“We will have regulations, but from now on, the rules will be written by people who love your industry, not hate your industry”
- Donald Trump (2024)
From dismissing cryptocurrencies as assets ‘based on thin air’ (in 2019) to championing their potential to ‘go to the moon’ (in 2024), Trump’s crypto U-turn created waves in the US election cycle. The crypto industry has been buzzing with optimism, hoping for relaxed US regulations after his win. Trump has promised a Crypto Advisory Council (to streamline crypto regulations and for inter-regulatory coordination) and is set to appoint a pro-crypto chairman to the SEC. He may also establish a federal bitcoin reserve. Heck, even Trump’s newly promised department of government efficiency is a wink to Dogecoin!
The US crypto market has responded favourably. Bitcoin has crossed the $100,000 mark. Many believe that this buzz will not just be limited to the US – it could influence other economies like India which remain undecided on their broader policy on crypto regulations. India today leads the world in adoption of cryptocurrencies. High taxes, regulatory uncertainty and incidents like the WazirX hack (which led to wipeout of Rs. 2000 crore) haven’t deterred Indian crypto investors. What’s transpiring in the US may be a shot in the arm for the Indian crypto growth spurt.
Trump’s promises are suggestive of a sea change in crypto policies which could seal crypto’s legitimization as a financial asset. For India, this could mean pressure to craft enabling regulations for the crypto space – and may be this won’t be such a bad thing. The regulatory oversight will enable the government and regulators to leverage the potential and manage the pitfalls of crypto businesses. The Financial Intelligence Unit (FIU-IND), Indian money laundering watchdog, has already covered a fair bit of ground despite being the only regulator for crypto-businesses at the moment. It has engaged with crypto businesses to understand their operations, monitored threats and penalized non-compliant players.
A comprehensive regulation with measures to prevent frauds, security breaches and other illegal activities could safeguard investors and fuel innovation in the crypto domain. This could help attract foreign investment and nurture homegrown crypto startups. It could also help elevate India’s position in the global crypto economy – so that it is not deprived of opportunities which the US’ wholehearted participation in the space may create. In any case, the future is looking up. So, fellow crypto enthusiasts, keep your fingers crossed and wallets ready.
Now onto our Fintales menu for the month.
Main Course: deep dive on regulation of supply chain financing product offered by NBFCs and solution to SEBI’s enforcement woes in the digital space.
Dessert: sweet news about RBI’s progressive policies.
Mints: a refresher on recent fintech developments.
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⚖️ Is regulation the answer to Supply Chain Finance woes?
The RBI has been looking closely at Supply Chain Finance (SCF) offerings of NBFCs. This isn’t just a casual glance – reports suggest that the RBI has raised concerns about the structuring of these products. It is believed that the central bank may have asked NBFCs to either restructure their SCF offerings or even consider ceasing them altogether. Amidst RBI’s scrutiny on these offerings, it’s worth noting the vital role SCF plays as a financing tool for micro, small and medium enterprises (MSMEs).
MSMEs currently account for 29% of India’s GDP. The government aims to increase this to 50%. Despite their crucial role, MSMEs often struggle to access timely and affordable working capital. The sector faces a significant credit gap, estimated at INR 20–25 trillion. Typically, traditional financing options available to the MSMEs are overdraft facilities or term loans. However, these options often come with drawbacks such as high interest rates, and inflexible terms. This is why SCF – a product curated for MSMEs – is a more viable alternative.
SCFs inject immediate cash flow into the business chain. To illustrate how SCF works, let’s consider a transaction between a large corporation (say MTC Ltd.) and a small supplier. MTC Ltd. may follow a 30-180 day payment cycle, but the small supplier needs urgent funds to maintain its operations. This is where SCF products can help bridge the payment gap. MTC Ltd. partners with an NBFC to ensure that the small supplier is paid upfront. The supplier gets cash, MTC Ltd gets extended payment terms, and the NBFC earns interest on the loan. Everyone wins!
But there is a catch. Certain SCF offerings (depending on their structure) may look like a revolving line of credit (RLOC) – a risky financial product which is subject to stringent RBI regulations. The RBI, however, does not specifically regulate SCF (as a product category).
