Prof Vinay Dutta

Senior Professor of Finance

FORE School of Management, New Delhi
 The Payment Role of Banks

Carrying out payments for goods and services on

behalf of their customers (such as by issuing and
clearing checks , wiring funds, providing a conduit
for electronic payments, and dispensing currency
and coin)
 Why Payment Systems ?

• Domestic trade market: For example, substantial percentage of the Indian

GDP is contributed by domestic trade and only small portion Constitute
international trade
• Forex market: Trades currencies in excess of USD1.5 billion in India and
USD 1.5 trillion globally every business day
• Securities market: Average daily volumes in the securities markets are
growing year on year basis– value of these transactions runs into over
thousand crore of rupee
• International trade market: Value of merchandise trade of India in value
terms exports US $ 314.31 billion and imports US$ 467.19 billion during
2019-20.
 What do these markets require?

• Industry participants
• Investors
• Broker-dealers
• Clearing/settlement houses
• Custodians
• Regulators,

• and most importantly …

Robust messaging and payment infrastructure

Payment System Trends: Vision 2018 and Vision 2019-2021
Vision 2018 facilitated
a) continued decrease in the share of paper-based clearing
instruments;
b) consistent growth in individual segments of retail electronic
payment systems such as the National Electronic Funds Transfer
(NEFT), Immediate Payment Service (IMPS) and card
transactions;
c) increase in registered customer base for mobile banking;
d) launch of new products like Unified Payments Interface (UPI)
and Bharat QR (BQR);
e) significant growth in acceptance infrastructure; and
f) accelerated use of Aadhaar in payment systems
 Payment System Trends: Vision 2018 and Vision 2021
Vision 2021 Statement:
Empower every Indian with access to a bouquet of e-payment
options that is safe, secure, convenient, quick and affordable.
Vision aims towards:
• enhancing the experience of Customers;
• empowering payment System Operators and Service Providers;
• enabling the Eco-system and Infrastructure;
• putting in place a Forward-looking Regulation;
• supported by a Risk-focused Supervision.

To achieve the above, the Vision envisages four goal-posts (4 Cs) –

Competition, Cost, Convenience and Confidence
 What are payment systems?

• A set of payment instruments

• The institutional and organizational framework
• The operating procedures and communication network
 What is required for moving money ?

Methods Medium Infrastructure

• Cash • Banks • Clearing Houses
• Paper based • Card companies • Messaging
• Plastic • Communication
• Electronic • Legal basis
 How the payment infrastructure helps?

• Moves money
– Buyer to seller/payer to payee/benefactor to beneficiary/ lender
to borrower/employer to employee/…….

• Moves money efficiently

– Minimum time
– Cost-effective
– Increased automation/lesser manual intervention

• Moves money globally

– Facilitates growth of global trade
– Helps cross-border capital flows
Payment systems
 Payment infrastructure classification

Payment systems

Retail systems Wholesale systems

• Typically used in b2c and p2p • Used for securities transactions;

scenarios disbursement or repayment of
loans; make large-value, time-
• Generally higher transaction
critical payments and settlement
volumes and lower average rupee
of forex transactions
values

• Cheques
• RTGS systems
• Card transactions
• Other large-value interbank
• e-bill payments
transfer systems
• Automated clearing house
 Evolution of payment systems
High High

electronic funds
A transfer - RTGS
v.
S
e
t
Electronic funds c
x
transfer - ach u
n.
r
i
v Paper-based check t
a systems – automated y
l processing - MICR
u
e
Paper-based check
systems – manual
processing
Low Low

High Typical settlement time Low

Payment instruments
 Payment Cards

Definition

• A financial instrument
• Usually issued by a bank or a financial institution to
• A credit worthy customer to
• Pay for goods and services upfront or
• For availing credit or draw cash
Payment Cards from the Perspective of Merchants

