PAYMENT SYSTEMS IN INDIA – AN OVERVIEW

EVOLUTION OF PAYMENT SYSTEMS IN INDIA

While cash transactions still account for a sizeable volume of payment transactions
in the country, the non-cash modes of payment are gaining wider increase in
volumes. Until the early 1990s, payment transactions in India and their settlement
process were predominantly paper-based to include cheques, drafts, Payment
Orders, ‘At Par’ Cheques (Interest / dividend warrants, refund orders, gift cheques
etc which were payable at any city without application of a discount factor). The
statutory basis for these instruments was provided by the Negotiable Instruments
Act, 1881 (NI Act). Therefore, the payments process has been facilitated by evolving
appropriate institutional arrangements. The dominant feature of the Indian Banking
system is its large geographic spread and branch-centered banking. The vast
network of branches implies that the logistics of collection and delivery of paper
payment instruments becomes formidable. And this significant aspect of our Banking
structure has always been taken into consideration while evolving other payment
systems features and products.

The milestones in the evolution of payment systems in India are detailed below:

The CLEARING SYSTEM in India provides a convenient and well-
established institutional mechanism to take care of the problem of physical
delivery of instruments as well as funds transfer between different banks.

Computerisation of clearing operations was the first major step towards
modernisation of the payments system.

The next important milestone was mechanization of the clearing operations
with the introduction of Magnetic Ink Character Recognition (MICR) based
cheque processing technology (in 1986) using High Speed Reader Sorter
Systems (HSRS).

The Computerised Cheque Clearing Process has been further consolidated
through the introduction of magnetic media based input settlement as an

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 intermediate step towards complete automation of cheque clearing through
MICR processing especially to facilitate the high-value and inter-bank
clearing.

Greyscale Imaging Technology has been introduced (in 2000) as a value
added service to the members of the Clearing Houses in some cities which
will serve as a forerunner for the introduction of electronic presentment and
cheque truncation.

The Electronic Clearing Service (ECS) was introduced (in 1994) whereby a
series of electronic payment instructions are generated to replace paper
instruments to meet the requirement of a cost-effective system which would
serve as an alternate method of effecting bulk, low value, recurring payment
transactions, thereby obviating the need to issue and handle paper
instruments.

Another development that took place in the payments system scenario was
the introduction of the Electronic Funds Transfer Scheme (in 1998) which is
a retail funds transfer system and enables an account holder of a bank to
transfer funds to another person having an account with any of the
participating banks, without any physical movement of instruments from one
center to another.

Centralised Funds Management System (CFMS) – was introduced (in
2002) to facilitate better funds management by account holders with RBI by
providing on-line consolidated information about their transactions / balances
across accounts maintained with Deposit Accounts Departments in different
offices.

Negotiated Dealing System / Securities Settlement System - NDS/SSS –
was developed (in 2002) as a system to provide an electronic platform for
trading and reporting of transactions in government securities market and to
facilitate settlement of these transactions through the delivery versus payment
mechanism.

Clearing of Forex transactions – was instituted (in 2002) as a system to
provide net settlement arrangement for forex transactions between members /

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 entities in the foreign exchange market in the country. The process of settling
only net obligations reduced the liquidity requirements of foreign currency,
sought to reduce transaction costs (SWIFT related) and also take care of
settlement related risks since the mechanism was facilitated by guaranteed
settlement through central counter party arrangement of the Clearing
Corporation of India.

Real Time Gross Settlement (RTGS) System – was introduced (in 2004) to
facilitate predominantly the settlement of inter-bank payments on a real-time
and gross basis so as to reduce the incidence of risks in the payment
systems.

ROLE OF RBI IN PAYMENT SYSTEMS

The Reserve Bank of India participates in the payment systems as a user of the
system, as the service provider for various components of the systems and is also
the regulator of the systems in many instances.

As a user, the RBI submits instruments for clearing in the cheque-based clearing
operations. RBI also participates as an user in the ECS and EFT systems for making
its own internal payments to its employees, vendor payments etc. Similarly, RBI
transactions in Repo / Reverse Repo under LAF, Open Market Operations etc.,
would also be settled through the respective components of payment systems.

As a provider of payment system services, the RBI has taken many initiatives as
can be seen under the evolution of payment systems in the country in the
development and operationalisation of the systems. Under this, the clearing houses
and ECS systems are managed by the RBI at 16 and 15 centres respectively and
EFT systems are completely managed by RBI at the 15 centres. The CFMS,
NDS/SSS and RTGS systems have been fully developed, operationalised and
maintained by RBI. Besides the above, RBI (through IDRBT) has also provided the

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communication back bone to the financial system in the country in the form of
INFINET (Indian Financial Network).

