Embedded Finance Models: Compliance Considerations

Regulatory Framework for Embedded Payments

Embedded payment solutions such as checkout integrations, subscription billing, and split-payment features fall under a strict regulatory regime in India to ensure safety, transparency, and consumer protection. These solutions are primarily governed by RBI’s Payment Aggregator (PA) Guidelines and other associated legal frameworks, requiring fintech platforms to either obtain a PA licence or partner with a licensed bank or payment aggregator to operate lawfully.

Payment Aggregator (PA) Guidelines

• Licensing Requirement: Platforms facilitating online payments must be registered as Payment Aggregators under RBI’s regulations or operate through partnerships with licensed entities.

• Merchant Due Diligence: RBI mandates thorough KYC and background checks on merchants before onboarding to prevent fraud and money laundering.

• Escrow Account Compliance: All customer funds must flow through regulated escrow accounts, ensuring transparency and secure settlement.

• Data Security Standards: Strict controls on data handling are required, including prohibiting unauthorised access, storage, or misuse of sensitive information.

• Recent Compliance Updates (2025): RBI has introduced enhanced merchant KYC verification in phases, imposed restrictions on card data storage to align with global PCI DSS standards, and tightened the monitoring of fund flows to prevent misuse.

Key Legal Provisions

• Payment and Settlement Systems Act, 2007: This is the foundational law regulating payment systems in India. It sets the legal basis for licensing, operation, and oversight of payment aggregators and ensures the secure and efficient functioning of payment channels.

• RBI Circular on Tokenisation (2023): To enhance payment security, this circular prohibits merchants and payment aggregators from storing sensitive card data. Instead, they must use tokenisation a method that replaces card details with unique tokens to protect consumers from breaches.

• Master Direction on Digital Payment Security Controls: This mandates robust security controls for embedded payment channels, including secure authentication protocols, encryption of payment data, fraud monitoring systems, and periodic security audits.

Embedded Lending and Digital Credit Models

Embedded lending often seen in Buy Now, Pay Later (BNPL) solutions, contextual credit for e-commerce, or small business financing within digital platforms is one of the fastest-growing areas of embedded finance. However, due to the inherent credit risk and consumer protection concerns, this space is governed by strict regulatory norms issued by the Reserve Bank of India (RBI). These regulations ensure that lending remains transparent, accountable, and under the control of regulated financial entities.

Digital Lending Guidelines (2022, updated 2025)

• Regulated Entities Only: According to RBI’s Digital Lending Guidelines, only licensed financial institutions such as banks and Non-Banking Financial Companies (NBFCs) can offer loans. Fintech companies can participate only as Lending Service Providers (LSPs), acting under legally binding agreements with these entities.

• Direct Fund Flow Requirement: All loan disbursements and repayments must occur directly between the borrower’s bank account and the regulated lender’s account. Fintech platforms are strictly prohibited from handling loan funds, which ensures traceability and reduces risks of fraud or misappropriation.

• Mandatory Disclosures: Lenders must clearly disclose the Annual Percentage Rate (APR), including all fees and charges, before loan sanction. This transparency helps consumers make informed borrowing decisions.

• Grievance Redressal and Data Localisation: Every digital lender must set up a grievance redressal mechanism and appoint a nodal officer for consumer complaints. Additionally, all borrower data must be stored and processed in India, complying with RBI’s data localisation directives.

First Loss Default Guarantee (FLDG) Compliance

• Definition and Purpose: FLDG is a risk-sharing arrangement where a fintech company or third party agrees to compensate the lender for a portion of loan losses in case of defaults. It is often used in embedded credit partnerships to make lending more attractive to banks or NBFCs.

• RBI’s Revised Guidelines: Under updated norms (2025), FLDG arrangements are capped as a percentage of the total loan exposure, and such agreements require board-level approval by the regulated lender. This ensures that credit risk remains manageable and is not disproportionately shifted to unregulated entities.

• Restrictions on Risk Transfer: Unregulated fintech platforms cannot assume significant credit risk, as this would blur the line between regulated and unregulated lending activities. The accountability for credit underwriting and risk management must remain with the bank or NBFC.

Outsourcing, API Integration & IT Governance

As embedded finance platforms scale, they often rely on third-party service providers and technology vendors for critical operations like KYC verification, fraud detection, credit scoring, or transaction processing. While outsourcing improves efficiency and innovation, it also introduces regulatory, operational, and cybersecurity risks. To address these, the Reserve Bank of India (RBI) has issued comprehensive guidelines to ensure fintech companies maintain control and accountability over outsourced functions and API integrations.

