“The power of the future is the power of the mind.” - Winston Churchill

Payment and Settlement Systems in India

1. Background and History

The history of the payment system can be said to be virtually co-terminus with the evolution of money. The earliest form of payment system could perhaps be traced back to the pre-historic days of barter trade when the settlement of consideration took place through exchange of conch shells, goods, cattle and later commodities. Such a system, in the absence of money as a medium of exchange, was obviously very cumbersome due to highly improbable ‘coincidence of wants’ of the two parties to a barter transaction. Subsequently, more formalized payment instruments, such as coins, developed. The earliest payment instruments known to have been used in India were coins, which were either punch-marked or cast in silver and copper; even leather is known to have been used for making coins. Thus, with the advent of institutionalized forms of money, initially in the form of coins and later as paper money, the barter trade withered away and the usage of currency became the order of the day. With the further advancement of monetary system and growth of economies the transactions grew complex and a need for replacement of currency by other payment instruments became the order of the day. In the eighties and nineties the emerging world economies started opening up to each other resulting in even more complex nature of financial settlement which cleared the way for electronic settlements to take over the manual ones. The enormity of transactions brought about the challenge of mitigating systemic risk which finally resulted in the birth of Real Time Gross Settlement and other payment and settlement Systems.

2. Emergence of Paper Money and Cheques.

Paper money, in the modern sense, has its origin in India in the late 18th century with the note issues of private banks as well as semi-government banks. Amongst the earliest issues were those by the Bank of Hindustan, which was the first joint stock bank established in 1770, the General Bank in Bengal and Bihar, and the Bengal Bank. Later, with the establishment of three Presidency Banks since 1809, the work of issuing notes was taken over by them and each Presidency Bank had the right to issue notes within certain limits. The private banks and the Presidency Banks introduced other payment instruments in the Indian money market and Cheques were introduced by the Bank of Hindustan. Buying and selling bills of exchange became one of the items of business to be conducted by the Bank of Bengal from 1839. The Paper Currency Act of 1861 conferred upon the

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Government of India the monopoly of Note Issue, thus, bringing to an end the note issues of private and Presidency Banks. In 1881, the Negotiable Instruments Act (NI Act) was enacted, formalizing the usage and characteristics of instruments like the cheque, the bill of exchange and promissory note. The NI Act provided a legal framework for non-cash, paper payment instruments in India and continues to be an operative legislation even today.

While the modern cheques came into being in India only in the 19th century, it is noteworthy that India had pioneered the use of non-cash based payment systems long ago, which established themselves as strong mechanism for the conduct of trade and business. The most important form of credit instrument that evolved in India was termed as ‘Hundis’ and their use was reportedly known since the twelfth century. Hundis were used as instruments of remittance, credit and trade transactions, and were of various types, each type with its own unique features.

3. Evolution of Clearing Houses and MICR based Clearing

With the steady rise in volumes of trade and commerce and the growing confidence of the public in the usage of cheques, etc., there was also rapid growth in the payment transactions using these instruments. With the development of the banking system and higher volume of cheques used, the need for an organised cheque clearing process emerged amongst the banks. Clearing associations were formed by the banks in the Presidency towns and the final settlement between member banks was effected by means of cheques drawn upon the Presidency Banks. With the setting up of the Imperial Bank in 1921, settlement was done through cheques drawn on that bank. After the establishment of the RBI in 1935, the Clearing Houses in the Presidency towns were taken over by the RBI, and continued with it for more than five decades.

It is noteworthy that the volume of paper-based clearing we handle is the sixth largest in the world.

4. Clearing House Regulations

The bankers’ clearing houses constitute the critical nodes in the entire payment system of the country and their efficient and orderly functioning is crucial for a robust payment system. However, prior to 1986, there were no formal regulations and rules governing the transaction of business in the clearing houses and each clearing house had its own rules and regulations, based on local conventions and convenience. Hence, in case of disputes, resolution of the problem proved to be difficult. In 1986, therefore, the Reserve Bank formulated a set of guidelines known as the Uniform Regulations and Rules (URR) for

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the Bankers' Clearing Houses, so as to harmonize, across the country, the framework governing the conduct of the clearing houses. These guidelines had also become necessary in the backdrop of increasing computerization in the banking industry and the consequential changes in the functioning of the clearing houses. The Regulations have since been adopted individually by the general body of each clearing house in the country. Individual clearing houses are free to frame their own rules consistent with the broad framework provided by the Regulations. The Uniform Rules and Regulations represent a significant step forward in providing a formal institutional framework for the payment system in the country.

5. MAGNETIC INK CHARACTER RECOGNITION (MICR) BASED CLEARING

The solution was the introduction of Magnetic Ink Character Recognition (MICR) based mechanized cheque processing technology. The existing cheques had to be redesigned incorporating a MICR codeline4 which could be read by document processing machines called reader-sorters. The RBI introduced two types of reader-sorters - the Medium Speed Reader Sorters, capable of processing 300 instruments per minute for Inter-city instruments and the High Speed Reader Sorter Systems (HSRS) with speeds of 2400 documents per minute, for the clearing of local instruments. Driven by mainframe computers the HSRS systems were the state of- the-art systems available at that time. These were installed in Mumbai (1986) followed by Chennai, New Delhi, (1987) and Calcutta(1989). By the middle of 1989 MICR cheque clearing operations in the four metropolitan cities had become fully operational and stabilized. 3 Several committees of the Reserve Bank recognized the importance of reforms in the clearing systems and underscored the need for computerization on a priority basis. (See Annexure for details). 4 MICR Code line contains basic cheque information in designated fields for data capture and mechanical sorting of the cheques. The code line is both pre-printed and later encoded using special MICR ink, using standardized E13B Font.

In the wake of financial sector reforms, the maturing of the banking system and the rising volume of paper-based clearing, the RBI has now adopted a policy stance of moving away from the actual management of retail payment and settlement systems. Thus, for a few years now, the task of setting up new MICR-based cheques-processing centers has been delegated to the commercial banks. The management of clearing houses also stands decentralized to a large extent and in many cities and towns, the commercial banks have been entrusted with the management of the bankers’ clearing houses.

Just to provide an overview, there are 1089 Bankers’ Clearing Houses operating in India, of which 1036 are managed by State Bank of India and its Associates, 17 by the Reserve Bank, and the remaining 36 by 12 nationalized banks. The mechanized cheques processing using MICR technology (Magnetic Ink Character Recognition) is now available at 60 locations and six more locations are being upgraded with this technology. Thus, the

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computerized clearing houses numbering 915 (including the 60 MICR centers), account for 84 per cent of the total number of clearing houses in the country. This demonstrates that our payment system has indeed made remarkable progress during the last two decades, with ongoing adoption and up-gradation of technology.

6. CLEARING HOUSE INSTITUTIONAL FRAMEWORK

6(1).INTER-BANK CLEARING:

Inter-bank payments are usually settled among banks by issuing cheques drawn on their accounts with Reserve Bank of India. This practice resulted in a large number of cheques being presented to Deposit Accounts Department (DAD) of the Reserve Bank, leading to heavy work pressures throughout the day. It was therefore, decided to start a separate Inter-bank clearing. In the Inter-bank clearing banks no longer use the RBI cheques to settle their claims against each other. Instead, they use their own Bankers Cheques. The settlement is carried out through Floppy Based input statements, submitted to the Clearing House. The pay orders are however, dropped in the designated receptacles, from where they are collected by banks' representatives. Since there is no return for these instruments, the credit / debit are instantaneous.

Inter-bank clearing is used by banks mainly for four types of transactions: call money transactions, Rupee payment of foreign currency transactions, Bank to Bank transfers for funding upcountry requirements and Inward remittances. Inter-bank clearing was introduced in Chennai in April 1989, followed by Mumbai, Calcutta and New Delhi. This clearing which is basically a debit clearing has been converted into a credit clearing at Chennai from 1996 onwards. Instead of bankers' cheques, banks generate credit advices using software provided to them by the Reserve Bank and settlement is effected at the Clearing House on the basis of the consolidation of the credit data furnished by all the member banks. This has been rendered possible due to computerization of all the service branches in Chennai.