By way of being the central bank, the RBI derives regulatory powers in certain
jurisdictions of payment systems. However, specific oversight powers for payment
systems for RBI is sought to be obtained through appropriate legislation in the form
of the Payment Systems Legislation and the setting of Board for Payment and
Settlement Systems.

ORGANISATION STRUCTURE

Moving from a technology-based solution towards issues of Payment and Settlement

systems, the Reserve Bank of India has adopted a holistic approach, in which
Information Technology is an integral component. In order to usher in and establish
a modern, robust payments and settlement system consistent with international best
practices, the Reserve Bank has adopted a three-pronged strategy of Consolidation
of existing Payment Systems, Development of Payment Systems and Integration of
the Payment and Settlement System.

In order to drive this Payment System reform process an institutional framework

and structure has been created within the Reserve Bank. The base layer of this
structure consisted of the Payment Systems Group, which included an exclusive
team of inter-disciplinary professionals representing IT, Banking Operations,
Supervision, Legal, Economics, Government & Bank Accounts, and Foreign
Exchange operations. The Group focused on the System Design of an integrated
payments system, Payment Instruments, Electronic Banking systems, Clearing and
settlement arrangements, technological infrastructure, legal issues, Monetary Policy
implications, Change management and responsibilities of banks. The Group was
disbanded in December 2002.

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The next tier in the institutional framework is the Payment Systems Advisory
Committee which is a permanent body and oversees the operations of the Payment
Systems Group and reviews the developments in the area of Payment Systems.

The apex layer in the institutional structure is the National Payments Council. The
council lays down the broad policy framework and guidelines for the implementation
of a sound and efficient payments and settlement system for the country. The NPC
is chaired by the Deputy Governor in charge of the Department of Information
Technology and represented by the Executive Director-in-Charge of the Department
of Information Technology, Chairman of the Indian Banks Association, Joint
Secretary, Banking Division, Ministry of Finance, Chairmen and Managing Directors
of two Public Sector banks, one Private bank, a Nonbanking financial company,
Securities Exchange Board of India and the National Stock Exchange. The National
Payments Council is assisted by five permanent Task Forces, each of which is
headed by a member of the National Payments Council and comprises of a few
experts appointed by the Chairman from different disciplines / institutions. It is
assisted by the respective Head of the Department concerned within the Reserve
Bank. These are the:
· Task Force on Monetary Policy and related issues;
· Task Force on Payment and Settlement Systems Oversight;
· Task Force on Legal Issues;
· Task Force on Technology Related Issues;
· Task Force on Systems and Procedures related issues.

LEGAL FRAMEWORK

The Negotiable Instruments Act, 1881 (N. I. Act) continues to be the predominant
legal base for all cheque-based (instrument-based) payment systems in India. The
latest amendments to the definition of cheque in NI Act by inclusion of the “electronic
image of a truncated cheque” and a “cheque in the electronic form” have opened up
avenues for introducing new methods of processing paper-based payment

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instruments. Enactment of the Information Technology Act, 2000, and further
amendments to it making it applicable to N.I. Act, has brought about legal status to
usage of electronics-based payment systems in Indian banking. The security
features to be adopted by any electronic payment system has also been
standardized by providing legal recognition to PKI-based security through the IT Act,
2000.

The cheque-based clearing systems are governed by the provisions contained in the
Uniform Regulations and Rules for Bankers’ Clearing Houses. These rules are
contractual in nature. Similarly, the electronic payment systems like ECS, EFT, NDS,
RTGS, etc. work on the basis of agreements made specifically for each one of them
which are contractual in nature between the participant and the manager of the
systems. The process of netting of payables and receivables is adopted by all
payment systems except RTGS where the settlement is on gross basis. Existing
legal structure does not explicitly cover ‘netting’ and ‘finality of settlement’. The
proposed Payment Systems legislation for the country aims to provide legal basis for
settlement by way of netting as well as for finality of settlement under various
systems, besides being the highest in the hierarchy of legislations in the country
pertaining to financial transactions.

OVERSIGHT ARRANGEMENTS

Continuous efforts are being made by the Bank to ensure that the systems operated
by it are complying with the requirements of the core principles – both in case of
already existing payments systems and the ones being introduced newly. Broadly,
the RBI derives its regulatory and supervisory powers over the banking system
through the provisions of Banking Regulation Act, 1949.

With the enactment of IT Act, 2000 amendments were carried out to Sec 58 (2) (pp)
of the RBI Act, 1934 entrusting RBI with the powers of regulation of fund transfer
through electronic means between banks and other financial institutions, including

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laying down of the conditions subject to which banks and other financial institutions
shall participate in such fund transfers, the manner of such fund transfers and the
rights and obligations of the participants in such fund transfers.

