Unmasking AML Threats: UPI & BNPL in India’s Digital Banking Revolution

The fintech landscape in India has transformed dramatically, with digital payments projected to grow from $3 trillion to an estimated $10 trillion by 2026. This revolution is primarily driven by the Unified Payments Interface (UPI), which now boasts over 500 million active users and processes nearly 19.5 billion transactions monthly as of July 2025.

While we celebrate these advancements, a darker reality demands our attention. Despite impressive growth, India's digital fraud losses have surged from ₹276 crore in 2022-23 to an alarming ₹1,457 crore in 2023-24. The Buy Now Pay Later (BNPL) sector in India, projected to reach $21.95 billion in 2025, presents particular challenges as it grew 21% in six months, outpacing global benchmarks. In fact, money laundering alone costs the global economy nearly 5% of its GDP – over $2 trillion annually.

In this article, we'll examine how to prevent money laundering in India's evolving digital payment ecosystem, particularly focusing on UPI and BNPL services. We'll explore the complex AML risks, regulatory frameworks, and technological solutions that fintech companies must implement to ensure compliance and security in this rapidly evolving landscape.

Understanding AML in the Context of UPI and BNPL

Anti-money laundering (AML) refers to a comprehensive framework of laws, regulations, and procedures designed to identify individuals involved in disguising illegally obtained funds as legitimate income. As digital financial services expand, AML has become increasingly crucial for maintaining the integrity of India's financial system.

What is AML, and why does it matter in digital finance

AML compliance isn't merely a regulatory checkbox—it's the cornerstone of financial system security. For fintech companies, robust AML practices build customer trust, attract institutional partners, and satisfy regulatory requirements. Furthermore, these measures help prevent illegal activities on digital platforms, ensuring companies operate within legal boundaries.

The stakes are exceptionally high in India's booming digital economy. With UPI transactions reaching unprecedented volumes, financial criminals are exploiting security gaps. Money laundering undermines public trust in digital payment platforms, erodes investor confidence, and potentially finances illicit activities like organized crime and terrorism.

How UPI and BNPL models introduce new AML risks

The BNPL market is experiencing explosive growth, with global customers expected to make retail purchases worth INR 8438.05 billion in 2021—up from INR 2025.13 billion in 2020. However, this rapid expansion creates unique vulnerabilities.

BNPL services present distinct money laundering risks due to:

• Minimal upfront verification and lax identity checks

• Open-format loan mechanics with lighter credit scrutiny

• Regulatory ambiguity around classification (NBFC, lender, or e-commerce facilitator)

• High-velocity digital onboarding with minimal friction

Similarly, UPI's rapid growth has outpaced regulatory frameworks. Cybercriminals exploit technical weaknesses in the UPI system through phishing, SIM-swap attacks, and spoofing. The sheer volume of online transactions makes suspicious activity detection extremely challenging.

The fintech India report's perspective on compliance gaps

According to recent findings, digital fraud losses in India reached ₹276 crore in 2022-23 and surged to ₹1,457 crore in 2023-24. These numbers highlight significant compliance gaps across the ecosystem.

The RBI has already taken action, including barring Paytm from onboarding new customers due to KYC and AML compliance failures in 2022. Additionally, several crypto exchanges faced Enforcement Directorate scrutiny for inadequate transaction monitoring and failure to report suspicious transactions.

Most notably, the RBI formed a working group for digital lending oversight and prohibited BNPL for wallet refills—signaling heightened regulatory vigilance. The introduction of Digital Lending Guidelines marks a turning point, holding platforms to rigorous standards of accountability and responsible lending.

BNPL Credit Risks and Fraud Vectors

BNPL services present unique credit risks that can facilitate money laundering in India's digital payment ecosystem. These risks stem primarily from the streamlined lending process that prioritizes convenience over thorough verification.