Computerization of service branches which accompanied the computerization of the clearing houses (both MICR and Floppy based) at banking centers with large volumes of business has resulted in the creation of a base for the introduction of automated clearing operations at other centres. This has also enabled the introduction of electronic payments services on an experimental basis so that future expansion of these services using the clearing infrastructure is possible. However, there is a lot of scope for developing backward and forward linkages to fully utilise the advantage of the item-wise data base created by the MICR cheque processing.

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6(2).INTER-CITY CLEARING :

The four metropolitan centers viz., Mumbai, New Delhi, Calcutta and Chennai are covered by two way inter-city clearing. The other offices of the RBI are connected with these four centers under one way inter-city clearing. Under this system, inter-city cheques drawn on any of the metropolitan centers are processed at the MICR clearing and are sent to the drawee centre by postal courier where they are integrated with the local clearing of that centre. This National Clearing has sharply reduced the time taken for realization of these cheques.

6(3).REGIONAL GRID CLEARING OPERATIONS :

As a logical step towards extension of Inter-city clearing at all the major cities, a regional grid clearing was introduced in a small way. Important commercial centers/district headquarters in a region were connected for one way clearing with the nearest MICR centre. Thus, cities such as Coimbatore, Madurai, and Pondicherry were linked to Chennai, Pune and Vadodara to Mumbai, Asansol and Jamshedpur to Calcutta etc. The benefits of reduced time for inter-city clearing were thus extended to such cities too.

6(4).CLEARING HOUSES MANAGED BY THE RBI :

The settlement operations in all non-MICR based clearing centres managed by the RBI viz., the clearing houses at Ahmedabad, Kanpur, Bangalore, Hyderabad, Nagpur, Patna, Jaipur, Thiruvananthapuram, Guwahati and Bhubaneshwar were also computerised by the introduction of a magnetic media based input settlement software package, developed in-house. The clearing data from the banks aggregated as receivables, are submitted in floppies to the clearing house and settlement is carried out.

The magnetic media based input settlement represents an intermediate step towards complete automation of cheque clearing through MICR processing and enables banks and the clearing house to get accustomed to a computerised environment. The system has been in operation for nearly four years and is functioning satisfactorily. It covers presentation clearing, return clearing, High Value/High Value return clearings and inter-bank clearing but does not cover inter-city clearing.

6(5).HIGH VALUE CLEARING:

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High value clearing is a value added service. In this clearing select branches located in a central business/commercial area and in the vicinity of the Clearing House/Service Branches of banks present instruments with a face value of Rs.100,000/- and above deposited by their customers within a specified cut-off time, to the clearing house. The instruments are dropped into the respective receptacles of the drawee banks and settlement is carried out through floppy based input statement. The return clearing is held before close of banking hours on the same day. In 1994, the total value of instruments presented in this clearing at the 4 metros was Rs.522,871 crores. By 1997, this had gone up to Rs.949,502 crores. (1 crore is equivalent to 10 million).

High value clearing enables a customer who deposits a cheque on day 1 to withdraw the amount on day 2 itself, provided, there is no return. High value clearing is therefore, faster compared to regular MICR clearing where credit is afforded on Day 2 and withdrawals are permitted on Day 3, after the Return discipline cycle is completed. High value clearing was first introduced in Chennai in April 1989, and was then extended to Mumbai, Calcutta and New Delhi respectively. It has since been extended to Ahmedabad, Bangalore, Hyderabad, Jaipur and Kanpur. The 5 remaining RBI managed clearing centres are likely to introduce high value clearing shortly.

7. COMPUTERIZATION OF CLEARING AND SETTLEMENT OPERATIONS

Computerization of clearing operations was the first major step towards modernization of the payments system3. The introduction of technology for clearing operations began with the setting up of 'Claim Based Settlement System' using Microprocessor based computer systems at Mumbai, Chennai and Delhi, in the early eighties. These systems were used for generating settlement reports on the basis of input statements containing the aggregate value of (cheques presented) claims of one bank over the other banks in the clearing house. Clearing balancing and settlement, which used to take a long time due to differences and errors in manual balancing, were reduced, apart from providing accuracy in the final settlement.

The next important milestone was fully automating the clearing operations. The rapid growth of cheque volumes in the eighties made the task of manual sorting and listing a very difficult task. Banks were unable to cope with the huge volume of cheques which had to be physically handled prior to their presentation in the clearing house. Though the clearing settlement became easy because of computerization, the heavy volumes of paper that had to be processed introduced delays in presentation, resulting in delayed credit to the customers. The growth in the volumes could therefore, be managed only by mechanization of the entire clearing process.

8. EMERGENCE AND OBJECTIVES OF THE PAYMENT SYSTEM

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A monograph on Payment Systems in India was prepared by the RBI in 1998 to increase the awareness, both within the country and abroad, of the payment systems existing in India. The monograph also detailed the objectives that needed to be achieved. To that end, a Payment System Vision Document for 2001-04 was prepared to draw up the roadmap for consolidation, development and integration of payment systems in the country. Once these objectives were achieved, a Vision Document for 2005–08 was published in May 2005, articulating the Reserve Bank’s vision for the coming four years for the payment and settlement area. The mission enshrined in the Vision Document is the establishment of safe, secure, sound and efficient payment and settlement systems for the country, towards which all the up gradation efforts are focused. Whereas safety in payment and settlement systems relates to risk reduction measures, security pertains to confidence in the integrity of the payment systems. All payment systems are envisaged to be on sound footing with adequate legal backing for operational procedures and transparency norms. The Principle of Safe Secured Sound and efficient Payment and Settlement System is a Core BASEL requirement to prevent Systemic Risk. Efficiency enhancements are envisaged by leveraging the benefits of technology for cost-effective solutions. Thus, as part of its public policy objectives, the Reserve Bank has played a major role in the design, development and functioning of payment and settlement systems, and the multidimensional efforts of the RBI over the years have been geared to realize this vision.

9. MICR AND ELECTRONIC CLEARING

9(1).DETAIL GUIDELINES REGARDING MICR ENCODERS

MICR CHEQUE ENCODER is a table top machine which can print the coded particulars of cheques and other instruments in magnetic ink in the 5/8” read band in the specified position. A conventional encoder of standalone type has a keyboard, a programmable journal printer and a MICR cassette/ribbon typewriter. The machine can simultaneously with encoding, endorse on the reverse of the instrument, a fixed or variable stamp i.e. clearing stamp of the presenting bank/branch. The encoder can, during encoding, proof the pay-in-slip amount or the control total by marking off successive amounts of encoded cheques thus arriving at a zero balance when all the cheques are encoded, bringing out during the process any discrepancy in the totals or wrong encoding, if any. The encoder should have facility to encode all the five fields or any of the fields desired to be completed by pressing the relevant functional keys and by keying in the digital information i.e. the code number of the field concerned. There should also be a provision to automatically endorse the clearing stamp on the reverse, simultaneously with the

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encoding. In addition, it should be possible to skip the encoding or endorsement when needed, say when amount field is already encoded and the instrument is being represented.

There should be a provision for multiple positioning of endorsement on the reverse to take care of such cases. At the end of encoding each lot of cheques, the encoder should have facility to encode the branch-wise Batch Ticket for the number and amount of cheques in the lot and ultimately the Block Ticket prepared for the bank as a whole on the basis of the cumulated batch values of instruments presented by a bank.

Initially, when MICR technology was introduced at the four metropolitan centers a decade ago, banks had installed stand alone encoder machines without PC interface. Presently, however, the technology has advanced and encoders with P.C. interface are available, by use of which additional data including the information of pay-in-slip can be entered so that full outward clearing information could be taken on the P.C. at the branch for balancing of outward clearing and also for further processing of the data so captured for accounting purposes. MICR Readers are available with PC interface for capturing the preprinted information in the MICR code line to save on data entry and also ensuring accuracy. Recently, MICR Reader-cum-Encoders have also come in the market, using which it is possible to capture the 27 data of the pre-printed fields in the MICR code line and supplement the information with data entry as also encoding of the instruments simultaneously. This will enable balancing of the outward clearing and also building up the data base on cheques presented for subsequent use say for posting of the ledgers, etc. Encoding of the instruments could be done simultaneously or later on by encoding the instruments at one go (power encoding) on the basis of the data file. The type of encoder to be purchased by a member bank would, therefore, depend upon the existing and proposed level of computerization in the branches/ Service Branch where the encoders are to be located.

