Payment the payment systems in the country also evolved

Payment and
Settlement Systems in India: Challenges






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Payment system is considered as one of the major
components of the infrastructure of any modern country. As economy develops and
moves to a sharper growth path, economic transactions among individuals and
institutions tend to increase rapidly. In order to facilitate these
transactions smoothly and effectively, there is a need to develop an efficient
payment and settlement system. Modernization of the payment system of any
country is a necessity to ensure efficiency of the economy in general and the
financial system in particular.


The instruments for payment in
India have evolved over time from precious metals to currency to cheques and
finally to e-payments. Correspondingly, the payment systems in the country also
evolved over time, but the changes were more rapid during the last decade,
especially from the year 2004 onwards. These changes were necessary to
facilitate the ever-increasing volume of transactions taking place as a result
of faster economic development in India during the decade. Rapid advances in
information technology, changes in regulatory framework, setting up of new
institutions like CCIL, NPCI, etc., have initiated the emergence of new payment
processes, products and delivery channels for small as well as large value and
‘time critical’ payments.


The payment system of any
country, though advanced and sophisticated, does face various risks, viz. bank failures, frauds,
counter-party failures, etc. Such eventualities may trigger a chain-reaction,
which might ultimately result in disruption of the payment system of the entire
country. Such systemic failure of the payment system can hamper effectiveness
of monetary policy and adversely affect the real sector. Minimization of systemic
risk is, therefore, a critical challenge facing the regulator. The Central bank
in any country is, therefore, keenly involved in promoting a sound and
efficient payment system and in initiating appropriate measures to reduce
potential systemic risks.







In the
year 1999, the Committee on Payment and Settlement Systems of the BIS developed
certain core principles for important payment systems. These principles provide
guidelines to improve the efficiency of payment systems to handle the increasing
volumes, and, the value of payment flows both within the country as well as in
international transactions. Each country,
however, has to evolve its own approach and strategies in the design of its own
fabric of the payment system to suit its unique requirements. The present study
aims to analyze the issues involved in ensuring efficiency in the functioning
of the payment systems in India in the light of the progress made during the
last two decades, more especially during the recent period.



findings of the study and related suggestions are as follows




Cheque clearing and ECS payment
systems are being run on a decentralized basis across several clearinghouses
spread throughout India. The cost of processing payment instructions, as a result,
is very high.


In India, NEFT is a centralized
retail electronic payment system which processes one-to-one payments; whereas,
ECS is an electronic payment system which processes bulk and repetitive types
of payments. The users of these systems at times get confused due to these
multiple payment systems delivering the same jobs like in the case of ECS
Credit and NEFT.


At present, the NEFT payment
system cannot be used for processing payments that are of urgent/critical
nature on a 24 x 7 real time basis.


Retail payment systems do not
have any foolproof risk-mitigation mechanism except resorting to ‘unwinding’ in
case of failure of any bank in fulfilling its obligation.


The RTGS system in India adopts a
pure gross settlement mechanism for funds settlement. In this mechanism, as
banks are unaware of the incoming credits, it creates strain to manage
liquidity requirements to meet the debit obligations on real time basis,
resulting in high liquidity costs for the banks. This might result into
settlement risk, in case a bank fails to meet its obligation.


The Reserve Bank of India owns
and operates the major interbank funds transfer systems, like RTGS, NEFT and
NECS, in the country. The said approach termed as ‘Public Service Approach to
Payment Systems Development’ is not considered very efficient since a large
share of fixed costs is absorbed by the Central Bank and the cost recovery is
based on subsidization.


In the absence of a domestic
price setter, today Indian banks incur significant costs for affiliation to
international card associations like VISA/MASTERCARD. Moreover, in the process,
domestic card transactions, which account for more than 90 per cent of the
total, are routed to switches located outside the country. This, apart from
posing security concerns regarding customer privacy, also results in the
migration of valuable foreign exchange.


As of now, there are no standards
in place for various ‘financial inclusion’ operations and components. As a
result, in spite of the banks agreeing to share their networks, their customers
cannot use their smart cards at other banks’ terminals.


The analysis of relevant data for
the period 1990-91 to 2009-10 for the selected banks indicated that,
irrespective of their size, there existed a strong relationship between
profitability and technology investment. One bank however stood out of the
rest. This bank has been able to exploit the power of technology much faster
than the others. Technology adoption has also led to increased efficiency of
its Payment Systems which is quite evident from the increasing number of RTGS
and NEFT transactions emanating from its branches and alternate delivery


Taking into consideration the
progress of the selected banks in the year 2009-10 over the base year 2005-06,
it was observed that all the sample banks were successful in more than doubling
their total business. However, two banks expanded their business by 3.5 times
and 4 times respectively. As these two banks had taken steps to provide the maximum
banking services using information technology extensively, they reflected the
highest progress among all the sample banks Both these banks have also recorded
significant progress in its payment and settlement systems.


By considering the month-wise volumes
and values of RTGS, for the period June 2008 to April 2011 for the selected
banks, it is observed that the majority of banks covered by the study have
created enabling features to significantly increase the volume and value of
their transactions.


In terms of the month-wise
progress of NEFT from June 2008 to April 2011, it is seen that all the 20
sample banks indicated lower rates of growth in their NEFT volumes and values
up to June 2009; but they attained higher rates of growth during



the following period. This trend
is due to the stabilization of their NEFT systems by mid-2009, and, these banks
were making sincere efforts to migrate low value payments to NEFT.


