Vol. 3 Jamia Law Journal 2018

RE-ARCHITECTING PAYMENT SYSTEM IN INDIA

Faizanur Rahman*

ABSTRACT

Every country needs a sound financial system which aids in capital and economic growth by embolden and mobilizing the saving habits from household and other segments and apportion them into formative usage such as trade and commerce, manufacture, etc. A financial system consists of three constituents, viz. the financial market, the financial products and the market participants. Thus, a financial system, broadly, administer with the financial transactions that are conducted between two or more parties. The payment system is a set of arrangements recognized by society for the transfer of wealth and accordingly often mirrors the technological sophistication of a country. The development of any economy necessitates the adaptation of its payment system to meet new challenges and satisfy new demands. The present paper examines the evolution and performance of the payment and settlement systems of India in improving the financial performance of the economy.

I. Introduction IN INDIA, THE instruments facilitating payment system have a very long history. From ancient period to Modern era, the dimensions of the payment system have been drastically remodelled. Due to innovations in technology over past several years, the facets of the payment system in India have been entirely revamped. The payment system has adopted a new form in modern era to facilitate four essentials to any financial transactions i.e. Safety, Security, Soundness and Efficiency.

*Assistant Professor, Faculty of Law, Jamia Millia Islamia, New Delhi.

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The Reserve of India can be understood as the key player in development of the payment and settlement system of India. The initiatives taken by the Reserve in the mid- eighties and early-nineties was mainly focused on technology-based solutions for the improvement of the payment and settlement system infrastructure in India. Such ambitious initiatives coupled with the introduction of new payment instruments resulted in the technological advancements of the banking system in India. Modern payment systems are actually the result of innovations and advancement of technology. With the advent of computers and electronic communications, a large number of alternative payment practices have emerged which gradually became an important part of the current payment system. The instruments of modern payment system not only provided an alternative to traditional mode of payment system but also proved to be a time saving and cost-effective ways for effecting payment.1

II. Underpinning Payment Systems A financial transaction is an agreement made between a buyer and a seller in order to exchange goods or services for payment. It actually involves alteration in the situation of the finances of the parties involved viz., businesses or even individuals. The buyer and seller are basically separate entities which often involve the exchange of some items of value, such as information, goods, services, and money. A transaction would be termed as a financial transaction even if the goods or services are exchanged at one time, and the money at another. A financial system covers both the credit and cash

1S. Gurusamy, Financial Services and Systems, (Tata McGraw-Hill Education Pvt. Ltd., New Delhi, 2008).

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Published in Articles section of www.manupatra.com Vol. 3 Jamia Law Journal 2018 transactions in the economies and all financial transactions are ultimately dealt with by a system called as a ‘payment system’.2 Section 2 (1) (i) of the Payment and Settlement Systems Act, 2007, defines a ‘payment system’ as “any system that actually cause or facilitates exchange of money between two persons viz. a payer and a beneficiary”. Further, a payment system also involves clearing process or settlement service or both, but does not include a stock exchange. Section 34 of the Payment and Settlement Systems Act, 2007 expressly provides that scope of payment system will exclude the stock exchanges or any clearing corporations set up under the stock exchanges. Thus, a payment system, broadly, is a process or system through which the financial transactions made between two people are settled. It is provided by the Explanation to Section 34 of the Act that all those systems except herein- above mentioned which is carrying out either clearing or settlement or payment operations or all of them shall be regarded as ‘payment systems’. Further, all those institutions which are operating such systems shall be called as ‘system providers’ and also all those which operates fund transfer systems or card payment systems or similar systems shall fall within the meaning of system provider. Thus, in order to identify an entity as operating payment system, it would be desirable to check whether it performs either the clearing process or settlement service or payment function or all of them. It is further stated by way of an Explanation to Section 2 (1) (i) of the Act that a ‘payment system’ shall also include those systems enabling operations, money transfer operations or similar operations.

2Bruce J. Summers, Payment Systems: Design, Governance and Oversight 3 (Central Banking Publications Ltd, London, 2012)

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According to Bank for International Settlements (BIS), a ‘payment system’ can be described as a “set of instruments, procedures, and rules for the transferring funds between or among the participants.” Thus, it is a process where some value is alienated from one person and transferred to another. In other words, it helps in transferring of some value between a payer and a beneficiary through which former discharges his payment obligations towards the beneficiary.3 Payment system is the medium of transferring funds between the parties which ultimately facilitates businesses and economies. It actually enables the two-way flow of payments in exchange of goods and services in the economy. Lately, the cash based payments have been conventional and widely used instruments to complete a financial transaction. A person habitually transacts through cash in order to purchase goods and services. However, now-a-days, the Government is promoting the cashless economy and thus and financial institutions are offering electronic payment instruments through different platforms that may be used instead of cash based payments for performing trade and commerce. A payment system can be used by any individual, banks and other financial institutions, Governments, etc. to perform a financial transaction. It actually works with the cooperation of several institutions, regulatory authorities and the Government. It is supervised through enactment of different guidelines, rules, procedures and standards. An ordinary payment system is actually the operational network in which bank accounts are linked to each other and it facilitates monetary exchange between them using the bank deposits.

3Beth Anne Wilson & Geoffrey N. Keim, “India and Global Economy”, Business Economics, January 2006.

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An efficient payment system always strives for reducing the transaction cost of goods or services which ultimately helps in the growth of economy because of the reason that latter is directly influenced by the efficacious functioning of the former. A weak and inefficient payment system may dent the progressive capacity of the economies of a country in negative direction. However, not only the reduction in transaction cost but also the technical potentiality of a payment system is important for the progressive development of economy. The failure in a country’s payment system can ultimately result in inequitable risk-sharing among agents, actual losses for participants, inefficient use of financial resources and loss of confidence in the financial system.