RBI Outsourcing of IT Services Directions, 2023

• Vendor Due Diligence: Before outsourcing any IT-related activity, fintech companies must thoroughly evaluate third-party vendors for their security posture, regulatory compliance, data protection standards, and operational resilience. This helps prevent vulnerabilities that could lead to data breaches or regulatory violations.

• Contractual Obligations: All outsourcing contracts must include key clauses such as audit rights, breach notification requirements, and termination provisions. These legal safeguards ensure that fintechs retain oversight and can respond promptly to risks.

• Data Segregation & Security: Companies must ensure that customer data shared with vendors is properly segregated, stored securely, and used strictly for the agreed-upon purpose. Unauthorized data access or sharing can lead to legal penalties under the DPDP Act, 2023.

• Exit Strategy: Firms must develop well-defined exit strategies to manage vendor dependency risks. This includes having backup service providers or plans to migrate operations without disruption if a vendor relationship ends.

IT Governance and Risk Controls (2023)

• Board Oversight: The RBI mandates that the board of directors or a designated committee oversee IT governance, including cybersecurity policies, access management, and the overall risk framework. This ensures accountability at the highest level of management.

• Secure Software Development: Companies must implement secure software development life cycles (SDLC) with regular security reviews, code audits, and vulnerability assessments to mitigate risks associated with API and software integration.

• Access Control and Authentication: Strong access controls are mandatory. This includes the use of mutual TLS (mTLS) for secure communication between servers, token-based authentication to verify users and systems, and certificate pinning to prevent man-in-the-middle attacks.

• Encryption and Data Protection: Data in transit and at rest must be encrypted using advanced standards such as AES-256. This not only complies with regulatory expectations but also protects sensitive financial data from breaches or misuse.

Data Privacy and Security Obligations

With embedded finance platforms handling vast volumes of sensitive financial and personal data, data privacy and cybersecurity compliance are among the most critical regulatory priorities. Companies must align their operations with India’s data protection laws and cybersecurity mandates to safeguard consumer information and maintain regulatory trust.

Digital Personal Data Protection Act, 2023 (DPDP Act)

The DPDP Act, 2023 is India’s comprehensive data protection law, setting the foundation for how personal data is collected, processed, stored, and shared. Its key requirements include:

• Consent-Based Data Processing: Platforms must obtain free, informed, and specific consent from users before collecting or using their data.

• Purpose Limitation and Data Minimisation: Data can only be used for the stated purpose during collection and should be limited to what is strictly necessary.

• Obligations for Significant Data Fiduciaries (SDFs): Larger platforms classified as SDFs must appoint a Data Protection Officer (DPO) and conduct regular Data Protection Impact Assessments (DPIAs) to identify and mitigate risks.

• Breach Notification Requirements: In case of a data breach, platforms are legally required to inform the Data Protection Board of India and notify affected individuals promptly. Failure to do so can result in heavy penalties.

These provisions ensure that users retain control over their personal information and that companies maintain high standards of privacy governance.

CERT-In Directions (2022)

Complementing the DPDP Act, the Indian Computer Emergency Response Team (CERT-In) issued mandatory cybersecurity directions to improve incident response and cyber resilience. These include:

• Timely Incident Reporting: All cybersecurity incidents such as data breaches, unauthorised access, or ransomware attacks must be reported within 6 hours of detection.

• Log Retention and Synchronisation: System logs must be retained for at least 180 days and synchronised with Indian Standard Time (IST) to aid in forensic investigations and regulatory audits.

• Third-Party Vendor Compliance: These obligations extend to all embedded service providers and their technology partners, ensuring that the entire data ecosystem follows consistent security practices.

Account Aggregator (AA) Compliance

The Account Aggregator (AA) framework, introduced by the Reserve Bank of India under the NBFC-AA Directions, 2016, is a key pillar of India’s open banking and consent-driven data-sharing ecosystem. It enables customers to securely share their financial information such as bank statements, mutual fund holdings, insurance policies, and tax data with third-party service providers in a fully controlled and transparent manner. For embedded finance platforms, integrating with AA infrastructure allows them to offer personalised credit, wealth management, and financial planning services while remaining compliant with data protection regulations.

NBFC-AA Directions, 2016

• Granular Consent Mechanism: Embedded platforms must ensure that users provide explicit and detailed consent before any financial data is shared. Consent artefacts should clearly mention the purpose of data usage, the type of data being shared, the duration for which access is granted, and the frequency of data retrieval.

• Revocability of Consent: Users must have the right to revoke consent at any time, and once consent is withdrawn, the platform must immediately cease accessing or processing their data.

• Data Security: All financial data exchanged through the AA network must be encrypted end-to-end during transmission and decrypted only by the authorised Financial Information User (FIU). This ensures that sensitive data remains secure and inaccessible to intermediaries or unauthorised parties.

