Regulatory gaps in Nepal’s fintech

There is a severe lack of dedicated fintech-related education in the country. Regulatory gaps in Nepal’s fintech

SHUTTERSTOCK

Nischal Dhungel & Umesh Rijal

Published at : March 14, 2024

Updated at : March 24, 2024 15:07

The fintech sector is one of the fastest-growing industries in the world, offering numerous opportunities and challenges for developing countries like Nepal. Nepal Rastra Bank (NRB), the country’s central bank, formulated the National Payment Systems Development Strategy (NPSDS) 2014 under the NRB Act 2002 to modernise the payment systems and develop a secure, robust and efficient payment system. Digital payments in Nepal gained momentum in early 2016 and significantly increased from 2020 onwards.

As of mid-January 2024, the number of Payment System Operators (PSO) and Payment Service Providers (PSP) stood at 10 and 27, respectively. Mobile banking (23,216,383 customers) is the most popular access to payment systems, followed by Wallet (a total of 21,228,529 users), as per the NRB data as of mid-January 2024. Similarly, regarding payment usage, real time gross settlement stood the highest (2,629,048), whereas mobile banking topped the number of transactions (28,903,872) during the same period. As Nepal's digital payment industry is growing, examining the NRB's current regulatory policies relating to PSPs (E-sewa and Khalti) and PSOs (Nepal Clearing House Limited and Nepal Electronic Payment System) is crucial.

Current gaps

Current Gaps:

There are many gaps in regulatory policies. Clause 4 of the Policy Related to Licensing to PSP/PSO, 2079 (First Amendment, 2080) outlines the functions and scopes of PSP/PSOs. Specifically, two main activities are within the scope of PSO activities - operating the payment card network and the payment switch. Nepal's banking and financial institutions (BFIs) can also engage in these activities. The services that PSOs (excluding BFIs) provide, except for clearing house services, are subject to VAT and they must collect it as per the prevailing VAT Act, 2052. However, since BFIS are providing financial services (which is exempt from VAT) they are not required to register themselves under VAT.

This discrepancy results in BFI gaining an undue advantage of 13% (the prevailing VAT rate) over other PSOs when providing similar services. As per the general understanding of the law, BFIs providing services subject to VAT must collect VAT on the same; however, they are not registered under VAT and hence, they can’t collect VAT even if they are providing some taxable services. Consequently, even if other PSOs were to match BFIs' pricing, their services would inherently be 13 percent more costly due to VAT. As PSP/PSOs play a crucial role in national strategies, such as promoting digital payments in Nepal, the NRB and the Government of Nepal must consider exempting VAT for services provided by PSP/PSOs to make these services more affordable and accessible.

FDI bottleneck

Clause 13 of the Policy Related to Licensing to PSP/PSO, 2079 (First Amendment, 2080) specifies that the maximum foreign investment limit shall be 15 percent of the paid-up capital of the concerned institution. For instance, for a PSP with a minimum capital requirement of Rs50 million, the foreign investment limit would be Rs7.5 million. However, the minimum threshold for an investment to qualify as foreign direct investment (FDI) in Nepal is Rs20 million.

This discrepancy means that a foreign investment of Rs7.5 million would not qualify as FDI and, therefore, would not be eligible for the associated benefits. To address this issue, the NRB and the Government of Nepal should collaborate to attract foreign investment in the payment and fintech sectors. This could facilitate the transfer of foreign technology and knowledge into the Nepali market and encourage PSPs and PSOs to seek foreign investments. An initiative to relax the FDI limit, specifically for investments in PSPs and PSOs, could be a significant step forward. Additionally, Clause 13 should be amended to allow foreign investments from individual investors, not just foreign firms or companies, to maximise investment opportunities in Nepal's payment industry.

Moreover, most important documents, such as licensing policies, directives, etc., are only available in Nepali. Foreign investors looking to invest in the Nepalese payment or fintech industry face challenges in reading or understanding Nepal's prevailing policies and practices. To encourage foreign investment in the fintech industry, the NRB should address this gap by issuing relevant documents in both English and Nepali.

Potential solutions

Regulators struggle to keep up with the latest technological developments, creating hurdles in introducing new products and services due to regulatory constraints. For example, India recently launched its Unified Payments Interface (UPI) in France, where Indian tourists can now make payments using rupees while in France. This is an example of embracing technological development in digital payment systems beyond the country. Unlike the Reserve Bank of India (RBI), which uses a system in India allowing for thorough inspection of licensed institutions, such a system is not implemented in Nepal, preventing the central bank from conducting inspections more frequently. The lack of a technology research and test department within the regulatory bodies is evident. Technology blurs the lines between purely financial and non-financial products, potentially leading to regulatory oversight.

Other proposed solutions to reform the digital payment landscape include implementing centralised KYC (National ID), linking Permanent Account Number (PAN) to every bank account, integrating mobile banking/internet banking with wallets and vice versa, linking wallets to each other, and other payment channels to develop a unified QR or similar system capable of accepting any type of payment. For example, a unified QR (accepting payments from all service providers) will reduce costs and foster healthy competition. The central bank has mandated the players to work for interoperability by easing the payment system. Currently, no dedicated fintech-related courses are included in the syllabus of any university or college in Nepal. For the first time, a practical course of 1 credit hour about fintech is taught to Tribhuvan University’s MBA students, highlighting the gap in fintech education. The NRB must amend these policies to create a thriving fintech industry in Nepal.