Laissez-faire no more: On RBI’s cross-border payments regulations, compliance and the way forward
Compliance is costly, but fraud is costlier
Hi,
In the ever-evolving landscape of India's digital payments sector, the Reserve Bank of India (RBI) has issued a resounding call for change through its latest Payment Aggregator-Cross Border (PA-CB) guidelines.
Light-touch regulations are no longer the norm; a fully licensed regime is on the horizon.
Under these new regulations, the RBI is set to intensify its scrutiny and direct oversight of players in the digital payments realm. The objective is to bring harmonization to payment regulations, affecting both domestic Payment Aggregators (PAs) and PA-CBs. However, this heightened oversight comes with a price tag, significantly increasing compliance costs for these entities.
Notably, even global heavyweights like PayPal found their plea for lighter regulations during a July Delhi High Courthearing losing ground in the face of the RBI's stringent approach. This shift means that all significant players will now be subject to regulatory scrutiny, with speculation that future regulation may extend to UPI service providers such as PhonePe and Google Pay. Previously, payment accounts for these entities were managed by sponsor banks or authorized dealers (ADs), but now they face the prospect of operating as full-stack payment systems, without the protective shield of an AD bank.
These guidelines, originally known as Online Payment Gateway Service Providers (OPGSP) for import-export payments, have been in existence for over a decade. In 2022, draft suggestions emerged to classify these entities as Online Export Import Facilitators (OEIF), eventually leading to their regulation as PA-CBs. While this move towards regulatory clarity may present challenges for some, it is also expected to attract more venture funding, particularly as new-generation companies explore India's burgeoning import and export sector.
The RBI's new rules have provided much-needed clarity by addressing various regulatory gray areas. They encompass maintaining an escrow account, reporting requirements, and permissible transactions, offering certainty to entities in this domain. Notable changes include aligning Know-Your-Customer (KYC) of merchants with anti-money laundering rules, akin to bank-level KYC.
Additionally, the contentious issue of Financial Intelligence Unit (FIU) reporting has been resolved, with the RBI mandating that all non-bank PA-CBs register with the FIU-IND.
Compliance is costly, fraud is costlier
While regulatory clarity brings benefits, it also ushers in heightened scrutiny and a burden of increased compliance costs, particularly impacting fintechs operating on thin margins.
The hurdles are twofold. First, securing a Payment Aggregator license is no small feat, with numerous firms awaiting final approval despite obtaining principal approval from the RBI. Even well-established PAs must now seek explicit RBI permission to continue cross-border transactions, incurring substantial compliance costs.
Second, cross-border payments inherently come with added complexity compared to domestic transactions. They face challenges like compliance with anti-money laundering and counter-terrorism financing regulations. Given the size of financial crime compliance makes it even more complicated -
In fact, an RTI response from a news organization revealed that Indian banks lost Rs 4.7 lakh crores between 2014 and 2023 due to fraud.
A 2022 survey by LexisNexis Risk Solutions unveiled that the average spend for each financial institution in India is approximately 95 crores. This substantial investment reflects the scale of Indian banks' operations, serving a vast clientele and managing high transaction volumes. The evolving financial landscape in India has shifted the focus from Know Your Customer (KYC) to encompass customer due diligence (CDD) and enhanced due diligence (EDD), alongside addressing cybercrime and stolen identities.
How can compliance challenges be mitigated?
The growth in cross-border payments is projected to be substantial, especially in the B2B sector, with estimates ranging from US$30 to 40 trillion for 2021/2022. For large businesses, the costs of cross-border payments may be offset by the transaction value, but the time required for these payments to be completed remains a significant concern. For consumers, both time and cost are crucial, especially for foreign workers sending remittances overseas.
Cross-border payment costs, as a percentage of transaction value, vary by sector (B2B, C2B, B2C, C2C). Additionally, cross-border payments can take several days and cost up to ten times more than domestic payments. SWIFT data indicates an average payment processing time of 8 hours and 36 minutes, with significant variations based on payment routes. Payments can spend more time at the beneficiary leg than in-flight due to currency controls and regulatory requirements.
Central Bank Digital Currencies (CBDCs) have gained attention as a potential solution for cross-border payments. Many central banks are exploring or actively developing digital versions of their fiat currencies. CBDCs have shown promise in reducing costs and improving speed. A recent pilot project called "mBridge" involved 20 banks from China, Hong Kong, Thailand, and the UAE using CBDCs for real-time cross-border payments.
Anti-money laundering (AML), counter-terrorism financing (CTF), and sanctions compliance remain significant challenges in cross-border payments. Existing sanctions screening processes are inefficient and generate friction due to the multitude of names to check and a high rate of false positives. An innovative approach called the Global Sanctions Screening (GSS) platform, endorsed by over 40 banks, seeks to improve sanctions screening by automating alert generation, disposition processes, and information sharing.
Financial compliance in India is a multifaceted challenge influenced by the scale of operations, changing demographics, and the rise of digital payments. While the average cost of compliance is substantial, it aligns with India's complex financial landscape. To minimise costs, institutions should prioritise people, processes, and technology.
Regulatory bodies like the RBI play a crucial role in safeguarding the economy from the ever-evolving nature of financial fraud. As India continues to be a pioneer in setting global compliance standards, the nation's journey toward comprehensive financial crime compliance remains dynamic and evolving
That’s all from me this week!
Cheers,
Rajat