Compliance Best Practices

• Consent Logging and Record-Keeping: Platforms should maintain detailed logs of consent flows, user authorisations, and transaction histories. These records are crucial for demonstrating compliance during regulatory audits and resolving disputes.

• Data Handling Restrictions: Embedded platforms must avoid storing raw credentials, passwords, or sensitive financial data on their systems. Instead, they should use tokenised or anonymised data to minimise security risks.

• Regular Compliance Audits: Periodic internal and external audits should be conducted to ensure ongoing adherence to RBI’s AA framework, the Digital Personal Data Protection Act, 2023, and other data governance laws. This proactive approach helps identify vulnerabilities, ensure transparency, and build customer trust.

Embedded Insurance and Investment Services

As embedded finance grows beyond payments and credit, platforms are increasingly integrating insurance and investment products directly into their digital ecosystems. This creates seamless customer journeys such as purchasing insurance during checkout or investing small amounts directly through an app but it also brings these services under the supervision of sector-specific regulators like the Insurance Regulatory and Development Authority of India (IRDAI) and the Securities and Exchange Board of India (SEBI). Compliance in these domains is crucial to ensure consumer protection, regulatory approval, and operational legitimacy.

IRDAI Guidelines

• Mandatory Registration: Platforms embedding insurance products whether life, health, or general insurance must register with IRDAI under the Insurance Regulatory and Development Authority of India (Registration) Regulations. Depending on their role, they may operate as Corporate Agents, Insurance Brokers, or Web Aggregators. Each registration type has its own eligibility criteria, governance obligations, and operational restrictions.

• Mandatory Disclosures and Consent: Platforms must provide clear product information, including policy features, exclusions, premium structure, and claim procedures. They must also obtain explicit customer consent before policy issuance to ensure transparency and prevent mis-selling.

• Data Protection and Security: Customer information, including sensitive health or financial details, must be handled in compliance with IRDAI data security standards and the Digital Personal Data Protection Act, 2023. Strong encryption, restricted access, and regular audits are mandatory to safeguard personal data.

SEBI Regulations

• Licensing Requirements: Platforms that offer embedded investment services such as micro-investments, SIPs, or mutual fund distribution must be registered with SEBI as Investment Advisors (IAs) or Mutual Fund Distributors (MFDs). These licenses ensure that platforms adhere to suitability assessments, risk profiling, and disclosure norms before offering investment advice or products.

• KYC and Investor Protection Compliance: All entities must comply with the SEBI (KYC Registration Agency) Regulations, 2011, which govern customer onboarding and verification. They must also adhere to SEBI’s Investor Protection Guidelines, which include transparency in fee disclosures, conflict-of-interest management, and grievance redressal mechanisms.

• Ongoing Compliance Obligations: Platforms must maintain detailed records of investor interactions, conduct periodic compliance audits, and submit regular reports to SEBI. Misrepresentation or breach of fiduciary duty can lead to severe penalties, suspension, or cancellation of registration.

Future Regulatory Trends

India’s embedded finance sector is evolving under increasing regulatory scrutiny, with authorities aiming to strengthen consumer protection, enhance system security, and align domestic standards with global best practices. As financial technology continues to expand into critical areas like payments, lending, insurance, and wealth management, compliance expectations will become more stringent and holistic. Companies must anticipate and adapt to these future shifts to remain competitive and avoid regulatory friction.

Enhanced Compliance Expectations

• Payment Security Framework (2026): The Reserve Bank of India (RBI) is set to roll out a new Payment Security Framework effective from April 2026, which will mandate multi-factor authentication (MFA) across all embedded payment channels. This enhanced security layer will significantly reduce fraud risks in online transactions. Additionally, platforms will be required to deploy real-time fraud detection and monitoring systems, including behavioural analytics, transaction risk scoring, and anomaly detection tools. These measures will help strengthen the integrity of digital payment ecosystems and build greater consumer confidence.

• Revised Video-KYC Rules: Future amendments to RBI’s Video-KYC and Aadhaar-based verification guidelines are expected to introduce stricter privacy safeguards, limiting the scope of Aadhaar usage and imposing higher consent requirements. Enhanced standards will likely include improved encryption protocols, stricter verification procedures, and real-time audit trails to ensure data integrity. These changes will increase compliance obligations for platforms offering remote onboarding and digital lending services.

• Global Convergence and Best Practices: India’s regulatory landscape is steadily moving towards global data protection and security standards, inspired by frameworks such as the General Data Protection Regulation (GDPR). To future-proof their operations, fintech companies are encouraged to implement internationally recognised certifications and controls, including:

  • ISO 27001: For establishing robust information security management systems (ISMS).

  • PCI DSS: For ensuring secure handling of payment card data.