A secure, reliable and convenient means of

guaranteed payment
Types of Payment Cards
 Credit Cards

Credit versus Open Credit

Credit
Receiving cash, using cash for goods or services with
obligation to pay later
Examples : Auto loans, personal loans etc.
Open credit
Credit that one can use and repay at one’s own pace
so as long as the user pays the required minimum
monthly payment.
Examples : Credit cards
Payment Cards from the Perspective of Merchants
Business model of Visa
Parties to Payment Card Business
 Payment Card-Transaction Processes and Flows

Cardholder Card Merchant

Statement Authorization? Statement

Debit details

Debit Credit
Clearing and
account account
settlement

Card issuer Merchant acquirer

 Sharing of Merchant Service Charge

Merchant service Made up of Who gets what

charge or
transaction fee

Transaction Merchant
processing acquirer
charge
Paid by merchant
to merchant
acquirer

= Card issuer (paid
Inter via payment
change scheme)
 Payment Cards
Various functional areas in payment card operations being outsourced
to BPO companies

• Application assessments and process for record generations.

• Transaction processing of credit card charges - data processing
• Processing of rejected, non-payment cases
• Settlement of credit card dues – cheque processing, ACH etc.
• Administrative services such as address changes, cycle cut dates,
balance payment services and add on details etc.
• credit card statement generations, dispatching, corrections.
• detection and analysis of fraudulent, default and disputed cases and
follow up with inbound and outbound collection services
• 24-hrs. customer services to card members (existing), prospective
customers and service establishments
 Revenue stream versus cost in payment card business

Revenue Cost

From merchants Payment to acquiring bank

Fees Collection & field agencies
Own card transaction
DSA’s
Other card transaction
Fees to Visa/Mastercard
Intl. card transaction
Merchant activities
From cards:

Annual fees etc.

Interest

Other fees

Cash withdrawal

Drafts
 Key Business Drivers and Profit

Drivers Elements

Revenue Average Balance, Yield, Acquisitions, Fees

Trading
Cost Acquisition costs (Sales, Credit, Account Profit
Set-up), Maintenance Costs (Operations,
Management), Collections

Debt Sourcing quality, underwriting, controls &

collections (Flow rates, Skips,
Shortfalls,Recoveries)
Clearing and Settlement systems
Paper Based Instruments
 Clearing house and clearing process

Clearing house is an intermediary agency that

facilitates exchange of instruments and processing
of payments among participating banks at a central
point which is usually the central bank
Logistics of payment instruments
 Clearing House
All banks have an account here debits drawee bank
credits presenting bank

C C
Credit confirmed Credit passed
h h
e e
q q
u Service Service u
e Branch or CPC Branch or CPC e

t t
Confirms cheque is ok Credit passed r
r
debits client a
a
credits clearing house v
v Her bank My bank
account e
e branch branch
l l
s s

p p
Gets cheque with Cheque deposit h
h a/c statement
y y

Gives cheque to payee

Payer Payee
 Settlement systems

• Bilateral versus multilateral net settlement

• Deferred net payment versus RTGS system

 Exchange settlement account

• Accounts maintained by banks at the central bank

• Settlement takes place by debiting-crediting these
accounts
• Central banking authority (Reserve Bank of India) is
not a counter party to the settlement. it only acts as
the “settlement agent” facilitating settlement
among clearing members
 Multilateral net settlement

Receiving bank Total payments

a b c d
a - 10 5 0 15

Paying bank b 4 - 1 6 11

c 3 7 - 2 12

d 0 8 4 - 12

Total receipts 7 25 10 8 50

Less total payments 15 11 12 12

Multi lateral net position - 8 +14 -2 -4 0

 Risks in multilateral settlement mechanism

Systemic collapse : any bank’s failure to meet its

settlement obligations results in disruption of
payment system value chain and may threaten
overall financial system stability
Remedies for Revival of Payment System
 SWIFT

Society for Worldwide Interbank Financial Telecommunications (SWIFT) is

member-owned cooperative that provides safe and secure financial
transactions for its members. Established in 1973, SWIFT uses a standardized
proprietary communications platform to facilitate the transmission of
information about financial transactions. Financial institutions securely
exchange this information, including payment instructions, among
themselves.