III. Categories of Payment System The ‘payments system’ can be broadly distinguished on the basis of time and value of transactions. On the basis of time, it can be categorized into Traditional Payment System and Modern Payment System while on the basis of transactions into Large Value Systems and Retail Payment Systems4. The Traditional Payment System is a practice of carrying the financial transactions in a way which is habitually done by most of the users. It generally includes those payments that are made through the promissory notes, bill of exchange, cheques or demand drafts. The Modern Payment System is the outcome of innovations and advancement of technology. With the coming of computers and electronic gadgets, a large number of alternative payment instruments have emerged. These instruments have gradually become an important part of the modern payment system. Thus, an online carrying out of financial transactions is called as e-commerce

4Franklin Allen and Douglas Gale, Comparing Financial Systems (The MIT Press Cambridge Massachusetts, London, 2001).

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Published in Articles section of www.manupatra.com Re-Architecting Payments System in India or e-payment system or modern payment system. These includes payments cards, viz., debit cards, credit cards or smart cards, electronic funds transfers, internet banking, etc. The Large Value Payment System (LVPS) is the mechanism where a person enters into a high value financial transaction. It is actually a payment system for electronic wire transfers of large sums of money. It facilitates the participating individuals or other institutions and their clients to send large sums of money to one other securely with entire certainty that the transaction will settle. Thus, LVPS actually takes care of large value financial transaction and thus, ensures the smooth functioning of the economy and the financial system. The value of the transactions is quite high, however, the volume of transactions entered is quite low. Thus, if this system fails, it could trigger disruptions or transmit shocks within the economy. The large value payment system is generally electronic based and is related to inter-financial or inter- bank institutional transactions. For maintaining the proper security of the large value financial transaction, it is regulated by the of a country. These systems offer speed, reliability, safety, convenience, cost and accuracy. Few instances of LVPS are the Inter-Bank Clearing System, Government Securities Clearing System, Real Time Gross Settlement System (RTGS) or Society for the Worldwide Interbank Financial Telecommunication (SWIFT).5 The Retail Payment System (RPS) is a system which handles a large volume of payments but of relatively low value. The common instruments of retail payment system are such as cheques, direct debits, ATM terminals and Electronic Funds Transfer at Point of Sale transactions (EFTPOS). This system is comparatively as important as others because it has comparably larger user group. This system generally handles transactions which are low in value, but very large

5 Kenneth C. Laudon and Carol G. Traver., E- Commerce, Business, Technology, Society (Pearson Education, United States, 2014).

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Published in Articles section of www.manupatra.com Vol. 3 Jamia Law Journal 2018 in volume as compared to the ‘large value payment system’. This system is comprised of both paper based as well as electronic based systems. A person with a payment card of any kind viz., debit card, credit card or smart card can make payments through retail payment system. The retail payment system is generally classified in ‘cash payments’, paper based payments’, ‘card based payments’ and ‘electronic payments and remittance.

IV. Evolution of Payment System in India The payment system has a very long historical progress in India. The rupee in our pocket has basically a long but interesting mysterious past. Behind Mahatma Gandhi’s smiling face lies a long history of struggle, exploration, and wealth that can be traced back to the ancient India. In India, one of the earliest payment instruments that were in practice were ‘coins’, either in form of gold, silver or copper. To trace the origin of coins, it is relevant to look back into the remote past where man had limited needs. As social interaction and communication grew, families grouped together to form tribes or communities. Each tribe or community had a monopoly over the products that were available in their region or locality. As interaction grew between tribes and communities, products available in other territories were discovered. This discovery paved the way for trade.6 In its infancy, trade was practiced as an exchange of products- something we call as barter system. It is similar to the way children trade collectible cards or marbles and stamps or tazos. The tribes, communities and merchants exchanged grains, sugar, and many other products and this exchange of products became a necessity as communities grew into localities and slowly into towns and cities. The ‘barter system’ was a great mode of payment, but the problem arises there where the commodities being exchanged were not of the

6K. N. Chaudhary, Trade and Civilization in the Indian Ocean (Cambridge University Press, United Kingdom, 1985).

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Published in Articles section of www.manupatra.com Re-Architecting Payments System in India same value. Like when a person seeks to exchange a pound of sugar or rice for a cow. Gradually, peoples began to look at other modes of payment and decided that a common commodity would serve as an intermediary medium of exchange, as ‘money’. As time went by, certain commodities gained preference over others and were assigned higher values. They were slowly given the status of ‘money’ and became a standard to which the value of other things was measured.7 In the Vedic Age, pastoral communities used cows as a medium of exchange. A passage from the rigveda mentions the value of an image of Lord Indra as being ten cows. Many instances in later Vedic literature also mention that the Dakshina or fees to the priest was paid in cows. This practice of using cows as a medium of exchange, perhaps, met the needs of the age because the animals did not perish as quickly as food grains or agricultural products did and also, they could supply milk be and put to work. However, they need someone with the skill and knowledge of animal husbandry. Also, they could not be used for purchases of a small amount, nor could you divide them to pay for it. As they were not suitable for all transactions, a stable, divisible, and a more convenient means of exchange was required. At one point in history, the shells and beads were also used as a medium of exchange. They were small and easily divisible for purchases of lesser values and were also easy to carry on your person without adding substantial weight. One could be discreet and inconspicuous to the amount of money they owned which is something that was not possible with cows. Everyone have heard the Hindi phrase ‘Phooti Cowdie’ which refers to broken cowry shells as the smallest denomination. The problem with using beads and shells

7Himanshu Prabha Ray, Coins in India: Power and Communication, (J.J. Bhabha Marg Publication, New Delhi, 2006).

