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I N F O R M AT I O N T E C H N O LO GY

REAL TIME GROSS SETTLEMENT


SYSTEM (RTGS) – AN OVERVIEW
The effectiveness of the function of a Chartered Accountant, whether it be as an ac-
countant or an auditor or a financial executive, phenomenally improves with the de-
gree of understanding of the business processes and the technologies deployed in
the said processes. This article purports to present an overview of one such process
(viz. RTGS) and a related technology deployed in the Banking Sector.

I
n the early nineties, a public sector bank Access, control and leverage are the significant
introduced a product into the market called features of this product. This article explains the
Cash Management Services (CMS), which features of RTGS.
received a phenomenal reception. Till then, It has become imperative for Banks in India,
entities, which had several work points had their in their process of adaptation to the global pay-
cash parked at each of these centers to meet ments and settlement systems, to have in force
their needs and could not use those resources “a congenial transfer of payments or funds”. To
to the optimum extent. CMS changed it all and quote, The Committee on Payments and Settle-
moving funds to the place of need became easy. ment Systems of the Bank for International Set-
Entities were able to maximize the leverage such tlements, Basle (CPSS), “a payment system is a set
instant mobility provides. Currently it is said that of instruments, procedures and rules for the trans-
funds to the extent of rupees eight lakh crores fer of funds among the system’s participants”. This
get handled under the CMS product. RTGS (Real committee’s report is referred to as Significantly
Time Gross Settlement) is a sub-product under Important Payment Systems (SIPS), which is the
the CMS umbrella and on a pan-India basis. network of major channels, for transmission of
This product is currently being offered through funds across domestic and international finan-
20000 branches of various banks. RTGS would be cial systems. It has been stated that by putting
of immense help especially in handling overseas into operation the electronic transfer of funds
remittances and enterprises can transfer funds to systems “anyone can make payments to whom-
their business partners/associates with minimum soever one likes, whenever one likes, in whatever
loss through pipeline costs. Till now inaccessibility type of currency one likes, at the cost of a few
to funds in the pipe line or substantial access cents per transaction”. There are neither settle-
costs were putting the business entities in to ment delays nor mountains of paper work. The
enormous pressure in the global context. To these value is received instantaneously. There are no
entities and especially to finance executives, CMS distinctions in cost or nature between a domestic
and RTGS have proved to be of immense value. and foreign currency transaction. Interest is com-
puted on real-time, instead of on a “settlement
day, a practice from the ancient times when ac-
- CA. S. Devarajan counting was done manually”. In such systems,
(The Author is a member of the Insti- “privacy and security are guaranteed”.
tute. He can be reached at Sethura-
man.devarajan@gmail.com) Reserve Bank of India, in an attempt to adapt
to the international practices, has recommended
the introduction of RTGS.

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The objectives behind introduction of RTGS there are a number of Banks, which have not or
are: are in the process of implementing core banking
1. Protection of the key existing assets of the solutions. In some of the rural areas the Bank
Banking system, which are obviously the branches are either not computerized or yet to
brand name and customer relationship. be networked. Besides, our banking system is
different from the western ones in its objective,
2. To widen and strengthen the customer scope and operation. Therefore, standardization
base. of any practice is a slow process. Due to this
3. To reduce the prevalent transaction cost peculiarity, the implementation of RTGS can
and to explore revenues for generating only be in stages and wherever appropriate. In
additional income for the Banks. Though other words, RBI cannot introduce RTGS across
CPSS established a task force on payment the board saying that they are going global. Such
systems, principles and practices as early an action would not address the vulnerabilities
as in May 1998, to establish the principles that are endemic to any system from within and
for the design and operation of payment without.
system in our country, RBI has taken a
cautious approach and has provided norms CORE PRINCIPLES OF THE PAYMENT
and guidelines only in 2005, with a view to SYSTEM:
provide time and space for the constituents 1. The system should be legally robust and be
to adapt. It is pertinent to note that a bill
firmly grounded on the present legal system
titled “Payment Systems Bill” was passed
as applicable to all jurisdictions. In other
in the year 2002 in our Parliament. The
words, the system should be synthesized to
implementation of the electronic settlement
the country’s legal environment.
systems in our country has been slow but
firm because payment systems are not fault 2. The participants to the system should be
free and can go berserk. Any developments made aware of the functional risks in the
or suggestions of a core principle governing system. The rules and procedures should
such electronic payment systems should facilitate the process of educating the
factor in the weaknesses and address the participants and be clear as to the impact
process of elimination of the inherent of the entailed functional risks that they
weaknesses. may incur by participating in the system.
Therefore, the rules and procedures are
As per our Payment Systems Bill 2002, a
expected to be comprehensive and up to
payment system means "a system that enables
date. The legal base of the system should
payment to be effected between a payer and a
be clearly spelt out. Accessibility should be
beneficiary and includes clearing, settlement
ensured.
or payment service." A good payment system
creates a comfort zone in liquidity for the 3. An ideal system or a preferred system clearly
participants and consequently plays a lead role defines the procedures for management of
in making the financial markets buoyant. It has credit and liquidity risks. It should specify
got tremendous impact on the domestic and the relative responsibility of the system
international transactions with respect to the operator and that of the participants.
speed of transfer, financial risk, reliability and of It would be preferable if appropriate
course the costs. RBI’s recommendation for the incentives were also provided.
introduction of RTGS has taken into account the 4. An effective payment system should address
uneven automation process of various private and apart from credit risk, liquidity risk, legal risk,
public sector banks in India. To cite an example, operational risk and systematic risk. The

