G Padmanabhan: Random payment system issues of systemic relevance
for the new year
Keynote address by Mr G Padmanabhan, Executive Director of the Reserve Bank of India, to
the Bankers' Club, Thiruvanathapuram, 2 January 2013.
* * *
Assistance provided by Smt C S Kar and Saswat Mahapatra in the preparation of the address and the
comments/suggestions on the draft by S/Shri G Mahalingam, S Ganeshkumar, A Madhavan and Smt Radha
Somakumar gratefully acknowledged.
It is always a pleasure to be in God's own country to welcome the New Year. I am thankful to
the Bankers Club of Thiruvanathapuram for affording this opportunity by inviting me over. I
also deem it a privilege to be addressing the Bankers of the state which recently captured the
imagination of the nation when one of the districts - Ernakulam - was declared as the first
financially included district in the country. I am aware of the enormous efforts put in by the
bankers in the State under the stewardship of our Regional Director Shri. Salim
Gangadharan. Congratulations to the entire banking community of the State.
The year that went by was quite challenging for the financial sector. The worsening of the
sovereign debt crisis in Europe and the unsteady recovery in the USA had posed significant
risks to emerging markets like India, with domestic factors playing a major role-perhaps in
balance a more decisive role in shaping the course of Indian financial markets which
remained volatile. As current account deficit burgeoned and reached a record high, debate
on the contributory role of gold imports intensified. Without getting into the thick of the
debate, let me state two things. First, the argument that a central bank which had diversified
its own assets into gold has no moral right to preach against investment/import of gold is
missing an important point. A central bank diversifying its dollar reserves into gold is entirely
different from private agents in a country having capital controls investing in gold as it has the
same effect of allowing such assets to be held in foreign currency! It has to be clearly
recognised that the Central bank undertakes the onerous responsibility of managing the
forex reserves of the country with the objectives of safety, liquidity and return in that order
and investment in gold is in pursuit of these objectives! In the case of private savers, by
stashing away his savings in gold, the economy stands to lose the benefit of accumulated
savings which can go a long way in adding to the GDP of the country. Second, given the
insatiable lure for gold in the country, it is imperative that we introduce gold linked products
which results in the existing gold in bank lockers getting converted as financial products
rather than unabated import of gold, if we are to find a sustainable solution for our current
account problems.
Moving on, as we welcome what appears to be another year of turbulence for the markets,
and when the Indian banking system is readying to adopt Basel III norms even in the face of
growing NPAs, I thought it fit to discuss certain important issues relating to payment systems.
You will appreciate that the payment systems all over the world including in our country
functioned efficiently even while the crisis was crippling the markets. The issues that I
propose to flag are of relevance to all stake holders using the Indian payment system.
Decline of cheques - a myth or a must?
The growth in electronic payments (in volume terms), in recent years is quite heartening
when one sees that the share of electronic payments as a percentage of total payments have
grown from 15% in 2003-04 to 48% in 2011-12. Despite this, in absolute terms cheque
volume continues to be high (52% of total payments), even though the growth is showing a
declining trend. While this high cheque volume could be attributed to overall growth in the
economy and the consequent growth in financial transactions, it is nonetheless desirable that
transactions in electronic form increases at an increasing rate rather than being contended
with transactions through cheques increasing at a decreasing rate. It would also be desirable
to migrate the existing cheque usage to an electronic form in view of the benefit which would
accrue to both the payer and payee of the cheque which in turn has a positive impact on the
economy as a whole.
In fact, the "Payment Systems in India - Vision 2012-15" talks about drawing up a strategy
for disincentivising usage of cheques above a certain threshold limit by customers and
corporates which may include prescribing a cut off limit for cheques cleared through clearing
house arrangements. As announced in the "Second Quarter Review of Monetary Policy" we
are in the process of preparing a Discussion Paper on the methods aimed at disincentivising
the issuance and usage of cheques in India and placing this paper in the public domain for
comments.
