THE EVOLUTION OF PAYMENT SYSTEMS

Transcription

1 CHAPTER - II THE EVOLUTION OF PAYMENT SYSTEMS The Payment System provides the arteries or highways for conducting, trade, commerce and other forms of economic activities in any country. It enables one party in an economic transaction to transfer purchasing power to another. An efficient payment system functions as a lubricant, speeding up the liquidity flow in the economy and creating a momentum for economic growth. Payment instruments and mechanisms have a very long history in India. The earliest payment instrument known to have been used in India, was coins, which were either punch-marked or cast in silver or copper. Coins represented a physical equivalent and credit systems involving bills of exchange facilitated inter-spatial transfers. Loan deed forms called rnapatra or rnalekhya were in use in ancient India. These contained details such as the name of the debtor and creditor, amount of loan, the rate of interest, the condition of repayment and the time of repayment. The deed was witnessed by a person of respectable means and endorsed by the loan deed writer. Execution of loan deeds continued during the Buddhist period, when they were called inapanna. In the Mauryan period, an instrument called adesha was in use, which resembled the Bills of Exchange of today. It was an order on a banker desiring

2 21 him to pay the money of the note to a third person. Considerable use of these instruments was made during the Buddhist period. Merchants in large towns gave letters of credit to one another and there were numerous references to promissory notes. The loan deed continued in the Mughal period. Two types of deeds viz., dastawez-e-indultalab, payable on demand and dastawez-e-miadi, payable after a stipulated time were used during such period. Foreign travellers too used the Bills of Exchange in the then great commercial centres. It may be noticed from their writings that bankers too issued Bills of Exchange on foreign countries mainly for financing sea borne trade. These bills were widely accepted and traded at high discounts, which included insurance premium for risk coverage thereby ensuring safe arrival of goods. Another prominent instrument used during the Muslim rule was 'Pay Order' which was issued from the Royal Treasury on one of the District or provincial treasuries. These resembled the present day drafts or cheques and were called barters. The most important and widespread credit instrument that evolved in twelfth century and continues to hold prominence even today is 'Hundi\ ft represents the oldest surviving form of credit instrument, ft is used-

3 22 o As remittance instrument to transfer fiinds from one place to another. o As credit instrument to borrow money. o For trade transaction as bill of exchange. Hundies were of many types and each had the following distinguishing features: Dhar Shani Hundi: This was a demand Bill of Exchange payable on presentation according to usage and custom of the place. It was mainly of four types: a) Sah-Jog: A Hundi payable only to a shah or his order but transferable by endorsement and delivery. The shah is a respectable and responsible person, a man of worth and substance and was well in the market b) Dhanni-jog: This was a demand Bill of Exchange payable only to the dhanni (ie) payee and it was not negotiable. c) Firman jog : These were payable to the order of the person named in it. These would be negotiated with a simple or conditional endorsement. d) Dekhavanhar. This is similar to a bearer cheque and is payable to the person presenting it to the drawee. Muddati Hundi: This is a time bill payable after a stipulated period, on a determinable future date or on the happening of a certain stipulated event. These hundis also had the same features as 'Dharshani Hundi'. Jokhami Hundi, the most important one was a documentary Bill of Exchange, which corresponds to the

4 23 present day Bill of Lading. This had been in use for centuries and the payment was conditional on the safe arrival of goods. Coins: The princely states of India had their own distinct coins. The Arcot rupee coin struck by the Nawab of Arcot in the Madras presidency was an example for this. The Europeans secured the privilege of making coins by 17* century and then these coins came to be known as English, French and Dutch arcots. To bring un throughout British India, the East India company introduced the company's Rupee. This phase culminated in the enactment of Negotiable instruments Act, 1981, which formalized the use and characteristics of instruments like the cheque, bills of Exchange and promissory notes. The NI Act provided and Still provides the legal frame work for non-cash paper payment instruments in India. Paper Money: In late 18* century, Private Banks and semi-government banks started issuing paper Money. The earliest of such issues, was made by Bank of Hindoostan, the General Bank in Bengal and Bihar. The job of issuing notes, was taken over later, by the three presidency banks, established then. Each presidency bank had the privilege of issuing notes within certain limits. Notes issued by the Bank of Bengal were circulated within the environs of Calcutta and were mainly used for effecting large transactions.