Depending upon the total volume of the cheques presented in clearing and the volume handled at the individual branches, encoders may have to be installed at the

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Service Branch to encode cheques centrally or having encoders also at some branches having adequate volume so that the cheques could be encoded at the branches and the completed batches could be forwarded to Service Branch for presentation. The banks will have to take their own decision on whether to encode cheques centrally or decentralize encoding work, fully or partly, depending upon the cheque volume, space and organizational availability. Necessary guidance in this regard could also be obtained by the banks from their Service Branch at any of the existing MICR centers.

Presently, some MICR Document Encoders are manufactured / assembled locally. Several companies are also supplying imported MICR Document Encoders/Readers/ Reader-cum-Encoders with PC interface. M/s APLAB Industries Ltd., M/s Bradma India Ltd., M/s Kores India Ltd., M/s NCR Corporation (India) Pvt., Ltd.,M/s Tata Infotech Ltd., etc., are some of the companies who supply such equipments. The list is only indicative and not exhaustive, there could be more such suppliers. For further information and guidelines for procurement, the member banks are advised to get in touch with their Service Branches at the four metropolitan cities or their Computer Policy and Planning Department.

The encoders, being computer peripherals, need dust free environment. Suitable site preparation, power connection, air-conditioning, etc., may have to be provided in consultation with the suppliers of the machines. Encoder operation, being quite simple, the existing staff could handle the work with minimum training. The vendors supply the necessary operation manuals along with the equipment and also provide training to the operators. They also provide post-warranty maintenance of the machines.

The quality of encoding is crucial to the MICR cheque processing system since bad quality encoding or use of sub-standard MICR ribbon could lead to large number of rejects during machine processing of the instruments at the MICR centres. This, apart from increasing the workload at the cheque processing centre, could also lead to errors in reading/data correction resulting in avoidable clearing differences. It is, therefore, necessary that the encoders are placed in clean environment and are serviced by vendors regularly. The quality of the MICR ribbon used on the encoder machines is also another important factor. The bank should procure good quality MICR ribbons. The ribbons have a

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limited shelf life and hence should not be procured in bulk and also should be stored properly in dust free environment. The banks should peruse the Reject Analysis Report furnished by the MICR Cheque Processing Centre regularly and take prompt corrective action.

9(2).Electronic Payments through MICR

Cheque is still being predominantly used as an important instrument of cashless paper based mode of payment and, therefore, sustaining and promoting efficiency in this system for clearing and settlement of cheques assumes importance. During 2008-09, six new MICR cheque processing centres (Belgaum, Bhavnagar, Jamnagar, Kota, Tirunelveli and Anand) were opened. At present there are 71 MICR-CPCs functioning in the country. At centres where setting up of MICR-CPC was not found to be viable, the settlement operations have been computerised (1064 clearing houses) so that the settlement is done electronically even though the instruments still continue to be sorted manually. So far, operations of more than 99.3 per cent of the total number of 1138 Clearing Houses in the country have been computerised. The year 2008-09 registered a decline of 5.0 per cent in the volume and 3.0 per cent in the value of MICR transactions. This decline could be attributed to shift to electronic modes of payment and general slowdown in the economy.

Payment System Indicators - Annual Turnover

Item Volume (000s) Value (Rupees crore)

2005-06 2006-07 2007-08 2008-09 2005-06 2006-07 2007-08 2008-09

1 2 3 4 5 6 7 8 9

Others                

1. MICR Clearing 10,15,912 11,25,373 12,01,045 11,40,492 44,92,943 54,01,429 60,28,672 58,49,642

2. Non-MICR Clearing

2,54,922 2,23,177 2,37,600 2,33,566 18,54,763 16,06,990 18,67,376 20,60,893

3. Retail Electronic Clearing

83,241 1,48,997 2,18,800 2,80,610 1,06,598 1,86,160 9,71,485 4,16,419

4. Cards 2,01,772 2,29,713 3,16,509 3,87,215 39,783 49,533 70,506 83,903

Total Others (5 to 8) 15,55,847 17,27,260 19,73,954 20,41,883 64,94,087 72,44,112 89,38,039 84,10,857

          (1.8) (1.8) (1.9) (1.6

9(3).Reserve Bank’s initiatives for electronic payments and banking :

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As part of its public policy objective of promoting a safe , secure , sound and efficient payment system , the Reserve Bank has taken several initiatives to develop and promote electronic payments infrastructure. Towards this end, the RBI introduced the Electronic Clearing Service (ECS) and the Electronic Funds Transfer (EFT) system in 1995, the Real Time Gross Settlement (RTGS) system in March 2004, the National Electronic Funds Transfer (NEFT) system in November 2005 and Cheque Truncation System (CTS) in February 2008.

9(4).Electronic clearing Service

With a view to upgrading our payment system to the international standards, the Reserve Bank took the initiative and set up Electronic Clearing Service in India, in the mid 1990s, which is the counterpart of the automated clearing house (ACH) system in certain other countries. It has two variants – ECS - Credit Clearing and ECS - Debit Clearing. While the Credit Clearing operates on the principle of ‘single debit-multiple credits’ and is used for making payment of salary, pension, dividend and interest, etc., the Debit Clearing functions on the principle of ‘single credit-multiple debits’ and is used for collecting payments by utility service providers like electricity, telephone bills as well by banks for receiving principal / interest repayments for housing and personal loans from the borrowers. At present, about 18 million transactions flow through the ECS system every month. This facility is currently available at 70 centres in the country. Settlement takes place on T+1 basis and the cycle gets completed on T+1. RBI is also in the process of developing a National ECS system.

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9(5).National Electronic Clearing Service (NECS)

The National ECS is a product being developed by the RBI to enable centralized processing of the ECS transactions, in contrast to the existing ECS system that has decentralised operations at 70 locations, spread all over the country. Under the National ECS, the processing of all the ECS transactions would be centralised at the National Clearing Cell at Nariman Point, Mumbai and sponsor banks would need to only upload the relative files to a web server, with online data validation facility. Destination banks would receive their inward clearing data / file at a central location, through the web server. The National ECS would leverage the Core Banking platform of the commercial banks, to enable around 50,000 core-banking-enabled branches of the various banks, to avail of this service. The system would facilitate end-to-end seamless posting of the NECS transactions in a straight-through-processing (STP) environment. This would help the users and member banks to send, receive and process the data files at one centralised place, thereby improving the efficiency of the payment system.

The ECS Debit works on the strength of the mandates given by the destination account holders to the user institution for effecting payment from their accounts. The mandates are required to be authenticated (primarily for signature verification of the bank’s customer) by the respective bank within a period of seven days from the date of receipt of such requests. After authentication, the branch would retain a copy for its record, and the customer would submit the other copy to the user institution. At the time of authenticating the mandates, the destination bank should ensure the nomenclature of the accounts vis-à-vis those appearing in the mandates. RBI has issued guide lines to all the banks intending to participate in NECS to obtain mandate from all their customers presently using ECS services without which the ECS debit will not be passed in the accounts.

10. ELECTRONIC PAYMENTS (E-PAYMENTS)10(1).National Electronic Funds Transfer System

Yet another product innovation by the RBI was the National Electronic Funds Transfer System, which was introduced in November 2005 as a more secure, nation-wide retail electronic payment system to facilitate funds transfer by the bank customers, between the networked bank branches in the country. It is a deferred net settlement system and is an improvement over other modes in terms of security and processing efficiency. It provides six settlement cycles a day and enables funds transfer to the beneficiaries account on T+0 basis. This facility is currently available at over 46,300 bank branches throughout the country. The daily average of the transactions is over 80,000 by volume and over Rs.500 crores by value. It is envisaged that all the RTGS-enabled bank branches would also be NEFT-enabled and the customer would have a choice between the

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RTGS or the NEFT systems, based on time criticality, value of the transaction and willingness of the customer to pay different charges for the two systems. With the introduction of NEFT, the Electronic Funds Transfer system, introduced in 1994 for retail funds transfer, is now available only for Government payments.

