RBI’s Forex Mechanism: Bold Leap into Financial Evolution

[By Runjhun Sharma]

The author is a student of Dr. Ram Manohar Lohiya National Law University.



Indian commercial landscape has encountered a wide array of variations throughout the entire course of this decade. Regulatory authorities face the challenge of ensuring smooth transitions and efficient transactions amidst increased accessibility to financial services and digitization of the economy To underpin this assertion, the author highlights the shift in the approach of market regulators over the decade.  The Securities and Exchange Board of India (SEBI) has permitted the Association of Mutual Funds to govern the functioning of Mutual Fund Distributors since the early 2000s. Insurance Regulatory and Development Authority of India introduced a set of guidelines to govern ‘Bima Vahaks, which is an insurance distribution channel. The Reserve Bank of India (RBI) rationalized the licensing framework by introducing multiple licenses for entities engaging in foreign exchange (Forex) services, back in 2006. In a fashion similar to other market regulators, the RBI, very recently, introduced a Draft Licensing Framework for Authorised Persons (APs) to rehaul the existing forex framework. In the said framework, it intends to delegate the task of governing a novel entity, Forex Correspondent (FxC), to Authorised-Dealer Category I (AD-Cat I) and Authorised-Dealer Category II (AD-Cat II) entities. AD-Cat entities are authorized dealers licensed by the RBI under Section 10(1) of the Foreign Exchange and Management Act, 1999 (FEMA) to deal with foreign exchange transactions. The said framework will be discussed in detail in this piece. Hence, it is well-established by the aforesaid instances that regulatory authorities are switching to a self-regulatory approach from a direct regulatory one. 

Need of the Draft Licensing Framework 

The recent framework introduced by the RBI was a much-warranted move, in light of the de-concentration of financial services, which has led to inclusivity in the access to such services. The increased usage of these services has resulted in a regulatory burden for the RBI and posed hindrances to efficient governance. With regard to the aforesaid, the financial regulator is compelled to look for additional modes of governance to streamline the provision of financial licensing services. The Draft Framework by RBI intends to expand the scope of services provided by AD-Cat entities and ease the eligibility criteria to engage in forex services. This move goes a long way to instill inclusivity for forex service providers and mitigate the load of governance of forex transactions. 

Comparative Review of the Draft Framework with the Existing Mechanism 

The major highlight of the Draft Framework is the introduction of  FxCs. FxCs are a category of money changer entities that are in an agency arrangement with AD-Cat entities. The transactions undertaken by them will be reflected in the books of the AD-Cat banks. The rationale behind the introduction of this novel entity seems to facilitate the accessibility of forex to general masses, businesses and tourists while ensuring checks and balances. Another motivation for this move may be that the majority of forex transactions do not necessitate the involvement of the RBI and take place at the level of APs. Under Section 10(1) of FEMA, AD-Cat banks are required to secure a license from the RBI to engage in forex transactions. However, in light of the agent-principal relationship between FxCs and AD-Cat banks, FxCs will not be required to secure separate licensing from the RBI and they will be able to deal in forex transactions. Before the introduction of the said Draft Framework, the licensing framework of the RBI sought to authorize entities that may deal in forex as: APs and Full-Fledged Money Changers (FFMCs). The authorization granted was exclusive to the aforesaid entities allowed to deal in forex transactions.  

In the extant framework, an AD-Cat II license is initially granted for a period of one year, followed by subsequent renewal of license for one to five years. However, the Draft Framework does away with the specified timelines and introduces renewal of AD-Cat II licenses on a perpetual basis, conditional upon fulfillment of the revised eligibility criteria. This move comes in the face of promoting ease of doing business in transactions involving forex.  

The Draft Framework is also seen as relatively liberal, which is evidenced from the expansive definition of ‘annual forex turnover’. It has outlined a comprehensive interpretation of “annual forex turnover,” encompassing the total sum of foreign currency notes, coins, and travelers’ checks acquired from or dispensed to the public, including transactions conducted through agents or franchisees, as well as the total value of remittances facilitated throughout the fiscal year. The criteria for annual forex turnover in the Draft Framework is most suitable as it excludes the turnover of Financial Year 2020-21 and 2021-22 to compute the ‘annual forex turnover’. This is so because the aforesaid years saw a striking decline in revenue generation and turnover in light of the impact of the pandemic. The concept of ‘annual forex turnover’ is of relevance as it provides a basis for determining whether a money changer entity should be deemed an FxC or AD-Cat entity. 

