Report on Currency and Finance 2023-24

REPORT ON CURRENCY AND FINANCE 2023-24 INDIA’S DIGITAL REVOLUTION RESERVE BANK OF INDIA“ The findings, views and conclusions expressed in this Report are entirely those of the contributors from the Department of Economic and Policy Research (DEPR) and do not represent the views of the Reserve Bank of India”.

In India - ₹ 575 (Normal) - ₹ 625 (Inclusive of Postal Charges) Abroad - US $ 22 (Inclusive of Air Mail Courier Charges) © Reserve Bank of India 2024 All rights reserved. Reproduction is permitted, provided an acknowledgement of the source is made.

ISSN 0972-8759 Published by G V Nadhanael for the Reserve Bank of India, Mumbai-400 001 and printed at Jayant Printery LLP, 352/54, Girgaum Road, Murlidhar Temple Compound, Near Thakurdwar Post Office, Mumbai - 400 002.FOREWORD The digital wave embracing the world is unprecedented and transformative. No aspect of life is untouched by its sweep. Digitalisation is driving innovation and efficiency, fostering a new model of economic growth, and facilitating quality improvements. Digital transformation is also evident in the financial sector, where adoption of technology solutions by financial institutions, coupled with the advent of new market players like financial technology firms (FinTechs) and large corporations (BigTechs), is reshaping the conventional notions of finance. Frontier technologies involving application programming interfaces, artificial intelligence and machine learning, and cloud computing are powering financial innovations worldwide. In turn, this revolution is expanding and diversifying the role of central banks and financial regulators.

India is leading the global digital revolution, emerging as a frontrunner on the back of its robust digital public infrastructure, rapidly evolving institutional arrangements, and a growing tech-savvy population. Globally, India ranks first in biometric-based identification (Aadhaar) and real-time payments volume; second in telecom subscribers; and third in terms of the startup ecosystem.

The flagship Unified Payments Interface (UPI) has revolutionised the retail payment experience for end- users, making transactions faster and more convenient. In the digital currency arena, the Reserve Bank is at the forefront with pilot runs of the e-rupee, the central bank digital currency (CBDC). The digital lending ecosystem is becoming vibrant with initiatives such as the Open Credit Enablement Network, the Open Network for Digital Commerce and the Public Tech Platform for Frictionless Credit. FinTechs are collaborating with banks and non-banking financial companies (NBFCs) as lending service providers. They are also operating platforms to facilitate digital credit. BigTechs are backing payment apps and lending products as third-party service providers.

Digitalisation in finance is paving the way for next-generation banking; improving access to financial services at affordable costs; and enhancing the impact of direct benefit transfers by effective targeting of beneficiaries in a cost-efficient manner. Loans in the retail segment are being enabled by online payments and innovative credit assessment models with instant disbursements. E-commerce is being boosted through embedded finance. All these innovations are making financial markets more efficient and integrated.

On the external front, digitalisation is driving growth in India’s services exports and lowering remittance costs. India’s digital journey is setting a benchmark for peer economies. The Reserve Bank’s initiatives for internationalisation of home-grown payment modes, cross-border fast payment network linkages and knowledge and experience sharing with peers is energising the transformation of its digital public infrastructure as a global public good.

At the same time, digitalisation also presents challenges related to cybersecurity, data privacy, data bias, vendor and third-party risks, and customer protection. Increased inter-connectedness may lead to systemic risks. Additionally, emerging technologies can introduce complex products and business models with risks that users may not fully understand, including the proliferation of fraudulent apps and mis-selling through dark patterns. Digitalisation may induce human resource challenges in the financial sector, necessitating strategic investments in upskilling and reskilling.In this rapidly evolving landscape, balancing financial stability, customer protection and competition will remain the key policy challenge. Regulatory and supervisory frameworks must scale up and become more sophisticated to navigate these complexities and future-proof the financial system. The goal is to balance effective regulation with fostering financial innovations in a safe, robust and trustworthy ecosystem.

The Reserve Bank has taken several measures in this regard, including the issuance of guidelines on account aggregators, peer-to-peer lending, digital lending, regulatory sandbox, Reserve Bank Innovation Hub, framework for self-regulatory organisations and strengthening of the supervisory approach by going beyond an entity-focused approach towards a more thematic and activity-based approach. The Reserve Bank is also fostering a strong risk culture focused on customer centricity, governance and business conduct in financial sector entities. The endeavour is to promote a sustainable and resilient financial sector.

Against this backdrop, this year’s Report on Currency and Finance has adopted “India’s Digital Revolution” as its theme. The Report has been prepared by a team from the Department of Economic and Policy Research (DEPR), with inputs from several operational departments. The Report is supported by surveys of key stakeholders and data-based analysis. The comprehensive assessment of the country’s digital transformation, with a focus on the financial sector and the payments landscape, should shed more light on the range of opportunities and challenges associated with digitalisation. It is expected that the Report will enable appreciation of the various contours of digitalisation in finance and the ways in which the common person is served while contributing to overall economic and financial development of the Indian economy.

I am confident that the Report will spur further deliberations on strengthening and deepening India’s digital transformation.

Shaktikanta Das Governor July 29, 2024CONTENTS Sr. No. Page No.

Chapter I: India’s Digital Revolution: Opportunities and Challenges 1-39

1. Introduction 1

2. The State of Play 2

3. Expanding the Opportunities Frontier 9

4. Future Shocks: Digitalisation’s Challenges 21

5. Digitalisation and the Reserve Bank of India 30

6. Concluding Observations 31 40-76

Chapter II: Digitalisation and Financial Innovation

1. Introduction 40

2. Financial Innovations: Conceptual Framework and Economic Facilitators 41

3. Financial Innovations: Adoption by India’s Financial Institutions and 43 Customers

4. Collaboration of FinTechs and BigTechs with Financial Institutions 51 (Banks and NBFCs)

5. Digital Lending 55

6. Financial Innovations: Implications for the Banking Sector 65

7. Regulatory Concerns and Policy Initiatives 66

8. Concluding Observations 72

Chapter III: Digitalisation and Payment Revolution in India 77-112

1. Introduction 77

2. Evolution of Digital Payment Systems: A Cross-country Analysis 78

3. The Digital Payment Revolution in India 85

4. Impact of Digital Payments 98

5. Challenges in the Digital Payments Landscape and Way Forward 106

6. Concluding Observations 108 ISr. No. Page No.

Chapter IV: Open Economy Digitalisation: Challenges and Opportunities 113-153

1. Introduction 113

2. India’s Journey towards Open Economy Digitalisation 115

3. Internationalisation of Digital Public Infrastructure 133

4. Data Embassies and India’s Potential 142

5. Challenges to Open Economy Digitalisation 147

6. Concluding Observations 148

Chapter V: Digitalisation - Tackling Emerging Risks and Challenges 154-178

1. Introduction 154

2. Opportunities and Risks of Digitalisation: Insights from a Survey of 155 Banks and NBFCs

3. Digitalisation and Customer Behaviour 163

4. Digitalisation: Financial Stability and Macroeconomic Implications 167

5. Concluding Observations 175 IILIST OF BOXES Sr. No. Page No.

I.1 History of India’s Digitalisation 4 I.2 Role of Digitalisation in India’s Future Growth Path 10 I.3 Regulation-Innovation Nexus: Peer-to-peer Lending in India 27 II.1 The Impact of Digitalisation on Efficiency of Banks 44 II.2 Bank Risk in the Digital Age 67 II.3 Financial Innovations and Financial Market Liquidity 68 III.1 Determinants of Adoption of Digital Payment Technology: A Cross- 84 country Analysis III.2 Impact of Digital Payments on Money Demand 105 IV.1 Do India’s Services Exports Defy the Gravity Model? 122 IV.2 Cost of Remittances to India – The Case for Digital Disruption 127 IV.3 Factors Influencing the Adoption of CBDCs 143 V.1 Data Collection Practices of Banking and FinTech Apps: Assessing the 164 Necessity and Scope V.2 Impact of Digitalisation on Monetary Policy Transmission 173 IIILIST OF TABLES Sr. No. Page No.

I.1 Composition of Employees in Scheduled Commercial Banks (SCBs) 26 II.1 Products that Exited the Regulatory Sandbox and Adopted Commercially 71 III.1 Payments Infrastructure Development Fund (PIDF) 91 III.2 Consumer Digital Payments Awareness - by States 98 III.3 Gains from DBT and Other Governance Reforms of the Union Govern- 101 ment IV.1 Granger Causality Test Results between Digitalisation and Cross-Border 117 Digital Trade in Services IV.2 Scenario Assumptions for India’s Digital Trade Estimates 121 IV.3a India’s Trade Agreements with e-Commerce/Digital Trade Provisions 129 IV.3b India’s Trade Agreement with e-Commerce/Digital Trade Chapters 129 IV.4 Global Finance – Key Indicators 131 IV.5 Ways to Internationalise the INR 132 IV.6 Major Leading Digital Public Infrastructure and Digital Public Goods in 134 India IV.7 Key Learnings from Cross-Country DPIs 135 IV.8 Roadmap to Enhance Cross-Border Payments: Global Targets to be 141 Achieved by end - 2027 V.1 FinTechs and Financial Stability 168 IVLIST OF CHARTS Sr. No. Page No.

I.1 Size of the Core Digital Economy in Select Countries 3 I.2 Region-wise Cashless Payments 3 I.3 Growth in Global FinTech Ecosystem 4 I.4 Digitally Connected Population in India 6 I.5 Trends in Digital Enablers in India 6 I.6 India Stack – Schematic Presentation 7 I.7 Jan Dhan Beneficiaries and RuPay Cards 7 I.8 e-Delivery of Government Services in India by Sector 8 I.9 Payment Infrastructure 8 I.10 Global Footprint of India’s DPI 9 I.11 Global Trends in Bank Account Ownership 11 I.12 Global Trends in Mobile Money Account Ownership 11 I.13 Strides in India’s Financial Inclusion 12 I.14 Digital Penetration – Lower-Income States Catching Up 12 I.15 Cumulative Gram Panchayats Connected through BharatNet 13 I.16 Digital Literacy Program Beneficiaries 13 I.17 Gender-wise Adoption of Digital Enablers 13 I.18 Gender Divide Goes Down in India 14 I.19 Direct Benefit Transfers in India 14 I.20 Composition of Outstanding Loans 15 I.21 Integration of Mandis with the e-NAM Platform 16 I.22 Distribution of Kisan Credit Card among Agricultural Households 16 I.23 Progress in Digitisation of Land Records 17 I.24 Usage of Electronic Media by Farmers 17 I.25 Digitally Enabled Cross-border Flows in India 18 VSr. No. Page No.

I.26 Composition of Power Sector in India 19 I.27 Role of ICT in Inflation in India 19 I.28 India’s e-Commerce Market – Projected Growth 20 I.29 Herfindahl-Hirschman Index (HHI) of UPI Applications 21 I.30 Security Incidents in India 22 I.31 Industry-wise Distribution of Cyber Attacks India - 2023 22 I.32 Global Average Data Breach Costs 22 I.33 Complaints under RB-IOS, 2022-2023 23 I.34 Dark Patterns 24 I.35 Privacy Practices in FinTech Applications 25 I.36 Top 10 Countries in Embedded Finance Revenue, 2022 25 I.37 Affordability and Speed of Internet Services 25 I.38 Average Employee Turnover Rates in SCBs - 2022-23 26 I.39 Relative AI Skill Penetration Rate 26 I.40 Adoption of Fintech-specific Regulations Worldwide 29 I.41 Artificial Intelligence - Global Landscape 29 II.1 Financial Innovations – A Conceptual Framework 41 II.2 India’s GDP Growth 42 II.3 Consumption and Bank Credit 42 II.4 Maturity Profile of Loans and Advances by SCBs 43 II.5 Share in Total Credit of SCBs by Population-group 43 II.6 Share of FinTech Funding in Total Startup Funding in India 43 II.7 Banks’ Focus on Digital Technologies 44 II.8 Bank-group wise Focus on Digitalisation and Cyber Security 45 II.9 NBFC-ICCs’ Focus on Digitalisation and Cyber Security 46 II.10 Survey on Innovation Adoption by Banks 47 II.11 Growth in the Issuance of Cards 48 VISr. No. Page No.

II.12 Adoption of Cards for Digital Transactions 48 II.13 Usage of Mobile and Internet Banking by Customers 49 II.14 Mobile Banking Adoption by Customers vis-à-vis Bank Size 49 II.15 User Ratings of Mobile Banking Applications 49 II.16 Bank-group wise Average User Rating of Mobile Banking 50 Applications II.17 Average User Ratings of Mobile Applications – NBFC-ICCs and 50 LSPs II.18 Issuance of Prepaid Payment Instruments (PPIs) to Customers 50 II.19 Overlap in FinTech Activities 51 II.20 FinTech Collaboration Index of Financial Institutions 52 II.21 Services Provided through Collaboration between Banks/NBFCs 52 and FinTechs II.22 Indicators of Embedded Finance in India 53 II.23 BigTech Sales in India 53 II.24 Collaborations of BigTechs with Banks for UPI 54 II.25 BigTech Penetration in UPI Payments 54 II.26 BigTechs’ Collaborations with FIs for BNPL and Co-branded Credit 55 Cards II.27 Revenues of B2C e-Commerce Startups in India 55 II.28 BNPL in e-Commerce – Global Picture 55 II.29 Digital Lending Ecosystem in India 56 II.30 Digital Personal Loans of Select SCBs - 2022-23 56 II.31 Lending by FinTechs Registered as NBFC-ICCs 57 II.32 Annual Revenue of Select FinTech LSPs 57 II.33 Lending through e-Commerce Platforms 57 II.34 Characteristics of Loans using FinTechs 58 II.35 FinTech Loan Origination by Value in 2022-23 59 VIISr. No. Page No.

II.36 Distribution of FinTech Personal Loans by Ticket Size 59 II.37 FinTechs Personal Loans by Average Ticket Size 59 II.38 FinTechs Personal Loans by Gender 59 II.39 Share of FinTech Personal Loans by Population Group 60 II.40 Composition of EMI Options on a BigTech Platform 60 II.41 Availability of EMIs across Durations 61 II.42 Flow of Data under AA 62 II.43 Progress of NBFC-AAs 63 II.44 Progress in MSME Financing through TReDS 64 III.1 Open Loop Payment System (UPI’s case) 79 III.2 Closed Loop Payment System 79 III.3 Cross-country Trends in Retail Digital Payments 80 III.4 Relative Importance of Different Forms of Retail Digital Payments, 80 2022 III.5 Retail Digital Payments as Percentage of Total Retail Payments 81 III.6 A2A RTP Transactions 82 III.7 Progress in A2A RTP Payments 82 III.8 Mobile Money 83 III.9 Evolution of Payment System Landscape in India 85 III.10 Payment System in India in a National Innovation Systems (NIS) 88 Framework III.11 Payment System Operators and Systems 90 III.12 Payment Systems Landscape in India 92 III.13 Intensity of Digital Payments Adoption 93 III.14 Retail Payments Trend 94 III.15 Timeline of UPI Evolution and Adoption 95 III.16 Parameters (Weight in Parentheses) and Sub-parameters of RBI’s 95 Digital Payments Index (DPI) VIIISr. No. Page No.

III.17 RBI - Digital Payments Index 96 III.18 Merchant Digital Payments - Awareness, Adoption and Usage in 96 2022 III.19 Consumer Digital Payments - Awareness, Adoption and Usage in 97 2022 III.20 Consumer Digital Payments - by Age Group 97 III.21 Consumer Digital Payments - by Gender 98 III.22 Deposit Accounts with Commercial Banks 100 III.23 Progress in Financial Inclusion (FI Index) 100 III.24 Currency in Circulation (CiC) to GDP Ratios 103 III.25 CiC and Digital Payments in India 103 III.26 India’s Broad Money (M3) and its Components 104 III.27 Digital Literacy across States and UTs, Rural and Urban Areas 107 Combined IV.1 Cross-Country Indicators on Digital Infrastructure and Value Added 116 in ICT Digital Infrastructure - 2022 IV.2 Conceptual Framework for Digital Trade 116 IV.3 Open Economy Digitalisation – A Schematic Presentation 117 IV.4 Cross-Border Digital and Non-Digital Trade: India vis-à-vis World 118 IV.5 India’s Trade in ICT Goods 119 IV.6 Cross-Border Digital Trade in Services: India vis-à-vis World 120 IV.7 Decomposition of India’s Digitally Delivered Services Trade Growth 120 IV.8 Digital Trade Estimates: India vis-à-vis World 122 IV.9 Remittances and Average Sending Cost 124 IV.10 Population Projections: India vis-à-vis Ageing Economies 125 IV.11 Remittances to India 125 IV.12 Banks, MTOs and RemTechs: Forex Margins and Costs 126 IV.13 Digital Trade Policies – Global Trends 129 IxSr. No. Page No.

IV.14 Number of Countries with Real Time Payments System 137 IV.15 Number of Data Centres - 2024 144 IV.16 Data Centre Density - 2024 144 IV.17 Data Centres - Investment and Key Drivers 145 IV.18 Global Enterprise Cloud Strategy 145 IV.19 Sectoral Mapping of Data Localisation Measures 146 IV.20 Revenue from Data Centres 147 IV.21 Global Spending on Cloud and Data Centres 147 V.1 Reasons behind Adoption of Digital Technologies 155 V.2 Types of Costs Reduced Following the Adoption of Digital 156 Technologies and Automation V.3 Impact of Digital Technologies on Customer Acquisition and Retention 156 V.4 Use of Digital Modes in Banks 157 V.5 Types of Loans Provided Digitally 157 V.6 Bank Branches in India 157 V.7 Expectations about the Role of Physical Branches in the Next Five 158 Years V.8 Reasons for Continued Importance of Physical Bank Branches 158 V.9 Current Association between Banks/NBFCs and FinTechs 159 V.10 Effectiveness of Collaboration between Banks/NBFCs and FinTechs 159 in Driving Digital Innovation V.11 Implications of New Innovative Digital Technologies on the Existing 159 Business Models V.12 Primary Challenges Hindering the Successful Adoption of Digital 160 Technologies V.13 Emerging Digital Technologies Impacting Banking in the Next Five 160 Years V.14 Motives behind Use of Cloud Computing Services 160 xSr. No. Page No.

V.15 Challenges in Using Cloud Computing Services 161 V.16 Potential Risks and Challenges of the Ongoing Digitalisation for the 161 Financial Sector V.17 Types of Risks that are Expected to Arise in Future 161 V.18 Role of Regulations with Respect to FinTechs 162 V.19 Adequacy of Existing Infrastructure to deal with Major Risks 163 V.20 Global BNPL Market Size 164 V.21 Complaints Received under RBI Ombudsman Framework 166 V.22 Distribution of Loan Origination by Lenders in India during 2023- 168 2024 V.23 Same Day Processing of Personal Loan Applications 169 V.24 Share of New and Above-Prime Borrowers in FinTech Lending 169 V.25 Banks’ UPI Downtime in India 170 V.26 Rolling Regression Estimates of Monetary Policy Transmission 172 V.27 Global AI Adoption 174 xIANNEX Sr. No. Page No.

I.1 India’s Digital Evolution Timeline 38 I.2 The Digital Personal Data Protection Act, 2023 39 xIILIST OF ABBREVIATIONS 5G Fifth Generation BBPOU Bharat Bill Payment Operating Unit A2A Account-to-account BBPS Bharat Bill Payment System AA Account Aggregator BCBS Basel Committee on Banking AD Authorised Dealer Supervision ADB Asian Development Bank BFSI Banking, Financial Services and AE Advanced Economy Insurance AePS Aadhar Enabled Payment BHIM Bharat Interface for Money System BigTech Large Technology Company AFA Additional Factor of Authentication BIS Bank for International Settlements AGR Alternate Grievance Redress BNPL Buy Now Pay Later AI Artificial Intelligence BoP Balance of Payment AML Anti Money Laundering BPSS Board for Regulation and Supervision of Payment and AML/CFT Anti-Money Laundering and Settlement System Combating the Financing of Terrorism BRICS Brazil, Russia, India, China and South Africa APBS Aadhaar Payments Bridge System BSA Bilateral Swap Agreement API Application Programming Interface C-DOT Centre for Development of APR Annual Percentage Rate Telematics AR Augmented Reality CASA Current Account Saving Account ARDI Annual Report Digitalisation Index C2B Consumer-to-business ARDL Autoregressive Distributed Lag C2C Consumer-to-consumer ASAG Advanced Supervisory Analytics Group CAGR Compound Annual Growth Rate ASEAN Association of Southeast Asian CBDC Central Bank Digital Currency Nations CBDC-R Central Bank Digital Currency- ASUSE Annual Survey of Retail Unincorporated Sector CBDC-W Central Bank Digital Currency- Enterprises Wholesale ATM Automated Teller Machine CBS Core Banking Solutions B2B Business-to-business CBUAE Central Bank of the UAE B2C Business-to-consumer CCIL Clearing Corporation of India BAU Business as Usual Limited xIIICCPA Central Consumer Protection DEPA Data Empowerment and Authority Protection Architecture CD Certificate of Deposit DFS Digital Financial Services CECPA Comprehensive Economic DGFT Directorate General of Foreign Cooperation and Partnership Trade Agreement DIGIT Digital Infrastructure for Governance, Impact and CEPA Comprehensive Economic Transformation Partnership Agreement DILRMP Digital India Land Records CERT-In Indian Computer Emergency Modernisation Programme Response Team DIP Digital Intermediation Platform CFL Centre for Financial Literacy DLAI Digital Lenders Association of CiC Currency in Circulation India CIMS Centralised Information DLG Default Loss Gurantee Management System DLT Distributed Ledger Technology CLS Continuous Linked Settlement DNA Data-Network-Activity CoFT Card-on-File Tokenisation DP Digital Payments CoWIN COVID-19 Vaccine Intelligence DPDPA Digital Personal Data Protection Network Act CPMI Committee on Payments and DPG Digital Public Goods Market Infrastructures DPI Digital Public Infrastructure CPMI-IOSCO Committee on Payments and DPI Digital Payment Index Market Infrastructures - DPIIT Department for Promotion of International Organisation of Industry and Internal Trade Securities Commissions DSGE Dynamic Stochastic General CPS Centralised Payment System Equilibrium CRPC Centralised Receipt and DSL Digital Subscriber Line Processing Centre DSTRI Digital Services Trade CTS Cheque Truncation System Restrictiveness Index DBT Direct Benefit Transfer DSUT Digital Supply and Use Tables DBU Digital Banking Unit e-BAAT Electronic Banking Awareness DEA Data Envelopment Analysis and Training DEA Digital Economy Agreement e-Commerce Electronic Commerce DeFi Decentralized Finance e-KYC Electronic Know Your Customer xIVe-NAM Electronic-National Agricultural FL Financial Literacy Market FPS Fast Payment System EASE Enhanced Access and Service FSB Financial Stability Board Excellence FSDC-SC Financial Stability and ECS Electronic Clearing Service Development Council Sub- EDDPE Expanding and Deepening of Committee Digital Payment Ecosystem FX Foreign Exchange EFT Electronic Funds Transfer G-sec Government Securities EM Emerging Market G20 Group of 20 EMD Earnest Money Deposit G2B Government-to-business EMDE Emerging Market and G2C Government-to-consumer Developing Economy G2P Government-to-person EME Emerging Market Economy G7 Group of Seven EMI Equated Monthly Instalment GB Gigabyte EU European Union GBIEM Global Bond Index for Emerging EUR Euro Markets EV Electric Vehicle GBP Great British Pound FACE FinTech Association for GCC Global Capability Centre Consumer Empowerment GDP Gross Domestic Product FATF Financial Action Task Force GDPR General Data Protection FDI Foreign Direct Investment Regulation FE Fixed Effects GeM Government Electronic FEMA Foreign Exchange Management Marketplace Act GenAI Generative Artifical Intelligence FI Financial Institution GFC Global Financial Crisis FI-Index Financial Inclusion Index GFCF Gross Fixed Capital Formation FIMMDA Fixed Income Money Market and GIFT Gujarat International Finance Derivatives Association of India Technology-City FinTech Financial Technology GIFT Global Interchange for Financial Transactions FIP Financial Information Provider GIS Geographic Information System FIRE Format for Incident Reporting Exchange GoI Government of India FIT Flexible Inflation Targeting GPRS General Packet Radio Service FIU Financial Information User GST Goods and Services Tax xVGSTN Goods and Services Tax INR Indian Rupee Network IoRS Interoperable Regulatory Sandbox GVA Gross Value Added IoT Internet of Things GVC Global Value Chain IPP Instant Payment Platform GW Giga Watt IPR Intellectual Property Right HHI Herfindahl-Hirschman Index IRDAI Insurance Regulatory and HPJ Half-Panel Jackknife Development Authority of India IAMAI Internet and Mobile Association IRTG Inter-Regulatory Technical of India Group ISO International Organization for IBCC Indian Banking Community Standardization Cloud IT Information Technology ICAAP Internal Capital Adequacy Assessment Process JAM Jan Dhan-Aadhaar-Mobile KCC Kisan Credit Card ICMTS Integrated Compliance Management and Tracking KFS Key Fact Statement System KLEMS Capital (K), Labour (L), Energy (E), ICT Information and Communications Materials (M) and Services (S) Technology KYC Know Your Customer ID Identification LAN Local Area Network IDRBT Institute for Development and LA Loan Agent Research in Banking Technology LCS Local Currency Settlement IFAD International Fund for LDA Latent Dirichlet Allocation Agricultural Development LDE Loss Data Exchange IFSC International Financial Services LEI Legal Entity Identifier Centre LFPR Labour Force Participation Rate IFSCA International Financial Services LLM Large Language Model Centres Authority LMIC Low- and Middle-Income IFTAS Indian Financial Technology and Country Allied Services LSP Lending Service Provider ILO International Labor Organization M0 Reserve Money IMF International Monetary Fund M1 Narrow Money IMPS Immediate Payment Service M3 Broad Money INFINET Indian Financial Network Mbps Megabits Per Second xVImCBDC Multiple Central Bank Digital NETC National Electronic Toll Collection Currency NFC Near Field Communication MeitY Ministry of Electronics and NFS National Financial Switch Information Technology NGCH National Grid Clearing House MICR Magnetic Ink Character NIM Net Interest Margin Recognition NIPL NPCI International Payments ML Machine Learning Limited MOSIP Modular Open Source Identity Platform NIS National Innovation System MoU Memorandum of Understanding NKPC New Keynesian Phillips Curve MPI Multidimentional Poverty Index NLP Natural Language Processing MSME Micro, Small and Medium NPCI National Payments Corporation Enterprise of India MTO Money Transfer Operator NPI National Payments Interface MW Mega Watt NSE National Stock Exchange NACH National Automated Clearing NSO National Statistical Office House OCEN Open Credit Enablement Network NASSCOM National Association of Software OECD Organisation for Economic and Services Companies Co-operation and Development NBBL NPCI Bharat BillPay Limited OFC Optical Fibre Cable NBFC Non-Banking Financial Company OLS Ordinary Least Squares NBFC-HFC Non-Banking Financial Company - Housing Finance Company ONDC Open Network for Digital Commerce NBFC-ICC Non-Banking Financial Company - Investment and Credit Company ORBIOs Offices of RBI Ombudsman NBFC-MFI Non-Banking Financial Company OTC Over the Counter - Micro Finance Institution P2B Person-to-business NCFE National Centre for Financial P2M Peer-to-merchant/Person-to- Education merchant NDP Net Domestic Product P2P Peer-to-peer/Person-to-person NDS-OM Negotiated Dealing System PA Payment Aggregator - Order Matching PDAI Primary Dealers’ Association of NEFT National Electronic Funds Transfer India NeGP-A National e-Governance Plan in PFRDA Pension Fund Regulatory and Agriculture Development Authority xVIIPG Payment Gateway RoA Return on Assets PIDF Payment Infrastructure RPC Regional Payment Connectivity Development Fund RRB Regional Rural Bank PLI Production Linked Incentive RTA Regional Trade Agreement PMJDY Pradhan Mantri Jan Dhan Yojana RTGS Real Time Gross Settlement PoC Proof of Concept RTP Real-time Payment PoS Point of Sale RS Regulatory Sandbox PPI Prepaid Payment Instrument S-SOC Sectoral Security Operations PPI-MTS Prepaid Payment Instruments- Centre Mass Transit System SAARC South Asian Association for PPF Public Provident Fund Regional Cooperation PRAVAAH Platform for Regulatory Application, SaaS Software as a Service Validation and Authorisation SCB Scheduled Commercial Bank PSBA PSB Alliance SDG Sustainable Development Goal PSO Payment System Operator SEBI Securities and Exchange Board PSP Payment Service Provider of India PSS Act Payment and Settlement SFB Small Finance Bank Systems Act SFMS Structured Financial Messaging PSTN Public Switched Telephone System Network SGD Singapore Dollar PTPFC Public Tech Platform for SLBC State Level Bankers’ Committee Frictionless Credit PVB Private Bank SME Small and Medium Enterprise PvP Payment versus Payment SMS Short Message Service PwC Pricewaterhouse Coopers SNA System of National Accounts QR Quick Response SRO Self-Regulatory Organisation RBI Reserve Bank of India SRO-FT Self-Regulatory Organisation for FinTech Sector RB-IOS Reserve Bank-Integrated Ombudsman Scheme SRVA Special Rupee Vostro Account RBIH Reserve Bank Innovation Hub STP Straight Through Process RCA Revealed Comparative Advantage SupTech Supervisory Technology RegTech Regulatory Technology SWIFT Society for Worldwide Interbank RE Regulated Entity Financial Telecommunication xVIIITAPED Trade Agreement Provisions on UNEP United Nations Environment Electronic-commerce and Data Programme TFP Total Factor Productivity UPI Unified Payments Interface TPAP Third-party Application Provider US United States TPSP Third-party Service Provider USD US Dollar TRAI Telecom Regulatory Authority of USSD Unstructured Supplementary India Service Data TReDS Trade Receivables Discounting System UT Union Territory TSP Technology Service Providers UTLBC Union Territory Level Bankers’ UAE United Arab Emirates Committee UN United Nations VR Virtual Reality UNCTAD United Nations Conference on WEF World Economic Forum Trade and Development WTO World Trade Organisation UNDP United Nations Development Programme YTD Year till Date This Report can also be accessed on Internet

URL : www.rbi.org.in xIxINDIA’S DIGITAL REVOLUTION:

I OPPORTUNITIES AND CHALLENGES* Digitalisation has fundamentally transformed the global economy, reshaping economic growth, employment, consumer welfare and living standards. In the adoption of digital technologies, the internationally recognised India Stack, a growing FinTech ecosystem and a burgeoning digitally-inclined population, combined with expanding internet and mobile connectivity, are driving India to become the fastest-growing digital economy. While digital technologies offer various opportunities for India, such as faster growth, financial inclusion and seamless fiscal transfers and cross-border payments, they also present challenges related to cybersecurity, data privacy and concentration risks.

Balancing financial stability, customer protection and fair competition in this dynamic landscape, the Reserve Bank is actively involved in developing a safe, efficient and robust digital ecosystem.

1. Introduction 2022). Perhaps the most dramatic effects of digitalisation are evident in the metamorphosis I.1 Over the past three decades, a silent of the financial infrastructure, including through revolution has been transforming the world, its network externalities. Financial transactions are tides sweeping across advanced and developing conducted more speedily and efficiently in real economies alike, with countries like India riding its time; the ambit of financial inclusion expands crest. The speed and scale of the digital revolution, over time and space; and fiscal transfers occur as it is ubiquitously known, has eclipsed all past seamlessly and with precision.

revolutions. Over the past decade itself, the global I.3 India is at the forefront of the digital digital economy has grown 2.5 times faster than revolution. As the next section portrays, it the physical world economy to account for more embraces not just financial technology (FinTech) than 15 per cent of global GDP (UN, 2023). As speeding up digital payments but also the the political commentator and author Thomas celebrated India Stack comprising biometric Friedman points out, the world’s gone from flat to identification, the unified payments interface fast, to smart, to deep (Friedman, 2019)!

(UPI), mobile connectivity, digital lockers I.2 Digital technologies are reshaping our and consent-based data sharing. The digital lives through their impact on economic growth, revolution is galvanising banking infrastructure employment, consumer welfare and living and public finance management systems standards. Process innovations are rapidly being covering both direct benefit transfers and tax generated, markedly in information collection, collections. Vibrant e-markets are springing up storage and exchange. Digital technologies are and expanding their reach. It is estimated that democratising innovation and entrepreneurship, the digital economy currently accounts for a tenth being less costly than conventional technologies of India’s GDP; going by growth rates observed to scale up and are seen as transfiguring over the past decade, it is poised to constitute a innovators into entrepreneurs (Panagariya, fifth of GDP by 2026 (Chandrasekhar, 2023).

* This chapter has been prepared by a team comprising Michael Debabrata Patra, Sarat Dhal, Rakhe Balachandran, Sakshi Awasthy, Kunal Priyadarshi, Soumasree Tewari, Ranjeeta Mishra, Rachit Solanki, Satyarth Singh, Abhinandan Borad, Rajnish Chandra and D. Suganthi.

1REPORT ON CURRENCY AND FINANCE I.4 Several enabling forces have come economy in the world with a digital ecosystem together to energise this revolution. Although set to cross US$ 1 trillion by 2025 (MeitY, 2019), internet penetration in India was at 55 per cent in the theme of this year’s report, India’s Digital 2023, the internet user base has grown by 199 Revolution, virtually selects itself. In this chapter, million in the recent three years (IAMAI-Kantar, we peer into the future at the fundamental ways in

2024). India’s cost per gigabyte (GB) of data which it will impact our developmental aspirations consumed is the lowest globally at an average and strategies after briefly reviewing the state of of ₹13.32 (US$ 0.16) per GB (Cable.co.uk, play in Section 2. Section 3 takes on a forward-

2024). India also has one of the highest mobile looking perspective, evaluating the exciting data consumption in the world, with an average opportunities that digitalisation is likely to throw up per-user per-month consumption of 24.1 GB in in this transformation, including through artificial 2023 (GSMA, 2024; Nokia, 2024). There are intelligence (AI). Section 4 assesses the trade- about 750 million smartphone users, which is offs involved in the challenges of digitalisation, expected to reach about one billion by 2026. India sometimes considered as a disruptive technology is expected to be the second largest smartphone at least in respect of traditional technologies, the manufacturer in the next five years (Deloitte, labour market and the like. Digital transformation is

2022). India has the world’s third largest startup also resource-intensive in demanding substantial ecosystem with over 1.4 lakh startups and over investment in technology, learning, infrastructure 100 unicorns (DPIIT, 2024; Tracxn, 2024a). The and above all, adaptability of employees and heavily tech-based startup ecosystem includes management to new digital tools and processes.

various sectors like FinTech platforms, viz., Digitalising operations can expose entities to potential cyber threats and data breaches, insurance and payments, gaming, software as a necessitating robust cybersecurity measures. The service (SaaS)-based tools, logistics, healthcare adoption of AI also brings challenges, including services, education technology, e-commerce ethical concerns, data privacy and potential and online markets. India has also leveraged on malicious use. Recent policy initiatives by Reserve public-private collaboration in the digitalisation Bank of India (RBI) are discussed in Section 5. The of its economy, with the government working on

chapter concludes with Section 6, which lays out telecom infrastructure projects with multinational the structure of the rest of the report, the theme of investors. Since 2015, the “Digital India” initiative each succeeding chapter and key findings.

has been expanding digital infrastructure across the country and further reforms are either 2. The State of Play operational such as the Open Network for Digital I.6 The term “digital economy” is believed to Commerce (ONDC) or on the anvil such as the have been coined in 1996 (Tapscott, 1996; ADB, BharatNet project, investments in developing 5G

2021). In a formal sense, it has been defined as the and 6G infrastructure, the internationalisation of contribution of any economic transaction involving digital public infrastructure, the digital rupee and both digital products and digital industries to GDP the development of data centres.

- digital products being goods and services with I.5 With India on course to reap late mover the main function of generating, processing and/or advantages to become the fastest growing digital storing digitised data (ADB, 2021). Digitalisation 2INDIA’S DIGITAL REVOLUTION:

OPPORTUNITIES AND CHALLENGES Chart I.1: Size of the Core Digital Economy in Chart I.2: Region-wise Cashless Payments Select Countries

Note: The core aspects of the digital economy comprise hardware technologies (computers and digital communication devices), software and web services (data processing and hosting) and enabling infrastructure (internet and telecommunication networks). The GDP share of the digital economy shows a decline or increase at a slower rate for some economies

owing to the falling prices of core digital products and increasing Note: Data pertain to retail digital payments and include payments done productivity of digital products over time (ADB, 2021). through cheques as well.

Source: ADB, 2021. Source: Committee on Payments and Market Infrastructures, BIS, 2024. has varied across geographies, reflecting differing in 2023, led by India (US$ 115.3 billion), Mexico levels of infrastructure, regulatory frameworks (US$ 66.2 billion), China (US$ 49.5 billion) and and technological readiness. For countries like the Philippines (US$ 39.1 billion) [World Bank, India, Malaysia and Thailand that have been fast 2024; RBI, 2024a].

adopters, the service-oriented structure of their I.8 Digitalisation has diversified the range economies has fostered deeper forward linkages of players in the financial services industry, with with core digital activities than others (Chart I.1).

a significant increase in the number of FinTechs I.7 In the financial sector, payment systems across nations (Chart I.3a). FinTechs are attracting serve as the first point of entry for digital funds from a range of investors, resulting in the technologies (Bech et al., 2018), with digital total value of FinTech investments standing at payment platforms, contactless cards and mobile US$ 61 billion globally in 2023 (Chart I.3b). India wallets becoming all-pervasive. Globally, BRICS is one of the top recipients of FinTech funding nations1 are contributing a larger share to total in recent years, with US$ 2.6 billion of flows in cashless payments than advanced nations 2023 (Tracxn, 2024b).2 Along with FinTechs, large (BIS, 2024) [Chart I.2]. India is leading the world technology companies (hereafter BigTechs) have with a share of 48.5 per cent in global real-time also entered the financial industry.

payments volume (ACI Worldwide, 2024). Global remittances that are increasingly being effected I.9 Advancements in digital payment systems, through mobile money and digital platforms are along with the increasing presence of FinTechs estimated to have increased to US$ 857.3 billion and BigTechs in the financial sector, is structurally 1 Brazil, Russia, India, China and South Africa.

2 Other countries being the US, UK and China.

3 noillib ni emuloV 1400 1200 1000 800 600 400 200 0 3102 4102 5102 6102 7102 8102 9102 0202 1202 2202 Advanced Economies BRICS Other Emerging EconomiesREPORT ON CURRENCY AND FINANCE Chart I.3: Growth in Global FinTech Ecosystem a. Rise in FinTechs b. Global FinTech Funding and Rounds

Note: Americas include North and South America; EMEA is Europe, the Middle East and Africa; APAC is Asia–Pacific. Data for 2022 is not available in chart a.

Source: Statista, Tracxn Database accessed in May 2024, and RBI staff estimates. shifting the global credit markets. Lending from 2.1 The Indian Experience FinTechs and BigTechs has steadily increased from I.10 India’s digital revolution is a blend of US$ 132 billion and US$ 22 billion, respectively, government-led initiatives and enabling regulatory in 2015 to US$ 223 billion and US$ 572 billion frameworks of financial market regulators (the in 2019, with BigTech credit projected to reach Reserve Bank and the Securities and Exchange US$ one trillion by 2023, indicating heightened Board of India (SEBI)) [Annex I.1]. This journey competition between traditional lenders and new traverses four phases since independence players (Cornelli et al., 2020; Asian Banker, 2022). (Box I.1).

Box I.1 History of India’s Digitalisation

Phase I: Digital Awakening (1950s-1980s) paved the way for electronic data processing in banks, introduction of automated teller machine (ATM) networks Prior to the nationalisation of the financial system, and credit cards, and the implementation of BANKNET3 computers were mainly seen as labour-saving tools and faced strict controls due to fear of unemployment. and Magnetic Ink Character Recognition (MICR)-based In the 1980s, however, a significant shift towards systems. Banks progressed from standalone computers to computerisation began [Committee on Mechanisation in local area networks (LANs) and to core banking platforms.

the Banking Industry, 1984 (Chairman: Dr. C. Rangarajan);

Phase II: Liberalisation and the InfoTech Boom (1990s) Committee on Communication Network for Banks and SWIFT Implementation, 1987 (Chairman: Shri T.N.A. During the 1990s, India underwent advancements Iyer) and Committee on Computerisation in Banks, 1989 in computer and telecommunication technologies, (Chairman: Dr. C. Rangarajan)]. These initial efforts influenced by the emergence of the internet. Early (Contd...) 3 The Reserve Bank recognised the pressing need to harness information technology for intra-bank and inter-bank communications in the 1980s and set up BANKNET as the communication network for the banking sector.

4 shceTniF fo rebmuN noillib $SU sdnuoR fo rebmuN 35,000 30,000 25,000 20,000 15,000 10,000 5,000 0 Americas EMEA APAC 8102 9102 0202 1202 3202 4202 180 6000 160 5000 140 120 4000 100 3000 80 60 2000 40 1000 20 0 0 Total Funding Number of Rounds (RHS) 1102 3102 5102 7102 9102 1202 3202INDIA’S DIGITAL REVOLUTION:

OPPORTUNITIES AND CHALLENGES telecom developments in the preceding decade like reached a high point with the launch of the UPI in 2016.6 the establishment of the Centre for Development of The Indian Financial Technology and Allied Services Telematics (C-DOT) and industry associations like the (IFTAS) was set up in 2015 to provide crucial IT services National Association of Software and Service Companies for the Reserve Bank, and other banks and financial

(NASSCOM) laid the foundation for further telecom institutions. Supporting these initiatives, the government advancements and modern digital banking. The granting undertook key initiatives such as the Aadhaar project of statutory recognition to the SEBI, the establishment of (2009), National Telecom Policy (2012), Direct Benefit the National Stock Exchange (NSE) and the subsequent Transfer scheme (2013) and Pradhan Mantri Jan-Dhan shift from public outcry systems to dematerialisation Yojana (2014), which promoted affordability, reliability and of securities democratised access to capital markets. financial inclusion, culminating in the Jan Dhan-Aadhaar- Following the recommendations of the Narasimham Mobile (JAM) trinity. The Digital India Mission (2015) Committees4 and active support of the Reserve Bank5, the and Startup India Mission (2016) were also launched to decade saw rapid technological modernisation in banking, enhance digital infrastructure and innovation. In its debt including the launch of the Indian Financial Network management function, the Reserve Bank promoted a

(INFINET) and the adoption of internet banking during robust government security (G-sec) market through the the late 1990s. Rising competition from private banks Negotiated Dealing System – Order Matching (NDS-OM) and growing customer expectations drove public sector platform for anonymous order matching in the secondary banks to embrace large-scale information technology market transactions, followed by the fully digital Retail

(IT) solutions, enhancing operational efficiencies across Direct Scheme in 2021. financial institutions. Concurrently, India’s domestic IT

Phase IV: Digital Financial Innovation at Centre Stage and telecom industries grew to cater to the increasing (2017 onwards) technological needs of the financial sector, driven by supportive central and state government policies. By 2017, India established a robust digital infrastructure, positioning itself as a leader in innovative, large-scale

Phase III: Building the Institutional and Legal payment systems.7 A surge in financial innovations, with the Framework (2000 – 2016) round-the-clock availability of all major payment systems, The Information Technology Act of 2000 set the stage by including RTGS and NEFT, functionalities like offline providing legal recognition to electronic transactions and payments, feature phone payments and conversational filings. Following major advancements in digital payment payments, the launch of Central Bank Digital Currency systems such as the introduction of Real Time Gross (CBDC) pilots and initiatives like the Regulatory Sandbox Settlement (RTGS) in 2004 and National Electronic Funds (2019), the Reserve Bank Innovation Hub (2021) and the Transfer (NEFT) in 2005, the Payment and Settlement pilot Public Tech Platform for Frictionless Credit (PTPFC) Systems Act of 2007 was enacted to support the rapidly [2023] fostered FinTech innovations. Currently, the growing payments industry. The National Payments internationalisation of home-grown payment modes is also Corporation of India (NPCI) was established in 2008, which progressing rapidly, enabling cross border transfers and led the shift towards digitalisation of retail payments that projection of India’s soft power.

4 Report of the Committee on the Financial System (1991) and the Committee on Banking Sector Reforms (1998).

5 The Reserve Bank established the Institute for Development and Research in Banking Technology (IDRBT) in 1996 and constituted the Committee on Technology issues relating to Payments System, Cheque Clearing and Securities Settlement in the Banking Industry (Chairman: Shri W.S. Saraf) in 1994.

6 NPCI, as the umbrella organisation, created a strong payment and settlement infrastructure in India comprising the National Financial Switch (NFS) in 2004, the Immediate Payment Service (IMPS) in 2010, Aadhaar enabled Payment Systems (AePS) in 2010, the RuPay network in 2012, National Automated Clearing House (NACH) in 2016, National Electronic Toll Collection (NETC) in 2016 and the Bharat Bill Payment System (BBPS) in 2017, among others.

7 The High-Level Committee on Deepening of Digital Payments (Chairman: Shri Nandan Nilekani), 2019, advocated a secure, inclusive, and scalable digital payment ecosystem, promoting feature phone payments and simplified regulatory measures.

5REPORT ON CURRENCY AND FINANCE The two fundamental drivers of this wave of Chart I.4: Digitally Connected Population in India

digitalisation are: (a) ubiquitous connectivity through mobile, internet-connected devices and communication networks; and (b) low-cost computing and data storage.

I.12 India is home to the second largest telecom subscriber base (TRAI, 2023) and internet user base globally (ICRIER, 2024). The growth in digital enablers has been powered by competitive offerings by telecom operators, advent of global tech giants and among the cheapest data prices UPI unique users Social media users Smartphone users in the world (Chart I.5).

Internet subscriptions Wireless subscriptions Aadhaar issued Total population I.13 The average time Indian users spent

Note: Data for wireless subscriptions, internet subscriptions, smartphone users and social media users are not unique, i.e., one individual may be online i.e., 6.45 hours per day, is close to the holding multiple subscriptions.

Source: Jan Dhan Dashboard, Telecom Regulatory Authority of India global average (6.4 hours) [Statista, 2024a]. In

(TRAI), Statista and RBI staff estimates.

2023, Indian internet users logged the second I.11 India has one of the largest digitally highest application downloads at 26 billion (data. connected population worldwide (Chart I.4). ai, 2024). The median mobile download speed has Chart I.5: Trends in Digital Enablers in India

Note: Data pertain to end-March.

Source: TRAI, 2024, International Telecommunication Union (ITU), 2023 and Nokia Mobile Broadband Index 2024.

6 srotacidnI 424 467 750 954 1165 1380 1410 Numberin million 0 002 004 006 008 0001 0021 0041 0061INDIA’S DIGITAL REVOLUTION:

OPPORTUNITIES AND CHALLENGES also increased, climbing from 1.3 Megabits per on demand without the need for physical second (Mbps) in 2014 to 107.03 Mbps in June presence and facilitates seamless authentication, 2024, partly driven by the rollout of 5G (Vaishnaw, verification and integration of identity information.

2023; Ookla, 2024). Since its inception in 2009, the 12-digit Aadhaar has become the world’s largest biometric-based

2.2 Digital Public Infrastructure identification system, with 1.38 billion ID holders I.14 India’s foundational Digital Public covering 98 per cent of the population (UIDAI, Infrastructure (DPI) – the India Stack – has use 2024; MeitY, 2024). The subsequent launch of cases across a spectrum of economic activities the Pradhan Mantri Jan Dhan Yojana (PMJDY) that allow private and public players to innovate propelled Aadhaar-linked bank accounts for 52.5 and build customer-centric solutions (Chart I.6). crore citizens, increasing threefold since 2017.

Built on the pillars of providing DPI as a public More than 50 per cent of the account holders are good, encouraging private innovation by providing women and 67 per cent of the total accounts are in open access, creating a level-playing field through rural and semi-urban areas of the country (Chart regulatory framework and empowering individuals I.7) [PMJDY, 2024]. Account ownership in India through a consent-driven data-sharing framework, has more than doubled in 10 years from 35 per India Stack has facilitated population-scale cent in 2011 to 78 per cent in 2021 (World Bank, delivery of services in a cost-effective manner, 2021).

particularly benefitting marginalised segments (D’ I.16 Since 2014, there have been over 116 Silva et al., 2019; Alonso et al., 2023). billion Aadhaar-based authentications and 20 I.15 The identity layer of India’s DPI enables billion electronic-know your customer (e-KYC) secure and unique identification of individuals authentications.8 This has helped to formalise Chart I.6: India Stack – Schematic Presentation Chart I.7: Jan Dhan Beneficiaries and RuPay Cards

Note: Data pertain to end-March.

Source: RBI staff illustration. Source: Jan Dhan Dashboard, accessed in June 2024.

8 Other initiatives include the Co-Win app, Government e-Marketplace (GeM), Jeevan Praman and the Unified Mobile Application for New- age Governance (UMANG) app.

7 noillim nirebmuN 600 500 400 300 200 100 0 5102 6102 7102 8102 9102 0202 1202 2202 3202 4202 Rural/Semi-Urban Branches Metro/Urban Centres Number of RuPay Debit Cards IssuedREPORT ON CURRENCY AND FINANCE the economy, with the Goods and Services Tax several banking features, seamless fund routing Network (GSTN) onboarding 1.4 crore taxpayers and merchant payments. The payment platform and issuing over 400 crore e-way bills (NASSCOM, has facilitated secure, convenient and low-cost 2024; GST, 2024). Direct Benefit Transfers (DBTs) transactions between individuals, businesses and have streamlined subsidies and reduced leakages, governments on demand, with settlement in fiat with ₹6.9 lakh crore transferred directly for 315 money inside the formal financial system.

schemes reaching 176 crore beneficiaries (non- I.18 Digital payments have recorded a unique) in 2023-24. The DBTs have resulted in an compound annual growth rate (CAGR) of 50 per estimated ₹3.4 lakh crore in cost savings over the cent and 10 per cent in volume and value terms, years till March 2023 (DBT, 2024). The e-delivery respectively, in the last seven years9 involving of government services has expanded across 164 billion transactions worth ₹2,428 lakh crore sectors, particularly in finance, local government in 2023-24. Payment infrastructure has also utilities and social welfare schemes (Chart I.8).

received a boost from the Payment Infrastructure I.17 Under the payments layer, the Development Fund (PIDF) [Chart I.9].10 development of a real-time, round-the-clock, scalable and interoperable retail payment option I.19 The UPI has seen a tenfold increase in is enabled by the UPI. It powers multiple bank volume over the past four years, increasing from accounts into a single mobile application, merging 12.5 billion transactions in 2019-20 to 131 billion Chart I.8: e-Delivery of Government Services in India by Chart I.9: Payment Infrastructure Sector

Note: Mandatory e-services offered by States and Union Territories (UTs), as reported by National e-Governance Service Delivery Assessment Report,

2021.

