Nearly a decade and a half after the launch of digital payment services in Nepal, the government has moved forward with the process of legally defining this sector by amending the ‘Nepal Rastra Bank Act, 2058 BS’. The draft of the amended bill also includes payment system operators (PSOs) and payment service providers (PSPs) within the definition of ‘financial institutions’. This has added to legal ambiguity and confusion among stakeholders.

Currently, banks and financial institutions are regulated under the ‘Banks and Financial Institutions Act, 2073 BS’ (BAFIA). PSOs and PSPs are regulated under the ‘Payments and Settlements Act, 2075 BS’. Some are concerned that placing both these services under the same ‘financial institution’ basket in the Rastra Bank Act may lead to conflict between the provisions of the two acts in the future and create confusion as to which act will be implemented. Therefore, stakeholders suggest that additional legal provisions related to digital payment services should be clarified now.

It seems that the revised bill of the Nepal Rastra Bank Act seeks to include PSOs, PSPs, remittance companies, etc. in the definition of financial institutions. In this case, PSOs, PSPs, remittance companies, etc. will also have to pay 30 percent income tax in the future, which will discourage shareholders and investors in the information technology sector, according to financial sector expert Parashuram Kunwar Chhetri.

‘Now is the time to encourage investment in the information technology sector. In such a situation, if a policy is introduced to pay additional taxes, investment in this sector may be discouraged,’ he said, ‘Currently, banks and financial institutions have been paying 30 percent income tax. While there are calls to reduce it to 25 percent, it is not appropriate to make the same arrangement for PSOs, PSPs, remittance companies, etc.’

If PSOs, PSPs, remittance companies, etc. are included in the definition of financial institutions, there is a possibility that the shares of these companies will also be divided into promoters and general public, and the regulatory body will have control when promoter shares are sold to the general public, says Kunwar. ‘Currently, banks and financial institutions have to obtain permission from the National Bank when selling promoter shares to the general public. If PSOs, PSPs, 

remittances are also included in the definition of financial institutions, the stakeholders are afraid that the shares of these companies will also have to be classified as promoters and general public and will not be able to be sold easily in the future.’

PSOs are the institutions that operate the infrastructure or system for digital payment services, while PSPs are the platforms that provide payment services directly to users through mobile wallets and QR codes. PSOs switch, clear and settle transactions between banks and financial institutions, wallets, card networks, etc. PSPs are front-end service providers. 

The National Bank should regulate PSPs, PSOs and remittance companies separately as they are now and they should not be included in the definition of financial institutions, said Chandra Prasad Dhakal, President of the Federation of Nepalese Chambers of Commerce and Industry. "It is because PSPs and PSOs are currently being encouraged that digital banking has been able to take a big leap in Nepal's financial sector in a short time," he said. "The use of artificial intelligence (AI) is currently increasing rapidly in the global market. Nepal will also have to follow the same path. The National Bank is conducting research and development for a Central Bank Digital Currency (CBDC). For this, the role of companies including PSPs and PSOs is also important. Therefore, it is necessary to encourage such companies in the coming years." He said that the expansion of PSPs and PSOs should also be encouraged to make Nepal's financial system modern and digital banking widespread. Payment service providers and experts are expressing interest in the proposed amendment to the Rastra Bank Act that was recently made public for comments. Guru Prasad Poudel, spokesperson of Nepal Rastra Bank and also the Executive Director of the Payment Systems Department, said that the main objective of the amendment is to slightly broaden the definition of financial institutions. Stating that PSOs and PSPs licensed by the National Bank are also supporting financial transactions like banks, he opined that keeping these institutions within the definition of ‘financial institutions’ would not create any ambiguity, but rather create a more comfortable environment for their work. ‘According to the Basel definition, only commercial banks are banks and other institutions are financial institutions. Internationally, we now need banking, not banks,’ he said. ‘In line with this concept, the definition of financial institutions is being broadened.’ He also said that the draft amendment on taxation would remove the confusion seen in the payment sector and bring uniformity. 

