FINTECH

Introduction

Rapid development in mobile communication technology has led to growth in the field of Fintech. Financial technology or fintech refers to technology based innovations which compete with traditional financial methods for the delivery of financial services.

Rise of Fintech in India

In order to curb black money and counterfeit notes, the Prime Minister of India Mr. Narendra Modi announced demonetization in 2016. This rendered the previous notes worthless the same midnight. What followed was widespread chaos and ATMs being dried up. Consequently, people were forced to adopt digital payment methods to pay of their essentials. The use of Debit Card grew a little more than 80% at Point of Sales. NEFT transactions among the businesses too saw a growth of around 80% along with five-fold increase in IMPS transactions.

Furthermore, the advent of Jio also added millions of new mobile users since its launch. It offered free mobile services initially, which resulted in access to modern technology to poor sections of the society. As their target market is the poor sections of the society, they continue to offer cheap mobile plans. As a result, these people embraced digital banking technologies and have incorporated these technologies in their life.

Regulatory Framework

Reserve Bank of India (RBI) is a body that is responsible for controlling the fintech in India. It is responsible for making rules and regulations governing the financial system under the Acts passed by the Parliament of India. The Payment and Settlement Systems Act, 2007 (PSSA) is a mother law governing the payment, settlements and transactions system in India. After that RBI has made several rules, regulations and master directions under this act which regulates the FinTech in India.

Entities desiring to operate a payment system in India have to register themselves as a “System Participant” with RBI. Only RBI has the supreme authority to authorize the settlement system.

A “payment system” has been defined as “a system that enables payment to be effected between a payer and a beneficiary, involving clearing, payment or settlement service or all of them”.

Transactions affected on stock exchanges are excluded under the purview of this Act. Payment Gateways, smart cards or prepaid cards, P2P digital lending, prepaid wallets etc. come under this system. The Department of Payment Systems has been established to give effect to the provisions of this Act.

Regulation on Prepaid Payments Instruments

RBI in 2017 issued Master Directions, Reserve Bank of India (Issuance and Operation of Prepaid Payment Instruments) Directions, 2017 (Master Direction), concerned with Prepaid Payments Instruments (PPI).

PPI are financial instruments that enables the purchase of goods and services against the value stored in such instruments, example such as digital wallets and prepaid smart cards

Classes of PPIs

The act divides PPIs into three classes: –

Closed System PPIs –

These PPIs facilitate the purchase of goods and services within the entities only and they do not allow cash withdrawal. These do not require approval from the RBI. For example: – Swiggy Wallet.

Semi-Closed System –

This PPI facilitate the purchase of goods and services at a clearly identified merchant establishment under the approval of the wallet issuer. These also do not support cash withdrawal. For example: – Paytm Wallet.

Open System PPI –

Only banks can issue PPIs used for the purchase of goods and services. Unlike other classes, they allow cash withdrawal. For example: – Forex Card.

Eligibility for issuance of PPI

The following are the eligibility requirements to carry on the business of PPI issuance: –

• Non-Banks shall be the companies incorporated under the Companies Act, 2013.
• Non-bank entities having the FDI shall meet the FDI capital requirements as prescribed by the government.
• Memorandum of Association of the company shall cover proposed activity of the company as a PPI issuer.
• Entities shall have the approval from RBI.
• Non-bank entities shall maintain the positive minimum net worth as prescribed by the master direction.
• Entities shall comply with the provisions of Prevention of Money Laundering Act, 2002 and rules framed under it.

The Act also governs several other areas of the fintech framework in the country. These include the authorization process, wallet reloading and maintenance procedure. It also deals with the infrastructure and security measures relating to the business of PPI. Further, it also provides the mechanisms for dispute resolution and settlement etc.

Peer to Peer Lending

Peer to Peer (P2P) is one of the emerging methods for financing one’s capital financing requirements. This is a form of crowd funding model. Here a borrower is matched with lender(s) willing to lend to invest their money. This whole process takes place over a digital platform. In addition, the platform conducts through due diligence of the parties involved and prepares their risk profile. The platform is also responsible for facilitation of settlement of disputes. The interest rate are either fixed by the platform, or can be mutually agreed upon by the parties.

P2P lending has allowed the individuals, who have been rejected by the banks, to have access to conventional sources of fund. RBI has issued Master Directions – Non-Banking Financial Company – Peer to Peer Lending Platform (Reserve Bank) Directions, 2017 for controlling these platforms.