Source: Statista and Department of Administrative Reforms and Public Grievances, GoI.

9 Between 2017-18 and 2023-24.

10 The PIDF scheme provides financial support to banks and NBFCs for expanding payment acceptance infrastructure in designated areas, including tier-3 to tier-6 cities and north-eastern India.

8INDIA’S DIGITAL REVOLUTION:

OPPORTUNITIES AND CHALLENGES transactions in 2023-24 - 80 per cent of all digital 2.3 Internationalisation of Digital Public payment volumes. Currently, the UPI is recording Infrastructure nearly 14 billion transactions a month, buoyed I.21 India’s DPI is going global by a) by 424 million unique users in June 2024. The collaborating with other nations to develop surpassing of UPI transactions volume for peer- digital identity solutions under the Modular Open to-merchant (P2M) transactions over the peer-to- Source Identity Platform (MOSIP) programme; b) peer (P2P) segment and high volume for small- interlinkage of the UPI with fast payment systems of other nations like Singapore’s PayNow, the value transaction categories indicate its high United Arab Emirates’ (UAE) Instant Pay Platform usage.

(IPP) and Nepal’s National Payments Interface I.20 The data exchange layer provides a

(NPI) for cost-effective and fast remittances; c) standardised, consent-driven and interoperable partnering with other central banks and foreign platform on which individuals, businesses and payment service providers to broaden UPI and government agencies can securely share and RuPay acceptance beyond geographical borders, access data for various purposes. Under the such as in countries like Bhutan, Mauritius, Singapore and the UAE; and d) sharing the Beckn Account Aggregator (AA) framework, entities protocol11 with nations to provide their public and are governed by the guidelines issued in 2016 private services through open, lightweight and by the Reserve Bank. AAs are built on the Data decentralised specifications (Chart I.10).

Empowerment and Protection Architecture (DEPA),

3. Expanding the Opportunities Frontier which serves as consent managers, empowering citizens to seamlessly access their financial data I.22 Digitalisation is unlocking opportunities and exchange it with third-party institutions. Since across various sectors of the economy. In this the framework was first launched in August 2021, Chart I.10: Global Footprint of India’s DPI nearly 80 million individuals and companies have benefited from easier access to financial services through AAs. Adoption is increasing rapidly, with around 40 million new accounts being linked in 2024 alone so far (Sahamati, 2024). DigiLocker, the online cloud-based document depository, has issued more than six billion documents, catering to 300 million users in 2024 (DigiLocker, 2024).

India has also enacted a Digital Personal Data UPI and RuPay MOSIP digital identity UPI Protection Act (DPDP Act) in 2023 to navigate the N pao yt me: e T nh t e in " tU eP rlI i" n c ka at ge eg so r ay n i dn c pl au rd te ns e rin shit ii pa sti v we is t hfo or t hU eP rI ca oc uce np trt ia en sc te o v dia ev Q elR o pc eo d Ue Ps I, - lf ia ks et infrastructure. The combined "UPI and RuPay" category covers countries where trade-off between ensuring effective regulation both UPI and RuPay acceptance initiatives are undertaken. The "MOSIP digital identity" category involves partnerships with countries to establish MOSIP-based digital identity systems.

and maintaining individual privacy (Annex I.2). Source: NPCI; MOSIP and RBI staff estimates.

11 Beckn protocol is a set of technology-agnostic specifications that allows the applications on Beckn to exchange information in a standardised manner irrespective of the technology form or medium of exchange.

9REPORT ON CURRENCY AND FINANCE

section, the focus is on areas where digitalisation transactions; and (v) supporting climate finance has permeated and has the potential to make and sustainability. In the process, economic value

further advances: (i) enhancing financial inclusion; generated by DPIs is expected to rise to 2.9 - 4.2

(ii) addressing gender, economic and social per cent of GDP by 2030 (NASSCOM, 2024), inequalities; (iii) channelling formal finance to lifting India’s growth while improving total factor agriculture; (iv) enabling seamless cross-border productivity (Box I.2).

Box I.2 Role of Digitalisation in India’s Future Growth Path Cross-country evidence has highlighted the positive Table 1: Real GVA Growth (Per cent) contribution of information communication and technology Scenarios 2030 2047

(ICT)12 to productivity (Kallal et al., 2021). Over the period Business as usual (BAU) 7.1 6.2 1980-2021, an augmented Cobb-Douglas production Scenario 1: Increase in non-ICT investment 8.1 7.0 function using KLEMS13 data with real gross value added while ICT investment growth is unchanged, given marginal increase in labour and productivity

(VA) at basic prices as a function of total factor productivity Scenario 2: Increase in both ICT and non-ICT 8.2 7.0

(TFP), labour (L), ICT capital (ICT) and non-ICT capital investment, given marginal increase in labour stock (K) can be written as: and productivity Scenario 3: Increase in both ICT and non-ICT 9.2 8.0 ... (1) investment, augmented by increase in labour employment and improved factor productivity Assuming constant returns to scale, equation (1) can be

Source: RBI staff estimates.

log linearised as: initial five years, based on the 10-year average of high ... (2) investment growth years), while investment growth in ICT capital and labour participation remains unchanged Based on factor income shares which are estimated to (Table 1 and Chart 1).

be 0.6 for K, 0.1 for ICT and 0.3 for L, the estimation of potential growth paths under different assumptions on Chart 1: Real GVA Growth (5 year Moving Average) factors of production shows that in the business as usual

(BAU) Scenario assuming all factors of production grow at historical trend rates and factor productivity growth remains constant, the economy can achieve a growth of 7.1 per cent by 2030, converging thereafter to its long run trend of 6.2 per cent by 2047. As gross fixed capital formation

(GFCF) has recorded robust growth in the recent years, increase in investment in non-ICT capital can lead to a higher growth path as indicated in Scenario 1, reaching

8.1 per cent by 2030 and 7.0 per cent by 2047 (assuming

Source: KLEMS and RBI staff estimates. growth of 7.8 per cent in non-ICT capital investments in the (Contd...) 12 Includes IT equipment, communications equipment, and software.

13 The KLEMS – Capital (K); Labour (L); Energy (E); Materials (M); and Services (S) – Database is part of a research project supported by the Reserve Bank to analyse productivity performance in the Indian economy at a disaggregated industry level.

10INDIA’S DIGITAL REVOLUTION:

OPPORTUNITIES AND CHALLENGES In Scenario 2, ICT investment growth in addition to the and non-ICT capital are augmented by growth in labour non-ICT capital investment under Scenario 1 will lead to a employment and improved total factor productivity.

higher growth path. Growth is, however, constrained by the The contribution of ICT capital to GVA growth highlights the current level of labour employment and factor productivity. crucial role of digital infrastructure. While it is necessary, it In this case, growth can reach 8.2 per cent by 2030.

is not sufficient to achieve the maximum growth potential.

Over time, the initial positive impact of ICT investments This hinges on technology driven momentum being diminishes, causing the growth rate to converge to that accelerated by higher employment and improved factor of Scenario 1. As investment’s contribution to growth productivity.

diminishes with increase in the capital-to-output ratio, the

References: investment-led growth path may lose momentum unless Kallal, R., Haddaji, A., and Fitti, Z. (2021). ICT Diffusion and supported by reforms that focus on productivity, human

Economic Growth: Evidence from the Sectoral Analysis of capital and higher labour force participation (RBI, 2022). a Periphery Country. Technological Forecasting and Social This is corroborated by Scenario 3 where the maximum Change, 162.

growth is achieved with a peak of 9.2 per cent by 2030 Reserve Bank of India. (2022). Revive and Reconstruct. and reaching 8.0 per cent by 2047, if investments in ICT Report on Currency and Finance 2021-22.

3.1 Financial Inclusion I.24 The evolution and adoption of technological advancements have led to massive improvement I.23 Digitalisation offers a unique and dynamic in deepening of digital financial services (Das, opportunity to expand the reach of financial

2021). Globally, there has been a notable increase services to the entire population, especially in the use of mobile money accounts, bridging disadvantaged and voiceless sections, thereby the gap between retail accounts and payments formalising the economy. Globally, there has been in emerging market and developing economies an increase in bank account ownership from 61

(EMDEs) [Chart I.12]. per cent of the adult population in 2014 to 74 per cent in 2021 (Chart I.11).

Chart I.11: Global Trends in Bank Account Ownership Chart I.12: Global Trends in Mobile Money Account Ownership

Source: World Bank Global Findex Database, 2021. Source: World Bank Global Findex Database, 2021.

11 0 01 02 03 04 05 06 07 08 09 World Sub-Saharan Africa Middle East and North Africa South Asia Latin America and Caribbean Europe and Central Asia East Asia and Pacific Per cent 2014 2017 2021 2014 2017 2021 0 5 01 51 02 52 03 53 World Sub-Saharan Africa Middle East and North Africa South Asia Latin America and Caribbean Europe and Central Asia East Asia and Pacific Per centREPORT ON CURRENCY AND FINANCE I.25 The potential for expanding financial inclusion in India by application of digital technologies is high in view of existing conditions.

First, the progress of financial inclusion in India is evident in the Reserve Bank’s Financial Inclusion Index and narrowing account access gap between income groups. In addition, usage has increased in borrowings, remittances and the receipt of private sector wages (Chart I.13).

Chart I.13: Strides in India’s Financial Inclusion a. Financial Inclusion Index I.26 Second, in rural India, 46 per cent of the population consists of wireless phone subscribers (TRAI, 2024) and 54 per cent are active internet users (IAMAI-Kantar, 2024). Internet accessibility b. Income Group-Wise Account Ownership in low-income states has recorded a higher average growth than in relatively higher-income states (Chart I.14).

I.27 Third, given that more than half of FinTech consumers are from semi-urban and rural India and more than a third of digital payment users are from rural areas (TransUnion CIBIL, 2023), there is potential for furthering digital penetration c. Usage of Financial Accounts and closing the rural-urban gap. Over two lakh gram panchayats have been connected through BharatNet in the last decade, enabling provision of services like e-health, e-education and e-governance in rural areas (Chart I.15). Various initiatives have also been taken to promote digital literacy in rural India (Chart I.16). The adoption of a community-led participatory approach through the establishment of Centres for Financial Literacy

Source: RBI and World Bank Global Findex Database, 2021.

(CFL) and the National Centre for Financial 12 eulav xednI tnec reP tnec reP )ega fo sraey 51 > snosrep( )ega fo sraey 51 > snosrep( 70 64.2

60.1 60 53.1 53.9 56.4

49.9 50 43.4 46 40 30 20 10 0 71-raM 81-raM 91-raM 02-raM 12-raM 22-raM 32-raM 42-raM Chart I.14: Digital Penetration - Lower-Income States Catching Up 12 Assam 9 Bihar 6 3 UP MP Odisha Maharashtra 0 WB KLKarnataka -3 Rajasthan TN -6 HR AP GJ -9 Punjab -12 -15 HP -18

0.3 0.8 1.3 1.8 2.3 2.8 Per capita average NDP ( lakh)

Note: UP: Uttar Pradesh, MP: Madhya Pradesh, WB: West Bengal, KL:

Kerala, TN: Tamil Nadu, AP: Andhra Pradesh, GJ: Gujarat, HR: Haryana

and HP: Himachal Pradesh. State-wise average per capita Net Domestic Product (NDP) pertain to 2020-21. The growth in internet subscribers is taken for 2022-23 over 2018-19. The size of the bubble is proportional to the number of internet subscribers.

Source: TRAI, National Statistical Office (NSO), and RBI staff estimates.

90 82 80 77 78 77 70 59 60 50 41 44 40 27 30 20 10 0 2011 2014 2017 2021 Bottom 40 Per cent Top 60 Per cent 45 39 40 34 35 30 25 22 20 18 15 12 9 10 5 0 Borrowed from Sent or Received Received Private a Financial Domestic Sector Wages in Institution Remittances in Account Account 2014 2021 )tnec rep( srebircsbus tenretni ni htworGINDIA’S DIGITAL REVOLUTION:

OPPORTUNITIES AND CHALLENGES Chart I.15: Cumulative Gram Panchayats Connected Chart I.16: Digital Literacy Program Beneficiaries through BharatNet

Note: Data pertain to beneficiaries under Pradhan Mantri Gramin Digital Saksharta Abhiyan.

Source: Ministry of Communications, GoI. Source: MeitY, GoI.

Education (NCFE), along with broadcasting activity and effectively targeting delivery of regional language financial education messages the public schemes for intended beneficiaries. and utilising community radio, reflects the public Globally, men outnumbered women internet users policy strategy for enhancing digital literacy (World by five percentage points in 2023 (Chart I.17a).

Bank and IFAD, 2021). For low-income countries, the gap increased to 14 percentage points in 2023, with the mobile

3.2 Bridging Gender, Economic and Social ownership gap between genders at 17 percentage Inequalities points vis-à-vis one percentage point for high- I.28 Digitalisation can play a vital role in income countries and seven percentage points increasing the contribution of women to economic overall (Chart I.17b). In terms of the adoption Chart I.17: Gender-wise Adoption of Digital Enablers

Note: The figures in the box indicate the gender gap.

Source: ITU.

13REPORT ON CURRENCY AND FINANCE and usage of FinTech products, a significant gap opportunities for women (Patra, 2024a). between gender persists globally14 (Chen et al., Sectors such as banking, financial services and

2023). insurance (BFSI), telecom and e-commerce are increasingly prioritised by women, with half of the I.29 Despite gender disparities in internet female job seekers preferring work-from-home accessibility in India, the gender gap in internet options (Press Trust of India, 2023).

adoption has narrowed significantly between 2017 and 2022 (Chart I.18). The digital gender I.30 Digitalisation is empowering India to gap has implications for expanding the female bridge economic inequalities through a paradigm labour force participation rate (LFPR), which was shift in social welfare schemes via DBTs. Over the 41 per cent relative to male LFPR of 78 per cent last decade and especially since the pandemic, in 2023 (MoSPI, 2024). Digitalisation, thus, offers funds disbursed directly to beneficiary accounts a unique opportunity to reap the demographic through DBT have been ramped up, along with dividend. Digital tools can contribute to gender- an increase in the number of beneficiaries (Chart neutral labour markets by offering flexible I.19). By harnessing DPIs in conjunction with schedules, virtual workplaces and coworking social welfare schemes and structural reforms, spaces, aiding women in overcoming mobility India has lifted 415 million people from poverty barriers and promoting work-life balance. within a span of 15 years between 2005 and Technologies like virtual reality (VR), augmented 2021 (UNDP, 2023)15. Multidimensional poverty reality (AR) and blockchain present exciting has dropped from 29.1 per cent of the total Chart I.18: Gender Divide goes down in India Chart I.19: Direct Benefit Transfers in India

Note: Number of beneficiaries are not unique, implying that the same person may receive both cash and in-kind transfers.

Source: IAMAI-Kantar. Source: DBT Dashboard, accessed in May 2024.

14 From a sample of 28 countries, including high-income and middle-income countries.

15 Global Multidimensional Poverty Index (MPI).

14INDIA’S DIGITAL REVOLUTION:

OPPORTUNITIES AND CHALLENGES population in 2013-14 to 11.2 per cent in 2022-23, smoothing, social ceremonies and medical surpassing the sustainable development goal emergencies together account for nearly 30 per well ahead of the deadline (NITI Aayog, 2024) 16. cent of total loans availed by rural households

3.3 Addressing Finance for Agriculture in 2018-19 (NSO, 2021). This indicates that a significant portion of loans by rural households are I.31 A significant number of lower-income driven by immediate and essential needs rather households and businesses in the informal sector than long-term investment, reflecting vulnerability remain excluded from credit registries as they in their financial position and access to services.

often lack the necessary information that financial institutions need to evaluate creditworthiness. This I.32 Digitalisation can significantly transform exclusion decreases their chances of obtaining the agriculture sector. Reforms such as the finance and increases the cost of loans when they decoupling of income support for all farmers do receive them (Carriere-Swallow et al., 2021).

through direct disbursement of PM-KISAN Consequently, informal finance is still thriving in instalments into bank accounts, the e-national rural India, despite the penetration of the formal agricultural market (e-NAM) for integrating mandis financial sector. Among the total outstanding loans online for transactions and development of Kisan of rural households, 31 per cent is sourced from Suvidha mobile app to facilitate dissemination of informal lenders. Penetration of informal loans information to farmers are playing a pivotal role.

is particularly high among the lowest economic So far, 1,389 wholesale mandis located in 23 strata of households (Chart I.20). Consumption states and four UTs have been integrated on the Chart I.20: Composition of Outstanding Loans e-NAM platform (Chart I.21).

I.33 At end-March 2023, the number of operative Kisan Credit Cards (KCCs) stood at

7.4 crore (Chart I.22a).17 KCC penetration is less than 20 per cent among marginal farmers having less than one hectare of land (Chart 1.22b). The reasons for the low penetration of KCCs are the unavailability of online land and revenue records as well as a lack of awareness about the scheme, among others (Mani, 2016). Amount outstanding under operative KCCs has grown consistently,

Note: Data pertain to loans of rural households including both agricultural as well as non-agricultural households. Agricultural household is defined although there is a wide variation across states as "a household which is having production from agricultural activities of value more than ₹4,000 and has at least one household member self- (RBI, 2023a). Digitalisation of agricultural employed in agriculture during the last 365 days” in 77th round.

Source: NSO 77th Round, 2021, GoI. finance through digital KCC products under the 16 Headcount ratios (the proportion of population which is multidimensionally poor) based on NITI Aayog’s National MPI. The National MPI retains all ten indicators from the global MPI and incorporates two additional indicators - maternal health and bank accounts, aligning with India’s national priorities (NITI Aayog, 2024).

17 This includes KCCs issued by scheduled commercial banks, regional rural banks, and cooperative banks.

15REPORT ON CURRENCY AND FINANCE Chart I.21: Integration of Mandis with the e-NAM Platform e-NAM mandis

Note: Data up to April 2024.

Source: e-NAM, GoI.

PTPFC will deepen inclusion through hassle-free map registry; and crop sown registry – has disbursement of loans. been finalised (PIB, 2023a). The Digital India Land Records Modernisation Programme I.34 Central government funding is being

(DILRMP) is aiding digitisation of land records,

provided to state governments through the National minimising discrepancies, enhancing accessibility e-Governance Plan in Agriculture (NeGP-A) for initiatives involving AI and Machine Learning (ML), and facilitating seamless land transactions robotics, data analytics and blockchain. This is (Chart I.23). The programme is reducing the time enabling IT-based solutions for crop planning and taken to disburse crop loans and will accelerate health, farm credit and insurance, crop estimation the formalisation of land leasing within the farm and market intelligence. The architecture of sector, seamless land acquisition and forest three core registries – farmer registry; village clearance for infrastructure planning.

Chart I.22: Distribution of Kisan Credit Card among Agricultural Households

Source: Report on Trend and Progress of Banking in India, RBI and NSO 77th round, 2021, GoI.

16INDIA’S DIGITAL REVOLUTION:

OPPORTUNITIES AND CHALLENGES

3.4 Enabling Seamless Cross-Border Payments Chart I.23: Progress in Digitisation of Land Records I.36 Digitalisation is transforming payments for internationally traded goods and services.

Technologies like real-time payment systems and blockchain enable instant transfers, reduce delays and improve tracking of funds. Automated processes cut costs, offer better exchange rates and ensure regulatory compliance through data analytics. User-friendly digital platforms also democratise access for small and medium-sized enterprises, making international trade more accessible. Powered by digitalisation, there has been a surge in cross-border payments worldwide in recent decades. India is a pioneer in digitally-

Source: PIB, GoI 2023. enabled remittances and international trade in digitally deliverable services (Chart I.25). It usually I.35 Digitalisation is also resulting in better price takes one to three business days to disburse discovery for agricultural households. Around funds, costing five per cent for sending US$ 200 16 per cent of them accessed technical advice on average.18 from digital sources, including radio/TV/electronic media (13.2 per cent), kisan call centres (1.5 I.37 The future of cross-border payments will per cent), smartphone-based applications (1.2 be characterised by the setting up of dedicated per cent) and agricultural clinics and agricultural payment rails for instantaneous transfers and business (0.5 per cent) in 2018-19 (NSO, 2021) greater harmonisation of payment regulations [Chart I.24]. across borders (Patra, 2023). The Association Chart I.24: Usage of Electronic Media by Farmers Kisan

Source: NSO, 2021 and Suganthi et al., 2024.

18 Average cost of remittance to India in the first quarter of 2024 as per the Remittance Price Worldwide Quarterly Report of World Bank (Issue 49, March 2024).

17REPORT ON CURRENCY AND FINANCE Chart I.25: Digitally-Enabled Cross-border Flows in India a. Remittances b. International Trade in Digitally-deliverable Services Exports

Note: In Chart a, "Traditionally Initiated" refers to payments started with cash or a bank account, with any pickup method. “Digitally Initiated” means payments started with a credit/debit/prepaid card or other digital methods (not a bank account), with cash as the pickup method. “Digital End-to-end” involves payments started with a credit/debit/prepaid card or other digital methods (not a bank account), with the pickup involving a bank account or other cashless payment instruments.

Source: Remittance Prices Worldwide Database, UNCTAD and RBI staff estimates. of Southeast Asian Nations’ (ASEAN) Regional economy that support a transition towards a net- Payment Connectivity (RPC) initiative, akin to zero emission economy, protect natural resources India’s UPI, is already adopted by countries like and minimise waste (UNEP, 2022). India has Singapore, Malaysia and Thailand and plays a committed to (i) achieve 50 per cent cumulative substantial role in facilitating cross-border flows electric power installed capacity from non-fossil for trade, investment and remittances. Currently, energy resources by 2030; (ii) reduce emission seven countries19 accept UPI payments (NPCI, intensity of GDP by 45 per cent by 2030 from 2005

2024). The Reserve Bank’s Payments Vision level; (iii) create an additional carbon sink of 2.5 to 2025 envisions that integrating with fast payment 3 billion tonnes through additional forest and tree systems of foreign jurisdictions and increasing cover (UNFCCC, 2022); (iv) achieve ‘Net Zero’ participation in global standard-setting bodies will emissions by 2070; and, (v) reduce projected facilitate trade and commerce, reducing remittance carbon emissions by one billion tonnes by 2030 costs and time. Increased digital payment adoption (PIB, 2021). The share of renewable energy will lower cash usage expenses, boost the share of in India’s power generation mix has improved digital payments in GDP and improve transaction from 15.9 per cent in 2015-16 to 20.7 per cent in transparency. The Reserve Bank plans to migrate 2023-24 (Chart I.26a). India aims to achieve 500 all RBI-operated payment messaging systems to Gigawatt (GW) of renewable energy capacity by ISO 20022 standard to ensure interoperability with 2030 (PIB, 2023b), up from 190 GW as on March systems of other jurisdictions.

31, 2024 (Chart I.26b).

3.5 Greening of Infrastructure I.39 The escalating demand for digital I.38 Digital technologies in finance can services increases data storage needs, raises facilitate environmental sustainability and a energy consumption and widespread electronic

circular economy by creating data-driven digital product adoption generates significant e-waste.

19 Singapore, Nepal, UAE, Bhutan, France (e-commerce), Mauritius, and Sri Lanka.

18 fo rebmun ni erahS )tnec reP( snoitcasnart noillib $SU 100 80 60 40 20 0 Traditionally Initiated Digitally Initiated Digital End-to-end 7102 8102 9102 0202 1202 2202 3202 250 232 200 150 100 50 0 0102 1102 2102 3102 4102 5102 6102 7102 8102 9102 0202 1202 2202INDIA’S DIGITAL REVOLUTION:

OPPORTUNITIES AND CHALLENGES Chart I.26: Composition of Power Sector in India

Note: Renewable sources include large hydropower.

Source: Central Electricity Authority, Ministry of Power.

As per the United Nations’ Global e-Waste I.40 The growing imprint of digitalisation in Monitor 2024, India ranks as the world’s third all these areas is transforming production and consumption patterns of economic agents.

largest generator of e-waste in 2022, following Digitalisation influences price levels through China and the US (UNITAR, 2024). Thus, the direct and indirect channels (Csonto et al., 2019). responsible development and use of technology, Under the direct channel, digitalisation can feed coupled with adoption of renewable energy into lower inflation rates through a decline in the and formal e-waste management, are vital in prices of ICT-related goods, as observed in the leveraging digital technologies to combat climate post-pandemic period across both hardware and challenges. software charges in India20 (Chart I.27).

Chart I.27: Role of ICT in Inflation in India

Source: NSO, MoSPI and RBI staff estimates.

20 ICT price index is derived as a weighted average of PC/Laptop/other peripherals, including software, mobile handset, landline charges, mobile charges and internet expenses.

19 tniop egatnecreP tnec reP

15.0

10.0

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0.0 -5.0 2018-19 2019-20 2020-21 2021-22 2022-23 2023-24 tnec reP a. ICT Contribution in Core Inflation b. Drivers of ICT Inflation

0.6 8.0

7.0

0.5

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0.4

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0.2 3.0

2.0

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0.0 -0.1 -1.0 PC/Laptop/Other Peripherals Mobile Handset

Telephone Charges: Landline Telephone Charges: Mobile Internet Expenses ICT Combined 61-rpA 61-guA 61-ceD 71-rpA 71-guA 71-ceD 81-rpA 81-guA 81-ceD 91-rpA 91-guA 91-ceD 02-rpA 02-guA 02-ceD 12-rpA 12-guA 12-ceD 22-rpA 22-guA 22-ceD 32-rpA 32-guA 32-ceD 42-rpA Contribution in Core Inflation Core inflation (RHS)REPORT ON CURRENCY AND FINANCE I.41 Digital technologies can also influence corresponding increase in digitally-influenced inflation indirectly through changes in firms’ retail purchases and number of digitally-influenced price-setting behaviour and market dynamics, consumers and online shoppers (Chart I.28).

with new players enhancing competition enabled I.42 This rise in digital engagement, coupled with by e-commerce. Dynamic pricing of goods increasing price and information transparency, can and services becomes possible with digital also put downward pressure on prices by lowering technologies, making prices more responsive search, replication, transportation, tracking and to economic changes by reducing menu costs, verification costs (Goldfarb and Tucker, 2019).

improving access to information and enhancing These developments can potentially make the price update flexibility (Glocker and Piribauer, Phillips curve steeper, enhancing the efficacy of

2021). Illustratively, price changes for vegetables monetary policy in securing price stability (Ari et al., and food items occur once in two and three days, 2023; Friedrich and Selcuk, 2022). Furthermore, respectively, on online platforms in India, which digitalisation can improve access to financial is much frequent than corresponding offline price services and enhanced financial inclusion is found changes (two to three weeks) [Nadhanael, 2022]. to improve the transmission of interest rate-based As internet penetration expands, there will be a monetary policy impulses (Patra, 2021).

Chart I.28: India’s e-Commerce Market – Projected Growth

Note: Figures from 2025 onwards are projections.

Source: IBEF, 2024; BCG, 2022 and RBI staff estimates.

20INDIA’S DIGITAL REVOLUTION:

OPPORTUNITIES AND CHALLENGES

4. Future Shocks: Digitalisation’s Challenges Chart I.29: Herfindahl-Hirschman Index (HHI) of UPI Applications I.43 While digitalisation opens several opportunities across sectors, it also brings in new challenges while accentuating existing ones. In financial markets, this is stark. Digitalisation is leading to the introduction of a variety of complex financial products and services, with implications for market structure and financial stability. The emergence of digital players with unreliable funding models accentuates vulnerability in the system and poses challenges for financial stability.

I.44 The hyper-diversification of financial services may lead to a “barbell”–like financial Note: HHI = s s s sn, where s n is the market share of firm n expressed as a decimal. H1HI2 can2 range2 from zero (perfectly competitive) to one (perfect structure, with a small set of dominant multi- monopoly), wi2 t+h v2 a+lu3 e+ a ⋯bo ve 0.25 indicating high concentration.

Source: NPCI and RBI staff estimates. product players leveraging network effects and economies of scale, alongside a large set of niche service providers benefitting from efficiency gains targeting the digital financial infrastructure.22 In and lower barriers to entry (Feyen et al., 2021). India, security incidents handled by the Indian I.45 In India’s digital payment ecosystem, Computer Emergency Response Team (CERT- various UPI applications have emerged21, In) have increased from 53,117 in 2017 to expanding customer choices and propelling 13,20,106 during the period January-October turnover. The major share of transactions is, 2023 (CERT-In, 2017; RBI, 2023a). Unauthorised however, cornered by a few applications, as network scanning/probing/vulnerable services evident from the Herfindahl-Hirschman Index account for more than 80 per cent of all security

(HHI) being in the range of 0.35-0.37 for both incidents in India (Chart I.30). volume and value of transactions on the platform (Chart I.29). In this context, the NPCI has capped I.47 Industry-wise distribution of cyber attacks the market share of a single third-party application in India shows that the automotive industry is the provider in volume terms to 30 per cent by most vulnerable, with smart mobility application December 2024 in order to address concentration programming interfaces (APIs) and electric risks (NPCI, 2022).

vehicle (EV) charging infrastructure emerging as

4.1 Cyber Security major attack vectors. The BFSI sector, governed I.46 Cyber security is an important challenge by well-defined regulations, is relatively protected owing to the diverse nature of cyber threats from such attacks (Chart I.31).

21 Currently, over 70 applications are operational.

22 The Colonial Pipeline ransomware attack in 2021, while not directly impacting financial institutions, demonstrated the interdependence of critical infrastructure systems and the potential for widespread effects across sectors, including banking, by triggering a run-on gas station, showcasing the ripple effects of a cyberattack.

21 eulav xednIREPORT ON CURRENCY AND FINANCE Chart I.30: Security Incidents in India Chart I.31: Industry-wise Distribution of Cyber Attacks in India - 2023

Note: IT/ITES: Information Technology/Information Technology-enabled Services; BFSI: Banking, Financial Services and Insurance.

Source: India Cyber Threat Report 2023, Data Security Council of India

Source: CERT-In. and SEQRITE, 2023.

I.48 Globally, cybercrime costs are expected growth (Das, 2023a). While digitalisation offers to reach US$ 13.82 trillion by 2028, up from US$ enhanced convenience and accessibility,

8.15 trillion in 2023 (Statista, 2023). The average the growing complexity of financial products cost of a data breach has also risen to US$ 4.45 also introduces new challenges in ensuring million in 2023, a 15 per cent increase over three customer protection. With the increasing adoption years (IBM, 2023). Recognising the significant of digital payments, the share of complaints costs involved, most central banks have increased Chart I.32: Global Average Data Breach Costs their cyber security investment budgets by five per cent since 2020 (Doerr et al., 2022). In India, the average cost of data breaches stands at US$ 2.18 million in 2023, a 28 per cent increase since 2020 albeit less than the global average cost of data breach (Chart I.32). The most common attacks in India are phishing (22 per cent), followed by stolen or compromised credentials (16 per cent) [IBM, 2023].

4.2 Consumer Protection I.49 Customers are the epicentre of the digital economy. The success of any enterprise is intricately tied to the satisfaction and trust of its customers, and thus, adopting a customer-centric

Source: Cost of Data Breach 2023, IBM. approach to innovation is vital for sustainable 22 )tnec rePINDIA’S DIGITAL REVOLUTION:

OPPORTUNITIES AND CHALLENGES every year by 74 per cent, making it a US$ 56 Chart I.33: Complaints under RB-IOS, 2022-23 billion market by 2026, the model has a high dependence on late fees to ensure profitability 20 which could become predatory for customers (HDFC securities, 2022). These risks are exacerbated by the seamless nature of digital 53 15 technologies, facilitating impulsive spending and debt accumulation (Pradhan et al., 2018).

12 I.51 Digitalisation is also giving rise to certain ‘invisible risks’ or ‘dark patterns’, whereby Mobile/ Electronic Banking ATM/ Debit Cards Credit Cards Others consumers are tricked into making decisions

Note: Others include complaints regarding loans and advances, deposit accounts related, pension payments, remittances, para banking, notes and detrimental to their interests (Rao, 2023a) coins, and others.

Source: Reserve Bank – Integrated Ombudsman Scheme (RB-IOS) Annual [Chart I.34].

Report, 2022-23.

I.52 The use of extensive customer data related to mobile/electronic banking, ATM/debit by companies raises concerns about data cards and credit cards received in the offices protection and privacy, potentially compromising of the RBI ombudsman accounted for 47 per customer trust and security (IMF, 2021). In India, cent of total complaints in 2022-23 (RBI, 2024b) three-fourths of the business-to-consumer (B2C) [Chart I.33].

funded FinTech applications23 request permission I.50 Digital financial innovations present to access camera, photo/media/files, location a trade-off between competition (thereby, and storage for using applications (Chart I.35).

enhancing customer convenience) and customer I.53 India is one of the top ten countries in terms protection. Illustratively, while the digital lending of embedded finance24 revenue (Chart I.36) and it platforms and buy-now-pay-later (BNPL) services bolster consumer convenience, they also entail is expected to expand at a CAGR of 30.4 per cent various costs, including exorbitant charges, over 2022-29 to reach US$ 21.1 billion in 2029 coercive recovery practices and hidden fees. In (PwC, 2023). While cross-selling25 and embedded India, BNPL constitutes around three per cent finance models enhance customer convenience, of total e-commerce finance by value (Statista, they may raise anti-competition concerns due to 2024b). While BNPL is projected to grow bundled services.

23 Information is collected from 181 FinTech mobile applications on Google Play Store identified from the Tracxn database with practice area tags, viz., payments, alternative lending, banking tech, forex tech, direct remittance tech.

24 Embedded finance refers to the integration of banking and various financial services into non-financial applications and services.

25 Cross-selling involves suggesting related or complementary products to existing customers and leveraging established relationships to offer additional items or services aligned with their needs or previous purchases.

23REPORT ON CURRENCY AND FINANCE Chart I.34: Dark Patterns

Source: Guidelines for Prevention and Regulation of Dark Patterns, 2023 and RBI staff illustration.

24INDIA’S DIGITAL REVOLUTION:

OPPORTUNITIES AND CHALLENGES Chart I.35: Privacy Practices in FinTech Applications Chart I.36: Top 10 Countries in Embedded Finance Revenue, 2022 United States United Kingdom Germany Canada Brazil France Italy Netherlands India Spain 0 5000 10000 15000 20000 25000 30000 US$ million

Source: Google Play Store and RBI staff estimates. Source: Statista, 2023 and Juniper Research, 2023.

I.54 The declining costs of internet-enabled requirements, and labour and regulatory policies. devices and mobile data have enhanced access; Implementation of AI in financial services is however, affordability remains a barrier to achieving shifting roles to higher-skilled tasks, automating universal internet usage (ICRIER, 2023). India routine functions and aiding decision-making.

also has immense potential to enhance the quality Digitalisation is decentralising financial labour of digital services (Chart I.37). through outsourcing and telework (ILO, 2022).

4.3 Reshaping of Labour Markets Automation replacing labour can potentially widen I.55 Digital technologies are impacting the gap between capital and labour returns, workforce composition, job quality, skill creating a fragmented labour market with low-skill/ Chart I.37: Affordability and Speed of Internet Services

Note: The indicators on “device affordability” and “average dowload speed for mobile users” are part of the Mobile Connectivity Index (MCI) by the Global System for Mobile Communications Association (GSMA) and have been normalised within a range of 0 to 100. In chart a, lower value of the index indicates lower affordability.

Source: GSMA, 2023.

25REPORT ON CURRENCY AND FINANCE Table I.1 Composition of Employees in Scheduled Chart I.38: Average Employee Turnover Rates in Commercial Banks (SCBs) SCBs - 2022-23 (Per cent) Year Officers Support Staff 2010-11 50 50 2014-15 57 43 2018-19 66 34 2022-23 74 26

Source: RBI. low-pay and high-skill/high-pay jobs, while middle- tier jobs are displaced by technology (Schwab,

2016).

I.56 Between 2013 and 2019, employees in support roles in the financial sector decreased in

Note: Data pertain to 31 SCBs. many countries, while the number of professionals Source: Business Responsibility and Sustainability Reports of Banks. and technicians rose (ILO, 2022). This is evident in the Indian banking sector as well (Table I.1). inadequate for this transformation, necessitating significant investments to build the required skills I.57 In digital recruitment platforms, a major at scale, leverage AI in learning and keep pace issue is the high average turnover rate of financial with the swiftly evolving demands of digital skills.

institutions, with some private sector banks in India reporting turnover rates of above 30 per cent Chart I.39: Relative AI Skill Penetration Rate in 2022-23 (Chart I.38). This raises significant risks for the financial sector, including loss of institutional knowledge, disruption in services and higher recruitment costs (Jain, 2023).

I.58 Upskilling and reskilling the labour force pose significant challenges, given the growing shift towards digital-intensive roles. The rising importance of AI-related skills in the labour market in India is reflected in the growth in AI talent recruitment relative to overall recruitment26 in 2023 (16.8 per cent y-o-y) and the highest relative AI skill penetration rate (Chart I.39) [Stanford

Note: The AI skill penetration rate signals the prevalence of AI skills across University, 2024]. Pre-existing traditional methods occupations, or the intensity with which LinkedIn members utilise AI skills in their jobs.

of learning and development, however, are Source: Stanford University, 2024.

26 The overall hiring rate is computed as the percentage of LinkedIn members who added a new employer in the same period the job began, divided by the total number of LinkedIn members in the corresponding location. For each month, LinkedIn calculates the AI hiring rate in the geographic area, divides the AI hiring rate by overall hiring rate in that geographic area, calculates the year-over-year change of this ratio, and then takes the 12-month moving average using the last 12 months.

26INDIA’S DIGITAL REVOLUTION:

OPPORTUNITIES AND CHALLENGES

4.4 Emerging Regulatory Challenges I.61 Challenges facing regulatory and supervisory mandates stem from loosening I.59 Digitalisation generates regulatory entry barriers, potentially risking FinTech challenges, necessitating that regulators stay lending being promoted on weak business ahead of the financial innovation curve while models with inadequate cyber infrastructure.

balancing the complex trade-offs related to Furthermore, unregulated non-bank payment financial stability, competition and customer protection. This will require enhancing the capacity services could disadvantage traditional banks, of regulated entities and oversight authorities, leading to regulatory arbitrage and deposit updating legal and regulatory frameworks, disintermediation (Sankar, 2023). Globally, engaging stakeholders to identify risks and countries have accordingly enacted regulations expanding consumer education (Patra, 2024b). to strengthen enforcement in FinTech-related activities (Chart I.40).

I.60 Regulations need to set boundaries to contain the irrational exuberance of participants I.62 BigTechs, that can quickly become ‘too big and ensure a sound and robust set of institutions, to fail’ and dominate markets, may pose significant thereby promoting financial stability (Rao, 2023b). challenges in assessing risk profiles due to their In the context of peer-to-peer lending applications unique characteristics, extensive group entities, in India, regulations have been found to have a interconnected activities and transnational positive impact in building trust, thereby enabling presence. Partnerships with incumbent firms can adoption of financial innovations (Box I.3). encourage excessive risk-taking, especially when Box I.3 Regulation-Innovation Nexus: Peer-to-peer Lending in India In order to ensure that the peer-to-peer ecosystem Chart 1: Sentiment Scores over Time develops in a responsible manner in India, the Reserve Bank issued P2P lending guidelines in October 2017 (RBI, 2017). The P2P platform has gained momentum in recent years. The user experience, measured by sentiment scores computed through text mining of online reviews of 11 P2P lending applications, has shown an improvement over time (Chart 1). The Bai-Perron structural break test indicates a significant break in the month of October 2017, coinciding with the issuance of the P2P lending guidelines. Average sentiment scores

Source: Scraped reviews of 11 P2P Applications from Google Play Store. rose from (-) 0.04 before October 2017 to (+) 0.13 since then, notwithstanding moderation during the COVID-19 Empirical analysis using autoregressive distributed pandemic. Topic modelling using the Latent Dirichlet lag (ARDL) models covering the sample period from Allocation (LDA) model suggests that the decline in November 2015 to January 2024 provides interesting sentiments during the pandemic could be attributed to perspectives. The baseline scenario (Model 1) illustrates loan rejections, registration issues and customer service that the sentiment of reviews is positively influenced by the concerns. overall digitalisation of the economy proxied by the log of (Contd...) 27REPORT ON CURRENCY AND FINANCE Table 1: User Experience of P2P Lending Platforms

Dependent Variable: Sentiment Scores of P2P Reviews Model 1 Model 2 Model 3 Model Type ARDL (1, 0, 0) ARDL (2, 4, 0, 1) ARDL (2, 0, 0, 4, 4) Explanatory Variables 27 I. Long Run Wireless Internet 2.53*** 1.84** 1.66* Subscribers (0.97) (0.82) (0.84) Mobile Payments 0.01 0.01** 0.01** (0.00) (0.00) (0.00) Regulation 0.30*** 0.27*** (0.09) (0.09) Sentiment Polarity 0.55 (0.16) II. Short Run COVID-19 Dummy -0.07 -0.12** -0.12** (0.05) (0.05) (0.05) Error Correction -0.68*** -0.87*** -0.84*** (0.09) (0.12) (0.11)

Note: (1) The standard errors are in parentheses. ***, ** and * refer to significance levels at 1 per cent, 5 per cent and 10 per cent, respectively.

(2) Bounds Test: F statistic: Model 1 (17.9), Model 2 (11.69) and Model 3 (9.74).

(3) Critical values for F statistic at 5 per cent level are around 4.0 and 6.0 for I(0) and I(1) assumptions, respectively.

(4) Model Tests for heteroscedasticity and autocorrelation are insignificant.

Source: RBI staff estimates. wireless internet subscriber base and the rate of FinTech impacts user experience. While extreme reviews are adoption proxied by the share of mobile payments to total controlled for through sentiment polarity, promotional digital payments volume (Table 1). The second model reviews, if any, may affect the results.

(Model 2) shows a positive and statistically significant

References: impact of regulation, represented by a dummy for the post Reserve Bank of India. (2017). Master Directions - Non- October 2017 period, on user experience. This suggests Banking Financial Company - Peer-to-Peer Lending that regulation can safeguard customer interests by Platform (Reserve Bank) Directions, 2017.

creating a more trustworthy, transparent, credible, adaptive and fair environment for both borrowers and Schoenmueller, V., Netzer, O., and Stahl, F. (2020). The lenders. The third model (Model 3) reports similar results, Polarity of Online Reviews: Prevalence, Drivers and with the inclusion of sentiment polarity28 in online reviews Implications. Journal of Marketing Research, 57(5), (Schoenmueller et al., 2020). COVID-19 negatively 853-877.

BigTechs handle the customer-facing aspect of product bundling and cross-subsidising activities. the value chain without assuming underwritten This can give rise to adverse economic and risks (Crisanto and Ehrentraud, 2021). Collection welfare outcomes.

of extensive data by BigTechs can be utilised I.63 Digitalisation generates vast amount of to favour their own products, obtaining higher data that can facilitate the use of advanced models margins by making financial institutions’ access to like AI and Generative AI (GenAI) in the financial prospective clients via their platforms, engaging in sector. The cumulative private investment in AI in 27 As per the Augmented Dickey-Fuller (ADF) Test, all variables are stationary at levels I(0) or first difference I(1) levels.

28 Sentiment polarity is computed as a ratio of the sum of the number of reviews with rating 5 and 1 over the total number of reviews (Schoenmueller et al., 2020).

28INDIA’S DIGITAL REVOLUTION:

OPPORTUNITIES AND CHALLENGES customer rights.29 The increased use of AI Chart I.40: Adoption of Fintech-specific Regulations Worldwide algorithms - particularly deep learning models - by financial institutions presents additional challenges, such as lack of explainability, potential discriminatory biases, false signals and substantial investment requirements to integrate with legacy systems. Central bankers must also closely monitor quantum computing developments due to growing concerns about the vulnerability of current cryptographic methods in securing financial transactions (Patra, 2024b).

I.65 It is crucial to ensure that model-based

Note: e-Money refers to ability of banks and non-bank financial institutions to issue prepaid payment instruments; Innovation facilitators include lending in banking and non-banking financial innovation hub, regulatory sandboxes and regulatory accelerators;

marketplace lending refers to peer-to-peer lending and equity crowdfunding. companies (NBFCs) employs robust, regularly

Source: World Bank. tested algorithms to mitigate undue risk India, however, is low relative to the rest of the accumulation and uphold underwriting standards world (Chart I.41a). The share of India in granted amidst evolving financial landscapes (Das, AI patents in the world is also low (Stanford 2023b). Designing responsible and ethical AI University, 2024) [Chart I.41b]. solutions for financial services would necessitate I.64 On the regulatory front, the challenge is to consideration of ten principles - fairness;

balance financial security through data analytics transparency; accuracy; consistency; data with the need to protect individual privacy and privacy; explainability; accountability; robustness;

Chart I.41: Artificial Intelligence - Global Landscape

Source: Stanford University, 2024.

29 Transaction data for monitoring suspicious activities can risk customer privacy and exposure to cyber-attacks. To address this trade-off, open banking regulations are being developed to securely share data with consumer consent.

29REPORT ON CURRENCY AND FINANCE monitoring and updating; and human oversight consultative, collaborative and forward-looking (Rao, 2023c). approach to regulation with customers at the centre of innovations (Rao, 2023b).

I.66 The online nature and cross-border reach of digital payments and trade across multiple 5.1 Financial and Digital Inclusion jurisdictions with diverse regulatory frameworks I.68 India has established digital banking units necessitate effective regulation through

(DBUs), improved UPI with offline payments and international collaboration, harmonisation and conversational payments in local languages, promotion of common protocols, standardised extended payment system access to non-bank APIs and secure communication channels.

entities and extended operational hours of Globally, efforts are underway to harmonise various digital modes to foster financial inclusion. cybersecurity regulations and anti-money Digitalisation of agricultural finance under the laundering/countering the financing of terrorism PTPFC, as noted earlier, will deepen inclusion.

(AML/CFT) frameworks. The Group of Seven (G7), The PIDF has been launched to broad-base the Basel Committee on Banking Supervision payment infrastructure.

(BCBS), the Financial Stability Board (FSB)

5.2 Customer Protection and the Committee on Payments and Market Infrastructure and International Organisation of I.69 In response to regulatory and customer Securities Commissions (CPMI-IOSCO) have protection challenges in the digital lending issued high-level principles on cybersecurity to ecosystem, the Reserve Bank issued the foster convergence in cyber resilience strategies. Guidelines on Digital Lending, based on recommendations of the Working Group on

5. Digitalisation and the Reserve Bank of India Digital Lending (Chairperson: Shri Jayant Dash).

I.67 The Reserve Bank, as a full-service central These guidelines include provisions for loan bank and enabler of the market economy, has servicing, comprehensive disclosures such as taken several policy initiatives to address various the key fact statement (KFS), grievance redressal aspects of financial sector digitalisation, built on mechanisms, credit assessment standards the principles of trust, stability and innovation and borrower data privacy (RBI, 2023b). The (Das, 2024a). Trust is fostered through market implementation of the Reserve Bank-Integrated reforms ensuring fair conduct, price transparency Ombudsman Scheme (RB-IOS) has resulted in and enhanced disclosures. Stability is upheld structural improvements in grievance redress by orderly market functioning and infrastructure. mechanism (Das, 2024b).30 Additionally, the Innovation is promoted through principle-based Bank has initiated public awareness campaigns regulation, new products/platforms and market like the ‘RBI Kehta Hai’ and electronic Banking access. The regulatory perimeter has also Awareness and Training (e-BAAT) programme expanded as the Indian financial system has across the country to educate the public about ventured into newer business models, product digital payment products, fraud prevention and lines and geographical territories, ushering in a risk mitigation (Das, 2024c).

30 With a complaint disposal rate of about 98 per cent and an average turnaround time of 33 days.

30INDIA’S DIGITAL REVOLUTION:

OPPORTUNITIES AND CHALLENGES

5.3 Data Protection governance standards, eligibility criteria and the like (RBI, 2024c). The SRO-FT would guide the I.70 To tackle issues relating to misuse conduct of its members, ensure adherence to of data, the Reserve Bank has implemented industry standards, compliance with relevant data localisation for payments data and issued laws and regulations and maintenance of high guidelines preventing digital lending applications ethical standards, encourage responsible from accessing private information without experimentation, address grievances, conflicts the explicit consent of users. In order to make of interest, or disputes and foster a fair, equitable digital payments more secure, safe and sound, and competitive FinTech environment in India.

the Reserve Bank has enabled card-on-file tokenisation (CoFT) through card-issuing banks 5.6 Digital Technologies in Regulation and and institutions. This will avoid any breach or leak Supervision of data since instead of card details, a specially I.73 Digital tools like regulatory technology created token is saved with the merchant.

(RegTech) and supervisory technology (SupTech)

5.4 Cyber Security are leveraged to broaden the supervisory and monitoring frameworks and reassess the I.71 The measures implemented in India to regulatory perimeter. The Reserve Bank has set up promote security of digital transactions include an Advanced Supervisory Analytics Group (ASAG) two-factor authentication for digital payments, increased customer control over card usage, to leverage ML models for social media analytics, faster turnaround time for transaction failures, KYC compliances and for gauging governance augmented supervisory oversight with simulated effectiveness. The establishment of an advanced phishing exercises. The Reserve Bank also issued off-site supervisory monitoring system - DAKSH - comprehensive guidelines and frameworks for is helping to digitalise supervisory processes. An IT and Cyber Risk management, encompassing Integrated Compliance Management and Tracking regulations on Digital Payment Security Controls System (ICMTS) and a Centralised Information and IT Services Outsourcing.31 Management System (CIMS) are other two major SupTech initiatives being implemented

5.5 FinTech Regulation for seamless reporting by supervised entities for I.72 To encourage FinTech innovations, the enhancing data management and data analytics Reserve Bank has launched the Regulatory capabilities, respectively (Patra, 2024b).

Sandbox scheme, the Reserve Bank Innovation

6. Concluding Observations Hub and FinTech Hackathons. To foster FinTech regulation through a consultative approach, the I.74 Digital technology infrastructure will be Reserve Bank has brought forth a framework India’s growth engine of tomorrow. The focus is on for Self-Regulatory Organisations (SROs) in the next-generation communication technologies like FinTech sector, laying down the characteristics 6G and satellite networks, alongside expanding the of FinTech SROs (SRO-FT) and their functions, 5G network to rural and hitherto uncovered urban 31 The Master Direction on Information Technology Governance, Risk, Controls and Assurance Practices (effective from April 1, 2024) requires REs to put in place a robust IT governance framework and adequate oversight mechanisms to ensure accountability and mitigation of business risks.

