This article analyzes the Delhi High Court’s judgement upholding the RBI’s Guidelines for Payment Aggregators. And contrasts it with previous judgements like the crypto banking ban case where courts have disagreed with the RBI.
The Delhi High Court has upheld the constitutionality of the RBI’s Guidelines for Payment Aggregators (PA Guidelines) in a judgement released last month (PA Regulation Case). The Delhi High Court held that the Payment and Settlement Systems Act, 2007 (PSS Act) empowers the RBI to direct PAs to (1) obtain prior authorization, (2) have minimum net-worth, and (3) hold funds in escrow accounts.
Since the RBI’s a specialized regulator, courts tend to defer to its wisdom. So, the Delhi High Court’s decision in the PA Regulation Case isn’t surprising. In the past, courts have rarely overruled the RBI. One notable exception is the Supreme Court’s decision to strike down RBI’s ban on access to banking services for the crypto-industry (Crypto Banking Ban Case). In this case, the Supreme Court acknowledged that the RBI had the power to regulate crypto-assets. However, it held that the banking ban was a disproportionate restriction on the right to freedom of business for three reasons. First, the banking ban effectively shut down crypto-exchanges. Second, the RBI couldn’t produce any empirical data about harm caused to its regulated entities due to servicing crypto-exchanges. Third, the RBI or the government hadn’t banned crypto-assets per se.
In both the Crypto Banking Ban Case and the PA Regulation Case, the courts held that the RBI had wide powers to regulate activities which could affect the financial system. However, while the RBI exercised this power disproportionately in the former, it didn’t in the latter.
Here’s a summary of the PA Regulation Case which explains the factors which led the Delhi High Court to this conclusion.
Petitioner’s arguments: The petitioner argued that PAs don’t operate a ‘payment system’ and are merely ‘system participants.’ Therefore, the RBI couldn’t mandate prior authorization for PAs.
RBI’s arguments: The RBI contended that the activities of a PA fall within the definition of a ‘payment system’. As PAs collect money from customers and transfer it to merchants after a time-gap. The PSS Act prohibits any entity from operating a payment system without prior RBI authorization. Therefore, the PA Guidelines are aligned with the PSS Act.
Court’s holding: The Court noted that the PSS Act pre-dates PAs becoming common. But the Court relied on the ‘updating principle’ which requires courts to update the scope of a law based on technological advancement. Unlike Payment Gateways (PGs), PAs handle funds. Based on this, the Court concluded that PAs operate a ‘payment system’ and must seek prior RBI authorization.
Petitioner’s arguments: The petitioner argued that the minimum net-worth requirement – Rs.15 crores at the time of application and Rs.25 crores within 3 years – was unreasonable. Because it’d stifle innovation, reduce competition and isn’t relevant for the functions performed by PAs.
RBI’s arguments: The RBI contended that minimum net-worth is necessary to cover losses if the PA fails to transfer the funds collected from customers to merchants.
Court’s holding: The Court noted that the RBI had originally proposed a minimum net-worth of Rs.100 crores in its discussion paper on the PA Guidelines. And only 19 out of 57 stakeholders objected to this. Despite most stakeholders not voicing any objections, the RBI reduced the minimum net-worth requirement to Rs.15 crores. Based on this, the Court held that the RBI had applied its mind prior to deciding the minimum net worth requirement. The Court also agreed with the RBI’s view that since PAs handle customer funds, they should be financially strong.
Petitioner’s arguments: The petitioner argued that PAs needn’t keep funds in an escrow account. And the older mechanism of keeping funds in the nodal account of a bank was sufficient. The PA doesn’t have access to funds in the nodal account and the funds are settled to merchants by the bank within 3 days. Further, the PA doesn’t need to have a beneficial interest in the funds held on behalf of its clients. And keeping all funds in a single escrow account instead of multiple nodal accounts of different banks would increase risk.
RBI’s arguments: The RBI contended that when funds are kept in a nodal account, they are the liability of the bank and don’t reflect on the PA’s balance sheet. The PA doesn’t have a beneficial interest in funds in the nodal account and can’t earn interest on them. Under the PA Guidelines, PAs have a beneficial interest in funds in the escrow account and can earn interest on the core portion of the amount. The RBI has also amended the PA Guidelines to allow PAs to maintain two escrow accounts in different banks. So, risks arising from concentration of funds in a single bank are mitigated. Moreover, under the PSS Act, the funds held in a payment system can only be used to pay merchants or repay customers. So, even if the PA or bank faces insolvency, the funds in the escrow account (which is a designated payment system) remain safe. And they can’t be used to settle the PA’s or bank’s liabilities till merchants and/or customers are paid in full.
Court’s holding: The Court found merit in the petitioner’s argument that holding funds in a single escrow account could increase risk because the relevant bank could become insolvent. But the Court held that the escrow account mechanism in the PA Guidelines provided a better solution to this problem. Because the escrow account as a designated payment system enjoys the legal firewall under the PSS Act. This firewall guarantees that in case of the PA’s or bank’s insolvency, the funds in the escrow account can only be used to pay merchants or repay customers. The funds can’t be used to discharge the PA’s or bank’s liabilities till merchants and/or customers are paid in full. This ensures the interests of customers and merchants are protected. The Court also noted that the RBI has allowed PAs to maintain two escrow accounts in different banks. Which mitigates risks arising from concentration of funds in a single bank to some extent.
For all these reasons, the Delhi High Court concluded that the PA Guidelines were a reasonable exercise of RBI’s powers.
Have more questions about the PA Guidelines? Reach out to our fintech team firstname.lastname@example.org.
(This post has been authored by the fintech team at Ikigai Law.)