Coming to the disclosure requirements and compliances for an FxC in the novel Draft, it is noteworthy that the financial regulator has proposed stringent disclosure requirements to make the mechanism watertight. The rationale behind this seems to be the complex nature of forex transactions which poses multiple apprehensions, including Anti-Money Laundering concerns. The disclosure requirements for an FxC are more or less similar to that of a Business Correspondent, with additional requirements of a Banker’s Report and a No Objection Certificate (NOC) from the Enforcement Directorate. Furthermore, since the permission to engage in forex dealings to all the outlets of FxCs is to be granted by the principal Authorised Dealer (AD) under the FxC Agreement, the said AD will be liable for the actions of the FxC. This is also underpinned by the relationship of agency between the principal AD and the FxC. Hence, the aforesaid provisions sufficiently highlight the fact that the RBI has opted to assuage the regulatory burden upon itself and strengthen the self-regulation of the said entities. 

The Draft Framework is also praiseworthy in terms of its apparent adaptability in the dynamic market landscape. The Draft proposes a flexible arrangement for AD-Cat entities and FFMCs to make transition from the extant framework. It provides sufficient discretion to the concerned entities to make strategic choices suitable for their functioning. The efforts of the RBI to ensure a framework as flexible as possible to ensure maximum compliance is admirable.  

A pre-existing FFMC, demonstrating an average annual forex turnover exceeding ₹50 crores in the past two fiscal years, has two options. The initial option entails pursuing an upgrade to AD Category-II, contingent upon fulfilling the updated eligibility standards. Alternatively, the FFMC can opt for voluntarily transition to FxC under the Forex Correspondent Scheme by relinquishing its current license. This determination must be reached either by the expiration date of the existing authorization or within two years from the introduction of the new framework, whichever occurs later. 

Entities with an annual forex turnover below ₹50 crores, whether they are FFMCs or AD Category-II entities, are presented with a simplified option. They can choose to convert voluntarily to FxC by adhering to the Forex Correspondent Scheme, without needing to fulfill the stricter eligibility criteria for AD Category-II. The transition period for this group aligns with the overall timeline, ensuring a coordinated implementation of the new framework. Moreover, all existing FFMCs must either upgrade to AD Category-II or transition into a FxC under the Foreign Correspondent Scheme within two years from the date of enforcement of the new framework or the expiration of their authorization, whichever is later.  

Throughout this transitional period, the current regulatory directives applicable to FFMCs will remain in effect. Additionally, the revised framework eliminates the requirement for prior approval from the RBI for tie-up arrangements between Money Transfer Service Scheme Indian Agents and Overseas Principals. AD Cat-I and AD Cat-II entities are now permitted to operate as “MTSS Indian Agents” and are obligated to inform the Foreign Exchange Department of the RBI within 30 days of entering into such arrangements. 

Way Forward 

The RBI’s Draft Framework signals a commitment to enhancing forex transaction efficiency. The revisions show adaptability to evolving banking needs, emphasizing self-regulation for timely transactions. Introducing FxCs reduces RBI’s regulatory burden, allowing focus on critical monitoring. The comprehensive ‘annual forex turnover’ definition reflects thoughtful deliberation in crafting the framework. Furthermore, concerns regarding any shortfalls can be disposed off by a robust monitoring and evaluation mechanism, including regular reviews and feedback loops, to assess the framework’s effectiveness in achieving its objectives. Concurrently, investing in capacity building initiatives for AD-Cat entities and FxCs will enhance their understanding of risk management. Leveraging technology solutions such as blockchain, AI, and data analytics will enhance transparency, security, and efficiency in forex transactions, aligning with regulatory objectives and industry best practices. Additionally, aligning the framework with international best practices and standards will promote interoperability, facilitate cross-border transactions, and enhance the global competitiveness of Indian forex services providers. As we comprehend this transition, the empowerment of the concerned financial entities by foreseeing the requirements of the financial market and preparing the groundwork for a foreign exchange landscape that is more effective, flexible, and user-centric.  

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