The ability to create a simple, easy to use, and complete end to end digital customer journey has been a key reason for the growing adoption of digital payments. Initially, the know your customer checks that required physical verification of documents was a challenge for many digital payment platforms, but in early 2020, the RBI permitted Fintech players to utilise certain modes of digital and video KYC to on-board customers. Video-based customer verification methods have since been adopted by several bank and non-bank Fintech players which has made customer on-boarding easy and cost-effective.

A clear use case for digital payments

Covid-19 has brought into focus the benefits of digital payment products in a time when face to face contact has to be minimized. Another key strength of digital products is that they are capable of a much wider reach than financial products delivered via brick and mortar models. There are two key reasons for this: (i) Fintech platforms have much lower customer acquisition costs than banks and are able to service customer segments that do not have access to formal banking products; and (ii) Fintech platforms leverage their use of technology to develop targeted customer acquisition tools and customized solutions.

Regulatory changes: transforming the digital payment ecosystem

The RBI has historically adopted a fairly restrictive regulatory regime for non-bank Fintech payment solution providers. However, as the digital payments sector has matured, the RBI has become more comfortable giving non-bank players access to the payments, financial and digital infrastructure that banks are able to access. The ability of Fintech platforms to address financial inclusion in a way that banks have not been able to tackle has also become apparent. Consequently, the RBI recently (in April 2021), announced several changes that will completely revolutionize how Fintech payment players will operate. These measures have quite correctly been hailed to be “game changers” for the digital payments ecosystem.

The RBI has made four key changes:

1. Access to RTGS and NEFT: membership to the RBI-operated centralized payment systems (such as RTGS and NEFT) was not open to issuers of pre-paid wallets and other non-bank entities. Recognizing the critical role that wallet issuers and non-bank payment platforms play in enabling digital payments (in terms of volume, innovation and access), the RBI has allowed payment system operators to participate in centralized payment systems. The RBI has also been mindful of minimizing systemic risk, and by opening up access to non-bank players in the RTGS and NEFT infrastructure, the RBI also hopes to minimize such risk. This move has been a long-standing industry ask and will create a much greater level playing field between bank and non-bank payment operators.
2. Inter-operability: In 2017, the RBI had introduced a full inter-operability framework for wallets to be adopted on a voluntary basis by wallet issuers. However, the market did not move towards full inter-operability inter-se wallets. While transfers between bank accounts and a single wallet issuer is possible, transfer of funds from one wallet to another wallet (issued by separate issuers) was not operationalized. The RBI, in order to push usage and creation of a uniform payments infrastructure, has now made full-interoperability mandatory.
3. Increase of limits: To minimize financial risk, the RBI had limited the amount that could be loaded onto a wallet at INR 1 lakh. This limit has now been increased to INR 2 lakhs which is also the same as the limit applicable to payment bank accounts. This is a significant move and in many ways recognizes the quasi banking functionality of wallets and other non-bank digital payment products. Given that the know your customer checks for a wallet are on par with what is required to open a bank account, the equalizing of limits for both products is welcome and was most likely triggered by the important role that digital payment products play in the financial ecosystem outside of the formal banking sector.
4. Cash withdrawal: the RBI had always been categorical about restricting non-bank wallet issuers from allowing cash withdrawal facilities. Cash withdrawal has now been permitted for all non-bank issued full KYC wallets. This makes a pre-paid instrument such as a wallet akin in many respects to a small value savings account and allows pre-paid payment products to become the “single point” that solves for multiple financial needs of the customer (payments, access to inter-operable infrastructure, cash withdrawal and the ability to transact up to INR 2 laks).

Market reaction

Fintech platforms are able to effectively use technology, artificial intelligence and big data analytics to understand their customers and deliver tailor made customised financial solutions. Digital payment operators rely not only on financial data but also on data sets such as the digital footprint of a customer and online behavioral data to target customers and deliver products.

As non-bank payment players roll out several of the quasi-bank features now permitted by the RBI, the market can expect significant product innovation which will increase customer usage, enable much wider penetration of pre-paid instruments and push the growth of digital payments.

A question that is being asked is how banks will react to these measures that remove a lot of the competitive advantage that banks have historically had. However, Fintech players tend to service several customer segments that banks find too expensive to tap into in the ordinary course. The market has, consequently, shifted to more collaborative model, with banks and non-bank entities partnering in several dimensions, each leveraging their respective strengths to provide customers easy-to-use financial products. Non-banks have the ability to leverage technology more effectively while banks have strong balance sheets. There are several partnerships in the payments space where banks have partnered with technology platforms to manage the customer and product interface for both pre-paid and UPI-enabled payment solutions.

Strengthening digital payments infrastructure

The RBI, with the intent of strengthening the digital payments infrastructure and also lowering systemic risk, had (in August 18, 2020) released a framework for the authorisation of a new pan-India umbrella entity focusing on retail payment systems, such as setting up automated teller machines and white labelled points of sale; developing clearance and settlement systems for participating Fintech players; undertaking systemic risk management; and ensuring competitive and efficient functioning of the payments space. The market expectation is the RBI will issue licenses to possibly 2-3 pan India umbrella payment entities. The new pan-India umbrella payment entities are likely to bring about innovation in digital payments infrastructure and products which will usher in the next big change in digital payments.

Financial access and inclusion

Given that digital products are capable of a much wider reach than the traditional financial products delivered via physical delivery channels, many more people can easily access Fintech products. Consumers only need a smart phone, and good mobile connectivity to be able to transact and access digital financial products.

Several Fintech players are now looking at Tier II, Tier II cities, and more remote locations as focus areas for their digital payment products. Digital and financial literacy will be critical to roll out this next phase of digitisation of payments in remote and unbanked areas. Investment in digital payments infrastructure particularly on last-mile delivery and on expanding internet connectivity in Tier II and Tier III cities will be crucial.

Digital payment products have become the first point of contact for many consumers to access a much wider set of financial products – credit products, small value loans, insurance and investment products. Wider penetration of digital payments therefore means not only digitization of payments but also increase in access to the formal financial sector for several sections of consumers.

The recent changes rolled out by the RBI has allowed Fintech platforms to offer quasi-banking facilities and meet a much wider set of financial needs of consumers. There is a clear recognition among market players, regulators and consumers that Fintech plays a critical role in the Indian financial services sector and has the ability to effectively meet the goals of financial inclusion and access.

This article was originally published in The Times of India on 13 July 2021 Written by: Shilpa Mankar Ahluwalia, Partner. Click here for original article

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