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Published in Articles section of www.manupatra.com Vol. 3 Jamia Law Journal 2018 was that they were found in plenty and beads could be manufactured by anyone possessing the apparatus which posed a risk to the economy of the region, as a result of which, a suitable replacement was again sought. There came the era of using metal as the medium of exchange. Metal was durable and handy and could easily serve as the perfect replacement for commodity and shell money. To serve the purpose of being a perfect medium of exchange, metal would have to be divided to pieces bearing uniform weight and size. As a result, they were weighed on a balance against a standard weight. But to weigh metal bits each time you make a transaction was a tedious process. To overcome this inconvenience, people began to standardize the weight and size of the ingots. Another issue with using metals was that although they were standard in weight and size, there was no guarantee of its purity. To address this issue, responsible authority figures, possibly merchants and traders, began marking the pieces as a sign of guarantee of purity. This practice, basically gave birth to the concept of a coin.8 The concept of standardized coin caught on well and thus, people found it easier to accept metal pieces with privy marks and slowly, coins with punches and symbols began to be issued. The value of those coins depended on the integrity and image of the person authenticating them. However, regardless of how the coin authentication began, later the responsible authorities took control of issuing coins. The first Indian coins, that is, the punch marked coins ere minted in the 6thcentury BC by the Mahajanapadas of ancient India which included Gandhara, Kuntala, Kuru, Panchala, Shakya, Surasena, and Saurashtra. These coins were made of silver of a standard weight but with irregular shapes, these coins had different markings, like-

8P. C. Prasad, Foreign Trade and Commerce in Ancient India, (Abhinav Publications, New Delhi, 2003).

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Saurashtra had a humped bull, Dakshin Panchala had a swastika, and Magadha had several symbols. Then the Mauryas Empire came, where the coins were marked with a royal standard. Chanakya, prime minister to the first Mauryan emperor Chandragupta Maurya mentions in his Arthashastra treatise, coins such as rupyarupa (silver), suvarnarupa (gold), tamararupa (copper) and sisarupa (lead). The Indo- Greek Kushan kings who came next introduced the Greek custom of engraving portrait heads on coins. Their example was followed for eight centuries and then the Gupta Empire produced large numbers of gold coins depicting the Gupta kings performing various rituals. This tradition of intricately engraved coins continued till the arrival of the Turkish Sultanate in North India. By the 12thcentury AD, the Turkish Sultans of Delhi had replaced the royal designs of Indian kings with Islamic calligraphy. The currency was made in gold, silver and copper and was now referred to as tanka, with the lower valued coins being called jittals. The Delhi Sultanate also attempted to standardize the monetary system by issuing coins of different values. The commencement of the Mughal Empire from 1526 AD brought forth a unified and consolidated monetary system for the entire empire.9 However, the defining moment in the evolution of the rupee occurred when, after defeating Humayun, Sher Shah Suri set up a new civic and military administration. He issued a coin of silver, weighing 178 grains, which was termed as the rupiya and was divided into 40 copper pieces or paisa. The silver coin remained in use during the remaining Mughal period. By the time the British East India Company set itself up in India in the 1600s, Sher Shah’s silver rupiya had already become the popular standard currency in the country.

9Santosh Kumar Das, The Economic History of Ancient India 229(Cosmo Publications, New Delhi, 2006).

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In 1717 AD, the English obtained permission from Mughal emperor Farrukh Siyar to coin Mughal money at the Bombay Mint. The British gold coins were termed carolina, the silver coins angelina, the copper coins cuppernoon, and the tin coins tinny. Paper money was first issued in British India in the 18th century, with the Bank of Hindustan, General Bank in Bengal and the Bengal Bank becoming the first banks in India to issue paper currency. During Mughal period, the practice of using ‘bill of exchange’ by merchants became famous in day-to-day trade and commerce. Later merchants started using ‘pay orders’ which was issued from the Royal Treasury on one of the District or Provincial treasuries. They were commonly called as ‘barters’ and were akin to present day drafts or cheques. During 12th century, the Hundis not only became one of the most important payment instrument but also an essential part of the financial system which has its existence even today. A Hundi was a financial instrument that developed during Medieval India for use in trade and commerce. They were used as a form of remittance instrument to transfer money from place to place and as a form of credit instrument to borrow money and as a bill of exchange in trade transactions. Before 1835, there were several trends of currency systems and coinage, however, afterwards, the East India Company interpolated ‘Company's Rupee’ in order to bring about uniformity of coinage in British India. Moreover, during 18th century, ‘paper currency system’ was introduced by Bank of Hindustan, and then after by the General Bank in Bengal and Bihar, the Bengal Bank and three Presidency Banks. Further, the passing of the Paper Currency Act of 1861 was a major turning point in the history of the payment system in India. It played a very important role in the progress of the payment and settlement system. It mainly conferred the monopoly to the British Government and the existing Presidency banks for regulating and managing the paper currency. However, afterwards when the

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Reserve Bank of India was established under the Act, 1934 under the British regime, all rights of regarding paper currency system was conferred over to the Reserve Bank of India. The Government of India nationalized the RBI, after the independence in 1949 with aim of progress and development in mind. Since then, the RBI is continually striving towards ensuring the betterment of the payment and settlement system in India.10

Digitalization of Payment System The RBI came up with the Electronic Clearing System (ECS) in 1990s as an alternative solution to cheques which aimed at providing a better alternative method of processing the bulk of transactions. Thus, this system facilitated a single person to effect a bulk of transactions to different persons at the same time. Primarily, there are two variants of the Electronic Clearing System that is, the Electronic Clearing System Credit (ECS Credit) and the Electronic Clearing System Debit (ECS Debit). The ECS Credit system enables the easy payment of amounts towards distribution of dividend, interest, salary, pension, etc., to a large number of beneficiaries of the user institution. Likewise, the ECS Debit is also a form of the Electronic Clearing System which is very useful in debiting the account of a large number of consumers when they are enjoying any service provided by a single institution. The Reserve Bank of India introduced the concept of Electronic Fund Transfer (EFT) in late 1990s which facilitate electronic transfer of the funds. Through the use of the Electronic Fund Transfer system an account holder can easily effect the electronic transfer of the funds from his account to another account irrespective of the participating bank.

