One of the most silent and yet dramatic changes in India in recent years is the expansion of the digital space. It is silent in the way it has permeated the remotest corners of the vast country of more than 1.4 billion, and dramatic in the way in which it has been adopted by ordinary people. Many of them became digitally literate without receiving formal education.
However, as digitalization of financial transactions becomes an effective tool of empowerment, the enabling financial system will need careful oversight of the regulators and company management for long-term sustenance.
With an official literacy rate of 77.70% – male 84.70%, female 70.30%; rural 73.5% and urban 87.7% – India accounts for 46% of all digital payments in the world with the number of digital payments growing to about 164.4 billion in FY24, up 44% from 113.9 billion in FY23, as per the Annual Report of the Reserve Bank of India (RBI) released on May 30.
In 2023-24, total digital payments recorded growth of 44.3% and 16.4% in volume and value terms, respectively. India has around 9 million point-of-sale devices and nearly 346 million QR codes registering a year-on-year growth of 8.9% and 35% respectively.
The increase in internet and smartphone penetration has contributed to the growth of the digital ecosystem in India, which has been also driven by factors such as the government’s push towards digitalization and the rise of e-commerce.
According to a report by the Internet and Mobile Association of India, the increase in internet users has also led to an increase in the number of mobile wallet users in the country, which is expected to reach 900 million by 2025. Meanwhile, the telecom industry in India with a wireless and wireline subscriber base of 1.19 billion as of March 2024 is the second largest in the world.
Urban telephone connections rose 19.8% to 665.38 million in March 2024 from 555.2 million a decade ago, while the growth in rural telephone connections was 41.31%, or double the increase in urban areas, rising from 377.8 million in March 2014 to 533.9 million in March 2024. The overall tele-density is 85.69%, of which, the tele-density of the rural market, which is largely untapped, stands at 59.19% while that of the urban market is 133.72 %.
Ambitious government targets
India added over 500 million new smartphone users over the last decade and is expected to have 850 million smartphone users by 2026, covering about 55% of the population. The government is targeting a combination of 100% broadband connectivity in the villages, 70% fiberization of towers, average broadband speeds of 50 megabits per second (Mbps) and 5 million kilometres of optic fibre rollouts at a pan-India level by December 2024.
Broadband connections rose to 924.07 million in March 2024 from 61 million in March 2014, growing by 1,414%. Of the internet subscribers, 40.91% belonged to the rural areas. The average monthly data consumption per wireless data subscriber has increased to 17.36 gigabytes in March 2023 from 61.66 megabytes in March 2014. India ranks 60th in the Network Readiness Index 2023.
This exponential growth of the telecom industry over the last few years is primarily driven by affordable tariffs, wider availability, the rollout of mobile number portability (MNP), expanding 3G and 4G coverage, evolving consumption patterns of subscribers, government initiatives towards bolstering India’s domestic telecom manufacturing capacity, and a conducive regulatory environment. To further speed up digital connectivity, the auction of IMT/5G spectrum for the deployment of 5G services across the country has been approved.
Despite this strong infrastructure backbone that is propelling the growth of digital financial transactions, there is still a large proportion of the population that relies on cash transactions. The government intends to promote digital payments by providing incentives for merchants like subsidies to purchase point-of-sale terminals, as well as tax incentives for businesses that adopt digital payment methods.
One of the key initiatives towards creating a cashless society and increasing financial inclusion was the launch of the Unified Payments Interface (UPI), which allowed for real-time inter-bank transactions, and the Bharat Interface for Money (BHIM) app, which simplified the process of making digital transactions. UPI has seen significant growth in India since its launch in 2016 by the National Payments Corporation of India.
One year after its launch, UPI recorded a YoY growth of 900%, processing over 100 million transactions worth 67 billion rupees (US$806 million) in 2017. At the end of CY2022, UPI’s total transaction value stood at 125.95 trillion rupees and accounted for nearly 86% of India’s GDP for FY2022. At the end of the CY2023, UPI’s total transaction volume stood at 83.75 billion.
Supervisory oversight intensifies
E-commerce has also been a major driver of the growth of the digital payment ecosystem in India with growing adoption in tier 2 and tier 3 centres. The country’s e-commerce market is expected to grow at a compound annual growth rate of 31% and reach US$200 billion by 2026.