Before coming to the challenges and strategies for moving paper based transactions to
electronic mode, let me touch upon the need for doing so. As we all know, cheques when
compared to electronic payments are less efficient for various reasons - it has high printing
and processing costs, requires manual interventions in the form of encoding and keying in
cheque details, poses significant reconciliation challenges in terms of payables and
receivables, needs to be preserved for longer period as per legal and regulatory
requirements, has longer clearing and processing cycle etc., in addition to having inherent
liquidity and credit risks. In contrast, electronic payments eliminate these inefficiencies and
provide a faster, efficient, secured mode of transactions at a fraction of the cost. Electronic
payments, where they are "credit-push" based imply that credit, liquidity and systemic risks
are substantially reduced, and there is also adequate certainty on funds availability to the
beneficiary. Despite these perceived virtues, physical instruments are still preferred by
people as they can be "seen" and therefore more "trustworthy" as compared to unseen
electronic transactions happening in seconds! Here the challenge for the bankers is to
change this mindset through training and education of customers.
Several studies have been undertaken on the cost and benefits of cheques vis-à-vis
electronic payments. A study undertaken by the Reserve Bank of Australia in 2007-08
pegged the average payment cost of cheques (for consumers, merchants and financial
institutions) at AUD7.69, as compared to AUD1.21 for credit cards and AUD 0.67 for
EFTPOS.1 The UK Payment Council in its report "The Future of Cheques in UK" (2009) has
indicated that the costs of electronic alternatives are at least one third lower than the cost of
cheques. The report also estimates that the closure of the cheque clearing could lead to cost
savings for the UK (for financial institutions and corporates) up to £1 billion per annum by
2018.Studies by Humphrey, Willesson, Bergandahl & Lindblom (2003)2
found that migration
away from paper-based payment methods was one of the key factor that contributed towards
reduction in bank operating costs (a 24 per cent reduction, accounting for $32bn) across
Europe from 1987-1999. Back home, studies by the Indian Banks' Association have also
revealed that the costs relating to paper based instruments are relatively higher than
electronic modes although the former is less efficient as well. To summarise, the key
conclusion from several studies3 is that there is a social business case for moving away from
paper based instruments. That's why several jurisdictions such as UK, Canada, Ireland and
Australia have drawn or are in the process of drawing the roadmaps for managing declining
cheque usage in their jurisdictions.
However, this is easier said than done. Consumer habits which have been ingrained over the
years do not change as quickly as changes in technology take place. So, even if newer
electronic forms of payments are introduced, widespread adoption of such modes takes time.
Many users - including the Government - may also be apprehensive of using a "new" mode
of payment and as such may resist the movement from their "comfort zone" (of using
cheques).Issuing of cheques does not cost money (most banks offer some number of
cheques leaves free of cost), whereas some charges have to be paid for initiating electronic
payments. Given the lack of awareness, cost considerations may override safety and speed
considerations.
Recognising the complexity of the challenge, any strategy to discourage the use of cheques
by individuals as well as institutional users has to have a multi-pronged approach
encompassing cost and time considerations, incentives for use of electronic modes of
transactions and disincentives for the use of paper-based instruments. However, the decline
of cheque usage has to be carefully managed so that the unwarranted ramifications such as
slippage to cash based transactions and inconvenience to vulnerable segments of the
customers having no access to alternative electronic modes of payments are avoided.
Why expand CTS if cheques are to be discontinued?
As you may be aware, gird CTS in Chennai now covers 43 clearing locations encompassing
the states of Tamilnadu, Kerala, Karnataka, Andhra Pradesh, West Bengal and the Union
Territories of Puducherry and Chandigarh. Pan-India roll out of CTS is expected to be
completed by December 2013. Questions are being raised on the need for expansion of grid
CTS for improving the efficiency of paper based clearing given the focus of the Vision
Document towards electronic payments. Let me try to address these questions.
First, the paper-based clearing continues to be the dominant mode of retail payments in the
country constituting 52% in terms of volume. It is also widely accepted that consumer
behaviour does not change as quickly as changes in technology. This being the case,
despite our objective of electronification of payments, requirements for safety and efficiency
enhancements in paper-based clearing cannot be ignored.
