Payment andSettlement Systems in India: Challenges Introduction Payment system is considered as one of the majorcomponents of the infrastructure of any modern country. As economy develops andmoves to a sharper growth path, economic transactions among individuals andinstitutions tend to increase rapidly. In order to facilitate thesetransactions smoothly and effectively, there is a need to develop an efficientpayment and settlement system. Modernization of the payment system of anycountry is a necessity to ensure efficiency of the economy in general and thefinancial system in particular. The instruments for payment inIndia have evolved over time from precious metals to currency to cheques andfinally to e-payments. Correspondingly, the payment systems in the country alsoevolved over time, but the changes were more rapid during the last decade,especially from the year 2004 onwards.
These changes were necessary tofacilitate the ever-increasing volume of transactions taking place as a resultof faster economic development in India during the decade. Rapid advances ininformation technology, changes in regulatory framework, setting up of newinstitutions like CCIL, NPCI, etc., have initiated the emergence of new paymentprocesses, products and delivery channels for small as well as large value and’time critical’ payments. The payment system of anycountry, 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 entirecountry.
Such systemic failure of the payment system can hamper effectivenessof monetary policy and adversely affect the real sector. Minimization of systemicrisk is, therefore, a critical challenge facing the regulator. The Central bankin any country is, therefore, keenly involved in promoting a sound andefficient payment system and in initiating appropriate measures to reducepotential systemic risks.
iIn theyear 1999, the Committee on Payment and Settlement Systems of the BIS developedcertain core principles for important payment systems. These principles provideguidelines to improve the efficiency of payment systems to handle the increasingvolumes, and, the value of payment flows both within the country as well as ininternational transactions. Each country,however, has to evolve its own approach and strategies in the design of its ownfabric of the payment system to suit its unique requirements. The present studyaims to analyze the issues involved in ensuring efficiency in the functioningof the payment systems in India in the light of the progress made during thelast two decades, more especially during the recent period. Specificfindings of the study and related suggestions are as follows Findings ? Cheque clearing and ECS paymentsystems are being run on a decentralized basis across several clearinghousesspread throughout India. The cost of processing payment instructions, as a result,is very high. ? In India, NEFT is a centralizedretail electronic payment system which processes one-to-one payments; whereas,ECS is an electronic payment system which processes bulk and repetitive typesof payments. The users of these systems at times get confused due to thesemultiple payment systems delivering the same jobs like in the case of ECSCredit and NEFT.
? At present, the NEFT paymentsystem cannot be used for processing payments that are of urgent/criticalnature on a 24 x 7 real time basis. ? Retail payment systems do nothave any foolproof risk-mitigation mechanism except resorting to ‘unwinding’ incase of failure of any bank in fulfilling its obligation. ? The RTGS system in India adopts apure gross settlement mechanism for funds settlement.
In this mechanism, asbanks are unaware of the incoming credits, it creates strain to manageliquidity requirements to meet the debit obligations on real time basis,resulting in high liquidity costs for the banks. This might result intosettlement risk, in case a bank fails to meet its obligation. ? The Reserve Bank of India ownsand operates the major interbank funds transfer systems, like RTGS, NEFT andNECS, in the country. The said approach termed as ‘Public Service Approach toPayment Systems Development’ is not considered very efficient since a largeshare of fixed costs is absorbed by the Central Bank and the cost recovery isbased on subsidization. In the absence of a domesticprice setter, today Indian banks incur significant costs for affiliation tointernational card associations like VISA/MASTERCARD.
Moreover, in the process,domestic card transactions, which account for more than 90 per cent of thetotal, are routed to switches located outside the country. This, apart fromposing security concerns regarding customer privacy, also results in themigration of valuable foreign exchange. ? As of now, there are no standardsin place for various ‘financial inclusion’ operations and components. As aresult, in spite of the banks agreeing to share their networks, their customerscannot use their smart cards at other banks’ terminals. ? The analysis of relevant data forthe period 1990-91 to 2009-10 for the selected banks indicated that,irrespective of their size, there existed a strong relationship betweenprofitability and technology investment. One bank however stood out of therest. This bank has been able to exploit the power of technology much fasterthan the others. Technology adoption has also led to increased efficiency ofits Payment Systems which is quite evident from the increasing number of RTGSand NEFT transactions emanating from its branches and alternate deliverychannels.
? Taking into consideration theprogress 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 doublingtheir total business. However, two banks expanded their business by 3.5 timesand 4 times respectively. As these two banks had taken steps to provide the maximumbanking services using information technology extensively, they reflected thehighest progress among all the sample banks Both these banks have also recordedsignificant progress in its payment and settlement systems.
? By considering the month-wise volumesand values of RTGS, for the period June 2008 to April 2011 for the selectedbanks, it is observed that the majority of banks covered by the study havecreated enabling features to significantly increase the volume and value oftheir transactions. ? In terms of the month-wiseprogress of NEFT from June 2008 to April 2011, it is seen that all the 20sample banks indicated lower rates of growth in their NEFT volumes and valuesup to June 2009; but they attained higher rates of growth during viithe following period. This trendis due to the stabilization of their NEFT systems by mid-2009, and, these bankswere making sincere efforts to migrate low value payments to NEFT. ? While analyzing the paymentproducts of selected banks, it was observed that banks, which were earlyimplementers of technology (CBS), have also been pioneers in introducing themaximum number of products and services. These banks also had a clear strategyto innovate and market their products.