5 24 The large proportion of the bank notes consisted of 100 rupees and upwards. These notes some times carried a small premium too reflecting the public confidence in the bank. With the conferment of monopoly power to the Government of India, by the paper currency Act of 1861, notes issue of private and presidency Banks came to an end. Other Paper Instruments: With the abolition of power of note issue by Private and presidency banks, they started issuing other paper instruments in the money market. The Bank of Hindoostan, the first Joint Stock Bank established in 1770 introduced cheques. In 1827, the British introduced post Bills. This was similar to Inland promissory notes issued by the bank on a distant place, the holder of which would be paid on acceptance after a specified number of days. These were similar to muddati hundis and these had a very small currency compared to bank notes, since, the government mainly refused to authorize their receipts in settlement of public dues. Such bills were mainly used by European businessmen for internal remittance purposes. Cash credit accounts were added to Bank of Bengal's array of credit instruments in The bank used to grant loans upto a limit of 1 lakh Sicca rupees against the security of company's paper, bullion, plate, jewels, goods of non-perishable nature or goods not liable to great alteration in value. From

6 , buying and selling of Bills of Exchange became one of the items of business to be conducted by Bank of Bengal. Transactions through use of cheques increased at a rapid pace with the steady growth in the volume of trade and commerce and the growing confidence of public in the use of cheques. Emergence of Cheque Clearing System: With the growth of cheque use, bank employees had to walk frequently to other banks, collect cheques and drafts, present them to drawee banks, to collect cash over the counter. Such methods could serve only for limited instruments besides the risk of loss in transit. The need for an organized cheque clearing process emerged amongst the banks with the development of the banking system and higher turnover in the volume of cheques. Clearing associations were formed by the banks in the presidency towns and the final settlement was effected by means of cheques drawn by the presidency Banks. With the setting up of Imperial Bank in 1921, the settlement was done through cheques drawn on that bank. The Calcutta Clearing Banks' Association, the largest bankers association at that time adopted clearing house rules in This had twenty five large banks as its members and eight, sub members. There were two ordinary clearings on each day except Saturday when there was one clearing. Since the association did not cover many banks functioning in Calcutta, the cheques and drafts of non-clearing banks were collected only on payment of

7 26 charges. This adds to a serious handicap, since the public were not Ukely to maintain accounts with such banks. To overcome this problem, these banks formed themselves into a group called Metropolitan Banking Association with 50 members, which conducted the Metropolitan Clearing House in In 1940, an Understanding was arrived at Calcutta clearing house besides two other clearing houses namely, "The pioneer clearing" and "The walks clearing". To conduct clearing in Bombay, the Bombay clearing house was established with no parallel systems or institutions comparable to the Metropolitan clearing house of Calcutta. This adopted uniform rules and regulations for collection of non-clearing banks' cheques, drafts, dividend Warrants etc. in the year With the passing of Reserve Bank of India Act of 1935, the clearing houses in the presidency towns were taken over by RBI. Modern Payment Systems (Mid 1900 to 1997) A Global Out-Look: At this stage, it is pertinent to record the happenings in this arena in the developed countries of the west, predominantly the US and Europe, briefly in chronological order: The Western Union issued 'Metal Cards' Franklin National Bank issued the first Bank Card.

8 Launch of first T& E Card AMEX started Bank of America (Visa) Card National Bank AmeriCard / MasterCharge Incorporated. Since then, several activities unfolded, closely concurrent with the technological wizardry, especially in Electronics, Computers and Communication fields. The path-breaking ones are: ATM (Automatic Teller Machine) installations begin. The ATM Cards come into vogue. Participation of Banks in shared networks. Merchant establishments install EFTPOS (Electronic Fund Transfer at Point of Sale) terminals, leading to lower cash handlings. Chip and Software Technology shoots off to stir-up e-commerce activities, through the Net. Internet; Open platforms; Java - combinations evolve a more flexible but rugged software plank for the ATMs, ATM-EFTPOS-Bank Networks, On- Line transaction processes etc. Here, it is interesting to observe a basic shift in paradigm, from one of Value Exchange to an Information Exchange, as presented below:

