What is Payment Systems? Domestic and International Payment Systems

What is Payment Systems?

A payment system is a set of processes, infrastructure, and rules that facilitate the transfer of monetary value between individuals, businesses, and entities. The primary purpose of a payment system is to enable the exchange of goods and services by providing a mechanism for the transfer of funds.

What is Payment?

A payment refers to the process through which a debtor discharges his indebtedness to a creditor. Payment can be used for paying to family, charity and consumer purpose. Payments are also the important part of businesses including B2B, B2C and C2B transactions. However, B2B transactions form the major part of payments. A system refers to a national/international level arrangement through which the debts may be discharged.

Therefore, a payment system refers to a national/international arrangement through which payments can be made by one individual/business to another individual/business. It includes processes and procedures through which payers and financial institutions settle their payments.

Payments are an important part of the financial operations of an organisation or bank. Most countries have their own currencies and payment systems. Due to this, the complexity and number of the payment systems increase. In addition, more and more payment systems are being introduced each year.

There are approximately 750 payment systems across the world. In addition, these systems change constantly as a result of new technology or government regulations. As per the Bank for International Settlements (BIS), a payment system consists of instruments, banking procedures and typically interbank funds transfer that ensures and facilitate the circulation of money. In essence, it facilitates corporation, businesses and consumers to transfer funds to one other.

Alternatively, a payment system is a set of processes and technologies used for transferring monetary value from one party to another. A payment can be made in one or multiple currencies by using one or more methods, such as cash, cheques, electronic payments and cards. A payment system uses substitutes for cash such as cheques or electronic messages and creates debits and credits that transfer value.

The transferred value is stored in the depository accounts of banks or other financial institutions. Banks and financial institutions are connected to one or more payment systems. Banks process payments on behalf of their customers using payment systems.

Payment systems are generally categorised into three types:

• Payment in national currency
• Payment by cheque
• Paperless payments

Payments made in national currency and cheque is included in paper-based payments. Paperless payments largely include electronic payments, which are also called wire transfers. Paper-based payments have been used traditionally, whereas paperless payments or electronic transfers are relatively newer and have grown since 2007.

Cash is the most widely used form of payment in India. In India, about 87% transactions were cash-based in 2012. About 23% of India’s GDP is derived from the informal economy, which usually deals in cash only. People also like to carry paper money or cash with them.

Let us now discuss the merits and demerits of payments made or received by use of cheques, cash and paperless payments. With special reference to developing countries such as India, it is often said that cash is still the king despite the convenience offered by the cards and other payment systems.

Advantages of Making Payments and Using Cash

The advantages of making payments and using cash are as follows:

• Individuals using cash as payment method are able to keep track of their spending and their spending are more controlled.
  
  
• Use of credit card or debit card is often accompanied by the merchants and other payment gateways asking for additional information (of the buyer) such as the buyer’s e-mail address. This may result in spamming of the buyer’s inbox with mass marketing e-mails.
  
  
• Buyer does not require keeping track of the receipts as in case of credit or debit card transactions.
  
  
• Buyer does not require reconciling the receipts with his/her credit/ debit card transaction details.

Disadvantages of Making Payments and Using Cash

The disadvantages of making payments and using cash are as follows:

• An individual can obtain cash (withdraw cash) by either visiting the bank or an ATM which causes certain degree of inconvenience and associated expenses.
  
  
• Cash is generally stored or kept in a wallet which may be stolen by a thief and used directly. (Note that cards may also be stolen but they cannot be used for withdrawing cash as their access is protected with a four-digit PIN).
  
  
• An individual can carry only a limited amount of money with him/ her. However, with use of a small card or multiple cards an individual can have access to a sufficiently large amount of money.
  
  
• Tracking of spending using cash becomes difficult for those customers that so not mind their purchases as against those individuals who keep track of their card spending using budgeting apps that automatically input the debit and credit card purchases.

Advantages for People Paying by Cheque

The advantages for people paying by cheque are as follows:

• An individual does not require carrying a lot of cash to make purchases, pay bills, etc.
  
  
• An individual’s account is not debited with money immediately until the cheque is cleared

Disadvantages for People Paying by Cheque

The disadvantages for people paying by cheque are as follows:

• Not all the merchants accept payment by cheque.
  
  
• Depositing cheques and clearance of cheques takes time.
  
  
• Cheques can be issued by an individual in lieu of services or purchases and the cheque may be stopped by the payer before it is cleared causing loss to merchant.
  
  
• Cheques are not ideally issued for small sums of money.
  
  
• Cheques can be dishonoured.