Board for Payment and Settlement System (BPSS) - The Reserve Bank of India
has on March 10, 2005 constituted a Board for Regulation and Supervision of
Payment and Settlement Systems (BPSS) as a Committee of its Central Board,
as per the Reserve Bank of India (Board for Regulation and Supervision of Payment
and Settlement Systems) Regulations, 2005 which were notified in the Gazette of
India dated February 18, 2005. The BPSS has come into effect from the same
date and will have tenure of two years. The BPSS has been constituted with the
following members:
• Shri Y.V.Reddy, Governor - Chairman
• Shri V Leeladhar, Deputy Governor -Vice Chairman
• Smt K J Udeshi, Deputy Governor - Member
• Smt S Gopinath Deputy Governor - Member
• Shri H P Ranina Central Board Member - Member
• Shri N R Narayanamurthy Central Board Member - Member

The Executive Directors in charge of the functions relating to payment systems and
financial markets and the Principal Legal Advisor are permanent invitees to BPSS. In
addition, Shri P S Shenoy, who has recently demitted office as the Chairman and
Managing Director of Bank of Baroda and has vast experience in the filed of
payment systems, will also be a permanent invitee. The BPSS will prescribe
policies relating to the regulation and supervision of all types of payment and
settlement systems, set standards for existing and future systems, authorise the
payment and settlement systems, determine criteria for membership to these
systems, including continuation, termination and rejection of membership. The
National Payments Council (NPC) set up in 1999 will continue to exist as an
advisory body to BPSS. In order to assist BPSS in performing its functions, the
Reserve Bank has also constituted a new department, the Department of Payment

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and Settlement Systems (DPSS).

The mandate for the BPSS includes:

Laying down policies for regulation and supervision of the payment and
settlement systems, both electronic and non-electronic systems as well as
domestic and cross-border systems

Laying down the standards for both existing and future payment and
settlement systems

Determining the criteria for access to membership, continuance of
membership, removal from membership as well as denial of membership of
entities to the various payment and settlement systems

Fixing and administering penalties for violation of rules/guidelines/directions

Pending the enactment of the Payment and Settlement Systems Act, the
BPSS will create the necessary administrative structure within the existing
rules and regulations for ensuring the effective regulation and supervision of
the payment and settlement systems.

Department of Payment and Settlement Systems (DPSS)

As decided by the Central Board a new department named the Department for
Payment and Settlement Systems (DPSS) has been constituted within the
Bank. The DPSS commenced its functioning from March 07, 2005. The Department
will function under the guidance of Deputy Governor Shri V. Leeladhar and Executive
Director Dr. R.B. Barman. A.P. Hota, Chief General Manager has taken charge of
DPSS. Created by carving out certain functions of the present Department of
Information Technology (DIT), DPSS would initially operate at the central office level.
The functions of the DPSS will include:

Formulation of payment and settlement system policies,

Regulation of payment and settlement systems,

Supervision of payment and settlement systems,

Implementation of the Core Principles relating to payment systems (as
enunciated by the Bank for International Settlements)

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Laying down standards for payment and settlement systems:

Functioning as the secretariat to the BPSS

Performing activities related to the National Payments Council (NPC) and the
Payment System Advisory Committee (PSAC)

Designing, developing and integrating systemically important payment system
projects and / or facilitating such implementations

Monitoring the operations of payment and settlement systems.

Acting as the nodal department for interaction with the Government (Ministry
of Finance and the Ministry of Communications and Information Technology),
banks and financial institutions, other central banks and the Bank for
International Settlements on payment and settlement systems related issues.

The DPSS would also be responsible for regulation and oversight on the Payment
and Settlement Systems which encompass the Cheque-based clearing systems
managed by the Reserve Bank and other commercial banks, Electronic Clearing
Service (ECS), Electronic Funds Transfer (EFT), the inter-institutional government
securities clearing, the inter-bank foreign exchange clearing as also the Real Time
Gross Settlements (RTGS). DPSS would not be directly involved in supervising the
market participants. The supervisors concerned will provide DPSS with all information
required for purposes of administering issues relating to the participation of supervised
entities in the system. The National Clearing Cells (NCCs) will assist DPSS in the
Regional Offices for other functions until further instructions. The participants in each
one of these systems would continue to be supervised by the respective supervisory
department, such as, all commercial banks would be supervised by Department of
Banking Supervision (DBS), co-operative banks by National Bank for Agriculture and
Rural Development (NABARD), urban banks by Urban Banks Department (UBD)
and Clearing Corporation of India Limited (CCIL) and Primary Dealers by Internal
Debt Management Department (IDMD).

(Prepared by Smt.C.S.Kar, Member of Faculty, RBSC)

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