Pointers To A Future-Ready Payments Policy

Regulation, almost always, lags technology development. But an opportunity to create a future-ready policy framework now seems close at hand

Events over the past few weeks have thrown up numerous pointers to what should be included in a future payments-system policy framework.

The Reserve Bank of India’s (RBI’s) 2017-18 annual report provided the first clue, proving a well-known policy paradigm: competition and freedom of choice are essential tools to avoid distorting markets and the broad economy. An overnight ban on Rs500 and Rs1,000 bank notes—accounting for about 85% of outstanding currency—dealt a body-blow to the economy in terms of jobs, incomes, livelihoods, investment appetite and overall economic growth. The ruinous effects manifested themselves last week: gross domestic product for April-June quarter grew by only 5.7%, the lowest in many quarters.

Demonetisation amounted to suppression of free choice—or freedom to decide how much cash to use, for which transactions—though different reasons were adduced to justify the decision. One of the reasons cited, which has persisted into the post-demonetisation period, is a desire to foster digital payments and to migrate the economy to a less-cash system.

This is a desirable economic objective. However, the policy vectors put in place reveal multiple gaps: lack of a robust competition and innovation policy; uncertainty over the payment regulator’s quasi-legislative powers; an unclear road map for achieving financial inclusion; and, an asymmetric preference hierarchy between different payment systems imposed on the consumer. The last one violates democratic principles by coercing the public to move away from a relatively low-cost payment system (such as cash) to a higher cost platform (such as, mobile wallets which involve connectivity costs).

The Supreme Court’s (SC’s) recent ruling on right to privacy as a fundamental right is likely to complicate the regulatory debate further and might necessitate a systems rethink. The judgement reads: “The balance between data regulation and individual privacy raises complex issues requiring delicate balances to be drawn between the legitimate concerns of the State on one hand and individual interest in the protection of privacy on the other.” The nine-judge bench, while acknowledging that the Centre has already appointed a committee under former SC judge B.N. Srikrishna to study the state of India’s data privacy and to submit a draft bill, hopes that the Union government will take “all necessary and proper steps”.

Still, the right to privacy ruling in itself does set out a future regulatory perimeter for digital financial services. The bench found some pointers in a 2012 report from an expert group on privacy, appointed by the erstwhile Planning Commission. Specifically, the report mentions a five-pillar conceptual scaffolding for drafting legislation to protect privacy: technological neutrality and inter-operability with international standards, which is still lacking; multi-dimensional privacy; horizontal applicability to state and non-state entities to ensure a level-playing field; conformity with privacy principles in line with global best practices; and a co-regulatory enforcement regime which envisages co-existence of independent regulators and self-regulating organizations. Ironically, some of these issues are still being debated in the policy space.

There are multiple views on what to make of SC’s judgement; for example, Chennai’s IFMR Trust, soon after the SC ruling, published a blog advocating stakeholder consultation to determine what kinds of data can and should be collected, the desirable regulatory regime for data mining and algorithmic techniques and a legislative terrain to “ensure that use of personal data is tied to legitimate proportional objectives and interests”.

There is another critical, and slightly obvious, ingredient necessary in the future regulatory mix: trust. This was evident when digital payments spiked during November-December 2016 and then tapered off subsequently; people abhor repression and any attempts to increase the value and volume of digital payments must be achieved through trust, not duress. Regulation must have a consumer bias and should not be designed to favour some service providers.

Lack of trust in paper money issued by sovereigns, and controlled by central banks, is growing as is wider acceptance of crypto-currencies. Already six large global banks—Barclays, Credit Suisse, HSBC, Canadian Imperial Bank of Commerce, State Street and the Mitsubishi UFJ Financial Group—have jointly launched a project to use block-chain for clearing and settling financial transactions, reducing time taken for conventional money transfers.

While bitcoins and other crypto-assets are still in an embryonic state in India, the pace of acceptance is slowly picking up. Many community-based initiatives have been advocating block-chain as an alternative to organized finance, viewed as exploitative. The finance ministry appointed a nine-member inter-disciplinary committee to suggest the way forward with crypto-currencies; the committee has submitted its report, which has not been made public yet. Eventually, though, RBI will have to decide whether it will allow money to also exist as crypto-currency, in addition to its role as a commodity (with or without intrinsic value), a financial claim and/or as an accounting entry.

Regulation, almost always, lags technology development. But an opportunity to create a future-ready policy framework now seems close at hand.