? Three of the banks in the samplehave created a new business vertical, namely ‘Transaction Banking’, to give athrust to products that involve payment and collection transactions. Thisvertical also states the percentage of the total transactions that havemigrated to electronic mode, and, also sets targets for the next year in itsannual report. ? Currently, there are manifoldchoices and multi-channels for customers to make payments. This has led totremendous complexity of relationships between payment channels (ATM, mobilephone, etc.), payment instruments (credit cards, RTGS, etc.) and customers.Banks are maintaining and servicing these relationships as separate paymentsilos with separate processing entities for each payment method leading toinfrastructure duplication.
Suggestions ? Steps should be initiated towardsconsolidation of the payment processing centers to ensure reduction in cost andeventually achieving economies of scale. NEFT and ECS should be merged into oneand India should eventually move over to an Automated Clearing House (ACH) asis prevalent in the USA (ACH), China (BEPS) and Japan (ZENGIN). This systemshould have the capability of doing one-to-one payments (credit transfers),one-to-many payments (bulk credit transfers), many-to-one payment (bulk debittransfers) and also one-to-one payment (debit transfers). ? In order to make NEFT operate ona 24 x 7 basis, the following model can be adopted : A pre-funded account canbe established which will settle the members’ obligations arising out of theinterbank settlement in NEFT. An interbank settlement viiiat predefined intervals can be carried out on a 24 x 7 basis.
If netdebit caps are reached, settlement of some payments can be deferred till thenext 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 riskin retail payment systems, appropriate steps, similar to the BACS paymentsystem in the UK, need to be taken. In fact, mechanisms, like the soft netdebit caps and the new referral type regression in appropriate circumstances,and, the introduction of the Liquidity Funding and Collateralization Agreementhave been implemented in the BACS.
? To mitigate the settlement riskin RTGS, it may be migrated to a Hybrid System, i.e. either to a Continuous NetSettlement system (like the new CHIPS Payment System in the USA) or to aQueue-Augmented RTGS System (like the RTGS plus system in Germany). The RBI hasalso initiated steps to revamp the current RTGS system by proposing tointroduce technological and liquidity saving features. ? Like in the USA, India shouldgradually migrate to ‘The Competitive Approach to Payment Systems Development’whereby both the public and private sectors own and operate interbank paymentsystems 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 takecare of domestic transactions by creating an INDIACARD, with the rest beinghandled by VISA/MASTERCARD. This will reduce costs and also minimize the valueof interbank liabilities (interchange fees) arising out of the cardtransactions.
? Standards need to be prescribedby an apex level agency for various ‘financial inclusion’ operations andcomponents, as is currently being done for credit and debit cards by VISA andMASTERCARD. This will address the non- interoperability issue. ? Indian banks should exploit thepower of technology smartly/vigorously to increase efficiency of their paymentsystems. They should also constantly focus on ixaugmenting non-interest income through diversification of income streamsby using the payment backbone and introducing new e-payment products andservices. ? Indian banks, in order to givemore thrust to products that involve payment and collection transactions,should create ‘Transaction Banking’ as a separate business vertical. This wouldfurther hasten the transition to electronic mode of payments. ? Banks should create a streamlinedIT architecture like a “Payment Hub”, which will eliminate point-to-pointinterfaces for various payment products. This would allow consolidation ofmultiple payment systems into one centrally managed mid-office payment system,which brings in better efficiency, reduces cost, enables more transparency inprocessing and improves customer service, thereby improving profitability inthe long run.
Scope for Further Research In India, the share of paper-based transactions isstill very high: in terms of volume, it still continues to be 65 per cent. Inthe CBS mode, today it is possible for banks to identify customers who makepaper payments and the purpose thereof. Banks should therefore be able toanalyze and understand the customer payment requirements and habits and workoutappropriate strategies to facilitate their migration to electronic paymentmodes. Further, banks should analyze the feedback of their customers on variouspayment products and services launched by them in the recent past and alsotheir expectations from the banks in the future. The analysis of such datawould not only provide a deeper insight into the expectations of theircustomers but also enable banks to design and deliver tailor-made products –payment solutions – to meet the requirements of their customers.
Similarly, thedominant (almost monopolistic) position of Indian commercial banks over retailpayment systems and services is being increasingly challenged by a variety ofnon-bank payment service providers and products. Indian Banks’ Association maylike to initiate appropriate study to find out the areas where the new serviceproviders are trying to enter and suggest ways and means so that banks maintaintheir lead by continuously innovating new payment methods, products andservices. In the same way, a successful payment model also requires thebuilding up of good bilateral and multilateral partnership arrangements, whichcan leverage on the respective strengths of the stakeholders. Such a study canalso suggest collaborative initiatives, so that both banks and non-banking xfinancial institutions can benefit in the long run.
A clear demarcationof the role of each service provider can also be worked out so that each onehas a level playing arena. xi