Second, even though Speed clearing hastens the process of cheque collection as compared
to outstation cheque collection, it pre-supposes the presence of the drawee bank (at least
one branch) in the clearing house location which could be a limitation. In comparison,
grid-based CTS, is a superior system as it encompasses a larger geographical area and the
chances of drawee bank not having presence in the grid location is significantly reduced.
Third, grid CTS would provide significant cost savings both to the system operators as well
as the system participants. From a systemic perspective consolidation of clearing locations
into a few grids would minimise the cost of replacement of aging MICR machines and the
related AMC costs. Banks will benefit from economies of scale as the grid CTS obviates the
need for establishing inward cheque processing infrastructure at various clearing locations.
Further, once local clearing houses are subsumed into the grid, the settlements which are
now spread across clearing locations would be subsumed into a single settlement, thereby
significantly reducing the liquidity requirements (opportunity cost included) for the banks. The
CTS will also result in other benefits in terms of reduction in the cheque processing fee,
reduction in operational overhead, elimination of clearing differences and reconciliation
issues etc.
Fourth, as long as physical instruments cannot be realistically wished away even in the
medium term scenario, it is economically sensible to leverage on technology to reduce the
recurring processing costs, though it might involve a onetime capital expenditure.
There are a few challenges as well. The CTS implementation and the model adopted in India
do not have a parallel elsewhere in the world and the features aimed at security and safety
need to be addressed optimally. This is the reason behind the directive to all banks to
migrate to the use of a uniform standard for the CTS cheques. Further, there is an increase
in the responsibilities of the collecting banker when compared to the non-CTS scenario. A
change in the mindset of the staff of banks is also a vital necessity, and this would transcend
to the ultimate customer too. While it is heartening to note the positive outcomes in all these
areas, we must recognize that full scale achievement of these would take time.
Entry of non-banks in payment system - a mirage or a threat?
It is quite discernible in many payment services that non-banks have made in-roads into an
area that was once considered the exclusive domain of banks. Traditionally, banks alone
played an important role in holding deposit funds (store of value) and providing payment
services (medium of exchange). With significant developments in technology going
hand-inhand with the growing demand for faster and more efficient payment services by users,
banks no longer find it possible, viable or even necessary to offer the whole range of
payment services (end-to-end) by themselves, when the same could be outsourced and
offered more cost-effectively. These reasons coupled with the growth potential have led to
the entry of non-banks into the payment services area.
Some of the reasons for the almost ubiquitous presence of non-banks in the payment
services area could be (a) the changing consumer behaviour with increasing demand for
more efficient and faster systems (b) advancements in technology which has greatly
facilitated innovations in payment services (c) trend for out-sourcing - possibly due to
objectives of reduction in capital investment by banks when the same task can be
outsourced on a fee-basis (d) financial inclusion drives where non-banks are also playing a
significant role especially in the field of mobile banking etc.
Given the fact that this trend is gaining strength, particularly in retail payments, the role of
banks vis-a-vis non-banks merits some closer examination. Especially, the aspect of
cooperation between the two or the lack of it needs some introspection. In India, despite the
poster-product of M-pesa in Kenya and other African country models led by MNOs, we have
consciously chosen the path of a bank-led model. Further, it would also be interesting to
debate whether outsourcing is in itself a type of cooperation or is it just a paid service? Is
there a level-playing field or is one partner the dominant one? And how would systemic risk
be addressed when there are players whose core business may only be relating to the
payment system offered by them and any misdemeanor in this area may well affect the entire
customer base of the entity concerned?
I am raising these issues here because they are very pertinent for the future and also raise
concerns for regulation. While healthy competition between banks and non-banks could have
positive repercussions on the provision of cost-effective and efficient payment services to
users, it could also have negative impact in case of non-transparent processes and charges
structure as well as issues pertaining to the continued sustenance of the services offered.
Further, increased risks, if any, due to presence of non-banks in payments area also needs
to be better understood and managed.