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responsibility for risk management is to be they should carry little or no credit risks.
clearly assigned. An effective management To put it in layman’s terms, most systems
of risk lies in the design of a safe payment involve the transfer of asset among system
system. Therefore the system design should participants to settle payment obligations.
contain appropriate details and incentives The common practice in India is to have this
with respect to the various risks established asset as an account balance on the Central
and management thereof. Bank representing a claim on the Central
Bank. As all the participants in the system
5. The payment system should provide prompt
must accept this asset, the system’s safety
functional settlement on the value date
depends, in part, on whether the asset leaves
preferably during the day. In other words,
the arbitrator with significant credit risk. In
this principle states that the settlement
some payment systems, a transferable asset
should be daily.
is used minimally. For instance, they may
6. An effective system where multilateral settle one claim by offsetting with another.
netting takes place should be capable However, one has to be consistent.
of ensuring timely completion of daily
8. The payment system should be highly
settlements and be capable of handling
any inability to settle by a participant with secured and operationally reliable. There must be
the largest single settlement obligation. In contingency arrangements for timely completion
multilateral netting systems a participant of process delays; i.e. a disaster management
may defer the settlement. Thus a participant system should be in force. The degree of security
faces the risk of not being able to meet its and reliability for providing adequate safety and
settlement obligations thereby invoking efficiency depends on the degree of systematic
the possibility that the other participants importance of the system and on the availability
will face unexpected credit and liquidity of alternative mechanism for effecting payments
pressures at the time of settlement. Therefore during contingencies.
strong controls and relative measures are 9. The system should be practicable,
required and should be embedded within economically efficient and effective.
the system. For example, this risk can be
addressed by ensuring that additional 10. The system should be transparent and
functional resources are available to meet accessible.
the contingency. It can be a combination 11. Accountability and responsibility of the
of the following: participants should be clearly spelt out.
a. A pool of collateral cash or security,
which are appropriately valued. IMPLEMENTATION OF RTGS SOLUTION IN
INDIA:
b. Committed lines of credit.
Due to the peculiar financial environment and
c. Fixing of maximum individual settle- practices prevalent in India, certain hard decisions
ment obligation. have been taken by the Reserve Bank of India
d. Evaluation and standardisation of the to bring it in conformity with the international
system design. practices. The salient features are discussed
briefly here below:
7. It would be appropriate that the assets
used for settlement should preferably be An RTGS payment system is one in which
a claim on the Central Bank; say, in India, it payment instructions between the Banks
can be the Reserve Bank of India or State are processed and settled individually and
Bank of India. When other assets are used, continuously throughout the day, as opposed to

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the net settlement systems such as paper based On receipt of the subset, the Central Bank
clearing houses. Though many institutions have verifies whether the sending bank has suf-
introduced electronic processors, they have ficient funds in its account. Then the Cen-
been made compatible to paper based clearing tral Bank informs the central processor the
systems i.e. the processing has been made status of the transfer as to whether settled
faster in contrast to the manual clearing. In the or queued or rejected. Once settlement
prevalent practices, though payment instructions takes place, the full message containing all
are processed throughout the day, the actual the information confirming the settlement
movement of funds between the Banks takes is rebuilt by the central processor and sent
place only afterwards, usually at the end of the to the receiving bank. In this structure, the
day. In contrast, under an RTGS system, the business information that is exchanged be-
payee banks and their customers receive funds tween the sending and receiving banks is
not known to the settlement agent viz. the
during the day itself. The lag or the lead-time
Central Bank.
between instruction process and settlement is
vastly reduced. This reduces the risk particularly 3. ‘L’ shaped structure: A structure concep-
in a large value funds transfer system. Even in tually similar to the ‘Y’ shaped structure
real time process and settlement such as an RTGS discussed above is also in practice. In this
System, there may be circumstances, which could structure, the payment message emanating
be a source of risk. from the sending bank is held at a system
gateway, which is attached to the sending
The Structure: There are three structures, in bank’s internal processing system. From the
practice, for an RTGS system: gateway a subset of the original message is
1. ‘V’ shaped structure: To initiate a fund created and sent to the Central Bank. If the
transfer, the sending bank dispatches a sending bank has sufficient funds in its ac-
payment message which is routed through count, the settlement is completed and the
a Central Bank, to a receiving bank. In this Central Bank confirms this, by way of a mes-
structure, the message with all necessary sage to the sending bank’s gateway. On
information about the payment is passed receipt of this confirmation message, the
on to the Central Bank. After the receiving original payment message is automatically
bank settles the transfers with Central relayed from the sending bank’s gateway to
Bank, the said information is passed on to the receiving bank.
the receiving bank. In this structure, the In all these types of structures, the common
Central Bank functions as an arbitrator and notable feature is that the receiving bank will
a postman. receive the full payment message only after the
2. ‘Y’ shaped structure: Those that use the transaction is being settled by the Central Bank.
Swift Network follow an alternative struc-
An alternative ‘T’ shaped structure, where
ture, which is a ‘Y’ shaped structure. In this
the sending bank routes the payment messages
case, the payment message is transmitted
directly to the receiving bank has also been
by the sending bank to the central proces-
thought of. However, it has been discarded, as
sor. The central processor filters the infor-
it is incompatible with the basic principles of
mation and takes a subset of information
that is necessary for settlement, from the RTGS.
original message and passes this subset The Reserve Bank of India has chosen the ‘Y’
to the Central Bank. The Central Bank’s shaped structure to meet this strategic objective,
processor retains the original message. which strips and retains the customer related

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confidential information and forwards only the back to the participant’s current account.
particulars of payment and settlement to the RTGS. Thereby, at the end of the RTGS day, all
This gives possibility for the central processor to settlement accounts will be zeroised. This
be an independent service provider. system has a facility to fund the RTGS
settlement account (of course during the
1. Introduction of RTGS in India has got strong
day) from the participant’s current account
technological support. It has a dedicated
by the use of own account transfers also.
and secured communication back bone
and state of the art messaging system. 4. Transaction priority: All payment
transactions emanating from a payment
2. The Reserve Bank of India has preferred the
systems gateway are processed strictly on
‘Y’ shaped message flow structure, because
a first in first out basis. The system also
it has its single gateway interface for each
allows the participants to assign priority to
participant, which is called as participation
the payment messages, which can facilitate
interface. The participation interface
urgent or time critical payment. Except
ensures that all messages, enquiries etc.
these time critical payments, all other
emanating from it are conforming to
transactions will be processed strictly on
the three norms namely, confidentiality,
FIFO basis.
integrity and non-repudiation. All these
messages will be received by the Inter Bank 5. Queuing: Originally, a payment instruction
Funds Transfer Processor (IFTP), which will is expected to be settled as soon as it is
act as a broker. Safety of the messages is received, which is a functionality of a real
ensured in the IFTP. In the case of payment time system. However, there exists scope
messages, IFTP will construct a settlement of some transactions not being capable of
message containing only the data required immediate settlement. In such cases, the
for settlement and will strip off the cover, RTGS system will maintain a payment queue
certain confidential customer data. This in within which the payment transactions will
turn will be forwarded to the Central RTGS be held on a FIFO basis. The participants
system. This settlement message will be are also provided facilities to view the
processed by the Bank’s central system and transactions held in payment queues, cancel
the fate will be advised to IFTP. Based on transaction(s) and can change the order of
the response received, IFTP will enrich the priority. In view of the confidentiality and
message received from the RTGS system, security concerns of participants, one can
say, by adding on the tools and transmit the view only the other participants in queue
settlement advice to both the sending and or one’s own pending incoming payment
beneficial participants. instructions.
3. Each participant would have a single 6. Own account transfer: In order to optimize
dedicated RTGS settlement account both funds deployment and economize on
for outward and inward RTGS payments. its intra-day liquidity requirements, an
This enables monitoring, tracking and RTGS system facilitates movement of
reconciliation of the transactions. Each funds between various accounts held by
participant is required to open a dedicated a participant. Such movement can take
settlement account, which will be an intra place between the participant’s settlement
day account. This account would be viewed account and current account or between
at the beginning of the day from a current two or more current accounts held by the
account. Balances in the RTGS settlement participants. This is an efficient tool for
account at the end of the day are swept liquidity management.

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7. Liquidity management: An RTGS system can be achieved. We are constantly in a transitory


warrants an active management of the intra- stage i.e. we are evolving and this evolution has
day liquidity. In order to ensure smooth got intermittent stages. The movement from one
settlement of transactions and avoid the stage to another is usually termed as transitory
delay of credit to the other participants, it stage. Sometimes the transition is voluntary or
is imperative that each participant ensures is necessitated by the environment. In some
that there are sufficient funds in their RTGS Western countries, RTGS enables inter funds
system account at the time of submission of transfer even outside the banking system. While
payment instructions. The RTGS system has our banking system and the practices by a
certain features to facilitate the participants plethora of banking institutions are at different
in its liquidity management effort. levels of development, an effective RTGS system
Queuing facilities, priority assignments in would pave way for smoothening of some of the
own account transfers etc. are such tools.
anomalies or disparities existing in these practices.
Besides, there are two additional intra-day
It can be stated that it is a first step to bring
liquidity management tools built in the
about the constituents of our banking system to
RTGS system.
a common platform. Therefore, it is mandatory
1. Intra-day liquidity: To meet their intra- that the employees of the participants and the
day liquidity requirements, a partici- users be properly trained using all means of
pant can avail intra-day lines of credit training devices, tools, techniques and methods
provided by the Reserve Bank of India.
for successful RTGS implementation.
However, the Reserve Bank of India
on its own discretion and under spe- Conclusion: It may not be out of place
cific terms and conditions will provide to mention that an RTGS system is a part of
such lines of credit. This line of credit an integrated accounting system. But the
has to be fully collateralized and will be procedures and functionality of an integrated
chargeable to the participant on partic- accounting system are not discussed here, as it is
ular transaction basis. It is to be noted a separate topic by itself. The principle opinion to
that these lines of credit are available be noted is that an RTGS system by its scope and
on an intra-day basis and any failure to
definition, is a vertical alternative to any manually
repay the credit to the Reserve Bank of
India would invite strict penal action. handled settlement systems or clearing systems.

2. Gridlock resolution mechanism: Some- While an RTGS system is an effective platform


times the entire system can clog and for inter-bank transfer of funds with adequate
cripple or paralyze the transactions. supporting devices, the implementation and
The RTGS has an inbuilt optimized grid- the success largely depend on the adaptation to
lock tool to release the lock. However, compatible systems by all the participants. As
this mechanism can be invoked only at stated earlier, different banks are using different
the discretion of the Reserve Bank of In- platforms, which are not necessarily compatible
dia for smooth settlement. to each other. We also have examples of banks,
which are in the initial stages of computerization.
Importance of Training:
For them it will be a giant leap forward to follow in
Training of the employees of the participants line with the RTGS system. The benefit would be
on a continuous basis is a necessity that should not that such non-compatible banks could do away
be overlooked. The systems and computers are with intermediate infrastructure and choose a
only tools. Without manual intervention nothing system, which is compatible to the RTGS.r

242 The Chartered Accountant August 2006

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