10M. V. Kini, Commentaries on The Negotiable Instruments Act, 1881(Alia Law Agency, Allahabad, 2007).

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This Electronic Fund Transfer system is no longer available for use by the general public because since November 2005, the National Electronic Fund Transfer (NEFT) system was introduced for facilitating one-to-one funds transfer requirements of individuals / corporates. The National Electronic Fund Transfer system provides for batch settlements at an interval of every hour, thus enabling the near real-time transfer of funds. The Reserve Bank of India in 2004 introduced Real Time Gross Settlement System (RTGS) which aimed at effecting a fund transfer from one bank to another on a ‘real time’ and on ‘gross’ basis. In other words, the payment transaction is not subjected to any waiting period and is bound to be settled on one to one basis without bunching or netting with any other transaction. This means that once a payment transaction is processed, they are final and irrevocable.11 During September 2008, the Reserve Bank of India introduced National Electronic Clearing Service (NECS), at National Clearing Cell (NCC), Mumbai, in order to centralize the Electronic Clearing Service (ECS) operation and bring in more uniformity and efficiency to the payment and settlement system. In the new National Electronic Clearing Service, the users have to prepare one consolidated NECS- File and submit it centrally to the National Clearing Cell, Nariman Point, Mumbai, through their sponsor banks. The sponsor banks would make use of the web-server provided for the purpose. The web-server also has the facility to get on-line data validation so that the error free data could be uploaded for processing. Thus, now because consolidated files are sent to a NECS- Centre, there is no chance of confusion regarding different files and also this brings more efficiency in the processing of the files. The National Electronic Clearing Service has primarily two variants, that

11Jonathan D. Freiden, Sean Patrick Roche, “E-Commerce: Legal Issues of the Online Retailer in Virginia”, Richmond Journal of Law and Technology(2006).

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Published in Articles section of www.manupatra.com Re-Architecting Payments System in India is, NECS (Credit) and NECS (Debit). The NECS (Credit) allows the multiple credits to beneficiary accounts against a single debit of the account of a user with the sponsor bank while the NECS (Debit) allows the multiple debits to account holders against single credit to user account. The National Electronic Clearing Service provided a national platform for the debit and credits of the different accounts across the country at the same time. Next to NECS, Regional Electronic Clearing Service (RECS) has been started in the year 2009 where the sponsor bank uploads the validated data containing credit/debit instructions to the customers of Core Banking System (CBS) which is confined to the bank branches within the jurisdiction of a Regional office of RBI. However, cheques have been continue to be the prominent mode of payments in the country due to which Reserve Bank of India decided to focus on improving the efficiency of the cheque clearing cycle. There was one more of a problem in cheques and that was physical transmission of cheques from the collecting bank branch to the drawee bank branch, which results in delay in payment and settlement process. Offering Cheque Truncation System (CTS) was a step to overcome this systemic handicap. Through Cheque Truncation System, the physical cheques do not get transported all the way but are stopped or truncated at a specific point in the payment cycle and then onwards only information about the instrument or its image flows electronically to the drawee bank for payment and settlement. The physical cheques are truncated by the presenting bank to derive maximum efficiency and promote quick settlement of cheques. The Cheque Truncation System has been implemented first in New Delhi with effect from February 1, 2008, then in Chennai and Mumbai respectively. After the advancement in banking sector, it can be easily observed that the processing and settlement of entire volume of physical cheques has been migrated from MICR system to Cheque Truncation System.

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However, with the passage of time, the traditional MICR-based cheque processing has been discontinued across the country.12 It is quite true that the Reserve Bank of India is not only the key regulator of the banking sector but also the key player in promoting and developing the payment and settlement system of India. The Reserve Bank of India took further action towards the proper governance of the payment system of the country and thus formed a full- fledged committee in 2005, commonly known as the Board for Regulation and Supervision of Payment and Settlement Systems (BPSS). The BPSS is at present the highest policy making body on payment systems in the country. Together with the BPSS, the Reserve Bank of India released a vision document incorporating a proposal to set up an umbrella institution for all the Retail Payment Systems in the country. Indian Banks Association's untiring efforts during the last few years helped to turn this vision into a reality and a new institution has been established namely, National Payments Corporation of India (NPCI) was incorporated in December 2008. NPCI became functional in early 2009. NPCI has taken over National Financial Switch (NFS) from Institute for Development and Research in Banking Technology (IDRBT). NPCI is expected to bring greater efficiency by way of uniformity and standardization in retail payments and expanding and extending the reach of both existing and innovative payment products for greater customer convenience.

V. Regulation of the Payment System in India The Central Bank of any country is basically having the important responsibility to strive to bring about the progress and development in national payment systems. It is actually the driving force to bring about a positive alteration in the payment and

12Ravi Kumar Sharma, “Technology and Security in Indian Banking System”,5(10) The Professional Banker 63-68 (2005).