31REPORT ON CURRENCY AND FINANCE areas. Graduating to advanced technologies will I.76 Chapter 3 explores the implications of unleash opportunities in the last mile. Attaining self- digitalisation on payment systems architecture, sufficiency in chip manufacturing is another key weighing benefits against emerging risks. Against step in ensuring the realisation of the full potential the backdrop of the evolution of payment systems of the digital revolution. As the semiconductor in India, the chapter undertakes a comparison and chip manufacturing ecosystem matures in of different modes of digitalisation of payments India, it will create strong backward and forward across countries and lays out the advantages of linkages in the digital world through a rise in cloud open-loop payment systems like the UPI where services and data storage including data centres.

banks and other third-party application providers Converting to renewable energy sources will be use the existing platform to process and settle critical while embracing these changes, as they payments. Empirical analysis in a cross-country involve energy consumption owing to voluminous setting shows that demography, which favours data generation and data storage requirements.

the younger population; penetration of internet;

Demographic shifts impacting the demand and and size of the formal economy are factors that operations of financial services will also need to condition the adoption of digital payments. An be taken care of while making policies.

All-India survey indicates that 42 per cent of the I.75 Against the backdrop of the contours of respondents had used at least one form of digital the digitalisation landscape and the opportunities payments in their lifetime (as of end-2022) and the and challenges it presents as it expands, the numbers are set to rise as more than three-fourths rest of the report is organised into four chapters. are aware of the facilities. The usage was found

Chapter 2 presents the current uptake of financial to be higher among metro and urban areas and innovations by financial institutions (FIs) and among younger respondents. customers and discusses economic factors that I.77 Chapter 4 provides an assessment of the facilitate the adoption of financial innovations in opportunities for India in an open-economy setting.

India. The chapter also highlights major aspects of Digitalisation matters for trade, especially for India’s FIs’ collaborations with FinTechs and BigTechs for services trade, given India’s relative comparative embracing financial innovations. Digital lending is advantage. Digitalisation in international payment picking up momentum in India, especially in the systems has the potential to reduce the cost of retail segment. The digital lending landscape is also sending remittances and to achieve the Sustainable getting boosted by several policy innovations. The Development Goal (SDG) target by 2030. Cross- adoption of digital technologies has improved the border digital trade policies and digitalisation, efficiency of banks in India, along with increasing along with measures aimed at internationalising competition in the banking sector. Overall digitalisation in the financial sector enables banks the Indian Rupee (INR) and the CBDC project, to reduce various risks and improves integration would play a crucial role in harnessing new across various financial markets, thus, boosting opportunities, supporting seamless international liquidity in these markets. The regulatory concerns transactions, reducing foreign exchange risks raised by financial innovations, especially by the and managing global liquidity. The availability new collaborations in the financial sector are also of e-payment services, policy support for digital discussed in the chapter along with major policy businesses, development of local digital skills initiatives. and data security would help attract digital foreign 32INDIA’S DIGITAL REVOLUTION:

OPPORTUNITIES AND CHALLENGES direct investment (FDI). Going forward, given the Ari, M. A., Garcia-Macia, M. D., and Mishra, S. significant surge in digital transactions, improving (2023). Has the Phillips Curve Become Steeper?.

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of payments (BoP) gains significance for better Asian Development Bank. (2021). Capturing policy formulation, monitoring and governance of the Digital Economy, a Proposed Measurement the digital economy.

Framework and its Applications: A Special I.78 Chapter 5 explores the risks and Supplement to Key Indicators for Asia and the challenges of digitalisation in India from a Pacific 2021. Asian Development Bank Report.

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37REPORT ON CURRENCY AND FINANCE Annex I.1: India's Digital Evolution Timeline

Note: This is not an exhaustive list and includes major policy milestones.

Source: RBI staff illustration.

38INDIA’S DIGITAL REVOLUTION:

OPPORTUNITIES AND CHALLENGES Annex I.2: The Digital Personal Data Protection Act, 2023 The Government of India has introduced key regulations to ensure safe e-commerce usage, including the Consumer Protection (e-Commerce) Rules, 2020, to prevent unfair trade practices, the Information Technology (Intermediary Guidelines and Digital Media Ethics Code) Rules, 2021, for digital platform accountability and the Digital Personal Data Protection (DPDP) Act, 2023, for comprehensive data protection (MoF, 2024). The DPDP Act of 202332 is a landmark legislation designed to fortify the protection of personal data in the rapidly evolving digital landscape. At its core, the Act establishes the Data Protection Board of India, a governing body appointed by the Central Government. This board is composed of individuals with specialised qualifications in data governance, administration, law, and technology, entrusted with the crucial task of overseeing and enforcing the provisions of the Act. Empowered with substantial authority, the Board can direct remedial measures in response to personal data breaches, impose penalties, and conduct inquiries into potential violations.

The Act introduces the concept of “Data Fiduciary” for entities handling sensitive personal data, imposing additional responsibilities like appointing Data Protection Officers and conducting mandatory audits, emphasising secure data handling. It also establishes Consent Managers for individuals to manage their data consent centrally, ensuring accountability. Disputes are resolved through an Appellate Tribunal.

Overall, the DPDP Act of 2023 aims to balance technological innovation with privacy protection.

The General Data Protection Regulation (GDPR), enacted by the European Union (EU) in 2018, marked a global shift in data protection laws. India’s DPDP Act shares similarities, focusing on consent, data rights, and accountability. It extends jurisdiction broadly and introduces “Data Fiduciary” roles. Unlike GDPR, it offers more flexibility for legitimate data processing and detailed cross-border transfer rules (Table 1).

Tailored to India’s needs, the DPDP Act presents a forward-thinking framework with potential advantages over GDPR.

Table 1: How DPDP Act 2023 compares with EU’s GDPR Features Digital Personal Data Protection Act (India) General Data Protection Regulation (EU) Significant Data Fiduciary (SDF) A data fiduciary or a category of data fiduciaries has been No equivalent concept present.

designated by the Indian government.

Consent Manager Consent managers, registered with the Data Protection Board No equivalent concept present. serve as representatives of data principals, handling the processes of reviewing, issuing, overseeing, and retracting consent.

Voluntary Disclosure As per the act, a data fiduciary can process personal data The GDPR lacks a dedicated legal foundation for without the explicit consent of data principals under the condition voluntary disclosure.

that the data principal voluntarily provides their personal data to the data fiduciary for a specific purpose and does not raise objections to the processing of said personal data.

Right to Grievance Redressal Data fiduciaries are required to offer data principals accessible Though it does not outline a distinct entitlement and efficient avenues for addressing grievances, promptly to grievance redressal, if a data subject lodges responding to any such complaints within the specified a complaint against a controller, the controller timeframe. is obligated to make efforts to resolve the data subject’s concerns.

Source: Official documents of the respective Acts.

32 The Digital Personal Data Protection Act, 2023 (No. 22 OF 2023). The Gazette of India, August 11, 2023.

39DIGITALISATION AND II FINANCIAL INNOVATION* Digitalisation is spurring product and process innovations in India’s banking and financial sector, while catering to diverse needs of customers. The hallmarks of financial innovations are the collaborations of banks and non-banking financial companies (NBFCs) with FinTechs and BigTechs in provision of financial services. Adoption of emerging technologies is enabling financial institutions to improve customer service, operating efficiency, and risk management, while also enhancing liquidity of financial markets. Leveraging India’s digital public infrastructure, platform-based lending and embedded finance are rapidly digitalising the credit space through initiatives like Account Aggregators, Peer-to-peer Lending, Open Credit Enablement Network, Trade Receivables Discounting System, Pilot on Public Tech Platform for Frictionless Credit, and Open Network for Digital Commerce. Several regulatory complexities arise in the wake of emerging financial activities, given the absence of definitive regulatory frameworks governing the technologies involved. Ongoing adjustments to the existing regulatory and supervisory frameworks in line with the transformations in the financial landscape would foster a conducive environment for innovations, while ensuring financial stability.

1. Introduction Rural Banks (RRBs), and cooperative banks (Das, 2020a). Globally, BigTech firms (hereafter II.1 Financial sector has been at the forefront BigTechs) offer personalised financial services at of the ongoing digital revolution, marked by the scale, tapping into their vast customer data that cascading effect of various innovations. India is a pioneer in financial innovations, benefiting from mitigate information asymmetries and reduce the the Government-led India Stack and enabling need for collateral (Feyen et al., 2021). The launch policies of the Reserve Bank. The state-of-the- of the pilot end-to-end digitally enabled Public art Unified Payments Interface (UPI), with its Tech Platform for Frictionless Credit (PTPFC) by potential to integrate across various platforms, has the Reserve Bank Innovation Hub has reduced opened new vistas for financial innovations like the turnaround time of certain categories of loans digital lending. The ‘building block approach’ to from a few weeks to less than an hour.

digitalisation has facilitated unbundling of various II.2 Financial innovations support economic components, including identity, payments, and data growth and development through various channels, management, and using them as foundational tools including reduction in the volatility of consumption for designing tailored financial solutions (Alonso (Cavoli and Gopalan, 2023), better risk sharing et al., 2023). New market players like financial technology companies (hereafter FinTechs) and (Allen and Gale, 1994), enhanced allocative other digital players are emerging as the fourth efficiency of capital (Beck et al., 2016), and segment of the Indian financial system, alongside financial inclusion (Feyen et al., 2023). Innovations large banks, mid-sized banks including niche have been contributing to banks’ business growth banks, Small Finance Banks (SFBs), Regional and have enabled financial intermediation in areas * This chapter has been prepared by a team comprising Rakhe Balachandran, Ashish Khobragade, Rajas Saroy, Sakshi Awasthy, Shashi Kant, Akshara Awasthi, Himani Shekhar, Rajni Dahiya, Radheshyam Verma, Anshu Kumari, Priyanka Upreti from the Department of Economic and Policy Research; Prasad Gajinkar, Jyothisree G, Ashis Mittal, Pramanshu Rajput from the Department of Regulation; Parimal Kumar Shivendu from the FinTech Department; and Sanjeev Kumar Gupta and Amarnath Yadav from the Department of Supervision.

Valuable insights provided by Shri Manoranjan Mishra are gratefully acknowledged. Assistance received from Mantisha, Rajkumar Bhandare and Uthara is thankfully acknowledged.

40DIGITALISATION AND FINANCIAL INNOVATION where it was previously unfeasible (Johnson and regulatory innovations are presented in Section Kwak, 2012). Digitalisation in finance helps better 5. Section 6 explores the implications of financial integrate various segments and boosts liquidity innovations, followed by regulatory concerns and and efficiency of financial markets. While the rapid policy initiatives in Section 7. Section 8 provides and widespread integration with technology brings concluding observations.

forth benefits, it also poses risks to the financial

2. Financial Innovations: Conceptual system. The role of central banks becomes more Framework and Economic Facilitators relevant and multi-faceted with the technological advancements leading to financial innovations II.4 Financial innovations seek to alleviate (Patra, 2024). An appropriate regulatory financial frictions emerging from regulation and approach, considering the inherent limitations and taxes, technology shocks (Silber, 1983), and incomplete markets (Duffie and Rahi, 1995), risks of digital technologies, would entail striking asymmetric information, and moral hazard a fine balance between enabling innovations and (Ross, 1989), high transaction, search, and preventing systemic risks (Das, 2022).

marketing costs (Merton, 1989), and cross-border II.3 Against this backdrop, the conceptual integration (Tufano, 2003). Such innovations framework on financial innovations and their provide customer-centric financial products and economic facilitators are discussed in Section 2.

services, spanning payments and credit, in a

Section 3 provides an overview of the technology speedy and efficient manner, and also impact adoption by financial institutions and customers. the operational efficiency and risk-taking of The collaborations of financial institutions traditional financial institutions like banks. Thus, (the Reserve Bank’s regulated entities) with digitalisation in finance has profound implications FinTechs and BigTechs in India are examined in for all stakeholders within the financial system –

Section 4 while developments in digital lending, consumers, firms, and financial intermediaries characteristics of FinTech and BigTech loans, and (Chart II.1).

Chart II.1: Financial Innovations – A Conceptual Framework

Note: e-KYC: electronic Know Your Customer; GSTN: Goods and Services Tax Network; AePS: Aadhaar enabled Payment System; APBS: Aadhaar Payments Bridge System; NACH: National Automated Clearing House; NETC: National Electronic Toll Collection; BBPS: Bharat Bill Payment System; DLT: Distributed Ledger Technology; AI/ML: Artificial Intelligence/Machine Learning; IoT: Internet of Things; ONDC: Open Network for Digital Commerce; OCEN: Open Credit Enablement Network; TReDS: Trade Receivables Discounting System.

Source: RBI staff illustration.

41REPORT ON CURRENCY AND FINANCE Chart II.2: India’s GDP Growth a. Cross-country GDP Growth b. India's Per Capita GDP at Constant Prices

Source: WEO, IMF and National Statistics Office (NSO).

Financial Innovations: Economic Facilitators II.8 The underserved credit regions in the country offer opportunities for digital banking II.5 India is the fastest growing large economy products and services. The share of rural areas in the world (Chart II.2a). The sustained increase in per capita income (Chart II.2b), ongoing financial (mainly tier 5 and 6 centres) and semi-urban deepening, economic dynamism and evolving areas (including tier 2, 3 and 4 centres) taken diverse social needs create strong demand together in total credit of SCBs has increased impulses for digital financial services and financial from 15.0 per cent in June 2017 to 17.7 per cent in innovations. December 2023 and therefore, credit flow to these II.6 In India, consumption-led-growth is further Chart II.3: Consumption and Bank Credit providing opportunities in areas of embedded finance1 and the peer-to-merchant (P2M) payment models (Chart II.3). The bank credit to GDP ratio at around 58.7 per cent in 2023-24 leaves room for further financial deepening, which can be facilitated by financial innovations (Chart II.3).

II.7 The share of short-term maturity loans (less than three months) by Scheduled Commercial Banks (SCBs) has reduced over time (Chart II.4). This provides opportunities for digital lending in small ticket loans. Financial innovations that reduce loan processing costs can help

Note: Private Final Consumption Expenditure (Current Prices) and Bank regulated entities (REs) penetrate this segment in Credit to Commercial Sector are plotted in the chart.

Source: RBI, NSO and RBI staff estimates. collaboration with FinTechs.

1 Embedded finance refers to the integration of banking and various financial services into non-financial applications and services.

42 tnec reP 12 10 8 6 4 2 0 -2 -4 -6 -8 -10 -12 European Union Japan UK Russia USA Brazil South Africa China India 5102 6102 7102 8102 9102 0202 1202 2202 3202 4202 5202 6202 7202 8202 9202 IMF Projecti ons 140,000 120,000 100,000 80,000 60,000 40,000 20,000 10-0002 20-1002 30-2002 40-3002 50-4002 60-5002 70-6002 80-7002 90-8002 01-9002 11-0102 21-1102 31-2102 41-3102 51-4102 61-5102 71-6102 81-7102 91-8102 02-9102 12-0202 22-1202 32-2202 42-3202 0 nIDIGITALISATION AND FINANCIAL INNOVATION Chart II.4: Maturity Profile of Loans and Advances by Chart II.5: Share in Total Credit of SCBs by SCBs Population-group

16.9

Note: Data as at end-March.

Source: RBI. Source: RBI. areas could benefit immensely from the evolving the extent of funding received by FinTechs in India financial innovations (Chart II.5). which is around 30 per cent of the startup funding during 2023 (Chart II.6).

II.9 The availability of funds from domestic and external sources supports the financial innovation

3. Financial Innovations : Adoption by India’s ecosystem. India - the third largest FinTech Financial Institutions and Customers ecosystem (after the United States and United II.10 The benefits of financial innovations reach Kingdom) - accounts for close to one-fourth of all customers through their interactions with financial the unicorns globally. This is partly reinforced by institutions. Banks are making extensive use of Chart II.6: Share of FinTech Funding in Total Startup financial innovations to service their customers Funding in India and also for enhancing operational efficiency. An analysis of the annual reports of 20 commercial banks shows that the use of words related to digitalisation and cyber security has increased steadily between 2013 and 2023, with a significant acceleration since the COVID-19 pandemic (Chart II.7a). Further, discussions on new topics like ‘FinTech’, ‘Blockchain/Tokenisation’, ‘Online Account Opening/e-KYC’, ‘Chatbot/Robot’, ‘AI/ ML’ and ‘Digital Lending’ have gained momentum in the recent period (2018-2023), in addition to the technology buzzwords of the previous period (2013-2017) such as ‘UPI’ and ‘Cyber Security

Source: Tracxn accessed on July 5, 2024, and RBI staff estimates.

Awareness’. Topics like ‘Internet of Things’ (IoT), 43REPORT ON CURRENCY AND FINANCE Chart II.7: Banks’ Focus on Digital Technologies

Note: The chart includes data for 20 SCBs. For chart II.7a, the vertical axis represents the number of sentences containing keywords related to digitalisation and cyber security as a share of the total number of sentences in the respective annual reports. For chart II.7b, banks focussing on emerging technologies were found out from the existence of related keywords in their annual reports between 2013-2017 and 2018-2023.

Source: Annual Reports of SCBs for years 2013 to 2023 and RBI staff estimates. ‘digital lending’ and ‘Account Aggregators’ have credit monitoring (Koulouridi et al., 2020; Agarwal experienced significant traction in discussions et al., 2019; Calli and Coskun, 2021). Digital post 2018 (Chart II.7b).

transformation can help banks automate and II.11 Digitalised financial sector can enhance standardise their business processes, reduce credit assessment, reduce default rates and human resources and operational costs broaden the access to finance (Berg et al., 2020).

(Parviainen et al., 2017). Digitalisation, facilitated Incorporating alternative digital data, such as cash by RegTechs2, automates and streamlines flow, telecom, utility, and social media sources compliance with regulatory guidelines. In India, and leveraging surrogate data allow creditors to digitalisation has improved the efficiency of comprehensively assess customers’ ability and willingness to repay loans and enable real-time banks (Box II.1).

Box II.1 The Impact of Digitalisation on Efficiency of Banks Financial innovation impacts efficiency of banks of digital payments which reflects relative position of by reducing operating costs, creating customer- each bank in processing retail digital transactions3 oriented business models, and strengthening risk each year. Bank efficiency is estimated using non- control capabilities (Wang et al., 2021). The impact of parametric data envelopment analysis methodology, digitalisation on operating efficiency of Indian banks which provides cost efficiency and technical efficiency is analysed using a panel dataset of 29 public and of banks. The efficiency scores are estimated using private sector banks at annual frequency for 2015- net interest income and non-interest income as output

2023. Digitalisation is proxied by an index of volume variables, and loanable funds, fixed assets, and total (Contd...) 2 Regulatory Technology (RegTech) refers to the application of technology to improve regulatory compliance and risk management within financial institutions (FIs). RegTech, a subset of FinTech, offers tailored solutions for compliance, reduces costs, and manages new regulations, litigation, and remediation. This technology streamlines regulatory processes, helping FIs navigate the evolving regulatory landscape efficiently, enhancing compliance, and reducing complexity (Suresh, 2018).

3 Includes National Electronic Funds Transfer (NEFT), debit and credit card transactions.

44DIGITALISATION AND FINANCIAL INNOVATION employees as input variables for technical efficiency.

Table 1: Digitalisation and Efficiency of Banks:

Empirical Estimates The corresponding prices are used as input variables Dependent Variable for cost efficiency. A pooled fractional probit model Independent Variables Cost Efficiency Technical with clustered standard errors is used to estimate the Efficiency impact of digitalisation on efficiency of banks, since the Digitalisation 0.0385*** 0.0321*** (0.00407) (0.00511) efficiency score lies between zero and one. The cross Cost of Deposits -0.235*** -0.331*** section-level fixed effects have been accounted for in (0.0771) (0.0952) the model following Woolridge (2010). The regression Inflation -0.0156 0.00934 (0.110) (0.152) estimates indicate that digitalisation increases Bank Size -0.436*** -0.179 efficiency of banks (Table 1).

(0.108) (0.132) Ratio of net NPA to net advances -0.0366** -0.0645*** References: (0.0147) (0.0186) Wang, Y., Xiuping, S., and Zhang, Q. (2021). Can Return on Advances 0.276*** 0.362*** (0.0460) (0.0569) FinTech Improve the Efficiency of Commercial Log(GDP) -0.0992 0.121 Banks? - An Analysis Based on Big Data. Research in (0.930) (1.442) International Business and Finance, 55, 201338.

Constant 0.142 -3.521 (15.59) (25.87) Woolridge, J. (2010). Econometric Analysis of Cross Observations 256 256

Section and Panel Data. MIT Press.

Note: 1) ***, **, * indicate significance at 1 per cent, 5 per cent and 10 per cent levels, respectively.

2) Figures in parentheses are robust clustered standard errors.

3) Standard errors are clustered at the bank level.

4) Bank size is proxied by the share of the bank’s assets to aggregate banking sector assets.

5) Following Woolridge (2010), cross-section fixed effects are accounted for by controlling for averages of time-varying cross-

section variables for each year in the model.

Source: RBI staff estimates.

II.12 The adoption of digital technology varies banks (PVBs) relative to public sector banks among bank groups. The share of the key words (PSBs) [Chart II.8a]. PVBs are also ahead of PSBs related to digitalisation in the annual reports, an in the realm of cybersecurity (Chart II.8b). Further, indicator of digitalisation, is higher in private sector in both public and private sectors, small banks Chart II.8: Bank-group wise Focus on Digitalisation and Cyber Security a. Digitalisation b. Cyber Security

Note: The chart includes data for 20 SCBs. The vertical axis represents the number of sentences containing keywords related to digitalisation and cyber security as a share of the total number of sentences in the respective annual reports. Banks were categorised into two groups, namely big and small banks, based on their asset size in 2022-23. The top five banks in each category, public and private, were classified as big banks, while the remainder were categorised as small banks.

Source: Annual reports of SCBs for 2013-2023 and RBI staff estimates.

45 tnec reP tnec reP

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0.00 Big Private Banks Big Public Banks Big Private Banks Big Public Banks Small Private Banks Small Public Banks Small Private Banks Small Public Banks 3102 4102 5102 6102 7102 8102 9102 0202 1202 2202 3202

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0.0 3102 4102 5102 6102 7102 8102 9102 0202 1202 2202 3202REPORT ON CURRENCY AND FINANCE Chart II.9: NBFC-ICCs’ Focus on Digitalisation and Cyber Security

Note: The chart includes data for nine upper layer NBFC-ICCs. Y-axis represents the number of sentences containing the keywords related to digitalisation and cyber security divided by the total number of sentences in the respective annual reports.

Source: Annual reports of NBFC-ICCs, 2011-2023 and RBI staff estimates. lag behind big banks in terms of digitalisation and Many SCBs plan on adopting chatbots in less cyber security. than a year (Chart II.10b). The surveyed banks exhibited muted interest in offering Online PPF, II.13 The use of digitalisation and emphasis on payment aggregator and gateway services, and cyber security is also increasing in the upper-layer Buy Now Pay Later (BNPL) [Chart II.10c]. All NBFC-Investment and Credit Companies (NBFC- respondent banks have embraced technology ICCs), as suggested by the frequency of these partnerships with FinTechs and have adopted keywords in their annual reports. The extent of digital technologies to enhance their front-end/ usage is, however, less than that of many SCBs customer interface. Digital technologies are (Chart II.9).

also used for facilitation of deposits, managing II.14 A special survey of SCBs4 conducted compliance requirements, and making lending in March 2024 on the adoption of various types decisions (Chart II.10d).

of financial innovations indicates that internet PSB Alliance – Innovation Adoption at the banking, mobile banking, online account opening, Community Level digital Know Your Customer (KYC), mutual fund investments, and doorstep banking through II.15 Public sector banks are collaborating digital means are being extensively used across amongst themselves on financial innovations banks (Chart II.10a). The adoption of more recent to enhance the quality of customer service and innovations like payment aggregator services, operational efficiency. PSB Alliance (PSBA), an chatbots, prepaid wallets, open banking, online umbrella entity in collaboration with 12 PSBs, has Public Provident Fund (PPF) and IoT based implemented several community-level financial applications has been relatively lower, with less innovations. Enhanced Access and Service than half of the surveyed SCBs adopting them. Excellence (EASE) reforms, governed by the 4 Twenty-five banks participated in the survey.

46DIGITALISATION AND FINANCIAL INNOVATION Chart II.10: Survey on Innovation Adoption by Banks

Note: Multiple responses were allowed. For charts a, b and c, banks were asked whether they are planning to adopt the listed categories of innovations and they had six options (‘we had introduced it, but the response was not good’; ‘we have already introduced it partially’; ‘we have introduced it completely’; ‘we plan to introduce it in less than a year’; ‘we plan to introduce it in coming two years’; ‘we do not plan to introduce it at this stage’) to choose from. Since the charts are plotted for only three categories (‘we have introduced it completely’; ‘we plan to introduce it in less than a year’; ‘we do not plan to introduce it at this stage’), they may not add to 100.

Source: Special survey of 25 SCBs and RBI staff estimates.

EASE Steering committee of the Indian Bank’s management, and an omni-channel interface.

Association, aim to enhance the capabilities of Built on a modular architecture with open APIs, PSBs to meet the changing demands of diverse the eBKray platform ensures ease of integration set of customers. With close to 40 per cent of with market ecosystem players. Single portal for banks’ total deposits held by senior citizens (above pre-auction, auction, EMD management, reporting 60 years of age), PSBA offers doorstep banking and post-auction is anticipated to enhance user facilities for both financial and non-financial experience.

transactions across 2,760 centres across India II.16 As part of risk management and data as on July 26, 2024. Further, PSBA is expanding exchange, the PSBA has also set up the doorstep banking technology to more centres. Operational Risk Loss Data Exchange (LDE). The It has introduced Unified Property Listing and LDE collects and consolidates the individual bank- Auction Portal (eBKray) with enhanced features level data on operational risk losses and shares and functionalities, including mobile application, AI- the sector-level data with member banks. Industry based search engines, loan sourcing capabilities, benchmarks of key risk indicators are prepared automated earnest money deposit (EMD) based on the Basel Committee on Banking 47REPORT ON CURRENCY AND FINANCE Chart II.11: Growth in the Issuance of Cards

Note: Data pertain to 19 SCBs for credit cards and 29 SCBs for debit cards. Compound Annual Growth Rate (CAGR) for the period 2015-24 is reported.

Source: RBI.

Supervision (BCBS) guidelines and are also – has moderated, with an increase in the usage of shared among member banks. The data collected digital payments by customers (Chart II.12). by LDE can be used for various purposes by II.19 On an average, ten and four per cent of member banks such as stress testing, scenario banks’ customers made active5 use of mobile analysis and calculation of economic capital for and internet banking, respectively, during Internal Capital Adequacy Assessment Process February and March 2024 (Chart II.13). Usage of

(ICAAP). The development of a community cloud, mobile and internet banking by PVBs’ customers agricultural lending and collateral monitoring platform, and digital supply chain finance platform Chart II.12: Adoption of Cards for Digital Transactions are also under consideration by the PSBA (PSBA,

2024).

Uptake of Financial Innovations by Banks’ Customers II.17 During 2015-24, the compound annual growth rate (CAGR) of credit cards issued across banks was in the range of 10 to 30 per cent, with a few banks reporting growth of more than 40 per cent, indicating faster adoption of credit cards by customers. The growth in the debit card segment hovered in the range 0-20 per cent across banks, Note: Cash-card ratio is the ratio of monthly average value of ATM withdrawals to monthly average ticket size of card payments (both debit partly reflecting the base effect (Chart II.11).

and credit cards). Cash-debit card ratio is the ratio of monthly average value of ATM withdrawals from debit cards to monthly average ticket size II.18 In India, the cash-to-card ratio – the ratio of of debit card payments.

Source: RBI staff estimates. average ATM withdrawal to average card payment 5 Active customers are defined as those who have used these facilities at least once in two months.

48DIGITALISATION AND FINANCIAL INNOVATION Chart II.13: Usage of Mobile and Internet Banking by Chart II.15: User Ratings of Mobile Banking Applications Customers

Note: Data on active mobile banking users pertain to 12 PSBs, 21 PVBs and 12 small finance banks. For Internet Banking users, data represent Note: The data pertain to mobile applications of 47 banks, where in 12 PSBs, 20 PVBs and 11 Small Finance Banks. Number of total savings the primary mobile banking application of each bank is included in the and current accounts (CASA) is taken as a proxy for total customers of analysis, as on May 30, 2024. The sample contains applications available bank groups. on Google Play Store.

Source: RBI staff estimates. Source: Google Play Store and RBI staff estimates. was higher than that of PSBs’ customers during out of 47) of applications have average user rating these months. of 4 or above, reflecting customer satisfaction with mobile banking. Mobile applications of three banks II.20 A correlation analysis reveals a positive received a rating of below three from customers association between bank size and their (Chart II.15).

respective mobile banking application installations II.22 Bank group-wise analysis of ratings of by customers, especially for PVBs (Chart II.14). mobile banking applications of 47 banks in India II.21 The frequency distribution of average user shows that ratings are generally higher for PVBs rating for primary mobile banking applications of as compared to PSBs and small finance banks 47 banks in India suggests that 55.3 per cent (26 (SFBs) [Chart II.16].

Chart II.14: Mobile Banking Adoption by Customers vis-à-vis Bank Size

Note: The data pertain to 47 bank applications, where in the primary mobile banking application of each bank is included in the analysis, as on May 30, 2024.

Source: RBI, Google Play Store, and RBI staff estimates.

49 snoitacilppa fo rebmuNREPORT ON CURRENCY AND FINANCE Chart II.16: Bank-group wise Average User Ratings of Chart II.17: Average User Ratings of Mobile Applications – Mobile Banking Applications NBFC-ICCs and LSPs

Note: The data pertain to mobile applications of 47 banks, where in Note: The data pertain to 31 mobile applications (primary universal the primary mobile banking application of each bank is included in the applications along with dedicated digital loan applications) of 20 upper and analysis, as on May 30, 2024. The sample contains applications available middle layer NBFC-ICCs and 48 LSPs, as on May 30, 2024. The sample on Google Play Store. contains applications available on Google Play Store.

Source: Google Play Store and RBI staff estimates. Source: Google Play Store and RBI staff estimates.

II.23 The mobile applications of 20 NBFC-ICCs II.24 Among the prepaid payment instruments belonging to the upper layer and middle layer (PPIs), issuance of wallets is higher than cards received an average rating of four from the users. (Chart II.18a). Private banks lead in the issuance The mobile applications of the major FinTech of PPIs to customers (Chart II.18b). Recent lending service providers (LSPs) of these NBFCs initiatives including developments regarding PPIs received a higher rating than the applications of for Mass Transit Systems (PPI-MTS) may boost the NBFCs themselves (Chart II.17). issuance going ahead.

Chart II.18: Issuance of Prepaid Payment Instruments (PPIs) to Customers

Note: Number of current and savings accounts (CASA) has been taken as a proxy for total customers. In chart b, red bar indicates a PVB and green bar indicates a PSB. The data are as on end-March 2024.

Source: RBI staff estimates.

50DIGITALISATION AND FINANCIAL INNOVATION

4. Collaboration of FinTechs and BigTechs Chart II.19: Overlap in FinTech Activities with Financial Institutions (Banks and NBFCs) II.25 FinTechs may be defined as entities that provide technological solutions for delivery of financial products and services to businesses and consumers or encompass regulatory and supervisory compliance in partnership with traditional financial institutions or otherwise (RBI, 2024a). India leads the world with FinTech adoption rate of 87 per cent, higher than the global average of 64 per cent (EY, 2019).6 According to

Note: The figure shows the number of FinTechs in India categorised under the Department for Promotion of Industry and banking, payment and lending business models on Tracxn. Banking Tech includes companies providing software solutions, innovative hardware Internal Trade (DPIIT), there are 8,011 FinTechs in solutions or tech-enabled services to banking institutions. It also includes internet-first banks.

India as on July 22, 2024. Revenues of FinTechs Source: Tracxn, accessed on May 8, 2024 and RBI staff illustration. in India are expected to grow exponentially from US$ 17 billion in 2022 to more than US$ 190 rapidly. FinTechs, however, lack a large client billion by 2030 (BCG, 2023). Between January base and the necessary expertise to navigate 2018 and December 2023, the FinTech sector in the regulatory landscape of the financial sector.

India has received approximately US$ 27 billion Banks, on the other hand, enjoy customer trust in funding7, including both domestic and external and confidence, a large pre-existing customer sources (Tracxn, 2024). The payments segment base, widespread geographical presence, legal leads in terms of fundraising within the Fintech backing to accept deposits, and experience in risk sector. FinTechs have not confined to a single management and regulatory compliance (Mundra, market, and some of them have also ventured into

2017). The annual reports of banks and upper several associated activities in India (Chart II.19). layer NBFC-ICCs have increasingly showcased II.26 The partnerships between banks/NBFCs their growing collaboration with FinTechs (Chart and FinTechs have unique strengths and are II.20)8. The names of payment FinTechs tend to mutually beneficial. The comparative advantages occur more than the lending and banking FinTechs, of FinTechs include better user experience, agility, highlighting maturity of these partnerships in the use of unconventional data, and the ability to scale payment space.

6 The FinTech adoption rate is the share of consumers who have used at least two categories of FinTech services, including money transfer and payments, budgeting and financial planning, savings and investments, borrowing, and insurance, among the total digitally active adults surveyed (EY, 2019).

7 Data accessed on May 14, 2024.

8 Based on text mining of the Annual Reports of the SCBs and the Upper Layer NBFCs from 2011 to 2023. The number of times the names of the FinTechs and the word “fintech” appears in the annual reports is used as a proxy for collaboration between the Banks/NBFCs and the FinTechs.

51REPORT ON CURRENCY AND FINANCE Chart II.20: FinTech Collaboration Index of Financial Institutions

Note: The index has been calculated as average number of FinTech names appearing in the annual reports of SCBs and upper layer NBFCs. Some FinTechs may fall under both, lending, and payments category as classified in Tracxn database accessed as on May 6, 2024. The sample constitutes 30 SCBs (chart a) and nine upper layer NBFC-ICCs (chart b).

Source: Annual reports of NBFC-ICCs and RBI staff estimates.

II.27 An analysis of the empanelled FinTechs of banks and 35 per cent of the surveyed a few SCBs reveals that FinTech collaborations NBFCs are partnering with FinTechs for offering are made for a range of services including lending, digital banking solutions (Chart II.21). These remittances and payment services, digitalisation collaborations with FinTechs are used to distribute of processes and products, insurance, wealth products/services on banking platform, including products, investments, marketing, and API digital banking solutions. According to the survey, development.

92 per cent of the responding banks reported II.28 A special survey of select NBFCs and that collaboration is effective in driving digital banks9 shows that 84 per cent of the surveyed innovation as against 60 per cent of NBFCs.

Chart II.21: Services Provided through Collaboration between Banks/NBFCs and FinTechs

Note: Due to the respondents selecting multiple categories, shares across all categories may not add up to 100. Data pertain to 25 banks and 34 NBFCs.

Source: A special survey of banks and NBFCs and RBI staff estimates.

9 The survey was conducted in March 2024. Responses were received from 25 banks and 68 NBFCs.

52DIGITALISATION AND FINANCIAL INNOVATION Chart II.22: Indicators of Embedded Finance in India Collaboration with BigTechs be either sold to third parties or utilised internally to refine services, innovate new offerings, and II.29 BigTechs, mainly through e-commerce and generate additional revenue streams (Bains et payment applications, are reshaping the financial al., 2022). By integrating cutting-edge technology, landscape, with implications for public policy, competitiveness, and financial stability. BigTechs BigTechs can deliver innovative financial services mainly operate as online multi-sided platforms, for households (De la Mano and Padilla, 2018).

facilitating direct interactions among different user II.31 There exists scope for seamless integration groups like buyers and sellers (Doerr et al., 2023). between financial services and non-financial Rising adoption of e-commerce, as suggested BigTech platforms to enhance user experiences.

by increasing e-commerce mobile application review counts, may be associated with demand Chart II.23: BigTech Sales in India for embedded finance in India (Chart II.22a).

Concurrently, the embedded financial transactions and the presence of BigTechs are also rising in India (Chart II.22b and II.23).

II.30 The business models of BigTechs are usually characterised by the data-network-activity reinforcing feedback loop (Shin, 2019). As user engagement on the platform increases, network externalities arise, enhancing the platform’s adoption and allowing BigTechs to accumulate more data which enables them to diversify into financial services, such as money management, Note: 1. Aggregated revenues of Indian subsidiaries of five major BigTechs.

2. List of group subsidiaries considered may not be comprehensive. insurance, and lending, attracting additional

Source: Profit and Loss Statements accessed from Capitaline and RBI staff estimates. users and perpetuating the cycle. Data can also 53 )erorc nI( sweiver fo rebmuN nIREPORT ON CURRENCY AND FINANCE through gateways, platform-specific digital Chart II.24: Collaborations of BigTechs with Banks for UPI wallets, co-branded credit cards, converting purchase bills into equated monthly instalments (EMIs or No-cost EMI) and BNPL. In India, five BigTechs have entered into collaborations with four PVBs and five NBFCs for offering BNPL through their platforms. Co-branded credit cards are also offered in collaboration with four SCBs (Chart II.26).

II.33 For lending activities, BigTechs rely on machine learning for credit risk assessment to address information asymmetries in lieu of

Note: Green indicates private sector banks, blue indicates public sector the traditional collateral-based lending (Doerr banks and yellow indicates BigTechs. Size of the bubble is proportional to the number of collaborations. et al., 2023; Gambacorta et al., 2019). They

Source: NPCI and RBI staff illustration. are positioned to capture a significant share of financial services market, including lending, due Within the financial services industry, BigTechs first entered the payment segment (BIS, 2019). to economies of scale and scope (Adrian, 2021).

In India, six banks have collaborated with seven In an environment of lower competition, there is BigTechs in the UPI payment space (NPCI, 2024). greater opportunity for BigTechs’ credit to thrive, Most of these collaborations involve PVBs (Chart attracted by higher profit margins. However, with II.24). BigTech-backed applications have made stringent banking regulations, credit activities their mark in the Indian payment industry, with of BigTechs might face setbacks (Cornelli et al., more than 90 per cent share in UPI payment volume and value (Chart II.25). 2023).

II.32 BigTech platforms offer multiple II.34 Standard EMIs and no cost EMIs are contactless payment options such as payment the most available lending options on BigTech Chart II.25: BigTech Penetration in UPI Payments

Note: Incumbents include apps by SCBs, Small Finance Banks and Payments Banks. NBFCs/FinTechs include UPI apps operated by companies. Others include Bharat Interface for Money (BHIM).

Source: NPCI.

54DIGITALISATION AND FINANCIAL INNOVATION Chart II.26: BigTechs’ Collaborations with FIs for BNPL Chart II.27: Revenues of B2C e-Commerce and Co-branded Credit Cards Startups in India

Note: Blue colour indicates a BigTech, green indicates a PVB, red indicates a PSB and yellow indicates an NBFC. Dotted black line indicates a collaboration for BNPL, while red arrow mark indicates a collaboration for co-branded credit card. Size of the bubble is proportional to the number of Note: 1) Data on top 50 B2C e-commerce startups in terms of mobile collaborations. Overlapping of an NBFC with a bank indicates co-lending application downloads.

model with one of the BigTechs. The same NBFC has an independent 2) In 2022-23, missing data for 11 startups have been linearly contract with another BigTech for BNPL. extrapolated.

Source: RBI staff illustration and websites of BigTechs. Source: RBI staff estimates and Tracxn Database accessed as on May 10, 2024. platforms. These EMIs are offered mainly through on their platforms and their business is gaining three channels, viz., co-branded credit cards, ground (Chart II.27). These embedded financial through credit and debit cards of banks and services include BNPL, credit cards, and through the BNPL. payments. India is among the top five nations in terms of the percentage of BNPL loans in II.35 Smaller e-commerce startups in India e-commerce transactions (Chart II.28). There are also offering embedded financial services are dedicated BNPL applications that provide Chart II.28: BNPL in e-Commerce – Global Picture BNPL services to smaller e-commerce startups in India. These applications had a high average user rating at 4.2, as of June 2024.10

5. Digital Lending II.36 Digital lending is remote and automated lending process, largely by use of seamless digital technologies for customer acquisition, credit assessment, loan approval, disbursement, recovery, and associated customer service (RBI, 2022a). Three attributes that differentiate digital credit from traditional credit are speed, automation, and remote operation (Chen and

Source: Worldpay Global Payments Report, 2024. Mazer, 2016). As digital lending operates 10 User ratings of six major dedicated BNPL applications on Google Play store are considered.

55 nIREPORT ON CURRENCY AND FINANCE Chart II.29: Digital Lending Ecosystem in India

Source: RBI staff illustration. through an online platform, it is also known were processed end-to-end digitally in 2022-23 as platform-based lending. Banks, NBFCs, (Chart II.30). as well as individuals and entities other than II.39 As of December 2020, surveyed NBFCs banks and NBFCs, participate in India’s digital (holding 10 per cent share in total NBFCs’ asset lending ecosystem as lenders (Chart II.29).

size) reported that digital lending constituted Lenders provide both secured and unsecured loans through these platforms, which are either publicly or privately owned. Loan origination and Chart II.30: Digital Personal Loans of Select SCBs - 2022-23 management services are also integrated in this ecosystem.

Size of the Digital Lending Market in India II.37 At end-December, 2020, the share of digital lending was two per cent of the total amount disbursed by surveyed banks, which have an asset size of 75 per cent of the total banking sector (RBI, 2021).

II.38 SCBs are digitalising their retail portfolio, especially personal and MSME loans. Information

provided by five SCBs, having 53 per cent share

Note: Data pertain to five SCBs accounting for 53 per cent share in the total in the personal loan market, indicates that personal loans by SCBs.

Source: Annual reports of select SCBs and RBI staff estimates. around 40 per cent of the personal loans by them 56DIGITALISATION AND FINANCIAL INNOVATION Chart II.31: Lending by FinTechs Registered as Chart II.32: Annual Revenue of Select FinTech LSPs NBFC-ICCs

Note: Data on 51 NBFC-ICCs, accessed on June 12, 2024. Note: Data based on 40 major FinTech LSPs of upper layer NBFC-ICCs.

Source: RBI staff estimates and Tracxn. Source: RBI staff estimates and Tracxn, accessed as on May 13, 2024.

11.4 per cent of their overall lending activities II.42 Crowdfunding through P2P platform, (RBI, 2021). Data for 51 NBFC-ICCs, that are which connects individual lenders with borrowers, also shown as FinTech on Startup India portal by to facilitate unsecured loans is another form of DPIIT, show that their lending is gaining traction digital lending in India (RBI, 2016). There are 26 at an increasing rate. The lending share of these NBFC-ICCs, however, constitutes only less than Chart II.33: Lending through e-Commerce one per cent of the total lending market of NBFC- Platforms ICCs (Chart II.31).

II.40 The increasing revenue of FinTech LSPs of upper layer NBFC-ICCs, mainly from operations, in recent years indicates that their scale of activity is experiencing significant growth (Chart II.32).11 II.41 Lending through e-commerce platforms including BigTechs is offered via credit cards, debit card EMIs and BNPL. Credit extended through credit cards on the e-commerce platforms

Note: Lending through credit cards on e-commerce platforms including including BigTechs, encompassing both EMI plans BigTechs is depicted in the chart. Data refer to loan disbursements and includes both lumpsum credit card purchases as well as purchases through and lumpsum credit, grew by 32.4 per cent (y-o-y) credit card EMIs.

Source: RBI staff estimates. in 2023-24 to ₹11 lakh crore (Chart II.33).12 11 Names of the FinTech LSPs of upper layer NBFC-ICCs are collected from their respective websites.

12 Data on credit extended through debit card EMI plans and BNPL are not available.

57 nI nI nIREPORT ON CURRENCY AND FINANCE P2P NBFCs registered with the Reserve Bank of FinTech Personal Loans India as on March 31, 2024 (RBI, 2024b). II.44 FinTech loan originations mainly include personal loans followed by business and consumer Characteristics of Loans through FinTechs loans (Chart II.35). In India, the personal loan II.43 Lending through FinTechs mainly catered market has seen an accelerated growth phase to semi-urban and rural areas in 2022-23 (Chart (Das, 2023b). FinTechs mainly cater to small- II.34a). Younger age groups (less than 25 years value personal loans with 68 per cent of personal loans falling in the category of less than ₹5,000 in and 26-30 years) are the major borrower group 2022-23 (Chart II.36). The average ticket size of (59 per cent of FinTechs loans) [Chart II.34b].

personal loans by FinTechs was around ₹11,000 Delinquency rates are higher among younger age in 2023 (Chart II.37) and these loans typically groups and are broadly similar across regions supplement or smoothen consumption (Agarwal (Chart II.34c and d). and Chua, 2020).

Chart II. 34: Characteristics of Loans using FinTechs FinTech Loan Origination

Note: Data pertain to 130 credit institutions (NBFCs).

Source: TransUnion CIBIL, 2023.

58DIGITALISATION AND FINANCIAL INNOVATION Chart II.35: FinTech Loan Origination by Value in Chart II.36: Distribution of FinTech 2022-23 (in Per cent) Personal Loans by Ticket Size

Note: Data pertain to 130 credit institutions (NBFCs).

Source: TransUnion CIBIL, 2023. Source: FinTech Personal Loans April 2018 – September 2023, FACE.

II.45 There exists vast gender-based divide Characteristics of Consumer Durable Loans in digital lending. The percentage of female through BigTechs borrowers of FinTech personal loans is around II.47 The credit options for purchasing consumer 14 per cent in 2022-23 (Chart II.38). durables on BigTech platforms include purchases through credit card (without EMI), UPI (credit line II.46 By population group, almost 31 per cent of FinTech personal loans in 2022-23 were and Rupay credit card linkage), pay later options, disbursed in rural areas (Chart II.39). no cost EMI and standard EMI. Out of the total EMI Chart II.37: FinTech Personal Loans by Chart II.38: FinTech Personal Loans by Gender Average Ticket Size

Note: Data pertain to loan disbursal of FinTechs. Note: Data pertain to loan disbursal of FinTechs.

Source: FinTech Personal Loans April 2018 – September 2023, FACE. Source: FinTech Personal Loans April 2018 – September 2023, FACE.

59REPORT ON CURRENCY AND FINANCE II.48 Under no-cost EMIs, the interest charged Chart II.39: Share of FinTech Personal Loans by Population group by the bank is offered as an upfront discount to the customer by the BigTech platforms. For 32 per cent of the total products sampled, the number of credit card no-cost EMI plans available per product was in the range of 17-108. Notably, debit card no-cost EMIs were not available on 79 per cent of the sample products.

II.49 Standard EMIs charge interest rates on loans offered through the BigTech platform. For 58 per cent of the products analysed, standard

Note: Data pertain to loan disbursal of FinTechs. EMIs were available for more than 100 credit

Source: FinTech Personal Loans April 2018 – September 2023, FACE. cards, making this as the most frequently available channel in offering credit through the options available on the sample 150 products13, BigTech platform. For only four per cent of the around 82 per cent were standard EMIs, the products analysed, credit card standard EMI was remaining being no-cost EMIs (Chart II.40a). In not available. For 20 per cent and 26 per cent of both no-cost and standard EMIs, the most offered the products, debit card standard EMI and BNPL standard EMI, respectively, were not available.

lending channel was credit card (Chart II.40b).

Chart II.40: Composition of EMI Options on a BigTech Platform

Note: Data pertain to 150 products across 15 product categories.

Source: RBI staff estimates and website of a major BigTech operating in India.

13 This sub-section is based on a case study, undertaken in July 2024, of 150 individual products randomly selected from varying price ranges across 15 product categories of consumer durables that are sold on a major BigTech platform in India. Consumer durables considered for this analysis are refrigerator, television, smart phone, almirah, sofa, stove, mixer grinder, cot, laptop, and headphone, among others.

60DIGITALISATION AND FINANCIAL INNOVATION II.50 Lending through the BigTech platform is across lending channels. The most frequently available for durations starting from three months available channel, viz., credit card EMIs, charges to 24 months. The most offered lending channel, the lowest interest rates, and interest rates viz., credit card EMI, is available uniformly across increase with the duration of loans. The highest all durations. Availabililty of debit card EMI is interest rate is charged on BNPL loans at 24 per higher in relatively smaller durations, viz., six and cent across various durations of loans. Notably, nine months. BNPL allows the customer to avail around 50 per cent of the total consumer durable loans without possessing a debit or credit card. In loans disbursed by the SCBs are at interest rates the sample, BNPL is mostly available in medium below 13 per cent. Banks that offer loans through durations such as nine and 12 months (Chart BigTech platforms also charge processing fees II.41a).

for these loans. Processing fee is applicable even II.51 Availability of no-cost EMIs decreases if the loan is a no-cost EMI loan. An 18 per cent as the duration of loan increases. In the sample, Goods and Services Tax (GST) is also applicable out of the total no-cost EMIs available, 32 per on the interest charged on these loans, which is cent are for three months, 30 per cent are for revealed on the EMI details page of the BigTech six months, and 21 per cent are for nine months.

platform. Depending on the chosen EMI plan, Since shorter duration makes the size of EMIs this varies from 0.4 per cent to 3.2 per cent of bigger, the benefits of these interest-free loans are the product price in the sample and GST amount restricted to a few who can afford higher EMIs.

chargeable goes up with the duration of the loans.

In contrast, the standard EMIs increase with the duration of the loan, with the highest percentage Regulatory Innovations in Digital Lending of standard EMIs available for 24-month plan II.53 The initiatives of the Government of (Chart II.41b).

India and the Reserve Bank have been playing II.52 The rate of interest charged on loans an important role in inculcating trust in platform- offered on the BigTech platform under study vary based lending by putting in place appropriate Chart II.41: Availability of EMIs across Durations

Note: Data pertain to 150 products across 15 product categories.

Source: RBI staff estimates and website of a major BigTech operating in India.

61REPORT ON CURRENCY AND FINANCE safeguards. The major initiatives are discussed II.55 The Reserve Bank has introduced below. enabling regulations for NBFC-AAs in 2016.

The NBFC-AA ecosystem is gaining momentum Account Aggregators in terms of the number of accounts linked and II.54 Account Aggregators (AAs) provide requests fulfilled (Chart II.43a). At present, the AA a technology-enabled interface based on system has 256 live FIUs and 71 live FIPs under standardised application programming interfaces the Reserve Bank. The number of successful

(APIs) for managing customer consent and data shares14 stand close to 40 million. The authentication, and sharing select financial lending through AAs is on the rise (Chart II.43b). information. AAs address the issue of non- Many RRBs are also coming live on AAs which standardised bank specific APIs, that are difficult for third-party applications to integrate and augurs well for the flow of bank credit to the rural thus, help break down data silos in the financial economy.

sector. Financial information of consumers, with Open Credit Enablement Network (OCEN) their consent, from one or more accounts held with banks, NBFCs, mutual funds, insurance II.56 The Government of India has launched companies, etc., known as Financial Information the OCEN with the goal of democratising credit Providers (FIPs) is digitally shared with other REs and extending financial inclusion to the last in the financial sector, called Financial Information mile. The OCEN is a framework of APIs which Users (FIUs), who provide services such as loans facilitates easy interaction and codified flow of or insurance to consumers (Chart II.42). credit among lenders, borrowers (especially Chart II.42: Flow of Data under AA Flow based Credit

Source: DEPA, NITI Aayog and RBI staff illustration.

