Conventus Law (CL): What Is Digital Rupee Or CBDC? What does the Budget 2022 say about its future regulations?
Anuroop Omkar (AO): In India, the Government has been making an effort to rollout CBDCs since 2021-22 and this year’s budget speech officially announced it. Though the budget does not give operational clarity as to how CBDCs shall be rolled out, it clarifies the intent of Reserve Bank of India, the central bank that the CBDC shall provide a stable means of exchange for households, consumers, and companies, supported by the government and managed by a central bank i.e. Reserve Bank of India (RBI). According to information available with us, wholesale CBDCs are anticipated to be rolled out before retail CBDCs. These wholesale CBDCs shall be used for inter-bank settlements among market participants. The government is aiming for a cautious rollout of retail CBDCs since it wants to ensure that the CBDCs do not in any way promote money laundering, tax evasion or terrorism.
Proposed CBDCs shall have a centralised ledger controlled by RBI only making them diametrically different from cryptocurrency. At the same time, since they shall be based on blockchain technology, they shall remove an important hurdle in implementing smart contracts in India. They shall also promote digital banking in a big way by paving way in the near future for faster, cheaper and well documented digital remittances and transactions.Since CBDC shall be a ‘currency’ it shall not be a private asset like cryptocurrency that can be traded for profits. It has also brought clarity on the issue on which I have written a previous article that cryptocurrency trading is subject to capital gains in India. It also has certain goods and service tax implications which traders and trading platforms should be aware of.
The Reserve Bank of India has outlined some of the benefits and risks with CBDC in its ‘Report on Currency and Finance 2020-21’ and clarifies that although CBDCs are essentially identical to banknotes, its adoption would necessitate the creation of an appropriate legal framework which is awaited.
CL: The Budget 2022-23 provided clarity on taxation of digital assets in India. Does this mean cryptocurrency is now legal in India?
AO: In 2021, India’s biggest cryptocurrency exchange saw an annual trading volume of USD 43 billion. This officially announced the arrival of cryptocurrency as an asset class in India although it had been a big market for quite some time now. This made it urgent for the government to clarify its stand.
The Finance Bill 2022-23 now define the term ‘virtual digital assets’(1) which includes NFTs and cryptocurrencies. Further, Finance Bill 2022 introduces Section 115BBH which requires separate computation of income from sale of digital assets from all other income and taxes it at 30% along with 1% tax deduction at source (TDS) at the time of transfer. In my previous article before the Budget, I had already predicted that just taxing cryptocurrency shall not make it legal. The Finance Minister in a statement after the Budget has also clarified this now.(2)
Although virtual digital assets like NFTs and cryptocurrencies employ blockchain technology in a similar fashion as CBDCs to store binary data and use cryptography in order to secure transaction records, these virtual assets are decentralized, therefore there is no single body that regulates their value and issuance. So, the government has taken a progressive step by addressing India’s vision for both centralised and decentralised digital assets in the 2022-23 Budget. This however, still leaves cryptocurrency regulation as a grey area though.
CL: What measures has Finance Minister Nirmala Sitharaman presented in the Union Budget 2022-23 to encourage digital banking and fintech in India?
AO: India has the second largest digital population in the world at 560 million internet users. The banking and finance mandate of the government is presently financial inclusion and these internet users are a big part of the digital banking market of India. For example, according to Credit Lyonnais Securities Asia, in financial year 2020-21 alone, the volume of digital payments made in India was a whopping USD 300 billion which is expected to grow to USD 1 trillion by 2026.
As a legal practitioner, we are regularly meeting foreign clients who are gearing up to tap into this digital population to facilitate digital payments and credit. Rollout of CBDC and its possible integration with blockchain is poised to bring down the transaction cost of digital transactions drastically.
To further push for a healthy digital banking arena, the finance minister announced INR 15,000 Crore for schemes that will provide an incentive to companies, especially NBFCs and FinTechs, to promote digital mode of payment not only in large and metropolitan cities but also in Tier-II cities and rural areas. The Government has further planned setting up of 75 digital banking units in 75 districts across India. Under the National Mission for Financial Inclusion the Government shall install core banking system in 1.5 lakhs post offices across India reaching out to literally every village in India. The Government’s intention with this scheme is to establish last mile connectivity to presently untapped digital population of India.
One of the challenges faced in the expansion of the present digital payments network has been lack of internet penetration in India. Keeping this in mind, the Government has announced BharatNet Project wherein it will lay optical fibres in rural and remote areas to increase internet penetration which shall indirectly promote digital payments in the hitherto unbanked areas of the Country.
All these measures shall only lead to further increase in the digital demography of India. We foresee the rise of the age for neo banks, tech enabled payment facilitators, payment aggregators and even factoring agencies in the mid-term.
CL: What regulatory developments are you expecting to see in the future with regards to fintechs in India?
AO: The fintech timeline has gone through a sea change since the first RBI report in 2015. Till 2020, RBI adopted a ‘soft touch’ regulatory approach towards the unregulated financial technology (Fintech) and digital lending platforms. However, RBI is in an all-round exercise of optimizing and streamlining the banking and finance space in India. It is the time for professionally run market players to outshine traditional banking modalities.
In November, 2021 RBI released the ‘Report of the Working Group on Digital Lending including Lending through Online Platforms and Mobile Apps’. The report analyses digital lending by unregulated online platforms and addresses concerns about behaviour of digital lending applications regarding consumer protection that have arisen in the recent past. The Report differentiates between balance sheet lenders which include regulated entities such as NBFCs, and unregulated digital lending platforms which include various applications and websites that facilitate lending. India has plans to self-regulate digital lending platforms which use contractual escrow structures for indirect balance sheet lending.
In a recent announcement, RBI is proposing to create a department for fintechs. However, we do not foresee need for licensing of fintechs in India in the mid-term. The International Finance Services Centre (IFSC) in India is also emerging as a strong ground for growth and innovation of international payment and forex fintechs. With the burgeoning Indian digital population and the push for financial inclusion there is a big market available for fintechs with well defined use cases and business strategies. For example, we have clients focused only on data intelligence and others with a focus on only micro, small and medium enterprises (MSME)- both uses with high market potential and scope of many more players.
With respect to the regulation of Fintech industry, there has been a constant struggle to strike the correct balance between consumer protection and product innovation, and although RBI appears to be prioritising consumer safety in numerous areas of fintech regulation, the effectiveness of this balancing will only be assessed when the final regulations on digital lending are revealed.
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1 The Finance Bill 2022 has made amendments in Section 2 of the Income Tax Act, 19612 Taxing cryptocurrencies does not give them legal status, clarifies India’s finance minister, Business Insider (February 11, 2022) available at https://rb.gy/fy8yqj
