Imagine an economy where cash and plastic cards trail behind digital payments. This shift will not just impact India but the world too, as low-cost QR codes are increasingly becoming popular for payments compared with high-cost point of sale or POS terminals.
And it’s not just this; there are other transformative reforms at play here in the Rs 177-lakh crore financial services sector. The path-breaking Insolvency and Bankruptcy Code (IBC) is expected to be fine-tuned this year to ensure faster insolvency proceedings. Consider the significant release of funds this promises for banks, empowering them to reinvest those funds. There is also the new development financial institution (DFI), which is poised to infuse substantial funds in partnership with banks into the rapidly growing infrastructure sector.
The financial services industry is on the cusp of an exciting transformation. While great progress has been made, there are many pieces that are part of the government’s and the Reserve Bank of India’s (RBI) unfinished agenda that are still in the works.
Less Cash
The digital payments revolution is making a significant impact not just in India but globally. In just seven years, Unified Payments Interface (UPI)-based payments have managed to capture a 20% market share in retail payments. These payments allow for instant money transfers between bank accounts, and as a result, the popularity of NEFT and debit cards is on the wane. Anubrata Biswas, MD & CEO of Airtel Payments Bank, says India has emerged as a global leader in digital payments with a robust digital public infrastructure built over the past few years. “With increasing smartphone penetration, the deployment of high-speed internet in semi-urban and rural areas, and 5G coming into play, this growth is expected to accelerate further,” says Biswas. “Today, payments banks serve millions of underserved customers in remote rural areas of the country. If they are allowed to offer microloans digitally, it will bring millions of people into formal credit,” he adds.
But digital still has to contend with a formidable rival: cash. The currency in circulation (CIC) continues to be quite significant, surpassing 12% of GDP. This could be because of structural issues like limited financial literacy, a lack of smartphones, a fear of cybercrime, and inadequate payments infrastructure like ATMs, POS, etc. “To expedite the transition from cash to digital, India should concentrate on consolidating digital payment options, simplifying the myriad methods available to consumers. Moreover, fostering interoperability among various digital payment platforms, embracing open banking principles, and bolstering data security measures will fortify India’s journey towards a less cash-reliant economy,” says Vinod K. Singh, a tech expert.
Besides, on some parameters, there’s still a lot to be done. “Data indicates that 78% of Indians own a bank account, but importantly, this is almost the same as it was in 2017. Thus, 22% of adults still remain unbanked, and the only medium of transaction for them is cash,” says Indranil Pan, Chief Economist at YES Bank.
Pan says progress could be critically linked to reducing the proportion of low-income households. “With a majority of cash transactions occurring in rural and semi-urban areas, there is a pressing need for a targeted initiative aimed at improving digital literacy. This initiative should focus on raising awareness and understanding of digital payment methods,” says George John, Executive Vice President of IT and Operations at ESAF Bank. “Facilitating the shift towards a less cash-dependent economy involves providing incentives for businesses to adopt digital payment systems through streamlined processes. Collaboration among the government, banks, and fintech companies is pivotal for driving innovation within digital financial services to cater to diverse needs,” says John.
Fintech Watch
Over the past few years, fintech or financial technology firms have aggressively pushed innovations in the payments and lending space. In fact, the top three players in UPI transactions are non-bank entities: GooglePay, PhonePe, and Paytm. As a result, this space has attracted considerable attention from the RBI, as innovations have far outpaced the speed of regulation.
The RBI has proposed the establishment of a self-regulatory organisation (SRO) for the fintech sector to encourage innovation and protect customer interests. In January, the RBI issued draft guidelines for the SRO. Jatinder Handoo, CEO of the Digital Lenders Association of India (DLAI), terms this an innovation in financial services regulation. “It plays a crucial role in promoting market stability, client protection, and responsible market conduct. It doesn’t merely monitor regulatory compliance and share market intelligence with the regulator, but also represents the industry’s perspective and builds market infrastructure and capacity, which is important for the growth and stability of the industry,” says Handoo. The SRO is expected to be formed in the coming year.
Madhusudan Ekambaram, Co-founder and CEO of KreditBee, emphasises the importance of an SRO in curbing rogue lenders. “This collaborative approach aligns with the RBI’s goal of fostering a healthy and sustainable financial ecosystem, emphasising ethical conduct and transparency,” says Ekambaram.
But considering the diverse space, will there be multiple SROs? “Given the distinct nature of fintech activities, chiefly lending and payments, it is likely that there may be two separate activity-specific SROs,” says Handoo.
Digital Money
India is among the few large countries that have developed a central bank digital currency (CBDC). Last year, the RBI conducted trials for both wholesale and retail CBDC to assess aspects like technical architecture, design options, and potential use cases. The CBDC has features like offline transactions and programmability and facilitates cross-border transactions within existing systems. “We believe, as in the case of UPI, that we will witness a considerable amount of innovation in this tokenised form of money,” RBI Deputy Governor T. Rabi Sankar said recently.
The RBI has also tested interoperability between UPI payments and the CBDC. But one big question that it must address is anonymity at the transaction level, which people enjoy with cash, especially for small-value transactions. But in a digital world, any transaction will leave a trail. “This is one area where the RBI has to work with the government,” says a banker.