14 Successful data shares refer to movement of the requested data from FIPs to FIUs that has actually taken place.

62DIGITALISATION AND FINANCIAL INNOVATION Chart II.43: Progress of NBFC-AAs

Source: Sahamati. small borrowers), loan agents (LAs)15 and Sahay and GST Sahay apps. The GeM Sahay technology service providers (TSPs)16 under a app provides unsecured short-term financing common set of standards. The OCEN helps LAs to sellers on the Government e-Marketplace to effectively provide embedded finance to their (GeM).17 There are 1.52 lakh GeM Sahay app customers. Borrowers get access to competing installs on the Google Play Store18. As at end- customised credit products on their preferred May 2024, four banks and seven NBFCs were applications. Lenders gain from nearly zero banking partners on this platform. GeM Sahay customer acquisition costs, opportunities to serve 1.0 has so far disbursed loans around ₹23 crore additional customers and ease of monitoring the (FICCI, 2024). GST Sahay is an application activities of borrowers through LAs. The OCEN developed under the Reserve Bank’s Regulatory helps lenders (banks and NBFCs), LAs and Sandbox (RS) that leverages the OCEN and TSPs to create innovative financial products AA framework for providing on-tap, real-time, tailored to the needs of a range of customers contactless, cash-flow based financing to micro and small businesses. It aims to reduce the enterprises.

cost of acquisition, underwriting, processing, Trade Receivables Discounting System (TReDS) disbursement and regulatory compliance related II.58 TReDS, facilitated by the Reserve to loans.

Bank, addresses the working capital and cash II.57 Owing to the policy focus on MSME credit, flow challenges faced by MSMEs arising from several cashflow based lending platforms have delayed payments. TReDS is a financing been developed on the OCEN such as the GeM framework, harnessing technology to discount 15 Any e-commerce company with a pre-existing user base can be a LA and act as a bridge between lenders and borrowers (users of that e-commerce company).

16 TSPs are FinTech companies that onboard lenders, borrowers, and platforms onto the OCEN.

17 It provides end-to-end digital loans up to a maximum of 80 per cent of loan-to-value (LTV) against GeM orders.

18 The number of installs given is as on April 22, 2024.

63 nI nIREPORT ON CURRENCY AND FINANCE bills and invoices. Currently, four entities are per borrower, dairy loans, MSME loans, personal operational as TReDS platforms, with steady loans, vehicle loans, tractor loans, digital gold growth in transaction volume and value loans, and home loans through participating (Chart II.44). banks. Given the end-to-end digital processing, PTPFC has demonstrably reduced the turnaround Public Tech Platform for Frictionless Credit time of KCC loans from a few weeks to less than II.59 In a major step towards digital financial an hour (RBIH, 2024).

inclusion in India, the Reserve Bank Open Network for Digital Commerce (ONDC) conceptualised the PTPFC. The Platform has been developed by the Reserve Bank II.60 The ONDC has been launched by DPIIT Innovation Hub (RBIH). It leverages open APIs under the Ministry of Commerce and Industry and standards to streamline availability of data19 in 2021. It aims to democratise e-commerce in a ‘plug and play’ model to enable disbursal by building an open, interoperable network, of credit in a frictionless manner. The reduced enabling buyers and sellers to transact, without the need to be present on the same platform. The cost of operations for lenders due to the ease of traditional model of e-commerce is constrained availability of data may help them offer credit at by dependence on specific platforms and affordable rates. The PTPFC pilot, launched in technologies, leading to concentration risk for 2023, focused on products such as fully digital both buyers and sellers. Decentralisation of Kisan Credit Card (KCC) loans up to ₹1.6 lakh operations, open standards, interoperability and unbundling of e-commerce value chains on the Chart II.44: Progress in MSME Financing through TReDS ONDC may lead to greater competition among platforms/applications, potentially lowering costs of engaging in digital commerce.

II.61 The ONDC has onboarded over six lakh sellers/service providers from more than 607 cities20 (ONDC, 2024a). The daily peak order volume on the ONDC platform has increased from 53,000 in October 2023 to 2,89,000 in June 2024 (ONDC, 2024b). In 2023, e-commerce constituted eight per cent of the total retail market value, indicating huge potential for the ONDC to grow (BCG and RAI, 2024). The ONDC has forayed into sectors, such as food,

Source: RBI. grocery, fashion, travel, electronics, and financial 19 The information available includes Aadhaar, e-KYC, land records from the state governments (viz., Tamil Nadu, Madhya Pradesh, Andhra Pradesh, Odisha, Uttar Pradesh, and Maharashtra), account aggregation by account aggregators, Permanent Account Number (PAN) validation, GST-related information, Aadhaar e-signing, milk-pouring data from select dairy co-operatives, and house/property search data, among others.

20 Data accessed as on July 23, 2024.

64 nI nIDIGITALISATION AND FINANCIAL INNOVATION services. Within financial services, the ONDC is II.64 Digitalisation has implications for a concentrating on credit, insurance, investments, competitive banking environment owing to new and gift cards. Within the credit domain, the entrants like FinTechs and BigTechs (Basel ONDC is focusing on personal loans and GST- Committee on Banking Supervision 2018;

based loans for individuals and sole proprietors, Dell’Arricia, 1998). Further, a competitive respectively (ONDC, 2024c). environment has implications for banks’ market power and price discovery process (Cuadros-

6. Financial Innovations: Implications for the Solas et al., 2024; Jia and Liu, 2024). In the Banking Sector Indian context, an empirical exercise indicates II.62 Financial innovations have implications for that digitalisation (proxied by the volume of digital the banking sector spanning various operational payments) is associated with a compression of aspects. According to a special survey of banks banks’ net interest margin (NIM)21.

conducted in March 2024, more than 90 per Financial Innovation and Banks’ Risk Taking cent of the respondent banks reported that their customer acquisition and transaction costs have II.65 Digitalisation can impact risk taking by decreased after adopting digital technologies. banks in both directions. On the one hand, it For 88 per cent of banks, employee costs have can improve the risk diversification capabilities come down and around 76 per cent of banks of banks through improvement in operational reported lower premises-related costs due to the efficiency, risk management capabilities and adoption of digital technologies (Chapter V). better monitoring and screening of debtors II.63 Digitalisation enhances customer (Chen et al., 2023; Yang and Masron, 2024; Li et acquisition by offering convenient onboarding al., 2022). By providing more data for analysis, processes and personalised digital marketing digital transformation helps financial institutions strategies, expanding reach and engagement with better identify, measure, and manage risks in different sections of consumers. Technological real-time and take timely measures to deal innovation can improve customer experience, with them (Yang and Masron, 2024). Reduced lower costs, increase product diversity, and reliance on physical interactions with customers increase access to financial services (Elekdag decreases the associated operational risks and et al., 2024). All the banks surveyed indicated the likelihood of human errors (Bhatia, 2022).

improvement in their customer acquisition On the other hand, while better and real-time and retention due to the adoption of digital monitoring of risks may foster an environment of technologies (Chapter V). relatively low macroeconomic risk, this may result 21 The fixed effect panel data model using data for 31 banks for the period Q4:2014-15 – Q4:2022-23 yielded the following estimated regres-

sion:

NIM = 3.487*** – 0.018(Digitalisation(t-4)) ** - 0.081(Relative Bank size) + 0.082(CRAR)*** – 0.007(Liquid asset ratio) - 0.021(GNPA ratio)** – 0.013(cost-income ratio)*** + 0.001(GDP growth) + 0.016(Inflation) + 0.094 (COVID Dummy)* + 0.349(Bank Merger Dummy)** – 0.083 Asset Quality Review Dummy ***, ** and * indicate significance at the 1 per cent, 5 per cent and 10 per cent levels, respectively.

Source : RBI staff estimates.

65REPORT ON CURRENCY AND FINANCE in an increased risk appetite of banks (Kero, broaden participation, widen the set of financial

2013). Digital transformation may also increase instruments, and ensure fair conduct by market operational risks due to excessive reliance on participants (Das, 2024). Advancements in information and communication technology, payment and settlement systems and significant financial crime risks (including data breaches), improvements in the market infrastructure and privacy concerns. have taken place, encompassing state-of-the- art primary issuance process for government II.66 Digitalisation may ameliorate certain securities, an efficient and completely types of risks, while exacerbating others. FinTech dematerialised depository system within the can increase credit and liquidity risks but may central bank, electronic trading platforms, trade reduce insolvency risk (Wu et al., 2023). The reporting and central counterparty settlement effect of FinTechs on the stability of financial (Das, 2020b). Digital payment and settlement institutions is market specific (Fung et al., 2020).

systems enhance market liquidity (Box II.3).

Although a stronger FinTech presence is linked

7. Regulatory Concerns and Policy Initiatives to increased risk-taking by financial institutions, the presence of robust domestic institutional II.68 Digitalisation in finance can contribute framework may encourage financial institutions significantly to the spread and pace of financial to reduce their risk levels (Elekdag et al., deepening in emerging and developing

2024). In the Indian context, adoption of digital economies. Such innovations cannot, however, technologies by banks appears to drive down be allowed to disrupt the financial system risk taken by banks (Box II.2). (Sankar, 2022). The financial stability can be safeguarded if the relationship between banks Financial Innovations and Impact on Liquidity and FinTechs is appropriately balanced. Not II.67 Liquidity-enhancing innovations are aligning the regulation of non-bank FinTechs expected to augment stability in financial markets to that of banks offering similar services (O’Hara, 2004). High transaction costs, shallow may, however, create inefficiencies, amplify markets, slow order execution, and operational risks of regulatory arbitrage, and create risks impede liquidity in financial markets. an uneven playing field. Notwithstanding Enhanced liquidity facilitates more effective these challenges, the imperative to regulate transmission of monetary policy, enables FinTechs remains. Taking into account these efficient crisis management and makes financial diverse perspectives, the Reserve Bank’s assets more attractive (Sarr and Lybek, 2002). regulation is premised on three principles – Historically, advancements in technology and encouragement of innovation, assimilation of financial innovation22 have catalysed structural innovation in the financial system in a non- transformations within financial markets, in the disruptive manner and customer protection process, affecting liquidity in the market (Bervas, (Sankar, 2022). The approach to regulation

2008). Digital technologies expand the reach of needs to be balanced, nuanced and reasonably financial markets, remove market segmentation, anticipatory with an oversight framework 22 Such as securitisation, introduction of new products including options, and exchange traded funds.

66DIGITALISATION AND FINANCIAL INNOVATION Box II.2 Bank Risk in the Digital Age The impact of digital adoption on risk-taking by Table 1: Digital Adoption and Risk Taking by banks is examined for the period 2015-2023. The Banks – Empirical Estimates extent of digital adoption by 17 banks is captured Independent Variables Dependent Variable:

Z-score through a survey conducted in 2024 by the Reserve Adoption of Digital Technologies 0.94*** Bank. The financial innovations that are considered (0.31) for capturing digital adoption are internet banking, Pricing Power of Banks 31.87*** (7.98) mobile banking, online account opening, digital Age -29.48*** KYC, investing in mutual funds, card-less cash (10.07) withdrawals, payment gateways, digital lending, Inflation -1.78 (1.80) payment aggregator services, chatbots, online Economic Growth 2.92*** public provident fund, prepaid wallets, open (1.11) banking, neo-banking, BNPL and IoT-based Ratio of Priority Sector Advances to -1.77*** Total Advances (0.51) applications. The digital adoption variable captures Credit to Deposit Ratio -0.92*** “percentage of financial innovations adopted (0.32) by a particular bank out of the total innovations Availability of Retail Funds 0.72 considered”. Since the variable is time-invariant, (1.60) Dependence on Long-term Loans 0.67** Least Square Dummy Variable specification is used (0.32) to estimate the model (Baltagi, 2021).

Diversification of Income 176.27** (75.2) Bank risk or financial stability risk is measured Net Forex Assets 5.59 through z score defined as z = (k+µ)/σ(µ), where k (3.65) is equity capital plus reserves as a per cent of total Bank Merger Dummy 9.01 (6.15) assets, µ is the return on assets (RoA), and σ(µ) is Public Sector Bank Dummy 2525.16*** the standard deviation of RoA for a rolling period (883.65) of five years (Lepetit and Strobel, 2013). A higher COVID Dummy -7.36 (7.30) z-score, therefore, implies a lower financial stability Asset Quality Review Dummy -23.82** risk. (10.60) Constant -5467.88*** The estimation is done after controlling for relevant (2091.60) macro-economic, bank-specific and policy variables.

Observations 246 The empirical estimates suggest that digital adoption R-squared 0.51 is associated with lower risk-taking by banks in India Bank Fixed Effects Yes (Table 1). Note: 1. The ‘Bank Merger Dummy’ is defined as 1 for the year in which a bank merged with the current bank and the

References: subsequent years, and 0 otherwise.

2. The ‘AQR Dummy’, representing the Asset Quality Review initiated in the financial year 2016, was set to 1 beginning Baltagi, B. (2021). Econometric Analysis of Panel from 2016 and 0 otherwise.

Data. Sixth Edition. Springer Texts in Business and 3. The ratio of interest income to non-interest income is used as proxy for diversification of income.

Economics.

4. Bank-specific fixed effects are accounted for using cross-

section dummies.

Lepetit, L., and Strobel, F., (2013). Bank Insolvency 5. ***, **, and * indicate significance at 1 per cent, 5 per cent, Risk and Time-varying Z-score Measures. Journal and 10 per cent levels, respectively. Robust standard errors are provided in parentheses.

of International Financial Markets, Institutions and 6. Net Interest Margin is used as proxy for pricing power of banks.

Money, 25, 73–87.

Source: RBI staff estimates.

67REPORT ON CURRENCY AND FINANCE Box II.3 Financial Innovations and Financial Market Liquidity Digitalisation-enabled advances in payments and and average daily turnover (in USD) are taken as settlement systems and improvements in the market measures of liquidity in the equity and forex markets, infrastructure can boost liquidity of financial markets.

respectively (Sarr and Lybek, 2002). The volume To examine these dynamics in the Indian context, of retail digital transactions is used as a proxy for Auto-Regressive Distributed Lag (ARDL) models for digitalisation-enabled financial innovation. The select financial market segments were estimated regression results indicate that higher digitalisation using monthly data from January 2009 to December

2023. Although no single metric encompasses is associated with increased liquidity in the equity all the aspects of liquidity, stock market turnover and foreign exchange markets (Table 1).

Table 1: Financial Innovations and Market Liquidity - ARDL Estimates I. Equity: II. Foreign Exchange:

Log (Stock Turnover) Log (Average Daily Turnover)

Model Type: ARDL (2,2,0,0,0,1) Model Type: ARDL (1,0,0,0,1,0,0) I. Long run Digital Transactions # 0.25*** Digital Transactions # 0.15*** (0.03) (0.05) Index of Industrial Production (IIP) # 0.74*** IIP # 0.66* (0.17) (0.39) Inflation -0.02** Trade # 0.23* (0.008) (0.13) Foreign Portfolio Investments (FPI; in INR trillion) 0.28** Exchange Rate # -0.42 (0.12) (0.55) Forward Premia (6 months) 0.05*** (0.01) FPI -0.01 (0.12) Constant 7.54*** Constant 5.41** (0.68) (2.26) II. Short Run Covid Stringency 0.004*** Covid Stringency -0.001 (0.001) (0.001) Taper Tantrum Dummy -0.09 (0.06) ECM Coefficient -0.54*** ECM Coefficient -0.54*** (0.07) (0.06)

Note: 1. ***, **, * indicate significance at 1, 5 and 10 per cent levels, respectively.

2. Figures in parentheses are heteroskedasticity and autocorrelation consistent standard errors.

3. # Log values are taken.

Source: RBI staff estimates.

Reference:

Sarr, A., and Lybek, T. (2002), Measuring Liquidity in Financial Markets. IMF Working Paper No. WP/02/232. that should be activity-based, risk-based, measures to address business conduct scale-based, and phased-in (RBI, 2024a). practices, such as dark patterns and the The recent interventions in this regard include framework for self-regulation. Other initiatives regulation of digital lending applications, to promote responsible financial innovations 68DIGITALISATION AND FINANCIAL INNOVATION include RS, hackathons, and proof of concept 2023, the RE must adhere to the cap on Default

(PoC) for Distributed Ledger Technology (DLT) Loss Guarantee (DLG)23 cover not exceeding applications, and adoption of SupTech. five per cent of the total loan portfolio, disclosure and capital requirements, specified forms of Regulation of Digital Lending DLG, due diligence and other requirements with II.69 The boom in digital lending has raised respect to the DLG provider.

several business conduct issues primarily related to unbridled engagement of third parties, The Insidious Nature of Dark Patterns mis-selling, breach of data privacy, charging of II.71 Dark patterns refer to deceptive practices exorbitant interest rates, and unethical recovery or design patterns in user interface or user practices. While there is evidence regarding the experience/interactions that are designed to positive impact of digital credit on the financial mislead users to do something they originally well-being of individuals during distress (Suri et did not intend to do, by subverting or impairing al., 2023), it can also result in opposite effects consumer autonomy, decision making or choice owing to high interest rates and poor information (CCPA, 2023). Examples include compelling regarding loan conditions (Brailovskaya et al., users to perform unrelated actions to proceed

2021). Over-reliance on technology for loan with intended purchases, adding items to the cart arbitration may be harmful, as AI-driven decision- without user consent, and creating a false sense making models can raise concerns associated of urgency to mislead users into making quick with algorithmic bias and financial exclusion.

purchases, among others (Chapter I).

II.70 To address digital lending-related II.72 In India, the Central Consumer Protection concerns, the Reserve Bank put in place the Authority (CCPA) has introduced the ‘Guidelines Guidelines on Digital Lending in September 2022 for Prevention and Regulation of Dark Patterns, that provide detailed procedures pertaining to customer protection and conduct requirements, 2023’, applicable to advertisers, sellers and technology and data requirements and regulatory platforms. Additionally, the Digital Personal Data framework. According to these guidelines, REs’ Protection (DPDP) Act, 2023, addresses dark outsourcing agreements with LSPs or Digital patterns by requiring companies to imbibe privacy Lending Applications (DLAs), do not lessen by design while collecting user data and to ensure the REs’ obligations and they must continue to informed consent for data processing activities.

adhere to the current outsourcing guidelines. The Insurance Regulatory and Development Further, the REs must ensure that the LSPs they Authority of India (IRDAI) has prohibited travel work with as well as the DLAs (whether of the portals in India from using pre-checked boxes for RE or the LSP the RE works with) follow the selling travel insurance. The Reserve Bank has guidelines. Under the guidelines dated June 08, mandated card issuers to obtain explicit consent 23 A DLG is a contractual arrangement in digital lending where an entity, such as an LSP, guarantees to compensate an RE for losses resulting from defaults on a specified percentage of the loan portfolio. LSP is an entity that offers lending services to borrowers, typically in the form of providing loans or credit facilities.

69REPORT ON CURRENCY AND FINANCE from cardholders when offering insurance through Regulatory Sandbox tie-ups with insurance companies (RBI, 2022b).

II.74 The ‘Enabling Framework for Regulatory Card issuers are mandated to provide customers Sandbox’ was announced in 2019 for facilitating the option to request closure of credit card responsible innovation in financial services, through multiple and prominently visible channels.

promoting efficiency, and benefiting consumers.

Unsolicited loans and enhanced credit limits shall Under RS, eligible domestic entities can live not be offered to the credit cardholders without test their innovative products or services in a explicit consent. To increase transparency in controlled environment with or without specified digital lending, the Reserve Bank’s Digital Lending regulatory relaxations for the limited purpose of Guidelines mandate that REs shall provide a Key testing. Through this learning-by-doing approach, Fact Statement (KFS) to the borrower before the regulators gather empirical evidence on the execution of the contract in a standardised format benefits and risks of emerging technologies and for all digital lending products. All-inclusive cost in their implications, enabling them to take a holistic the form of Annual Percentage Rate (APR) shall view on the regulatory changes or new regulations be clearly communicated to the customer in the that may be needed to support useful innovation, KFS. This measure can help provide the customer while containing the attendant risks. So far, four a clear picture of the loan product and mitigate theme-based cohorts on ‘Retail payments’, concerns around the presence of dark patterns in ‘Cross-border payments’, ‘MSME lending’ and any loan application.

‘Prevention and mitigation of financial frauds’ Framework for Self-Regulation have been completed. Some of the products II.73 Self-regulatory organisations (SROs) that exited successfully from these cohorts have could play a pivotal role in the FinTech industry by been deployed in the market (Table II.1). A theme- promoting responsible practices and maintaining neutral fifth cohort was open for application in ethical standards (Sankar, 2023). SRO is an 2023 and the shortlisted entities will commence industry-led entity responsible for establishing testing in due course.

and enforcing regulatory standards, promoting II.75 To facilitate testing of hybrid products ethical conduct, ensuring market integrity, falling within the regulatory ambit of more than resolving disputes, and fostering transparency one financial regulator, viz., the Reserve Bank, and accountability among its members. The Securities and Exchange Board of India (SEBI), Reserve Bank has come up with the Framework IRDAI, International Financial Services Centres for Recognising SROs for FinTech Sector (SRO-FT framework). The Framework contains Authority and Pension Fund Regulatory and the characteristics of an SRO for the FinTech Development Authority, a Standard Operating sector, and includes, inter alia, broad functions, Procedure for Interoperable Regulatory Sandbox governance standards, eligibility criteria and has been prepared by the Inter-Regulatory expectations for grant of recognition as an SRO- Technical Group on FinTech (IRTG on FinTech) FT (RBI, 2024a). constituted under the Financial Stability and 70DIGITALISATION AND FINANCIAL INNOVATION PoC Exercise in DLT Networks by RBIH Table II.1: Products that Exited the Regulatory Sandbox and Adopted II.77 RBIH has successfully conducted a PoC Commercially exercise in DLT networks by taking ‘inland letter of 1 ‘Framework for facilitating Small Value Digital Payments in Offline Mode’ - ‘UPI123Pay’ aimed at enhancing digital finan- credit’ as a use case. Eleven banks, three industry cial inclusion by enabling over 40 crore feature phone users to access the benefits of UPI in a safe and secure manner. partners and two FinTech startups participated in 2 ‘GST Sahay’ - offering MSME loans via Invoice Discounting, the PoC. The tested DLT-based letter of credit ensuring quick cash flow and growth with a hassle-free digital process, digital cash flow-based credit underwriting process. has the potential to fix issues in the current 3 Plug and play platform for cash flow-based financing to small paper-based process, such as slow speed, MSME sellers on TReDS;

labour intensiveness, susceptibility to frauds, 4 Real-time access to working capital through digital credit lines to MSMEs and dependence on outdated IT systems (RBIH, 5 Application for invoice-based finance to MSMEs and end-to-

2024). end digital straight-through process (STP) journey for MSME Mudra Loan.

G20 Tech Sprints

Source: RBI staff.

II.78 Given growing global economic integration, Development Council Sub-Committee (FSDC- cross-border payments are a priority area for SC). This framework has been operational since digital innovation. Under India’s G20 Presidency, October 2022.

the Reserve Bank and the BIS Innovation Hub HaRBInger Hackathon jointly conducted the G20 Tech Sprint, seeking II.76 The Reserve Bank launched a global innovative solutions to problem statements hackathon called ‘HaRBInger – Innovation for around cross-border payments from innovators, Transformation’, open to both domestic and entrepreneurs, startups, developers, and other experts (BIS, 2023; Apix, 2023).24 global FinTech companies, programmers, and students. The hackathon runs in four phases, Adoption of SupTech viz., Screening of entries (Phase I), Shortlisting II.79 Supervisory technology (Suptech) of entries for Solution Development (Phase II), refers to the utilisation of innovative technology Solution Development (Phase III) and Evaluation by regulatory bodies to enhance supervision and Selection of winners (Phase IV). The first (Broeders and Prenio, 2018). This technology edition was launched in 2021 with the theme increases access to more granular, diverse, ‘Smarter Digital Payments’, and the second edition timely and trustworthy data to improve operational was launched in 2023 with the theme ‘Inclusive efficiency and generate previously unattainable Digital Services’. In June 2024, the third global insights using data analytics, artificial intelligence, hackathon was launched with two themes of ‘Zero and machine learning (Cambridge Centre for Financial Frauds’ and ‘Being Divyang Friendly’. Alternative Finance, 2022).

24 This is the fourth edition of the G20 tech sprint. The three problem statements under this tech sprint are “AML/CFT/Sanctions technology solutions to reduce illicit finance risk”, “FX and liquidity technology solutions to enable settlement in EMDE currencies” and “Technology solutions for multilateral cross-border CBDC platforms”.

71REPORT ON CURRENCY AND FINANCE II.80 The Reserve Bank has been taking various firms have emerged as significant partners to measures to strengthen supervision, including banks and NBFCs, enabling them to leverage adopting the latest data and analytical tools and the latest technologies. Payment FinTechs leveraging technology for implementing more feature prominently in partnerships with financial efficient and automated work processes. The institutions, followed by lending and banking Advanced Supervisory Analytics Group (ASAG) technology FinTechs. Concurrently, collaborations has been set up in the Department of Supervision with BigTechs and B2C e-commerce startups to leverage ML models for social media analytics, have transformed the lending landscape. The KYC compliances and for gauging governance digital lending models have contributed noticeably effectiveness. The establishment of an advanced to the small ticket personal loan segment, while off-site supervisory monitoring system—DAKSH – increasingly addressing the credit requirements of is helping to digitalise supervisory processes. An underserved segments of the society.

Integrated Compliance Management and Tracking II.82 Policy innovations including AAs, TReDS, System (ICMTS) and a Centralised Information OCEN, PTPFC and ONDC are set to revolutionise Management System (CIMS) are also being the financial sector by enabling tailored and implemented for seamless reporting by supervised multifaceted financial products, including cash entities for enhancing data management and flow-based lending and invoice financing.

data analytics capabilities, respectively (Patra, Digitalisation has improved operating efficiency of

2024). The RBI has also utilised techniques like Indian banks. Improved real-time monitoring, and phishing simulation and cyber reconnaissance diversification into new markets and products, exercises to push for enhanced IT and cyber facilitated by digitalisation, is mitigating risks in the security governance processes in banks and banking sector. Digitalisation also has the potential other supervised entities (Das, 2023a). The to make financial markets more integrated and Platform for Regulatory Application, Validation, liquid.

and Authorisation (PRAVAAH) was launched to enhance the efficiency of various processes II.83 Several regulatory complexities arise in related to the granting of regulatory approvals and the wake of emerging financial activities, given clearances by the Reserve Bank. the absence of definitive regulatory frameworks governing the technologies involved. Issues

8. Concluding Observations pertaining to business conduct, including dark II.81 Technology adoption and innovations patterns and breach of data privacy, have by banks and NBFCs have increased over the warranted regulatory attention. Self-regulatory last decade, especially post-pandemic. These organisations can effectively promote responsible developments have enabled financial institutions to practices and ethical standards within the industry.

provide a diverse bouquet of services to customers. Looking ahead, fostering a regulatory environment FinTech has shown the way for providing contact- that encourages responsible innovation while less, paper-less, and cash-less banking services prioritising financial stability and customer in an efficient and scalable manner. FinTech protection remains paramount.

72DIGITALISATION AND FINANCIAL INNOVATION

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76DIGITALISATION AND THE PAYMENT III REVOLUTION IN INDIA* Payment infrastructure has made significant strides in recent years, aided by digital technologies enhancing the ease of payment delivery and reducing the cost of transactions. At the cross-country level, digital payments’ adoption is supported by banking penetration, technological advancements, degree of formalisation of economy and younger cohorts. India has been at the forefront of this payment revolution with UPI transforming the retail payment landscape. India’s payment architecture is influenced by a combination of factors like technological advancements, agents, institutions, and policy interventions. This transformation, while fostering financial inclusion and inclusive growth, can result in new challenges for policy makers.

1. Introduction product of India’s digital payment ecosystem, introduced in 2016, has emerged as the most III.1 Over the last two decades, digitalisation preferred choice for payments in India, owing to its has revolutionised the payment landscape, transactional ease and accessibility. The reach of transforming the organisational structure, India’s payment advancements has transcended business practices and fundamentally the reach national boundaries with the internationalisation of the payment services fostering inclusiveness.

of the UPI. Emerging market economies (EMEs), The ease and speed of digital payments have in general, are leading the digital payments made them a preferred choice, bringing in new revolution as evident in the success of UPI of India, players to the payments market, which hitherto M-PESA of Kenya, PIX of Brazil, and PromptPay was monopolised by the financial sector. From a of Thailand.

handful of alternate methods of payments such as cash, cheques, credit/debit cards and bank III.3 The efficiency gains from harnessing digital transfers, currently there are over 300 alternative technologies in payments are leading to significant methods of payments worldwide, most of which reduction in transaction costs and ease of doing ride on the digitalisation wave (Mauro and Li, business, benefitting consumers, businesses,

2021). The push towards a cashless society and economies. Along with e-commerce, digital has become synonymous with modernity and payments through the ease and convenience efficiency. of transactions have fostered entrepreneurship.

Further, digital trails have enabled easy credit III.2 India is a leader in development of state- appraisal resulting in the reduction of information of-the-art payment infrastructure and products asymmetry in the credit market.

leading to a wider adoption of digital payments (Das, 2021). India is a frontrunner in the global III.4 Central banks, being the fulcrum of digital payments revolution and is an inspiration payment architecture, have played a pivotal for other economies (The Economist, 2023). role in this digital payments’ revolution. At the The unified payments interface (UPI), a flagship same time, advancements in digital payments * This chapter has been prepared by a team comprising Rekha Misra, V Dhanya, G V Nadhanael, Madhuresh Kumar, Nandini Jayakumar, Arpita Agarwal and Rigzen Yangdol from Department of Economic and Policy Research; K Vijayakumar, Sachin Sharma and Ankur Patley from Department of Payment and Settlement Systems; Aniket Ranjan from FinTech Department; and Varsha Limbaji from Financial Inclusion and Development Department. Valuable insights provided by Shri P. Vasudevan are gratefully acknowledged.

77REPORT ON CURRENCY AND FINANCE have significant implications on central bank’s of goods and services in an economy, they are objectives, operations and policy instruments, imperative for the smooth conduct of economic and can enhance economic growth through activities. Payment infrastructure has evolved the productivity channel on the one hand and over time, with its progress mirroring the level of alter the price setting behaviour and inflation economic development as well as technology. The dynamics on the other. Digitalisation influences relationship between the medium of payments the nature, composition, and behaviour of money and technology has been deeply intertwined, in the economy, with ramifications for monetary with advancements in technology continuously aggregates and monetary policy transmission. shaping the nature and functionality of money Digital payments can foster financial inclusion, throughout history. For example, the development financial deepening and instantaneous transfer of flint blades in the stone age represented a of funds across financial intermediaries, with significant technological leap, which also served implications for financial stability and for the as a medium of exchange (Sahlins, 2013). As societies progressed into the bronze age, the regulatory and supervisory role of central banks.

discovery of metals and the development of Emerging cybersecurity risks associated with metallurgical techniques led to metals assuming digitalisation of payments also pose challenges. roles as currency in diverse forms (Curta, 2021).

III.5 Against this backdrop, this chapter The emergence of coinage can be attributed provides a detailed account of the evolution of more to social innovation than to technological digital payments and factors that contributed to advancement. Tiny pieces of metal were its rapid growth, the impact of digital payments in transformed into coins through stamping, with the various spheres of the economy and implications stamp serving as a guarantee of authenticity. Over for central banks and their policies. Section II time, growing trust and confidence in governmental examines the evolution of digital payments in a institutions paved the way for the adoption of cross-country perspective. Section III traces the paper and fiat currencies, which continue till date, stages of India’s digital payments trajectory and while incorporating stronger security features to examines the enabling forces; it also presents increase confidence and to prevent counterfeiting.

insights from a primary survey of merchants III.7 Continuing this tradition, the rapid and consumers on the awareness, adoption and advancements in information and communication usage of digital payments. Section IV analyses the technologies (ICTs) have led to the digitalisation impact of digital payments on the various facets of of payments and currency. At the core of this the economy. Section V explores the challenges revolution lies a profound philosophical notion that and way forward. Concluding observations are set ‘money is memory’, and a ‘superLedger’ could out in Section VI.

facilitate transactions akin to traditional currency.

This concept posits that a ledger not only tracks

2. Evolution of Digital Payment Systems: A who possesses what, but also who owes and Cross-country Analysis is owed what (Carstens, 2018). Within this

2.1. Historical Context superLedger framework, the exchange of money III.6 Payment systems are the lifeline of an can be seen as being analogous to transfer of economy (Das, 2021). By facilitating exchange data.

78DIGITALISATION AND THE PAYMENT REVOLUTION IN INDIA III.8 While technological advancements have Chart III.1: Open Loop Payment System (UPI’s case) taken place across the globe, countries have Remitter embraced different models of digital payments, Bank influenced by their technological readiness as well ReqPay debit4 5 RespPay debit as the existing financial landscape. The global ReqPay ReqAuthDetails 2 evolution of retail digital payments system can 1 RespAuthDetails Unified 3

be broadly categorised into two main types: open PayerPSP RespPay Payments ReqTxnConfirmation Payee PSP 8 Interface 9 and closed loop systems. In open loop systems, RespTxnConfirmation 10 payment systems are operated by central banks A B Financial or other payment system operators, allowing Acquiring Channel ReqPay credit6 7RespPay credit (Mobile App/E-Com) Non-Financial banks, non-bank payment service providers or Beneficiary Bank Customer Node third-party application providers (TPAPs) to use the system to process and settle payments. These Note: UPI utilises a series of requests (request for payment, request for authentication details and request for transaction confirmation) and systems link payers and payees without requiring response messages (response for payment, response for authentication details, response for transaction confirmation) to facilitate secure, real-time a direct relationship between them. An example of transfer of funds.

Source: India Stack. an open loop system is UPI1, where the National Payments Corporation of India (NPCI) owns and settlement of funds. These systems operate operates the payment system infrastructure. without intermediaries, establishing a direct The TPAPs develop and maintain user-friendly relationship between payer and payee within the mobile applications for end-users, collaborating payment network3 (Chart III.2). These payment with payment service providers2 (PSPs) that Chart III.2: Closed Loop Payment System connect to the UPI system. PSPs act as the link between TPAPs and the UPI system, facilitating P transactions. Therefore, payers and payees can Payment System use different UPI apps and have accounts in different banks but can still transact seamlessly (Chart III.1). Open-loop systems are accepted across multiple merchants and locations, rather than being restricted to a single organisation or group of organisations. Despite multiple participants in a transaction, the UPI enables instant payment on its platform unlike some card Purchase of Goods networks that operate on open loop systems. and Services B S III.9 In contrast, in a closed loop system, Buyer Seller the payment platform is managed by a single

Source: Verdier, M (2006). entity which is responsible for the payment and 1 Real-time account-to-account (A2A) payment systems like PIX and card networks are also examples of open-loop payment systems.

2 PSP in the UPI system is a bank or financial institution that facilitates UPI transactions. They are like the intermediaries between UPI apps (which may be developed by TPAPs or PSPs), the UPI system managed by NPCI, and the banks handling the transactions.

3 These payment systems are also sometimes referred to as three party systems.

79REPORT ON CURRENCY AND FINANCE Chart III.3: Cross-country Trends in Retail Digital Payments

Note: Retail digital payments consist of credit transfers, direct debits, card payments and e-money and other payment modes.

Source: BIS Red Book Statistics. systems have limited reach and are restricted III.11 In both advanced economies (AEs) and to specific networks or group of merchants, and EMEs, credit transfers5 accounted for most of the transactions are processed internally without the retail digital payments by value (Chart III.4). The need for external financial networks. Examples value of e-money payments made up only a small of closed loop payment systems include Alipay, share of the total, although it has witnessed strong WeChat Pay4, transit cards, retail specific cards growth in both groups of economies.

and gift cards. Initially, mobile money services also operated as closed loop systems, restricting Chart III.4: Relative Importance of Different Forms of money transfers only to registered consumers, Retail Digital Payments, 2022 and payments only to registered merchants within the system. Yet, over time, these services have evolved, and have now established connections through bilateral integrations to enable domestic interoperability and have subsequently integrated themselves into the broader financial system, expanding their outreach considerably (GSMA,

2023).

2.2. Digital Payments Revolution Across Geographies III.10 Retail digital payments, in terms of both

Note: Credit transfers, direct debits, card payments and e-money and volume and value, have recorded significant growth other payment modes constitute retail digital payments.

Source: BIS Red Book Statistics. across economies, led by EMEs (Chart III.3).

4 WeChat Pay is operated by Tencent and Alipay is affiliated with Alibaba.

5 Credit transfers are payment instruments based on payment orders made for the purpose of placing funds at the disposal of the payee (https://www.bis.org/cpmi/publ/d168.pdf).

80DIGITALISATION AND THE PAYMENT REVOLUTION IN INDIA Chart III.5: Retail Digital Payments as Percentage of Total Retail Payments

Note: Total retail payments include retail digital payments, cheques and bank notes and coins in circulation. In the absence of information on the value of transactions made through bank notes and coins, the outstanding currency and notes in circulation are added to the rest of the instruments to arrive at total retail payments.

Source: BIS Red Book Statistics.

III.12 Overall, the adoption of digital payments is which have taken the lead role in digital payment growing, especially in those countries where the evolution. Within the A2A RTP schemes, India’s initial share of digital payments has been low, and UPI stands out as the leading platform in terms of currently, this is the dominant mode of payment in the absolute number of transactions (Chart III.6).

major economies (Chart III.5). UPI crossed over a 100 billion transactions in 2023.

Examples of other A2A RTP are PIX system that is III.13 In AEs, card-based payment systems, being used by more than 80 per cent of the adult established prior to the internet era, are still widely population in Brazil; similarly, more than 80 per used (World Bank, 2023).6 While AEs dedicated cent of the Thai population uses PromptPay. The the past decade to upgrade their bank-based US Federal Reserve launched its own A2A RTP magnetic striped cards with chips, EMEs embarked rail called FedNow service in July 2023 with 35 on a transformative shift in their retail payment participating financial institutions, which increased landscape. Some EMEs adopted payment to 864 as on June 28, 2024. The penetration levels systems such as China’s closed-loop wallet of the A2A RTP systems in many EMEs are much system and mobile money models prevalent in higher than that of AEs (Chart III.7).

Sub-Saharan Africa. Other EMEs, including India, Brazil, Nigeria, Thailand and Malaysia, leveraged III.14 In this context, India’s experience is their banking systems to create account-to- notable. In 2008, India seemed an unlikely account (A2A) real-time payment (RTP) rails to candidate for implementing an A2A RTP system, boost the digitalisation of payments. In major AEs with only 1 in 25 people having formal identity, and and EMEs, central banks, sovereigns, and bank around one in four adults holding a bank account unions have invested in developing A2A RTP rails, (D’Silva et al., 2019). Additionally, mobile and 6 The Diners Club card, introduced in 1950, is often credited as the first successful charge card, allowing users to make purchases at participating merchants with the promise of payment to Diners Club later. Following the success of Diners Club, other companies began issuing their own cards (Norman, 2024).

81REPORT ON CURRENCY AND FINANCE Chart III.6: A2A RTP Transactions (2023)

Source: Respective central bank websites; and CEIC. internet penetration were significantly lower than III.15 The mobile money model, another variant global standards. The JAM trinity - Pradhan Mantri of digital payment system, has gained prominence Jan Dhan Yojana (PMJDY), Aadhaar, and Mobile7 in many developing countries, especially in Sub- - launched by government laid the foundation Saharan Africa (Chart III.8). Under this model, for the rapid and transformative rollout of UPI. a phone with an active connection and a valid The success of UPI has inspired other A2A RTP government ID would help customers to open a systems and NPCI is actively collaborating with mobile money account. The agents present in other countries to help them develop their own remote locations act as ATMs where people can systems similar to the UPI. use their services to deposit and withdraw cash Chart III.7 - Progress in A2A RTP Payments

Source: Respective central bank websites; and CEIC.

7 The three components of Jan Dhan, Aadhaar and Mobile (JAM) trinity are i) Pradhan Mantri Jan Dhan Yojana - a government scheme to expand and make available affordable access to financial services to the poor in India, ii) unique identity number, Aadhaar, which is nearly universal today within the country and iii) access to mobile phones.

82DIGITALISATION AND THE PAYMENT REVOLUTION IN INDIA Chart III.8: Mobile Money a. Availability of Mobile Money Services b. Registered Agents 350 300 250 200 150 100 50 0

Source: Global System for Mobile Communications Association (GSMA). from their mobile money account. Initially, mobile payments from businesses (such as wages), and money’s focus centred on enabling consumers receive government-to-person (G2P) payments to conduct person-to-person (P2P) payments (Suri, 2017). Globally, the mobile money digitally, eliminating the necessity for bank ecosystem has 315 mobile money services and accounts or wire transfers. As mobile money 1.6 billion registered mobile money accounts expanded its scope, it enabled the consumers to spread across 102 countries. In 2022, there were pay bills (including utilities), store money, execute 17.4 million registered agents with 65 billion person-to-business (P2B) payments, receive annual transactions totalling US$ 1.26 trillion. On 83 rebmuN 5002 6002 7002 8002 9002 0102 1102 2102 3102 4102 5102 6102 7102 8102 9102 0202 1202 2202 East Asia and Pacific Europe and Central Asia Latin America and the Caribbean Middle East and North Africa South Asia Sub-Saharan Africa snoilliM East Asia and Pacific Europe and Central Asia Latin America and the Caribbean Middle East and North Africa South Asia Sub-Saharan Africa 11-ceD 21-ceD 31-ceD 41-ceD 51-ceD 61-ceD 71-ceD 81-ceD 91-ceD 02-ceD 12-ceD 22-ceD 20 15 10 5 c. Registered Accounts d. Monthly Transactions by Volume snoilliM East Asia and Pacific Europe and Central Asia Latin America and the Caribbean Middle East and North Africa South Asia Sub-Saharan Africa snoilliB East Asia and Pacific Europe and Central Asia Latin America and the Caribbean Middle East and North Africa South Asia Sub-Saharan Africa e. Monthly Transactions by Value (USD) snoilliB 6 5 4 3 2 1 East Asia and Pacific Europe and Central Asia Latin America and the Caribbean Middle East and North Africa South Asia Sub-Saharan Africa 11-ceD 21-ceD 31-ceD 41-ceD 51-ceD 61-ceD 71-ceD 81-ceD 91-ceD 02-ceD 12-ceD 22-ceD 120 100 80 60 40 20 11-naJ 11-ceD 21-naJ 31-naJ 21-ceD 41-naJ 51-naJ 61-naJ 31-ceD 71-naJ 81-naJ 41-ceD 91-naJ 02-naJ 51-ceD 12-naJ 22-naJ 61-ceD 71-ceD 81-ceD 91-ceD 02-ceD 12-ceD 22-ceD 0 2000 1500 1000 500 0 0 0REPORT ON CURRENCY AND FINANCE average, a mobile money provider was connected III.16 The adoption of digital payments is to around 18 banks and processed US$ 22 billion supported by banking penetration, technological of international remittances in 2022 (GSMA, advancements, the degree of formalisation of the

2023). economy and younger cohorts (Box III.I).

Box III.I

Determinants of Adoption of Digital Payment Technology: A Cross-country Analysis The adoption of digital payment technologies varies economy, availability of bank branches and younger significantly across societies worldwide. Along with the generations. Furthermore, within the sample economies, penetration of information and communication technology the developing countries have a higher rate of digital

(ICT), factors such as user attitudes, cultural norms, payment adoption than the advanced economies. societal resistance, and institutional trust could condition Table 1: Drivers of Digital Payments Adoption- the adoption of digital payments. Additionally, age Regression Results demographics emerge as a pivotal factor, with younger Dependent Variable: Digital payments as a percentage of total generations often at the forefront of embracing new digital payments tools and platforms (Morris et al., 2005). Moreover, the Explanatory variable Coefficient formalisation of the economy acts as a significant catalyst Percentage of population using internet 0.215 *** (0.056) for the adoption of digital payments. The potential role Share of people above 65 years -0.102** of the various factors contributing to adaptation of digital (0.045) payments is examined in a panel framework for 24 countries Tax to GDP ratio 0.162*** for the period 2012 to 2022 (equation 1).8 (.043) DigPay β .IntPen β .Pop β .BankBr Dummy emerging economy 0.144*** it it it it (.049) β .TaxGdp β .IncLev α ε (1) = it1 +it 2 t 6it5 + 3 + Bank branches per lakh adults 0.059* (0.033) w4here the +de5pendent +varia+ble is retail digital payments as a percentage of total retail payments of country i at time Observations 264 t. IntPen represents the percentage of population using Number of countries 24 it internet while Pop indicates the share of people above Number of developing countries 8 it 65 years of age in total population. The variables BankBr Note: Figures in parentheses indicate standard errors; ***,**,*: indicate 65 it significance at 1, 5 and 10 per cent level, respectively.

and TaxGdp represent bank branches per lakh adults and

it Source: RBI staff estimates. tax to GDP ratio, respectively. The tax to GDP ratio is taken as a proxy for the size of formal economy. IncLev is a Reference: it dummy variable with zero for developed countries and 1 for Morris, M. G., Venkatesh, V., and Ackerman, P. L. (2005).

developing nations to assess the relative speed of adoption Gender and Age Differences in Employee Decisions About in these groups. αrepresents time fixed effects.

t New Technology: An Extension to the Theory of Planned The empirical analysis indicates that digital payments Behavior. IEEE Transactions on Engineering Management, are boosted by internet penetration, formalisation of the 52(1), 69-84.

8 Data Sources: BIS in its Redbook statistics publishes retail payments data which includes credit transfers; direct debits; cheques; card payments and e-money; other payment modes and currency and bank notes in circulation. Credit transfers, direct debits, card payments and e-money and other payment modes are considered to constitute retail digital payments. Data on internet penetration and age demography have been taken from World Telecommunication/ICT Indicators Database and World Bank, respectively. Tax to GDP ratio has been sourced from CEIC database while the classification of countries into AEs and EMEs is from the World Bank.

84DIGITALISATION AND THE PAYMENT REVOLUTION IN INDIA

3. The Digital Payment Revolution in India one of the most modern and diverse systems with a whole gamut of bill payments, merchant III.17 India has witnessed a revolution in its payments, vendor payments, transit payments, digital payments journey, without so realising, to and recurring payments (Das, 2024). The flexibility become a leader in the digital payments landscape of interoperability among payment systems has (Gandhi, 2016; Ramasastri, 2018). Underscored brought in unparalleled ease of transactions while by the Reserve Bank’s commitment to move towards a “less-cash” society, India’s journey to robust customer protection measures have made become a global leader in the payments’ space India’s retail payment system one of the safest in has witnessed many global firsts – a low cost, the world (BRICS, 2021).

interoperable, mobile-based acceptance solution

3.1. Evolution of Digital Payments in India like Bharat QR Code; Two Factor Authentication;

III.18 The foundation of an efficient digital Aadhaar enabled payment systems (AePS); and payment system was laid down in the 1990s when the UPI (Gandhi, 2017). This journey began in the modernisation of the payment and settlement relative obscurity in the 1980s, and the strong systems was accorded high priority in the agenda retail payments framework in the country today is of financial sector reforms to improve the efficiency comparable to that of any advanced country, and of financial intermediation and financial system perhaps even surpassing some in terms of the stability. The reform in payment and settlement variety and efficiency (Gandhi, 2016; RBI, 2022b).

The payments revolution in India offers critical systems were facilitated by advancements in lessons for cooperation between a central bank computerisation and technology. The payment and private firms in bringing about technological systems evolution in India can be roughly progress (Kearns and Mathew, 2022; D’Silva categorised in two distinct waves: a) digitalisation et al., 2019). Payment systems in India have of existing systems to improve efficiency, and b) not only navigated through the fast-evolving changes in payment space brought about by the technological innovations but also developed into digital revolution (Chart III.9).

Chart III.9: Evolution of Payment System Landscape in India

Note: MICR: Magnetic Ink Character Recognition; ATM: Automated Teller Machines; ECS: Electronic Clearing Services; EFT: Electronic Funds Transfer; CFMS:

Centralised Funds Management System; INFINET: INdian FInancial NETwork; SFMS: Structured Financial Messaging System; RTGS: Real Time Gross Settlement;

NFS: National Financial Switch; NEFT: National Electronic Funds Transfer; CTS: Cheque Truncation System; NECS: National Electronic Clearing Service; IMPS:

Immediate Payment Service; NACH: National Automated Clearing House; BBPS: Bharat Bill Payment System, UPI: Unified Payment Interface; BHIM: Bharat Interface for Money; TReDS: Trade Receivables electronic Discounting System; NETC: National Electronic Toll Collection; e-BAAT: electronic Banking Awareness and Training; PIDF: Payment Infrastructure Development Fund; CBDC: Central Bank Digital Currency; ICCW: Interoperable Card-less Cash Withdrawal.

Source: RBI staff illustration.