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Published in Articles section of www.manupatra.com Re-Architecting Payments System in India settlement system of the country. The RBI was established in 1934, under the British regime. The Government of India nationalized the RBI, after the independence in 1949 with aim of progress and development in mind. Since then, the RBI has been taken several initiatives for ensuring ‘Secure, Sound, and Accessible payment systems in the country.13 The present legal framework governing the payment system in India is regulated and controlled through the provisions of the Payment and Settlement Systems Act, 2007, which got assent of President of India on 20thDecember; 2007and came into force 12th August, 2008. The Act extends to the whole of India. The Act designates the RBI as the sole authority for the supervision and regulation of payment system and for all related matters. In terms of Section 4 of the Act, it is quite clear that no person other than the RBI can commence or engage in operating a payment system unless authorised by the same. The RBI is also authorized under the Act to constitute a Committee of its Central Board, which would be commonly called as the Board for Regulation and Supervision of Payment and Settlement Systems (BPSS). The BPSS would be responsible for exercising the powers on behalf of the RBI, for regulation and supervision of the payment and settlement systems under the Act. Thus, the BPSS is the highest governing and policy- making body on the matters relating to the payment system in the country. The Department of Payment and Settlement Systems (DPSS) of the RBI serves as the Secretariat to the Board and is entrusted with the responsibility of executing its directions. The Reserve Bank of India has since then authorised payment system operators of pre- Paid Payment Instruments (PPI), card schemes, cross-border in-

13Charles Northcote Cooke, The Rise, Progress and Present Condition of 177- 200(P.M. Cranenburgh, Bengal Print. Co., West Bengal, 1963).

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Published in Articles section of www.manupatra.com Vol. 3 Jamia Law Journal 2018 bound money transfers, Automated Teller Machine (ATM) networks and centralized clearing arrangements. The RBI for effective control over the payment system, has made two Regulations namely, the Board for Regulation and Supervision of Payment and Settlement Systems Regulations, 2008 and the Payment and Settlement Systems Regulations, 2008, which came into force on 12th August, 2008. The Board for Regulation and Supervision of Payment and Settlement Systems Regulation, 2008 draws out the constitution of the BPSS, its powers and functions, meetings of the BPSS and quorum, the constitution of other Committees by BPSS, etc. The Payment and Settlement Systems Regulations, 2008 covers the matters like granting authorization for commencing/ carrying on activities relating to payment and settlement system, furnishing of accounts/ returns/ documents/ other information, etc. The RBI has taken many initiatives not only for launching safe and efficient instruments of payment system to meet the demands of common people at large but also enhancing or upgrading the features of existing payment instruments. The large geographic spread of India and the vast network of banking system is surely a challenge in maintaining the efficiency of the payment system. Thus, it is desirable for the Reserve bank that this aspect of the banking structure must always be kept in mind while evolving the payment and settlement system. Now-a-days, the facet of the payment system in India has been entirely changed due to innovations over recent years in the field of technology. The payment system has taken a new form in modern times to provide the users four essential ends of their financial transactions i.e. Safety, Security, Soundness and Efficiency. Although these are the ultimate objectives of a sound payment system, the Indian payment system lacks in one or other matters due to large geographic spread of the country and the vast network of banking sector. However, now- a- days, because of presence of

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VI. Challenges to Electronic Payment System The electronic payment mechanism has no doubts, lots of advantages over the traditional payment system. However, despite its numerous advantages, it faces some drawbacks and challenges, even in the developed world.15The identified challenges as revealed through extensive research works are discussed as under:

Lack of Proper Infrastructure

While the Government of India is emphasizing towards the cashless economy, it is highly noticed that the electronic payment instruments do not have yet adequately reached to the common public.

(a) The availability of payment cards for enabling the e- payment transaction is currently limited to only a small fraction of the common public in the country. In a population of 1200 million people, the availability of credit cards and debit cards as in May 2017 is 30.86 million and 880 million respectively.

(b) Further, India has only 2, 22,318 ATM terminals and 28, 40,113 Point-of-Sale (POS) terminals as in August, 2017. India has one of the lowest numbers of point-of-sale terminals per capita in the world. The penetration of ATM terminals and POS terminals per capita in India is about 18 and 693 per one million people respectively. Most of these cards machines are located in

14R. K. Uppal, “Customer Perception of E-banking services of Indian Banks”, 7(1) The ICFAI Journal of Bank Management 63-78 (2008). 15 R. Rajesh, T. Sivagnanasithi, Banking Theory, Law and Practice, (Tata McGraw Hill Pvt. Ltd., New Delhi, 2009).

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the top 15 cities in India which are contributing to over 75 per cent of the total volumes of electronic transactions at these terminals. Whereas similar emerging countries such as Brazil, which has 32,995 terminals per million people and China, which has about 4,000 terminals.

(c) On the dispersion of smart phones in India, as in 2015, there is only 17 % which is estimated to increase up to 20% in 2017. As in 2017, only 26% of the Indian population has internet subscription only, that is, 180 million people have fixed broadband subscriptions while 317 million has mobile- cellular subscriptions.

(d) Furthermore, lack of proper electronic payment infrastructure in government departments is also contributing towards the slow growth of electronic payment system. Even today, there is lack of availability of point of sale terminals at the government departments, local authorities for enabling the common public to pay bills, challans, or other service charges through electronic payment instruments and they are required to be paid in cash.

In the light of above mentioned data it is quite clear that the access to and usage of digital payments have been growing steadily but at a very slow pace. In fact, the electronic payment system does not have adequate reach to the common public which is a significant barrier to the growth of electronic transactions.16 Thus, it is suggestive that unless and until, the proper infrastructure is provided with, the concept of cashless economy in India would be a myth.

16Ewaryst Tkacz and Adrian Kapczynski, Internet- Technical Development and Applications, (Springer- Verlag, Berlin, 2009).