‘There should not be one tax situation when a transaction of the same nature (such as paying for tea) is done through a bank and another when done through a wallet, the new system will clarify this,’ he said, ‘As institutions licensed by the National Bank are very transparent and when they earn profits, the financial system becomes more stable and strong, we believe that it is appropriate to provide some tax concessions or easy arrangements to such institutions.’ However, since the tax rate is the job of the government, he said that further discussions should be held with the concerned bodies on this matter.

According to the amendment made to clause (g) of Article 2 of the draft, an institution that operates a payment system or provides payment services has been defined as a ‘financial institution’. This definition includes a financial holding company, agricultural cooperative, industry or any other financial institution established under the prevailing law for the purpose of providing loans or collecting deposits from the general public, and other institutions that engage in remittance transactions, operate payment systems or provide payment services, and other institutions specified by the Government of Nepal by publishing a notification in the Nepal Gazette on the recommendation of the National Bank.

The current National Bank Act does not mention terms such as financial holding company, payment system operator and payment service provider, and digital bank. After payment service providers have been defined as financial institutions, are they also classified into promoter and public shares like banks? Do the provisions of the Bafia such as promoter share locking apply? There is also confusion on this issue. 

Currently, banks and financial institutions are paying 30 percent income tax and payment service providers are paying 25 percent income tax. Many are curious whether the new definition is an attempt to bring technology-based PSOs/PSPs under the same tax bracket. 

Schedule-1 of the Income Tax Act, 2058 BS has a clear provision that banks and financial institutions should pay 30 percent tax. As mentioned in Sub-section (2) of Section 2 (Regarding Entities) of Schedule-1 of the Act, there is a provision that any bank, financial institution, general insurance business, financial transaction entity, telecommunication and internet service provider, etc. will be taxed at the rate of 30 percent on the taxable income of such entities. Sub-section (1) of the same section of the Act states that the tax rate will be 25 percent in the case of other general entities or companies.

The draft of the amendment to the Nepal Rastra Bank Act is currently in its initial stage and is not final, said Tanka Pandey, spokesperson for the Ministry of Finance. “The ministry has sought opinions and suggestions from stakeholders by making the draft bill public,” he said, “It is currently in the process of consultation. Discussions are being held on the complaints and suggestions received from stakeholders on this issue. The bill will be taken forward by incorporating the suggestions received on provisions such as including PSO and PSP in the definition of financial institutions.' 

Information technology and digital banking expert Vivek Rana emphasizes that some points should be clear in this draft. According to him, although the concept of digital banking is positive, there is no clarity on what the basic rules will be since it is said to do business without physical branches. 'Banks not only deposit, withdraw or send money but also give loans. It is necessary to have a provision in the act to digitally receive documents such as land deeds used as collateral while disbursing loans and make them legally valid,' he said. 'To complete digital banking, the concept of digitally identifiable entity or digitally identified credential must be included. This is being missed.'

Expert Rana mentioned that the draft is silent on the legal coordination of banks and financial institutions and digital banking with non-banking systems such as national identity cards and land revenue systems. He warns that leaving such important matters open without legally addressing them will increase unnecessary disputes and create a loophole for fraud and other incidents. “Leaving space in the Act now for the National Bank to interpret later may be counterproductive,” he said. “If the law is not clear, it weakens the competitive environment and ultimately affects the overall economy.”

Foreign practices

The models for regulating banks and financial institutions and payment service providers (PSPs/PSOs) are different in different countries. In some countries, separate laws and bodies have been made for the payment system, while in some, the central bank oversees everything. In neighboring India, the main regulator for both is the Reserve Bank of India (RBI). For banks, there is the ‘Banking Regulation Act, 1949’, while for the payment system, a separate ‘Payment and Settlement Systems Act, 2007’ has been implemented. Within the RBI, there is the ‘Board for Regulation and Supervision of Payment and Settlement Systems’. It regulates digital payments and wallets. 

In the United States, the central bank called the Federal Reserve oversees the major payment systems, but there are different laws at both the state and federal levels. The Office of the Comptroller of the Currency (OCC) and the Federal Deposit Insurance Corporation (FDIC) regulate banks. Payment providers like PayPal are required to obtain a ‘money transmitter license’ from each state.