Top 5 Game changers for the Indian Financial System in 2016

As the year comes to a close, we put together the top 5 developments that we believe have shaped the Indian financial system in 2016. Expectedly the commentary in the past two months has been largely around demonetisation but the year also saw important steps being taken by both the government and the regulator that will shape the road ahead as we embark into the new year.

Below are our picks:

Withdrawal of Legal Tender Status for Rs 500 and Rs 1000 Notes

“To break the grip of corruption and black money, we have decided that the five hundred rupee and thousand rupee currency notes presently in use will no longer be legal tender from midnight tonight, that is 8th November 2016….” With these words the Indian Prime Minister in one stroke announced the withdrawal of what constituted 86% of Indian currency (by value) in circulation at that point in time. The announcement initially came with a list of caveats for exchange and withdrawal that have since seen frequent additions/revisions by the day (see this & this) and accompanied by stories of unprecedented disruptions to the daily life of citizens and businesses in the aftermath of the ban. Never before had the financial life of the average Indian occupied as much prime time news as in the last two months with financial inclusion data being debated with the passion usually reserved for cricket and politics!

Withdrawal of legal tender of such a magnitude has obviously brought focus on digital transactions with the Government claiming a 400-1000% increase in them since the withdrawal was announced. The RBI on its part released provisional data for electronic payments in November 2016, which in its present form is not entirely comparable when contrasted with the October data, as it comes with caveats that do not convey the full picture for digital transactions in November – [Mobile Banking data – is of 5 banks; Cards data – is of 4 banks; PPI data – is of only 8 non-bank issuers for goods and services transactions. On these there is no clarity on the entities whose data is captured, apart from RBI indicating that it is sourced from some of the major participants]. For data that is comparable we have put together the below table that provides a perspective on the actual volume & value of transactions in the October-November period.

Source: RBI; * – Provisional data; NACH – National Automated Clearing House; Colour red indicating negative growth as compared to the previous month.

Nonetheless, from being called a major mistake to being called a courageous reform, the move, has had an immediate and telling effect on the social and economic fabric of the country. It is not yet clear what the magnitude of the short-term disruptions will be on agriculture, small business and the GDP and it remains to be seen if the stated goals (reduction of “black money” & counterfeit currency and a cash-less society) of the policy change will be achieved sustainably.

Setting up of the Monetary Policy Committee

October 4^th, 2016 marked the first time that a committee, rather than one person, until then the RBI Governor, would decide the policy interest rates in the economy. Entrusted with the task of fixing the benchmark policy rate (repo rate) required to contain inflation within the specified target level, the Monetary Policy Committee was set-up with six members – three nominated from the Central Government and three from the Reserve Bank of India, with the RBI Governor getting the casting vote in case of a tie. This marks a major shift towards a more consensus-driven approach towards monetary policy decision-making similar to how interest rates are set in the US and UK.

Passage of the Goods & Services Tax Bill

Aimed at doing away with a host of Central and State taxes and ushering in a one tax regime for the entire country, both the Houses of Parliament passed the Goods & Services Tax Bill in August 2016, with the President giving his assent in September. Subsuming most of the Central and State taxes such as the Value Added Tax (VAT), excise duty, service tax, central sales tax, additional customs duty and special additional duty of customs, GST would lead to a uniform consumption-based tax structure across the land for almost all goods and services and the government has set a deadline of April 1, 2017 to roll this out. GST implementation would integrate the economy and provide for a common national market that enables businesses to leverage a simplified tax regime. Besides elimination of inter-state taxes would mean a decrease in procedural compliance and paperwork resulting in better utilisation of resources.

Passage of the Insolvency and Bankruptcy Code

In May 2016, both Houses of the Parliament passed the Insolvency and Bankruptcy Code that set in motion a national bankruptcy law to deal with insolvencies. The new law, which does away with at least 12 different legislations, some of which are centuries old, is expected to usher in an effective bankruptcy resolution system that improves the ease of doing business in India. The legislation seeks to create time-bound processes for insolvency resolution of companies and individuals. It will cover individuals, companies, limited liability partnerships and partnership firms and amend laws including the Companies Act to become the overarching legislation to deal with corporate insolvency. The Central Government in December notified the final regulations related to the insolvency resolution process under the Insolvency and Bankruptcy Code 2016, paving way for the operationalization of the 10-member Insolvency and Bankruptcy Board (IBBI).

Thrust towards digitisation of Government payments

2016 saw wide-ranging measures to incentivise greater adoption of digital payments with an all-round push by different Ministries and regulators. For instance, the Ministry of Electronics and Information Technology (MeitY) laid out Guidelines for Adoption of Electronic Payments and Receipts in November 2016 that covers a time-bound process for the integration of digital payments and receipts involving all Government departments. It has set an ambitious deadline of 31 December 2016 by which 90% of payments and receipts of all Government Departments are to be made online.

In addition the year saw a slew of Committees being set up by the Government such as the Watal Committee on Digital Payments that has come up with a series of recommendations and a roadmap for digital payments that are to be implemented. Likewise in November, Niti Aayog constituted a Committee of Chief Ministers to examine and implement measures for promoting digital payment systems in the country. RBI in June set up the Sudarshan Sen-headed Working Group to study the entire gamut of regulatory issues relating to Fin Tech and Digital Banking in India.

There have been many legitimate concerns raised around the preparedness of policy making in tackling issues around privacy, customer and data protection, denial of service and so on and these will require to be carefully addressed to unleash the full potential of this nation-wide effort.

Ps: In previous years, we have noted the developments with respect to licensing of Payment Banks and Small Finance Banks. This year ‘Capital Small Finance Bank’ became the first small finance bank when it launched in April. In November ‘Airtel’ became India’s first Payments Bank to go live when it launched operations in Rajasthan with over 1,00,000 customers signing up within a fortnight of the launch. The company this month rolled out operations in Andhra Pradesh, Telangana and Karnataka and intends to go pan-India in the coming weeks.

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We would like to wish our readers a very happy new year and look forward to your continued readership in the coming year. You can subscribe to receive email updates from our blog by signing up here and can also sign-up to receive our daily news clips compilation on financial inclusion here.

Once again, Happy New Year!