Soft credit checks and default risks

Unlike traditional lenders, BNPL providers typically perform soft credit inquiries that don't impact credit scores, allowing approval even for applicants with minimal credit history. This creates significant exposure to default risk, as borrowers with subprime or deep subprime credit scores account for 61% of BNPL originations. Moreover, the lack of comprehensive reporting to credit bureaus means other creditors remain unaware of a consumer's outstanding BNPL obligations, potentially enabling loan stacking across multiple platforms.

Account takeovers and chargeback scams

Among the most prevalent BNPL fraud vectors are account takeovers (ATOs), where criminals compromise legitimate user accounts through credential stuffing, phishing, or SIM swapping. Once inside, fraudsters can make large purchases while the genuine user remains unaware for weeks. Equally concerning are chargeback scams, where dishonest customers claim they never made a transaction and request refunds, forcing BNPL providers to cover chargeback costs and processing fees.

How to stop money laundering in BNPL transactions

To combat these threats, BNPL providers must implement comprehensive AML procedures beginning with robust identity verification at transaction initiation. Effective strategies include:

• Monitoring IP addresses and tracking unusual login patterns

• Implementing biometric verification with liveness detection for high-risk users

• Utilizing real-time transaction monitoring to identify suspicious patterns

• Establishing protocols for addressing first payment defaults

Use of alternate data for credit profiling

Given that many BNPL users lack traditional credit histories, alternate data has become essential for accurate risk assessment. This non-conventional information includes utility bills, telecom payments, social media activity, and spending behaviors. Research indicates that integrating alternative data into credit assessment models can enhance their predictive capabilities by 5-20%. This approach creates opportunities to increase credit access for customers with thin or no credit files, while maintaining appropriate risk controls.

KYC, CDD, and Regulatory Compliance Challenges

Regulatory compliance presents significant challenges for digital payment providers in India's evolving fintech landscape. The complex regulatory framework requires careful navigation to maintain operational integrity while preventing financial crimes.

Know Your Customer (KYC) and Customer Due Diligence (CDD)

KYC forms the foundation of AML frameworks, specifically focusing on verifying identities before establishing business relationships. Without robust KYC systems, AML controls are substantially weakened as risk identification begins with customer profiling. CDD extends beyond basic identification to include understanding transaction patterns, assessing risks, and monitoring suspicious activities. For fintech platforms, this means implementing comprehensive processes that balance user experience with regulatory requirements.

RBI's digital lending and PPI guidelines

The RBI has progressively increased oversight over digital lending, especially regarding consumer protection and transparency. Key provisions include ensuring lending occurs in the regulated entity's name, with all disbursals flowing directly between borrower and lender accounts without third-party involvement. For Prepaid Payment Instruments (PPIs), the Master Direction mandates that all issuers comply with KYC/AML/CFT guidelines, maintain transaction logs, and file Suspicious Transaction Reports to FIU-IND.

AML reporting obligations for fintechs and NBFCs

Financial institutions must submit Cash Transaction Reports (CTR) by the 15th of each succeeding month and Suspicious Transaction Reports (STR) within 7 days of identifying suspicious activity. The Principal Officer bears responsibility for timely submissions, maintaining utmost confidentiality. NBFCs must preserve transaction records for at least ten years to allow reconstruction of individual transactions if needed for prosecuting criminal activity.

Prevent money laundering through tiered risk-based KYC

Implementing a risk-based approach enables institutions to adjust due diligence based on customer risk levels. This strategic allocation of resources allows:

• Low-risk customers receiving basic verification

• Medium-risk customers undergoing standard checks

• High-risk individuals are facing enhanced scrutiny, including source of funds verification

Consequently, organizations can balance compliance costs with effective risk mitigation through tailored monitoring systems.

Technology and Partnerships for AML Resilience

Advanced technology serves as the cornerstone for combating financial crime in today's digital banking ecosystem. In this section, I'll explore how technological innovations strengthen AML compliance in UPI and BNPL services.

