The Chinese have a saying, “Cross the river by feeling the stones." It is attributed to Deng Xiaoping and refers to moving ahead with reforms pragmatically and slowly. It is natural for regulators to take Deng’s teachings to heart, but it may be worth remembering that they do emphasize “crossing the river". In its recently notified regulatory framework for prepaid payment instruments (PPIs), however, the Reserve Bank of India (RBI) has simply chosen to admire the proverbial river from its banks. Coming on the back of much anticipation, the framework leaves much to be desired.
KYC mandate poses churn risk
The Master Directions mandate that every PPI has to be upgraded to at least minimum details-KYC (know your customer) before 31 December this year. They also require PPI issuers to offer users the option of opting into a PPI issued with full-KYC. This requirement is a risk to user churn and adoption as users may find the full-KYC compliance too onerous, with limited upside. The ability to “pre-register" a beneficiary to whom the user may transfer up to Rs1 lakh per month may have limited-use cases—especially given that users have competing media like National Electronic Funds Transfer (NEFT)/Immediate Payment Services (IMPS) linked to the bank account itself, providing the same service with significantly more functionality.
At the same time, the default minimum-details PPI has several restrictions in terms of loading, transactions and amount outstanding. A monthly cap of Rs10,000 for each means users may only use them for such use cases as utilities, telephone bills and so forth. PPIs may lose transactions to card networks and bank accounts.
Doesn’t move the cheese on interoperability
The Master Directions have also in principle enabled interoperability for PPIs issued as wallets subject to KYC. In theory, this enables a PPI holder with, say, Paytm to transfer funds to a holder of, say, Freecharge. This is meant to facilitate “inter-scheme" peer-to-peer (P2P) and peer-to-business (P2B) fund transfers between KYC-compliant instruments. But it remains to be seen how much traffic it generates. In the absence of countervailing incentives, PPI issuers may offer incentives to keep the money within the loop.
We will have to await operational guidelines to see if the National Payments Corporation of India permits the “issuing PPI" to charge an interchange fee to the “acquiring PPI". Interchange fees will promote both P2P and P2B traffic, but consistent with the chicken-and-egg nature of the payments as a business, may dissuade users from using these. Moreover, PPI issuers that are already sitting on significant merchant and consumer networks will be agnostic to interoperability.
The Directions express the intent that they will make PPI wallets interoperable with bank accounts, and, thereafter, between PPIs issued as cards. As and when it happens, the payments cheese will have moved, but as of now, it does not appear to have.
Disproportionate net worth requirements are a market access barrier
PPI issuers seeking authorization from the RBI under the Payment and Settlement Systems Act to have a minimum net worth of Rs5 crore. Furthermore, the regulation mandates that the PPI issuer shall have achieved Rs15 crore by the end of the third financial year. Both these covenants are plenary and removed from any adjusting metric like the total value of PPIs outstanding. As such, they operate as a regulatory market access barrier. Such threshold conditions potentially exclude many lean start-ups with innovation rather than size at the centre of their business plan, from entering the market. Moreover, it is unclear whether just size itself makes the payments sector robust. An industry with fewer operators may be more fragile than one with many operators.
A moderate approach may have been to adjust the capital requirements against the value of PPIs issued. By way of benchmark, the Financial Conduct Authority, UK, links capital requirements to average outstanding electronic money.
Need for competition in cross-border inward remittance
Finally, the Master Directions could have enabled non-bank payment service providers to facilitate cross-border inward remittance. But for the present, the RBI has merely permitted authorized banks and Indian agents licensed under the Money Transfer Service Scheme to issue PPIs to beneficiaries of inward remittance. This has restricted competition in the cross-border inward remittance space.
The RBI has not permitted remittances into the PPI wallet via the RBI rupee drawing arrangement (RDA). RDA guidelines allow bank-to-bank remittance facility—predominantly used by remitters in developed countries like the US and Canada to send money to the accounts of their relatives in India. Regulations permit up to Rs50,000 to be paid to beneficiaries in cash under the money transfer service scheme, whereas the RDA is mandatorily account-based. So, this omission begs a question.
Restriction on open PPIs for non-banks is a missed opportunity
Now that the Master Directions enable full-KYC PPIs, there is a case for enabling non-bank payment service providers to issue open-loop PPIs (enabling cash-out transactions) and enabling parity in other respects like cross-border outward transactions, subject to full-KYC mandate. This regulatory change can induce competition in the cards market. Furthermore, PPIs can innovate around this development by, say, providing credit cards secured against the balance in PPIs. Such products can help build credit history for first-time users and act as feeders for more mature credit products. But the Directions have shied away from “crossing this river".
A facilitative regulatory framework for the payments sector is a catalyst for achieving broader social objectives like financial inclusion. It is high time we initiated structural reforms that will promote competition in the payments space. The stakes are too high to miss out. The extant regulations appear to fall short of that benchmark.
Mandar Kagade and Janak Priyani are, respectively, consultant and research associate with the Indira Gandhi Institute of Development Research.
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