Is the time ripe to review the role of the payment intermediaries?
RBI has been aware of the critical role played by the "intermediaries" in the e-commerce
arena. The intermediaries provide "platform" for acceptance and processing of payments
across multiple electronic payment channels. They offer payment aggregation services to a
large number of businesses (small to large), governments, utilities, banks, insurance
companies, etc. They act as payment aggregators by obviating the need for a merchant/
organization to set-up and manage a multiplicity of relationships with different financial
institutions - viz. banks, networks, wallets, prepaid issuers, etc. for accepting payments. Over
the years the volume and value of transactions handled by the intermediaries have grown
manifold. Reportedly, there are the intermediaries who handle daily volumes of 6-7 lakh
transactions for values Rs 150 to Rs.200 crore.
Though these entities at present are not authorised, they have been advised to follow
directions on protection of customer funds. The growing importance of intermediaries
warrants a review of the extant oversight mechanism. Some of the areas which need
attention are the need for intermediaries to provide complete and transparent information to
the customers on the success/failure of transactions; uniform and standard practice for
refunds to the customers for failed/cancelled transactions and related customer service
issues. Another area of concern is the operational risk that such entities may pose. As the
customers, merchants and financial institutions depend on the intermediaries for payments/
collections any disruption can negatively impact the payment system. While some of the big
merchants have "substitutability" or "interoperability" arrangement in the form of payment
gateway switching system, others fully depend on one intermediary. This underscores the
importance of the operational risk being effectively addressed by the intermediaries.
Given the above, the need to continue with the existing light touch regulations vis-a-vis a
focused oversight including authorisation for such of those entities which have a significant
presence in the market would need to be explored. Further, the intermediaries perform
certain niche functions which may not qualify to be part of the core businesses of banks.
When specialization and efficiency are existent, it would be appropriate to allow such
intermediaries to play their roles, but with the added covenants relating to safety, business
continuity, risk reduction and sustenance.
Do we need a payment industry council / association encompassing all stakeholders?
The payment landscape in India was for long primarily dominated by banks. Legislation of
Payment and Settlement Systems Act, 2007 paved the way for entry of non-bank payment
system operators. The payment system milieu covers an entire gamut of stakeholders like
banks, non-bank payment system operators, technology providers, outsourcing agencies,
network providers, intermediaries, customers, government etc. The increasing complexities
in payment system demands that all the stakeholders work in tandem and collaborate. In the
Indian scenario, the co-operation and co-ordination among stakeholders is more critical
considering the fact that a significant section of the society is under-banked or unbanked. For
example for mobile banking to leapfrog it is essential that banks and MNOs co-operate.
Similarly, growth of PoS transactions would require co-ordination among merchants, banks,
card networks etc.
Against this backdrop the need for an industry-level association open to all stakeholders
needs to be evaluated. There are several such association/payment councils like European
Payment Council (EPC), UK Payment Council, Australian Payments Clearing Association
(APCA) Payments Association of South Africa (PASA), to name a few, which provide the
necessary platform for partnerships, collaboration, advocacy, and awareness around
payments eco-system in their respective domains. In the Indian context, the Indian Banks
Association represents the banks but does not have representations from non-banks and
other stakeholders. It is true that there are small associations such as in the cards sector, but
these are not all-pervasive across payment systems as a whole.
Industry-wide payments council/association will provide an excellent platform to brainstorm,
collaborate and drive new technology proliferation, and thereby bring forth innovative
solutions to create a robust payments infrastructure. The need for such a co-operative
platform was touched upon in the "Payment Systems Vision 2012-15" which stated that the
feasibility of forming a standard setting body under the overall guidance of RBI with
representation from IBA, IDRBT and other stakeholders would be examined and taken
forward.
How will the White Label ATM (WLA) scheme help expand ATM network in India?
Deployment of ATMs in India is witnessing a 30% y-on-y growth in the last few years.