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Lack of Technical Knowledge:

Tech-Unsavvy are those people who do not know much about the modern technology. They are also called as the technology challenged people because they are among those sorts of people who find the simplest of everyday technological feats and gadgets as a challenge in their life. The Information and Communication Technology revolution is creating challenges for some of the common people. The perception of consumers also sometimes acts a barrier. They resist changing their cash based payment habits due to their wrong perception that that having cash helps you negotiate better. They also fear the usage of electronic payment instruments because of their fear of uncertainty against the settlement of transactions conducted through e-payment system. Further, the persons belonging to rural areas also prefer cash based payments instead of making the e-payments because they are financial illiterate and unfamiliar to such electronic gadgets. There is lack of general awareness among the public regarding the benefits of the e- payment system. The common man doesn’t know much about the ways of performing transactions through online medium. They also fear making e-payments because of the day to day cyber frauds. Moreover, the language is also inhibiting the growth of the e- payment system. Most of the e-payment instruments are currently programmed in English language and thus, they are difficult to be operated by those individuals who are residing in rural areas, especially those who do not know English language.

Security Problem

The security of information and data is almost a mandate of any payment system. In other words, a payment system is only successful when it can ensure the security of information and data in practice as well as in procedures. An ideal payment system is thus,

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(a) E-payment system represents a security challenge as they highly depend on the critical Information Communication and Technology systems that create susceptibilities in financial institutions, businesses and thus, may potentially harm the users.

(b) The electronic payment mechanism is entirely depends upon the Internet facility and since Internet facility is a part of public network of computers to which there is unrestricted access, it is quite desirable that the banks and other financial institutions using the Internet must have breach proof technology and systems in place to build an entirely secured network for handling of financial transactions.

(c) Another aspect of using a public network is that all information or credentials regarding financial transaction is transferred over the Internet which can be easily viewed or read by unauthorized persons. There are some in- built programmes such as ‘sniffers’ which can be used to collect data/ information like account numbers, passwords, account and credit card

17 Amrit Patel, “Rural Banking Policy Should Promote Effective Use of Technology”, IV (6) The Indian Banker 40-45 (June 2009).

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numbers of a person involved in the transaction. Furthermore, the risk of unauthorized, intentional or unintentional data alteration is also present there in the e-payment mechanism.

(d) One more important factor that affect the security of the financial transactions done through e-payment mechanism, that is, the unauthorized access to a confidential information of a banking company stores like accounting system, portfolio management system, etc. A breach in security management of the banking company could result in direct financial loss to the bank and thus, to the users. For example, there are professional hackers which operate through the Internet facility and try to access and interfere with secret customer information. They even can implant virus in the computer system of the banks which may result in loss of data or tampering with the customer information. The hackers may also try to theft the secret information of the banks and may disable bank’s internal computer system thus denying services to the customer for days and even weeks. Thus, ultimately resulting the loss of customers trust in the banks and their system.

(e) In addition to external attacks banks are exposed to security risk from internal sources also, for instance, employee fraud. The bank employees being aware with banking systems and their weaknesses become potential security threats in a loosely controlled environment. They can also manipulate the system to acquire the authentication data of the banks in order to access the customer accounts and thereby inflicting losses to the customers.

(f) It is important to note that the personal identity of the customer making a request for a service is very necessary to the bank

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because bank allows only such customers to conduct the financial transaction who are as such verified by the bank. A computer connected to Internet can be identified and traced by its Internet Protocol (IP) address. There are ways known to hackers through which they can masquerade a particular computer as another, which is commonly known as ‘IP Spoofing’. Hence, in such a situation, controlling the authentication of the customer through banks is also a challenge to the successfulness of the e- payment system.

(g) Lastly, there is another form of security risk to the e-payment system, that is, the operational risk or transactional risk. It originates due to inaccurate processing of financial transactions. This mainly arises due to some feebleness in the design, and implementation of banks’ security system. Besides deficit in the technical innovation of the bank, some human factors like negligence by the customers and employees, fraudulent activity of employees and hackers etc. can become a potential source of operational risk.18

Lack of Proper Incentive

The lack of adequate incentive is also a major factor behind the slow growth of the electronic payment system. There are currently no incentives which have been offered by the Government that could motivate the common public towards leaving their cash based payment habits and start using the instruments of electronic payments. The Key Advisory Group on the Payment Systems in India published a report which examined some of the steps taken by

18F. J. Miranda, R. Cortes, “Quantitative Evaluation of E-Banking Web Sites: An Empirical Study of Spanish Banks”, 9(2) The Electronic Journal Information Systems Evaluation 73-82 (2006).

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Published in Articles section of www.manupatra.com Re-Architecting Payments System in India the Latin American countries with respect to tax incentives for making electronic payments. In Argentina, since 2002, those consumers who purchases goods and services using credit and debit cards, they receive a monthly refund of 3 and 5 percentage points, respectively, of the standard rate of Value Added Tax (VAT) of 21%. Likewise, in Columbia, since 2004, those consumers who purchase goods and services using credit and debit cards receive a refund of 2% points of the VAT of 10-16 percent. In Uruguay, the Government provides tax rebates/abatement to both the consumers and merchants for using electronic transactions. If goods or products are purchased through credit or debit cards, consumers get 2% reduction in the VAT rate. VAT is totally exempted for the consumers when purchases are made with debit cards from the Conditional Cash Transfer Programme, Uruguay Social, or the Family Allowance programme. However, the Committee observed that some countries have put a cap on cash transactions in order to promote digital payments. Thus, not only positive incentives are provided worldwide but there are some countries which follows the practice of disincentives on cash transactions. If the amount of transaction is above the mentioned limit, the payment should be made through the bank. Further, in Greece, the cash payments (including VAT) for the merchandise are permissible up to 1500 euro and beyond that, payments must be made via bank accounts, cheques or credit/debit cards. Thus, it can be clearly observed that several countries worldwide are practicing the ways of providing incentives and the disincentives towards cash transactions to the common public for using instruments of electronic payment system. These practices are worth to try in India so that the common public can be motivated towards conducting electronic transactions.

