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Why new-age fintechs fear death by a thousand circulars

Since October 2017, the RBI has issued multiple circulars and reports that stumped India’s mushrooming fintech industry. (Photo: iStock)Premium
Since October 2017, the RBI has issued multiple circulars and reports that stumped India’s mushrooming fintech industry. (Photo: iStock)

  • New-age fintechs fear death by a thousand circulars even as RBI seeks to protect the consumer
  • Hundreds of fintech companies say they find themselves in the grip of new regulation, one that is forcing them to pivot, slow down, and in the worst case, shut down the business entirely

NEW DELHI : In October 2020, LotusPay, a young Bengaluru-based startup, moved court challenging the Reserve Bank of India’s (RBI) payment aggregator (PA) and payment gateway guidelines, which permitted only firms approved by the central bank to operate.

Payment aggregators receive, process, pool and transfer user payments to merchants. All companies applying for a PA licence from the RBI are mandated to have a minimum net-worth of 15 crore.

The startup said it didn’t apply for a PA licence as it “could never have met the net worth" criteria. In its plea, the payment gateway company asserted that the RBI’s requirements were arbitrary and violated Article 14 and Article 19 (1) (g), which guarantees the ‘freedom to trade’. The company argued that it would have to shut down because of the RBI policy.

The court has reserved judgment in the matter.

Then, there is IppoPay, a company providing payment infrastructure to small businesses. It had onboarded one lakh merchants in quick time since it started. However, the company’s PA application has been returned recently.

“We are a two-year old startup. When the RBI came up with the net-worth requirement (the guidelines were first circulated on 17 March 2020), we were a six-month-old startup. We got the tech right; we did everything by the book on compliance like following know your customer (KYC) norms. But, as a young startup, we were unable to get to 15 crore net-worth then," says Mohan Karuppiah, co-founder of the Chennai-based company.

The company, he stresses, is very well capitalized now with several banks working with it.

“We are part of the country’s digital inclusion story since we provide payment infrastructure to offline merchants in rural and semi-urban India. As an Indian entity, the RBI should encourage and give opportunity to home-grown fintech," Karuppiah adds.

LotusPay and IppoPay are not the only small players to run afoul of India’s banking regulator. Hundreds of fintech companies say they find themselves in the grip of new regulation, one that is forcing them to pivot, slow down, and, in the worst case, shut down the business entirely.

Since October 2017, the RBI has issued multiple circulars and reports that stumped India’s mushrooming fintech industry. Besides payment aggregator startups, the wide-ranging directions have thus far impacted cryptocurrency exchanges, paper meal voucher companies, wallet firms, and fintechs providing application programming interface (API) infrastructure, among others. Many lending platforms are on the edge, too, after the central bank published a report on digital lending in November last year—one recommendation is to prevent loan origination by unregulated entities and reign in first-loss default guarantee (FLDG), an arrangement where a fintech compensates the lender if the borrower defaults.

While the startups view these as “knee-jerk circulars", the central bank has solid reasons why it wants fintechs regulated. Surely, an industry that deals in money can’t be the Wild West. Any regulator’s job is to protect the consumer. The RBI, therefore, is worried about data privacy, cyber security and unethical behaviour. There are also concerns around compliance with anti-money laundering policies.

More of this later. First, let’s take a look at the many circulars and why they inflicted pain. The RBI did not respond to detailed clarifications sought by Mint.

The circulars

2016 and 2017 were the heady years for wallet companies. As these companies—the likes of Paytm and MobiKwik—made a mad rush to acquire more and more customers, the central bank stepped in.

In October 2017, the RBI asked wallet players to make sure that the Prepaid Payment Instruments (PPIs) issued by them were updated to meet full KYC norms by 28 February 2018. PPIs facilitate purchase of goods and services against the value stored therein, popularly called wallets.

In 2018, the regulator refused to extend the deadline for mandatory KYC compliance. That was a time when 90% of the wallets were non-KYC-compliant.

“Post that, even players with a higher net-worth struggled to stay afloat. Many PPIs remained dormant, and many licences got cancelled, revoked or were surrendered," a senior payment industry official, who didn’t want to be identified, said.

This was also a time when large banks became fearful of the disruption caused by fintech startups. The media widely wrote about how established banks would lose sight of the small transactions data—a space wallet companies had begun to dominate.

A second executive who didn’t want to be identified recollected that the State Bank of India was highly uncomfortable with fintech players in the business of money transfer. Migrant workers, for instance, send money back to their villages. Fintechs such as Oxigen, Eko and Itzcash facilitated such transfers through the PPI.

The RBI’s KYC guidelines impacted these businesses big time.

“The RBI made it compulsory for those in the money transfer business to have full KYC. Big banks were highly uncomfortable because their market share kept reducing due to competition from fintechs. So, at some stage, this circular created an arbitrage," the executive mentioned above, says.

The PPI continues to be a powerful tool today and nearly all fintech companies want the licence. Over the last one year, several dormant PPI holders have been acquired.

The central bank, reportedly, isn’t comfortable. On 4 July this year, it stated that any takeover of a non-bank payment system operator would require its approval from now on.

“Earlier, the RBI simply required prior ‘intimation’. Now, with Chinese money being routed through venture capitalists for acquisitions, the RBI seems to have woken up and wants to nip such acquisitions in the bud," says a fintech industry advisor.