Role of AI and ML in anomaly detection

Artificial Intelligence fundamentally transforms how suspicious activities are identified. Machine learning algorithms analyze vast datasets to detect patterns that traditional rule-based systems would miss, reducing false positives by up to 38%. Accordingly, 72% of compliance professionals now employ analytics and AI to enhance their procedures. These systems offer:

• Real-time transaction monitoring that flags suspicious activities instantly

• Continuous learning from historical data to predict normal behavior

• Automated alert prioritization based on contextual risk

Third-party partnerships to scale AML tools

RegTech platforms provide sophisticated compliance capabilities without extensive in-house development. These partnerships automate KYC processes, transaction monitoring, and regulatory reporting while reducing compliance costs by approximately 30%. Rather than building from scratch, fintechs can leverage established solutions that maintain regulatory currency.

System standardization and data analytics

Standardized systems enable seamless integration of AML tools across organizational silos. Data visualization techniques, including link analysis, geospatial mapping, and network visualization help uncover hidden relationships among entities. Primarily, these tools transform complex datasets into actionable intelligence.

Embedding privacy by design in AML systems

AML systems must simultaneously respect data privacy laws while fulfilling compliance obligations—a complex balancing act. Technologies like homomorphic encryption enable compliance checks without exposing personal data, satisfying both DPDP requirements and AML mandates.

Conclusion

The rapid growth of UPI and BNPL services marks a significant milestone in India's digital banking evolution. Still, this expansion brings substantial money laundering risks that demand immediate attention. Digital fraud losses have skyrocketed from ₹276 crore to ₹1,457 crore in just one year; therefore, financial institutions must strengthen their defenses accordingly.

Throughout this article, we explored how soft credit checks, account takeovers, and chargeback scams create vulnerabilities within the BNPL ecosystem. Additionally, UPI's massive transaction volumes make suspicious activity detection increasingly difficult. The RBI has already demonstrated its commitment to addressing these issues through stricter regulations and enforcement actions against non-compliant entities.

Effective AML strategies begin with robust KYC and CDD processes tailored to risk levels. Consequently, financial institutions must implement tiered approaches that balance customer experience with security requirements. AI and machine learning technologies stand as powerful allies in this battle, reducing false positives while enhancing real-time detection capabilities.

Third-party partnerships offer another viable solution for organizations seeking to scale their AML tools without extensive in-house development. These collaborations can reduce compliance costs while ensuring regulatory compliance. System standardization, coupled with advanced data analytics, helps transform complex information into actionable intelligence.

Last but certainly not least, privacy-by-design principles must underpin all AML systems. Technologies like homomorphic encryption allow compliance checks without compromising personal data protection.

The future of India's digital payment ecosystem depends on our ability to balance innovation with security. Financial institutions that adopt comprehensive AML frameworks will not only comply with regulations but also build lasting customer trust. Though challenges remain significant, the combination of regulatory vigilance, technological advancement, and industry collaboration provides a clear path toward a safer digital banking environment for all Indians.

Key Takeaways

India's digital payment revolution brings unprecedented growth alongside alarming AML risks that demand immediate action from fintech companies and regulators.

• Digital fraud losses surged 428% in one year - from ₹276 crore to ₹1,457 crore, highlighting critical security gaps in UPI and BNPL systems.

• BNPL's soft credit checks create money laundering vulnerabilities through minimal verification, account takeovers, and chargeback scams that criminals exploit.

• Risk-based KYC implementation is essential - tiered approaches balance customer experience with security while meeting RBI's stricter compliance requirements.

• AI and ML reduce false positives by 38% while enabling real-time suspicious activity detection across high-volume digital transactions.

• Third-party RegTech partnerships cut compliance costs by 30% and provide scalable AML solutions without extensive in-house development.

The combination of regulatory vigilance, advanced technology, and industry collaboration offers a clear pathway to securing India's digital banking future while maintaining innovation momentum.