According to market experts, the RBI has four potential approaches to preserve anonymity in CBDC transactions. One option involves maintaining anonymity at the transaction level, with the stipulation that custodians or banks retain wallet-level information, particularly pertaining to CBDC balances. Another alternative is to terminate the transaction while allowing banks ample time to resolve disputes arising from failed transactions. In addition, a minimum threshold could be established, below which transactions would be exempt from the provisions of the Prevention of Money Laundering Act. Furthermore, a legal provision could be enacted to uphold the confidentiality of CBDC transactions entirely.
Like with UPI transactions, the adoption of CBDC could significantly reduce the reliance on physical cash, cutting the considerable costs associated with printing currency, transporting it from the RBI to banks, and storing it.
Rupee International
India is making concerted efforts to internationalise the rupee, increasing its usage and acceptance in cross-border trade, investment, and reserve holdings. This is to reduce reliance on foreign currencies and elevate India’s global economic standing. The RBI has facilitated this by enabling banks from close to two dozen countries—including Sri Lanka, Israel, Russia, Germany, Singapore, and the UK—to settle payments in rupees. More countries are expected to be added.
But wider adoption of the rupee trade is easier said than done. Anuj Agarwal, Chief Economist and Head of Research at TruBoard Partners, says the internationalisation of a currency is a complex and gradual process that requires concerted efforts on multiple fronts. “The current environment presents several favourable conditions for initiating this process. India’s position as the fastest-growing major economy, coupled with its strong diplomatic ties and focus on concluding trade pacts, creates a solid foundation for the rupee’s acceptance globally,” says Agarwal. “The US dollar has significantly gone down in terms of its importance as a reserve currency but still maintains its top position for international trade and investments. India’s share in world exports is still less than 2%, and hence the rupee is unlikely to [become] an international reserve currency soon,” believes Pan of YES Bank. For “true internationalisation”, Pan says India will have to significantly improve its share in global trade.
Fine-tuning the IBC
The new financial architecture that has been put in place is best encapsulated in the IBC, introduced in 2016 to streamline corporate insolvency proceedings and maximise value for creditors. Since its inception, over 7,000 defaulters have entered bankruptcy proceedings. According to available data, approximately 16% of the closed cases have resulted in successful resolutions. When combined with the 19% of cases where corporations voluntarily agreed to settlements, the share rises to 35%. But the record is not very satisfactory in terms of the amount recovered by banks. The Ministry of Corporate Affairs (MCA) is expected to review amendments to the IBC after the General Elections.
The amendments for cross-border insolvency, pre-packs for large corporates, and clarification regarding some judgements of the Supreme Court are expected. “These matters are the principal areas where amendments are expected,” says Shardul S. Shroff, Executive Chairman of law firm Shardul Amarchand Mangaldas & Co.
The government has periodically increased the number of judicial and technical members of the National Company Law Tribunal (NCLT), but there’s still a big capacity issue given the rising cases. There are many alternative ways to reduce the NCLT’s burden. Shroff suggests that the MCA and the Insolvency Law Committee (ILC) examine whether applications by creditors under Sections 7 to 9 can be determined through a checkbox qualification approach rather than a detailed oral hearing. “It is judicially recognised, even by Supreme Court judgements, that oral hearings are not a necessary part of complying with natural justice. Written arguments can be the basis for compliance with natural justice at the admission stage of an application under Sections 7 to 9 of the IBC,” says Shroff.
But just as the mechanism was progressing towards stability, a notable challenge emerged: the lack of a framework for group insolvency. Currently, the group insolvency process has been developing under the guidance of the courts. “Perhaps the time has come for laying down appropriate principles in this regard through legislative changes. The task now is to move forward through appropriate legal changes,” RBI Governor Shaktikanta Das said at a recent seminar.
A Successful DFI Model
A faster recovery of bad loans under IBC by banks would increase lendable resources, enabling their deployment to address the country’s infrastructure requirements. Given the substantial government capital expenditure post-Covid-19 to offset the decline in private capital expenditure and stimulate growth, both the private sector and banks find themselves well-positioned to actively contribute to the ongoing growth narrative. The government has also revisited the DFI model to support the infrastructure sector. After the earlier stint of DFIs—IDBI, ICICI, and IDFC—which are now commercial banks, the government is betting big on the National Bank for Financing Infrastructure and Development (NaBFID) to play a pivotal role in financing India’s infrastructure needs.
NaBFID, under K.V. Kamath’s chairmanship, is focussing on developing innovative financing models, forging partnerships with private sector players, and implementing effective risk management practices. It is well-stocked with capital for the next three years. In addition, there is a window available to raise Tier 1 and Tier 2 bonds in the form of debt to augment its capital base. In terms of leverage, NaBFID is allowed to borrow 10 times its equity capital. This means there is a window to mobilise Rs 2 lakh crore. The NaBFID Act also provides for equity dilution, which is yet another source to raise equity. This new DFI is also exploring a larger role in infrastructure, not just financing. The objective is to be a catalyst.
Clearly, India’s financial sector is on the brink of exciting transformations. While progress has been made, there is still some unfinished business.
@anandadhikari