- Although paper-based transactions may never be completely eliminated due to the geographic spread of the country and limits of clearing house services, India has moved quickly into e-banking these past years.
- Large business centres now all have magnetic ink character recognition cheque-clearing processes, and the Reserve Bank of India has been instrumental in introducing an electronic clearing service, electronic funds transfer, and the special electronic funds transfer system.
- Credit, debit, and smart cards are also gaining popularity in India, but real-time gross settlement (RTGS) is seen as essential to moving India into full e-banking status.
- RTGS will impact banks' technology, their change and risk management, business practices and new products, and the legal system.
"Once upon a time, to make payments in India, you had to obtain a paper instrument and then send it to the beneficiary - hoping that it would not be lost in transit and/or fraudulently cashed. The beneficiary would then deposit the piece of paper with the banker and obtain payment after a few days. This entire payment process could take anywhere from a few days to a few weeks."
In the coming years, this paragraph may well be read as an extract from "A History of the Payment Systems in India". With the rapid development in the country's electronic payments, paper-based payments may soon become a thing of the past, at least in the major business centres.
Current Payment Environment
The current system of making and receiving payments in India is largely paper-based. The existing environment does not provide for any connectivity between clearing houses at different locations, thereby making it difficult for funds to be transferred across locations. While this is partly addressed through the networks established by the technologically advanced banks, the payments to and from banks continue to be paper-based, requiring manual processing.
The complexities in the Indian environment increase due to the large geographic spread of clearing locations. There are over 10,000 locations where banks have branches, while only about 1,000 locations have formal clearing-house arrangements.
For example, a cheque is drawn on a bank in New Delhi that is received by a beneficiary in Mumbai. The beneficiary needs to deposit the cheque with the banker in Mumbai who then sends it to New Delhi (typically to its branch or to a correspondent bank) for presentation through the clearing house in New Delhi. The physical instrument is sent to the drawee bank and, when the cheque is honoured, funds are transmitted back to the beneficiary through the route adopted for the movement of the cheque. This process requires greater complexity as locations become relatively remote and inaccessible through regular communication and postal channels.
The payment systems in India have substantially evolved in recent years. These changes have had an impact on all types of payments - whether business-to-business or business-to-consumer. From the days of manual clearing operations, all the large business centres now have a magnetic ink character recognition (MICR) clearing process. The Reserve Bank of India (RBI) manages the clearing house at the key business centres and has been at the forefront in driving the initiatives towards a more electronic payment and clearing system.
The first steps taken by the RBI were the introduction of the electronic clearing service (ECS) in the mid-1990s that enabled electronic clearing of low-value, large-volume payments (e.g. dividends). ECS provided a four-day settlement cycle for low-value direct credits and direct debits. However, one of the key challenges to the growth of ECS payments in India has been the degree of automation in the Indian banking industry. While most private sector banks have networked branches with highly automated systems, many other banks have limited automation with little or no inter-branch connectivity. This results in a lack of "last-mile connectivity". While the transactions are processed electronically at the clearing house, they are subsequently processed manually at the beneficiary banks, thereby largely obviating the benefits of an electronic settlement process. In spite of such issues, ECS is now quite popular in India for making large-volume payments, such as dividends.
ECS was followed by the electronic funds transfer (EFT) system. While participation in the EFT system was earlier restricted to state-owned banks, it was subsequently opened up to all banks. The EFT system enables an electronic transfer of funds inter-city and interbank, and is now available for high-value transfers as well (up to INR20m). Recently, the RBI further enhanced the EFT system with the introduction of the special electronic funds transfer (SEFT) system, which is expected to facilitate the migration to T+2 settlement in the securities market. The SEFT scheme provides for banks to define which of their branches will participate in the network, with the prerequisite that these branches be electronically linked with the coordinating branch in Mumbai, where all settlements take place. This system ensures that the beneficiary bank posts credits promptly, as the processing is electronic.
SEFT should address, to a large extent, the issue of last-mile connectivity and is another step in moving India towards a more electronic payments mechanism. The RBI has defined a clear vision for the development of payment systems in the country, and EFT and SEFT are key building blocks for further technological developments.
In addition to payment systems such as EFT and ECS, other payment mechanisms such as credit cards and debit cards are also gaining popularity in India. Many banks have recently started issuing debit cards with developments on smart cards; it is expected that their use will increase rapidly in India.
Key Drivers of Change
The RBI, as the central bank in India, has played a pivotal role in the design and development of integrated and modern payments and settlements systems in the country. The RBI used a three-pronged approach, based on the following:
- Consolidation of the existing payment systems: this has included the strengthening of the MICR cheque-clearing processes and expansion and enhancement of the ECS and EFT services.