With products that offer RLOC, a lender allows borrowers to withdraw from the credit line multiple times – subject to an upper monetary limit. The limit gets replenished as and when the borrower repays the borrowed amount. Borrowers also get the flexibility to pay a minimum amount (instead of the entire outstanding amount) and revolve the remaining due amount to the next payment cycle. To understand RLOCs better, let’s consider an example of a credit card facility. Tom has a credit card with a credit limit of Rs. 1,00,000. He uses his credit card to buy a phone for Rs. 25,000. This reduces the available credit limit to Rs. 75,000. Tom repays a minimum amount of Rs. 5,000 before his due date. The available credit limit is now replenished to Rs. 80,000. Again, Tom uses his credit card to book flights worth Rs. 30,000. The available limit drops to Rs. 50,000. This self-replenishing mechanism offers continuous borrowing capability to Tom, provided he doesn’t exceed the sanctioned limit. Tom can withdraw funds multiple times within the upper credit limit and repay only a portion of the outstanding amount while revolving the remainder to the next billing cycle. Thus, the essence of an RLOC is the ability of borrowers to vary the draw-down amount, repayment amount and repayment frequency.
SCFs may look like RLOCs – since an upper credit limit gets sanctioned to borrowers and the limit gets replenished when the borrower repays. However, other features of SCFs are different from RLOCs, making SCFs a separate product class altogether. For instance, unlike RLOCs, SCFs are structured to provide financing against a specific end-use, supported by invoices or purchase orders. Every draw-down in SCF is tied to invoices, with fixed disbursement amount and defined repayment schedule. This clips the flexibility attached to each draw-dawn and repayment. This also ensures proper paper trail and accountability. SCFs require borrowers to repay the loan in full by the due date, ensuring no rollover or variation in repayment terms. If a borrower fails to make even one repayment, the entire sanctioned amount is generally cancelled.
Because of its distinct features, SCF is a less risky product than RLOCs. However, lack of specific regulations means that some inherent risks associated with SCFs are unaddressed. For instance, some financial institutions may not check invoices, repayment behaviour (default) under SCF, etc. on a regular basis, as the same may not attract any regulatory repercussions. Terms of SCF displayed to borrowers may be unclear and non-transparent. Sellers and lenders may also collude to artificially inflate the interest amount. Also, if sellers partner with lenders and offer SCF as part of purchase journey to buyers (borrowers), the risk of borrowers getting non-favourable loan terms is high. For instance, Ram is a shopkeeper in a small town. When he opts for business loan, he typically compares interest rates offered by 5 different banks and goes with the best offer. However, when he buys his stock from his supplier who also offer him financing options, he does not enjoy the same flexibility. This is because the supplier may push him to go with the lender he partners with – even if the lender does not offer the most favourable terms. The lender may gradually increase the interest rate making it harder for Ram to repay the debt. Since Ram needs more supplies (and usually on credit), he relies on the same supplier (for both stock and credit). This makes it difficult for Ram to switch to another lender and supplier, leaving him stuck with the same unfavourable terms.
If left unchecked, these practices can severely harm the growth and sustainability of MSMEs and erode trust in the financial system. Therefore, regulatory oversight and transparency in SCF transactions are critical to protect the MSME sector.
A regulatory gap, however, doesn’t call for an outright ban on the product but requires a balanced approach. SCFs are the unsung hero of the MSME sector - providing immediate funds during cash crunches and enabling smaller players to compete with larger ones. Also, SCFs can be inherently different from traditional RLOC. They can have built-in checks to prevent misuse. For instance, every tranche can be monitored for overdue payments, and lenders can pause further disbursements on any sign of stress.
We don’t believe that NBFCs offering SCFs are actively trying to sneak past the regulatory magnifying glass – and need to stop offering SCFs. Instead, the RBI could consider ways to regulate them. A framework for SCFs could prescribe measures for effective risk management, early detection of borrower distress, regular check on borrower’s repayment history, checking the veracity of the invoice against which drawdown is sought – as suggested by the FIDC (an organization representing NBFCs) in its representation to the RBI on this issue. This can ensure that SCFs don’t spiral into a reckless evergreening loan product that the RBI fears.