The growth of the e-commerce market has led to an increase in the number of online shoppers, which is expected to reach 220 million by 2025. India’s digital payment ecosystem is also supported by a number of other private players, which offer a range of digital payment services such as mobile wallets, UPI payments, and QR code-based payments.
Under the DigiDhan Mission, a government initiative, the National Informatics Centre has set up the DigiDhan Dashboard, a platform that integrates 118 banks (public-sector banks, private-sector banks, payments banks, regional rural banks and foreign banks) to provide real-time data on digital transactions by volume and value.
This upward surge in volume, value and the number of players has been under the constant watch of the RBI, the central regulator for the country’s banking system. Moving from a light-touch regulation in the initial post-Covid phase where digital transactions were being promoted by the government both for facilitating financial transactions without human interface and for formalization of the digital economy, RBI has intensified its supervisory oversight in order to introduce greater checks on the system.
In the past few months, some of the financial institutions caught the attention of the RBI, which has imposed severe restrictions on some of the prominent players like Paytm Payments Bank Ltd (PPBL), which was barred from accepting new customers and fresh deposits after February 29 due to persistent non-compliance and material supervisory concerns.
The key reasons for RBI's action against PPBL are failure to identify beneficial owners and monitor payout transactions, breach of regulatory ceiling on customer balances, delayed reporting of cyber security incidents, concerns over KYC compliance as there were instances of millions of non-KYC-compliant accounts, and possible money laundering risks arising from multiple accounts using the same PAN (permanent account number) allotted by the income tax department.
Concerns over risk management
Similarly, RBI barred Kotak Mahindra Bank (KMB) from onboarding new customers online and issuing new credit cards due to significant concerns about the bank's compliance and risk management practices. KMB failed to address concerns about managing IT resources, updates, user access, and data security, leading to serious deficiencies and non-compliances in IT inventory management, vendor risk management, and data security. Despite being instructed to rectify issues, KMB did not adequately address the deficiencies in its IT systems over the past two years, resulting in frequent outages, including a major disruption on April 15, which impacted customers.
A third instance was the case of Bajaj Finance, which faced a ban by the RBI due to its non-compliance with extant provisions of digital lending guidelines. The ban was specifically related to the non-issuance of key fact statements (KFS) to borrowers under two lending products, eCOM and Insta EMI Card, as well as deficiencies in the KFS for other digital loans sanctioned by the company. KFS is a document mandated by RBI rules that details essential loan information such as amount, tenure, interest rate, fees, and penalties in a concise format for digital loan customers. Bajaj Finance failed to provide these crucial details to its customers, leading to the regulatory action by the RBI.
RBI has clarified that its action is against payment banks, not fintech companies like Paytm. Fintechs are free to grow as long as they are not NBFC (non-banking financial company) lenders. The RBI action points to the need for robust operational risk management (ORM) by these institutions referred to as “regulated entities” (REs), especially as they tend to increasingly employ AI tools to improve customer services.
Any laxity in oversight heightens the operational risks leading to institutional instability. According to Basel II norms, operational risk is defined as the “risk of loss resulting from inadequate or failed internal processes, people and systems or external events”.
Attending to gaps in ORM is critical as REs chase growth. “REs will need a data-driven mapping of the micro deficiencies and granular disruptions to the operational efficiency flowing from weaknesses in IT infrastructure, the outcome of the vulnerability tests of IT architecture, skill gaps, and weak systemic controls embedded in operations,” Kembai Srinivasa Rao says in his article “Lessons from RBI’s action against Kotak Bank” published in The Times of India on May 1 2024.
For its part, RBI has brought out a new guidance note on operational risk management and operational resilience that will open up “new areas of correction” by the REs. The RBI released two draft master directions on outsourcing of IT services and IT governance, risk, controls and assurance practices. Apart from these initiatives, the RBI has also launched various technology frameworks to curtail financial frauds.
The RBI’s action is an opportunity for the REs to strengthen their infrastructure, systems and processes in the interest of customers and their own interest and for continuing the spectacular growth of digital transactions in India, which according to a recent report by PhonePe and Boston Consulting Group, will grow to US$10 trillion by 2026.
Ashok Lavasa is a former finance secretary of India and vice-president of private sector and public-private partnership at the Asian Development Bank.
