Modernising the Regulatory Framework for Digital Payments
The need for an inter-regulatory coordinated approach to encourage innovation in financial technologies
The ongoing pandemic has brought digital payments into sharp focus, as governments and citizens exercise abundant caution in limiting person-to-person contact. The need for resilient and scalable digital payment systems is underscored by the requirement to reduce reliance on cash exchanges and facilitate a smooth transfer of stimulus funds to beneficiaries.
This calls for a legal framework that can better facilitate the promotion of and greater reliance on new modes of digital payments to meet changing consumer demands. However, the existing framework under the Payment and Settlement Systems Act, 2007 (PSS Act) is not best equipped to leverage digital payments to meet such needs. This is for three reasons. First, while the PSS Act primarily focuses on regulatory oversight, it remains silent on critical issues such as consumer protection, promotion of competition, and innovation. These issues are sought to be addressed through a gamut of subordinate legislation, creating regulatory uncertainty. Second, the PSS Act fails to adopt a risk-based approach to the regulation of payment systems. By including all payment, clearing, settlement systems, and payment services within the definition of ‘payment systems’, the PSS Act does not account for the risk profile that may be associated with different kinds of digital payments. Third, while the Reserve Bank of India (RBI) has launched a regulatory sandbox to promote innovation in the digital payments space, amongst other things, it fails to provide an enabling framework to scale up digital payment solutions. The new normal of curtailed physical interaction with an emphasis on digital-first is likely to lead to greater demand for integrated or cross-sectoral financial products that combine a bouquet of services like payments, lending, insurance, etc. This calls for an inter-regulatory coordinated approach to encourage innovation in financial technologies and scale up existing solutions.
The regulatory framework for digital payments under the PSS Act must be re-designed, to allow it to adapt to new payment product and service offerings. This will require amending the PSS Act and enacting a new, modernised legislation built on a risk-based approach that distinguishes between payment services and clearing and settlement systems from a systemic perspective and imposes regulation in a proportionate manner. This will lower the barrier of entry for low-risk products and services, and allow regulatory resources to be focused on the most systemically important actors. Further, critical issues pertaining to obligations of payment service providers towards consumers, open access, and interoperability that is currently scattered across different sets of subordinate legislation should be addressed through such a statutory framework.
- Enact a separate legislation to streamline the governance of payment services in India (Proposed Law). The Proposed Law should be technology-neutral and must be based on payment activities rather than payment products. It must provide a clear, graded framework within which emerging products and services along the payments value chain can be nested.
- The Proposed Law must incorporate a risk-based framework, that distinguishes payment activities on the basis of the risk that they pose to the financial system.
- The enactment of the Proposed Law will also require an amendment to the existing PSS Act to carve out such services from the ambit of the PSS Act. The PSS Act will continue to regulate clearing and settlement systems. It may also be used to regulate systemically important payment systems as may be designated by the RBI.
- The Proposed Law must be supplemented with the enactment of a standalone legislation that creates a structured mechanism for inter-regulatory coordination between the financial sector regulators to test fintech innovations that fall under the purview of more than one regulator.