The RBI’s commitment to responsible lending can co-exist with innovative credit-line products (like SCF) if the focus is on smart regulation rather than outright bans. Don’t throw out the cookies, just tell us when and how many to eat!
💡 Let’s not solve problem of enforcement through more regulation
SEBI has implemented a slew of measures to rein in illegal investment advice hosted on digital platforms. In August 2024, it prohibited its regulated entities (REs) from associating with anyone who shares investment advice without SEBI registration. It also introduced the concept of specified digital platforms (SDPs) – SEBI registered platforms hosting securities market content as per SEBI regulations.
In October, SEBI released a consultation paper to regulate REs’ online association with content creators. It seemed to propose that all platforms hosting securities market related content must mandatorily register with SEBI (as SDPs) and comply with a host of new preventive and curative obligations.. For instance, SDPs must adopt technological tools to identify and screen securities market content. They must be able to distinguish between educational content and securities market advice for each piece of content. They must ensure that only SEBI regulated entities share financial advice, verify the registration status of entities sharing securities related advice, and give them a special badge. SDPs must also take down illegal content, blacklist violators or take such action as prescribed by SEBI, and then report violators to SEBI. This may be a high bar for platforms to meet, particularly for those platforms that do not routinely deal with securities related content.
The paper drew criticism from all industry quarters. Some called it an overreach by SEBI. Others saw it as a curb on freedom of speech and in direct conflict with protection generally granted to platforms against liability for third party content. In response, SEBI issued a clarification last week stating that it never intended to make SEBI registration mandatory for the platforms. But REs engaging with content creators on / through an SDP will have an advantage – in case of a SEBI action, REs can take the defence that they engaged with the content creators on/through the SDP. REs can associate through unregistered platforms if they wish, but at their own risk. The circular and clarification seem to nudge REs to only associate through SDPs. This leaves digital platforms with a difficult choice--if they do register as SDPs, they have a sea of compliances to take care of. If they don’t, they run the risk of shrinking their financial content base. So, the platforms are damned if they register, and damned if they don’t.
SEBI is going through all this rigmarole to delegate some of its enforcement obligations to digital platforms. And it’s understandable why. SEBI lacks enforcement muscle in the digital arena. It is difficult for SEBI to intercept entities/individuals giving unauthorized financial advice through millions of digital platforms (with over 820 million Indian users) available on the internet. The problem is in no way unique to the SEBI. Regulators across different sectors and jurisdictions have faced this struggle. The RBI, for instance, has had a tough time enforcing digital lending regulations to rein in illegal lending apps. The sheer number of avenues where these apps are available makes it difficult to take them down.
To us, SEBI’s approach looks unviable. Most platforms neither have the means nor the motivation to take on these responsibilities. Smaller platforms are unlikely to invest in sophisticated technology tools necessary to detect such unlawful content. More importantly, it may be imprudent to delegate such wide ranging powers to the platforms. Platforms may end up taking widely divergent views on what is permissible and impermissible content (for instance, while distinguishing between investment advice and investor education).
We think existing SEBI regulations already enable SEBI to prosecute entities/individuals that post unauthorised financial advice. The SEBI Act, 1992, Prohibition of Fraudulent and Unfair Trade Practices Regulations, 2003, Investment Advisory Regulations 2013, and Research Analyst Regulations 2014 are a few examples. SEBI has prosecuted several individuals and entities (such as Mohammad Nasir – the face of ‘Baap of Chart’; PR Sundar and his company Mansun Consulting were fined over Rs. 6 crores; barring of Arshad Warsi from the securities market, etc. ) under these regulations for giving out unlawful securities market advice. Instead of issuing fresh regulation on the subject, SEBI could focus on strengthening enforcement:
- Leveraging SRO: SEBI could consider appointing an SRO to take on certain enforcement obligations. The SROs may have digital platforms, financial educators, financial influencers, financial advisors and research analysts as members. Recognition of SROs permitting membership from unregulated entities will not be unprecedented. The RBI, for instance, has also released a framework for fintech SROs which will have unregulated entities as their members.The SROs may: frame policies to distinguish between educational content and regulated advice; deploy tech tools (in collaboration with the industry) to identify and report rogue entities/individuals giving unlawful financial advice (to SEBI and digital platforms); and be on the lookout for new-age tools to handle emerging threats.