85REPORT ON CURRENCY AND FINANCE

3.1.1. Digitalisation of Existing Payment Systems grids to one national grid. The merger was to Improve Efficiency completed on October 13, 2023, and the merged grid has been named as National Grid Clearing III.19 In the 1980s, ICT revolution brought House (NGCH). The merger has improved significant changes in operating systems at liquidity and efficiency of the system and enabled the bank level, beginning from back-office rationalisation of cheque clearing infrastructure.

automation of cheques to the front desk total After the merger, all cheques presented through branch automation. Under changes in the banking the CTS are being processed as local cheques. methods, in the first phase, a three-pronged approach of consolidation, development and III.20 The introduction of Central Bank Digital integration was adopted (RBI, 2002). Connectivity Currency (CBDC) on a pilot basis in 2022 is the latest innovation which would entail a ‘more of bank branches through networking of computers efficient and cheaper currency management and inter-connectivity of banks were the earliest system’ (GOI, 2022; RBI, 2022c). Digital currency objectives for the modernisation of the payment and settlement systems.9 The operationalisation is expected to complement cash and current payment systems. “Digital Rupee”, is the digital of the INdian FInancial NETwork (INFINET), a form of India’s currency, the Rupee, and is a legal Closed User Group, in June 1999, was a major tender issued by the Reserve Bank of India. It can step forward in providing a robust communication be held as a store of value or used to carry out network for the exclusive use of banks and financial transactions. In May 2024, India was among the institutions. Until the 1990s, the major alternative 36 countries where CBDC was in pilot stage.10 to cash was the cheque clearing system. The Based on usage, CBDCs can be classified into switchover from physical currency to paper- wholesale (CBDC-W) and retail (CBDC-R). While based payment instruments and to electronic wholesale CBDC (CBDC-W) caters to institutional media warranted technological upgradation in participants of the financial markets, retail clearing arrangements. The evolution of cheque CBDC (CBDC-R) is a risk-free digital medium clearing systems progressed from manual to of exchange for the retail consumers. The initial Magnetic Ink Character Recognition (MICR) use cases for the pilot of CBDC-R included clearing in the mid-1980s, introducing automation Person to Person (P2P) and Person to Merchant and standardisation. MICR instruments enabled

(P2M) transactions. The pilot has also introduced electronic clearing while physically exchanging additional use cases using programmable and cheques. The Cheque Truncation System (CTS), offline functionalities. As of June 2024, 50 lakh introduced in 2008, allowed digital processing of users and 4.2 lakh merchants were participating cheques and eliminated the need for their physical in the CBDC retail pilot.

movement. Standardised under CTS-2010, with

3.1.2. Changes in Payment Space brought about enhanced security features, it replaced MICR by the Digital Revolution completely, starting 2014. To promote efficient cheque processing, the Reserve Bank decided to III.21 In the second wave, significant innovations migrate CTS from an architecture of three regional in the payment and settlement landscape were 9 Branch level computerisation and the establishment of connectivity between branches were recommended by the Committee on Computerisation in Banks (1988), chaired by Dr. C. Rangarajan, then Deputy Governor, Reserve Bank of India.

10 Retrieved from https://www.atlanticcouncil.org/cbdctrack on July 20, 2024.

86DIGITALISATION AND THE PAYMENT REVOLUTION IN INDIA driven by technology-based solutions. Early the National Electronic Toll Collection (NETC) initiatives in this regard were the introduction which allows for electronic toll payments have of credit cards and ATM networks in the late further enhanced convenience. Innovations 1980s. The current wave of innovations in like the Bharat Interface for Money (BHIM) payments system began with the rationalisation App, interoperable QR code, and 24×7×365 of of decentralised electronic products like ECS and NEFT and RTGS enhanced the convenience of EFT into centralised pan-India payment solutions these payment systems and ensured their rapid like the NACH and NEFT which enabled servicing acceptance. The facilitation of non-bank FinTech customers spread throughout the country with firms in the payment ecosystem as PPI issuers settlement at a central location. This phase offering stored value services to customers, and was facilitated by the adoption of Core Banking in payment gateway and aggregation services like Solutions (CBS)/centralised liquidity management Bharat Bill Payment Operating Units (BBPOUs) solutions in banks which enabled straight-through- and TPAPs in the UPI platform have furthered the processing of payments. In 2012, RuPay card adoption of digital payments in the country (RBI, was introduced as the first of its kind global card 2021a). Leveraging increasing mobile density, payment network of India with lower transaction PSPs, both banks and non-banks, have started fees and wider acceptance at ATMs, Point of Sale services using mobile as an access device as well devices, and e-commerce platforms across the as an access channel.11 country. Mass adoption of e-banking and newer III.23 The introduction of UPI in 2016 brought delivery channels for the customers – such as twin benefits for mobile banking - convenience internet banking (the primary mode of e-banking of operations for customers, and merchant in India) and mobile banking – evolved. As internet ‘pull’ payments. Prior to this, mobile banking connectivity and mobile phone penetration surged, applications were largely operating in silos, payment mechanism shifted from cards and particularly for merchant payments and were ATM networks to mobile phones as a convenient generally not interoperable across merchants and alternative for small value transactions. customers of different banks (Das, 2024). In 2022, the interlinking of RuPay credit cards with the UPI III.22 In recent years, new dimensions have platform offered more convenience to users and been added to the payment systems, such as the expanded the reach of digital payments.

Immediate Payment Service (IMPS) and the UPI, which provide instant credit to the beneficiary, III.24 To broaden access to digital payments in and are available round the clock for undertaking areas of low internet connectivity, a pilot scheme fund transfers. The Real Time Gross Settlement was launched in August 2020 to enable small value

(RTGS) has been developed as a Financial digital transactions in offline mode. In 2022, the Market Infrastructure, which processes large framework was formalised with offline payments payment transactions. Initiatives like Bharat Bill allowed using any channel or instrument like Payment System (BBPS) and Pre-paid Payment cards, wallets and mobile devices in proximity Instruments (PPIs) (which facilitate payment of (face-to-face) mode without mandatory Additional bills and purchase of goods and services), and Factor of Authentication (AFA). UPI Lite was 11 Banks provide mobile banking services through three channels – SMS, Unstructured Supplementary Services Data (USSD) and applications.

87REPORT ON CURRENCY AND FINANCE introduced in this framework in September and interactions initiate, import, modify and 2022 as a simplified version of the UPI payment diffuse new technologies” (Freeman, 1987), and system. Using the same account, payments of up “the elements and relationships which interact to ₹ 500 can be made without pin authentication, in the production, diffusion and use of new, and making payments faster and more convenient. economically useful, knowledge ... and are either In September 2023, UPI Lite X was introduced located within or rooted inside the borders of a for offline payments where transactions are nation state” (Lundvall, 1992). The concept rests carried out using the Near Field Communication on the premise that understanding the interactions

(NFC) technology. UPI Tap & Pay, introduced at among the actors involved in innovation is crucial the same time, allows tapping NFC-enabled QR for enhancing technology performance (OECD, codes at merchant locations and aids in faster 1997). Nations excel in specific industries because digital transactions.

their domestic environment is exceptionally

3.2. Factors Contributing to Digitalisation of forward-looking, dynamic, and challenging (Porter, Payments in India 1998).

III.25 The evolution of retail payment landscape III.26 Through the lens of the National in India can be analysed using the innovation Innovation Systems (NIS) framework, the systems approach, which was first introduced payment landscape in India can be seen as in the late 1980s as a framework to understand influenced by the interaction of various factors technological innovations at the national level. It including technological advancements, agents, has been defined as “the network of institutions institutions and policy prescription (Chart III.10).

in the public and private sectors whose activities The pace and sequencing of payment system Chart III.10: Payment System in India in a National Innovation Systems (NIS) Framework •Consumers •TPSPs •Commercial Banks Agents •Payment System Operators- RBI, NPCI, ATM Networks, TReDS, BBPOUs •IFTAS •Internet •INFINET & SFMS •ECS, NACH Technology & •RBI •National Financial Switch (NFS) Institutions •Government •India Stack -Aadhaar, Infrastructure •IDRBT (1996) KYC, UPI •IMPS, NEFT, RTGS •Direct Benefit Transfer (2013) •PM Jan Dhan Yojana (2014) Policy •Digital India Mission (2015) •AadhaarAct (2016) •Financial Inclusion Measures

Note: TPSPs: Third Party Service Providers; NPCI: National Payments Corporation of India; TReDS: Trade Receivables electronic Discounting System; BBPOUs:

Bharat Bill Payment Operating Units; IFTAS: Indian Financial Technology Application Services; IDRBT: Institute for Development and Research in Banking Technology; INFINET: INdian FInancial NETwork; SFMS: Structured Financial Messaging System; ECS: Electronic Clearing Service; NACH: National Automated Clearing House; KYC: Know Your Customer; UPI: Unified Payments Interface; IMPS: Immediate Payment Services; NEFT: National Electronic Funds Transfer

RTGS: Real Time Gross Settlement.

Source: RBI staff illustration.

88DIGITALISATION AND THE PAYMENT REVOLUTION IN INDIA reform has been impacted by several factors, III.29 The continuous establishment and viz., (i) the different degrees of computerisation development of several institutions by the in the financial system; (ii) geographical spread of Reserve Bank played an immense role in the the banking sector; (iii) the regulatory role of the evolution and regulation of payment systems.

Reserve Bank in relation to the payment systems; The Institute for Development and Research in

(iv) systemic risks in payment and settlement Banking Technology (IDRBT) was established in systems; (v) legal infrastructure; and (vi) impact 1996 with a focus on sculpting the technological of payment and settlement system reforms on the infrastructure of the banking sector. It pioneered conduct of monetary policy (RBI, 2001). vital technological infrastructure systems like the INFINET and the Structured Financial Messaging III.27 The public sector’s pioneering role in System (SFMS). The IDRBT also developed the the evolution of payments systems included a National Financial Switch (NFS) in 2004, which four-pronged strategy: treating digital financial is currently under the NPCI. The NPCI was infrastructure as a public good, fostering established in 2008 by the Reserve Bank of India private innovation with open access, ensuring and the Indian Banks’ Association exclusively for a fair regulatory environment, and empowering promoting payment systems. In 2015, the Indian individuals through a consensual data-sharing Financial Technology Application Services (IFTAS) framework. The top-down strategising fostered an was created as a subsidiary of the Reserve Bank open loop digital payments system, which enabled which took over key services like INFINET, SFMS, banks to take centre stage in the evolution and integrate themselves in the payment infrastructure. Indian Banking Community Cloud (IBCC), and These strategies led to innovative digital platforms Global Interchange for Financial Transactions that served specific needs like identity verification, (GIFT), offering uninterrupted 24x7 IT services to payments, and data sharing and collectively form the banking sector, including as a communication a powerful integrated system known as the Digital backbone, messaging platform, and community Public Infrastructure or the “India Stack” (D’Silva et cloud. In April 2020, NPCI International Payments al., 2019). The multidimensionality of the stack and Limited (NIPL) was established as a subsidiary the open loop system (where settlement happens dedicated to globalising NPCI’s payment systems, in the fiat currency), facilitated interoperability and focusing initially on the internationalisation of mass adoption, and enhanced financial inclusion. RuPay and UPI. The IDRBT has expanded its focus to research centres, addressing areas III.28 The Reserve Bank is vested with the like analytics, cyber security, mobile banking, power to regulate payment and settlement affordable technologies, cloud computing, and systems in the country under the Payment and payment systems. The setting up of the Reserve Settlement Systems Act, 2007 (PSS Act). The Bank Innovation Hub in March 2022 is another Board for Regulation and Supervision of Payment step taken to encourage and nurture financial and Settlement Systems (BPSS), a Committee of innovation in a sustainable manner through an the Central Board of the Reserve Bank of India institutional set-up.

oversees the payment and settlement systems in India. It is instrumental in prescribing policies and III.30 With institutions in place, the Reserve Bank setting standards for regulating and supervising authorised various agents like Payment System all the payment and settlement systems in the Operators (PSOs) such as NPCI (retail payments country. organisation), card payment networks, cross- 89REPORT ON CURRENCY AND FINANCE Chart III.11: Payment System Operators and Systems

Note: In Chart III.11b, the year of authorisation is reported at the end.

Source: RBI staff illustration. border inbound money transfers entities, ATM Yojana accounts (PMJDY, 2024). Mobile based networks, PPI issuers, Instant Money Transfer banking developed as fast payments systems like operators, TReDS platform providers and NPCI IMPS and UPI accorded multi-channel access Bharat BillPay Limited (NBBL) to operate payment including internet and mobile banking. Amidst systems in the country (Chart III.11a). Of all the this evolution, a universe of Third-Party Service operators, the Reserve Bank and the NPCI are Providers (TPSPs) developed simultaneously, the major ones entrusted with overseeing vital which includes, payment gateways (PGs), payment systems like RTGS, NEFT and UPI; payment aggregators (PAs), and TPAPs. These IMPS and NACH respectively (Chart III.11b). TPSPs play a significant role in furthering public- private partnership in the FinTech sphere.

III.31 Concurrently, changes in the payment landscape were brought from the perspective of III.32 To further expand the digital payment government payments. As noted earlier, the trifecta ecosystem in India, the Reserve Bank in 2019 of JAM trinity revolutionised the retail payment introduced the ‘Expanding and Deepening of landscape. Bulk and repetitive government benefit Digital Payment Ecosystem’ (EDDPE) programme.

and subsidy payments to Aadhaar-seeded bank Under this programme, State Level Bankers’ accounts of identified beneficiaries were facilitated Committees (SLBCs)/Union Territory Level by the Aadhaar Payments Bridge System (APBS). Bankers’ Committees (UTLBCs) of respective Aadhaar Enabled Payment System, operational states and union territories (UTs) provide every since 2011, uses Aadhaar authentication for online eligible individual in the identified district with at transactions and offers cash withdrawal, balance least one mode of digital payments viz., debit/ enquiry, and fund transfers. Nearly 352 million RuPay cards, net banking, mobile banking, RuPay cards have been issued under Jan Dhan UPI, USSD, AePS, to facilitate him/her to make/ 90DIGITALISATION AND THE PAYMENT REVOLUTION IN INDIA receive payments digitally in a safe, secure, quick, jumped from around 37 per cent during April to affordable, and convenient manner. As on March October 2016 to nearly 70 per cent in November 31, 2024, all districts across the country (except and 123 per cent in December 2016. There two districts from the UT of Andaman and Nicobar appears to be a structural break in the volume Islands) have been identified for the purpose, and and value of retail electronic payments, coinciding 179 districts were 100 per cent digitally enabled. with the onset of demonetisation (RBI, 2017). The COVID-19 pandemic also hastened the adoption III.33 The Payments Infrastructure Development of digital payments in India with consumers and Fund (PIDF) operationalised by the Reserve Bank businesses increasingly choosing contactless in January 2021 provided a further fillip to the transactions amidst social distancing norms and digital payments revolution. The PIDF Scheme, lockdowns. Realising the importance of financial initially implemented for a period of three years literacy in digital payments’ adoption, the Reserve was extended further for a period of two years, Bank, along with several non-governmental i.e., up to December 31, 2025. It encourages organisations and financial institutions, has deployment of payment acceptance infrastructure initiated various programmes to educate the such as physical Point of Sale (PoS) terminals underserved segments about the benefits of and Quick Response (QR) codes in tier-3 to tier-6 digital payments. The Reserve Bank has been centres, north-eastern states and UTs of Jammu conducting electronic banking awareness and & Kashmir and Ladakh, and beneficiaries of training (e-BAAT) programmes regularly to educate Street Vendor’s AtmaNirbhar Nidhi (PM SVANidhi the masses to move their focus of payments from Scheme) and PM Vishwakarma scheme in tier-1 physical presence of money to electronic money and tier-2 centres (Table III.1). The PIDF had a payments.

corpus of ₹1,239 crore in May 2024.

III.35 Overall, the evolution of the retail payment III.34 Apart from these factors, digital payments landscape in India within the context of the NIS were boosted by the demonetisation of banknotes reflects a dynamic ecosystem characterised of ₹500 and ₹1000 denominations in 2016. The by policy support, technological innovation, year-on-year growth in retail electronic payments stakeholder collaboration, and consumer-driven Table III.1: Payments Infrastructure Development Fund (PIDF) (As on May 31, 2024) Aadhaar enabled Location Physical devices* Digital devices** biometric devices Tier 3 & 4 Centres 5,15,476 1,05,70,839 1,775 Tier 5 & 6 Centres 4,00,945 1,68,59,577 3,670 Special Focus Areas 1,30,450 24,45,204 191 (North-eastern States and UTs of J&K and Ladakh) Tier 1 & 2 Centres 335 14,68,901 0 (PM SVANidhi and PM Vishwakarma Schemes) Total 10,47,206 3,13,44,521 5,636

Note: 1. *Physical devices include PoS, mPoS (mobile PoS), GPRS (General Packet Radio Service), PSTN (Public Switched Telephone Network), etc.

2. **Digital devices include inter-operable QR code-based payments such as UPI QR, Bharat QR, etc.

Source: RBI.

91REPORT ON CURRENCY AND FINANCE demand. These efforts were a part of a broader UPI has facilitated digital payments to merchants strategy to promote financial inclusion, enhance such as retail outlets/vendors across the country, the efficiency of the payment system, and the BBPS has ensured migration of bill payments boost the digital economy. Going forward, the from cash/cheques to digital mode. Likewise, the Payments Vision Document 2025 (RBI, 2022a) NETC system aided migration of toll payments to digital mode, and the NACH facilitated digital further builds upon the five pillars of integrity, direct benefit transfers (DBT).

inclusion, innovation, institutionalisation and internationalisation and is indicative of the future III.37 The transition to digital modes of payment evolution of payment systems in India. is borne out by the phenomenal growth witnessed across all facets of digital transactions over the

3.3. Trends in Digital Payments past decade. The volume of digital transactions III.36 Payment transactions in India currently recorded a compound annual growth rate (CAGR) comprise bulk payment transfers (RTGS), which of 52 per cent during 2013-14 to 2023-24 while include both customer and inter-bank transactions;

the value of these transactions exhibited a 12 per and retail payment transfers12 (Chart III.12). Except cent CAGR (Chart III.13a). The intensity of digital paper-based instruments, all other payments payment usage has shot up multi-fold: the number constitute digital transactions. The digital payments of transactions per lakh of GDP increased from system has been developed to offer a bouquet 0.8 in 2005-06 to 56 in 2023-24, and the number of products to cater to diverse needs. While the of transactions per capita from 0.2 in 2005-06 to Chart III.12: Payment Systems Landscape in India Payment Systems Financial Market Non-Digital Retail Payments Infrastructure Paper Based Credit Debit Card Prepaid Payment Credit Instruments Transfers Transfers Payments Instruments Transfers RTGS CTS (NPCI APBS BHIM Managed) Aadhaar Pay Credit Cards Cards Others AePS NACH (Dr) Debit Cards Wallets IMPS NETC NACH (Cr) NEFT UPI

Note: CTS: Cheque Truncation System; NPCI: National Payments Corporation of India; APBS: Aadhaar Payment Bridge System; AePS: Aadhaar enabled Payment System; IMPS: Immediate Payment Services; NACH(Cr): National Automated Clearing House (Credit); NEFT: National Electronic Funds Transfer; UPI: Unified Payments Interface; BHIM: Bharat Interface for Money; NACH(Dr): National Automated Clearing House (Debit); NETC: National Electronic Toll Collection; RTGS:

Real Time Gross Settlement.

Source: RBI staff illustration.

12 The classification between retail and non-retail segments is at Payment System/Instrument level and does not per se capture individual transaction values. For instance, NEFT is called as retail payment system, even though it allows for high value transactions. Contrastingly, for RTGS there is a lower limit of value defined, and is classified as wholesale/large value payment system.

92DIGITALISATION AND THE PAYMENT REVOLUTION IN INDIA Chart III.13: Intensity of Digital Payments Adoption a. Total Digital Payments Intensity of Digital Payments 3000 18000 16443 16000 2500 2428 14000 2000 12000 10000 1500 8000 1000 6000 4000 500 2000 0 0

Source: RBI; NSO; UN World Population Prospects; and RBI staff estimates.

114 in 2023-24. The average value of transaction (Chart III.14e). The integration of functionality per capita for total digital payments surged from of UPI with RuPay credit cards increased credit ₹0.4 lakhs to ₹16.8 lakhs over the same period card usage further in 2023. Consequently, the (Chart III.13b). market share of outstanding RuPay credit cards in circulation also increased from 3 per cent in 2022- III.38 The share of the volume of paper clearing 23 to 10 per cent in 2023-24.13 plummeted to 0.4 per cent in 2023-24 in total retail payments from 81.9 per cent in 2005-06. Further, III.39 UPI is now the most popular and preferred the share of digital retail transactions in total value payment mode in India revolutionising the P2P of retail payments increased to 90.9 per cent as well as P2M transactions (Das, 2023a).

in 2023-24 from 1.3 per cent in 2005-06 (Chart Apart from being a user-friendly interface and III.14a and b). UPI has emerged as the preferred facilitating QR code-based payments, the UPI method of retail payments, with a share of 79.6 has evolved to include advanced functionalities per cent in total volumes of retail payments made such as offline payments through NFC technology in 2023-24 (Chart III.14c). In value terms, NEFT (UPI Lite X), payments through feature phones transactions had the highest share (49.4 per cent) (UPI 123Pay) and AI based conversational in total retail payments in 2023-24, followed by payments (hello! UPI) [Chart III.15]. The volume UPI (25.3 per cent share in 2023-24 as compared of UPI transactions has increased multi-fold from to only 2.4 per cent in 2018-19) [Chart III.14d]. 539 crore in 2018-19 to 13,113 crore in 2023-24 Within card payments, the usage of credit cards and their value from ₹8.8 lakh crore to ₹200 lakh has increased over the years. In 2023-24, credit crore during the same period. Currently, UPI is cards accounted for 61 per cent of total volume processing close to 45 crore transactions in a day and 76 per cent of total value of card payments (June 2024).

13 In December 2023, RuPay credit card spending on UPI platform crossed ₹ 5,000 crore - almost 50 per cent of overall RuPay credit card spending.

93 50-4002 60-5002 70-6002 80-7002 90-8002 01-9002 11-0102 21-1102 31-2102 41-3102 51-4102 61-5102 71-6102 81-7102 91-8102 02-9102 12-0202 22-1202 32-2202 42-3202 erorC ni rebmuN 18 114.1 120 16 16.8 100 14 12 80 10

55.9 60 8 6 40 4 0.4 2 0.70.2 20 0 0 Volume (RHS) Value 50-4002 60-5002 70-6002 80-7002 90-8002 01-9002 11-0102 21-1102 31-2102 41-3102 51-4102 61-5102 71-6102 81-7102 91-8102 02-9102 12-0202 22-1202 32-2202 42-3202 rebmuN Transactions per Lakh of GDP (RHS) Transactions per Capita (RHS) Per Capita Value of Digital TransactionsREPORT ON CURRENCY AND FINANCE Chart III.14: Retail Payments Trend a. Share of Digital Retail Payments in Total Retail Payments b. Share of Digital Retail Payments in Total Retail Payments (By Volume) (By Value) 100 90 80 70 60 50 40 30 20 10 0 c. Retail Credit Transfers: Volume d. Retail Credit Transfers: Value e. Trend in Card Payments

Note: Aadhaar based payment methods include AePS, APBS and BHIM Aadhaar Pay.

Source: RBI; and RBI staff estimates.

III.40 The Digital Payments Index (DPI), payments: (i) payment enablers, (ii) payment constructed by the Reserve Bank of India with infrastructure – demand-side factors, (iii) March 2018 as the base year, captures the payment infrastructure – supply-side factors, extent of digitisation of payments across the (iv) payment performance and (v) consumer country. It comprises of five broad parameters centricity. Each of these parameters have sub- that capture demand and supply side factors to parameters that consist of various measurable measure deepening and penetration of digital indicators (Chart III.16).

94 tnec reP 60-5002 80-7002 01-9002 21-1102 41-3102 61-5102 81-7102 02-9102 22-1202 42-3202

81.9 0.4 100 90 80 99.6 70 60 50 40 30 20

1018.1 0 tnec reP 60-5002 80-7002 01-9002 21-1102 41-3102 61-5102 81-7102 02-9102 22-1202 42-3202 Digital retail payments Paper based instruments 100

79.6 80 60 40

22.1 25.5 20 6.2 1.6 7.2 3.6 9.6 4.4 5.62.0 3.6 19. 40 .8 4.6 0.4 0 tnec rep ni erahS sdohteM tnemyaP SPMI TFEN IPU HCAN stnemyaP draC sIPP desab repaP stnemurtsni 70 62.9 60 49.4 50 40 30 25.3 22.7 20 10 0.20.5 4.48.2 2.4 3.54.0 3.33.1 0.60.4 9.1 0 2018-19 2023-24 tnec rep ni erahS sdohteM tnemyaP SPMI TFEN IPU HCAN draC stnemyaP sIPP desab repaP stnemurtsni 60,000 20 18 50,000 16 40,000 35,610 12 30,000 22,860 8 20,000 6 10,000 4 0 0 hkaL ni rebmuN 61-5102 71-6102 81-7102 91-8102 02-9102 12-0202 22-1202 32-2202 42-3202

98.7 9.1

90.9

1.3 Digital retail payments Paper based instruments 2018-19 2023-24 Credit Cards (Volume) Debit Cards (Volume) Credit Cards (Value) RHS Debit Cards (Value) RHS desaB raahdaA desaB raahdaADIGITALISATION AND THE PAYMENT REVOLUTION IN INDIA Chart III.15: Timeline of UPI Evolution and Adoption

Source: RBI staff illustration.

III.41 Since March 2018, the DPI has increased across all parameters and driven particularly by more than four-fold to reach 445.5 in March 2024 payment performance and payment infrastructure (Chart III.17). The increase has been recorded across the country, over the period.

Chart III.16: Parameters (Weight in Parentheses) and Sub-parameters of RBI’s Digital Payments Index (DPI) Payment Infrastructure Payment Infrastructure Payment Enablers Payment Performance Consumer Centricity Demand Side Supply Side (25 per cent) (45 per cent) (5 per cent) (10 per cent) (15 per cent) Internet Debit Cards Bank Branches SD yi sg ti et mal sP - a Vy om lue mnt e Aw Ea dre un ce as tis o a nnd Business Digital Payment Mobile Correspondents Systems- Value Credit Cards Declines Aadhaar ATMs Unique Users Prepaid Payment Instruments Complaints Bank Accounts PoS Terminals Paper Clearing Customer Registered-Mobile Frauds Currency in Participants and Internet Banking QR Codes Circulation Merchants FASTags Intermediaries Cash Withdrawals System Downtime

Source: RBI staff illustration.

95REPORT ON CURRENCY AND FINANCE

3.4.1. Merchants Chart III.17: RBI- Digital Payments Index III.43 As per the survey, familiarity with digital payments is widespread across geographical locations with 88.8 per cent of the merchants being aware of digital payments (the highest in metro areas at 93.4 per cent). About two-third of the survey respondents had tried digital payments at least once.15 The adoption levels were, however, lower than the awareness levels suggesting scope for expanding the usage of digital payments. In metro areas, the percentage of merchants who had adopted digital payments was higher at 75.2 per cent, along with higher current usage (Chart III.18). At an all-India level, about one-fifth of

Source: RBI. the merchants had never used digital payments despite being aware of it, while another 11.2 per cent had never used digital payments because

3.4. Awareness and Adoption of Digital Payments of the lack of awareness. Around 60 per cent of

in India: Evidence from User Survey III.42 Even as there has been significant progress Chart III.18: Merchant Digital Payments – Awareness, Adoption and Usage in 2022 in digital payments adoption in India as captured by the broad aggregates discussed above, micro level evaluation from the users’ perspective is crucial to extract important policy lessons regarding the degree of penetration of digital payments as well as gaps, if any, which need focused attention.

Accordingly, the Reserve Bank conducted a nationwide survey of merchants and consumers with approximately 90,000 participants from both the rural as well as urban areas in all States and Union Territories (UTs), ensuring a proportionate representation according to population size and geographies in 2022.14 The major survey results are set out below. Source: RBI Survey.

14 The survey’s execution was delegated to National Payments Corporation of India (NPCI), and the field work for the survey was conducted from September 2022 to December 2022.

15 If the respondent has used digital payments at least once in his/her life time, it is considered as ‘adoption of digital payments’ and if she/ he continues to use digital payments at the time of survey, it is considered as ‘usage of digital payments’.

96DIGITALISATION AND THE PAYMENT REVOLUTION IN INDIA merchants observed an uptick in digital payments Chart III.19: Consumer Digital Payments - Awareness, Adoption and Usage in 2022 usage following the COVID-19 pandemic. This pattern was consistent across different groups, with a notably higher increase among merchants in metro areas.

3.4.2. Consumers III.44 The pattern of digital payment awareness among consumers was like that of merchants, although the awareness levels were somewhat lower. As in the case of merchants, the awareness among metro and urban consumers was higher and the awareness in semi-urban and rural areas did not see a significant drop from the all-India

Source: RBI Survey. average. The adoption levels among consumers were lower compared to merchants, with only 41.9 digital payments pre-Covid, 64.7 per cent reported per cent consumers having used any of the digital an increase in their usage post-Covid.

payment modes at least once in their lifetime. The adoption of digital payment modes was higher in III.46 By age groups, the awareness of digital metros and urban areas. The conversion from payments was high among the younger age awareness to trial was 54.3 per cent, suggesting groups. Adoption and current usage followed scope for further penetration. similar trends, with the age group 18-30 years using digital payments the most (Chart III.20).

III.45 According to the survey, about 36.1 per cent consumers were current users of any of the Chart III.20: Consumer Digital Payments - by Age Group digital payment modes in India. When compared to 41.9 per cent of users who have tried digital payments at least once, this translates to a conversion rate of 86.1 per cent, implying that most people having once used, continue to use digital payments regularly. This also indicates that efforts towards initiating consumers to digital payments on a trial basis could result in long term adoption. The current usage of digital payments was also found to be higher among metro and urban residents (Chart III.19). Approximately 4 in every 10 consumers reported that they started using digital payments post the pandemic. Among

Source: RBI Survey. the remaining 59.9 per cent who had been using 97REPORT ON CURRENCY AND FINANCE Table III.2: Consumer Digital Payments Chart III.21: Consumer Digital Payments - by Gender Awareness - by States State/UT Awareness State/UT Awareness (per cent) (per cent) Andaman Nicobar Islands 81.6 Lakshadweep 84.4 Andhra Pradesh 73.5 Madhya Pradesh 69.2 Arunachal Pradesh 81.4 Maharashtra 74.8 Assam 75.8 Manipur 87.4 Bihar 84.4 Meghalaya 83.2 Chandigarh 73.7 Mizoram 80.6 Chhattisgarh 60.8 Nagaland 91.5 Dadra and Nagar Haveli 80.6 Odisha 82.7 Daman and Diu 92.1 Puducherry 78.8 Delhi 93.7 Punjab 77.2 Goa 86.4 Rajasthan 77.6 Gujarat 75.7 Sikkim 83.7 Haryana 93.3 Tamil Nadu 79.3 Himachal Pradesh 77.6 Telangana 70.5

Source: RBI Survey.

Jammu and Kashmir 76.6 Tripura 66.7 Jharkhand 67.4 Uttar Pradesh 72.3 III.47 Awareness and usage levels among males Karnataka 80.5 Uttarakhand 89.9 were higher than females. While 51.8 per cent of Kerala 85.1 West Bengal 78.8 the males had used digital payment mode at least All India 77.2 once in their lifetime, the number was 28.7 per Source: RBI Survey.

cent for females, according to the survey (Chart consumers’ habituality with cash (30.7 per cent) III.21). and unacceptability of digital payments (19.7 per III.48 Across states, the overall awareness was cent).

in the range of 60-93 per cent, with twelve states/ UTs exhibiting awareness levels equal to or higher 4. Impact of Digital Payments than the all-India average (Table III.2).

III.50 Through their fast, convenient, cost-

3.4.3. Key Drivers of Adoption of Digital Payments effective, and transparent nature, digital payments offer significant advantages to consumers as well III.49 The survey also elucidated information on as producers – they foster financial inclusion what facilitated the adoption of digital payments and inclusive growth and boost productivity ecosystem from the consumers’ perspective.

and incomes. In a panel of 90 economies over Ease and convenience were cited as key reasons, 2014-19, a one percentage point increase in with 61.8 per cent consumers quoting the same.

Amongst users of digital payments in the country, digital payments use was associated with 0.04

86.6 per cent respondents did not face any percentage point and 0.10 percentage point difficulty while using digital payment methods. growth in total factor productivity and GDP per Among the small set of customers who did face capita, respectively (Aguilar et al., 2024). The difficulty while using digital payments, server study also found that digital payments facilitated being down/not working was reported as the key greater access to credit and resulted in 0.06 issue (59.1 per cent). Other challenges were percentage point decline in the share of informal 98DIGITALISATION AND THE PAYMENT REVOLUTION IN INDIA employment. Digital payments enhance the well- Higher access to payment services is associated being of households by reducing the risk from with a reduction in income inequality, particularly economic shocks; they also facilitate informal- for those at the lower end of the income distribution, risk-sharing networks by facilitating timely transfer and when female financial inclusion is high (Čihák of small amounts of money, enabling mitigation of and Sahay, 2020). Additionally, DFS reduce negative shocks, and more efficient investment gender gap in financial inclusion by addressing decisions (Jack and Suri, 2014; Jack and Suri, constraints that affect women in particular, such as

2011). mobility and time constraints (Khera, 2023). DFS also holds promise for reducing costs, improving

4.1 Financial Inclusion and Inclusive Growth speed, security, and transparency, and facilitating III.51 The emergence of digital payments more tailored financial services that cater to the has quickened the pace of financial inclusion disadvantaged and underserved populations by breaking many of the obstacles faced by (Thomas and Hedrick-Wong, 2019; Pazarbasioglu traditional financial inclusion channels, like cost, et al., 2020).

geographical barriers, and information asymmetry III.53 Digital payments help in consumption- (Khera et al., 2022). Digital finance complements smoothing and increasing savings for households, traditional finance in areas where formal finance while helping in stabilising income and increasing is already engraved and supplements in places sales for firms in the informal sector. In where traditional financial modes have limited Bangladesh, mobile banking increased urban- reach. Inclusive digital financial services, to-rural remittances; rural households receiving including online accounts, mobile money services, digital payments borrowed less, saved more, and electronic payments, combinations of insurance and credit as well as FinTech applications have consumed more in the lean season (Lee et al., the capacity to reach individuals and firms 2021). Based on a study of 400 million mobile which were hitherto excluded. Digital financial money users in India, Patnam and Yao (2020) services (DFS), by virtue of being faster, more found that mobile money use increased the efficient, and typically cheaper than traditional resilience of households to shocks by dampening financial services, are becoming increasingly the impact of rainfall shocks on economic activity capable of reaching lower-income households and household consumption. The study also as well as micro, small, and medium enterprises indicated that firms adopting mobile payments

(MSMEs) [Khera, 2023]. The advent of digital improved their sales after six-months of use, had innovations and payments has the potential to be lower subjective uncertainty and greater sales an enabler for the next level of financial inclusion optimism.

where the quality of inclusion takes precedence III.54 India’s financial inclusion initiatives over just the availability of financial services received a fillip when PMJDY was launched in (Rao, 2022).

2014 (Chart III.22). The digital technological III.52 By widening the reach of financial payments revolution widened the usability of bank accounts to poor households and micro enterprises, from a traditional deposit or credit account to a digital payments enhance their opportunities for payment intermediary. As per the World Bank’s participating in formal economic activities, fostering Findex database, 78 per cent of Indian adults growth and bringing down poverty and inequality. (population with 15 years or more of age) had a 99REPORT ON CURRENCY AND FINANCE Chart III.22: Deposit Accounts with Commercial Banks Chart III.23: Progress in Financial Inclusion (FI Index) FI-Access (35) FI-Usage (45) FI-Quality (20) FI-Index (RHS)

Note: Figures in parentheses indicate weights (per cent) in FI-Index.

Source: Financial Access Survey, IMF. Source: RBI. bank account in 2021 as compared to 53 per cent financial services. Ouyang (2021) found that in 2014. cashless payment adoption in China increased credit access by 56.3 per cent, and a 1 per cent III.55 The strides in furthering financial inclusion rise in payment flow increased credit line by 0.4 are captured by the Reserve Bank’s Financial per cent. These effects were found to be more Inclusion Index (FI-Index), a comprehensive index pronounced among individuals with lower levels incorporating details of banking, investments, of education, and the older population. Digital insurance, pension as well as the postal sector.

payments also simplify the transaction process, The FI-Index, on a scale of 0 to 100, comprises of making it faster and more efficient and eliminate three broad parameters, viz., access (35 per cent), manual cash handling and record-keeping. In usage (45 per cent) and quality (20 per cent), with India, internet adoption by small businesses each of these consisting of various dimensions.

has increased over the years, though the The index improved to 64.2 in March 2024 from usage remains low. As per the Annual Survey

43.4 in March 2017, with growth across all sub- of Unincorporated Sector Enterprises (ASUSE) indices (Chart III.23).

2022-23 (October-September), 21.1 per cent

4.2 Improving Credit Assessment and Availability of unincorporated establishments used internet III.56 Digital payments generate real-time for entrepreneurial purposes during the year data on sellers’ businesses, timing of cash compared to 4.0 per cent in 2015-1616. A major flows, and buyers’ purchasing habits, allowing share of these establishments with internet used payment providers to offer credit, savings, wealth internet banking (61.5 per cent) for business management, collections, insurance, and other purposes during 2022-23.

16 Estimated using microdata of National Sample Survey Office (NSSO) 73rd round - Survey on Unincorporated Non-Agricultural Enterprises (Excluding Construction) - July 2015- June 2016.

100 xednI xednI 90 70

64.2 80 60.1

56.4 60 70 53.1 53.9

49.9 60 46.0 50

43.4 50 40 40 30 30 20 20 2017 2018 2019 2020 2021 2022 2023 2024 End-MarchDIGITALISATION AND THE PAYMENT REVOLUTION IN INDIA III.57 Digital payment history enables lenders businesses to innovate and explore new business to gauge cash flow, revenue patterns, and models such as subscription services, online repayment habits of borrowers, enhancing their marketplaces, and digital platforms, enabling ability to obtain credit at more favourable lending them to transcend geographical boundaries and terms and opportunities for expansion. This reach a wider customer base both domestically and internationally.

data-driven approach bridges the gap that often hampers credit access for smaller businesses. 4.3 Better Targeting of Government Support For India, Dubey and Purnanandam (2023) found Schemes that digital payments alleviated credit constraints III.58 Digital payment systems facilitate a cost- and transaction cost frictions, especially in areas effective expansion of government-to-persons where the presence of conventional banking social assistance programmes, given their ability infrastructure was limited. Digital payment to reach far-flung and remote areas (Yawe et al., infrastructure helped reduce impediments

2022). In India, one of the most significant impacts faced by marginal self-employed households, of digital payments on under-served populations such as hawkers and small traders; and small has been through the implementation of DBTs.

entrepreneurs’ borrowing from formal sources The Aadhaar Payment Bridge (Digital ID and of financing increased with digital payments. Digital Payment) allowed the government to make Additionally, digital payments help small direct transfers of subsidies, wages, and other Table III.3: Gains from DBT and Other Governance Reforms of the Union Government (Cumulative savings up to March 2023) S. Ministry/ Department Scheme Estimated Savings / Remarks No Category Benefits (in ₹ Cr) 1 Ministry of Petroleum and Natural PAHAL 73,443 Elimination of 4.15 crore duplicate, fake/ Gas non-existent, inactive LPG connections.

2 Department of Food and Public PDS 185,573 Deletion of 5.04 crore duplicate and fake/ non-existent Distribution ration cards.

3 Department of Rural Development MGNREGS 42,534 Deletion of 7.10 lakh fake job cards (2022-23).

4 Department of Rural Development NSAP 537 Deletion of 11.05 lakh duplicate, fake/ non-existent, ineligible beneficiaries.

5 Ministry of Minority Affairs Scholarship 1,917 Deletion of 30.92 lakh duplicate, fake/ non-existent Scheme beneficiaries.

6 Department of Social Justice and Scholarship 1,055 Deletion of 12.28 lakh duplicate, fake/non-existent Empowerment Scheme beneficiaries.

7 Ministry of Women and Child Others 1,524 Reduction of 98.8 lakh duplicate, fake/non-existent Development beneficiaries.

8 Department of Fertilizers Fertilizer 18,700 Reduction of 158.06 lakh metric tonnes of fertilizer sale to retailers.

9 Department of Agriculture and PM-KISAN 22,106 Deletion of 2.12 crore ineligible beneficiaries.

Farmers Welfare 10 Others Others 1,176 Total 348,565

Note: PAHAL: Pratyaksh Hanstantrit Labh; PDS: Public Distribution System; MGNREGS: Mahatma Gandhi National Rural Employment Guarantee Scheme; NSAP: National Social Assistance Programme; PM-KISAN: Pradhan Mantri Kisan Samman Nidhi Yojana.

Source: Direct Benefit Transfer Mission, Government of India.

101REPORT ON CURRENCY AND FINANCE benefits into beneficiaries’ bank accounts in an GDP ratio, which is even higher than major EMEs efficient, transparent, and speedy manner, while (Chart III.24). Sweden’s payments market, on the reducing leakage and corruption. The number of other hand, has digitalised at a rapid pace, with its transfers as well as the total amount transferred CiC to GDP ratio at 1.1 per cent in 2022, among under DBTs have witnessed a significant rise in the lowest in the world.

recent years (See Chapter I, Chart I.19). DBTs III.61 In India, currency/GDP ratio has been and other governance reforms have led to an broadly range-bound in recent years, with estimated savings of ₹3.49 lakh crore till March variations due to events such as demonetisation 2023 (Table III.3). During 2023-24, 1006 crore in 2016 (and subsequent remonetisation), a DBT transactions were made by the Central temporary jump in precautionary demand due to Government amounting to ₹ 6.9 lakh crore.17 uncertainties induced by the COVID-19 pandemic

4.4 Impact on Central Banking Operations and the withdrawal of ₹2000 banknotes in May III.59 The rapid pace of technological 2023 (Chart III.25a). CiC growth has recorded advancements in digital payments could have some moderation amidst strong expansion in a significant bearing on monetary transmission digital payments (Chart III.25b). The negative mechanism and central banks’ operational and statistically significant substitution effect frameworks and instruments. This would require between cash and digital modes can, however, be them to adapt their policies and frameworks outweighed by the combination of positive income to navigate the realities of the new financial and precautionary effects depending upon the landscape efficiently and effectively to maintain prevailing circumstances (Awasthy et al., 2022).

their key objectives of price and financial stability III.62 Digital payments influence monetary (BIS, 2020). aggregates – both narrow money (M1) by

4.4.1. Money Demand influencing CiC and demand deposits (Columba,

2009) and broad money (M3) by affecting levels III.60 Even as digital payments are growing of saving and deposits (Demirgüç-Kunt et al., rapidly, demand for cash still remains generally

2022). Further, as transactions become faster high. Cash continues to be used as a store of and more seamless in the digital mode, money value and a preferred choice during periods of heightened uncertainty, as seen during the can change hands faster, thereby affecting the COVID-19 pandemic (Ashworth and Goodhart, velocity of money. Digital payments can also 2021; Awasthy et al., 2022). It is also the make it easier to respond to changes in interest dominant mode of payment for certain segments rates, with implications for interest rate sensitivity of population, like older people (Khiaonarong of money and monetary policy transmission (Kahn and Humphrey, 2022). These developments and et al., 2022). In several countries, like the US, country-specific factors are reflected in divergent Canada, China, Kenya, Singapore, and Sweden, currency to GDP ratios and trends across the the digitalisation of payments was accompanied world. For instance, among the major AEs, Japan by a structural shift and instability in money has the highest currency in circulation (CiC) to velocity. The effect was, however, dampened 17 As on July 12, 2024.

102DIGITALISATION AND THE PAYMENT REVOLUTION IN INDIA Chart III.24: Currency in Circulation (CiC) to GDP Ratios

Source: BIS Red Book Statistics. by other macroeconomic factors. In the US, III.63 In India, in the aftermath of the COVID-19 important innovations in the payment space were pandemic, M3 growth accelerated transiently, as accompanied by an increase in income velocity its largest component, aggregate deposits, grew of M1, while a decline of the same was registered sharply owing to COVID-19 induced uncertainties and the lack of avenues to spend (Chart III.26). This in the aftermath of the GFC and the COVID-19 also led to a sharp drop in the velocity of money pandemic. Canada experienced a similar uptick (RBI, 2021b). The velocity of money returned to its in money velocity for narrow money, coinciding long run trend in 2022-23 (RBI, 2023).

with the introduction of credit cards. In the case of China, expansion in mobile money around 2002 III.64 In India, financial innovations (cards and led to an increase in volatility of money velocity mobile banking, among others) are important (Lukonga, 2023). determinants of real money balances (Adil et al., Chart III.25: CiC and Digital Payments in India a. CiC-GDP Ratio b. Growth in CiC and Digital Payments*

Note: *Total digital payments.

Source: RBI.

103 tnec reP tnec rep ni htworg y-o-Y

16.0

14.4

14.0

12.0 12.0 11.9

10.0

8.0

6.0

4.0

2.0

0.0 31-raM 31-peS 41-raM 41-peS 51-raM 51-peS 61-raM 61-peS 71-raM 71-peS 81-raM 81-peS 91-raM 91-peS 02-raM 02-peS 12-raM 12-peS 22-raM 22-peS 32-raM 32-peS 42-raM 60 40 20 0 -20 -40 -60 CiC Digital payments value 81-raM 81-nuJ 81-peS 81-ceD 91-raM 91-nuJ 91-peS 91-ceD 02-raM 02-nuJ 02-peS 02-ceD 12-raM 12-nuJ 12-peS 12-ceD 22-raM 22-nuJ 22-peS 22-ceD 32-raM 32-nuJ 32-peS 32-ceD 42-raMREPORT ON CURRENCY AND FINANCE Chart III.26: India’s Broad Money (M3) and its Components

Source: RBI.

2020). In China, digital finance impacts stability as it brings down settlement risk, reducing the of money demand differently across monetary liquidity needs for settlement of transactions

aggregates: it leaves M0 unaltered, has no effect (Sankar, 2021). At the same time, it can also on the volatile M1, but disrupts the previously reduce bank deposits affecting the credit creating stable M2 (Zhan et al., 2023). In Italy, the diffusion capacity of commercial banks. As deposits are of ATMs and PoS had a negative impact on a cheap and stable source of funding for banks, CiC, but a positive impact on M1, as payment substitution of bank deposits with CBDCs could innovations lead to a shift away from cash towards impact banks’ overall funding, and ability to lend demand deposits (Columba, 2009). In the Indian (Chang et al., 2023). Bank disintermediation due context, digitalisation appears to reduce money to introduction of CBDCs would depend, inter demand (Box III.2).

alia, upon the design features of the CBDC (for

4.4.2. Impact of CBDC example, whether remunerative or not). CBDCs could also impact the commercial bank reserves III.65 CBDCs are being introduced in different at the central bank and open market operations.

economies in pilot mode, including India. While Countries with banking systems dominated by CBDCs offer a range of benefits like reduced small retail deposits and a high share of non- dependency on cash, lower currency management interest-bearing demand deposits could be more cost and reduced settlement risk, these also vulnerable to deposit disintermediation (Lukonga, have implications for financial stability, monetary policy, financial market structure, and cost and 2023). The implications of CBDC for central availability of credit (RBI, 2022b). Conceptually, banking operations and monetary policy essentially CBDCs can induce changes in public’s demand depend on the way it is designed and its degree of for currency; banking system deposits and credit; usage. If the CBDCs get a positive remuneration, retail, wholesale and cross-border payments; and higher usage and adoption of CBDCs could monetary policy implementation and transmission. weaken monetary policy transmission. A reduction CBDC can reduce transaction demand in deposits, in availability, and/or an increase in the cost 104 tnec rep ni erahS tnec rep ni htworg y-o-Y 100% 16 90% 14 80% 12 70% 60% 10 50% 8 40% 6 30% 4 20% 10% 2 0% 0 61-raM 61-nuJ 61-peS 61-ceD 71-raM 71-nuJ 71-peS 71-ceD 81-raM 81-nuJ 81-peS 81-ceD 91-raM 91-nuJ 91-peS 91-ceD 02-raM 02-nuJ 02-peS 02-ceD 12-raM 12-nuJ 12-peS 12-ceD 22-raM 22-nuJ 22-peS 22-ceD 32-raM 32-nuJ 32-peS 32-ceD Other deposits with RBI Demand deposits with banks Time deposits with banks Currency with public M3 growth rate (RHS) 3 quarter moving average (M3 growth rate (RHS))DIGITALISATION AND THE PAYMENT REVOLUTION IN INDIA Box III.2 Impact of Digital Payments on Money Demand With digitalisation gaining traction, digital payments Table 2: Long-run and short-run ARDL Results have emerged as an attractive alternative to cash, with Dependent variable: Log_M3

potential implications for demand for money and monetary Sample period: June 2013 - March 2023 aggregates. Using quarterly data from June 2013 to Standard Variable Coefficient Error March 2023, an Autoregressive Distributed Lag (ARDL) Long-run equation model (Pesaran et al., 2001) is deployed to examine the log_Nominal GDP(-1) 1.25*** 0.26 dynamic relationship between money demand (Broad log_Digital Payments (-1) -0.33** 0.13 money M3) and digitalisation in payments. Based on Adil G-Sec_Yield -0.08** 0.03 et al. (2020), money demand is postulated to depend upon Sensex (-1) -0.10 0.19 nominal income (income effect, represented by gross Constant 4.66** 1.92 domestic product (GDP) at market price, 10-year G-Sec ECM term yield (opportunity cost of holding money balances) and Gamma -0.14*** 0.02 total value of digital payments. Further, to capture wealth/ Short-run equation D(log_M3(-1)) -0.52*** 0.09 substitution effects, stock price (closing values of BSE D(log_M3(-2)) 0.41*** 0.09 Sensex) is included in the model. GDP, M3, Sensex and D(log_M3(-3)) 0.23** 0.09 digital payments are seasonally adjusted using X-13 ARIMA D(log_NGDP) -0.085* 0.04 filter and log-transformed. The effect of demonetisation and D(log_NGDP(-1)) -0.072** 0.03 the COVID-19 pandemic are controlled through dummy D(log_DIGI_S) 0.02 0.02 variables. All variables considered in the regression are D(log_SENSEX) 0.06*** 0.02 either I(0) or I(1), as is the requirement of ARDL model D(log_SENSEX(-1)) 0.02 0.02

which takes the following general long run form: D(log_SENSEX(-2)) -0.07*** 0.02 Demonetisation Dummy -0.04*** 0.00 Covid-19 Dummy -0.03** 0.01 Observations 40 Adjusted R-squared 0.73 where, LM is log of broad money (M3), X i are the Log-likelihood 154.01 explanatory variables (nominal GDP, 10-year G-Sec yield Note: 1. ***,**,*: indicate significance at 1, 5 and 10 per cent level, 3 and value of digital payments). D are the dummy variables, respectively.

t 2. D denotes first difference operator. as noted above. ε is the white noise error term and p and 3. Data pertains to all digital payments. t q are the optimal lag lengths. Source: RBI staff estimates.

The long-run coefficients and the short run dynamics are The corresponding error correction model (ECM) form is presented in Table 2. In the long-run, money demand is

given by the following equation: positively associated with income and negatively with digital payments and G-sec yield. Thus, growth in digital payments can dampen the demand for money. The error where, ∆ is the first difference operator and ECM is the correction coefficient is negative and significant, and about t– error correction term which measures the deviation1s from 14 per cent of any deviation from the long run equilibrium long-run equilibrium relationship. The Akaike Information path is corrected within one quarter.