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Presence of Intermediaries

The involvement of several intermediaries in the e- payment system is another major challenge which is inhibiting the growth of the cashless economy. The e- payment system basically operates through the co-operation of several intermediaries which create the front-end payments interface for the user. There are instances where banks or other licensed financial institutions enter into arrangements with the mobile app developers for compliance purposes. The app developers are entrusted with the duty of maintaining the software and the IT systems while the banks and other financial institutions are responsible for taking care of the proper accounting details of the financial transactions. Moreover, due to the involvement of intermediaries the costs of doing business increases through commissions which ultimately forces the payment companies to shell out more to facilitate access to their services by the consumer. Thus, the cost of providing e- payment facility to the consumer increases due to recurring maintenance/servicing cost which thereby leads to burden the consumer with high cost of availing the facility. Further, from the legal perspective, this also creates issues relating to indemnity and liability, data security and other contractual obligations among the involved parties. For instance, PhonePe is a new UPI wallet app which is developed by Flipkart Company and ‘powered’ by . In such scenario, strong tripartite agreements or back-to back commercial agreements have to be negotiated and finalised to protect the interests of all the parties. Moreover, if any dispute arises between the parties, ultimately the consumer would suffer.

Cross Border Risks

The electronic payments system allows a person to enter into not only national but also in transactions that have effect even

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Published in Articles section of www.manupatra.com Re-Architecting Payments System in India beyond the national borders. It is designed or operated in such a way as to extend the geographic reach of banking system and their customers.19 This expansion leads to various legal and regulatory risks, like there may be uncertainty about legal formalities in some countries and there may occur jurisdiction ambiguities with respect to the responsibilities of different national authorities. Such uncertainties may expose banks to several legal risks associated with non-compliance of different national laws and regulations, including consumer protection laws, record-keeping and reporting requirements, privacy rules and money laundering laws. If a bank uses a service provider located in another country, it will be more difficult to monitor it thus, causing operational risk. Further, those banks accepting foreign currencies in payment for electronic money may be subjected to market risk because of the movements in foreign exchange rates.

Deduction of Merchant Discount Rate Charges

In order to facilitate the electronic payment system, the merchants need to have proper electronic payment infrastructure like point of sale machines and an account with a bank which is called as the merchant account, to avail payments from the customers. As the banks provide payment services, the merchants are required to give a commission to the bank for using the payment infrastructure of the bank. This payment is commonly called as the Merchant Discount Rate (MDR). MDR is a charge deducted upon the income of a merchant by a bank for accepting payment from their customers in credit and debit cards, every time a card is swiped in their stores. The merchant discount rate is expressed in percentage of

19Abhijit Chaudhary and Jean Pierre Kuliboer, E- Business and E- Commerce Infrastructure (Tata McGraw Hill Education Pvt. Ltd., New Delhi, 2002).

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Published in Articles section of www.manupatra.com Vol. 3 Jamia Law Journal 2018 the transaction amount. In order to regulate the rate of MDR, a directive is issued under Section 10(2) read with Section 18 of the Payment and Settlement Act, 2007, effective from 1stApril, 2017. Under the guideline, the small merchants with turnover less than 20 lakhs p.a. is required to pay not exceeding 0.40% of the value of transaction if done through physical POS infrastructure and not exceeding 0.30% of the value of transaction if done through digital POS infrastructure. There are different MDR rates for different categories of merchants. Thus, deduction of MDR is also discouraging the merchants from enabling cashless transactions to their customers.

VII. Trend and Progress in E-Payment Systems The cashless economy in India has been lately, the subject of interest for the Department of Payment and Settlement System (DPSS). It has continually worked to make it possible for the society to move from traditional payment habits to a ‘less-cash’ society through a process of developing a regulatory framework which is responsive to emerging developments and innovations. Among other things, providing for a better infrastructure with multiple channels and instruments for payment services has definitely broadened the customer base.20 As already discussed, there are many options available to either an individual or any institution through which it can make a payment transaction. Those channels include firstly, the paper- based instruments, and secondly, the electronic or digital instruments such as Prepaid Payment Instruments (PPI) like smart cards, online wallets, etc., internet banking, mobile banking, ATM based payments, NEFT, RTGS and other online transactions. The RBI

20Himanshu Prabha Ray, Coins in India: Power and Communication (J. J. Bhabha Marg Publications, New Delhi, 2006).

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Report in regard of usage of digital payments methods revealed that today only 20% of the total payment transactions and 5% of personal consumption expenditure are conducted digitally in India. Even today, the current data suggests that a large part of Indian economy is operating on cash. 21 Before moving to the specific issues which are giving rise to concern, it is worth taking stock of the facts pertaining to the current status of the payment system in India. For better analysis of the situation, a Committee on Digital Payments was set up under the chairmanship of Ratan P. Watal in August, 2016 in order to review the status of the digital payment infrastructure and related issues. The Committee observed that paper cheques have continually preferred for making payments, constituting 54 % in terms of volume and 82 % in terms of value with retail electronic payments.22 With respect to smart cards, in May 2017, a total of 30.86 million credit cards and 880 million debit cards were in operation. Between May, 2016 and May, 2017, India added some 0.48 million credit cards and added 13.03 million debit cards.23 As a matter of interest, in terms of usage smart cards, currently the debit cards are mostly used at ATMs for cash withdrawal while a very few transactions are happening at point of sale terminals (POS). As per the data recorded, the usage of debit cards continues to account for around 112.87 million of total value of e- payments in March, 2016. Debit card usage has been increased to

21Available at: http://fletcher.tufts.edu/~/media/Fletcher/Microsites/Cost%20of%20Cash/COC- India-lowres.pdf (last accessed on 25th August, 2017). 22Government of India, Committee on Digital Payments: Medium Term Recommendations to Strengthen Digital Payments Ecosystem (Ministry of Finance, 2016). 23Available at: http://www.thehindubusinessline.com/money-and-banking/creditdebit- card-usage-surges-on-demonetisation/article9341080.ece/ (last accessed on 25thAugust, 2017).