While analyzing the payment
products of selected banks, it was observed that banks, which were early
implementers of technology (CBS), have also been pioneers in introducing the
maximum number of products and services. These banks also had a clear strategy
to innovate and market their products.


Three of the banks in the sample
have created a new business vertical, namely ‘Transaction Banking’, to give a
thrust to products that involve payment and collection transactions. This
vertical also states the percentage of the total transactions that have
migrated to electronic mode, and, also sets targets for the next year in its
annual report.


Currently, there are manifold
choices and multi-channels for customers to make payments. This has led to
tremendous complexity of relationships between payment channels (ATM, mobile
phone, etc.), payment instruments (credit cards, RTGS, etc.) and customers.
Banks are maintaining and servicing these relationships as separate payment
silos with separate processing entities for each payment method leading to
infrastructure duplication.




Steps should be initiated towards
consolidation of the payment processing centers to ensure reduction in cost and
eventually achieving economies of scale. NEFT and ECS should be merged into one
and India should eventually move over to an Automated Clearing House (ACH) as
is prevalent in the USA (ACH), China (BEPS) and Japan (ZENGIN). This system
should have the capability of doing one-to-one payments (credit transfers),
one-to-many payments (bulk credit transfers), many-to-one payment (bulk debit
transfers) and also one-to-one payment (debit transfers).




In order to make NEFT operate on
a 24 x 7 basis, the following model can be adopted : A pre-funded account can
be established which will settle the members’ obligations arising out of the
interbank settlement in NEFT. An interbank settlement




at predefined intervals can be carried out on a 24 x 7 basis. If net
debit caps are reached, settlement of some payments can be deferred till the
next cycle.


Leads may also be taken from the operations of ‘Faster Payment Service’
in the UK which is a 24 x 7 running payment system.


To mitigate the settlement risk
in retail payment systems, appropriate steps, similar to the BACS payment
system in the UK, need to be taken. In fact, mechanisms, like the soft net
debit caps and the new referral type regression in appropriate circumstances,
and, the introduction of the Liquidity Funding and Collateralization Agreement
have been implemented in the BACS.


To mitigate the settlement risk
in RTGS, it may be migrated to a Hybrid System, i.e. either to a Continuous Net
Settlement system (like the new CHIPS Payment System in the USA) or to a
Queue-Augmented RTGS System (like the RTGS plus system in Germany). The RBI has
also initiated steps to revamp the current RTGS system by proposing to
introduce technological and liquidity saving features.


Like in the USA, India should
gradually migrate to ‘The Competitive Approach to Payment Systems Development’
whereby both the public and private sectors own and operate interbank payment
systems so that cost recovery is fully taken care of.


A national payment Point of Sale
(POS) switch using the IDRBT’s INFINET network should be established to take
care of domestic transactions by creating an INDIACARD, with the rest being
handled by VISA/MASTERCARD. This will reduce costs and also minimize the value
of interbank liabilities (interchange fees) arising out of the card


Standards need to be prescribed
by an apex level agency for various ‘financial inclusion’ operations and
components, as is currently being done for credit and debit cards by VISA and
MASTERCARD. This will address the non- interoperability issue.


Indian banks should exploit the
power of technology smartly/vigorously to increase efficiency of their payment
systems. They should also constantly focus on






augmenting non-interest income through diversification of income streams
by using the payment backbone and introducing new e-payment products and


Indian banks, in order to give
more thrust to products that involve payment and collection transactions,
should create ‘Transaction Banking’ as a separate business vertical. This would
further hasten the transition to electronic mode of payments.


Banks should create a streamlined
IT architecture like a “Payment Hub”, which will eliminate point-to-point
interfaces for various payment products. This would allow consolidation of
multiple payment systems into one centrally managed mid-office payment system,
which brings in better efficiency, reduces cost, enables more transparency in
processing and improves customer service, thereby improving profitability in
the long run.


Scope for Further Research


In India, the share of paper-based transactions is
still very high: in terms of volume, it still continues to be 65 per cent. In
the CBS mode, today it is possible for banks to identify customers who make
paper payments and the purpose thereof. Banks should therefore be able to
analyze and understand the customer payment requirements and habits and workout
appropriate strategies to facilitate their migration to electronic payment
modes. Further, banks should analyze the feedback of their customers on various
payment products and services launched by them in the recent past and also
their expectations from the banks in the future. The analysis of such data
would not only provide a deeper insight into the expectations of their
customers but also enable banks to design and deliver tailor-made products –
payment solutions – to meet the requirements of their customers. Similarly, the
dominant (almost monopolistic) position of Indian commercial banks over retail
payment systems and services is being increasingly challenged by a variety of
non-bank payment service providers and products. Indian Banks’ Association may
like to initiate appropriate study to find out the areas where the new service
providers are trying to enter and suggest ways and means so that banks maintain
their lead by continuously innovating new payment methods, products and
services. In the same way, a successful payment model also requires the
building up of good bilateral and multilateral partnership arrangements, which
can leverage on the respective strengths of the stakeholders. Such a study can
also suggest collaborative initiatives, so that both banks and non-banking




financial institutions can benefit in the long run. A clear demarcation
of the role of each service provider can also be worked out so that each one
has a level playing arena.