MoneyRules is Back!: 7th November 2022

RBI's take on CBDCs and offline aggregators, SEBI's The Big Short moment, credit cards on UPI and more!

Welcome back to MoneyRules! After a hiatus, we are back with Setu’s newsletter on fintech regulatory developments in India, written by Sriya Sridhar, Madhuri and Vinay Kesari. 

An update right at the top, MoneyRules will now be a monthly newsletter, covering the regulatory changes which caught our eye in the previous month. We hope you’re as excited about our relaunch as we are. Let’s get to it!

RBI launches CBDC pilot

On October 31st, the RBI announced that it will begin a pilot launch of the ‘Digital Rupee’ on November 1st, in the wholesale segment with 9 banks identified to participate. For this pilot, the use case is the settlement of secondary market transactions in government securities. The hope is reduction in transaction costs by eliminating the need for settlement guarantee infrastructure or for collateral, since (1) adoption of CBDCs could mean same day settlements instead of the current T+2 and T+3 cycles, and (2) reduce the number of intermediaries required for settlement of government securities, forex transactions and inter-bank settlements. The RBI also hopes to commence pilot launches for the retail segment, other wholesale transactions and cross border payments soon.

Taking a step back – what is CBDC? CBDC stands for ‘Central Bank Digital Currency’ and is defined by the RBI as ‘legal tender issued by the bank in digital form’. This is essentially a digital token like a cryptocurrency and would be pegged to the value of a country’s fiat currency. The currency is transacted using wallets backed by a blockchain. Unlike cryptocurrencies, a CBDC would have the full backing of governmental financial institutions. The types of CBDCs being introduced by the RBI are CBDC-Rs (available for retail consumption) and CBDC-Ws (for interbank transfers and transactions between financial institutions). 

In its concept note on CBDC released earlier in October, the RBI explores the merits and demerits of the ‘e-Rupee’ for India. The RBI primarily sees the following benefits of CBDCs: 

1. reduced operational and transaction costs, more seamless cross border payments, 

2. improved financial inclusion in under-banked areas, and 

3. reduced credit and liquidity risks, since there would be no worry of losing money if your bank fails and it appears as a liability on the books of the RBI. 

There’s a fair bit to unpack. Starting with the model – the RBI is of the opinion that the 'indirect model’ is most suitable for the Indian use case. This essentially means that the RBI would issue tokens to authorised entities known as Token Service Providers (TSPs), who would then distribute the tokens to end users, meaning that a certain portion of the money supply in the economy would be digital. While the potential implications of this on a macro-economic scale are yet to be seen, the regulator hopes that this would reduce expenditure on printing money (which is among the RBI’s largest spends). 

The RBI envisions that TSPs would be banks and other entities which currently offer customer-facing services in the financial supply chain, which could be leveraged to provide services such as distribution of CBDCs to the public,  account-keeping services, customer verification such as KYC, adherence to AML/CFT checks, and transaction verification. The rationale is that banks and fintechs are likely to have a larger competitive advantage than the central bank, and are more likely to be able to enrich customer experience, which would in turn facilitate wider adoption. This likely means a big opportunity for fintechs to manage, distribute, and provide value added services around CBDCs. 

 CBDC-Ws would be ‘token-based’, that is, the RBI would issue the tokens, and ownership is deemed, which will enable financial institutions to instantly settle funds. CBDC-Rs would be ‘account based’, which would entail account and fund verification, like current digital transactions. Of course, how this will be integrated within the existing payment infrastructure, the role of private players and app providers, and who’s allowed to participate, are aspects that will determine the competitiveness and efficiency of the ecosystem.

The RBI has also considered a threshold on CBDC transactions to combat the possibility of anonymous illegal transactions, imposing limits on CBDC balances, and has taken a stand against an interest-bearing CBDC to avoid depositors fleeing banks and impact the creation of credit. All these factors together, could limit the extent to which (1) CBDCs reduce credit and liquidity risks, and (2) CBDCs are able to achieve mass adoption. 

On the issue of cross-border payments – this would be highly dependent on international efforts towards interoperability and standard setting, which does pose some challenges given the varied approaches of different international regulators.Global efforts to implement CBDCs have had mixed results, with ventures in Nigeria and the Bahamas struggling with technical glitches as well as adoption rates of 5% or less. While major jurisdictions such as the USA are still in the research phase, there are potential learnings which could be gleaned from trials being conducted by the Switzerland based Bank of International Settlements in collaboration with central banks of Australia, China, Singapore and France, among others Singapore will also soon be testing its Retail CBDC, the Singapore Dollar. 

What’s missed in the note? We hope future releases on the CBDC from the regulator include more elaboration on proposed privacy frameworks, grievance redressal mechanisms and offline functionalities of CBDCs (since these would, theoretically, be crucial to advance the cause of financial inclusion in remote areas with lower digital and financial literacy, as well as internet access). 