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48 % as compared to usage in March, 2015. Whereas the credit card usage at ATMs accounted for around 1.18% of value of total credit card transactions and use of credit cards for electronic transactions accounted for 72.22 million of total value of e-payments in March 2016. There has been increase noted in the total usage of credit card transactions up to 27% as compared to March 2015. In nutshell, number of transactions using credit cards grew by 47% year on year, while it rose by 100% for debit cards for the 12-month period ending May, 2017. In May, total number of transactions through credit cards was 115.3 million while the figure for debit cards was 267.5 million.24 With respect to prepaid payment instruments (PPI), recorded at 488 billion as compared to 212 billion in 2015-16. Mobile banking service has registered its growth increased by about 126.6 per cent in terms of volume and 290.3 per cent in terms of value while handling 389 million transactions valued at 4 trillion during the year.25With respect to acceptance infrastructure, India has one of the lowest numbers of ATM and POS terminals per million populations. The penetration of ATMs is 165 per million populations and that of POS terminals is 1080 per million populations. In the Annual Report of the Reserve Bank of India which was submitted on 30th June, 2017 to Central Government, it was observed that in overall the payment and settlement systems registered sound growth during 2016-17, with volumes and value growing at 55.7 % and 24.8%, respectively. In terms of the volume, the share of e- payments in total financial transactions has moved to 89.0 % from

24 Available at: https://www.medianama.com/2017/07/223-india-credit-cards-debit-cards- may-2017/(last accessed on 25thJuly, 2017). 25The Reserve Bank of India, ‘Annual Report’ (2016-17), available at:https://www.rbi.org.in/scripts/AnnualReportPublications.aspx (last accessed on 25th September, 2017).

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84.4 % in the previous year and also in terms of value, from 94.6 % to 95.2 %.26 From further records, it is known that during 2016-17, total transactions that performed through credit cards were about 1.1 billion transactions, valued at around 3.3 trillion while total 2.4 billion transactions, valued at 3.3 trillion were carried out through debit cards. On the other note, it was estimated that the total PPIs transactions were recorded at about 2.0 billion transactions, valued at 838 billion as when compared to 748 million transactions valued at 488 billion in the previous year.27

VIII. Conclusion The payment mechanism of a country is like the arteries in the human body where latter facilitates pure blood to all parts of the body and former is a path or highways for conducting trade, commerce and all other forms of economic activities in the country. It enables one person to transfer purchasing power to another. A progressive payment mechanism works as a lubricant for swiftness of the liquidity flow in the economy and thus, creating a stimulant for the economic growth of the country.28 The paramount aim of a payment system of any country is to encourage secure, convenient and affordable modes of payment infrastructure. When global developments as above were taking place at a phenomenal pace, though India initially lagged far behind, several actions were set in motion to formulate a systemic

26The Reserve Bank of India, ‘Annual Report’ (2016-17), available at: https://www.rbi.org.in/scripts/AnnualReportPublications.aspx (last accessed on 25th September, 2017). 27Available at: http://indianexpress.com/article/business/business-others/debit-cards- transactionsslow-credit-cards-grow/ (last accessed on 25th September, 2017). 28Ananya Mukherjee Reed, “Corporate Governance Reforms in India”, 3(3) Business Ethics 253 (2002)

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Published in Articles section of www.manupatra.com Vol. 3 Jamia Law Journal 2018 foundation in the payment mechanisms. Though, in India, the retail payment system primarily depended over cash based payment system, with rapid globalization and embracing technology in the Indian economy during early 1990s, led to spinning the wheel in the banking Industry. The digitalization of clearing operation was a key step towards modernization and computerization of the payment system. The modern payment system has truly showed that it is the need and requirement of time. Now with the computerization and digitalization, the common public has seen the benefits of the modern payment system. It has added convenience and low-cost availability like features to the life of common public. Due to such features, now a person does not want to shop in complexes and shopping malls but prefer to choose online shopping portals because they can easily make payment towards their shopping through their payment cards. The modern payment system has also added more compliance to the rules and regulations of Government because every financial transaction is now recorded and can be easily accessible. This in turn, curbed the malpractices of black money and thus contributed towards the welfare of society.29 Inspite of having features like convenience, speed and time- saving, the instruments of modern payment system have been not quite up to the mark of the requirements of the common public. They are quite useless for those people who are residing in the rural areas and if accessible, they cannot make a use of it due to their financial illiteracy. It is true that the modern payment instruments have reduced transaction cost per person but in whole each transaction have their cost which in turn, have exerted a lot of cost

29Amal Kanti Ray, “India’s Social Development in a Decade of Reforms”, 87(3) Social Indicators Research 410 (2008).

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Published in Articles section of www.manupatra.com Re-Architecting Payments System in India burden over a person who is associated with businesses of trade and commerce. A 100 rupee note paper may have production cost of Rs. 5 or 10 but in modern payment system, every transaction which is of value Rs. 10 to lakhs and crores are having cost to the person transacting thus, creating a lot of extra revenue for the banks and other financial institutions. Thus, a person transacting through modern payment system has a heavy burden of transaction cost to bear which makes traditional payment instruments in preference to the modern.30

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30Bruce J. Summers, Payment Systems: Design, Governance and Oversight (Central Banking Publications Ltd., London, 2012).

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