The article originally appeared in Mint newspaper on September 6, 2017, and can also be read here

It’s All In The Sequencing

There is silence on how the digital payments universe will foster competition, spur innovation and design a regulatory framework to protect consumers

Public policy discussions globally have often debated the role and sequencing of regulatory reforms in the series of structural changes necessary for introducing market dynamics to state-controlled economies. In India, post 1991 reforms, this critical issue was not adequately deliberated; worse, the government’s piecemeal approach to reforms and policy planners’ disregard for prioritizing regulatory reform inevitably led to regulatory capture and crony capitalism.

The demonetisation exercise is another pertinent example of how non-systemic reforms, without preceding regulatory reform, lead to chaos and economic dislocation. The withdrawal of 86% currency overnight was accompanied by a steady stream of shifting narratives: launched initially to curtail counterfeiting and currency hoarding, the objective soon segued to facilitating a digital payments infrastructure. But the lack of any planning before introducing this coercive shock, or the absence of preparatory infrastructure build-up and roll-out, has nullified all initial benefits.

Digital payments values and volumes went up between 8 November and 31 December 2016 because people had no other options. A recent research report from securities firm Motilal Oswal estimates that digital payments reduced substantially by May. For example, Motilal Oswal’s calculations show cumulative value of transactions across all digital payments channels during May at Rs111.55 trillion, down from the December 2016 peak of Rs131.45 trillion. The report disregards the Rs180.73 trillion spike during March, attributed primarily to seasonal phenomena.

Even a senior executive from the National Payments Corporation of India (NPCI) was quoted in this newspaper as saying the December spike in digital payments had ebbed by April.

So, what has demonetisation achieved? Observers cite two tangible, but divergent, results: a political victory through electoral gains in Uttar Pradesh and deepening agricultural distress leading to widespread farmer unrest. While there is no detailed, granular research linking demonetisation and these two outcomes, there is one noteworthy collateral benefit though: casting a wider net exposes the asymmetrical regulatory landscape in the payments and settlement ecosystem.

Soon after demonetisation, the Ratan Watal committee on digital payments advanced its deadlines and rushed through its report submission. Another committee of chief ministers was set up by Niti Aayog under Andhra Pradesh chief minister N. Chandrababu Naidu. This committee spawned another committee for digital payments security under IT secretary Aruna Sundararajan. Niti Aayog has set up another committee helmed by chief executive officer Amitabh Kant to “enable 100% conversion of government-citizen transactions to the digital platform”. Meanwhile, the ministry of electronics and information technology (Meity) has issued its own guidelines to facilitate adoption of electronic payments and receipts for various government services. Before all this, in June 2016, the Reserve Bank of India (RBI) had set up an inter-regulatory working group on fintech and digital payments, though the fate of this committee is not yet known. Besides, demonetisation also occasioned a host of other private reports.

Predictably, such a surfeit of committees and reports has led to overlaps and repetition. A cursory reading might even give the idea that committees are competing among themselves to say the same things. However, the burst of reports and recommendations in the first flush of demonetisation seems to have petered out: nobody seems to be listening and there doesn’t seem to be any urgency to implement many of the suggestions.

For example, the Watal committee’s recommendation of carving payments regulation out of RBI’s jurisdiction and making it into an independent body met with resistance from the central bank; eventually, finance minister Arun Jaitley announced the setting up of a payments regulatory board in his 2017-18 Budget speech (to replace the existing Board for Regulation and Supervision of Payment and Settlement Systems, or BPSS) on the lines suggested by the committee, but with one critical exception: the board will have three members from RBI and an equal number from the government, thereby diluting its independent status.

Many other skews in the regulatory architecture have been pointed out but remain unresolved. For example, as owner and operator of the retail digital payments network, the NPCI is a provider of critical infrastructure; but, simultaneously, it also competes with users by pushing its own payment products and services. In addition, its entire equity capital is owned by 56 banks, which automatically puts non-bank payment service providers at a distinct disadvantage and raises questions of infrastructure neutrality.

There is also complete silence on how the digital payments universe and its regulators will foster competition, encourage innovation and design a regulatory framework to protect consumers. Currently, allowing only banks to access the payments network—and denying that to non-banks—seems to be the default regulatory design.

The attention of policy planners and administrators might have been temporarily diverted to the other elephant in the room: goods and services tax, which goes live from 1 July. But, GST’s success is also predicated on a robust and secure digital payments network; an ad hoc digital payments network spells only provisional success for GST.

The above article was originally published in Mint newspaper and can be read here as well