However, the deployment is largely restricted to the urban/metro areas while locations in
Tier III to VI areas have not witnessed much ATM presence. Further, when compared to
other countries the per capita ATM deployment in India continues to lag. Given the recent
policy initiatives in Financial Inclusion, it is expected that a large number of bank accounts
would be opened in Tier III to VI centres triggering a demand for basic banking services
including convenience banking through ATMs. Thus, there is a need for expanding
deployment of ATMs to increase availability and access especially in the rural areas.
Some of the reasons that were being attributed to the low deployment as indicated above
were high cost of deployment and operation, inadequate support infrastructure, large
requirement of human resources etc. The WLA concept exemplifies the benefits of
partnership between banks and non-banks in building the payment infrastructure. The banks
need not lock their funds since the capital investment is undertaken by the WLA operator and
the operator gets a fee plus other charges for every transaction from the bank which has
issued the card. RBI is in the process of authorising the first set of non-bank entities for
operating WLAs.
WLA scheme is a watershed initiative for bank and non-bank partnership in payment space.
However, the success would depend on how well the banks and non-bank entities
complement each other. The efforts of non-banks to create ATM infrastructures need to be
complemented by banks by bringing the financially excluded into the ambit of banking and
issuing them cards, besides providing a mutually beneficial cash management and
settlement of transactions services. Further, banks and non-banks need to act in tandem in
redressing customer grievances relating to failed transactions. RBI would be closely
monitoring the progress and proactively intervening when warranted.
Consumer protection in electronic payments - a peek through the looking glass or a
Pandora's Box?
Having raised the issues of discouraging the use of cheques, moving to electronic platforms
of payments, and the entry of non-banks into the payment domain, I also need to discuss
one other important issue regarding "consumer protection and rights" in payments. Just as it
is well-understood that consumer behaviour does not change easily or quickly, it is also a
moot point that some of the main underlying factors influencing customer choice relates to
how transparent and secure the system is and how confident the customer is about getting a
fair treatment in case of complaints / grievances. Often, the doubts the customer has about
getting a "raw deal" tilts the scale towards traditional payments - cash or cheque - just so
that the customer wants to "avoid the hassles" about failed transactions occurring in a media
(online, electronic) that is unfamiliar to him/her.
Consumer protection issues mainly revolve around fraudulent and/or unauthorised
transactions, unauthorised or excessive charges, failed transactions - non-delivery and
rejections, late delivery of transactions, and disputes arising out of any or all of the above
and complaint redressal. The catch is, as any banker would vouch for, while good consumer
experience may not necessarily make for a second or repetitive use of the medium, bad
consumer experience certainly creates a bitter feeling.
Even globally, it can be said that the need for and the discussion about consumer protection
in electronic payments is a relatively new phenomenon as compared to cheques. Under
cheques, consumer protection is provided by the nature of the banker-customer contract,
which is not imposed by either of the parties but has been historically defined by "practice" as
a series of common law cases (which is true in most countries). However, with the
introduction of electronic funds transfer systems and also the entry of non-bank entities,
many contractual terms and conditions began to be imposed on consumers who often ended
up bearing all the losses for unauthorised transactions. Gradually, many regulatory
developments have taken place with the objective of enhancing consumer trust in online
payments including addressing the issue of disproportionate charges for services rendered,
limiting consumer liability etc. For instance, the Dodd-Frank Wall Street Reform and
Consumer Protection Act, 2010 requires the Federal Reserve to establish standards for
interchange fees that are reasonable and proportional to the cost of processing debit card
transactions, the EU Directive on Payment services in the internal market (Directive 2007)
provides rules on transparency, timing of payments and information requirements (including
rights and obligations of users and providers of payment services, liability rules etc.), EU
Directive on Consumer Rights 2011 (to be implemented by December 2013 by all member
states) aims to harmonise consumer protection in particular relating to purchase of digital
content products and in cross border transactions.