9 28 Value Exchange \ Bank/Merchant Connectivity Information Exchanse Bank/ Merchant/ Consumer Connectivity Physical Market Single Purpose Product Limited Functionality POS / ATM Device Plastic Self Funding Domestic Border J Virtual Market Multi Purpose Broad Functionality Remote Access Multi-device Device Shared Funding Global, across borders ^ Customer / Bank "^ Fragmentation of Customer Relationship Owner Participants The Indian Scenario: 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 foundation in the payment mechanisms. Computerization of clearing operation was a key step towards modernization of the payment system. The introduction of Magnetic Ink Character Recognition (MICR) based mechanised cheque processing technology in Mumbai (1986), Chennai, New Delhi (1987) and Calcutta (1989) was a significant milestone.

10 29 The MICR clearing centres possess the state of the art reader-sorter based processing capabiuties; As of now there are 40 MICR Centres, which account for 70% of cheque volumes of the country. Physical transmission of paperbased instrument from the collecting bank branch to the drawee bank branch results in delay in payment and settlement process. Reducing the time taken for processing of payment instruments has been engaging the attention of RBI in the recent past. To overcome this systemic handicap, cheque truncation is introduced whereby the paper instruments 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 branch for payment. The physical cheque will be truncated within the presenting bank to derive maximum efficiency and settlement will be done on the basis of the current structure of MICR fields. Implementation of cheque truncation by all banks could help in accelerating the cheque clearing and settlement process and to reduce the delay in the payment system. This would help in further improving the customer service. Cheque truncation on a pilot basis was initiated in the National capital Region of Delhi during However, the volumes in cheque clearing continued to reflect an upward trend, creating considerable pressure on the existing workflows. This was mainly due to 'at par' items such as dividend and interest warrants issued by corporates. The existing system of paying interest / dividend through paper

11 30 instruments is also fraud prone because of postal interception and encashment, often resulting in real beneficiaries not getting their dues at all, or at times getting delayed payments. Hence it was decided to introduce a system that would decrease the volume of paper instrument in MICR clearing and improve customer service by ensuring prompt and secure interest / dividend payments to the beneficiaries. Such a system needs to be cost effective and at the same time serve as an effective alternate method of effecting bulk, low value, recurring payment transactions thereby obviating the need to issue and handle paper instruments. Electronic Clearing System (ECS) provided the answer to these problems. In ECS -Credit, a series of electronic payment instructions is generated to replace paper instruments. Under this system, one single transaction triggers a large number of credit entries. These electronic payment instructions which contain details about the beneficiaries account number, bank branch are communicated to the bank branches through the respective service branches for crediting in the accounts of the beneficiaries either through magnetic media duly encrypted or through hard copy. Companies and Government departments, which have to effect payments to large number of beneficiaries, submit details of payments in magnetic media to the bank managing the clearing house, through a sponsor Bank. The user institutions are required to obtain mandates from beneficiaries for crediting in their accounts under ECS. The corporate bodies should in

12 31 addition advise the beneficiaries about the due date of credit under ECS. The minimum number of transactions per user institution is 2,500 with an upper limit of Rs. 1,00,000 for any single item. A very low service charge is prescribed for this service. The National clearing coporation / clearing agency would sort the records on the basis of city code and transmit the file to the relevant destination. Electronic Clearing Service -Debit is a scheme, which facilitates payment of charges to utility services such as electricity, telephone companies, payment of insurance premium and loan instalments etc. It envisages a large number of debits resulting in a single credit simultaneously. It works on the principle of pre-authorised debit system under which the account holders' account is debited on the appointed date and the amounts are passed on to the utility companies. This scheme facilitates: 1. Faster collection of bills by companies. 2. Better cash flow management. 3. Eliminates the trouble involved in going to designated banks for payment of dues. For ECS-Debit to become widely accepted and popular, customers should have faith in the correctness of the bill amounts raised on them by utility companies. A blanket permission to debit the account could result in excess payment to the utility company in case of wrong billing, causing lot of concern for the customers. To obviate this difficulty, a variant of ECS Debit called ECS

13 32 Utility Bills payment - RAPID (Receipts and Payments of Instruments and Documents) has been introduced on a trial basis. This is a post verification debit scheme wherein the consumer verifies the bill and has the option to pay the bill either in cash or can authorize the bank branch to debit his account. This scheme is useful to corporates as they get the amount due to them on a stipulated date and is usefiil to the customers too as they are in a position to verify the accuracy of the billed amounts, before effecting payment. Another major development in ECS -Debit was the implementation of OLTAS (Online Tax Accounting System) during the year It helps in streamlining tax payment procedures, improving tax administration and building up an information base as an input for policy formulation. This was introduced on a pilot basis in June 2003 covering 48 branches of 16 banks in four cities. At present, 11,000 bank branches are connected to OLTAS and more than 5,150 branches collected 8.58 lakh challans^ that were transmitted during the quarter, January - March The collection and transmission of data on tax collections is on a T+1 cycle basis, where T is the day of initiation of the transaction. With a view to providing funds transfer electronically across a large number of bank branches in the country and as a forerunner to the nationwide funds transfer system (NEFT), the Special Electronic Funds Transfer (SEFT) system was introduced from April 1, It has succeeded in faster credit transfers to branches that are computerised and networked even though they are

14 33 situated at locations where the Reserve Bank does not have a presence. The settlement is centralised at Mumbai and the system provides for same day funds settlement (T+0) with multiple settlements during the day. SEFT covers 2,312 branches of 29 banks situated in 127 cities across the country^. A major milestone, in the development of payment system is the implementation of Real Time Gross Settlement (RTGS) system from March 26, This is in compliance with the core principles framed by the Bank for International Settlement (BIS). By end of July 2005, 95 banks including the Reserve Bank provided the RTGS facility at over 8,200 branches in 418 centres^- The RTGS system, which was originally meant for settling pure inter-bank transactions, were permitted to settle customer based inter-bank transactions from April 29, Salient features of RTGS system are: 1. Settlement of high value and retail payments, transaction by transaction. 2. Final and irrevocable settlement of funds. 3. Immediate use of funds settled on real time basis. 4. It uses digital signature and Public Key Infrastructure (PKI) based encryption for safe and secure message transmission, ensuring 100% security of transaction. Provision of Intra-day liquidity support to member banks smoothens the temporary mismatch of funds flow. More than 75% of the volume of Inter-bank

15 34 transactions, which was earlier being settled through Deferred Net Settlement (DNS) system, are now being settled through RTGS (Maximum of 2 hours). Where are we now? The evolution has left India with myriad payment systems. The key characteristics of such payment systems are presented below. Key Characteristics of Large Value Payment System: Name Inter - bank clearing High- Value clearing Characteristics Paper based debit instruments Deferred Net settlement system (DNS), Value int+0 Paper based debit instruments Deferred Net settlement system (DNS), Value int+0 Amt. Locations Restriction covered No A1116RBI Restriction Centres 1,00,000 and above 12 Centres Bank Participants Only for interbank transaction. Cleared on intracity basis All members of local clearing house, cleared on intra-city basis. Over 5000 Electronic credit, Banking Real Time Inter-bank customer Centers - on 3000 branches of Gross transactions. Near No Banks' 70 banks, covering Settlement real time value Restriction Declaration over 500 banking (RTGS) (Maximum of 2 hours) of participating Branches centres.

16 35 Key Characteristics of Retail Payment System: Name Characteristics Amt. Restriction Locations covered Bank Participants MICR Clearing (Cheques) Paper based debit instruments, DNS, value in T+2 No Restriction 39 Centres (Covering 70% ofchq. Volume) All members of local clearing house, cleared on intra-city basis Non MICR (Cheques) Paper based debit instruments, DNS value date varies. No Restriction Centres All members of local clearing house, cleared on intra-city basis Electronic Clearing Services - Credit (ECS -Credit) Electronic bulk transfers (One to many) Deferred Net Settlement, Value in T+3. No Restriction w.e.f. Nov Centres All members of clearing houses at the cities where ECS - Credit is offered. Electronic bulk ECS -Debit transfers (one to many) Deferred Net Settlement, Value in No Restriction w.e.f.nov. 45 Centres where ECS - Debit is offered. T+3.(ManytoOne) Electronic, One to Inward EFT is Electronic Funds Transfer (EFT) One Deferred Net Settlement, Value in No Restriction 15 Centres mandatory for all banks; outward T+0 or T+1 EFT is optional Special Electronic, One to Electronic Funds Transfer (SEFT) as first step towards National One Deferred Net Settlement (3 settlement cycles/day). Value in No Restriction 2312 Branches of29 Banks in 127 Cities Inward EFT is mandatory for all banks; outward EFT is optional. EFT. T+0, or T+1 Card-Based On-Line and Off-Line (Credit Card, Debit Card, ATM Card, Smart Card modalities with ATMs / POS Terminals (One to One) T+0 for On- As stipulated by the Issuer Card Issuers, Banks, Payment Processors. etc.) Line