Criterion (AIC) suggests an ARDL (4,2,0,1,3) model. References:

The bounds test establishes the existence of a long-run Adil, M., Hatekar, N., and Sahoo, P. (2020). The Impact equilibrating relationship between the variables (Table 1).

of Financial Innovation on the Money Demand Function:

Table 1: Bounds Test Results An Empirical Verification in India. Margin-The Journal of Test Statistic Value Applied Economic Research 14(1).

F-statistic 8.419*** Pesaran, M. H., Shin, Y., and Smith, R. J. (2001). Bounds

Note: *** denotes significance at 1 per cent. Testing Approaches to the Analysis of Level Relationships.

Source: RBI staff estimates.

Journal of Applied Econometrics, 16(3), 289-326.

105REPORT ON CURRENCY AND FINANCE of credit from the banking sector could impact explain some of the variation in usage of digital aggregate demand and supply in the economy financial services and financial inclusion across and weaken the bank lending channel of monetary countries (Sahay et al., 2020). As per the financial policy transmission; alternatively, positively literacy and inclusion survey carried out by the remunerated CBDCs could lead to more effective National Centre for Financial Education (NCFE) monetary policy transmission as banks will need to in 2019, only 27 per cent of the respondents compete for more deposits, and thereby maintain had achieved minimum required FL levels.18 competitive deposit rates. Further, interest bearing Furthermore, heterogeneity exists between the CBDCs could transmit monetary policy actions components of FL within the socio-economic directly to economic agents improving efficacy of groups with urban respondents as well as salaried transmission (RBI, 2022c).

class/retired persons reporting higher level of FL (Jangili et. al., 2023).

5. Challenges in the Digital Payments Landscape and Way Forward Digital Divide III.66 India has made significant strides in digital III.68 Although there has been a consistent payments. Small value transactions majorly increase in the availability of digital infrastructure account for digital payments, and there is immense in the country, as of April 2024, internet scope for a further jump in their usage. Ensuring penetration19 in the country at 55.3 per cent is that digital payment systems are accessible and below the worldwide average of 67.1 per cent.20 affordable for all segments of society, including Moreover, there is geographical and regional those without access to smartphones or the

divide in the availability: internet subscriptions per internet, is an ongoing challenge. While many 100 population in urban areas were more than 2 individuals may technically have access to digital times higher (111.8) compared to rural India (44.2) financial services, regular and meaningful use with an all-India average of 68.2 (TRAI, 2024).

could be impeded by barriers like financial literacy, Among the rural households, only 9.9 per cent mistrust in digital systems, insufficient network have access to a computer, while the proportion infrastructure, and the complexity or inaccessibility is 32.4 per cent among the urban households of digital financial products.

(NSO, 2019). On the positive side, internet costs Financial Literacy in India are among the lowest in the world, with III.67 Financial literacy (FL) is a precondition for 1GB data costing on average US$ 0.17 in 2022.21 promoting digital financial inclusion. Barriers in FL Tele-density at the all-India level was at 85.2 per 18 OECD/INFE (International Network for Financial Education) guidelines were followed, wherein a person is regarded financial literate if he/she has a combined score of at least 15 out of 22 with a minimum of 3 in financial attitude, 6 in financial behaviour and 6 in financial knowledge. If a respondent continues to use digital payments at the time of survey, it is considered as ‘usage of digital payments’.

19 Percentage of population using the internet.

20 Retrieved from https://www.meltwater.com/en/resources/digital-2024-april-global-statshot-report on July 24, 2024.

21 Statista.

106DIGITALISATION AND THE PAYMENT REVOLUTION IN INDIA cent, with urban areas and rural areas being at Chart III.27: Digital Literacy across States and UTs,

133.8 per cent and 58.6 per cent, respectively.22 Rural and Urban Areas Combined Similarly, in case of digital literacy, wide diversity exists across states (Chart III.27).

III.69 Improved tele-density in rural areas and increased internet access could contribute to further penetration of digital payments in the country. Service providers can ensure availability through community networks and public WiFi/ internet access points. Innovative solutions, such as NFC-enabled QR codes, could address these concerns related to digital access to some extent and scaling up the infrastructure requirements, particularly in rural areas, would hasten seamless Note: Percentage here indicates percentage of digitally literate households among total households. Map is for illustrative purpose only.

adoption of digital payments in the country. Source: Mothkoor and Mumtaz (2021).

Consumer Protection: Concerns Emanating or attempted frauds (54.2 per cent), followed from Digital Payments by phishing (37.2 per cent), misuse of ‘collect III.70 A pre-requisite for wider use of digital request’ (28.7 per cent), and remote access (25.5 payments is ensuring security of payments.

per cent).23 Additionally, approximately 11 per cent Cybersecurity threats in the digital payments of digital frauds or fraud attempts involved the ecosystem not only pose risks to the integrity and use of fake numbers associated with e-wallets or availability of payment systems but also undermine banks. While at the aggregate level, the incidence consumer trust and financial stability. Key of fraud is low, digital payments can attract more cybersecurity threats in digital payments include users by ensuring safer, reliable, and trustworthy phishing, card skimming, man-in-the-middle digital payment ecosystem.

attacks, malware, ransomware, among others, and a focused arttention is required to ensure III.71 The gamut of cybersecurity threats in that risks arising from such threats are mitigated digital payments is complex and constantly and customers’ interests are protected. As per evolving, requiring a multifaceted approach to the Reserve Bank’s survey regarding awareness risk management. Financial institutions, PSPs, and use of digital payments, 94.5 per cent users and consumers must collaborate to enhance the reported that they have not experienced any security of digital payment systems. Adopting fraud. The incidence of an encounter with fraud or advanced technological solutions, promoting attempted fraud was lower in metros (4.1 per cent) cybersecurity awareness, and adhering to best relative to semi-urban areas (6.4 per cent). Vishing practices and regulatory standards will ensure emerged as the most prevalent method in frauds that the risks are minimised.

22 The Indian Telecom Services Performance Indicators, Telecom Regulatory Authority of India, October-December 2023.

23 The total may add up to more than 100 as same individual can select more than one response.

107REPORT ON CURRENCY AND FINANCE Scalability Issues payment disclosures, and false urgency26. The challenge is to ensure that the payment systems III.72 Digital payment solutions need to be scaled remain one step ahead of the malicious agents up to handle the growing number of transactions and safeguard customers from these threats to without compromising performance or security.

retain and strengthen their trust (Rao, 2023).

Scalability issues can lead to system outages, slow transaction processing, and customer III.74 Laws and guidelines protecting consumers dissatisfaction. As the digital economy continues from deceptive practices and consumer to expand, the ability to scale efficiently will be awareness can go a long way in combating dark a crucial factor for the success and resilience patterns. Digital literacy programmes that cater of payment systems worldwide. It will require a to the specific needs and capabilities of different combination of technological innovation, strategic demographic groups could increase awareness planning, and collaboration across the financial through hands-on training on how to use digital ecosystem. By investing in scalable infrastructure, financial services, navigate online platforms, and embracing modern architectural approaches, and protect against cyber risks (Swaminathan, 2024).

leveraging new technologies, payment providers

6. Concluding Observations can enhance their capacity to support growth, maintain performance, and ensure the security III.75 Countries have embraced diverse and reliability of digital transactions. models of digital payment methods, shaped by their technological preparedness, financial Dark Patterns environment and demography. Unlike the other III.73 As discussed in Chapter I, digital platforms major technological advancements where AEs had often employ “dark patterns” in their user taken a lead in adaptation and EMEs have had to interfaces - design choices that manipulate users catch-up, the ongoing digital payment revolution into making decisions that may not be in their is spearheaded by EMEs. India is heralded as a best interest, such as subscribing to services they global leader whose experience holds important do not need or sharing more personal data than policy lessons for other countries. The evolution of necessary. These practices can undermine trust India’s digital payments landscape has been driven and raise ethical concerns. These tactics exploit by concerted efforts to modernise the existing psychological biases and can significantly impact systems as well as bring in new forms of payments user trust and financial well-being. Some common in a proactive manner. The Government, the dark patterns encountered in the realm of digital Reserve Bank and other public institutions aided payments are hidden fees, forced recurring infrastructure building which helped consumers subscriptions, complicated cancellation process, and other agents in adoption as well as ensuring bait and switch24, sneak into basket25, incomplete that the growth is inclusive. The intersection 24 Promotions or offers that catch a user’s attention may lead them towards initiating a transaction. However, at the last moment, the conditions change, or the offer is no longer available, and users are steered towards making a more expensive purchase.

25 During the checkout process, additional products or services (such as warranties or donations) are automatically added to the user’s basket. Users may not notice these additions and may inadvertently purchase them.

26 A countdown shown to nudge users into hasty purchases.

108DIGITALISATION AND THE PAYMENT REVOLUTION IN INDIA of technology, regulation, and collaboration III.78 Overall, India stands ready to further supplemented innovation by providing a robust harness the benefits of the digital payments feedback loop that expanded financial access and revolution, leveraging on a rapidly growing deepened digital infrastructure, making India a economy, a large and young population, global leader in digital payments. increasing internet and smartphone penetration, and supportive government policies. These factors III.76 The Reserve Bank’s survey shows that create a fertile ground for further innovation, both consumers and merchants exhibit high levels investment, and growth in digital payments. India’s of awareness of digital payments. Certain aspects, rich and successful experience in digital identity however, require policy focus, such as the gap and payments offers fine guidance on pathways between awareness and adoption rates. The to improving the lives of the common man (Das, conversion rates for those who have at least once 2023b).

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112OPEN ECONOMY DIGITALISATION:

IV CHALLENGES AND OPPORTUNITIES* Open economy digitalisation1 offers unique opportunities for India to reap dividends from cross-border digital trade.

India’s state-of-the-art digital public infrastructure (DPI) has enormous potential for enhancing cross-border trade across sectors like finance, health, education, agriculture and MSMEs and boosting India’s productivity and growth potential. The rising digitalisation share in cross-border remittance flows would help reduce the cost of sending remittances, increase their volume and improve income of the recipients. The internationalisation of the INR is benefitting from the comprehensive and integrated approach and would impart vibrancy to India’s external sector. India’s DPI resilience can be augmented by strengthening self-reliance in sea cables, expanding satellite internet connectivity, making UPI global, and providing pro-active policy support to data localisation. There exists immense potential in building cross-border interoperable fast payment systems and CBDCs to leverage open economy digitalisation.

1. Introduction digitalisation also presents opportunities for hastening internationalisation of the rupee.

IV.1 India has embarked on a transformative The DPI can be easily exported due to its open journey to become a developed nation by 2047. and modular architecture. In this context, this This aspiration will get a boost from the significant

chapter provides an in-depth assessment of the progress that has been achieved in India’s digital opportunities and challenges related to open public infrastructure (DPI) and the potential to economy digitalisation.

scale it up manifold. The “India Stack” is well recognised as a world-class DPI which has IV.2 Digitalisation is set to break the ‘iron laws’ of fostered innovation and competition, promoted cross-border trade and bring about a fundamental financial inclusion, improved efficiency of public structural shift in global production processes, expenditure, facilitated direct transfers of social trade, and investment flows via the re-allocation safety payments, and reduced leakages and of tasks through the use of robotics, automation corruption (Alonso et al., 2023). There exists and artificial intelligence (AI), servicification of the enormous potential to leverage India’s DPI in an production processes and the rise in e-commerce open economy setting to expand and diversify (Bekkers et al., 2021). Geographically, digital digital merchandise and services trade, promote trade has been gradually shifting from advanced cost-effective remittances, and increase FDI into economies (AEs) to emerging market economies digital sectors. By enabling its emergence as a (EMEs) [IMF, OECD, UN, and WTO, 2023].2 India’s preferred currency for cross-border payments, digital trade is projected to increase to US$ 2.4 * This chapter has been prepared by a team comprising Dhirendra Gajbhiye, Sujata Kundu, Rajas Saroy, Alisha George, Dirghau Keshao Raut, Manu Sharma, Abhilasha, Prashant Kumar, Satyendra Kumar, Thangzason Sonna, Ramesh Kumar Gupta from the Department of Economic and Policy Research; and Aniket Ranjan from the FinTech Department.

1 Open economy digitalisation refers to the use of digitally-enabled products/services in trade, income and investment in a cross-border setting.

2 In 1995, OECD countries represented 82 per cent of estimated global digital trade (exports). Their share fell to 73 per cent by 2018 (González et al., 2023).

113REPORT ON CURRENCY AND FINANCE trillion in 2047 - more than 13 times its level in which augurs well for global trade and payments.

2020. India’s fast adoption of frontier technologies Central bank initiatives such as interlinkage of and its state-of-the-art DPI encompassing an array FPSs across economies and central bank digital of critical sectors in the economy such as finance, currencies (CBDCs) are expected to support health, education, industry and governance are seamless international transactions, reduce expected to expand economic opportunities while foreign exchange risks and effectively manage strengthening its linkages with the rest of the world. global liquidity.

Cross-border digital ordering and delivery of goods IV.4 While digitalisation in an open economy and services have picked up at an accelerated brings immense benefits, it is not devoid of pace since the pandemic.3 During the pandemic, challenges. These include, inter alia, ensuring digital trade enhanced economic resilience across interoperability and adoption of standards; cross- geographies by maintaining business operations border digital governance and accountability;

and delivering goods and services amidst physical rising technological dependency and disruption restrictions. risks; digital monopolies and market concentration;

IV.3 Digitalisation is also rapidly transforming and safeguarding intellectual property. Policies on cross-border migrant remittances and global data security and privacy need to strike a delicate capital flows by lowering costs, increasing balance between global harmonisation and transparency and efficiency, fostering financial country-specific preferences. Moreover, digital inclusion, and aiding coordination and risk trade policies may be needed to prevent digital management. Given considerations of financial trade wars. The volume and types of cross-border stability and global coordination, the shift towards transactions and exchanges have increased open economy digitalisation is expected to be significantly. This necessitates measurement of gradual and measured, which has been India’s digitalisation in the System of National Accounts approach. The internationalisation of the UPI is

(SNA) and Balance of Payments (BoP) statistics. a pertinent example of this approach. The initial Moreover, the adoption of digital supply and use steps were aimed to enable Indian travellers and tables (DSUTs) could improve the measurement of diaspora to make merchant payments using UPI the digital economy (OECD, 2024a). To be future abroad. The next upgradation was the ability to ready, there is also a need to enhance India’s DPI make person-to-person remittances using UPI with resilience by building self-reliance in sea cables, the same efficiency as of domestic transactions.

expanding satellite internet connectivity, ramping Going forward, the goal is to globalise the UPI up cybersecurity, and providing pro-active policy such that every other country will have some fast support to data localisation.

payment system (FPS), either its own or the UPI (Sankar, 2023). Such a network would ensure that IV.5 Against this backdrop, this chapter all cross-border payments can happen on a FPS, discusses digital trade in goods and services, 3 As per IMF (2018a), digital trade is defined as all cross-border transactions that are either digitally ordered (i.e., cross-border e-commerce), digitally facilitated (by platforms) or digitally delivered. While digital trade forms a part of the conventional cross-border trade statistics, non-monetary digital flows, which comprise cross-border non-monetary information and data flows, are not included.

114OPEN ECONOMY DIGITALISATION:

CHALLENGES AND OPPORTUNITIES digital remittances, and digital capital flows, producers that primarily produce such products. while also focussing on supply-side enablers Within digital economy, ‘core’ digital economy such as DPIs, cross-border FPSs, CBDCs, includes economic activity from core information and data embassies. Section 2 delves into and communications technology (ICT) goods and the existing landscape, significance, and digital services producers in the following five prospects of digitalisation within India's external product groups: hardware, software publishing, macroeconomic framework. Digitalisation of trade, web publishing, telecommunications services, services and remittances is discussed along and specialised and support services. The with the implications for the internationalisation broader concept of ‘digitally dependent economy’ of the INR. Section 3 explores the supply-side is the combined output from the core digital sector dimensions, such as the expanded influence of and ten digitally disrupted sectors4, with the latter India’s DPIs on the global stage, with a special as defined by the UN Advisory Expert Group on focus on the internationalisation of the UPI National Accounts, 2019. In 2019, the size of the and global prospects stemming from CBDCs. core global digital economy was estimated at 8.8

Section 4 elucidates opportunities for India from per cent of world output, and the corresponding data localisation in the realm of data centre figure for India was 8.5 per cent5. India’s overall infrastructure. Section 5 discusses the potential digitally dependent economy was estimated at challenges due to rapid advancements in around 22 per cent of GVA in 2019 (Gajbhiye digitalisation. Section 6 provides concluding et al., 2022).6 India’s performance on various remarks.

indicators of the digital economy compares well

2. India’s Journey Towards Open Economy against many of its peer EMEs (Chart IV.1).

Digitalisation IV.7 Within a digital economy, cross-border IV.6 The digital economy encompasses all digital trade constitutes a key component. While activities that use digitised data and can be traditional trade statistics make a distinction measured as the contribution of economic between cross-border trade in goods and transactions, that involve both digital products services and further classify services based on and digital industries, to output (IMF, 2018b; the four modes of supply7, digital trade entails ADB, 2021). Digital products are goods and new dimensions. The growth of cross-border services that primarily generate, process, and/ e-commerce has helped in identifying the or store digitised data, while digital industries are ordering and delivery process (both of which 4 These 10 digitally disrupted sectors include: land transport services and transport services via pipelines; accommodation services; food and beverage serving services; publishing services; motion picture, video and television programme production services; sound recording and music publishing services; financial and insurance services; advertising and market research services; travel agency, tour operator and other reservation services; education services; and gambling and betting services.

5 Estimate for the global digital economy is from ADB (2021) and for the Indian digital economy is from Gajbhiye et al., (2022).

6 Gajbhiye et al., (2022) follow the Asian Development Bank (ADB) approach that uses national Input-Output Tables (IOTs) to measure the size of the digital economy.

7 The General Agreement on Trade in Services (GATS) distinguishes between four modes of supplying services: cross-border trade, consumption abroad, commercial presence and presence of natural persons.

115REPORT ON CURRENCY AND FINANCE Chart IV.1: Cross-Country Indicators on Digital Infrastructure and Value Added in ICT Digital Infrastructure - 2022

Note: Per cent share of time connected in Chart (a) indicates availability expressed as the share of time users spend connected to 5G. *: Data pertain to 2023.

Source: World Bank (2024a) and Statista (2023). can be digital), and has also brought attention analysis using world digital trade estimates to the different (institutional) nature of partners following González et al. (2023), and fixed involved in international trade. The literature Chart IV.2: Conceptual Framework for Digital Trade identifies three key dimensions of digital trade [Chart IV.2] – the nature of the transaction (‘how’), the product (‘what’) and the partners involved (‘who’) – and suggests a close relationship between digitalisation, internet connectivity and international trade (Choi, 2010; Lin, 2015;

González and Sorescu, 2021; Herman and Oliver, 2023).

IV.8 Digitalisation matters for trade, and more so for services trade, because the trade in modern services may not be conditional upon the geographical proximity between

Note: DIP stands for digital intermediation platform.

Source: Reproduced from OECD (2023a). trading partners. Bivariate Granger causality 116OPEN ECONOMY DIGITALISATION:

CHALLENGES AND OPPORTUNITIES Table IV.1: Granger Causality Test Results between Digitalisation and Cross- Border Digital Trade in Services 1 2 A. Bivariate Granger Causality Test Fixed broadband usage does not Granger-cause global digital trade F-Statistic: 2.95 Probability-value: 0.09 Global digital trade does not Granger-cause fixed broadband usage F-Statistic: 0.24 Probability-value: 0.79 B. Panel Granger Causality Test Internet usage does not Granger-cause digitally delivered services exports HPJ Wald test: 47.82 Probability-value: 0.00 Internet usage does not Granger-cause digitally delivered services imports HPJ Wald test: 773.82 Probability-value: 0.00

Note: Juodis et al. (2021) Panel Granger non-causality test was used for the cross-country panel dataset.

Source: WTO, OECD Tiva Database, World Bank and RBI staff estimates. broadband usage per 100 people during 2001 Goods and Services in the Digital Age to 2020 suggests unidirectional causality from IV.9 Digital trade in goods refers to digitally digitalisation to global digital trade. These results ordered goods comprising international are corroborated by Granger causality tests on e-commerce transactions (Chart IV.3). Digital a panel dataset for 58 economies (both AEs trade in services constitutes digitally ordered and EMDEs) and a sample period from 2015 to and/or delivered services (IMF, OECD, UN and 2021 which indicate unidirectional causality from WTO, 2023). Globally, the share of digital exports digitalisation (proxied by share of internet users in total world exports has risen from around 22 in the population) to trade in digitally delivered per cent to around 29 per cent during 1995 to services (Table IV.1). 2020 (Chart IV.4a).

Chart IV.3: Open Economy Digitalisation – A Schematic Presentation

Source: RBI staff illustration.

117REPORT ON CURRENCY AND FINANCE (Chart IV.4b). Digitally delivered services have Chart IV.4: Cross-Border Digital and Non-Digital Trade:

India vis-à-vis World recorded a significant surge globally and India has outperformed global trends (Chart IV.4c).

IV.11 India is a net importer of ICT products (Charts IV.5a and IV.5b). ICT products, the backbone of the global digital economy, are primarily intended to fulfil or enable the function of information processing and communication by electronic means, including transmission and display (OECD, 2008). In line with the needs of its growing digital economy, India’s share in global ICT goods imports has increased from 0.3 per cent in 2000 to 1.8 per cent in 2022 (Chart IV.5c). India is set to become a major adopter of the frontier technologies on ICT, which would in turn further increase the demand for ICT goods (Chart IV.5d). On the export side, communication equipment dominates exports of ICT products.

The ongoing efforts to onshore their production through the production linked incentive (PLI) scheme are helping India’s exports of these products and as a result, the trade deficit in electronics may moderate going forward.

IV.12 Across major services exporting economies, digitally deliverable services dominate exports, gaining in share especially after the pandemic (Charts IV.6a and IV.6b).

With an average annual growth rate of 8.2 per cent between 2005 and 2023, global exports

Source: WTO and RBI staff estimates. of digitally delivered services have outpaced other services and goods (WTO, 2024). Growth IV.10 Goods account for over three quarters of has accelerated in recent years (10.9 per cent global trade, and the limited evidence available annually between 2020 and 2023), due to the on digitally ordered goods suggests that around pandemic-induced surge in remote work. AEs two-third of e-commerce sales relate to goods.

have generally dominated the exports of digitally For India, the share of digital trade in total trade delivered services, and only around 21 per cent is estimated to have risen from around 20 per of digitally delivered services exports in 2023 cent in 1995 to around 29 per cent in 2020 originated from EMDEs.

118OPEN ECONOMY DIGITALISATION:

CHALLENGES AND OPPORTUNITIES Chart IV.5: India’s Trade in ICT Goods

Note: ICT goods as defined in the OECD Guide on Measuring the Information Society 2011. The Frontier Technologies Readiness Index includes technological capacities related to physical investment, human capital and technological effort, and covers national capacities to use, adopt and adapt these technologies.

Source: UNCTAD and RBI staff estimates.

IV.13 India’s services exports in US dollar (7.7 per cent CAGR). As a result, the share terms recorded a compound annual growth of India’s digitally delivered services exports rate (CAGR) of 10.3 per cent over the recent in world digitally delivered services exports two decades (between 2005 and 2023), doubled from 3.0 per cent in 2005 to 6.0 per cent significantly higher than India’s merchandise in 2023. In the case of imports, the shares have export growth (7.9 per cent) as well as world risen from 1.9 per cent in 2005 to 3.1 per cent in services export growth (5.9 per cent). Over the 2023.

same period, India’s digitally delivered services IV.14 India’s digitally delivered services trade exports grew by more than 8 times (from US$ (exports plus imports) comprised 10.5 per cent 31 billion to US$ 257 billion), whereas digitally of India’s nominal GDP in 2023, up from 6.0 delivered services imports rose by more than per cent in 2005. Whereas, the share of India’s 6 times (from US$ 18 billion to US$ 111 billion) digitally delivered services exports in India’s [Charts IV.6c and IV.6d]. During this period, the GDP went up from 3.8 per cent in 2005 to 7.4 per expansion in India’s digitally delivered services cent in 2023. India’s services exports exhibited exports (CAGR of 11.9 per cent) was well above resilience during the pandemic primarily on that in world digitally delivered services exports account of a larger share of telecommunication, 119REPORT ON CURRENCY AND FINANCE Chart IV.6: Cross-Border Digital Trade in Services: India vis-à-vis World

Source: WTO and RBI staff estimates. Source: WTO and RBI staff estimates. computer and information services and business improve India’s participation in global value chains services in its export basket (Gajbhiye et al., (GVCs). Generative AI is projected to become

2024).

Chart IV.7: Decomposition of India's Digitally Delivered Services Trade Growth IV.15 India’s rise as a preferred destination for global capability centres (GCCs) has raised the trend growth of digitally delivered services trade (Chart IV.7). The number of GCCs housed in India has increased by around 60 per cent since 2015- 16 to reach more than 1580 in 2022-23, and the number is expected to reach 2400 by 2030 (EY,

2023). The wave of big data, artificial intelligence

(AI), machine learning (ML), internet of things

(IoT) and advancements in compatible hardware, generative AI and spatial computing has opened up new opportunities to expand India’s services

Source: WTO and RBI staff estimates. exports, especially in business services, and may 120 tnec reP stropxe secivres latot fo erahS )tnec reP( c. Composition of Digitally Delivered Services Exports: India d. Composition of Digitally Delivered

Services Imports: India noillib $SU noillib $SU a. Share of Digitally Deliverable Services in Total Services Exports 90 85.3 81.1 78 00 75.9 75.0 70.7 70.0 69.6 68.0 67.9 65.0 60 50 40 30 20 10 0

Source: UNCTAD. Source: UNCTAD. dnalerI gruobmexuL KU aidnI nedewS dnalniF SU napaJ dnalreztiwS adanaC 80 75 70 65 60 55 50 45 40 35 30 2022 2010 0102 1102 2102 3102 4102 5102 6102 7102 8102 9102 0202 1202 2202 World Asia India 260 240 220 200 180 160 140 120 100 80 60 40 20 0 5002 6002 7002 8002 9002 0102 1102 2102 3102 4102 5102 6102 7102 8102 9102 0202 1202 2202 3202 120 80 40 0 Telecommunications, Computer and Information Services Telecommunications, Computer and Information Services Personal, Cultural, and Recreational Services Personal, Cultural, and Recreational Services Charges for the Use of Intellectual Property n.i.e. Charges for the Use of Intellectual Property n.i.e.

Total Digitally Delivered Services Exports Total Digitally Delivered Services Exports Insurance and Pension Services Insurance and Pension Services Other Business Services Financial Services Other Business Services Financial Services 5002 7002 9002 1102 3102 5102 7102 9102 1202 3202OPEN ECONOMY DIGITALISATION:

CHALLENGES AND OPPORTUNITIES a US$ 1.3 trillion market by 2032 (Bloomberg, Table IV.2: Scenario Assumptions for India’s

2023). India is also experiencing the generative Digital Trade Estimates AI boom with currently around 100 start-ups (as 1 2 3 on July 2024) and a projected market size of US$ Baseline Higher Growth Variable Scenario Scenario 17 billion in 2030 (Inc42, 2024).

10.1 per cent Nominal GDP (realised during 13.6 per cent during IV.16 Cross-border e-commerce offers a more growth (in US$ 2001-19) during 2024-479 terms): India affordable point of entry compared to conventional 2024-47

6.6 per cent (realised 7.6 per cent (realised businesses, demands fewer personnel, and Digital trade to during 2011-19 for during 2015-23 for enables firms to directly connect with customers, GDP ratio: India digitally delivered digitally delivered services trade) services trade) thereby reducing reliance on intermediaries

5.2 per cent Nominal GDP to access global markets (Majumdar et al., growth (in US$ (realised during 8.1 per cent during 2001-19) during 2024-4710 terms): World

2020). Cross-border e-commerce transactions 2024-47 are mainly classified into four types depending Digital trade to 5.8 per cent (realised 6.0 per cent (realised

GDP ratio: World during 2011-19) during 2015-20) upon the sector involved – business-to-business

Source: RBI staff estimates.

(B2B), business-to-consumer (B2C), consumer- (Chart IV.8a). India’s share in world digital trade to-consumer (C2C) and government-to-business is projected to increase from 5.6 per cent in 2020

(G2B). The Indian e-commerce market is also to around 12 per cent by 2047 in the baseline gradually gaining ground. scenario and around 14 per cent in the higher IV.17 Following González et al. (2023) and growth scenario (Chart IV.8b).

assuming India’s annual nominal GDP growth during 2024-2047 is at the same pace as recorded IV.18 With the advent of digitalisation and during 2001-19 (10.1 per cent in US$ terms), technological advancements, India is witnessing India’s digital trade is projected to increase to growing servicification of its manufacturing around US$ 0.5 trillion in 2030, and US$ 2.4 exports. India’s domestic services value-added trillion in 2047 from around US$ 0.2 trillion in share in gross manufacturing exports rose to 2020 (Table IV.2)8. Scenario analysis suggests 17.7 per cent in 2020 from 13.4 per cent in 2011.11 that if the annual nominal GDP growth were to Moreover, India has a revealed comparative be 3.5 percentage points above its historical pace advantage (RCA) in modern services exports, (2001-19), India’s digital trade could go up to US$ particularly in computer services exports (Gajbhiye

0.7 trillion in 2030 and US$ 5.8 trillion in 2047 et al., 2024). Further, its RCA has improved in the 8 Based on the assumption of 10.1 per cent growth in India’s nominal GDP (in US$ terms) during 2001-2019; and the annual average share of India’s digitally delivered services trade in India’s GDP of 6.6 per cent – the value realised during 2011-2019, a period of significant advances in digitalisation in India.

9 Assuming real GDP growth to be 9.6 per cent (RBI, 2023a), and inflation to be around 4 per cent, as envisaged in the current target of India’s flexible inflation targeting monetary policy framework.

10 Assuming world real GDP growth to be 2.6 per cent (PWC, 2017), and inflation of around 5.5 per cent, which is the historical average from 1993-2023.

11 Trade in Value Added (TiVA) 2023 ed. Principal Indicators, OECD.Stat.

121REPORT ON CURRENCY AND FINANCE Chart IV.8: Digital Trade Estimates: India vis-à-vis World

Source: IMF, OECD TiVA, WTO and RBI staff estimates. case of business services exports. Digitalisation IV.19 Recent developments in AI and Large is expected to support the exports of Indian Language Models (LLMs) provide an additional services (Box IV.1). avenue to boost India’s digital trade. Due to rising Box IV.1 Do India’s Services Exports Defy the Gravity Model? The gravity model, the workhorse model for bilateral log exports α log distance log GDP i,j,t t ij i,t trade between economies, posits that countries trade in log GDP region dummy common legal origin ( j,t) = + ( j ) + ( ) + ij proportion to their economic size (measured as their share common language internet usage ... (1) ( ) + ij + j,t + in world GDP), and a set of trade costs, some of which where, i represent+s India, j represents the importer and t are bilateral, such as geographical proximity or distance represents year. In the case of services exports, alternate (Tinbergen, 1962; Gurevich, et al., 2018; Herman, 2023).

specifications using total services exports (Specification 2) While GDP size is expected to impact trade positively, and modern services exports (Specifications 312 and 413) bilateral distance between the economies dampens trade have been estimated, given India’s revealed comparative on account of an increase in trade costs. Given the growing advantage in the latter. Variables, other than distance, such importance of digitalisation in cross-border trade flows, as region dummy, common legal origin of the economies recent literature has used augmented gravity equations to and common language are also used as controls.14 The analyse the impact of digitalisation and internet connectivity regression results indicate that the gravity model holds on global trade (Herman and Oliver, 2023).

in the case of India’s merchandise exports and total Against this backdrop, the following gravity equation is services exports (Table 1), albeit with a lower coefficient estimated for India’s merchandise and services exports for in the latter. However, in the case of modern services the period 2015-2021 and a sample of 56 countries, which exports, the distance variable turns out to be statistically comprise around 90 per cent of India’s total trade.

(Contd...) 12 Services exports-Category 1 includes insurance and pension services, financial services, telecommunication, computer and information services and other business services.

13 Services exports-Category 2 includes telecommunication, computer and information services and other business services.

14 Standard gravity models include controls such as distance, contiguity/common region, common language and former colony/common legal origin.

122OPEN ECONOMY DIGITALISATION:

CHALLENGES AND OPPORTUNITIES Table 1: Gravity Model Results15 Specification Specification Specification Specification

(1) (2) (3) (4) Variables Merchandise Services Services Services Exports Exports-Total Exports -Category 1 Exports-Category 2 logdistance -1.01*** -0.98*** -0.58*** -0.63*** -0.18 -0.26 -0.16 -0.25 i,j (0.22) (0.22) (0.17) (0.17) (0.23) (0.25) (0.23) (0.25) ( ) logGDP 1.32*** 1.15*** 0.52* 0.78*** 0.33 1.00*** 0.37 1.04*** i,t (0.26) (0.20) (0.30) (0.16) (0.42) (0.21) (0.41) (0.22) ( ) logGDP 0.81*** 0.82*** 0.76*** 0.75*** 0.79*** 0.79*** 0.79*** 0.79*** j,t (0.22) (0.07) (0.07) (0.06) (0.08) (0.09) (0.08) (0.08) ( ) region dummy 0.22 0.25 -0.22 -0.27 -0.13 -0.31 -0.10 -0.27 j (0.29) (0.30) (0.34) (0.31) (0.42) (0.43) (0.42) (0.43) common legal origin 0.63** 0.67*** 0.46** 0.41** 0.59** 0.48* 0.59** 0.48* i,j (0.26) (0.24) (0.20) (0.20) (0.27) (0.29) (0.27) (0.29) common language 0.49** 0.43** 0.70*** 0.81*** 0.73*** 0.90*** 0.73*** 0.90*** i,j (0.21) (0.21) (0.22) (0.23) (0.27) (0.29) (0.28) (0.31) internet usage -0.01 - 0.01* - 0.02*** - 0.02*** - j,t (0.003) - (0.004) - (0.01) - (0.01) - broadband usage - -0.01 - 0.02** - 0.03*** - 0.03*** j,t - (0.01) - (0.01) - (0.01) - (0.01) constant -43.09*** -38.65*** -24.62*** -31.11*** -24.84** -42.51*** -25.89** -43.45*** (8.36) (6.78) (8.60) (4.88) (11.74) (7.05) (11.68) (7.20) Observations 392 392 385 385 392 392 392 392 F-Statistic 57.70*** 56.31 46.62*** 66.23*** 28.30*** 37.88*** 29.65*** 40.50*** R-squared 0.78 0.78 0.79 0.80 0.74 0.73 0.73 0.72

Note: Standard errors (clustered by distance) in parentheses; *** p<0.01, ** p<0.05, * p<0.1.

Source: RBI staff estimates. insignificant, suggesting that the cross-border trade in References modern services may not be impacted by transport costs. Gurevich, T., et al. (2018). The dynamic gravity dataset:

For total services exports by India, distance remains a key Technical documentation. Washington, DC: US factor as indicated by the statistically significant negative International Trade Commission. coefficient, as traditional services exports (such as travel Herman, P. (2023). Gravity Estimation: Best Practices and and transportation) depend upon the distance between the Useful Approaches. US International Trade Commission.

economies. The results also indicate the positive impact Herman, P. R., and Oliver, S. (2023). Trade, policy, and of digitalisation (proxied by percentage of internet usage economic development in the digital economy. Journal of in the economy and fixed broadband subscriptions per Development Economics, 164, 103135.

100 people in alternate specifications) in services exports, suggesting that digitalisation may help moderate the impact Tinbergen, J. (1962). Shaping the World Economy: of trade costs arising due to geographical distance. Suggestions for an International Economic Policy.

digitalisation, AI is expected to increase India’s the highest relative AI-skill penetration rate16, annual GVA growth rate by 1.3 percentage points and it has shown the largest increase in AI talent to 7.1 per cent in 2035 (Statista, 2023). India has between 2016 and 2023 (Maslej et al., 2024). This 15 Similar results are obtained under panel fixed effects with year dummies. Further, similar results were obtained when the sample period was restricted to pre-pandemic years, i.e., 2015-19.

16 A measure of the intensity with which LinkedIn members use AI skills in their jobs.

123REPORT ON CURRENCY AND FINANCE upskilled talent could help India’s software export flows. Remittances have become the premier markets leverage AI seamlessly and move them source of finance for low- and middle-income up the value chain. Additionally, India’s pool of countries (LMICs), even exceeding FDI flows by highly skilled workers is well-primed to take up jobs US$ 274 billion in 2023 (World Bank, 2024b). The as AI specialists in non-software domains, such size of international migrant stock, the driver of remittance flows, has nearly doubled from 153 as those requiring the building of domain-specific million in 1990 to 302.1 million in 2023. Globally, AI models for tailor-made use by organisations.

inward remittance flows have increased more Hence, there is potential to increase export value than seven-fold between 2000 and 2023 to US$ addition through AI across all product types. India 857 billion, with flows to LMICs amounting to US$ is in an advantageous position to develop LLMs 656 billion.

and their applications suited to the Eastern world, especially for culturally similar regions like South IV.21 Migrant stock from India comprised 1.3 per cent of its population in 2020. India is the highest and Southeast Asia.

remittance recipient country in the world, with its Digitalisation of Cross-Border Remittance Flows share increasing over time (Chart IV.9a). India’s IV.20 Digitalisation has the potential to improve inward remittance receipts stood at US$ 115 billion the landscape of the cross-border remittance in 2023, which is 13.5 per cent of the world total.

Chart IV.9: Remittances and Average Sending Cost

Note: Figure c pertains to the payment instrument used to fund the transaction – either cash or digital payment modes (bank account transfer or credit/debit cards).

Source: Remittance Prices Worldwide, World Bank and RBI staff estimates.

124OPEN ECONOMY DIGITALISATION:

CHALLENGES AND OPPORTUNITIES The cost of sending remittances has decreased Chart IV.11: Remittances to India over time, with digitalisation playing a key role (Charts IV.9b and IV.9c). The average cost of receiving remittances in the case of India stood at 5.01 per cent in Q1:2024 (marginally lower than 5.04 per cent in Q4:2023), but higher than the Sustainable Development Goal (SDG) of 3 per cent per US$ 200 remittance (Chart IV.9d).

IV.22 In India, the ratio of remittances to GDP has gradually increased from 2.8 per cent in 2000 to 3.2 per cent in 2023 and is now above that of gross FDI inflows to GDP ratio (1.9 per cent in 2023), providing strength to India's external sector. In 2021, more than half of India’s Source: RBI.

inward remittances were from the Gulf countries, while North America accounted for 22 per cent which along with continuing skill upgradation of share. Going forward, India is poised to be the the workforce would provide a sustained boost world’s leading supplier of labour as India’s to inward remittances. Based on the trends working age population is expected to rise till observed over the past decade, remittances to 2048, while it has started dwindling for major India are estimated to increase to around US$ AEs (Chart IV.10). Thus, the global demand 160 billion in 2029 from US$ 115 billion in 2023 for Indian migrant workers will remain high, (Chart IV.11).

Cost of Remittances to India: Potential for Chart IV.10: Population Projections: India vis-à-vis FinTech Disruption Ageing Economies IV.23 The global average cost of sending US$ 200 as remittance stood at 6.35 per cent in Q1:2024, marginally lower than 6.39 per cent in Q4:2023 (World Bank, 2024c). Nonetheless, it is more than double the SDG target. For India, in Q4:2023, the cost of remittance from Singapore, Malaysia, the UK, Kuwait, Italy and Bahrain was within the SDG target, while the cost from Thailand and South Africa was more than 10 per cent (Chart IV.9d). This may be due to the dominance

Note: Working age population includes those aged 15-64 years. Ageing economies include Australia, Austria, Belgium, Bulgaria, Canada, China, of banks in the latter set of countries, while the Czech Republic, Finland, France, Germany, Greece, Italy, Japan, Portugal, Russia, Singapore, South Korea, Spain, Sweden and the UK. Projections former countries have a competitive remittance based on the UN medium-fertility scenario.

Source: United Nations World Population Prospects, 2024. industry with banks facing competition from 125 noitalupop ega gnikrow ni egnahC )noilliM(REPORT ON CURRENCY AND FINANCE Chart IV.12: Banks, MTOs and RemTechs: Forex Margins and Costs

Note: 1. Figures pertain to receipt of remittances equivalent to US$ 200.

2. Average forex margin is the average of percentage difference between the foreign currency exchange rate applied to the transaction by the remittance service provider and the interbank exchange rate.

3. The RemTech group is a subset of the MTO group, and includes Azimo, InstaRem, Remitly, TransferGo, Wise, WorldRemit and Xoom (da Silva Filho, 2022).

Source: World Bank and RBI staff estimates. money transfer operators (MTOs) and FinTechs. IV.24 As the world progresses towards a more Additional factors that influence remittance interconnected and digitally driven era, the cost include the speed of money transfer, the creation of integrated cross-border payment payment instrument used for transfer (cash or frameworks and CBDCs would provide new bank account), and the access point/mode of avenues for FinTechs to provide cheaper transfer (bank branch, internet or agent). The solutions in cross-border payments (Box IV.2) digitalisation of cross-border remittance flows Role of Trade Policy in Cross-Border Digital would improve the speed and transparency Trade of transactions, while reducing liquidity costs IV.25 Cross-border digital trade policies play and fees. Since the banking channel requires a crucial role in harnessing new opportunities, involvement of several banks communicating building trust, and facilitating coordination through SWIFT messaging, transaction costs are on regulatory aspects like data security and higher in general, while settlements are slower cybersecurity. Provisions facilitating digital trade than through FinTechs (Church, 2023). Though can significantly increase trade, especially in banks, MTOs and RemTechs17 operate on nearly services (Herman and Oliver, 2023), and help the same foreign exchange margin, the average increase competitiveness. This is especially cost of receiving remittances (US$ 200) through true for LMICs, where an enabling regulatory RemTechs is significantly lower than that of the environment can help reduce costs of digitally banks (Chart IV.12). Realising the potential of delivered services trade (IMF, OECD, UN, and FinTech, the Reserve Bank had selected cross- WTO, 2023; González et al., 2023). Digital trade border payments as the second cohort under its policy discussions are gaining prominence in Regulatory Sandbox initiative (RBI, 2022a). multilateral fora, bilateral trade agreements, 17 FinTechs specialising in transferring remittances.

126OPEN ECONOMY DIGITALISATION:

CHALLENGES AND OPPORTUNITIES Box IV.2 Cost of Remittances to India – The Case for Digital Disruption The cost of sending US$ 200 remittance declined globally Following Beck et al. (2022), the determinants of the cost from 9.2 per cent in 2012 to 6.3 per cent in 2023, with of remittances to India for a sample of 20 countries for the significant regional variations - the highest in Sub- period Q2:2016 to Q3:2023 are estimated using the World Saharan Africa (7.9 per cent) and the lowest in South Bank’s Remittance Prices Worldwide dataset - a quarterly Asia (5.8 per cent) [World Bank, 2023]. Lower transaction survey dataset providing the cost of remittances.18 costs boost remittances and enhance incomes/savings Interaction terms of access point (type of location where of the recipients. A one per cent decrease in the cost the remittance service is available – bank branch, internet of remitting US$ 200 leads to about a 1.6 per cent or money transfer agent) and payment instrument (used increase in remittances (Ahmad et al., 2021). If the cost by the sender to pay for the transaction – cash or bank of sending remittances could be reduced by 5 percentage account) were added to examine the role of digitalisation.

points relative to the value sent, remittance recipients in Pooled OLS19 estimates suggest that the cost of sending developing countries would receive over US$ 16 billion remittances through bank branches and agents is higher as more each year (World Bank, 2023). compared with accessing remittance services directly from Table 1: Remittance Costs - Marginal Effects from Pooled OLS20

Dependent Variable: Specification Specification Specification Cost of Sending US$ 200 (Per cent) (1) (2) (3) Access Point = Agent 4.822*** 4.623*** (0.379) (0.454) Access Point = Bank Branch 6.587*** 6.558*** (0.812) (0.805) Access Point = Internet 4.364*** 3.404*** (0.254) (0.635) Payment Instrument = Bank Account 5.447*** 5.015*** (0.228) (0.336) Payment Instrument = Cash 7.029*** 5.095*** (0.440) (0.588) Speed > 1 Hour (Slow) 5.471*** 6.404*** 5.517*** (0.090) (0.091) (0.0832) Speed <= 1 Hour (Fast) 5.347*** 5.827*** 5.312*** (0.222) (0.258) (0.213) Firm Type = Bank 6.030*** 9.232*** 6.629*** (0.318) (1.046) (0.685) Firm Type = MTO 4.680*** 4.765*** 4.670*** (0.276) (0.412) (0.271) Interaction Terms Access Point x Firm Type Yes No Yes Access Point x Speed Yes No Yes Payment Instrument x Firm Type No Yes Yes Payment Instrument x Speed No Yes Yes (Contd...) 18 Data are collected at the customer level for the major service providers in each corridor, including both the primary MTO and banks active in the market. The dataset includes the costs for two amounts – the equivalents of US$ 200 and US$ 500 in local currency. Since data may be collected for different individuals across periods, pooled OLS estimates are used with errors clustered by country.

19 The underlying estimation also controlled for other variables affecting cost of remittance such as income level of sending country, coverage of the respective MTO’s network in sending and receiving countries, and the forex margin charged.

20 Average adjusted predictions of remittance cost as estimated in the pooled OLS regression models, if all observations in the dataset were to assume the same value for variable of interest X as indicated, with the value for other predictors remaining the same.

127REPORT ON CURRENCY AND FINANCE

Dependent Variable: Specification Specification Specification Cost of Sending US$ 200 (Per cent) (1) (2) (3) Access Point x Payment Instrument No No Yes Observations 6,915 6,915 6,915 R-squared 0.590 0.575 0.591 Country FE Yes Yes Yes Year FE Yes Yes Yes Quarter FE Yes Yes Yes Year*Quarter FE Yes Yes Yes Standard Errors clustered by Country Country Country

Note: Standard errors (clustered by country) in parentheses; *** p<0.01, ** p<0.05, * p<0.1; MTO – Money Transfer Operator; Pooled OLS was used as different respondents are tracked over time.

Source: RBI staff estimates. the internet; a bank account as the payment instrument References costs less than remitting using cash; fast payments Ahmed, J., Mughal, M. and Martínez-Zarzoso, I (2021). were found to be cheaper, demonstrating the cost Sending Money Home: Transaction Cost and Remittances effectiveness of digital payments technology; and MTOs to Developing Countries. The World Economy. 44, 2433– provide a cost-effective alternative to banks in the 2459.

remittance business (Table 1). Deepening digitalisation Beck, T., Janfils, M. and Kpodar, K (2022). What Explains – for example, through global acceptability of the UPI Remittance Fees? Panel Evidence. IMF Working Paper and the development of CBDCs - can lower the cost of No. 2022/063.

remittances, enhance their volume and improve income/ World Bank (2023). Remittance Prices Worldwide savings of the recipients. Quarterly Issue 48, December. and regional trade agreements (RTAs), digital and designed to deepen mutual understanding economy agreements, and domestic regulations of the digital economy, while being responsive to (Chart IV.13a). According to the Trade the latest technological developments, business Agreement Provisions on Electronic-commerce models and regulatory challenges.

and Data (TAPED), among the operational trade IV.26 Many countries, including India, have agreements since 2000, 184 contained provisions passed data protection acts22 to deal with issues of on e-commerce/digital trade, while 102 contained privacy, national security, and intellectual property a chapter dedicated to e-commerce/digital trade.

Dedicated digital economy agreements (DEAs)21 rights (IPRs). India’s data protection regulations aim to align with global standards. Globally, there have gained prominence in recent times. While incorporating many of the issues discussed in has been intense intervention in issues pertaining trade agreements, DEAs also extend discussions to digitalisation, especially in data governance, to emerging areas such as cooperation on AI, content moderation, competition, consumer digital identity, data innovation, FinTech and protection and authorisation, registration, and digital payments. DEAs are dynamic in nature licensing (Chart IV.13b). Restrictive trade 21 Examples include Australia-Singapore Digital Economy Agreement (2020), the Digital Economy Partnership Agreement (DEPA) between Singapore, Chile and New Zealand, and the Digital Partnership Agreement between South Korea and Singapore (2023).

22 India passed Digital Personal Data Protection Act (DPDPA) in August, 2023.

128OPEN ECONOMY DIGITALISATION:

CHALLENGES AND OPPORTUNITIES Chart IV.13: Digital Trade Policies – Global Trends

Note: The agreements considered in the chart are currently in force. Source: Digital Policy Alert Activity Tracker by St. Gallen Endowment for

Source: Calculations reproduced as in González et. al. (2023) using digital Prosperity through Trade, 2023. provisions and digital trade chapters data from TAPED (November 2023 Update) and WTO RTA Database.

policies and restrictive domestic regulatory privacy, consumer protection and cybersecurity environment may distort global digital trade are key tasks for policymakers (IMF, OECD, UN, and risk fragmentation of global value chains and WTO, 2023; OECD, 2024b).

(GVCs): 0.1 percentage point rise in the OECD’s IV.27 India has seven trade agreements Digital Services Trade Restrictiveness Index with digital trade provisions and two trade

(DSTRI) can lead to a 15.4 per cent increase in international trade costs (González et al., agreements with dedicated chapters for

2023). Conducive trade policies and an enabling e-commerce/digital trade (Table IV.3). Harnessing domestic regulatory space that balance the technology for customs and trade facilitation benefits of digital trade with the risks to data and policies encouraging favourable customs Table IV.3a: India’s Trade Agreements with e-Commerce/Digital Trade Provisions S.No. Agreement Country/ Group Year in Force 1 2 3 4 1 Framework Agreement for Establishing Free Trade Area between Thailand and India Thailand 2004 2 Comprehensive Economic Cooperation Agreement between India and Singapore Singapore 2005 3 Framework Agreement on Comprehensive Economic Cooperation between India and the Association of Southeast Asian Nations ASEAN 2010 4 Comprehensive Economic Cooperation Agreement between India and Malaysia Malaysia 2011 5 Comprehensive Economic Cooperation and Partnership Agreement (CECPA) between Mauritius and India Mauritius 2021 6 Australia-India Economic Cooperation and Trade Agreement Australia 2022 7 Comprehensive Economic Partnership Agreement (CEPA) between India and UAE UAE 2022 Table IV.3b: India’s Trade Agreements with e-Commerce/Digital Trade Chapters 1 Comprehensive Economic Cooperation Agreement between India and Singapore Singapore 2005 2 Comprehensive Economic Partnership Agreement (CEPA) between India and UAE UAE 2022

Source: Taped Dataset and Taped Codebook (November 2023).