Meanwhile, the industry is still reeling from the after-shocks of another ban—on 22 June, the RBI said that PPIs must not be loaded through credit lines from non-bank lenders. Using credit lines to top up prepaid cards was becoming a popular way among fintechs to operate in the Buy Now, Pay Later (BNPL) segment. The RBI didn’t want the PPI to be  used  as  a credit instrument. Also, there are concerns about some fintechs aggressively extending unsecured lines of credit, increasing the risk in the financial system. This circular spelt trouble for companies such as Slice, Uni, LazyPay, PostPe, MobiKwik, Ola Postpaid, and EarlySalary.

The founder of a non-banking financial company believes the worse is yet to come. “The RBI is expected to come up with digital lending guidelines in a few days and the biggest concern of the industry is that FLDG might be banned," he says.

That could impact nearly all fintech lending platforms.

RBI’s worries

In 2015, India’s largest e-commerce venture Flipkart acquired a majority stake in payment services startup FX Mart Pvt Ltd. The company provided electronic payments, remittance and foreign exchange. And it already had a licence for prepaid instruments. Back then, the deal was viewed as a move by Flipkart to offer its own digital wallet as a payment option.

According to the CEO of a fintech firm, the RBI came to know about the deal only from the newspapers. Prior intimation for acquiring a PPI entity was not mandatory yet, so no rules were flouted. But some executives at the central bank were still upset about the fact that there was no “courtesy intimation", the CEO informs.

All acquisitions of PPI entities now require not just prior intimation but also prior approval from the RBI. While industry insiders point to the Flipkart deal of 2015 as the trigger, the reasons why the central bank wants oversight of fintech companies go much deeper. Like we mentioned earlier, the RBI wants to protect consumers, avoid risks to the banking system, and also protect the banks.

In its monthly bulletin for the month of June 2022, the RBI acknowledged the growth of fintech and its benefits. However, it also issued a word of caution. “The advent of fintech has exposed the banking system to new risks which extend beyond prudential issues and often intersect with other public policy objectives relating to safeguarding of data privacy, cyber security, consumer protection, competition and compliance with AML policies (anti-money laundering)," the RBI stated.

“Complex intertwined operational linkages between Big Tech firms and financial institutions could lead to concentration and contagion risks and issues relating to potential anti-competitive behaviour," it added.

In a discussion paper issued in November 2021 on digital lending, the central bank stated that the digital lenders aggressively market, nudge and even hand-hold consumers to avail loans but are lacking in their efforts to provide grievance redressal. “This is not only a violation of extant guidelines and consumer rights, but also endangers the adoption, acceptability and trustworthiness of digital lending amongst the masses in the long run," the RBI said.

“The RBI frustrates me because they don’t consult enough; it frustrates me because they don’t move fast enough. But I won’t say that the RBI is not progressive. Directionally, they are one entity, after the Supreme Court, that puts the consumer first," the CEO quoted above says. “You can argue about the user experience getting hampered with tokenization and two-factor authorizations, but it helps the consumer," he adds.

The central bank wants to ensure that consumers are protected from fraud. It, therefore, came up with the concept of ‘tokenization’—a process of replacing actual card details with a unique alternate code called the token. Merchants and payment aggregators have to delete card details and replace it with tokens by 30 September this year.

Meanwhile, the regulator is also aware of the valuation game at play in the startup world.

“Many venture capitalists have no idea how their money is used. Some fintechs take advantage of that and operate in totally grey areas. And these fintechs are playing on the RBI’s delay (in acting) to extract as much value as they can," a top fintech executive, who interacts frequently with the RBI, says.

PPIs, for instance, are a payment instrument. But companies used it as a credit instrument to offer lending products—a grey area the RBI plugged with the June circular.

Why the delay?

So, why does the RBI wake up so late? Can regulation be proactive rather than reactive?

Officials who have worked closely with the regulator say that the RBI has always followed a wait-and-watch philosophy. They don’t act fast because they want to identify the good actors, says the fintech CEO quoted earlier.

Others aren’t that sure.

Shinjini Kumar, co-founder of Salt App and the former CEO of Paytm Payments Bank, says the RBI only looks at big problems. “The regulatory thing is like grass growing. As long as you attain the same height (as the rest of the grass), you are not visible. The moment you become taller than the others, the attention is on you, and you might get cut," she says.

The RBI’s functioning, meanwhile, is a mystery to the startups. Fintech founders say that the central bank doesn’t seek any advice or feedback, mostly relying on its own opinion based on research its officials conduct. If true, this approach needs to change.

“Is the regulator engaging with the right influencers from the fintech ecosystem and is there proper representation to work jointly on what should be the expectations? Or, does it come after the investment (in a startup) is already done and the consumer base has reached a good number?" asks Pratekk Agarwaal, the former chief business officer at BharatPe. He advises fintechs.

There are subtle signs that the RBI may be moving towards a more collaborative approach. The hint is in its June bulletin.

“Regulators and supervisors face a challenging balancing act between innovation-friendliness and managing risks to financial stability, which requires more engagement of stakeholders such as regulators, the fintech industry, and the academia to work towards common principles for management of fintech activities…," the central bank stated.

Those are reassuring words for startups that feel somewhat suffocated today.

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