akshay Luhadia & Rohit Gupta

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