129REPORT ON CURRENCY AND FINANCE duties on electronic transmission; contracts laws to protect intellectual property and data using e-signatures, e-invoicing and paperless privacy regulations (Stephenson, 2020). They also transactions; consumer protection against data look for availability of e-payment services, policy breach and fraudulent transactions; and protection support for digital businesses and local digital of software source code may be advocated. skills along with international, domestic, and urban Building digital readiness for e-commerce is connectivity. Additionally, global investors seek an important issue under the discussions of the ease of receiving licenses for digital infrastructure, UNCTAD’s Intergovernmental Group of Experts availability of digitally skilled workforce, use of on e-commerce and the Digital Economy. Key international standards and regional coordination hindrances identified include addressing digital for infrastructure investment.

divides to mitigate the risk associated with limited Opportunities for Internationalisation of the Rupee access to financing, particularly for micro, small IV.30 The US dollar remains the dominant and medium enterprises (MSMEs).

currency for international payment transactions, Digitalisation and Capital Flows notwithstanding a fall in its share in total allocated IV.28 In the sphere of capital flows, digital reserves from around 71 per cent in 2000 to around foreign direct investment (FDI) is comparatively a 58 per cent in 2023 (Table IV.4). The US dollar newer area of discussion in the international fora. also remains the dominant invoicing currency, Although the definition of digital FDI has not yet with around 70 per cent share in cross-border been formalised globally, it may be defined as a trade invoicing in the Asia-Pacific region (Bertaut cross-border investment that is often asset-light et al., 2021). A currency may internationalise as a as the foreign enterprise does not need to invest reserve instrument by becoming a global store of in building production or delivery assets in the value, or as a medium of exchange by being used host economy (Chaisse, 2023). The digital FDI for international payments (Gopinath and Stein, framework comprises three key pillars – new digital 2018). Technological innovations in payment activities, digital adoption of traditionally non- systems could promote use of other currencies, digital firms and digital infrastructure, and each of leading to more currency competition and the these pillars is associated with certain facilitating development of digital currency areas or regional elements (UNCTAD, 2017). By attracting digital reserve currencies (Brunnermeier, James, and FDI, economies are expected to boost their digital Landau, 2019; BIS, IMF, and World Bank 2021).

capabilities. However, digital FDI requires certain IV.31 Historically, the two roles - store of value pre-requisites from both supply and demand and medium of exchange - have progressively perspectives. While the supply-side elements converged. However, this may not hold in a involve policies and structural reforms enabling digitalised world. For a national currency to digital-friendly investment climate and ecosystem, become a reserve asset, full capital account on the demand side, domestic firms need to convertibility is a demanding prerequisite.

showcase their need, priorities, and opportunities However, to internationalise as a medium of involving digital investment. exchange, a currency may leverage cross-border IV.29 Global investors engaging in new digital trade using well-developed digital networks activities seek data security legislations, copyright to create a digital currency area. Advances in 130OPEN ECONOMY DIGITALISATION:

CHALLENGES AND OPPORTUNITIES Table IV.4: Global Finance – Key Indicators (Shares in Per cent/Index) Pound Japanese Chinese Indian Metrics Period US Dollar Euro Sterling Yen Yuan Rupee 1 2 3 4 5 6 7 8 Global Forex Reserves End-2023 58.4 19.9 4.9 5.7 2.3 _ Export Invoicing June 2021 54 30 4 4 4 _ Forex Transactions April 2022 88 31 13 17 7 2 Global GDP 2023 26.1 14.8 3.2 4.0 16.9 3.4 Global Trade 2022 11.2 16.0 3.5 3.2 11.0 2.7 Financial Markets Index 2021 0.900 0.715 0.854 0.856 0.635 0.582 Chinn-Ito Index 2021 2.299 2.275 2.299 2.299 -1.242 -1.242

Source: Currency Composition of Official Foreign Exchange Reserves, IMF, Boz et al., (2022), BIS (2022c), World Economic Outlook Database, April 2024 (based on GDP at current prices US$ billion), World Bank’s World Development Indicators, 2022 (based on current US$), European Commission, IMF’s Financial Development Index Database, Chinn and Ito (2006) and Atlantic Council Dollar Dominance Monitor.

payment technologies could reduce currency suggests that the INR is accepted in Bhutan, switching costs23, thus weakening existing network Nepal, Singapore, Malaysia, Indonesia, Hong effects and inertia (Kim et al., 2024). With the rise Kong, Sri Lanka, the UAE, Kuwait, Oman, Qatar, in global geopolitical tensions and geoeconomic and the UK, among others. The Nepal Rastra Bank, fragmentation, bilateral and regional economic Royal Monetary Authority of Bhutan and Bank cooperation agreements are gaining ground. Negara Malaysia hold Government of India (GoI) Nearly a decade ago, the IMF had noted that securities and Treasury Bills. Some sovereigns, the INR alongside the Brazilian real, the Chinese like Singapore, hold Indian equity and bond assets renminbi, the Russian ruble and the South African (including G-secs) through their sovereign wealth rand have gained significant regional importance funds. The Reserve Bank’s efforts in recent years and have also shown a marked increase in to develop India’s financial markets have fostered their usage in international transactions, thus, trust, stability, and innovation by making capital exhibiting their potential to internationalise, while raising more efficient, removing segmentation highlighting that full capital account convertibility between onshore and offshore markets, and may not be a necessary prerequisite for the same expanding the participation and product base (IMF, 2011; RBI, 2022b).

(Das, 2024). Banks are now allowed to access IV.32 Given the potential benefits of offshore INR markets for FX and interest rate internationalisation of INR in terms of lower derivatives with a view to improve the efficiency of transaction costs for cross-border trade and price discovery and provide greater opportunities investment operations and lower exchange rate to domestic participants. Market-makers have risk, various measures have been taken towards been permitted to deal in such products beyond this end over the years. Anecdotal evidence domestic market hours. Rupee derivatives settled 23 In Hayek’s view (Hayek, 1976), currencies would compete primarily as stores of value. Historically, however, this type of competition has been limited due to switching costs and network externalities. Currencies that act as a store of value may compete with one another, while others that act as a medium of exchange compete separately. When switching costs are low, there is no longer a strong incentive to use one currency for store of value, medium of exchange and unit of account simultaneously. Instead, users of the network can seamlessly switch among currencies and convert units when needed.

131REPORT ON CURRENCY AND FINANCE in foreign currency have also been permitted in cent of this demand and could be a starting point in GIFT City. Further, Indian government bonds exploring interoperability and expansion of digital have begun to be included, in a phased manner, public infrastructure towards bilateral/multilateral in the JPMorgan Global Bond Index for Emerging solutions for cross-border payments. Recently, Markets (GBIEM) starting June 28, 2024, and the Reserve Bank has joined Project Nexus, will be included in the Bloomberg Emerging a multilateral international initiative to connect Market (EM) Local Currency Government Index, the FPSs26 of four ASEAN countries (Malaysia, starting January 31, 2025. With this facilitative Philippines, Singapore, and Thailand) and India.

environment in place, there are multiple ways for These four countries account for more than two- internationalisation of the INR as a currency for thirds (US$ 110 billion) of India’s total flows with cross-border payments (Table IV.5).

ASEAN countries. Its extension to the complete IV.33 India’s merchandise and services trade, ASEAN bloc could add cross-border flows to the investment and remittance flows taken together tune of around US$ 45 billion annually. While generated demand for cross-border payments India has a merchandise trade deficit with these worth US$ 1.9 trillion in 2023-2424. Based on the nations, it is set off to a large extent by its services latest available bilateral data for 202125, the top exports, remittances from Indian migrant workers, ten partner countries account for more than 50 per and FDI inflows.

Table IV.5: Ways to Internationalise the INR S. No. Method Objective/Examples 1 2 3

1. Bilateral/Multilateral Trade/ To support liquidity arrangements in times of a financial crunch. Examples include the Asian Payments Arrangements Clearing Union (ACU)27, the SAARC Currency Swap Framework28, the UPI-PayNow linkage between India and Singapore and bilateral MoUs such as with the Central Bank of UAE.

2. Special Rupee Vostro Accounts Authorised Dealer (AD) banks are permitted to open SRVA to settle trade transactions in INR

(SRVAs) with any country. Rupee payments for imports can be credited to these accounts. Balance in the SRVA can be used for any permissible current and capital account transactions.

3. Local Currency Settlement (LCS) / To facilitate wider use of local currencies in current and capital account transactions to improve Bilateral Swap Arrangement (BSA) ease of doing business and reduce dependency on hard currencies. Examples include MoUs on LCS with the UAE and Indonesia and the India-Japan BSA.

Source: RBI (2022b).

24 While investment flows include both FDI and FPI, we consider only FDI in our analysis.

25 RBI staff estimates using data for calendar year 2021 (the latest available bilateral data) for merchandise trade (Ministry of Commerce and Industry, GoI), services trade (WTO-OECD Balanced Trade in Services Dataset), FDI flows (Department for Promotion of Industry and Internal Trade, GoI), and remittances (World Bank).

26 A special type of retail payment system in which the transmission of the payment message and the availability of the final funds to the payee occur in real time or near real time and on as near to a 24/7 basis as possible.

27 The ACU, started in 1974, is presently operating as a clearing and payment system among its members (Bangladesh, Bhutan, Iran, India, Maldives, Myanmar, Nepal, Pakistan and Sri Lanka) for the promotion of trade among the participating countries.

28 The SAARC Currency Swap Framework came into operation on November 15, 2012, to provide a backstop line of funding for short- term foreign exchange liquidity requirements or short-term balance of payments stress till longer-term arrangements are put in place.

Afghanistan, Bangladesh, Bhutan, India, Maldives, Nepal, Pakistan and Sri Lanka are part of the SAARC grouping. Under the Framework for 2024-27, a separate INR Swap Window has been introduced with various concessions for swap support in INR. The total corpus of the INR support is ₹250 billion. The RBI will continue to offer swap arrangement in US$ and Euro under a separate US Dollar/ Euro Swap Window with an overall corpus of US$ 2 billion. The Currency Swap Facility will be available to all SAARC member countries, subject to their signing the bilateral swap agreements.

132OPEN ECONOMY DIGITALISATION:

CHALLENGES AND OPPORTUNITIES IV.34 The Report of the RBI’s Inter- optimise costs and settlement time for bilateral Departmental Group on Internationalisation of trade transactions (RBI, 2024a). This model can INR (October, 2022) recommended facilitating be extended to other similar countries. The LCS Local Currency Settlement (LCS) framework and the BSA frameworks can act as a catalyst for bilateral transactions in local currencies and for the financial market deepening and stability operationalising bilateral swap arrangements in the region. Besides a reduction in transaction

(BSAs) with the counterpart countries in local costs, the internationalisation of the INR may also currencies. A LCS framework could be the most reduce India’s dependence on hard currencies for readily acceptable arrangement with economies cross-border payments.

with which payment flows (to and from) are nearly IV.36 As envisaged in the Reserve Bank’s balanced. Taking an illustrative threshold flow Payments Vision 2025, a mechanism for gap of US$ ±2 billion, seven large29 economies international INR settlement through Continuous fulfil this criterion. For these seven countries, Linked Settlement (CLS) would help increase the annual merchandise and services trade, global acceptance of the INR. The CLS is an remittances and investment flows were US$ 163.6 initiative by a consortium of the world’s largest billion in 2021 (around 11.5 per cent of India’s foreign exchange clearing banks to enable FX total such flows). In this regard, any deficit in settlement in Payment versus Payment (PvP) trade account can be offset by a surplus in capital mode to address Herstatt risk30. Currently, it account, remittances or services. Such patterns supports 18 of the most actively traded currencies of bilateral cross-border flows can incentivise globally. The CLS mechanism settles transactions nations to look towards mutual acceptance of worth more than US$ 6.5 trillion daily (CLS, 2024), each other’s currencies for settlement of cross- which is nearly 87 per cent of the global daily FX border transactions. Additionally, there are turnover (BIS, 2022c).

various large trading partners with whom trade is invoiced in USD and other foreign currencies. 3. Internationalisation of Digital Public The acceptance of INR could be increased in such Infrastructure cases by leveraging the onward trade relationship IV.37 The integration of DPI into economic of these partners with other countries, where the activities has profound implications for India’s INR enjoys acceptability.

open economy digitalisation. India’s G-20 IV.35 Recent initiatives to promote the use of presidency in 2023 placed DPI on the global the INR and the UAE dirham for cross-border map. The key pillars of India’s DPI, such as digital transactions and cooperation for interlinking identity, digital payments financial infrastructure, payment and messaging systems between India digital governance, and digital industries/ and the UAE will help reduce settlement risk, education, offer tremendous opportunities due foreign exchange risk, and dollar dependence to their flexible and modular approach, for which in their bilateral trade (RBI, 2023b). Similarly, various cross-border use cases have been the use of local currencies for cross-border identified (Table IV.6). Furthermore, India’s G-20 transactions between India and Indonesia would task force on DPI suggested the creation of Digital 29 Size of total annual flows greater than US$ 10 billion.

30 The settlement risk that one party will deliver foreign exchange but the counterparty financial institution will fail to complete its end of the contract.

133REPORT ON CURRENCY AND FINANCE Table IV.6: Major Leading Digital Public Infrastructure and Digital Public Goods in India S. Cross-Border Potential use cases for Name Description/useful for Launch Usage* No. Business Potential cross-border trade 1 2 3 4 5 6 7 Digital Identity A 12-digit unique identification 1.4 billion Aadhar Distribution of Government

1. Aadhaar 2009 G2C, B2C number numbers issued scheme through DBT

14.7 billion eKYC Electronic authentication using

2. eKYC 2013 completed as on G2C, B2C Digital onboarding Aadhaar March 31, 2023 18 empanelled eSign Legal enforcement of digital

3. eSign Legally valid electronic signature 2016 B2B, B2C, G2C service providers contract Digital Health Ayushman Enhancing health services 0.36 billion health

4. Bharat Digital 2020 B2C, G2C Digital health records -teleconsultation and e-pharmacy records linked Mission

2.2 billion Covid-19 Web portal for COVID-19 Verifiable health certifications,

5. CoWIN 2020 vaccinations G2C, B2C vaccination registration telemedicine facilitated Digital Payments/Financial Infrastructure

5.5 billion Facilitating online access Aadhaar Enabled Payment

6. AePS 2010 transactions in B2C, B2B, G2C to banks through digital System 2023-24 identification

1.4 billion Help reduce leakages from

7. APB Aadhaar Enabled Bank Accounts 2011 transactions in G2C, B2C welfare schemes using direct 2023-24 bank transfers Using RFID technology for toll 88.2 million tags Easily deployable across

8. FASTag 2014 B2C, G2C payments issued countries

131.2 billion UPI B2C, G2C, B2B,

9. UPI Instant real-time payment system 2016 transactions in Financial / banking penetration C2C 2023-24

1.4 billion

10. BBPS Integrated bill payment system 2016 transactions in B2C, G2C Recurring payment ecosystem 2023-24 Track and manage the tax 14 million active Offers leakage proof tax

11. GSTN 2017 G2B, G2C liabilities under the GST system. taxpayers compliance system Account Consent-based flow of digital 64 million cumulative

12. 2021 B2B, B2C Digital financial data aggregation Aggregator financial information across FIs successful consents Digital Governance Allows storage and access to 0.29 billion users as

13. DigiLocker 2015 G2C, B2C Facilitate paperless governance verified digital documents on July 10, 2024

2.0 billion citizens Digital Infrastructure for across 10 countries Good governance technology

14. DIGIT Core Governance, Impact and 2017 G2C benefitted as on July platform Transformation 10, 2024 Digital Industries/Education

27.3 million Allowing MSMEs to access MSME (Udyam) Enhance ease of doing business

15. Udyam government schemes and 2020 G2C Registrations as on and facilitate cross-border trade benefits.

July 10, 2024 Digital Infrastructure Enables collaborative learning 1.71 crore registered

16. for Knowledge and teaching and generates 2017 users on DIKSHA as G2C Resource and expertise sharing Sharing customisable content on July 15, 2024

(Diksha)

Note: eKYC: Electronic Know Your Customer, eSign: Electronic Signature, CoWIN: COVID-19 Vaccine Intelligence Network, AePS: Aadhaar enabled Payment System, APB: Aadhaar Payments Bridge, BBPS: Bharat Bill Payment System, GSTN: Good and Services Tax Network, DIGIT Core: Digital Infrastructure for Governance, Impact and Transformation Core. *: Data as on March 31, 2024, unless otherwise indicated.

Source: National Payments Corporation of India (NPCI), Sahamati, eGov and Government of India.

134OPEN ECONOMY DIGITALISATION:

CHALLENGES AND OPPORTUNITIES Public Goods (DPG) packages that will ensure government transfers contributed to 865 million availability of the assets such as software codes people worldwide opening their first financial and documentation among others required for the account to receive money from the government successful deployment of the DPI solution (GoI, (Demirgüç-Kunt et al., 2022). Countries that

2024). already had elements of DPI in place (such as Learnings from DPIs Worldwide digital databases or ID records and data-sharing IV.38 DPI provides tremendous opportunities platforms) could reach more than three times the to countries in fostering financial inclusion, beneficiaries during the pandemic than those empowering women, enhancing transparency, that had to collect latest information (World Bank, and increasing efficiency (Table IV.7). Digitalising 2022).

Table IV.7: Key Learnings from Cross-Country DPIs Sr. No. Country Benefit Key Learnings 1 2 3 4

1. Brazil Pix plus digital wallets with remote onboarding and pro-digital policies contributed  Fostering financial to 75 per cent of Auxilio Emergencial31 cash transfer beneficiaries using the funds inclusion digitally (Lara de Arruda et al., 2022)

2. Mozambique Beneficiaries spend less than 30 minutes waiting for mobile money payments versus  Reducing time lag more than one hour waiting for cash payments.  Enabling faster settlement

3. India (i) The use of digital payments has reduced delays in the payment of maternal  Cost Saving health conditional cash transfers by 43 per cent.  Time Saving

(ii) The onboarding cost of a typical firm is estimated to significantly reduce from  Reduces leakages around INR 1,500 to INR 10 (World Bank, 2018).  Increases transparency

(iii) The introduction of biometric-based digital payments in employment and pension schemes reduced leakages by 41 per cent (Muralidharan, et al., 2016).

(iv) NITI for States DPI platform is a live repository of 7,500 best practices, 5,000 policy documents, 900+ datasets, 1,400 data profiles, and 350 NITI publications.

The knowledge products on the platform span 10 sectors (PIB, 2024).

4. Niger Households where women received digital social assistance payments have shown  Women empowerment 16 per cent higher diet diversity than those who received benefits in cash (Aker et al., 2016).

5. Singapore eKYC, facilitated by the Singpass consented data-sharing service, has reduced the  Reducing time lag time to complete digital transactions by 80 per cent (OECD, 2022).  Enabling faster settlement

6. Estonia The government, citizens, and residents save a significant amount of working time  Time saving every year due to the X-Tee data-sharing platform (Vainsalu, 2017).

7. Zambia Choice-based payments in the educational sector allowed for greater competition  Foster competition among payment service providers and improved customer service.

8. Türkiye The Integrated Social Assistance Service Information System, which is linked to 28  Increasing efficiency public databases, reduced the number of documents needed for applicants of social assistance programmes from 17 to just 1 (World Bank, 2023).

Source: World Bank, OECD and various countries' government websites.

31 As per the World Bank, the Auxílio Emergencial, a social protection programme, reached up to 55.6 per cent of the population, considering both direct and indirect beneficiaries. The programme helped to improve the average income and reduce the prevalence of poverty and inequality as compared with the immediate pre-pandemic level.

135REPORT ON CURRENCY AND FINANCE Leveraging India’s DPI – New Areas for Cross- (AR)/virtual reality (VR) and AI-ML technologies, Border Trade which aim to make learning collaborative, engaging, and accessible to learners across the IV.39 By integrating emerging technologies like globe. Third, the recently launched open-source AI capabilities, India’s DPI can cater to significant e-commerce platform, “Open Network Digital global demand and propel a transformative Commerce (ONDC),” is poised to be a catalyst leap forward towards ‘Digital Public Intelligence’ for local commerce in India. The open source (INDIAai, 2023; WEF, 2023; GoI, 2024). First, ONDC encourages start-ups to innovate and build India’s digital public health infrastructure and specialised applications, enhancing accessibility user base can be leveraged for cross-border to reliable services (Deloitte, 2023). It can also telemedicine, remote patient monitoring, and facilitate seamless exports for Indian businesses medical diagnostic research. India’s CoWIN by connecting SMEs, logistics providers, and platform, which managed COVID-19 vaccination financial institutions across cross-border payment programme, shows its capability in building providers. The ONDC’s interoperable framework scalable digital public goods and can help other reduces complexities and costs associated with countries develop similar platforms for access international trade, encouraging more MSMEs to to healthcare services and data exchange.

engage in global commerce. Finally, the ONDC’s Furthermore, the evolution of the National Health transparent platform helps businesses adhere to Portal into a consolidated repository of health information signifies a significant leap towards a international trade regulations to access global unified and interconnected healthcare model. The markets.

infusion of modern technologies, including Natural IV.41 DPI can also be deployed for the Language Processing (NLP), sensors, genetic infrastructure sector under the National analysis, and AI, promises a patient-centric Infrastructure Pipeline, which has a total healthcare system. The convergence of IoT investment of more than ₹108 lakh crore.

devices and robotics is set to revolutionise DPI can leverage computerised land records healthcare delivery, moving beyond traditional and digitised maps created under the hospital settings to embrace home-based care.

Digital India Land Records Modernization India can also carve a niche in specialised Programme, electronic government clearances, digital solutions for the increasing population of developments in Geographic Information senior citizens worldwide. These include robots, System (GIS), drones and IoT to enable real customised hardware such as mobiles, tablets, time, detailed and accurate monitoring of wearables, and security devices, as well as infrastructure and industrial projects. This can digitally delivered services such as telemedicine, be a specialised DPI available to prospective counselling, and financial advice.

investors, governments and contractors to enable IV.40 Second, in the education sector, India’s DPI project selection, planning and implementation experience has the potential to accelerate the pace in a plug-and-play manner. Not only can this of equitable learning experiences across the globe. help attract foreign investment, but it can also This can be facilitated via digitally empowered be exported to other countries that face pressing classrooms, incorporating augmented reality infrastructure needs.

136OPEN ECONOMY DIGITALISATION:

CHALLENGES AND OPPORTUNITIES Strengthening India’s DPI: Cross-Border Fast transactions per day (SWIFT, 2022). Median Payments transaction processing time for SWIFT can vary from less than five minutes to more than two days IV.42 By leveraging new digital technology, depending on the corridor, while cross-border reducing the number of intermediaries, enhancing payments via the UPI-Pay Now interlinkage can openness and competition, FPSs have the potential to make cross-border payments cheaper be completed within a minute (Nilsson et al., 2022;

and faster, while increasing transparency. Cross- RBI, 2023c). Additionally, charges are not uniform border payments include commercial payments across SWIFT participant banks, which leads to executed by financial institutions on behalf of uncertainty for the customer. Hence, there is a their clients (B2B, B2C, C2B, and C2C flows) and case for interlinking of FPSs for cross-border treasury payments related to the settlement of payments to make them faster, cheaper, more inter-bank trades, securities, foreign exchange, transparent and inclusive, as envisaged under the money markets, among others. While banks G20 roadmap to enhance cross-border payments.

dominate the B2B and B2C cross-border payment IV.44 Payment system interoperability and segments, FinTechs have occupied the C2B and extension is one of the priority themes to help C2C segments. The market for cross-border achieve the G20 targets for cross-border payments payments has expanded in the recent years driven (FSB, 2022). With more than 70 FPSs operating by a rise in cross-border labour and capital flows globally (Chart IV.14), interlinking arrangements32 owing to the spread of global manufacturing supply chains and e-commerce, foreign investment flows Chart IV.14: Number of Countries with Real Time and cross-border asset management. The value Payments System (Cumulative) of cross-border payments is estimated to surpass US$ 250 trillion in 2027 (Bank of England, 2024).

The USD and the EUR are the two most widely used currencies for cross-border payments, with each having an approximate share of 40 per cent (Perez-Saiz et al., 2023).

IV.43 At present, correspondent banking based on SWIFT messaging is the dominant mechanism for cross-border payments. SWIFT also facilitates securities and FX settlement, KYC/AML compliance, trade finance, corporate treasury operations and business intelligence (SWIFT,

Source: ACI Worldwide (2024).

2024). It processes approximately 45 million 32 Interlinking arrangements for cross-border payments can be defined as a set of contractual agreements, technical links and standards, and operational components between payment systems of different jurisdictions, allowing their respective participating payment service providers (PSPs) to transact with one another as if they were in the same system (BIS, 2022b).

137REPORT ON CURRENCY AND FINANCE would constitute the first step towards faster and System (SFMS) of India with the messaging system cheaper cross-border payments. Growing use of in the UAE (RBI, 2023b). There are limits to the APIs33 and the adoption of the ISO 20022 financial scalability of the bilateral model since every FPS messaging standard34 have opened avenues may have different technical standards, business for payment system interlinking, which would processes, governance framework and regulatory involve benefits such as shortening of transaction requirements, thus, requiring complex technical chains, reduction of transaction and funding integration and multi-party legal negotiation (BIS,

2023). costs, increased payment speed, transparency in fees, and improved competition in the provision IV.46 At present, India is one of the major of foreign exchange and cross-border payment countries with a 24x7 RTGS system. According services. to Central Banking’s Payments Benchmarking 2022, only 12 per cent of the respondent central IV.45 The interlinking of payment arrangements banks operated their RTGS 16–24 hours a day, can be differentiated by the type of link (direct with a majority operating it for only 7-12 hours or intermediated) between participants and the per day. India’s RTGS runs on ISO 20022 currency arrangement (single/multi-currency standard and is ready to be streamlined with the and with/without currency conversion). There internationally accepted standard for cross-border

could be four key types of links: (i) single access fund transfers. Additionally, the natural working point model, (ii) bilateral link, (iii) hub and spoke hours of India’s financial sector lie comfortably model, and (iv) common platform model. The within the global settlement window. Several UPI-PayNow linkage is a pertinent example of the global outreach initiatives to expand the footprint bilateral model, which leverages open banking of the UPI are already underway through bilateral APIs to allow account holders of participating and multilateral linkages and collaborations with financial institutions in India and Singapore to relevant stakeholders. As per the Reserve Bank’s conduct cross-border remittance transactions with Payments Vision 2025, steps can be taken to the same ease as domestic transactions through migrate all the Reserve Bank-operated payment the individual FPSs (RBI, 2023c). In a bilateral link, messaging systems to ISO 20022 standard.

two FPSs are connected directly through nostro/ The feasibility of expanding RTGS to settle vostro accounts of linked systems. The Reserve transactions in major trade currencies such as Bank has also signed an MoU with the Central USD, EUR and GBP can be explored through Bank of UAE to link the UPI with the UAE’s FPS – bilateral or multilateral arrangements. These the Instant Payment Platform (IPP), the respective arrangements could provide real time proceeds in Card Switches (RuPay switch and UAESWITCH) foreign currencies to traders and help develop the and to explore the linking of payments messaging country as a major centre for international financial systems – the Structured Financial Messaging trades.

33 APIs enable a software application to request a specific piece of data from one or more other software applications, and for data transfer from the data providing application back to the requester, provided the original request was valid.

34 The ISO 20022 standard enables the consistency of data in payment messages, the ability to reuse components across messages and is more data-rich than its predecessors. It can facilitate automated payment processing with faster messaging and lower payment failure rates.

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CHALLENGES AND OPPORTUNITIES IV.47 The system of liquidity bridges for seamless fiberised, while 6G technology will require 100 per transfer of funds can also be explored. In a bilateral cent fiberisation (KPMG, 2023).

liquidity bridge, collateral – usually in the form of Strengthening Sea Cable Network cash – is held by payment system participants IV.50 For a sustainable growth of India’s DPI, at a specific central bank (the facilitating bank), reliable high-speed connectivity between strategic denominated in the currency issued by it. The locations would be paramount. Globally, US$ facilitating bank notifies the receipt of the collateral which enables the provision of intraday liquidity 418 billion needs to be mobilised to connect by another central bank (the lending bank) in its unconnected households (Amaglobeli et al., native currency to the participants or their affiliated 2023). The expected rise in internet penetration entities (e.g., branches or subsidiaries) within (46 per cent in 2021), adoption of AI, 5G, IoT and the jurisdiction of the lending bank (BIS, 2022a). an ever-increasing reliance of the Indian economy The benefits of maintaining liquidity bridges on DPIs require expansion in the number and include efficient management of global liquidity quality of internet connections. Around 99 per cent requirements, lower foreign exchange risk and of all international data is transferred through a credit risks for payment system providers (PSPs), labyrinth of OFC stretching across ocean floors. As and a credit line in times of financial stress. of June 2024, there were approximately 600 such active and planned cables, spanning nearly 1.4 IV.48 For the extension of its payments technology million kilometres. Traditionally, undersea cables associated DPI into the global arena, India can were owned by telecom carriers who would form provide technical assistance to standardise a consortium of all parties interested in using the processes and protocols across countries to make cable. Lately, content providers such as Google, them compatible with the UPI. Given that the Meta, Microsoft, and Amazon have been major UPI offers features like plug-and-play innovation investors, accounting for almost a fifth of the US$ through APIs, CBDC interoperability (with the 12 billion in planned investments in new systems e-₹), offline capability, ability to link credit cards over the next four years (The Economist, 2023).

and collect requests, it is also a highly attractive Centrally located countries in the global OFC candidate for countries exploring the market for network enjoy faster and cheaper connections to a readymade FPS to adopt in their jurisdictions (Watson, 2024). the internet. In view of the economic importance of internet services, and to counter the dominance Improving India’s DPIs: Challenges and Building of BigTech and a handful of countries over Resilience the global data pipeline, India could benefit by IV.49 Despite being one of the leading expanding its OFC connections to the world with producers of optical fibre cable (OFC) in the targeted policies to crowd in such expenditure by world, the fiberisation in India’s broadband lines telecommunications firms at a large scale.

remains low. There is a significant share of digital Strengthening Satellite Network subscriber line (DSL) and other non-fibre lines in India’s broadband lines, which may hinder internet IV.51 An alternative satellite internet backbone speed and 5G adoption (TechHerald, 2021). Only for the nation can diversify risk as well as around 38 per cent of India’s mobile towers are connect remote geographies. In recent years, 139REPORT ON CURRENCY AND FINANCE especially during times of geopolitical tensions involvement of both the public and private sectors and fragmentation, satellite internet has emerged may be needed to create and promote cyber as a critical supplement to OFC. Moreover, norms to balance innovation and systematic cyber satellite internet is crucial for disaster recovery risk within cross-border financial systems (Huang and development of next-generation services like and Madnick, 2020).

telemedicine, remote education, and for the IoT.

Role of CBDCs in Cross-Border Payments Utilising constellations of small, mass-produced IV.53 Policy discussions on CBDC have satellites, some companies have promised cheap, graduated from the preliminary concerns around high-speed internet access throughout the world technology and its impact on cash, bank deposits (Graydon and Parks, 2020). Indian telecom giants and monetary policy to more granular, practical, have also started exploring satellite internet and operational areas such as legal implications, solutions, and these efforts would get a boost from operability across jurisdictions, cross-border the recent policy framework to attract FDI in the payments, and privacy concerns. Pilot projects space sector.

have been introduced to explore cross-border Cybersecurity use cases. Multiple benefits such as financial IV.52 Although digital trade increases inclusion, reduction in the cost of printing currency cybersecurity risks, trade policy can also strengthen notes, environmental benefits, and creating a more cybersecurity (Meltzer and Kerry, 2019). Trade secured and cost-effective settlement mechanism agreements can include commitments to building are some of the driving factors prompting central public and private sector real-time information banks to consider the launch of CBDCs and explore its functionality for cross-border transactions.

sharing mechanisms to promote awareness, Currently, in more than 90 countries, CBDCs are plan responses, and help targets adapt and in various stages of exploration/implementation. respond. They can also help popularise the use of international cybersecurity standards where IV.54 In October 2020, the G20 endorsed a they exist as a basis for domestic regulation, and roadmap to enhance international cross-border help achieve greater uniformity and coordination. payments and the targets stipulated therein are to Cybersecurity compliance certification schemes be achieved by 2027 (Table IV.8). The identified may also be used to establish export conformity frictions such as fragmented and truncated data across jurisdictions in international trade. Under formats, intricate compliance checks, restricted the G20 New Delhi Leaders’ Declaration, India has operating hours, outdated technology platforms, welcomed the Financial Stability Board’s (FSB’s) lengthy transaction chains, funding costs, and recommendations to achieve greater convergence limited competition were associated with higher in cyber incident reporting and the updates to the cost, lesser speed, and lower accessibility in cross- Cyber Lexicon. It has also expressed interest in the border payment infrastructure. The roadmap aims initiative to develop a common format for incident to enhance the existing payment infrastructure, reporting exchange (FIRE). Additionally, on the while outlining an international dimension into the lines of the Financial Action Task Force (FATF), design of CBDCs as part of the forward-looking a Financial Cybersecurity Action Task Force with initiatives (FSB, 2023).

140OPEN ECONOMY DIGITALISATION:

CHALLENGES AND OPPORTUNITIES Table IV.8: Roadmap to Enhance Cross-Border Payments: Global Targets to be Achieved by end-2027 1 2 3 4 Challenges Retail Payments (<US$ 1,00,000) Wholesale Payments (>US$ 1,00,000) Remittances Cost Global average cost not more than 1 Global average cost of remitting US$ per cent with no corridor costing more 200 not more than 3 per cent (by 2030) _ than 3 per cent. with no corridor costing more than 5 per cent.

Speed 75 per cent of payments to be credited 75 per cent of payments to be credited 75 per cent of payments to be credited within an hour from payment initiation, within an hour from payment initiation within an hour from payment initiation, the remainder within one business day. or pre-agreed settlement date and the remainder within one business day.

time (forward-dated transactions), the remainder within one business day.

Access All end-users to have access to at least All FIs to have access to at least one More than 90 per cent of individuals one infrastructure or provider. infrastructure or provider (multiple who wish to send/receive a remittance infrastructures/ providers wherever should be covered.

appropriate).

Transparency Transaction cost (including fees, charges by intermediaries, foreign exchange rate and currency conversion charges), Disclosures expected fund delivery timings, payment status tracking and terms/conditions of service.

Source: FSB (2021).

IV.55 Central banks consider CBDCs as an including mBridge, which connects China, opportunity to streamline and improve cross- Thailand, the UAE, Hong Kong and Saudi Arabia border transactions, providing 24/7 settlement and has more than 26 observing members (BIS, even outside closed-loop solutions or those 2024). Central banks are exploring both retail controlled end-to-end by money transfer and wholesale cross-border CBDC arrangements operators. CBDCs could offer inherent advantages (with focus towards the latter), and the ongoing in cross-border transactions by streamlining the projects endorse both bilateral transactions and multilateral arrangements. One approach cost of international remittances, minimising to developing cross-border CBDCs involves risks associated with multiple intermediaries, interlinking individual domestic CBDC systems, enhancing efficiency through faster settlement making them compatible through adherence to times, and providing greater transparency in common international and technical standards payment status (Auer et al., 2021). However, the as well as aligning them to legal, regulatory and cross-border use of CBDCs may expose EMDEs supervisory frameworks. Additional interlinkages to various macroeconomic and financial sector of CBDC systems can be achieved either through risks, including currency substitution, heightened a shared technical interface or a common clearing volatility in capital flows and exchange rates, and mechanism (for example, Project Jasper-Ubin exacerbation of issues like tax avoidance and and Project Jura), taking into account the member illicit activities (BIS, 2021; Chen et al., 2022, and central banks during the development stage itself Prasad, 2023).

to reduce reliance on coordinated policy moves in IV.56 Wholesale CBDC developments have later stages (BIS, 2021). A more nuanced approach doubled in the last two years due to geopolitical involves establishing a single multiple-CBDC environment (Atlantic Council, 2024). There are (mCBDC) system across jurisdictions, exemplified presently around 13 cross-border CBDC projects, by projects like Inthanon-LionRock, Aber, mCBDC 141REPORT ON CURRENCY AND FINANCE Bridge, and Dunbar. This concept revolves around emphasising its role in enhancing efficiency.

having a unified set of rules, a single technical He (2021) underscores the significant impact of system and a singular set of participants. While high cross-border remittance costs on both the this deeper integration and wider access offers financial system and the prevalence of unbanked potential operational functionality and settlement populations, particularly in less-developed efficiency, it poses policy challenges and raises regions. Countries also consider external sector governance and control concerns (BIS, 2021). implications while adopting cross-border CBDCs (Box IV.3).

IV.57 In India, apart from enhancing international transactions, cross-border CBDC has the potential 4. Data Embassies and India’s Potential to overcome challenges relating to turnaround IV.59 Data is the pulse of the digital economy.

times, high costs, transparency as well as legal The explosion in the data volume necessitates and regulatory requirements across jurisdictions, innovative approaches for data protection while reinforcing the role of central bank money as and resilience to secure digital information for an anchor for cross-border payments. Accordingly, uninterrupted functioning of the digital economy.

the Reserve Bank is examining bilateral and Data can be stored within the country in data multilateral collaborations. In this direction, the centres35 through legal provisions such as data Reserve Bank has also signed an agreement with localisation policies or housed outside the country Central Bank of United Arab Emirates (CBUAE) in “data embassies”36.

in the area of FinTech initiatives including cross- IV.60 In recent years, India’s focus has been on border CBDC payments. To learn about global developing both data centres and data embassies. initiatives and progress, the Reserve Bank has This move not only enhances cybersecurity joined the BIS Innovation Hub led multilateral but also ensures that a comprehensive range projects ‘Mandala’ and “mBridge” as an “Observer”.

of financial information is safeguarded in a Factors Influencing Cross-Border CBDCs systematic manner. This aligns with global IV.58 Several factors such as digitalisation efforts to strengthen data protection and privacy of commerce, the widespread use of private measures. Data embassies have become a viable digital currencies, and specific policy concerns option for storing and managing duplicate copies related to financial inclusion, informality, and data of vital state data outside the domestic territory privacy could influence the adoption of CBDCs that ensures data sovereignty, while imparting (Auer et al., 2023). However, the reasons behind security and resilience in the event of major cyber the issuance of CBDCs vary among countries. threats, natural disasters, and terrorist attacks.37 Duffie (2020) delves deeper into the importance India is looking to establish data embassies at the of interoperability in the context of CBDCs, GIFT IFSC for countries and businesses looking 35 A dedicated secure space within a building/centralised location where computing and networking equipment is concentrated for the purpose of collecting, storing, processing, distributing or allowing access to large amounts of data (Data Centre Policy – 2020, MeitY).

36 A data centre of a country housed within the borders of another country while remaining under the formal jurisdiction of the former country.

37 The origin of data embassies derives from a bilateral agreement in 2017 when Estonian government’s cloud backup was housed in a Luxembourg data facility. Similarly, in 2021, Monaco’s e-embassy was set up in Luxembourg, hosting a digital twin of the Monegasque sovereign cloud. Luxembourg appears to be an attractive destination for modern data centres because of its robust business continuity, resilient communication infrastructure, and comprehensive disaster recovery capabilities (Bharat, 2023).

142OPEN ECONOMY DIGITALISATION:

CHALLENGES AND OPPORTUNITIES Box IV.3 Factors Influencing the Adoption of CBDCs Taking cues from Auer et al. (2023), which finds high mobile potential economic/institutional factor x. α and β represent i phone usage and innovation capacity important for CBDC coefficients and ε denotes error term.

i adoption, the role of factors such as volatility in exchange Empirical analysis suggests that the level of economic rate, economic development and the share of inward development (measured by per capita GDP) and share in remittances in influencing cross-border CBDC adoption is the global inward remittances encourage CBDC adoption, examined. A sample of 97 countries, which have already while volatility of exchange rate discourages its adoption announced/implemented some version of CBDC has been (Table 1). Adverse spillovers from volatility in capital flows analysed using a cross-sectional Probit regression model: and exchange rate could accentuate in the presence of cross-border CBDC (Popescu, 2022). On the other hand, Prob CBDC_cross_border = ǀ x f α βx ε (1) i i i the countries with a higher share in the global inward where, the probability o0f ,1a ju=ris(dic+tion +i t)o announce/ remittances have an inherent advantage in adopting cross- implement a cross-border CBDC project (equals to 1) or border CBDC as a faster, more efficient, cost effective and not (equals to 0) has been represented as a function of a secure option for global payment systems.

Table 1: CBDC Adoption - Results of Cross-sectional Probit Regression

Dependent Binary Variable: Whether the country has announced/implemented Cross-Border CBDC project (1) or not (0) 1 2 3 4 Independent Variables Specification 1 Specification 2 Specification 3 Constant 0.24 -3.93*** -4.93*** (0.89) (-3.05) (-3.60) Exchange Rate Volatility@ -0.15*** -0.12** -0.12** (-2.89) (-2.31) (-2.18) Log (Per Capita GDP) 0.44*** 0.53*** (3.39) (3.85) Remittance Share$ 0.17** (2.27) Observations 93 92 92 McFadden R-squared 0.12 0.22 0.26 @: Standard deviation in the monthly real effective exchange rate over a period of 5 years till December 2023.

$: Share in global inward remittances.

Note: 1) *** p<0.01, ** p<0.05, * p<0.1.

2) Robust errors (Huber-White).

3) Figures in parentheses are z-statistics.

Source: RBI staff estimates.

References:

Auer, R., Cornelli, G., and Frost, J. (2023). Rise of the central bank digital currencies. International Journal of Central Banking, 19(4), 185-214.

Popescu, A. (2022). Cross-Border Central Bank Digital Currencies, Bank Runs and Capital Flows Volatility, IMF Working Paper No 2022/083. for digital continuity solutions (GoI, 2023). The to give a significant spurt to investment in India’s establishment of data embassies will primarily be data industry, especially from technology facilitated through bilateral agreements with the infrastructure providers and cloud storage interested countries. Multinational corporations companies. This would help India emerge as a could use these embassies to store the data of major and trusted player offering a full-fledged Indian users within the country. This is expected data storage ecosystem.

143REPORT ON CURRENCY AND FINANCE Encouraging Establishment of Data Centres in fast-paced rise and spread of digitalisation and India growing demand for advanced technologies such as 5G, AI, blockchain and cloud computing (CBRE, IV.61 The requirement for establishing data

2023). The main drivers creating a conducive centre infrastructure in India is reinforced by the environment for development of data centres in data localisation provision in the Digital Personal India include fiscal incentives, better technology Data Protection Act (DPDPA), 2023 for the infrastructure and regulatory push. The data centre protection of the digital sovereignty of the citizens market in India is, however, still at its nascent stage, in an increasingly connected world. India has relative to both AEs and peer EMEs (Charts IV.15 enablers in the form of a favourable geographical and IV.16). The Union Budget 2022-23 afforded location, established global connectivity through the status of ‘infrastructure’ to data centres, submarine cables, readily available skilled thereby placing them at par with sectors such as workforce, a large data consuming market and railways, roadways, and power. This has enabled huge potential for growth in digital infrastructure38.

access to long-term credit on improved terms for These can lay the foundation for a robust and the development of the sector. Most states in India secure digital ecosystem for fuelling economic have defined data centres as ‘essential service’ growth in India and making India a global data to ensure uninterrupted operations throughout the centre hub.

year. While most state incentives are in the form of IV.62 India’s data centre capacity is estimated stamp duty exemption, power subsidy and ease of to have more than doubled from 521 megawatt approval, some offer tax benefits and a select few

(MW) in 2020 to 1048 MW in 2023 in the light of offer capital subsidies.

Chart IV.15: Number of Data Centres - 2024 Chart IV.16: Data Centre Density - 2024

Note: Digital population is defined as the number of individuals using the internet.

Source: Statista. Source: Statista and Digital 2024: Local Country Headlines Report.

38 Table A.5 of World Bank (2024a) gives cross-country comparison of select indicators of digital infrastructure.

144 rebmuN 6000 5000 4000 3000 2000 1000 0

SU ynamreG KU anihC ecnarF aissuR napaJ ocixeM ylatI lizarB aidnI dnaloPOPEN ECONOMY DIGITALISATION:

CHALLENGES AND OPPORTUNITIES Chart IV.17: Data Centres - Investment and Key Drivers E: Estimate.

Note: Chart (b) presents the results of the Enterprise Edge Adoption Trends Survey, a global survey carried out by Datacentre Dynamics in 2023.

Source: NASSCOM, Amadeus Capital, Arizton and Statista.

IV.63 The annual investment in data centres in IV.64 In the aftermath of the pandemic, the India is expected to be US$ 5 billion by 2025, a proportion of enterprises with no plan for cloud CAGR of 6.6 per cent since 2019 (Chart IV.17a). adoption is close to zero, whereas the proportion of enterprises with hybrid cloud which combines This growth is attributed to India’s increasing both public and private clouds has increased internet usage and cloud computing demands further (Chart IV.18). Public cloud adoption is also with low latency (best speed and fastest response increasing. Cloud adoption is mainly guided by time) and high bandwidth, Government-led cost and performance.

digitalisation initiatives, and the localisation efforts of digital service providers (Chart IV.17b). The IV.65 With a view to enhancing the security, growing investment in data centres stokes demand integrity and privacy of financial sector data, the for related infrastructure, encompassing India’s IT, Chart IV.18: Global Enterprise Cloud Strategy electrical, mechanical, and general construction services. As data centres require round-the-clock and large amount of electricity, appropriate policies would be needed to meet the higher energy demand in a sustainable way along with increased role of technology in clean electricity generation.

Furthermore, the proper management of e-waste generated by data centres and establishment of green data centres may be encouraged (Raj,

2022). Some voluntary initiatives for greening

Note: 1. Public cloud is managed by service providers who rent out a part data centres include switching over to renewable of their distributed data centre infrastructure to customers.

2. Private cloud is dedicated cloud infrastructure of a single company, energy and implementing guidance provided by managed by the company itself or by a third-party service.

3. Multiple cloud means more than a single cloud. The most common type of multiple cloud is hybrid cloud – a combination of public established frameworks such as the Green Data and private clouds.

Source: Flexera Software.

Centre Rating Systems (RBI, 2022c).

145REPORT ON CURRENCY AND FINANCE Reserve Bank is in the process of establishing a Chart IV.19: Sectoral Mapping of Data Localisation Measures cloud facility for the financial sector in India. The proposed facility would also facilitate scalability and business continuity (Das, 2023). The cloud facility will be set up and initially operated by the Indian Financial Technology and Allied Services

(IFTAS), a wholly-owned subsidiary of the Reserve Bank (RBI, 2024b). Besides, the Reserve Bank is also developing a state-of-the-art greenfield data centre39 to address capacity expansion constraints in catering to the rapidly growing IT ecosystem’s requirements, while also offering a buffer to region- specific risks (Patra, 2024).

Data Localisation and Ring Fencing Source: Reproduced from OECD (2023b).

IV.66 The multi-fold increase in digital IV.67 Global revenues from data centres are transactions across the financial landscape has projected to grow to US$ 575 billion by 2028 necessitated regulatory measures for storage of from US$ 312 billion in 2022, a CAGR of 10.7 per critical data in the form of data localisation. Data cent, led by the US (Chart IV.20). The revenue localisation is broadly defined as the requirement growth presents opportunities for spending on of physical storage or processing of data within the territory of the country where it has been Chart IV.20: Revenue from Data Centres generated. Countries view the necessity of localisation measures in the light of growing digital interconnectedness amongst economies, that may have strategic or political implications (Bailey and Parsheera, 2018). As of early 2023, 96 data localisation measures across 40 countries were mandated, prescribing either storage or processing of data within the domestic territory (OECD, 2023b). More than two-third of these measures require domestic storage and prohibit data flow outside the country. Financial, banking and payments sectors have the maximum

Note: F: Forecast, the numbers on top of the bars indicate total revenue localisation measures, followed by public sector from all sources.

Source: Statista. and telecommunications (Chart IV.19).

39 The Reserve Bank currently has three data centres – two brownfield and one greenfield.

146OPEN ECONOMY DIGITALISATION:

CHALLENGES AND OPPORTUNITIES released the circular “Framework for Adoption Chart IV.21: Global Spending on Cloud and Data Centres of Cloud Services by SEBI Regulated Entities” in March 2023, which provides guidelines on data localisation while availing cloud services. It mandates that the storage and processing of data should be done within India’s domestic territory.

Furthermore, the regulated entity shall keep the original data/transaction/logs for investors incorporated outside India. Similarly, the Insurance Regulatory and Development Authority of India

(IRDAI) requires all insurance records to be stored in data centres located in India. Moreover, the DPDPA, 2023 provides overarching powers to agencies or regulators operating in various areas

Source: Statista. to frame their own rules on data storage and processing. cloud infrastructure services (Chart IV.21). The

5. Challenges to Open Economy Digitalisation spending on cloud infrastructure, which has IV.69 The challenges to digitalisation in an overtaken that on data centre hardware and open economy are multi-faceted, evolving, software, helps accelerate internet penetration, and far encompassing. These include aspects digital transformation initiatives and the rise of related to cybersecurity, data privacy, digital e-commerce, especially in developing economies.

rights and access to information, divergent IV.68 Recognising the primacy of data and its regulatory frameworks, data management and vitality, regulators of various financial domains data sovereignty, digital infrastructure gaps in India have framed data localisation rules. The and digital divide, skill gaps, job displacements, Reserve Bank in April 2018 issued the circular on resource constraints and resistance to adoption of “Storage of Payment System Data” which deals digital technologies, among others. Furthermore, with storage and processing of payments data, issues related to interoperability and adoption constituting end-to-end transaction details and standards, digital governance and accountability, information pertaining to payments. In view of ethical dilemmas and social implications of AI and the fast-paced growth in the payment ecosystem, automation, algorithmic bias and discrimination, these localisation measures were required to digital monopolies and market concentration, facilitate unrestricted access to all payment data digital trust and confidence, and digital for supervisory purpose. The payment data is to disinformation and misinformation also confront be stored in systems located in India with some policymakers. Intellectual property protection, exceptions. Even though payments data are digital environmental footprint, digital infrastructure allowed to be processed outside India, they have resilience, sustainability and preparedness from to be brought back to India after processing. The disruption risks, including possible adverse Securities and Exchange Board of India (SEBI) implications of digitalisation on geopolitical 147REPORT ON CURRENCY AND FINANCE tensions and trade barriers are amongst the other from an emerging market economy to an issues facing policy scrutiny. advanced economy. Digitalisation can provide a strong boost to India’s external trade in goods and IV.70 There is immense scope for India to services, given the country’s relative comparative contribute to an inclusive global economy through advantage in modern services exports, which are its digitalisation and digital trade. According to not conditional upon the geographical proximity the World Bank and the World Economic Forum, of the trading partners. Further, digitalisation in while online opportunities are accessible to at international payment systems has the potential to least 80 per cent of the population in developed reduce the cost of receiving remittances, thereby countries, only 35 per cent of the population leading to higher remittances and income/savings has access to such opportunities in developing for the recipients. Cross-border digital trade countries. Globally, 19 out of every 100 people policies would play a crucial role in harnessing had fixed broadband subscriptions in 2023, new opportunities, building trust, and facilitating while the figure for high-income countries was coordination on regulatory aspects like data security 39 per cent. In contrast, Asia-Pacific and Africa and cybersecurity. The internationalisation of the had 19 per cent and 1 per cent fixed broadband INR is progressing backed by a comprehensive subscription penetration, respectively (ITU, 2023).

and integrated policy approach.

