Regulating buy-now-pay-later Fintechs

Back to Asia Pacific Regional Forum publications

Akshay Bhargav
Khaitan & Co, Mumbai
akshay.bhargav@khaitanco.com

Kaushalya Shetty
Khaitan & Co, Mumbai
kaushalya.shetty@khaitanco.com

Vaishali Nayar
Khaitan & Co, Mumbai
vaishali.nayar@khaitanco.com
 

Introduction

In today’s fast-paced retail environment, we are spoilt for choice with online business platforms trying to offer a plethora of services to ensure they retain their customers and achieve optimum customer acquisition. New ways are being invented to expedite online checkout – all with the objective of reducing the steps involved in, and the time spent on, transaction settlements. Faster checkouts ensure customer convenience and consequently, customer retention. Digital wallets have become popular,, but they are only convenient if they are preloaded. And, the extra ‘know-your-customer’ checks, introduced by a Reserve Bank of India (RBI) directive dated 11 October 2017, has only added to the processes which customers must undergo.

Enter the ‘buy now, pay later’ (BNPL) feature, one of the latest additions to the variety of payment/settlement mechanisms made available by financial technology companies (Fintechs). BNPL attempts to mimic the ease that credit cards once offered in the absence of the two-step verification, made mandatory in India in 2009. It also plays on the gap in the market in access to credit currently faced by a large proportion of India’s population.

The feature largely gained traction in 2018 and essentially allows consumers to complete purchases or orders while allowing them to pay at a later, more convenient time. Of course, to implement this, small short-term credit has to be extended to consumers, which essentially brings us to the regulations involved in governing Fintechs offering such services; or rather, their lack of clarity.

Frequent questions arise as to:

• whether companies offering such features would be treated as non-banking financial companies (NBFCs);
• whether separate authorisations under the Payment and Settlement Systems Act 2007 (Payments Act) are necessary; and
• considering that many of these Fintechs are start-ups, whether there would be any difficulty in receiving foreign direct investments (FDI).

Is an NBFC registration necessary?

The Reserve Bank of India Act, 1934 broadly defines NBFCs to include a company which carries on as its business or part of its business financing, whether by way of making loans or advances or otherwise, of any activity other than its own. It would therefore appear that the activity of extending short-term loans would require Fintechs offering BNPL services to be registered as NBFCs. However, to alleviate the need for such a registration, BNPL service providers typically partner with NBFCs. These partner NBFCs extend credit to consumers and settle transactions with the merchants or sellers in separate cycles.

If, on the other hand, a Fintech is underwriting any bad-debt risk or financing the debt owed by the consumer through any mechanism, then it may qualify as having undertaken NBFC activities. This may in turn, trigger the need for appropriate registration with the RBI. In the absence of any such financial activity, a Fintech should be seen as a ‘pure play’ service provider, only focusing on a particular product or activity. Having said that, this must be reviewed on a case-by-case basis.

Treatment under the Payments Act

The Payments Act governs payments systems which enable payment between a payer and a beneficiary, including systems enabling credit card and similar operations. The operators of such systems require RBI approval prior for commencing any operations.

Unlike payment system operators, payment aggregators typically bring together various payment gateways, digital wallets, etc, and offer technology that: provides consumers with a single interface consisting of various methods of payment; and facilitates merchants with the acceptance of such payments. As such, they end up operating with other entities that have either been authorised by the RBI as payment systems or pre-paid payment instruments operators and therefore, do not require to be authorised separately – assuming such services are not offered in-house. They are, however, considered as intermediaries under the 2009 RBI directives (Intermediary Directives) and are therefore required to maintain nodal accounts to accept and process digital payments made by consumers to the merchants.

It may be safe to say that the Payments Act did not originally envisage services such as BNPL. In its essence, the BNPL feature is akin to what a credit card is expected to offer – a method of transaction allowing consumers to purchase goods or place orders, without having to pay for it immediately. Considering the similarities, and the fact that credit cards or similar operations require RBI authorisation, the question arising is whether entities offering such services should be registered as payment systems operators under the Payments Act.

Again, since a BNPL feature relies heavily on a financial partner registered as an NBFC for payments and settlements, Fintech entities offering BNPL do not obtain authorisation. These are viewed as entities providing tech-enabled services. The absence of many well-known Fintechs that solely offer the BNPL service from the list of authorised ‘payment system operators’ released by the RBI, dated 5 November 2019 appears to suggest that this a sector-wide view. However, there are differing views, albeit in the minority, to suggest that Fintech entities only offering BNPL services may be classified as intermediaries under the Intermediary Directives if they are seen as providing a platform for facilitating digital payments ie, collecting monies received from customers for payment to merchants using any electronic or online payment method, akin to payment gateways and payment aggregators.

While on the subject, the RBI recently released a discussion paper on regulating payment gateways and payment aggregators. Citing the activities of the payment gateways and payment aggregators as being extremely crucial, the RBI is, according to the discussion paper, evaluating the following approaches for such entities:

• continuing with the existing framework;

• introducing limited regulations covering minimum net-worth, merchant on-boarding, timelines for settlement of funds, IT security etc; or

• requiring such entities to be authorised under the Payments Act and subject them to full and direct regulations covering capital requirements, governance, safeguards against money laundering, etc.

The deadline for submitting comments on the paper was October 2019. It remains to be seen how things pan out and whether the BNPL service providers will be distinguished from payment gateways and payment aggregators.

Eligibility for Foreign Direct Investment

The current policy on foreign direct investment (FDI) policy allows foreign investment in ‘other financial services’. Regulated activities are eligible for foreign investment up to 100 per cent of the share capital under the automatic route and unregulated activities are permitted up to 100 per cent with the prior approval of the government ie, under the approval route.

Given the close association of Fintechs with financial services, it is often speculated whether such entities will be classified as those engaged in financial services or as IT/ITES companies, which are eligible for foreign investment up to 100 per cent of the share capital under the automatic route. It would be safe to say that as these companies are technology providers and enablers, their close association with the financial services sector should not obscure this. However, this will have to be determined on a case-by-case basis after taking into account all activities undertaken by such companies.

In the extreme scenario that Fintechs are considered as companies providing financial services, the absence of any specific registration or licences from the concerned financial sector regulator (in this case, the RBI) may lead to these entities being considered as operating in an unregulated space. This could be disturbing if a company is positioning itself to receive foreign investments in the future. Apart from prior approval of government, the minimum capitalisation requirements mandated in April 2018 by the Ministry of Finance may also have to be taken into account.

Conclusion

In the recent years, India’s government has been making a huge push for digital transactions. And with online transactions increasing exponentially, Fintech innovation is welcome. But it is equally important that such new technology also adheres to governmental norms. This will only be possible with clarity in, and development of, the regulatory framework which must act as a facilitator of growth. It is vital that the law nurtures and supports innovation by reviewing and updating legislation from on an ad hoc basis, and making the regulatory environment more hospitable to the growth of new technologies and models.

The need for any additional government intervention, as proposed in the RBI discussion paper, will also have to be thought through, as such intervention may hinder growth and stifle innovation. For example, digital wallet companies have in the past made representations to the RBI to lessen regulatory interference fearing that increased regulatory requirements will affect product use. Innovation, and consequently, the Fintech space, can only thrive in an evolved regulatory environment.

Back to Asia Pacific Regional Forum publications