Master Directions for Peer to Peer lending

Salient features of the Master Directions are: –

1. Registration: –
   1. Non-banking entity should be a company.
   2. No entity should engage in this business without obtaining the Certificate of Registration from the RBI.
   3. Entities shall have net worth equal to or more than twenty million Rupees.
   4. The company should be incorporated in India. It shall have adequate capital structure, shall implement robust secure and technological system, and shall have a viable business plan. The purpose of the company or the management should not be prejudicial to the public interest.
   5. The promoters and directors of the company should be fit and proper.
2. Scope: – It is also prescribed that the platform should not engage in raising the deposits, lending its own money, provide credit guarantee, not permit international flow of money and cross sell any product.
3. Prudential Norms: – The platform shall maintain a leverage ratio not exceeding 2. Furthermore, this direction has put a cap on aggregate exposure of the lender to the tune of Rupees fifty thousand and the maturity of loans shall not exceed 36 months.

This act further provides for the operational guidelines, fund transfer mechanism, transparency and fair disclosures requirements, grievances redressal and fair practices code. Since, it is a relatively new concept, the rules regulating this lending model are slowly catching up.

Blockchain and Cryptocurrencies

The first cryptocurrency ‘Bitcoin’ was created in 2009. An anonymous person who goes by the name Satoshi Nakamoto created bitcoin. Bitcoin was designed as a digital asset. Its purpose is to be a medium of exchange as an alternative to the real-world money. A distributed ledger keeps the record of coin ownership. Cryptography secures each of these ledgers. Hence, it is nearly impossible to manipulate or cheat the system. Moreover, each transaction or ownership of coin has to be authenticated by various “ledger operators” or node and requires no central authority.

This system of distributed ledger is called blockchain. Bitcoin is one of the applications of blockchain Technology. In addition, other cryptocurrencies gaining prominence are Ethereum, cardano, iota etc. and have used modified form of blockchain technology. Financial Industry has embraced this technology and have even incorporated this technology in their infrastructure.

The cryptocurrency transactions are fully anonymous in nature and do not require KYC (Know Your Customer/Client). As a result, it is cumbersome for the tax authorities to track individual transactions. Consequently, this has created apprehensions of encouraging and boosting money laundering, terror financing and other criminal activities.

Regulation of Cryptocurrencies

Around the world, the government in various jurisdiction are trying to understand the implications of cryptocurrencies. Currently, the cryptocurrencies are not regulated in India. That said, cryptocurrencies are not legal tender in India. The present government is intensely interested in blockchain technology but have vehemently refused the trading of cryptocurrencies.  RBI in 2018 had issued a circular which prohibited trading in cryptocurrencies. It cut-off access to the banks for the cryptocurrency traders or the exchanges. However, the Honorable Supreme Court struck down this circular in March 2020.

A bill titled ‘Banning of Cryptocurrency and Regulation of Official Digital Currency Bill, 2019’ has been in introduced in a parliamentary committee which purports to ban the cryptocurrency trading in India. Also, the Indian Government has proposed to levy 18% GST (Goods and Services Tax) on cryptocurrency trading and trading would be considered as supply of goods. Right now, the future of cryptocurrencies stands in grey area.

Sandbox

Sandbox is a closed environment that allows safe experimentation of new products and services. RBI through circular dated August 2019 allowed Regulatory Sandbox. As a result, companies or start-ups can live test their products in a controlled relaxed regulatory environment for the limited purpose of testing of the products. Moreover, this allows the regulators to collect empirical evidence on the viability and risks of the new technology.

Not all products are allowed experimentation in this sandbox. For instance, if the proposed financial service is similar to the one already in public, RBI may not allow sandbox testing. The applicant needs to show that entirely different technology is being applied. Alternatively, if the same technology is being applied in more efficient manner, the entity may be allowed entry in this program. This allows RBI to make efficient rules and regulations where there is absence of them.

RBI has set up minimum criteria that must be met before being permitted in this program. Some of these criteria are: –

• The entity should be a company incorporated in India or a bank registered with RBI.
• Entity shall have minimum net worth of Rs. 25 Lakhs as per the latest audited Balance Sheet.
• Promoters and directors of the company should be fit and proper and shall have good credit history.
• Entity shall comply with existing regulations on consumer protection and data security.
• Shall have robust and secure IT infrastructure.
• Test scenario, expected outcomes and KPIs shall also be clearly defined.

Furthermore, entities shall satisfy that there is a gap in the market and how the proposed product helps to seal the gap.

CONCLUSION

These are some of the regulations that are relevant to the Fintech environment in India. However, this is not an exhaustive list as this is an emerging field and new technologies may emerge tomorrow. Consequently, new regulations will come up to control them.

About The Author

Ajay Birbal is a practicing legal consultant in Delhi, India. His areas of advisory include Technology, Commercial Law and Mediation.

He is passionate about technology and emerging developments in science.