10(2).Real Time Gross Settlement System

The payment system in the country largely follows the deferred net settlement regime, under which the net amount is settled between the banks, on a deferred basis. Such a dispensation entails an element of settlement risk. Hence, as a step towards risk mitigation in the large value payment systems, the RTGS was operationalised by the RBI in March 2004, which enables settlement of transactions in real time, on a gross basis. Almost all the inter-bank transactions in the country and many time-critical customer transactions are now settled through this system. RTGS is fully secured electronic funds transfer system where banks and customers can receive payments on real time basis. The outreach of RTGS transactions has also grown geographically. Out of about 75,000 bank branches in the country, more than 48,300 bank branches now accept requests for remittance through RTGS system for customer transactions as well as inter-bank transactions. A minimum threshold of rupees one lakh has been prescribed for customer transactions to ensure that RTGS system is used only for large value transactions and retail transactions take an alternate channel of electronic funds transfer. The daily average of transactions is over 34,000 by volume and over Rs.2 lakh crore by value. The RBI also provides collateralised Intra-Day-Liquidity (IDL) support to the member banks for the RTGS operations. With the progressive expansion of the RTGS volume, a view needs to be taken on the continued need and relevance of the high-value clearing system – since the two systems have a functional overlap on account of the same value threshold and the target clientele.

Payment System Indicators - Annual Turnover

Item Volume (000s) Value (Rupees crore)

2005-06 2006-07 2007-08 2008-09 2005-06 2006-07 2007-08 2008-09

1 2 3 4 5 6 7 8 9

1. High Value clearing

15,924 18,730 21,919 21,848 49,81,428 50,34,007 55,00,018 45,50,667

2. RTGS 1,767 3,876 5,840 13,366 1,15,40,836 1,84,81,155 2,73,18,330 3,22,79,881

Total SIPS (1+2) 17,691 22,606 27,759 35,214 1,65,22,264 2,35,15,162 3,28,18,348 3,68,30,548

          (4.6) (5.7) (6.9) (6.9)

The number of RTGS enabled bank branches stood at 55,006 as on March 31, 2009 with the addition of 11,494 branches to the RTGS network during the year 2008-09. The increased network coverage is reflected in the increase in the volume and value settled in RTGS. RTGS peak volume and value in a day were 1,28,295 transactions and Rs.2,73,450 crore, respectively, on March 30, 2009.

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RTGS being a systemically important payment system, which is reflected in value settled in RTGS and also with other Multilateral Net Settlements relating to important retail and large value payments being settled in RTGS, it was imperative to assess the operations of the system against the international standards. The assessment was done against the Core Principles for Systemically Important Payment Systems, published by the Committee on Payment and Settlement Systems of the Bank for International Settlements (BIS). The Reserve Bank’s own assessment published as part of the Report of the Committee on Financial Sector Assessment (CFSA) assessed that the RTGS system in India fully complied with 6 core principles and broadly complied with the Core Principle numbers 3, 7 and 8 relating to management of credit and liquidity risk, operational reliability and efficiency. Core Principle 5 is not applicable to RTGS.

Reserve Bank also commissioned an external assessment of the RTGS system by a team of experts from the Swiss National Bank. These experts viewed that the RTGS system in India is compliant with all the Core Principles, except the one on efficiency. The recommendations made by the team for compliance with this Core Principle is to have a strategy and project business development over the next 5 to 10 years, to monitor the relationship with third-party vendors and ensure effective safeguards in order to retain full control over all aspects of the RTGS system, to have a cost-benefit-analysis, appropriate pricing of payment services, etc.

10(3).COMPARISION OF ECS, NECS & NEFT

Electronic fund transfer systems comprising electronic clearing service (ECS), electronic funds transfer (EFT) and national electronic funds transfer (NEFT) showed a decline of 57.1 per cent in value during 2008-09 as compared to a rise of over 422.0 per

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cent during 2007-08. The sharp growth in 2007-08 was due to the transactions relating to refund of oversubscription amount relating to IPOs floated by companies through ECS Credit and NEFT. The ECS Debit and EFT/NEFT showed a growth of 36.9 per cent and 79.6 per cent, respectively, in terms of value. The coverage of ECS has been increased to 75 centres and T+1 Settlement cycle (from earlier T+3) is implemented across all the centres. A new system called National Electronic Clearing Service (NECS) having centralised processing capabilities was operationalised with effect from September 29, 2008 to bring in uniformity and efficiency in the system. While NECS-Credit facilitates multiple credits to beneficiary accounts at destination branches across the country against a single debit in the account of a user with the sponsor bank from a single central location at Mumbai, the NECS-Debit when implemented shall facilitate multiple debits to destination account holders across the country against a single credit to the user account at Mumbai. The NECS is a nationwide system leveraging on core banking solutions (CBS) of member banks. All CBS bank branches are participants in the system, irrespective of their location. As of March 31, 2009 as many as 114 banks with 26,275 branches participate in NECS. Local ECS (Credit) at Mumbai was merged with NECS-Credit effective from March 24, 2009.

It has been decided to extend the waiver of charges for processing electronic payment products (ECS / NECS / NEFT / RTGS) for a further period of one year, i.e., up to 31st March 2010.Retail Electronic Funds Transfer Systems

Item Volume (000s) Value (Rupees crore)

2005-06 2006-07 2007-08 2008-09 2005-06 2006-07 2007-08 2008-09

1 2 3 4 5 6 7 8 9

ECS / NECS Credit 44,216 69,019 78,365 88,394 32,324 83,273 7,82,222 97,487

  (10.4) (56.1) (13.5) (12.80) (60.2) (157.6) (839.3) (-87.5)

ECS Debit 35,958 75,202 1,27,120 1,60,055 12,986 25,441 48,937 66,976

  (135.0) (109.1) (69.0) (25.9) (344.6) (95.9) (92.4) (36.9)

EFT/NEFT 3,067 4,776 13,315 32,161 61,288 77,446 1,40,326 2,51,956

  (20.3) (55.7) (178.8) (141.5) (12.2) (26.4) (81.2) (79.6)

Note: 1. Figures in parentheses represent percentage change over previous year.2. The ECS Credit figures of 2007-08 include transactions for refunds of oversubscribed IPOs by various companies as mandated by the Stock Exchange.

10(4).Cheque Truncation System (CTS)

The latest electronic payment product introduced by the RBI is the Cheque Truncation System, which was launched, on a pilot basis, in the National Capital Region of New Delhi on February 1, 2008, with the participation of 10 banks.the second phase of CTS implementation is scheduled at Chennai.At present all the banks are participating in the system through 53 direct member banks. The main objective of the CTS is to improve the

15

efficiency and substantially reduce the cheque processing time in the system. The traditional clearing system requiring the physical presentation of cheques in the clearing house for payment and settlement, inevitably entails consequential inefficiencies in terms of clearing time and infrastructure required. The enormity of the logistics needed for physical cheque clearance can be gauged from the fact that we cleared about 1.46 billion cheques in the country during the year April 2007 to March 2008. In contrast, the main advantage of cheque truncation is that it obviates the physical presentation of the cheque to the clearing house; instead, the electronic image of the cheque would be sent to the clearing house. The CTS would enable the realization of cheques on the same day, and provide a more cost-effective mode of settlement than manual and MICR clearing. Smaller banks, which may find it unviable to set up the infrastructure, could utilise the services of service bureaus set up for this purpose by a few larger banks.

Once the CTS become fully operational, the system would be the largest in the world and would leapfrog the country from the paper-based instruments to a fully electronic mode of payment and settlement. Necessary amendments have been made to the Negotiable Instruments Act, 1881, which provides legal recognition to the electronic image of the truncated cheque. These amendments provide a legal basis for the cheque truncation system.

Truncation is the process of stopping the flow of the physical cheque issued by a drawerto the drawee branch. The physical instrument will be truncated at some point en-routeto the drawee branch and an electronic image of the cheque would be sent to the drawee branch along with the relevant information like the MICR fields, date of presentation, presenting banks etc. Thus with the implementation of cheque truncation, the need to move the physical instruments across branches would not be required, except in exceptional circumstances. This would effectively reduce the time required for payment of cheques, the associated cost of transit and delay in processing, etc., thus speeding up the process of collection or realization of the cheques.