SWIFT neither holds funds on its own nor manages external client accounts.
The cooperative began operating in 15 countries in 1973 and now operates
in 210 countries, linking more than 10,000 financial institutions. Today, the
co-op delivers over 24,000,000 messages a day – up from 2.4 million
messages per day in 1995.

SWIFT is headquartered in Belgium and has offices in the United States,

Brazil, Australia, India, Japan, Korea, Austria, Belgium, France, Germany,
Italy, South Africa, Spain, Sweden, Switzerland, the United Kingdom, UAE
and Russian Federation.
 Key Benefits of SWIFT

Security: SWIFT guarantees the delivery of messages, and

has a network and system availability greater than
99.999%.
SWIFT has elaborate contingency plans including data
encryption, audit tracing and intrusion detection to ensure
data confidentiality and integrity.
Businesses who use SWIFT to exchange financial
information safely and securely can:
• Lower their costs.
• Reduce operational risk
• Eliminate operational inefficiencies.
 Breaking Down SWIFT Transactions

For money transfers, SWIFT assigns each participating

financial organization a unique code with either eight or
eleven characters. The code has three interchangeable
names: the bank identifier code (BIC), SWIFT code, SWIFT
ID, or ISO 9362 code.
 Payment Banks-Differentiated Banks
A payment bank has been categorised as a
“Scheduled bank”.

It is mandatory for the companies to include the word

“Payment bank” in its name in order to differentiate
it from other regular banks.

Payment bank is allowed to perform not all but only

certain selective functions of banking.

The main objective of introducing payment banks in

India was to extend the financial services horizon to
small business, migrant labour workforce and low
income households
 Factors Driving Advent of Payment Banks

 The rise of usage of Smart Phones

 Increased mobile internet user base
 The tremendous growth in e-commerce market in
India
 Easy and Convenient, ‘while on the go’,
‘wherever you go’
 Enhanced security features
 Providing more than ‘core services’ anytime –
anyplace, payment banks are hailed as a much-
needed step in the direction of financial inclusion for
the last mile.
 Services Offered by the Payment Banks
 A payment bank can accept deposits up to a maximum of Rs.1 lakh
only per individual customer. Demand Deposits and saving bank
deposits can be accepted from individuals, small firms and other
entities.
 Payment bank can pay interest on the deposits just like normal
banks.
 Payment banks are allowed to transfer payments through any
channels like Branches, Automated Teller Machines(ATMs), business
correspondents etc.
 Payment banks can issue debit cards/ATM cards to its customers.
 Mobile banking and internet banking can be provided by payment
banks. This includes payment mechanism as approved by RBI such as
RTGS/NEFT/IMPS.
 A payment bank app can be used to make utility bill payments as
well.
 A payment bank can involve in providing basic financial services like
access to mutual funds, insurance products, pension products, forex
services subject to the conditions set by RBI.
 Services Payment Banks cannot offer

 Payment banks cannot issue credit cards.

 Payment banks cannot deal with any kind of lending
business i.e. they are not allowed to issue any kinds of
loans like personal loans or any other loans to their
customers.
 Payments banks cannot accept deposits from non-
resident Indians (NRIs)
 Payment banks are not allowed to setup subsidiaries
for undertaking non banking financial services.
 Traditional banks versus payment banks
Features Traditional Banks Payment Banks

Accept deposits Yes Yes

Pay Interest on Deposits Yes Yes

Withdrawal facility for Yes Yes

customers
Provide loans or involve in Yes No
lending activities
Issue credit cards Yes No

Investment products Yes Yes

Maximum Deposit limit No limit Rs.1 lakh only per

individual customer.
Source: Smart Payment Bank Model
“They are an add-on to the banks rather than
competitors. Payments banks will be feeders into the
universal banks… Payments banks can’t do something
universal banks can do. Payments banks will
revolutionize banking, make it very exciting for
customers and existing lenders will have to improve
service to retain depositors. ”
“For a number of years, we have been saying that
there is a need of a revolution in the banking sector.
The revolution is upon us today.”

Dr. Raghuram Rajan, The Former Governor of the Reserve Bank of India
on Payment Banks: