Transforming the Financial Landscape: RBI’s Overhaul of Forex Authorization Framework

[Harshal Chhabra and Shaswat Kashyap are 2^nd year and 3^rd year students respectively at Gujarat National Law University]

In response to the dynamic shifts in the financial landscape, the Reserve Bank of India (the RBI) on 26 December 2023 introduced a draft licensing framework for Authorized Persons (APs) under the Foreign Exchange Management Act, 1999 (the Act). This move signifies a pivotal reassessment of the existing authorization framework, last examined by the RBI in March 2006. The impetus behind this review arises from the widespread accessibility of banking services to the public, compelling the RBI to explore alternative models for more effective facilitation of foreign exchange-related services. This initiative unfolds against the backdrop of an accelerated financial services outreach, driven by diverse financial inclusion efforts, heightened integration of the Indian economy globally, the digitization of payment systems, and an evolving institutional structure over the past two decades.

The comprehensive review centres on three key focus areas: first, the rationalization of the authorization framework for money changers considering the widespread availability of banking as well as other financial services; second, the exploration of alternative models for foreign exchange services to broaden the scope of services provided by AD-Category II entities; and third, an overarching review of the regulatory framework for APs.

This post aims to delve deeper into these focus areas, shedding light on the RBI’s vision for a more efficient, adaptable, and user-friendly foreign exchange landscape, while maintaining a vigilant regulatory framework.

The Current Landscape: Forex Authorization Framework Before the Transition

According to section 2(c) of the Act, an “authorised person” means an authorised dealer, money changer, off shore banking unit or any other person who has been authorised under section 10(1) of the Act to deal in foreign exchange and foreign securities. In adherence to the relevant circular issued under the Act, the RBI possesses the authority to authorize individuals, upon application, as “authorized persons” to engage in foreign exchange or foreign securities dealings. This authorization extends to entities designated as Authorized Dealers (ADs) or in any other capacity deemed suitable by the RBI. The exclusive permission to engage in the transfer or dealing of foreign exchange or foreign securities is reserved for these APs.

Significantly, a substantial portion of forex transactions presently occurs through APs, with the RBI not directly involved in the process. Recognizing this shift, the RBI has proposed the introduction of a new category of money changers. These entities, operating under the agency model, would function as Forex Correspondents (FxCs) affiliated with Category-I and Category-II ADs. This move aims to expand the accessibility of foreign exchange services and introduces the concept of a Forex Correspondent Scheme (FCS)

In this proposed scheme, AD Cat-I or AD Cat-II would act as the principal for FxCs, eliminating the need for FxCs to obtain a separate authorization from the RBI, as opposed to the mandate under section 10(1) of the Act. Transactions conducted by FxCs on behalf of the AD will be recorded in the principal AD’s books. Moreover, both the FxCs and their customers dealing with FxCs shall be granted general permission to engage in foreign exchange dealings.

Currently, entities operating as AD Cat-II receive initial authorizations for a one-year period, with subsequent renewals ranging from one to five years. In a bid to alleviate regulatory burdens and enhance business efficiency, the RBI suggests a shift towards perpetual renewals for existing AD Cat-II authorizations, contingent upon meeting the revised eligibility criteria outlined in the impending new framework. Moreover, to foster innovation, competition, and an improved consumer experience, AD Cat-II entities are poised to be granted the additional capability of facilitating trade-related transactions up to ₹15 lakh per transaction.

The evolving regulatory framework over the years has led to a substantial share of forex transactions being undertaken through APs without direct involvement from the RBI. Section 3(a) and section 10(1) of the Act underscore the regulatory underpinnings, emphasizing the importance of APs in facilitating foreign exchange transactions. The existing structure issues authorizations to APs in the form of licenses, encompassing both ADs and Full-Fledged Money Changers (FFMCs), as well as select institutions granted specific authorizations for foreign exchange transactions related to their business activities.

Empowering Financial Entities: Navigating the New RBI Framework

The amended framework proposed by the RBI has significant implications for FFMCs and (AD) Category-II. The primary objective behind this initiative is to enhance operational efficiency and ensure compliance within the evolving financial landscape.

Entities falling under the purview of this transition are granted the opportunity to make strategic decisions in accordance with their existing roles and turnovers. For instance, an existing FFMC, with an average annual forex turnover of ₹50 crores or more over the last two financial years, faces two viable options. The first option involves seeking an upgrade to AD Category-II, subject to meeting the revised eligibility criteria. The second option allows the FFMC to voluntarily convert to FxC under the Forex Correspondent Scheme after surrendering its existing license. This decision must be made either by the expiry date of the current authorization or within two years from the initiation of the new framework, whichever comes later.

Entities with an annual forex turnover below ₹50 crores, be they FFMCs or AD Category-II, are provided a streamlined option. They can voluntarily convert to FxC by adhering to the Forex Correspondent Scheme, without the necessity of meeting the higher eligibility criteria for AD Category-II. The transition period for this group aligns with the overarching timeline, ensuring a harmonized approach to the implementation of the new framework. Furthermore, all existing FFMCs are required to either upgrade to AD Category-II or transition into a Forex Correspondent (FxC) under the FCS within two years from the date of the new framework’s enforcement or the expiry of their authorization, whichever occurs later.

During this transitional period, the existing regulatory directions applicable to FFMCs will remain in force. Additionally, the revised framework eliminates the need for prior approval from the RBI for tie-up arrangements between Money Transfer Service Scheme (MTSS) Indian Agents and Overseas Principals. AD Category-I and AD Category-II entities may now function as “MTSS Indian Agents” and are required to report any tie-up arrangements to the Foreign Exchange Department (FED) of the RBI within 30 days of entering into such arrangements.

It is imperative to comprehend the concept of ‘annual forex turnover’ in this context. This term encapsulates the aggregate of foreign currency notes, coins, travellers’ cheques bought from or sold to the public, and the value of remittances facilitated. Ultimately, this comprehensive transition approach empowers existing entities with flexibility, ensuring that their strategic choices align with their business volumes and operational preferences. Whether upgrading to AD Category-II or embracing the Forex Correspondent Scheme, these changes underscore a commitment to adaptability and compliance within the financial sector.

Conclusion

The RBI’s transformative overhaul of the forex authorization framework is a strategic response to the evolving dynamics of financial markets. The draft licensing framework for APs under FEMA reflects the RBI’s commitment to enhancing operational efficiency and ensuring compliance in a rapidly changing financial landscape. The proposed changes, including perpetual renewals for AD Cat-II authorizations, facilitation of trade-related transactions, and exclusion of turnover figures for specific financial years, underline the RBI’s dedication to adaptability and compliance within the financial sector, empowering entities to align strategic choices with business volumes and operational preferences. As we navigate this transition, the RBI’s vision prioritizes flexibility for existing entities, anticipating the needs of the financial market and setting the stage for a more efficient, adaptable, and user-friendly foreign exchange landscape.

– Harshal Chhabra & Shaswat Kashyap