10(5).Benefits of Cheque Truncation

Cheque Truncation speeds up collection of cheques and therefore enhances customer service, reduces the scope for clearing related frauds, minimizes cost of collection of cheques, reduces reconciliation problems, eliminates logistics problems etc. With the other major product offering in the form of RTGS, the Reserve Bank created the capability to enable inter-bank payments online real time and facilitate corporate customer payments. The other product, National Electronic Funds Transfer, is an electronic credit

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transfer system. However, to wish away cheques is simply not possible and that is the reason why the Bank decided to focus on improving the efficiency of the Cheque Clearing Cycle. Cheque Truncation is the alternative. Moreover contrary to perceptions, Cheque Truncation is a more secure system than the current exchange of physical documents in which the cheque moves from one point to another, thus, not only creating delays but inconvenience to the customer in case the instrument is lost in transit or manipulated during the clearing cycle.

In addition to operational efficiency, Cheque Truncation has several benefits to the banks and customers which includes introduction of new products, re-engineering the total receipts and payments mechanism of the customers, human resource rationalization, cost effectiveness etc. Cheque Truncation thus is an important efficiency enhancement initiative in the Payments Systems area, undertaken by RBI.

10(6).Specifications and standards prescribed for data and images :

To ensure security, safety and non-repudiation the PKI (Public Key Infrastructure) is being implemented across the system. The banks will send the captured images and data to the central clearing housefor onward transmission to the payee/drawee banks. For that purpose RBI will be providing the banks software called the Clearing House Interface (CHI) that willenablethem to connect and transmit data in a secure way and with non-repudiation to the Clearing House (CH). The Clearing House will process the data and arrive at the settlement figure for the banks and send the required data to payee/drawee banks for processing at their end. The drawee/payee banks will use the same CHI mentioned earlier for receiving the data and images from the Clearing House. It will be the responsibility of the drawee bank Capture System to process the inward data and images and generate the return file for unpaid instruments.

10(7).The criteria for banks participating in the Cheque truncation system are:

i. Membership of the clearing house in the NCR.

ii. Membership of the Indian Financial Network (INFINET)

10(8).Truncation in non-INFINET member banks

In respect of banks who are not members of the INFINET, the following alternatives are available

(a) They may become the sub-members of the direct members or

(b) Such banks may use the infrastructure of the other banks having INFINET membership without being the INFINET members themselves and there clearing

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settlement can be done either directly or through the member through whom they are participating.

10(9).Infrastructure requirement

The infrastructure required for CTS from banks end are connectivity from the bank gateway to the clearing house, hardware and software for the CTS applications. RBI shall be providing member banks with the CHI and the banks have to procure other hardware and system software for the CHI and the application software for their capture systems on their own.

The hardware requirement is based on the volume of the cheques processed by the banks. Based on the volume the CHI is categorized into four types and the hardware requirement is different for each category. The band width requirement for each bank is calculated based a number of factors like the peak inward and outward volume of the bank, average size of an image, efficiency factor of the network etc. In addition to that future requirement have been taken into consideration for calculating the band with requirement.

10(10).Image specification

Imaging of cheques can be based on various technology options. The cheque images can be black and white, Grey Scale or coloured. Black and White images do not reveal all the subtle features that are there in the cheques. Coloured Images increase storage and network bandwidth requirements. So it was decided that the electronic images of truncated cheques will be in gray scale technology. There will be three images of the cheques i.e. front grey, front black & white and back black & white which will be made available to member banks.

The image specifications are:

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Image Type Minimum DPI Format Compression

Front GrayScale 100 DPI JFIF JPEG

Front Black & White 200 DPI TIFF CCITT G4

Reverse Black & White 200 DPI TIFF CCITT G4

The image quality of the Grey Scale image shall be 8 bits/pixel (256 levels).

Gray-scale image (Truncated cheque-front view)

Gray-scale image (Truncated cheque-Back view)

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Scanners also function like photo-copiers by reflecting the light passed through narrow passage on to the document. Tiny sensors measure the reflection from each point along the strip of light. Reflectance measurements of each dot is called pixel. Images are classified as black and white, gray-scale or colour based on hoe the pixels are converted into digital values. For getting a gray scale image the pixels are mapped onto a range of gray shades between black and white. The entire image of the original document gets mapped as some shade of gray, lighter or darker, depending on the colour of the source.

In the case of black and white images, such mapping is made only to two colours based on the range of values of contrasts. A black and white image is also called a binary image.

Preparatory steps for implementation of cheque truncation on a pilot basis were initiated in the National Capital Region of Delhi during the year.

ATMs have become an important channel for delivering banking transactions and services in India, particularly for cash withdrawal and account balance enquiry. The spread of ATMs has increased from 34,789 in March 2008 to 43,651 in March 2009.

Card-Based Payment Transactions

Item Volume (000s) Value (Rupees crore)

  2005-06 2006-07 2007-08 2008-09 2005-06 2006-07 2007-08 2008-09

1 2 3 4 5 6 7 8 9

Credit Cards 156,086 169,536 228,203 259,561 33,886 41,361 57,985 65,356

  (20.6) (8.6) (34.6) (13.7) (31.9) (22.1) (40.2) (12.7)

Debit Cards 45,686 60,177 88,306 127,654 5,897 8,172 12,521 18,547

  (10.0) (31.7) (46.7) (44.6) (10.0) (38.6) (53.2) (48.1)

11. THE ROLE OF THE RBI IN DEVELOPMENT OF PAYMENT AND SETTLEMENT SYSTEMS

The development of a payment system is one developmental role that is common to most of the central banks. It is well recognized that an efficient payment and settlement system is essential for efficient functioning of the modern financial system. The Reserve Bank has, therefore, played a catalytic role, over the years, in creating an institutional framework for development of a safe, secure, sound and efficient payment system for the country. It has also initiated a variety of institutional, procedural and operational measures to strengthen and refine the payment system

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12. REGULATION, SUPERVISION AND POWERS OF RESERVE BANK OF INDIA: 12(1).POWER OF RBI TO DETERMINE STANDARDS:

(1) The Reserve Bank may, from time to time, prescribe— (a) The format of payment instructions and the size and shape of such instructions; (b) The timings to be maintained by payment systems; (c) The manner of transfer of funds within the payment system, either through paper, electronic means or in any other manner, between banks or between banks and other system participants. (d) Such other standards to be complied with the payment systems generally; (e) The criteria for membership of payment systems including continuation, termination and rejection of membership; (f) The conditions subject to which the system participants shall participate in such fund transfers and the rights and obligations of the system participants in such funds.

(2) Without prejudice to the provisions of sub-section (a) The Reserve Bank may, from time to time, issue such guidelines, as it may consider necessary for the proper and efficient management of the payment systems generally or with reference to any particular payment system.

12(2).NOTICE OF CHANGE IN THE PAYMENT SYSTEM:

(1) No system provider shall cause any change in the system which would affect the structure or the operation of the payment system without—

(a) The prior approval of the Reserve Bank; and (b) Giving notice of not less than thirty days to the system participants after theapproval of the Reserve Bank: Provided that in the interest of monetary policy of the country or in public interest,

the Reserve Bank may permit the system provider to make any changes in a payment system without giving notice to the system participants under clause (b) or requiring the system provider to give notice for a period longer than thirty days. (2) Where the Reserve Bank has any objection, to the proposed change for any reason, it shall communicate such objection to the systems provider within two weeks of receipt of the intimation of the proposed changes from the system provider. (3) The system provider shall, within a period of two weeks of the receipt of the objections from the Reserve Bank forward his comments to the Reserve Bank and the proposed changes may be affected only after the receipt of approval from the Reserve Bank.

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12(3).POWER TO CALL FOR RETURNS, DOCUMENTS OR OTHER INFORMATION:

The Reserve Bank may call for from any system provider such returns or documents as it may require or other information in regard to the operation of his payment system at such intervals, in such form and in such manner, as the Reserve Bank may require from time to time or as may be prescribed and such order shall be complied with.