  • SOC 2: For demonstrating strong internal controls around data security, availability, and confidentiality.

Conclusion

Embedded finance is transforming how financial services are delivered, offering seamless access to payments, credit, insurance, and investments within everyday platforms. However, this rapid growth also brings heightened regulatory responsibilities. Compliance with key frameworks including those issued by the RBI, SEBI, IRDAI, and the DPDP Act is essential to ensure legal adherence, data security, and consumer protection. By integrating strong governance, robust cybersecurity, and transparent API practices, companies can build a trusted and resilient financial ecosystem.

A proactive approach to compliance does more than meet legal obligations it strengthens customer confidence, reduces regulatory risks, and enhances business credibility. It also helps fintech platforms attract institutional partnerships, expand globally, and innovate without disruption. In today’s evolving financial sector, compliance is no longer a box to check but a strategic advantage that drives sustainable growth and long-term success.

Frequently Asked Questions (FAQs)

Q1. What is embedded finance, and why is compliance so important?

Ans. Embedded finance refers to integrating financial services such as payments, lending, insurance, or investments directly into non-financial platforms like e-commerce websites, ride-hailing apps, or SaaS tools. Compliance is crucial because these services operate within regulated domains governed by RBI, SEBI, IRDAI, and data protection laws. Non-compliance can lead to heavy penalties, license cancellations, reputational damage, and restrictions on operations. It also ensures user protection, secure data handling, and trust in financial ecosystems.

Q2. What regulatory licenses are required to offer embedded payment services?

Ans. Platforms offering embedded payment solutions must either:

• Obtain a Payment Aggregator (PA) license under the Payment and Settlement Systems Act, 2007, or

• Partner with a licensed bank or PA to process transactions.
  They must comply with RBI Payment Aggregator Guidelines, including merchant KYC, escrow account management, card tokenisation, and enhanced transaction monitoring.

Q3. Can fintech platforms offer lending services directly?

Ans. No, only RBI-regulated entities such as banks or NBFCs can lend. Fintechs can partner with them as Lending Service Providers (LSPs) under the Digital Lending Guidelines, 2022. They must ensure transparent APR disclosures, direct fund transfers between lender and borrower, proper grievance redressal, and compliance with FLDG caps and board approvals if risk-sharing arrangements are involved.

Q4. How does the Digital Personal Data Protection Act, 2023 impact embedded finance?

Ans. The DPDP Act, 2023 governs how personal and financial data is collected, processed, and shared. Platforms must obtain explicit consent, limit data usage to the stated purpose, and adopt data minimisation practices. They must notify the Data Protection Board and affected users in the event of a breach. Significant Data Fiduciaries (SDFs) also need to appoint a DPO and conduct Data Protection Impact Assessments (DPIAs). Non-compliance can attract penalties up to ₹250 crore.

Q5. What are the compliance requirements for Account Aggregator (AA)-based data sharing?

Ans. Under the NBFC-AA Directions, 2016, AA-based models require:

• Granular consent artefacts specifying data type, purpose, duration, and frequency.

• End-to-end encryption with decryption only by the Financial Information User (FIU).

• Consent revocability, allowing users to withdraw permissions anytime.
  Platforms must also maintain detailed consent logs and avoid storing raw credentials to ensure compliance with RBI and DPDP norms.

Q6. Are there cybersecurity and incident reporting obligations for embedded finance platforms?

Ans. Yes. Under the CERT-In Directions (2022), fintech platforms must:

• Report cybersecurity incidents within 6 hours of detection.

• Retain system logs for at least 180 days.

• Synchronise logs with Indian Standard Time (IST).
  Additionally, they should implement MFA, conduct regular vulnerability testing, and maintain a Disaster Recovery Plan (DRP) to ensure business continuity and regulatory compliance.

Q7. What future regulatory changes should fintechs prepare for?

Ans. Key upcoming changes include:

• Enhanced Payment Security Framework (April 2026): Mandatory advanced authentication and fraud monitoring.

• Stricter FLDG rules: More transparent risk-sharing and provisioning requirements.

• Updated Video-KYC and Aadhaar guidelines: Stronger privacy safeguards and consent-driven verification.

• Global alignment: Increasing emphasis on GDPR-like principles and compliance with ISO 27001, PCI DSS, and SOC 2 standards.

Q8. What are the penalties for non-compliance in embedded finance?

Ans. Penalties vary based on the regulation breached. For instance:

• Violations under the DPDP Act can attract fines up to ₹250 crore.

• Non-compliance with RBI lending guidelines can lead to license revocation or business restrictions.

• Breach of CERT-In directions can result in penalties under the IT Act, 2000.
  Moreover, reputational damage and loss of customer trust can significantly impact business continuity.