- Supervisory tech tools: SEBI could explore advanced supervisory tech tools to bolster its enforcement capabilities. It has already constituted an advisory committee to receive specialised advice in this respect. SEBI has also dabbled with an AI-based supervisory tool called ‘Picture-based Information News Accumulator and Key Information Analyser’ (Pinaka). Pinaka scans through TV shows that display stock tips. Next, it compares the data with the trading patterns of the person giving the tips to identify violations of securities market regulations. Regulators such as RBI are also implementing similar tools for better enforcement. Reserve Bank Innovation Hub (RBIH) has developed MuleHunter.ai – an AI/ML tool to detect mule accounts (accounts of unsuspecting individuals used by criminals to launder money). It can analyse transactions and account details related datasets to predict mule accounts. The RBI has requested banks to collaborate with RBIH to bolster the tool’s capabilities.
- Leveraging existing enforcement machinery: SEBI should consider leveraging different government departments, regulators and SROs such as Ministry of Electronics and Information Technology, Ministry of Information and Broadcasting, and the Advertising Standards Council of India (ASCI) to prevent dissemination of illegal securities advice. For instance, ASCI has already prescribed strict pre-requisites and disclosure norms for advertisements by influencers (including financial influencers). SEBI could consider coordinating its efforts with ASCI which has done considerably well in enforcing its norms in the digital space.
- Investor awareness: SEBI may also consider redirecting its efforts towards investor awareness so that investors are trained to: receive advice only from registered advisors or analysts; do their own research before investing; be wary of advisors promising high returns; and understand the market manipulations such as pump and dump and front running. The impact of investor awareness drives can be immense. For instance, the mutual fund industry’s ‘mutual fund sahi hai’ campaign played a crucial role in attracting investors to invest in mutual funds.
The suggested route may be more arduous for the regulator but it will set the right tone for enforcement in the digital space.
DESSERT
🎁 RBI’s year ends gifts
RBI’s has announced a few collaborative, progressive and innovation friendly policies this month:
- RBI will launch ‘Connect 2 Regulate’ programme to make regulation making more collaborative. Under it, stakeholders may share their ideas and inputs (as case studies, concept notes, etc.) on topics proposed by RBI.
- RBI will launch a podcast to spread awareness and share its thought process behind its decisions.
- Small Finance Banks will now be permitted to link their credit lines to UPI.
- RBI will constitute a committee to recommend a framework for adoption of AI by financial sector.
MINTS
🏧 Net-banking – the new UPI
NPCI is in the process of integrating with banks to make net-banking and mobile-banking payments interoperable. Once the integration is live, online and offline merchant outlets can rely on it to accept net-banking payments. The initiative will reduce stress on the UPI infrastructure as customers can rely on net-banking as an alternative.
👩💻 UPI for NRIs
Non-resident Indians (NRIs) from 12 countries can now make UPI payments by linking their international number to their NRE/NRO account. To provide this facility, member banks will have to ensure that the accounts are compliant with FEMA and RBI regulations
📑 NPCI issues warning letter to fintechs
The NPCI recently issued a letter to banks and fintechs asking them to use UPI APIs only for payment settlement and account validation. Reportedly, fintechs have been using UPI IDs to verify customer’s name, bank account status, alternate UPI IDs and mobile number.
🚫 Warning against illegal PGs
The Indian Cybercrime Coordination Centre (I4C) and the Ministry of Home Affairs (MHA) issued an alert against illegal payment services offered using mule accounts. Some of the payment processors identified are PeacePay, RTX Pay, PoccoPay, RRPay, etc. I4C has warned citizens against selling/renting their bank accounts/company registration certificate/Udhyam Aadhaar Registration certificate to anyone.