12(4).ACCESS TO INFORMATION :

The Reserve Bank shall have right to access any information relating to the operation of any payment system and system provider and all the system participants shall provide access to such information to the Reserve Bank. 12(5).POWER TO ENTER AND INSPECT:

Any officer of the Reserve Bank duly authorized by it in writing in this behalf, may for ensuing compliance with the provisions of this Act or any regulations, enter any premises where a payment system is being operated and may inspect any equipment, including any computer system or other documents situated at such premises and call upon any employee of such system provider or participant thereof or any other person working in such premises to furnish such information or documents as may be required by such officer.

12(6).POWER TO CARRY OUT AUDIT AND INSPECTION:The Reserve Bank may, for the purpose of carrying out its functions under this Act,

conduct or get conducted audits and inspections of a payment system or participants thereof and it shall be the duty of the system provider and the system participants to assist the Reserve Bank to carry out such audit or inspection, as the case may be.

12(7).POWER TO ISSUE DIRECTIONS:

Where the Reserve Bank is of the opinion that,— (a) A payment system or a system participant is engaging in, or is about to engage

in, any act, omission or course of conduct that results, or is likely to result, in systemic risk being inadequately controlled or

(b) Any action under clause [a] is likely to affect the payment system, the monetary policy or the credit policy of the country,

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The Reserve Bank may issue directions in writing to such payment system or system participant requiring it, within such time as the Reserve Bank may specify –

(i) To cease and desist from engaging in the act, omission or course of conduct or to ensure the system participants to cease and desist from the act, omission or course of conduct; or

(ii) To perform such acts as may be necessary, in the opinion of the Reserve Bank, to remedy the situation.

12(8).POWER OF RESERVE BANK TO GIVE DIRECTIONS GENERALLY:

Without prejudice to the provisions of the foregoing, the Reserve Bank may, if it is satisfied that for the purpose of enabling it to regulate the payment systems or in the interest of management or operation of any of the payment systems or in public interest, it is necessary so to do, lay down policies relating to the regulation of payment systems including electronic, non-electronic, domestic and international payment systems affecting domestic transactions and give such directions in writing as it may consider necessary to system providers or the system participants or any other person either generally or to any such agency and in particular, pertaining to the conduct of business relating to payment systems.

12(9).DIRECTIONS OF RESERVE BANK TO BE COMPLIED WITH:

Every person to whom a direction has been issued by the Reserve Bank under this Act shall comply with such direction without any delay and a report of compliance shall be furnished to the Reserve Bank within the time allowed by it.

12(10).RIGHTS AND DUTIES OF A SYSTEM PROVIDER SYSTEM PROVIDER TO ACT IN ACCORDANCE WITH THE ACT, REGULATIONS, ETC:

Every system provider shall operate the payment system in accordance with the provisions of this Act, the regulations, the contract governing the relationship among the system participants, the rules and regulations which deal with the operation of the payment system and the conditions subject to which the authorization is issued, and the directions given by the Reserve Bank from time to time.

12(11).DUTIES OF A SYSTEM PROVIDER:

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(1)Every system provider shall disclose to the existing or potential system participants, the terms and conditions including the charges and the limitations of liability under the payment system, supply them with copies of the rules and regulations governing the operation of the payment system, netting arrangements and other relevant documents.

(2) It shall be the duty of every system provider to maintain the standards determined under this Act.

12(12).DUTY TO KEEP DOCUMENTS IN THE PAYMENT SYSTEM CONFIDENTIAL :

(1) A system provider shall not disclose to any other person the existence or contents of any document or part thereof or other information given to him by a system participant, except where such disclosure is required under the provisions of this Act or the disclosure is made with the express or implied consent of the system participant concerned or where such disclosure is in obedience to the orders passed by a court of competent jurisdiction or a statutory authority in exercise of the powers conferred by a statute.

(2) The provisions of the Bankers’ Book Evidence Act, 1891 (18 of 1991) shall apply in relation to the information or documents, or other books in whatever form maintained by the system provider.

12(13).INFORMATION, ETC., TO BE CONFIDENTIAL:

(1) Subject to the provisions of sub-section 2, any document or information obtained by the Reserve Bank under sections 12 to 14 (both inclusive) shall be kept confidential.

(2) Notwithstanding anything contained in sub-section 1, the Reserve Bank may disclose any document or information obtained by it under sections 12 to 14 (both inclusive) to any person to whom the disclosure of such document or information is considered necessary for protecting the integrity, effectiveness or security of the payment system, or in the interest of banking or monetary policy or the operation of the payment systems generally or in the public interest.

12(14).SETTLEMENT AND NETTING:

(1)The payment obligations and settlement instructions among the system participants shall be determined in accordance with the gross or netting procedure, as the case may be, approved by the Reserve Bank while issuing authorization to a payment system.

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(2)Where the rules providing for the operation of a payment system indicates a procedure for the distribution of losses between the system participants and the payment system, such procedure shall have effect notwithstanding anything to the contrary contained in any other law for the time being in force.

(3)A settlement effected under such procedure shall be final and irrevocable.

(4)Where a system participant is declared by a court of competent jurisdiction as insolvent or is dissolved or wound up, then notwithstanding anything contained in the Companies Act, 1956 (1 of 1956) or the Banking Regulation Act, 1949 (10 of 1949) or any other law for the time being in force, the order of adjudication or dissolution or winding up, as the case may be, shall not affect any settlement that has become final and irrevocable and the right of the system provider to appropriate any collaterals contributed by the system participant towards its settlement or other obligations in accordance with the rules, regulations or bye-laws of such system provider.

12(15). PENALTIES:

(1) Where a person contravenes the provisions of section 4 or fails to comply with the terms and conditions subject to which the authorization has been issued under section 7, he shall be punishable with imprisonment for a term which shall not be less than one month but which may extend to ten years or with fine which may extend to one crore rupees or with both and with a further fine which may extend to one lakh rupees for every day, after the first during which the contravention or failure to comply continues.

(2) Whoever in any application for authorization or in any return or other document or on any information required to be furnished by or under, or for the purpose of, any provision of this Act, willfully makes a statement which is false in any material particular, knowing it to be false or willfully omits to make a material statement, shall be punishable with imprisonment for a term which may extend to three years and shall also be liable to fine which shall not be less than ten lakh rupees and which may extend to fifty Iakh rupees.

(3) If any person fails to produce any statement, information, returns or other documents, or to furnish any statement, information, returns or other documents, which under section 12 or under section 13, it is his duty to furnish or to answer any question relating to the operation of a payment system which is required by an officer making inspection under section 14, he shall be punishable with fine which may extend to ten Iakh rupees in respect of each offence and if he persists in such refusal, to a further fine which may extend to twenty-five thousand rupees for every day for which the offence continues.

25

(4) If any person discloses any information, the disclosure of which is prohibited under section 22, he shall be punishable with imprisonment for a term which may extend to six months, or with fine which may extend to five lakh rupees or an amount equal to twice the amount of the damages incurred by the act of such disclosure, whichever is higher or with both.

(5) Where a direction issued under this Act is not complied with within the period stipulated by the Reserve Bank or where no such period is stipulated, within a reasonable time or where the penalty imposed by the Reserve Bank under section 30 is not paid within a period of thirty days from the date of the order, the system provider or the system participant which has failed to comply with the direction or to pay the penalty shall be punishable with imprisonment for a term which shall not be less than one month but which may extend to ten years, or with fine which may extend to one crore rupees or with both and where the failure to comply with the direction continues, with further fine which may extend to one lakh rupees for every day, after the first during which the contravention continues.

(6) If any provision of this Act is contravened, or if any default is made in complying with any other requirement of this Act, or of any regulation, order or direction made or given or condition imposed there under and in respect of which no penalty has been specified, then, the person guilty of such contravention or default, as the case may be, shall be punishable with fine which may extend to ten lakh rupees and where a contravention or default is a continuing one, with a further fine which may extend to twenty-five thousand rupees for every day, after the first during which the contravention or default continues.

