Digital wallets in India: The road ahead for India’s fintech?

By Anuj Bhasme and Gaurav Dugar, Shardul Amarchand Mangaldas & Co
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Financial technology (fintech) in India has been attracting significant attention from legacy financial services providers, venture capitalists and regulators alike. A recent KPMG and NASSCOM study suggests that the Indian fintech ecosystem could grow up to US$45 billion by 2020. Traditionally a cash driven economy, India is developing a dynamic ecosystem offering fintech companies a platform to potentially grow into billion dollar unicorns with the launch of digital wallets

Anuj Bhasme, Partner, Shardul Amarchand Mangaldas
Anuj Bhasme
Partner
Shardul Amarchand Mangaldas

Fintech in India is governed by an intricate regulatory framework, comprising multiple regulators. The focus of this article is primarily on digital wallets (m-wallets): (i) the applicable regulatory framework, (ii) the M&A opportunities in this area, and (iii) the potential challenges.

M-wallets are similar to prepaid cards, which need to be “pre-loaded” by the consumer. Once loaded, consumers can use the m-wallet to make payments to identified partner merchants. Since such companies have access to consumer funds (stored in the m-wallet), companies wishing to set up and operate m-wallets are required to obtain prior approval from the Reserve Bank of India (RBI).

M-wallets are primarily governed by the Payment and Settlement Systems Act, 2007. Section 3 of the act designates the RBI as the nodal authority to regulate payment systems. To this end, the RBI has constituted the Board for Regulation and Supervision of Payment and Settlement Systems, which is chaired by the governor of the RBI. The RBI has also issued detailed guidelines regulating the process to apply for and operate an m-wallet, anti-fraud mechanisms and standards, and know your customer requirements.

The RBI’s impetus towards financial inclusion, and drive towards a cash-free economy, is often overlooked as a key catalyst for the growth of m-wallets in India. This is augmented by improved telecom reach and services, and willingness and ease of the average Indian consumer to use handheld devices for financial transactions. Unlike typical Indian regulators, the RBI has embraced the technological advantages offered by m-wallets.

Another key driver in the growth of such payment systems, or m-wallets, has been the RBI’s continued (and welcome) use of additional security measures for regular banking transactions such as the 2 factor authentication process (2FA) for debit and credit card payments, including the one-time password generated for “card not present” transactions.

Gaurav Dugar, Associate, Shardul Amarchand Mangaldas
Gaurav Dugar
Associate
Shardul Amarchand Mangaldas

Notably, the 2FA requirement does not apply for transactions made using an m-wallet. While the RBI has recently liberalized its stance on 2FA, market reports suggest that this change has not significantly affected the operations of m-wallets. That said, the introduction of the unified payment interface (UPI) may pose the first real challenge to India’s m-wallet ecosystem. Once the UPI is in full operation, using a bank’s native mobile app may be as easy as using an m-wallet. Accordingly, m-wallets will offer consumers limited operational advantage vis-à-vis their UPI-enabled banking counterparts. The m-wallet’s benefits will be limited to continued use stemming from reluctance to migrate to the UPI ecosystem, or simply a familiar, easier to use interface.

Unlike the Indian e-commerce sector, m-wallet companies have, until very recently, been removed from any significant M&A activities. Notable acquisitions in this sector are limited to Snapdeal’s strategic acquisition of Freecharge in a majority stock deal, and the all-cash acquisition of Citrus Pay by PayU.

Given the introduction of the UPI and benefits of economies of scale in this sector, consolidation appears imminent. Strategic reasons aside, shareholders of such companies are: (i) founders and employees (through employee stock ownership plans), and (ii) pure play financial investors. These categories of shareholders are typically receptive to consolidation if it results in an increased user base and shareholder value.

Some of the concerns hindering consolidation in this sector are: (i) getting existing shareholders/investors on board, and (ii) prior approval from the RBI for any significant M&A activity. While private M&A remains an option for consolidation, given the limited grounds hindering consolidation and save any deal-specific challenges, court approved mergers may also become an attractive option to achieve consolidation.

The recent constitution of the National Company Law Tribunal and impending notification of the relevant provisions of the Companies Act, 2013, relating to mergers should help allay historical concerns related to court approved mergers. One of the largest acquisitions in the Indian start-up area has been from this sector, and that may just be the tip of the fintech iceberg.

Anuj Bhasme is a partner and Gaurav Dugar is an associate at Shardul Amarchand Mangaldas & Co. The views expressed in this article are those of the authors and do not reflect the position of the firm.

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