[Ritvij Ratn Tiwari is a 5th-year B.A., LL.B. (Hons.) student at the National Law School of India University, Bengaluru]
In February 2024, the Reserve Bank of India (‘RBI’) moved decisively to curtail the operations of certain fintech companies, particularly Business Payment Service Providers (‘BPSPs’), by labelling their activities as unauthorized “payment systems” under the Payment and Settlement Systems Act of 2007 (‘PSS Act’). BPSPs, by facilitating payments from commercial cards to non-card accepting merchants, brought immense value to the business-to-business (‘B2B’) space. However, the RBI’s intervention has raised significant legal questions about the classification of these operations, specifically whether BPSPs truly operate as payment systems, requiring licensing, or if they function more as aggregators.This post builds on questions posed in a previous post, which explored the regulatory ambiguity surrounding payment systems. I argue that BPSPs do not meet the criteria of “payment systems” under the PSS Act and should not face the same regulatory constraints as full-fledged systems like the National Payments Corporation of India (‘NPCI’) framework. The current regulatory framework overreaches, stifling innovation and limiting financial inclusion. To support this argument, the author analyses case law involving PayPal, Lotus Pay Solutions, and the broader legal boundaries that define what constitutes a payment system.
RBI’s Concerns: Addressing Risks in BPSP Operations
The RBI has expressed several concerns over the operations of BPSPs, primarily revolving around transparency and compliance with existing legal frameworks. One key issue is that BPSPs aggregate payments and transfer funds through traditional banking channels like National Electronic Funds Transfer (‘NEFT’), Real Time Gross Settlement (‘RTGS’) and Immediate Payment Service (‘IMPS’), without the required authorization. The RBI argues that this constitutes a “payment system” because it involves the settlement and transfer of funds between businesses and vendors.
Additionally, the RBI is concerned about the potential risks BPSPs pose regarding anti-money laundering (‘AML’) and Know Your Customer (‘KYC’) compliance. By processing large volumes of payments, BPSPs must ensure they meet stringent KYC guidelines, which the RBI claims are currently insufficiently addressed. Furthermore, the pooling of funds in accounts not designated for payment system purposes raises red flags for the central bank, as it poses risks of fraud or misuse of funds.
Defining the Issue: The Role of BPSPs
BPSPs emerged as an innovative solution for commercial card payments. Corporates used BPSP platforms to pay vendors who lacked card infrastructure, with the funds transferred via traditional banking channels like NEFT, RTGS, or IMPS. As of December 2023, BPSP transactions accounted for 12.5% of total credit spending, equating to roughly ₹20,000 crore per month. Despite this significant volume, the RBI classified these transactions as an unauthorized payment system because of the handling and settlement of funds by BPSPs.
However, this view overlooks the essential function and nature of BPSPs. A careful reading of the PSS Act makes it clear that not all systems that handle payments fall under the category of a “payment system.” The Act defines a payment system as one that facilitates the actual clearing, settlement, or payment between a payer and a beneficiary. BPSPs, by contrast, act as intermediaries and facilitators of transactions, and do not engage in the core functions of clearing or settling payments.
The Contours of a Payment System: Legal Precedent
The case of PayPal Payments Private Limited v. Financial Intelligence Unit is particularly instructive in defining the limits of a payment system. The Delhi High Court ruled that while PayPal facilitated international transactions, it did not itself engage in clearing or settling the transactions. PayPal provided the platform but relied on other systems for the actual transfer of funds, meaning it could not be classified as a payment system operator under the PSS Act.
This ruling is applicable to BPSPs, which, like PayPal, provide a platform that enables transactions but do not themselves settle or clear the funds. The commercial cards used by corporates are processed through established card networks such as Visa or Mastercard, which then interact with banking channels. BPSPs, therefore, are one step removed from the core operations that define a payment system.
Lotus Pay Solutions Pvt. Ltd. v. RBI further supports this argument. In this case, the court ruled that payment aggregators can facilitate payments without being considered payment systems as long as they do not directly engage in settlement or clearing. BPSPs, like Lotus Pay, operate as facilitators and intermediaries, not as the entities responsible for the actual clearing and settlement of transactions.
The courts, in both cases, made it clear that the primary test for whether an entity is a payment system is whether it performs clearing or settlement functions, something BPSPs do not do. By classifying them as payment systems, the RBI overlooks this critical distinction, stretching the definition far beyond its intended scope.
The Regulatory Overreach of the PSS ActIn the course of invoking the PSS Act against BPSPs, the RBI is engaging in regulatory overreach. The PSS Act was designed to regulate systems which perform clearing, settlement, and payment for various transactions. BPSPs, by contrast, operate more like payment aggregators, whose role has been explicitly delineated as not requiring the same stringent licensing under RBI guidelines.
The RBI’s justification for its actions is based on the fact that BPSPs aggregate payments and remit them via NEFT or RTGS. However, this does not change the fact that the core payment system functions of clearing and settlement are handled by licensed entities, not by BPSPs themselves. The RBI’s intervention, therefore, represents an overextension of the PSS Act, wrongly applying the regulatory burden meant for full-scale payment systems to intermediaries like BPSPs.
BPSPs, which have been instrumental in increasing access to credit for small businesses, are now facing prohibitive compliance burdens. For small and medium enterprises (‘SMEs’), BPSPs offered a lifeline by facilitating around ₹20,000 crore per month in credit transactions. Banks and credit card firms, however, have not disclosed the exact number of commercial cards issued or the full volume of spending. With the current regulatory uncertainty, businesses are now expected to explore alternative credit lines to make up for the loss of BPSP-driven transactions. Financial Inclusion and the Stifling of Innovation
One of the most significant contributions of BPSPs is their role in enhancing financial inclusion. By enabling vendors who do not have point-of-sale (‘POS’) infrastructure to receive payments, BPSPs are expanding the reach of digital transactions. These vendors, many of whom operate in rural or underserved markets, rely on BPSPs to access the formal financial system. In December 2023, India’s credit card spending rose to ₹1.65 trillion from ₹1.61 trillion the previous month, with BPSPs playing a key role in facilitating these transactions.
The RBI’s intervention not only misapplies the PSS Act but also stifles this innovative model that supports financial inclusion. Additionally, the regulatory burdens imposed by the PSS Act, particularly its strict KYC norms and compliance requirements, are designed for full-scale payment systems. BPSPs, which act as intermediaries, do not have the same level of control over transactions, and imposing such requirements is disproportionate and counterproductive. The intention of regulation is to create secure, transparent systems, but in this case, it risks driving small players out of the market, ultimately benefiting only large, established financial institutions that can afford the compliance costs.Conclusion
Classifying BPSPs as payment systems under the PSS Act is not only an overreach but also a misapplication of regulatory power. The case law surrounding PayPal and Lotus Pay Solutions makes it clear that intermediaries, like BPSPs, do not engage in the critical functions of clearing or settlement that would warrant such classification. BPSPs serve as facilitators of transactions, operating in the space between businesses and established financial networks, but they do not handle the core mechanics of a payment system as outlined by the PSS Act.
By misclassifying BPSPs, the RBI risks stifling a vital part of the fintech ecosystem that enhances financial inclusion and provides businesses, particularly SMEs, with much-needed access to credit. Instead of fostering innovation, the current regulatory stance imposes undue burdens that could drive small players out of the market and ultimately benefit only well-established financial institutions.
– Ritvij Ratn Tiwari