13. THE BOARD FOR PAYMENT & SETTLEMENT SYSTEM (BEFORE ENACTMENT OF PSS ACT 2007

In order to strengthen the institutional framework for the payment and settlement systems in the country, the Reserve Bank constituted, in 2005, a Board for Regulation and Supervision of Payment and Settlement Systems (BPSS) as a Committee of its Central Board.

The Board is chaired by the Governor, RBI while all the four Deputy Governors and two external Directors of the Central Board are its members. The role of the BPSS is to lay down policies relating to the regulation and supervision of all types of payment and settlement systems, set standards for existing and future systems, approve criteria for authorisation of payment and settlement systems, and determine criteria for membership to these systems, including continuation, termination and rejection of membership. Thus, the BPSS is the highest policy making body in regard to the payment and settlement systems in the country and encompasses electronic, non-electronic, domestic and cross-

26

border payment and settlement systems which affect the domestic transactions. In its relatively short span since its inception, the BPSS has provided valuable guidance in shaping the emerging contours of the payment and settlement system in the country and has helped widen the reach of the payment services of the banks to the hinterland areas.

Cross-country experience indicates that there are special administrative arrangements for regulation and oversight on payment and settlement systems. These arrangements are in the form of a board, council or a committee, constituted either within the ambit of central banks or under specific statutory provisions. In Australia, the Reserve Bank Act (1959) gives the Payments System Board the responsibility for determining the Reserve Bank of Australia payments system policy.

The European Central Bank (ECB) has set up the Payment and Settlement Systems Committee (PSSC) to deal with issues of oversight and development of payment systems. In contrast, the South African Reserve Bank regulates and oversees the activities of the payment system management body, called the Payments Association of South Africa (PASA) and of its members. In Canada, the regulatory responsibility for payments system is shared between the Bank of Canada and the Ministry of Finance.

Efforts are also underway in India to build the infrastructure for effective regulation and supervision of payment and settlement systems in anticipation of the statutory changes envisaged under the draft 'Payment and Settlement Systems Bill'. A Board for Payment and Settlement Systems (BPSS) is proposed to be constituted under the Reserve Bank of India Act, 1934, which will be in the form of a Committee of the Central Board of Directors of the Reserve Bank. The mandate of the BPSS would cover:

• 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.

Reduction of the time taken for processing of paper-based instruments has been engaging the attention of the Reserve Bank. To the extent that the physical instrument needs to be transported from the collecting bank branch to the drawee bank branch, delay

27

is in-built into the paper based instrument clearing mechanism. Cheque truncation is one of the measures adopted in several countries to remove this systemic handicap. Payment instruments do not get transported all the way, but get stopped or truncated at a point in the cycle and thereafter, only information about the instrument and/or its image flows electronically to the drawee bank branch for payment. A Working Group on Cheque Truncation and E-cheques (Chairman: Dr. R.B. Barman) was constituted to recommend a suitable model of cheque truncation for India. The Group submitted its report in July 2003.

14. PAYMENT AND SETTLEMENT SYSTEMS ACT 2007

It is internationally acknowledged that payment and settlement systems should function on a well-founded legal basis. This entails among other things, proper authorization requirement for setting up and payment systems, legal recognition for netting, settlement finality, providing for regulation and oversight of the payment and settlement systems. Many countries have either provided for these requirements in their central bank statutes or have drafted separate and comprehensive laws for this purpose. In India where the economy is growing at a fast pace increasingly large volumes and values are being handled by payment systems. Non-bank entities who are outside the explicit regulatory purview of the central bank are running/ are likely to run important payment systems. A number of innovative payment instruments/ systems have been introduced by unregulated entities. While large payment systems which are unregulated present risks to the stability of the financial systems, unauthorized retail payment systems without proper management and operational structures can undermine public confidence in the efficacy of the payment systems as a whole. The Reserve Bank and the Government felt that there should be an explicit law to regulate the payment and settlement systems.

The Parliament has enacted the Payment and Settlement Systems Act in December 2007. This Act empowers the Reserve Bank to regulate and supervise the payment and

28

settlement systems and provides a legal basis for multilateral netting and settlement finality. The Act empowers the Reserve Bank to lay down the policies for regulation and supervision of the payment and settlement systems, authorize their setting up/continuance, for issuing directions, laying down standards, calling for information/data, initiating prosecution/levying penalties for violation of the provisions of the Act, its regulations and directions etc. The Act will come into operation very shortly.

14(1).BOARD FOR REGULATION AND SUPERVISION OF PAYMENT AND SETTLEMENT SYSTEMS (BPSS)

In order to strengthen the institutional framework for the payment and settlement systems in the country, the Board for Regulation and Supervision of Payment and Settlement Systems (BPSS) as a Committee of its Central Board was constituted by the Reserve Bank in March 2005 following the notification of the Reserve Bank of India, Regulations, 2005. The BPSS was reconstituted in August 2008 following the notification of the PSS Act and the Board for Regulation and Supervision of Payment and Settlement Systems Regulations, 2008. The Board met on five occasions during the period from July 2008 to June 2009. The operationalisation of the PSS Act, issuance of guidelines for smooth operations of payment systems and transparency in charges levied to customers for the services offered by banks were some of the key focus areas of the BPSS at its meetings. The important directions of the Board, inter-alia, include:

(i) Grant of authorisation to various payment system providers in terms of the provisions of the PSS Act.

(ii) Guidelines on mobile payments.(iii) guidelines on issuance and operation of prepaid payment instruments in

India(iv) Rationalization of the charges for electronic payment products and

outstation cheque collection.(v) Migration of large-value payments to more secure electronic modes and (vi) Incentivizing the usage of satellite communication for penetration of

banking services to remote places.In accordance with the directions of the BPSS, operative guidelines on mobile

banking for banks were issued on October 8, 2008 and Guidelines for prepaid payment instruments in India were issued on April 27, 2009. The use of other bank ATMs for cash withdrawal has become free of charge with effect from April 1, 2009. The Reserve Bank has also rationalised the service charges for ‘Electronic Payment Products’ and outstation cheque collection. Steps have been initiated to increase the threshold limit of cheques in ‘High Value Clearing’ from Rs.1 lakh to Rs.10 lakhs and to progressively discontinue this service in view of alternate channels being already available to clear high value transactions.

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14(2).SECRETARY'S DEPARTMENT

Secretarial work connected with the meetings of the Central Board and its Committee as also the Administrators of the Reserve Bank of India Employees' Provident Fund and Reserve Bank of India Employees' Co-operative Guarantee Fund.

Secretarial work relating to Top Management Group.

Secretarial work relating to the Deputy Governors' Committee Meetings

Conveying the decisions taken in all the meetings mentioned above to the concerned Central Office departments and also all the Regional Offices in case of Senior Management meeting and monitoring the implementation thereof.

Work relating to joining / retirement / relinquishing charges by Governor and Deputy Governor.

Work relating to terms and conditions of service of Governor and Deputy Governors.

Work relating to constitution of Central Board / Local Board.

Providing administrative support to the Top Management, including staff support and various non-establishment payments.

Work relating to administration and non-establishment payments pertaining to Secretary's Department, IDMD and PRD.

Providing hardware (computers, printers, fax machines, cell phone) and software support to Secretary's Department, IDMD, PRD, Top Management and their secretarial staff.

Providing administrative Secretarial Support including hardware / software to various Boards viz. Advisory Board on Banking, Commercial & Financial Fraud (ABBCFF).

Protocol Services to visiting foreign dignitaries, Parliamentary delegations, Bank's Top Executives, Central Board Directors etc.

Work relating to reservation of Conference Rooms, Auditorium, Executive Lounge and the VVIP Guest House.

14(3).DEPARTMENT OF PAYMENT AND SETTLEMENT SYSTEMS

The Department of Payment and Settlement Systems (DPSS) is a new department in the Reserve Bank which was operational with effect from March 2005. The Department is 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) System, the inter-institutional Government Securities clearing, the inter-bank foreign

30

exchange clearing as also the RTGS. The Department also provides secretarial support to the newly constituted Board for regulation and supervision of Payment and Settlement Systems (BPSS), which happens to be a Committee of the Central Board.

The functions of the Department include the following:

Formulation of Payment and Settlement Systems 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).

Laying down standards for payment and settlement systems.