News coverage we liked on this topic: An explainer on the CBDC concept note (and CBDCs in general) in The Hindu, and a summary on the RBI’s policy stances in MediaNama. 

Credit cards on UPI launched

The Global Fintech Festival saw the launch of the UPI linked RuPay credit card, and the following week saw the NPCI’s operating guidelines for these credit cards. The guidelines primarily address the mode of operationalising the RuPay credit card, payment fees, and the role of issuers/app providers. While this has been hailed by the industry as the next big opportunity, there are still some aspects to think about when it comes to large scale adoption. 

Although the NPCI’s guidelines say that credit card disputes will be solved through Online Dispute Resolution (ODR), there’s not too much guidance on how easy it may be for a customer or merchant to use. Some guidance could be drawn from this communication to UPI Members, and PhonePe’s recent enablement of an ODR platform for UPI. This also begs the question of whether customers would be dependent on private players for effective dispute resolution. 

The NPCI’s guidelines also talk about payment fees – UPI payments will be free for transaction values up to INR 2000, in favour of small merchants (merchants with an annual turnover of up to INR 20 lakhs). Transactions above this threshold will be chargeable at RuPay’s existing interchange rates. Additionally, acquiring banks will now need to share the wealth with the customer’s payment service provider bank and the third-party application provider, by reimbursing 8 basis points (0.08% of the transaction value) to each - this marks a key shift from the present UPI regime, with a guaranteed source of revenue for participants in the ecosystem. 

The guidelines also provide some insight into the potential role of application providers, aka, fintechs. Fintechs will also have their work cut out for them – enabling customers to check their balances and transaction history, allow repayments, and sending notifications during each event of the credit card lifecycle. This comes with a lot of opportunity for growth for fintechs, since the NPCI envisions that application providers can offer other value-added services such as EMI conversion, limit management, reward updates and redemptions. 

News coverage we liked on this topic: An article on the big question marks, in The CapTable

RBI brings offline aggregators into the fold 

At the end of September, the RBI announced that regulations governing Payment Aggregators would extend to offline Payment Aggregators as well. This measure aims to harmonize compliance and unify data collection and storage standards across the board. What this means is that entities which acquire merchants through physical card payment terminals or QR codes at points of sale, would also need to be authorized by the RBI to carry on business. While this may be a cautious regulatory move, what does it mean for barriers to entry in the payments business, and does it exclude smaller players? Another key question is whether the regulations will now extend to entities facilitating cash collections. We’ll need to monitor the industry response and further norms which the RBI may release. 

News coverage we liked on this topic: An article on the RBI’s approach to PA licenses, in The Morning Context.

SEBI cracks down on Brickworks Ratings 

On the 6th of October, SEBI ordered the Credit Ratings Agency (CRA) Brickworks Ratings (BWR) to shut shop within 6 months. This is quite a bold move for the regulator, which has not cracked down on any CRA in this way before. The grounds for the order were BWR’s failure to declare fresh ratings on companies despite having knowledge that the companies had defaulted on borrowings and other debt related obligations. This has opened the door to scrutiny on the incentives for CRAs to issue ratings and conduct due diligence for fees, reminding us of this scene from The Big Short – only time will tell if this leads to a re-think on the regulations governing CRAs and/or acts as a deterrent against flouting the rules. 

News coverage we liked on this topic: A super easy to understand explainer, on Finshots. 

• Stories from D91: D91 Labs released a great explainer on the impact of the ONDC on B2B e-commerce.

• Change in eSign norms: Execution for Regulated Entities (REs) got a whole lot easier, with MEiTY issuing a notification which allows electronic execution for Powers of Attorney and Cheques in favour of REs. This is likely to usher in the recognition of electronic execution as the norm in future when dealing with REs (NBFCs, banks, insurance brokers, capital market intermediaries, NPS, and so on). If you are an RE covered under this new notification, do check out Setu’s eSign product here! 

• Launch of Digital Banking Units: The Government of India announced the launch of 75 Digital Banking Units (DBUs). DBUs are like a physical bank branch and will offer traditional banking services – such as opening accounts, cash withdrawal and facilitating deposits. DBUs will operate as a hybrid physical and digital unit, with both a Self Service Zone and Digital Assistance Zone. Scheduled banks will also be allowed to set up DBUs without permission from the RBI. This has the potential to significantly improve financial inclusion in more remote areas and relieve public sector banks. 

• New regulation from RBI: The RBI issued Draft Master Directions on Information Technology Governance, Risk, Controls and Assurance Practices, which prescribe compliances to be implemented for IT Governance, IT infrastructure and service management, risk and information security, business continuity and disaster recovery management, and audits. This is an attempt to consolidate and update all IT related requirements into one unified regulation and applies to all REs. 

This wraps up the updates which caught our eye in October’ 22! Feel free to write to DM us on Twitter or LinkedIn, or fill out this form with feedback or topics to include in our November edition.