How are we placed in terms of consumer protection and responsibilities of banks and
customers in an electronic banking environment where physical transaction is replaced by
electronic transaction, physical trail is replaced by electronic trail, and a physical signature is
replaced with a digital one? How can we define the roles and responsibilities of banks and
customers in such an environment to achieve a win-win situation for all? Is the customer
really aware of his/her rights and responsibilities, or does the "fine print" put all the liability on
the customer? Does the regulatory requirement of "authorisation" provide a sufficient
safeguard for users of electronic payments? Are the existing Consumer Protection Act,
Banking Ombudsman Act, and other grievance redressal mechanisms really up to handling
issues arising out of payments systems arena which is increasingly getting electronic? Or
does the law need to be strengthened further while focussing exclusively on consumer
protection issues arising out of electronic transactions? Is there a need to dovetail Consumer
protection with Consumer awareness as well since there is a lot of synergy between these
two requirements? For instance, even as the RBI is taking steps to make Card Present
transactions more secure, customer awareness can go a long way in enhancing customer
protection while using Magstripe cards at a POS terminal. A simple case in point is how
many of us really pay attention to the fact whether the merchant is checking the signature on
the card during a transaction at the POS terminal? Today, matching the signature on
chargeslip with that on the card is perfunctory. Should not this become a more serious exercise? I
would encourage the Bankers' Club to arrange a Round Table to debate on these issues and
come up with a technical paper.
As I conclude, let me also take this opportunity to provide some inputs on two other areas
which will see vast improvements in large value payments as well as bring in additional
messaging avenues - I am referring to the Next-Gen RTGS and the proposed entry of
SWIFT for domestic messaging in India.
The existing RTGS system was commissioned in 2004. The volume of RTGS transactions
have grown over the years and currently settles approximately a volume of around 3 lakh
transactions a day. This raised issues of scalability of the existing RTGS system which was
developed to handle a volume of 50,000 per day. Further, it is a well known fact that RTGS,
being a gross settlement system, is liquidity intensive system.
The next generation RTGS (NG-RTGS) is structured to be equipped with liquidity saving
features, an advanced gridlock resolution mechanism, increased security measures,
operational reliability, business continuity and be compliant with international standards. It
would encourage inter-operability with alternative systems. The new system would endorse
(a) the latest technology; (b) high scalability and flexibility to adapt to changes in the financial
environment and other requirements; and (c) enhance accessibility to cope with changes in
the financial environment, such as globalisation of financial transactions and networking of
settlement infrastructures. It has been decided to adopt ISO 20022 message formats in the
NG-RTGS system.
Currently, there is only one messaging solution - SFMS available for domestic messaging. In
order to have an alternate messaging infrastructure, SWIFT has been accorded an
in-principle approval for domestic messaging with specific terms and conditions. The
participants would have the option to choose multiple channels to route the transactions to
the central server in the Bank. The multiple channels are INFINET / SFMS, SWIFT and the
Internet.
One must recognise that payment systems have become a dominant factor affecting our day
to day lives and has the potential to spur economic growth as well. Coupled with its capability
to be omnipresent and have a plethora of players with varied backgrounds and interests, the
need to ensure safe, secure and efficient payment systems gains importance. It is this task
which the Reserve Bank is now concentrating upon. Like effective teams which achieve
success in their efforts, the various players in the payment systems space also need to work
in unison, with the ultimate objective of ensuring customer satisfaction. It may be good to
pause and examine in an unbiased manner whether this has been achieved or not. If the
level of achievement is not substantial enough, then we need to work out strategies for
ensuring that they are achieved. For instance, how do we move away from cash
transactions? Can we for instance try this at petrol bunks across the country? Can we
implement wireless POS/mobile POS across the country for replacing all cash-on-delivery
payments to electronic payments, be it cooking gas or pizza delivery? I recall that more than
two decades ago, it was this state which witnessed the introduction of new players in
transferring payments from the Gulf - the private exchange houses which played a very
specific role which was required at that point of time. Today, as the country is looking with
great expectations for innovations in payment systems, can we look forward to an encore
from the southernmost state of the country? Can the payment system operations in the
God's own country function qualitatively and in terms of customer delight invoke even God's
envy?
Thank you for your attention. Once again, wish you all a wonderful New Year.