Designing, developing and integrating Systemically Important Payment System (SIPS) projects and / or facilitating such implementation.

Monitoring the operations of payment and settlement systems.

The National Clearing Cells assist the department at the Regional Offices.

15. COMMUNICATION NETWORK AND PAYMENT GATEWAYS FOR PAYMENT AND SETTLEMENT SYSTEMS

15(1).INDIAN FINANCIAL NETWORK (INFINET)

The INdian FInancial NETwork [INFINET] is the communication backbone for the Indian Banking and Financial Sector. All Banks, Public Sector, Private Sector, Cooperative, etc., and the premier Financial Institutions in the country are eligible to become members of the INFINET. The INFINET is a Closed User Group [CUG] Network for the exclusive use of member banks and financial institutions. The communication backbone is based on IP VPN Layer 3 Network with full mesh VPN network. Presently, the network is spread across 300 cities in our country.

The INFINET is primarily based on Multi-Protocol Label Switching network, where the packet and label switching takes place at service providers’ level. A detailed IP addressing scheme has been devised by IDRBT for all CUG members, which has to be followed by all CUG members, while accessing RBI, CCIL and IDRBT applications.

INFINET MPLS Architecture

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In order to build High Availability IP VPN Network, IDRBT has selected two MPLS Service Providers. With a view to achieve High Availability features, the network architecture was designed to have Link Level, Path Level, Device Level and Service Provider Level Redundancy through Network-Network-Interface.

Under MPLS Phase 1A, IDRBT have successfully migrated 14 RBI locations on to MPLS IP VPN Network from the existing Terrestrial Network and also seamlessly integrated members banks through Terrestrial Leased Lines. Under MPLS Phase – 1B, the supply of equipment, link and configuring them is in progress.

16. INTERNATIONAL PAYMENT ARRANGEMENTS

16(1).SFMS (STRUCTURED FINANCIAL MESSAGING SYSTEM)

SFMS (Structured Financial Messaging System) - Message formatIBM’s S/390 mainframe system - The RTGS and RBI's Core banking systemMQ Series - Messaging systemParticipant interface (PI) - RTGS Client for the participating banks

32

IFTP - Inter-bank Funds Transfer ProcessorIAS - Integrated Accounting SystemCFMS - Centralised Funds Management SystemINFINET - Indian FInance NETworkSSS - Securities Settlement System

So when a bank needs to pay another bank, it uses the participant interface to send the payment request to IFTP. The IFTP will remove all information that is not needed by the settlement system and send the message to RTGS.

If the payment can be settled, the RTGS sends a response to the IFTP that the settlement is successful. The IFTP will construct a message with the RTGS information, add all the other information that came with the original payment request and then send the response to the Bank that initiated the request and the recipient bank.

If the payment can not be settled for any reason, the RTGS sends response to the IFTP that the settlement failed. The IFTP will construct a message with the RTGS information, add all the other information that came with the original payment request and then send the response to the Bank that initiated the request. Here Host means the banking system of the bank.

16(2).SWIFT

Introduction

The Society for Worldwide Interbank Financial Telecommunication (SWIFT) is an industry-owned limited liability cooperative society set up under Belgian law and controlled by its member banks (including central banks) and other financial institutions.

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SWIFT’s business is to supply secure messaging services and interface software, to contribute to greater automation of financial transaction processes and to provide a forum for financial institutions to address issues of common concern in the area of financial communication services. Messaging services are provided to banks, broker/dealers and investment managers, as well as to market infrastructures in payments, treasury, securities and trade.

SWIFT was founded in 1973 by 239 banks from 15 countries. Since then, there has been a steady increase in the number of financial institutions and countries connected to SWIFT. There are three categories of SWIFT users: members (shareholders), sub-members (ie subsidiaries controlled by members) and participants. Members can benefit from all the services offered by SWIFT, whereas participants only have restricted access to a range of services that relates to their business. Types of participants include securities brokers and dealers, investment management institutions, fund administrators, money brokers and various other institutions, mainly from within the securities business. The average daily value of payment messages on SWIFT is estimated to be above EUR 6 trillion.

SWIFT is a private member-owned cooperative connecting nearly 9,000 banking organizations, central banks, clearing and settlement infrastructures, securities institutions and corporate in 209 countries worldwide. SWIFT is also overseen by the central banks of the G10 countries.

Since June 2009, Database and FIN traffic can be broken down as follows:

SWIFTNet FIN traffic (in number of messages)

Total number of messages (year to date) 1,501,829,160

Message growth (total traffic year to date) -4.38%

Average daily traffic (year to date) 14,781,783

Message growth (average daily) -2.78%

Latest peak day: 15 October 2008 17,860,068

SWIFTNet FIN availability

SWIFTNet FIN systems 99.999%

SWIFTNet FIN customer base

Live countries 209

Live members 2369

Live sub-members 3,321

Live participants 3,318

Total live users 9,008

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SWIFT is the most widely used payment services provider worldwide. As the main carrier for payment information, its message types, formats and technical infrastructure set a kind of benchmark for the processing of payments. SWIFT’s core application is called FIN, a store-and-forward messaging service. In 2002, availability of FIN was consistently above 99.99%. FIN traffic can be broken down as follows: (1) FIN traffic distribution by market__ Payments 60.7%__ Securities 30.5%__ Treasury 6.0%__ Trade finance 2.4%__ System 0.4%(2) FIN traffic distribution by region__ Europe 66.6%__ Americas 18.0%__ Asia-Pacific 11.7%__ Africa 2.4%__ Middle East 1.2% In 2002, SWIFT started the migration of its core FIN application from an X.25 network (a network technology that is becoming obsolete) to an IP-based network. With the introduction of IP-based technologies, SWIFT will expand its services base, offering new interactive services. The suite of new services is grouped under SWIFTNet services. SWIFTNet business solutions that are currently being developed relate to cash reporting, bulk payments processing and securities reporting. To promote the use of SWIFTNet and XML-based cash reporting tools among major cash clearing banks and their correspondents, a working group has been set up to design the industry solution and to agree upon query/response standards rule book. In bulk payments, a new XML-based message standard was developed and introduced in 2002. In 2001 the first domestic market infrastructures went live on SWIFTNet. The SWIFTNet messaging services using the new Secure Internet Protocol Network (SIPN) were fully implemented by the Deutsche Bundesbank’s RTGS plus and the Bank of England’s Enquiry Link. In the world of e-commerce, SWIFT is developing some of the tools necessary to deliver the value that the internet can offer to the financial industry and is also working with member institutions to develop e-payment initiation standards.

17. FUTURE VISION OF PAYMENT AND SETTLEMENT IN INDIA

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The Mission Statement articulated for payments system objectives of the Bank has six distinct and succinct components that would be integrated to form the universe of scope and premise of action. To briefly elucidate, the components represent -

• Safety – Keeping the risks in various payment system products minimum and manageable if they are necessary and unavoidable.

• Security – Giving confidence to stakeholders that the payment systems can be trusted and are reasonably protected from threats and vulnerabilities.

• Soundness – Demonstrating the capability and ensuring the payment systems function in a non-disruptive manner.

• Efficiency – Providing measures to assure that the payment systems are cost-effective, reliable and promote financial and economic stability.

• Accessibility – To ensure reach of various payment systems at reasonable cost to various segments of the populace.

• Authorisation – According entities permission to operate payment systems as per the provisions of the Payment & Settlement Systems Act and the Regulations framed thereunder.

Conclusion

The payment and settlement system constitutes the backbone of the financial

sector and enables conclusion and settlement of financial contracts. The country has made

phenomenal progress in enhancing the reach and improving the efficiency of the national

payment system – in which the RBI and the banking system have been equal partners.

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Creating a world-class payment system in the country is a long, arduous but an exciting

journey in which a constant striving is needed to better the past achievements. The banking

community would surely make dedicated and systematic efforts in this direction to meet

the challenges ahead and actively contribute to realizing the vision for the payment system

has been set for the country.

Bibliography

1. http://rbidocs.rbi.org.in/rdocs/PublicationReport

2. wikepedia.com

3. google.com

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4. RBI ANNUAL REPORTS

5. RBI TRENDS REPORT 2009-10

6. V. leeladhar’s speech

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