Digital divide can exacerbate inequalities limiting opportunities for economic participation, social IV.73 Central bank policy initiatives such as inclusion and digital empowerment. Further, interlinkage of FPSs across economies, setting there are challenges pertaining to labour market up the system of liquidity bridges and CBDCs disruptions, generation of e-waste and carbon are expected to support seamless international footprint. Digitalisation could also lead to skill transactions, reduce foreign exchange risks mismatches and polarisation of employment and manage global liquidity in an effective opportunities between high-skilled, technology- manner. India has the potential to revolutionise intensive jobs and low-skilled, routine tasks the global landscape with its DPI. Given solid susceptible to automation.

foundational physical and digital infrastructure, IV.71 Addressing these challenges require the amount and strength of human capital, and comprehensive strategies and collaborative openness to innovation, India can emerge as a major manufacturing hub, leading exporter of efforts between governments, businesses, civil services, and provide higher relative returns on society organisations, and other stakeholders global capital. The robustness of India’s DPI, to build trust, promote responsible use of recognised by international bodies like the IMF technology, and harness the benefits of and the G20 (WEF, 2023), provides a scalable digitalisation for sustainable development and model that can address pressing issues in EMDEs, shared prosperity in an open economy.

such as financial inclusion, leakages in welfare

6. Concluding Observations payments, education, and ease of doing business.

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153DIGITALISATION - TACKLING EMERGING V RISKS AND CHALLENGES* India’s financial sector is experiencing a significant transformation driven by digitalisation. Providing enhanced customer experience, ensuring competitiveness, improving operational efficiency and risk management are key factors influencing digital adoption. Banks and NBFCs view FinTechs as both complementary and competitive to their businesses and they favour regulation of FinTechs. Cybersecurity, data privacy, and vendor and third-party risks are key challenges. While digitalisation improves accessibility and convenience of financial services, it can expose consumers to impulsive spending, herd behaviour and data security concerns. Digitalisation can also create a more complex and interconnected financial system with implications for financial stability.

The Reserve Bank has been undertaking proactive policy measures to harness the benefits of digitalisation while mitigating emerging risks to enhance customer protection and ensure financial stability. Digitalisation-induced changes in the behaviour of consumers and financial intermediaries can have implications for monetary policy.

1. Introduction these could impinge upon macroeconomic and financial stability.

V.1 Digitalisation in the financial sector provides enormous benefits in terms of fostering V.2 India’s financial sector is undergoing a innovations, expanding access to financial significant transformation driven by the relentless products and services, reducing financial pace of digitalisation, which is reshaping how intermediation costs, improving customer financial institutions operate and interact with experiences and enhancing competition among their customers. New technologies, such as the service providers, thereby boosting efficiency artificial intelligence (AI), big data and blockchain, and inclusivity of the financial sector. These are fostering innovations that can enhance the benefits flow from collaborations between efficiency and accessibility of financial services.

Yet, the journey towards digitalisation is not traditional players like banks/NBFCs and FinTech without its challenges. As India continues to firms, enabling both the parties to leverage their leverage technology to drive inclusive growth and strengths and drive innovation in the financial sustainable development, it becomes imperative sector. At the same time, digitalisation can bring to critically examine the opportunities and new risks and challenges through complicated challenges that accompany this transformative financial products and business models, complex journey.

linkages between financial intermediaries and third-party technology/service providers, market V.3 Against this backdrop, this chapter explores concentration, impulsive spending by consumers, the multifaceted landscape of digitalisation within cybersecurity risks and financial frauds; all of the financial sector. Section 2 discusses the * This chapter has been prepared by a team comprising Harendra Behera, Binod B. Bhoi, Somnath Sharma, Himani Shekhar, Sambhavi Dhingra, Satyam Kumar, Ashish Khobragade, Nishant Singh, Ranajoy Guha Neogi and Shahbaaz Khan from Department of Economic and Policy Research; Rakesh Kumar from Financial Stability Department; Shesadri Banerjee from Monetary Policy Department; Renu Ajwani from Department of Supervision; and Vinodh Rajkumar from FinTech Department. Valuable insights provided by Shri Suvendu Pati are gratefully acknowledged.

154DIGITALISATION - TACKLING EMERGING RISKS AND CHALLENGES emerging risks and challenges emanating from Chart V.1: Reasons behind Adoption of Digital Technologies digitalisation based on a survey of Indian banks and NBFCs. Section 3 dwells on the effects of digitalisation on customer behaviour. Section 4 discusses the implications of digitalisation for financial stability and monetary policy. Section 5 provides concluding observations.

2. Opportunities and Risks of Digitalisation:

Insights from a Survey of Banks and NBFCs V.4 Given the immense benefits and opportunities provided by the digitalisation of finance on the one hand and the evolving risks associated with this process on the other,

Source: RBI staff estimates based on survey responses from 25 banks and 57 NBFCs. this section focuses on understanding the perspectives of banks and NBFCs - the key stakeholders – on these critical issues, drawing customers and increasing operational efficiency upon a focused survey conducted in March amidst revenue growth, profitability, and business 2024 covering 25 scheduled commercial banks expansion were seen as other important factors.

(SCBs) and 68 NBFCs1. The survey aimed at For NBFCs, increasing operational efficiency, and understanding the factors driving the adoption of improving risk management and compliance were digitalisation in banks and NBFCs, the extent of the major driving factors behind digitalisation, digital adoption in their business operations, the along with motives like improving customer reach impact of digitalisation on customer acquisition and gaining competitiveness. These motivating and retention, risk perceptions related to data factors for the Indian banks and NBFCs align privacy, cybersecurity, third-party and contagion with the findings in the literature (Liu, 2021; PwC, risks, their preparedness to deal with such risks,

2023). and their views on the regulatory approach to V.6 The adoption of digital technologies and FinTech. automation has helped banks and NBFCs bring Factors Driving Digital Adoption by Regulated down their costs related to customer acquisition, Entities (REs) transactions and employees, according to the V.5 Digitalisation, according to the surveyed survey (Chart V.2). A higher proportion of the banks, is driven by the need to provide respondent banks compared to NBFCs noted enhanced customer banking experience and cost reductions across all the parameters.

remain competitive (Chart V.1). Reaching more Large banks may derive greater benefits from 1 The number of respondent banks and NBFCs differs for different survey questions, and the results presented in this chapter are based on actual responses.

155REPORT ON CURRENCY AND FINANCE Chart V.2: Types of Costs Reduced Following the Adoption Chart V.3: Impact of Digital Technologies on Customer of Digital Technologies and Automation Acquisition and Retention

Source: RBI staff estimates based on survey responses from 25 banks and Source: RBI staff estimates based on survey responses from 25 banks and 51 NBFCs. 49 NBFCs. digitalisation due to substantial initial investment banks expect to collect more than 50 per cent of requirements and increasing returns to scale in deposits through online modes (Chart V.4a).

the banking industry (Liu, 2021).

V.9 On the credit side, about three-fourth of V.7 Technological innovations can improve the surveyed banks are extending up to 10 per customer experience, lower costs, increase cent of their total lending through digital modes.

product diversity, and enhance access to financial Over the next 5 years, 33 per cent of the surveyed services (Elekdag et al., 2024). Most of the banks indicated that they would lend more than 50 surveyed REs indicated improvement in customer per cent digitally (Chart V.4b). These trends can acquisition and retention due to the adoption of be expected to improve credit deepening in the digital technologies (Chart V.3). country going forward.

V.8 Banks, NBFCs and FinTechs employ V.10 Digital lending by both banks and NBFCs technology to provide new products and business is primarily in the form of unsecured consumer models that expand credit access to sectors loans; other major lending categories are secured like households and micro, small and medium consumer loans for banks and high value loans enterprises (MSMEs) [Ernst & Young, 2023]. Many for NBFCs (Chart V.5). According to Ernst & banks have also introduced digital platforms in the Young (2023), the share of NBFCs in total loans primary intermediation services like bank deposit disbursed through digital channels by banks and mobilisation and lending activity. While banks are, NBFCs has increased from six per cent in 2016- at present, mobilising only a small portion of their 17 to 32 per cent in 2021-22. This is driven by deposits through digital mode, the importance of both supply and demand side factors, including this channel is perceived to be increasing rapidly. efforts to promote financial inclusion, smartphone In the coming five years, 44 per cent of surveyed and internet penetration, improving socio- 156DIGITALISATION - TACKLING EMERGING RISKS AND CHALLENGES Chart V.4: Use of Digital Modes in Banks

Source: RBI staff estimates based on survey responses from 24 banks. economic conditions, and supportive regulatory and mergers in the domestic banking sector frameworks. (Chart V.6).

V.11 The evolution of digital banking based on V.12 Around a third of the respondent banks and mobile apps and online platforms helps banks to NBFCs expect a decrease in the role of physical rationalise their branch network to reap efficiency branches in the next 5 years, but most respondents gains (ILO, 2022). India has also witnessed see no change in the current importance of bank rationalisation in its bank branch network in recent branches (Chart V.7). A majority of banks and years, reflecting the impact of both digitalisation NBFCs see continued importance of the role of Chart V.5: Types of Loans Provided Digitally Chart V.6: Bank Branches in India (At end-March) ₹

Note: Data pertain to all scheduled commercial banks (SCBs) including

Source: RBI staff estimates based on survey responses from 25 banks and regional rural banks (RRBs).

30 NBFCs. Source: RBI.

157REPORT ON CURRENCY AND FINANCE Chart V.7: Expectations about the Role of Physical Chart V.8: Reasons for Continued Importance of Branches in the Next Five Years Physical Bank Branches

Source: RBI staff estimates based on survey responses from 25 banks and Source: RBI staff estimates based on survey responses from 16 banks and 50 NBFCs. 37 NBFCs. physical branches in reaching customers with no/ V.14 Greater technological complexity limited access to digital technology (Chart V.8). involved with FinTech poses potential systemic risks (Cevik, 2023). With the intermingling of

Impact of Digitalisation on Business Models:

FinTech into the financial system, increased Complementarity vs. Competition competition among banks can, in principle, V.13 FinTech players and the growing popularity lead to heightened financial instability (the of their innovative products have challenged the ‘competition-fragility’ view) or more stability (the existing financial sector players in maintaining ‘competition-stability’ view) [Elekdag et al., 2024].

their market share, margins and customer base Therefore, successful collaboration requires (Das, 2022). The incumbent banks and NBFCs careful planning, effective communication, and are responding to these challenges by adopting a shared vision for mutual growth and value various strategies, including making investments creation. In this respect, the survey indicates in FinTech companies, partnering with them, as that majority of respondent banks collaborate well as enhancing their in-house capabilities. A with FinTech firms to provide new/emerging higher proportion of banks (84 per cent of banks services, indicating banks’ willingness to harness compared to 35 per cent of NBFCs) provide a FinTech’s potential in developing new products/ range of digital banking services in collaboration services (Chart V.9). FinTechs upend traditional with FinTechs as per the survey (See Chapter 2, financial services for banks, forcing them to adapt Chart II.21). Most of the banks highlighted to stay relevant (Pascual and Natalucci, 2022).

the importance of collaboration with FinTech Nonetheless, most NBFCs compete as well as companies in providing products and services on collaborate with FinTechs in providing financial banking platforms. services.

158DIGITALISATION - TACKLING EMERGING RISKS AND CHALLENGES Chart V.9: Current Association between Banks/NBFCs and Chart V.10: Effectiveness of Collaboration between Banks/ FinTechs NBFCs and FinTechs in Driving Digital Innovation

Source: RBI staff estimates based on survey responses from 25 banks and Source: RBI staff estimates based on survey responses from 25 banks and 52 NBFCs. 57 NBFCs.

V.15 Most of the respondent banks and NBFCs concerns as the primary reasons hindering viewed their collaboration with FinTech firms the successful adoption of digital technologies as effective or highly effective in driving digital (Chart V.12).

innovation (Chart V.10).

Chart V.11: Implications of New Innovative Digital Technologies on the Existing Business Models V.16 Majority of respondent banks and NBFCs considered digital technology to be less or moderately disruptive2 (Chart V.11). Digital disruption by FinTech and platform-based competitors can impact banks’ profitability and limit credit growth; it can also help in the reduction of various costs (OECD, 2020).

V.17 On the factors hindering digital adoption, most respondent banks identified cybersecurity threats, the prevalence of legacy core banking applications and customer unwillingness as key challenges. NBFCs reported implementation

Source: RBI staff estimates based on survey responses from 25 banks and 63 NBFCs. costs, customer unwillingness and cybersecurity 2 Disruptive FinTech refers to innovative financial technology solutions that challenge traditional banking and finance models through AI, blockchain, and data analytics advancements to offer financial services. One example of disruptive FinTech is peer-to-peer lending platforms, which connect borrowers directly with lenders, bypassing traditional financial institutions.

159REPORT ON CURRENCY AND FINANCE Chart V.12: Primary Challenges Hindering the Successful Chart V.13: Emerging Digital Technologies Impacting Adoption of Digital Technologies Banking in the Next Five Years

Source: RBI staff estimates based on survey responses from 25 banks and Source: RBI staff estimates based on survey responses from 25 banks and 55 NBFCs. 64 NBFCs.

V.18 Emerging technologies like AI have the consistent with the study by Cheng et al. (2022). potential to impact the banking industry significantly For NBFCs, cost of migrating workload and in the next five years (Chart V.13). AI can benefit regulatory compliance were the key concerns the banking sector through operational efficiency (Chart V.15).

and better risk management but can also give rise to challenges such as data privacy, reputational Chart V.14: Motives behind Use of Cloud Computing Services risk and model hallucinations3 (Hernández de Cos, 2024).

V.19 Another emerging digital technology being adopted by the REs is cloud computing.

Better infrastructure provision through improved flexibility, scalability, and business continuity are the primary motives behind its adoption (Chart V.14). Cloud computing can help improve efficiency through cost reduction, faster processing, and business scalability and flexibility. However, while using cloud services, banks viewed regulatory compliance and data

Source: RBI staff estimates based on survey responses from 24 banks and 65 NBFCs. privacy and security issues as prime hurdles, 3 Model hallucinations occur when an AI model generates information that is not based on input data or real-world context.

160 noitpmusnoc ygrene decudeR tnirptoof nobrac dnaDIGITALISATION - TACKLING EMERGING RISKS AND CHALLENGES Chart V.15: Challenges in Using Cloud Computing Chart V.16: Potential Risks and Challenges of the Ongoing Services Digitalisation for the Financial Sector

Note: This chart presents frequency-weighted risk scores based on survey responses. Banks and NBFCs were asked to attach risk weights to the listed categories of risks and challenges that may arise as part of the ongoing digitalisation of the financial sector on a scale of 0 (no risk) to 10 (extremely high risk).

Source: RBI staff estimates based on survey responses from 22 banks and Source: RBI staff estimates based on survey responses from 25 banks and 58 NBFCs. 63 NBFCs.

Digitalisation and Financial Stability (Pascual and Natalucci, 2022). Regulators may adopt a passive approach to monitor FinTechs V.20 Digitalisation could pose financial stability through bespoke regulation or adopt test-and- concerns owing to cybersecurity threats, data learn policies through institutional arrangements breaches and the speed at which information like innovation hubs and sandboxes (Bains and and rumours can flow through the system.

Wu, 2023). Currently, the changes that seem Cyber fraudsters are increasingly targeting small can grow rapidly endangering the stability financial institutions instead of end users globally. Accordingly, cyber risks and frauds, third- Chart V.17: Types of Risks that are Expected to Arise in party risks, and data privacy issues were indicated Future as the most significant risk factors by banks and NBFCs at the current juncture as well as going ahead (Charts V.16 and V.17). Risks associated with cloud services and technology integration and implementation were also highlighted as major concerns going forward.

Regulatory and Supervisory Approaches V.21 Regulation of FinTech involves balancing innovation with customer protection, ensuring fair competition, and maintaining financial stability.

Note: This chart presents frequency-weighted risk scores based on Although most FinTech companies are relatively responses. Banks and NBFCs were asked to attach risk weights to the listed categories of risks that are more likely to arise in the future on a scale of 0 (least important) to 10 (most important).

small, they can grow faster than traditional lenders

Source: RBI staff estimates based on survey responses from 21 banks and 39 NBFCs. across riskier clientele and industry sectors 161REPORT ON CURRENCY AND FINANCE of the financial system, which requires regulators Chart V.18: Role of Regulations with Respect to FinTechs to be watchful of all the financial developments that are taking place and respond appropriately (Rao, 2022).

V.22 In India, the regulatory approach has been to strike a balance between mitigating the potential risks without impeding financial innovations through several tools that include research on FinTech developments, proactive engagement with existing and new entrant FinTech firms, clear communication with various stakeholders, risk mitigation strategies, modifications to supervisory processes and issuing guidelines or regulations.

As the FinTech ecosystem is a force multiplier, the

Source: RBI staff estimates based on survey responses from 25 banks and 58 NBFCs.

Reserve Bank has taken several steps to create a nurturing environment to foster innovation, involved, governance standards, eligibility criteria including issuance of guidelines for Account and expectations.

Aggregators (AAs) in 2016 and laying out of Preparedness in Dealing with the Risks regulations for P2P lending in 2017, recognising the sector’s potential in India (Sankar, 2023). V.24 The evolving digital landscape requires In August 2019, the RBI released a regulatory continuous assessment of preparedness for sandbox framework for live testing of innovative various risks by the REs as well as the regulators products or services in a controlled environment to design suitable policy responses at their end.

for their effective implementation. The qualitative assessment of survey responses indicated that the respondent banks and NBFCs V.23 Most of the respondent banks and NBFCs are largely equipped to deal with major risks preferred regulation of FinTechs and favoured (Chart V.19). NBFCs also indicated that there is incentives to collaborate with them (Chart V.18).

scope for improvement in the case of third-party However, as FinTechs bring innovation, they also risk, data privacy risk, cyber risk, and human raise concerns related to customer protection, resource challenges.

data privacy, cybersecurity, grievance handling, internal governance, and financial system V.25 To sum up, the survey suggests that integrity. The regulation of this dynamic sector banks and NBFCs in India are increasingly needs to be balanced, nuanced, and reasonably leveraging the digital revolution to reduce costs anticipatory. The Reserve Bank’s approach, related to customer acquisition, transactions therefore, has been to encourage self-regulation and employees, while favouring collaboration in the FinTech sector. In this regard, the Reserve with FinTechs to maximise gains. Cybersecurity Bank released the ‘Framework for Self-Regulatory threats, implementation costs, legacy core Organisation(s) for FinTech Sector’ (SRO-FT banking applications and customer unwillingness framework) in May 2024, detailing the processes are seen as the primary challenges hindering the 162DIGITALISATION - TACKLING EMERGING RISKS AND CHALLENGES Chart V.19: Adequacy of Existing Infrastructure to deal with Major Risks

Source: RBI staff estimates based on survey responses from 24 banks and 64 NBFCs. adoption of digital technologies. The respondent allowing information about investments, spending banks and NBFCs identified cybersecurity, data habits, and financial products to spread rapidly privacy and third-party risks as key challenges across social networks. This viral spread and indicated that they are largely equipped to can result in social contagion, as consumers deal with such risks. The surveyed REs favoured are influenced by the financial actions and regulation of FinTech firms for harnessing the recommendations of their peers, influencers, or benefits of digitalisation and securing financial trending topics (Shrotryia and Kalra, 2022). When stability in India. customers observe large groups engaging in certain financial activities, such as mass buying or

3. Digitalisation and Customer Behaviour selling of stocks during a market frenzy, they are V.26 Digitalisation has transformed the way more likely to follow the crowd. Similarly, driven consumers interact with the market while offering by herd behaviour, depositors may withdraw their convenience, personalised experiences, and money from banks, leading to potential bank unprecedented access to goods and services. runs/failures. Sentiments in social media amplify Digital financial services through mobile banking the classic bank run risk factors (Cookson et al., apps, online payments, and digital wallets enable 2023). The combination of social contagion and consumers to conduct transactions with a few herd behaviour in financial digitalisation can lead clicks at any time from any location, overcoming to rapid collective shifts in customer actions, the constraints of traditional banking hours or often amplifying market trends and contributing to physical branch presence. These advantages, volatility.

however, come with risks related to impulsive V.28 Globally, digital platforms offer deferred spending, herd behaviour, data security and cyber payment options like Buy Now Pay Later (BNPL), fraud. where lenders do not undertake a detailed credit V.27 Digital platforms enable quick check or rigorous assessment of a consumer’s dissemination of financial trends and choices, ability to repay. This can lead to consumers 163REPORT ON CURRENCY AND FINANCE overextending themselves financially, particularly Chart V.20: Global BNPL Market Size if they use multiple BNPL services concurrently.

In India, BNPL is treated as a credit product and requires similar due diligence and credit appraisal standards as for other loans. The global annual BNPL transactions are projected to grow from US$ 309 billion in 2023 to US$ 566 billion in 2026 (Chart V.20). India is among the top five countries in terms of BNPL users. BNPL share in e-commerce was about 3 per cent in India in 2023 as compared to 5 per cent globally.

V.29 With the integration of FinTechs and e-commerce platforms, consumers may become more vulnerable to misuse of their personal and confidential information (Box V.1). Source: Statista.com.

Box V.1

Data Collection Practices of Banking and FinTech Apps: Assessing the Necessity and Scope In the digital age, mobile applications (apps) have become Against this backdrop, the permissions sought by the face of banks and FinTech firms, mirroring the front apps listed on Google Play Store are assessed by desk of traditional financial institutions. These apps, pivotal extracting information on data/privacy-related policies of banks and FinTechs using Google Play Scrapper4.

for customer interaction, handle a spectrum of functions, This analysis of access to users’ data by FinTech apps ranging from onboarding and service delivery to grievance suggests that Indian apps largely seek similar types of handling and continuous monitoring. In this process, these permissions as in the case of the US (United States) and apps might be collecting more data than declared in their the EU (European Union)5, barring mainly access to SMS privacy policies (Austin et al., 2018). FinTech apps in India data (Table 1).

often collect more information than necessary, sometimes Further, a detailed analysis of requested permissions by even critical personal data that could jeopardise users’ practice area tags for India, encompassing 339 FinTech privacy (Arrka, 2023). Also, mobile wallets access the and banking apps6, indicates that around 42 per cent of maximum number of sensitive permissions amongst them access contacts, with banking Tech apps leading the various apps, while banking apps feature in the list at the pack (Table 2). Nearly three-fourth of the apps track user fifth position. location and access photos, media, and storage7.

(Contd...) 4 Mingyu, J. (2019). Google-Play-Scraper. MIT. Available at https://pypi.org/project/google-play-scraper/ 5 FinTechs in the US and EU are identified by using database maintained by Cambridge Centre for Alternative Finance, while Tracxn database is used in case of India.

6 Google Play Store publishes permissions requested (that the developer of the app takes from the user in course of installation/usage of the app) by each app on its platform. Accordingly, information was collected from 339 mobile applications (158 banking apps belonging to 48 banks, and 181 FinTech apps belonging to 172 business-to-consumer FinTech firms identified from the Tracxn database with practice area tags, viz., payments, alternative lending, banking tech, forex tech, remittance tech), identified manually on Google Play Store for each bank/FinTech.

7 Since FinTech apps pertaining to digital lending may also be providing payments services, they may be using permissions which otherwise are not encouraged for digital lending apps.

164 noilliBDIGITALISATION - TACKLING EMERGING RISKS AND CHALLENGES Table 1: FinTech Apps Seeking Permissions to Access Users’ Data – A Global Perspective Share (Per cent) Additionally, a comparison of data safety practices of the EU on select parameters indicates that the surveyed Indian apps vis-à-vis their counterparts in the US and Indian apps appear to perform relatively better in terms 165 ytitnedI stcatnoC enohP aremaC radnelaC iF-iW noitcennoc noitamrofni enohporciM dna DI eciveD noitamrofni llac egarotS noitacoL /aideM/sotohP seliF ppa dna eciveD yrotsih SMS EU 10 30 40 83 3 68 65 35 83 45 83 0 0 US 18 40 40 68 3 80 30 38 80 68 80 0 0 India 14 35 55 86 6 73 44 51 76 72 76 3 34

Note: The analysis covers 40 apps each in case of the US and the EU and 181 apps in the case of India.

Source: Google Play Store; RBI staff estimates.

Table 2: Data Permissions Sought by Bank and FinTech Apps in India sppA fo rebmuN ppa dna eciveD yrotsih noitacoL /aideM/sotohP seliF aremaC egarotS enohP radnelaC dna DI eciveD noitamrofni llac SMS enohporciM stcatnoC noitcennoc iF-iW noitamrofni ytitnedI Counts (Number) Alternative Lending 99 2 71 63 89 63 46 7 41 37 44 21 73 13 Bank Apps 158 19 118 116 119 116 116 3 114 79 50 79 116 33 Banking Tech 20 1 16 19 15 19 14 1 12 6 11 15 16 3 Payments 50 2 38 45 44 45 36 2 36 17 23 23 33 9 Others 12 0 6 10 8 10 4 0 4 1 2 4 10 0 Grand Total 339 24 249 253 275 253 216 13 207 140 130 142 248 58 Share in Grand Total (Per cent) Share of Apps 7.1 73.5 74.6 81.1 74.6 63.7 3.8 61.1 41.3 38.3 41.9 73.2 17.1

Note: The categorisation may not be mutually exclusive, and certain permissions may be necessary for app functionality for other functions being

provided by the app. The analysis covers 181 FinTech apps and 158 banking apps.

Source: Google Play Store and RBI staff estimates.

Chart 1: Comparison of Data Safety Practices of FinTech Apps

Note: The analysis covers 40 apps each in case of the US and the EU and 158 apps in the case of India.

Source: Google Play Store and RBI staff estimates. (Contd...)REPORT ON CURRENCY AND FINANCE of data sharing with third-parties, while being laggards References: in data encryption and users’ choice to request data Arrka. (2023). Privacy Research and Insights Study of deletion (Chart 1). It may be noted that the RBI’s digital Mobile Apps and Websites. INDIA. PRISM.IN 2023.

lending guidelines advocate for minimal and necessary Available at https://arrka.com/wp-content/uploads/2024/01/ PRISM_IN_2023.pdf access to customer data (RBI, 2022). These guidelines emphasise the importance of obtaining explicit user Austin, L., Lie, D., Sun, P. Y., Spillette, R., D’Angelo, M., and Wong, M. (2018). Towards Dynamic Transparency:

consent, suggesting a path towards more responsible The AppTrans (Transparency for Android Applications) data management. Compliance with regulatory guidance Project. on data privacy becomes paramount in letter and spirit.

Reserve Bank of India (2022). Guidelines on Digital App stores also have a crucial role in upholding privacy Lending. RBI Notifications, September 2, RBI/2022- standards. 23/111/DOR.CRE.REC.66/21.07.001/2022-23.

Ensuring the integrity and privacy of user data is, As more personal and financial transactions shift to therefore, pivotal. The journey towards a more online platforms, the digital footprint of individuals secure digital FinTech landscape not only involves and businesses has expanded, creating a target regulatory compliance but also includes building for cybercriminals.

trust and ensuring the ethical use of technology.

V.31 Population groups with low levels of digital V.30 The total number of complaints received and financial literacy have a higher risk of falling by Offices of RBI Ombudsman (ORBIOs) and victim to online frauds or scams (OECD, 2021). In a consumer survey conducted by the Committee the Centralised Receipt and Processing Centre for Review of Customer Service Standards

(CRPC) increased in 2022-23 due to intense public (Chairman: Shri B. P. Kanungo), 16.3 per cent awareness initiatives and the simplified process of respondents considered technology-based for lodging of complaints under the Reserve Bank services as a major area of concern (RBI, 2023).

- Integrated Ombudsman Scheme (RB-IOS), 2021 (Chart V.21) [RBI, 2024a]. Approximately 20 per V.32 The Reserve Bank has taken several cent of the complaints received by the ORBIOs in customer-centric measures to improve service 2022-23 pertained to mobile or electronic banking. quality and consumer protection (RBI, 2024b).

Chart V.21: Complaints Received under RBI Ombudsman Framework

Source: Reserve Bank of India.

166DIGITALISATION - TACKLING EMERGING RISKS AND CHALLENGES It has formulated a Charter of Customer Alert Family’ in March 2024 to create awareness Rights, which outlines five basic rights for bank among public about the modus operandi of the

customers: fair treatment; transparency, fair and frauds, provide guidance on financial frauds honest dealing; suitability; privacy; and grievance and dispel common misconceptions regarding redress and compensation. The Reserve Bank - various banking services and facilities, while Integrated Ombudsman Scheme (RB-IOS) 2021, also providing inputs on precautions to adopt in by adopting a One Nation-One Ombudsman carrying out financial transactions. In addition, the approach, has integrated the erstwhile three Reserve Bank has introduced measures to ensure Ombudsman Schemes of RBI and brought the the safety of customer transactions, viz. (a) facility Non-Scheduled Primary (Urban) Cooperative to switch on/switch off card transactions, (b) Banks with deposit size of and above ₹50 crore, Card-on-File tokenisation, (c) mandating legal and the Credit Information Companies under entity identifier (LEI) for high-value transactions its ambit; and simplified the grievance redress in centralised payment systems (CPS), (d) process by adoption of ‘deficiency in service’ positive pay system for high-value cheques, and as a single broad-based ground for filing of (e) mandating additional factor of authentication complaints. Furthermore, Fair Practices Codes (RBI, 2022). These measures by the RBI are have been instituted for lenders, underscoring aimed at fostering a transparent, fair and efficient the importance of ethical treatment and financial system, and instilling a sense of transparency in their interactions with customers. reassurance and confidence in the stakeholders.

The Reserve Bank conducted various focused

4. Digitalisation: Financial Stability and customer awareness programmes including Macroeconomic Implications Ombudsman Speak, Talkathon and Nationwide Intensive Awareness Programme to educate 4.1 Digitalisation and Financial Stability customers on safe banking practices; RBI’s V.34 The digitalisation of finance presents Alternate Grievance Redress (AGR) mechanism, significant benefits to the economy and the and extant regulations for protection of consumer financial system by promoting efficiency, interests. To disseminate information about safe transparency, accessibility, and convenience of digital banking, the RBI has also been conducting financial services (Table V.1). FinTech lending8 Electronic Banking Awareness and Training can reduce transaction costs and information (e-BAAT) programmes, actively undertaking asymmetries and increase financial inclusion by digital awareness campaigns in the print and alleviating collateral constraints (Sahay et al., Audio-Visual media, including the Reserve Bank’s

2020). On the other hand, lending by FinTech flagship programme “RBI Kehta Hai”. platforms may involve greater financial risks due V.33 Furthermore, the RBI launched three to concentration and over-reliance on data-driven booklets viz., ‘Be(A)ware’ in March 2022, ‘Raju algorithms (Cevik, 2023). The interconnectedness and the Forty Thieves’ in April 2022, and ‘The among banks, FinTechs, and technology firms 8 In India, FinTech entities do not lend on their own balance sheets and merely act as loan sourcing agents (defined as Lending Service Provider in Digital Lending Guidelines). In other jurisdictions, FinTech lending can mean multiple things – including lending by FinTechs on their own balance sheets, P2P lending, or simply loan sourcing.

167REPORT ON CURRENCY AND FINANCE Table V.1: FinTechs and Financial Stability Benefits Risks Decentralisation / diversification Cyber risks • FinTech can lead to greater decentralisation and diversification of the • Susceptibility of financial activity to cyber-attacks is higher in the financial system, dampening the effects of financial shocks in some interconnected network of financial institutions, especially in the cases. presence of weaker institutions.

Efficiency Third-party reliance • Financial innovations have the potential to enhance efficiency in • FinTech activities could increase reliance on third-party service decision-making processes and improvement in the models used by providers exposing the system to operational risks.

financial institutions and investors.

Transparency Contagion • Increased and better use of data can reduce information asymmetries. • Greater automation with more sophisticated algorithms may lead to new and unpredictable sources of contagion in financial markets.

Access to, and convenience of, financial services Procyclicality and excess volatility • Potential for greater access to a range of financial services across • Interaction between investors and borrowers on FinTech lending economic functions and regions. platforms could exhibit larger swings in sentiment-based borrowing and lending leading to undue volatility.

Source: BCBS (2024) and FSB (2017). complicates risk assessment and management, offering specialised services and unlocking new potentially accelerating financial contagion. business opportunities. In collaboration with Moreover, digitalisation can amplify traditional banks and NBFCs, they have accelerated lending financial risks like liquidity, pro-cyclicality, and to new borrower accounts, particularly focusing concentration risks, stemming from reliance on on the personal loan segment (Chart V.22). This specific market infrastructures or third-party service emphasis on low-ticket loans enables access to providers (BCBS, 2024). Globally, the growth of Chart V.22: Distribution of Loan Origination by non-bank institutions in the lending business also Lenders in India during 2023-24 adds a new dimension that could raise regulatory arbitrage between traditional banks and FinTech firms. FinTech firms have complex and less transparent funding structures, making it harder to assess their risk transmission on overall stability.

However, in the case of India, non-bank entities in lending are regulated as NBFCs by the RBI, while FinTechs and banks work in partnership in bank-led model subsiding any issue of regulatory arbitrage. Moreover, FinTech entities cannot lend on their own balance sheet; they only act as a loan sourcing agent.

Note: Data of FinTech lenders pertain to a cohort of about 130 credit V.35 In India, FinTechs are quickly integrating institutions based on the on-book lending.

Source: TransUnion CIBIL. themselves into the financial intermediation chain, @ The methodology for classifying FinTechs is based on TransUnion CIBIL’s market knowledge that they have a digital first approach for their lending business and/or are members of industry bodies like FACE, DLAI and IAMAI.

168 stnuoccA fo tnec reP FinTech Lenders@DIGITALISATION - TACKLING EMERGING RISKS AND CHALLENGES Chart V.23: Same Day Processing of Personal Loan Chart V.24: Share of New and Above-Prime Borrowers in Applications FinTech Lending

Note: Others pertain to banks and NBFCs. Note: Data pertain to lending for consumer durables and personal loans.

Source: TransUnion CIBIL. Source: TransUnion CIBIL. credit for individuals previously excluded from in their loan portfolio (Chart V.24). The share of traditional banking due to factors like lack of new-to-credit borrowers serviced by FinTech credit history or sub-prime status. This strategy, lenders has declined, which could be reflective however, could entail credit risk for the lenders of the caution exercised by lenders due to higher due to surge in unsecured personal loans. As per observed delinquencies in small ticket personal available information, secured lending through loans (RBI, 2024c) as well as proactive measures digital lending partners has also started. by the Reserve Bank in terms of issuance of digital lending guidelines in September 2022.

V.36 By leveraging on technology in application processing, KYC checks, identity and risk checks V.38 Notwithstanding the fast penetration of with automated scorecards, FinTechs also have a FinTech firms in India, they still face significant higher proportion of same day loan processing as challenges in counterparty credit risk assessment.

compared to conventional lenders (Chart V.23). A large portion of the population lacks a formal Despite sophisticated lending practices, it is hard credit history, making traditional scoring models to implement true risk-based pricing by using big less reliable. As per the FinTech lending risk data and advanced technologies, as compared to barometer study conducted by FACE (2023), the traditional credit rating framework (Johnson et issues related to data rank among the top ten al., 2023). For India, a study on FinTech lending risks faced by the Indian FinTech sector. BigTech firms suggests that alternate credit scoring using companies from sectors like e-commerce, social mobile and social footprints can expand credit media, and ride-hailing are expanding into and reduce the overall default rate (Agarwal et al., finance, leveraging extensive customer data

2020). to tailor offerings for those with limited credit V.37 In India, the share of prime and above- history. Even traditional lenders are adopting prime borrowers in FinTech lending has been FinTech platforms for credit assessment. While rising since 2018-19, suggesting improvement these developments could have a positive impact 169REPORT ON CURRENCY AND FINANCE in terms of enhancing inclusion and further Chart V.25: Banks’ UPI Downtime in India penetration of financial services, they also raise concerns about concentration risk and potential spillovers. Therefore, potential risks to public policy objectives of maintaining competition, market and business conduct, operational resilience, data privacy, cybersecurity and financial stability need closer attention (Das, 2022).

V.39 As per the systemic risk survey conducted by the Reserve Bank among financial sector professionals and academicians, cyber risks have been increasing consistently since 2020 (RBI, 2024c). The dominance of a few technology service providers, outages or cyber incidents could give rise to macro-financial stability risks

Source: National Payments Corporation of India (NPCI). (IMF, 2024). In India, the incidence of outages, as reflected in banks’ UPI downtime, has been falling releasing the SRO-FT framework in May 2024.

(Chart V.25). Furthermore, to accelerate and widen the reach of digital banking services and lessen the hesitation Policy Initiatives by the Reserve Bank among customers for availing financial services V.40 To harness the benefits of digitalisation in digitally, the concept of “Digital Banking Units” the financial sector while mitigating the emerging

(DBUs) was introduced by the Reserve Bank in risks, the Reserve Bank has been undertaking April 2022. proactive policy measures. These include (i) issuance of digital lending guidelines in 2022, V.41 The Reserve Bank also undertook several focusing on credit intermediation, customer initiatives for strengthening the cybersecurity protection, data privacy and cybersecurity issues;

preparedness of supervised entities, including

(ii) issuance of guidelines in 2023 for further initiating the process of setting up of cyber range strengthening banks’ IT systems as well as for conducting cyber drills, examining the feasibility employing robust frameworks for fraud prevention of implementing the Cyber Sectoral Security and detection measures; (iii) issuance of master Operations Centre (S-SOC), and conducting directions on outsourcing of IT services in April phishing simulation exercises (RBI, 2024b).

2023, which stipulate REs to report cyber incidents It also proposed to set up a Digital Payments within six hours of detection by a third-party Intelligence Platform for network-level intelligence service provider; (iv) issuance of Guidance Note in and real-time data sharing across the digital April 2024 for improving and further strengthening payment ecosystem in June 2024. To enhance banks’ Operational Risk Management Framework to identify, mitigate and recover from cyber the safety and security of digital transactions with incidents and technology failures and enhancing a focus on detecting, preventing, and combating their ability to deliver critical operations, thereby financial frauds, the Reserve Bank announced its ensuring their Operational Resilience; and (v) third edition of the global hackathon, “HaRBInger 170DIGITALISATION - TACKLING EMERGING RISKS AND CHALLENGES 2024 – Innovation for Transformation” with two adjust interest rates on deposits and loans in overarching themes viz., ‘Zero Financial Frauds’ response to policy rate changes, potentially and ‘Being Divyang Friendly’ (RBI, 2024d). The accelerating the transmission of monetary policy.

Reserve Bank launched initiatives in line with the The impact of policy under the risk-taking channel Payments Vision Document 2025 across anchor could be stronger due to digital lending if risk goalposts of integrity, inclusion, innovation, appetite of FinTechs is more sensitive to changes institutionalisation and internationalisation during in monetary policy (Stein, 2013; IMF, 2016; Ding 2023-24 for enhancing the payments ecosystem and He, 2023).

and fostering a regulatory environment conducive V.43 The overall impact of digitalisation on to the growth of payment systems. As part of the monetary policy transmission is ambiguous agenda for the run-up to RBI@100, the Reserve (Hasan et al., 2024). It would depend, inter alia, on Bank has taken initiatives to establish a cost- whether financial services offered by non-banks effective cloud facility for the financial sector complement or substitute those offered by banks.

to enhance the security, integrity and privacy of While the complementarity could lead to higher financial sector data while facilitating scalability financial intermediation and stronger monetary and business continuity.

policy transmission, substitution of bank deposits

4.2 Digital Transactions and Monetary Policy could enhance financial disintermediation and weaken monetary policy transmission. Against V.42 The digital transformation of the financial this backdrop, the evolution of monetary policy sector is reshaping the landscape in which transmission in India is examined by estimating monetary policy operates. Digitalisation influences the response of deposit and lending interest rates various aspects of the economy, from financial to the policy repo rate in a recursive regression intermediation and credit conditions to market framework for the period April 2004 to March dynamics and global integration, reshaping the

2024. The results suggest an improvement in the traditional channels through which monetary degree of interest rate pass-through since 2016- policy affects economic variables such as growth 17, reflecting, inter alia, the combined impact and inflation. The widespread adoption of digital of the adoption of flexible inflation targeting payment platforms alters how money circulates

(FIT) framework in 2016 and the introduction of in the economy, which can enhance or mitigate mandated external benchmark system for lending the liquidity effects of monetary policy. Financial rates for select categories starting 2019, even as digitalisation could amplify the effects of monetary there has been rapid pace of digitalisation over policy by loosening credit constraints. The the same period (Chart V.26).

monetary policy impact could be dampened if Digitalisation and Inflation digitalisation leads to shifting of credit supply from banks to less-regulated / unregulated nonbanks V.44 Digitalisation also has implications for (Buchak et al., 2018; Elliott et al., 2022; Chen the primary monetary policy objective of inflation et al., 2018), or by offsetting reductions in bank management. Digitalisation can impact the deposits (Xiao, 2020). Financial inclusion can flexibility of prices, relative prices of online and enhance the effectiveness of interest rate based offline products, market competition, and market monetary policy by increasing the number of concentration, all of which may potentially people responsive to interest rate cycles (Patra, influence the New Keynesian Phillips Curve

2021). Digital financial system can automatically (NKPC) – the central element of the workhorse 171REPORT ON CURRENCY AND FINANCE Chart V.26: Rolling Regression Estimates of Monetary Policy Transmission

1.0 1.0

Note: The charts show the impact of a one percentage point rise in repo rate. Dashed lines represent one standard deviation error bands.

Source: RBI staff estimates. model employed by modern central banks with lower scaling costs, can lead to a higher level for assessing inflation dynamics and policy of market concentration and the emergence of evaluation. Digitalisation can increase the degree natural monopolies or “superstar” firms. The rise of flexibility in prices (Anderton et al., 2021; in online product competition can lower inflation, Anderton et al., 2020). It can also reduce menu while the increase in market concentration of cost as changing the prices of goods is possible firms, and the resulting higher mark-ups and profit margins, could lead to upward inflation pressures.

at almost zero cost without reprinting price tags The net effect of digitalisation on the market power or re-establishing pricing strategies. Information can vary across sectors, depending on changes costs have also undergone significant changes in market competition, inflation responsiveness, under the influence of digitalisation. Digital tools, and changes in the structure of the NKPC.

such as search engines, e-commerce platforms, Digitalisation forces can, thus, impact inflation and social media greatly reduce the time and by impinging upon all the key components of the energy costs for consumers to obtain information, NKPC, i.e., the slope, mark-up, slack (output gap), compare prices, and make purchasing decisions, and inflation expectations (Chu et al., 2023):

thereby changing the process of price formation and adjustment (Cavallo, 2018; Cavallo, 2017;

Jiang and Zou, 2020). Digital technology is key in reducing menu and information costs and reducing price stickiness. A decrease in price stickiness Where, , and are constants, π represents may weaken the effectiveness of monetary policy t current inflation, π represents the current (Alvarez et al., 2016; Glocker and Piribauer, 2021). � � � t expectation of the on+e1 period ahead inflation, { } V.45 Algorithmic pricing strategies in the digital represents the current slack, i.e., the realm may lead to collusion, resulting in prices deviation of current output from potential above competitive levels. Additionally, the large level , and d represents time-varying markup t initial investment in digital technologies, coupled emanating from price elasticity of current demand.

172DIGITALISATION - TACKLING EMERGING RISKS AND CHALLENGES V.46 The slope channel is dependent on slope of the NKPC, while the availability of the price stickiness (i.e., the fraction of firms more product varieties can offset the impact of not adjusting the prices), the price elasticity of increased market concentration, and lower mark- demand, the elasticity of marginal cost to sales ups. Technological shocks can impact mark- and the elasticity of firms’ mark-up (Anderton ups and marginal costs more frequently, which et al., 2021). The NKPC could become steeper, may negatively affect inflation expectations and making inflation more volatile if the impact of the stability of the NKPC. Given these diverse higher price flexibility, induced by digitalisation, channels, a small-scale New Keynesian model, outweighs the impact of greater availability of calibrated to Indian macroeconomic conditions, product varieties. By lowering the labour share suggests that digitalisation can, on balance, in aggregate output, the digitalisation-induced enhance the effectiveness of monetary policy higher market concentration may reduce the transmission (Box V.2).

Box V.2 Impact of Digitalisation on Monetary Policy Transmission To study the potential impact of digitalisation on monetary model (Banerjee et al., 2023; Sharma and Behera, 2022) is policy transmission, a New Keynesian model with three compared with counterfactuals performed by changing the structural parameters of (i) labour’s share in the production equations, namely dynamic IS equation, NKPC, and an process, (ii) price stickiness, and (iii) elasticity of demand inflation-targeting interest rate rule, is considered (see as an indicator of competitiveness in the market. These Galí, 2015). The IS equation captures, inter alia, the parameters are changed one at a time and the resulting responsiveness of aggregate demand to the expected paths of impulse responses of output gap and inflation are real rate of interest. The NKPC characterises the compared.

responsiveness of inflation to the output gap along with In the baseline model, a 100 basis points (bps) rise in backward-looking and forward-looking inflation expectation the policy rate leads to a fall in output and inflation by 40 components. The interest rate rule features inflation gap bps and 25 bps, respectively, at their peak (Chart 1). In and output gap, including the interest rate smoothing the scenario of digitalisation improving factor productivity, term. To assess the implication of digitalisation, a baseline Chart 1: Effects of Digitalisation on Monetary Policy Transmission

Note: Impulse responses show the impact of 100 bps rise in policy rate.

Source: RBI staff estimates. (Contd...) 173REPORT ON CURRENCY AND FINANCE

the peak effect of monetary tightening on output remains References: the same while that on inflation is lower at 20 bps. If Banerjee, S., Behera, H., and Patra, M. D. (2023). A digitalisation were to lead to a decline in nominal rigidity by Prototype Dynamic Stochastic General Equilibrium Model 10 per cent, say, due to the rising online presence of retail for India. RBI Bulletin, July.

stores and dynamic pricing algorithm, inflation fall could Galí, J. (2015). Monetary Policy, Inflation, and the Business be higher at 35 bps. If the price elasticity of demand falls,

Cycle: An Introduction to the New Keynesian Framework inflation could drop by 30 bps (5 bps more than its baseline and its Applications. Princeton University Press. level) due to steepening of the slope of the Phillips curve.

Considering all three channels together, the peak impact Sharma, S., and Behera, H. (2022). A Dissection of Indian of a 100 bps increase in the repo rate on inflation could be Growth using a DSGE Filter. Journal of Asian Economics, around 35 bps (10 bps more than its baseline level). 80, 101480.

Monitoring and Forecasting in the Age of Big central banks, Big Data and Machine Learning are Data being used in a variety of areas, including research, monetary policy, and financial stability (Doerr et V.47 An improved understanding of digitalisation al., 2021 and Serena et al., 2021). Big data and induced changes in the behaviour of consumers, ML can improve inflation forecasting performance firms and financial intermediaries would be necessary for enhancing the effectiveness of (Chakraborty and Joseph, 2017; Singh and Bhoi, data-driven policy making. The availability of large 2022); however, elevated geopolitical tensions, volumes of data enabled by digitalisation has more frequent climate shocks and high volatility opened up scope for the use of AI/ML techniques in global financial markets and commodity prices for faster processing and analysis of data as well continue to pose significant challenges for the as for macroeconomic forecasting (Chart V.27). In assessment and forecasts of output and inflation.

Chart V.27: Global AI Adoption

Source: McKinsey (2022); and Central Banking (2022).

174DIGITALISATION - TACKLING EMERGING RISKS AND CHALLENGES

5. Concluding Observations goals. Empirical analysis suggests a strengthening of monetary policy effectiveness amidst reforms in V.48 Digitalisation is transforming India’s policy framework and operating procedures, along financial sector by changing the way financial with the ongoing digitalisation in India.

institutions operate and interact with their customers and provide financial products and V.51 Digitalisation can also bring new risks and services. Amidst several benefits, e.g., fostering challenges for customer protection and financial innovation, expanding access, enhancing stability. While improving accessibility and competition, reducing intermediation costs, and convenience of financial services for customers, improving customer experiences, digitalisation digitalisation raises concerns related to impulsive also brings new challenges in terms of complex spending, herd behaviour and data security. The financial products, greater interconnectedness, Reserve Bank has been undertaking proactive cybersecurity risks, financial frauds, and policy measures to harness the benefits while customer protection, with implications for macro- mitigating the emerging risks of digitalisation financial stability. These issues need to be in the financial sector. The regulatory sandbox addressed to realise the full potential of financial approach has produced practical and innovative digitalisation. solutions in domains such as retail payments, cross-border payments, MSME lending and V.49 A survey of select banks and NBFCs in prevention of financial frauds (Das, 2023). By India indicates that providing enhanced customer integrating digital payment systems and FinTech banking experience, remaining competitive, innovations into its regulatory framework, the and improving operational efficiency and risk Reserve Bank has maintained financial stability management are the major drivers of their while fostering economic growth. The RBI has digitalisation efforts. There is an improvement set out guidelines for banks to implement robust in customer acquisition and retention due to the cybersecurity measures, ensuring the safe and adoption of digital technologies. Banks and NBFCs secure functioning of digital financial transactions.

benefit from collaborating with FinTech companies While encouraging innovation, the Reserve in providing products and services, and they Bank is also proactive in safeguarding customer prefer regulation of FinTechs. The respondents interests (Patra, 2024). These measures include, view cybersecurity, data privacy, and third-party inter alia, formulating a charter of customer rights, risks as their prime concerns.

integrated ombudsman scheme for grievance V.50 Digitalisation can impact inflation redressal, laying down of fair practices codes for and output dynamics, and monetary policy lenders, and several consumer awareness and transmission in diverse manners and the overall educational programmes to reinforce confidence impact could vary over time given the fast pace of stakeholders in the financial system. Through of developments. In this environment, central these strategic initiatives, the Reserve Bank has banks would need to incorporate digitalisation been playing a constructive role in creating an aspects comprehensively into their models for innovation-friendly ecosystem in the financial the continued efficacy of monetary policy and the sector consistent with its macro-financial achievement of their price and financial stability objectives.

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