17 36 Along with RTGS and SEFT, almost all commercially important centres of the country have been brought under a net with the potential to offer the customers, a far superior electronic mode of fund transfer services. In the retail payment segment, Card-based transactions have emerged as the most preferred electronic mode of payments. The first entrant in the card sector was the credit card, which has witnessed large-scale acceptance as a medium of use at many Points of Sale (POS), across different merchant establishments. Soon banks started issuing other types of cards such as Debit Cards, ATM Cards and Smart Cards. Amongst the latter, the growth of ATM /Debit card issuance and use have been phenomenal. As of April 2004, the number of Credit Cards issued was Lakhs; ATM /Debit Cards Lakhs and was expected to reach around 160 and 300 Lakhs respectively, by The ATM installation base, which was 5489 in March 2002, was expected to be in the order of 15,667 by 2005^. This gives an idea of the magnitude of systemic changes in our payment or cash handling methods. Apart from Card modes, another fast emerging concept will take the form of a fancy futuristic instrument - the 'E-Check'! This is expected to substitute the traditional paper cheque- a Digital Signature replacing the hand-written one (or thumb impression); the electronic Certification and Authentication replacing the manual verifications! This project on E-Checks- the protocols, model and security aspects for clearing and settlement system, has recently been finalized by IDRBT (Institute for Development and Research on Banking Technology) and the Ministry of Communication and Information Technology. This will go a long way towards an effective and trustworthy e-com environment in India.

18 37 The Major Concerns henceforth: Having presented an overview of the evolution of the Payment System globally as also in India, the forces that would play a vital role in shaping the future of the system are: 1. A rapid growth in the volume of financial transactions exerts a burden on the payments infrastructure. More so, wherein the growth outstrips that of the nation's GDP. At the present juncture, the bulk of the global GDP and savings are more from the emerging economies rather than the developed ones. Obviously, the futuristic plans shall take this factor into account. 2. With the economies and markets moving more and more borderless, the sheer volume of the global level transactions tend to become mind-boggling. The entire system becomes a patch-work of national and inter-state ones, involving the payment and settlement issue as common, but legalities, infrastructures and polity being highly divergent. This in turn falls upon the international institutions, exposing them to a wide variety of associated risks. 3. In the capital market segment, the infrastructure tends to lag behind that of the market operations involving documentation legalities, post-trade processing etc. 4. Post September 11, terrorism, both international and cross-border, poses a new threat perception in the domain of safety, robustness and resilience of the system. 5. The cyber crimes worldwide form yet another dimension to be addressed. 6. As multiple payment methodologies like cash, cheque, cards, e-money products co-exist (may be in different volumes), and what with newer ones like E-Checks

19 38 cropping up, there is an urgent need to arrive at a convergence of technologies to take care of such a wide spectrum, now as also in foreseeable future. The vital pre-requisites for such a system can be listed as- 1. Assured Security 2. Functional Multiplicity. 3. Easy Portability. 4. Future Technological Adaptability. 5. Virtual Mode (while under web), but personalized. 6. Cost Effectiveness. 7. Service Supports. 8. Network Stability. 9. Inter-Operability. All these have paved the way for the formulation of world standards, for the components of the system too. With all these features and standards incorporated, the system should ultimately reach its piimacle- Fully Universal, Secure and assured Sustenance over a long period of time, with a ' One-World-One-Currency' norm! REFERENCES: 1. Reserve Bank Of India, Annual Report, , pi Reserve Bank Of India, Annual Report, , pl Reserve Bank Of India, Annual Report, , pi Reserve Bank Of India, Annual Report, , pi Indian Payment Card Industry Survey Report, , Venture Infotek Ltd., Mumbai.