- Development of the payment systems: key initiatives include the interconnection of clearing houses through INFINET (Indian Financial Network, a proprietary telecom network), the opening of new clearing houses, and the implementation of systems such as a centralised funds management system (CFMS) and real-time gross settlement (RTGS).
- Integration of the payments and settlements systems: this includes the integration of the various payment products with the systems of individual banks, using the facilities offered by computerisation and networking.
While the RBI has been at the forefront of various developments, there are also several market forces contributing to the development of these payment systems. Electronic payments are cheaper to process on a marginal basis (the fixed costs may be high, however) than manual payments and are also less prone to error. With increasing automation in the Indian banking sector, banks are keen to migrate payments to electronic systems, thereby reducing costs and improving customer service. Also, the Indian market has witnessed an increased penetration of the Internet, which has created greater awareness of the potential for electronic payments and also greater acceptability of e-payments. Businesses have also realised that it is cheaper for them to process electronic payments, as they are able to integrate their systems with the external world and thereby enhance productivity and reduce cost.
The enactment of the Information Technology Act (IT Act) in 2000 has further assisted in legalising electronic transactions and records by providing a legal framework. Coupled with the legal framework, the advances in technology have made more secure technology available to users at a relatively reasonable cost.
Implications of the Emerging Scenario
While the above developments have initiated electronic payments into the Indian payment environment, the one development that will bring about the greatest change will be the implementation of RTGS in the country. An RTGS system will propel India into the top league of nations that have a well-developed payment and clearing system. It will enable immediate settlement between participating banks in a secure and efficient manner. The RBI has already started work on the implementation of an RTGS system and development is in progress.
India is moving rapidly towards a more networked payment system that will enable businesses and consumers to use e-payments for a variety of payments. These developments are expected to radically alter the way businesses and consumers interact.
The emerging scenario will have wide-ranging implications on banking and business in India. Some key areas that will be impacted are detailed below.
Technology and Investments
The implementation of the new payment systems will require significant investments by banks. Given the level of computerisation in the Indian banking industry, several players will need to invest substantially to network their branches as well as to upgrade their banking systems to interface with the external payment systems and benefit from it. Banks that do not invest or are unable to upgrade their technology will be at a significant competitive disadvantage in the market.
Corporates will also be able to benefit from electronic payment systems. Integration of their back-office systems with the bank will enable them to electronically transfer funds to the beneficiaries. This will also require appropriate technical set-ups at the corporate level.
More efficient payment systems will lead to significant changes. These additional payment systems will enable banks to provide value-added products and services to their customers, enabling them to create differentiating products and services. In the Indian scenario, substantial upgrade in technology will also require the training of bank staff on the new payment systems and technologies.
Corporates will need to factor in the truncated payment cycles in their liquidity management process. For all electronic payments, their accounts will be debited much faster than with payments made by cheques.
Legal and Regulatory
While the IT Act in India recognises electronic transactions, there are further changes in Indian law being proposed to facilitate electronic payments and settlements. It will be important for all participants in such electronic payment systems to appreciate the legal and regulatory requirements and ensure adherence to the controls prescribed therein.
Risk Management and Control
Electronic connectivity between clearing houses will enable banks to manage their funds better across locations, besides improving productivity and the use of funds. Also, electronic payment systems such as RTGS will create the need for greater monitoring of the liquidity positions of banks.
Corporates will obtain funds faster than in the current paper-based environment and therefore will be able to improve their receivables management. Businesses will be able to use the new technology to receive funds quicker and make payments more efficiently, thereby lowering their operating costs as well as reducing the possibility of fraud.
Business Practices and New Products
Greater efficiency in the payment systems will result in the loss of float income to banks and this will possibly increase the cost of providing payment services. For corporates, migration to electronic payments will definitely enhance the predictability of cash flows across locations and enable more efficient liquidity management across locations. Taking full advantage of these benefits will be a key challenge for businesses.
The Dawn of a New Era
Will these developments in payments systems in India mean the demise of paper-based payments? It seems unlikely if one goes by the experience in more developed countries where paper-based payments continue to co-exist with advanced electronic payments systems. Also, the large geographic spread of locations in India makes the creation of a pan-India payments infrastructure a complex proposition, and the acceptance of electronic payment mechanisms across all levels of users will take some time. It is therefore quite likely that paper-based payments mechanisms will continue to exist in the Indian market. One thing is certain however - current trends do herald the beginning of a new era in the country's payments systems, and new chapters in the history of payments systems in India will soon be written.
Vikram Aditya is a senior business development manager for global payments and cash management at HSBC, India.
This article was orginally published in "HSBC's Guide to Cash and Treasury Management in Asia Pacific 2004".