Advantages for People Receiving Payment by Cheque

The advantages for people receiving payment by cheque are as follows:

• Receiving payments by means of crossed cheques is a safe and legal way of receiving payments.
  
  
• Cheques can be taken in advance (post-dated cheques).
  
  
• Cheques can be stopped when required.

However, one major disadvantage for people receiving payment by cheque is that clearing process of cheques is time consuming. Local cheques are cleared on T+1 basis. The outstation cheques are cleared in maximum of 7 days if the location of drawee bank is in any state capital. If the drawee bank is in any major city, it may take a maximum of 10 days. Lastly, if the location the drawee is in any city apart from state capitals and major cities, cheque clearanace may take a maximum of 14 days.

Paperless payments and receipts include means such as debit/credit card and other electronic means such as NEFT, RTGS, etc.

Advantages of Making (and Receiving) Paperless Payments

The advantages of making (and receiving) paperless payments are as follows:

• Use of electronic payments helps in saving time of an individual as these transactions are processed almost instantaneously. Imagine your DTH TV connection balance becomes nil; you recharge your DTH account online and make payment using your debit card, the services of your DTH would resume instantly. Now, imagine you do not have any means to recharge DTH online. You only have cash, you will need to visit a store or local shop where you can get your DTH account recharged.
  
  
• The spending done using the electronic payment systems are stored in the transactions history and the individual can keep a track of his spending and budget all his other expenses accordingly. This helps in controlling expenses.
  
  
• Risk of loss and theft is not very significant as the electronic payments cannot be processed without an individual’s input such as PIN or One Time Passwords (OTPs).
  
  
• The charges incurred for paying through electronic banking systems are very less as compared to the charges for making payments through mediators or through Unattended Payment Terminals (UPT).
  
  
• Electronic transactions are much more convenient and user friendly.

Disadvantages of Making (and Receiving) Paperless Payments

The disadvantages of making (and receiving) paperless payments are as follows:

• The regulatory bodies, the banks and the financial institutions impose certain restrictions related to the maximum amount (subject to maximum amount in balance), number of allowed transactions etc. that can be transferred using the electronic payment systems
  
  
• Electronic payment systems and gateways can be hacked by certain wrong or mischievous individuals and the funds may be redirected for wrong/illegal purposes.
  
  
• Electronic payment systems require the individual to have access to internet which might not be possible at all times.

---

Domestic and International Payment Systems

The central bank of any country is an important factor for the development of domestic payment systems. In India, RBI is the central bank and helps in the development of Indian payment systems. The RBI takes timely and appropriate steps for safe, secure, sound, efficient, accessible and authorised Indian payment systems. The RBI’s central committee has formed a sub-committee named the Board for Regulation and Supervision of Payment and Settlement Systems (BPSS).

BPSS is the highest policy and decision making body in India. The regulation and supervision of payment and settlement systems in India is the responsibility of this sub-committee. This sub-committee authorises, prescribes policies and sets standards for payment systems in India.

The Payment and Settlement Systems Act (PSS Act) was introduced in 2007. The Section 4 of PSS Act states that no person other than the RBI is authorised to commence or operate a payment system in India without the permission of RBI. The RBI has authorised various operators of payment systems such as prepaid instruments, card schemes, cross-border and inbound transfers, Automated Teller Machine (ATM) networks and centralised clearing arrangements.

While developing payment systems, the geographic spread and the population must be kept in consideration. The network of banks of the Indian banking system requires that there is presence of adequate logistics for the collection and delivery of instruments.

---

Important Aspects of Payment Systems

Let Us Now Describe a Few Important Aspects of Payment Systems:

Paper-based payments

Paper-based methods include cheques, demand drafts etc. and they account for more than 60% of non-cash based transactions by volume. In terms of value of transactions, it accounts for nearly 11% transactions. This share of non-cash payment methods has been decreasing over time due to growth in the popularity of electronic payment methods against conventional methods such as cheques and demand drafts.

The RBI has introduced the Magnetic Ink Character Recognition (MICR) technology for increasing the speed and efficiency of processing of cheques. The RBI also introduced a high value clearing for cheques of value Rs 1, 00,000 or more; however, this was discontinued from May 2009. Now, Rs 10, 00,000 qualifies as a high value.

Now, the RBI has introduced speed clearing for rapid clearing of paper-based payment methods for clearance of outstation cheques drawn on core-banking enabled branches of banks. In addition, the Cheque Truncation System (CTS) has also been enabled. The use of CTS (image based clearing system) enables the use of images for the processing of payment instead of physical movement of cheques. The use of CTS is to reduce the movement of paper cheques for the clearance of local and outstation clearance of cheques.

Electronic payments

The RBI started taking initiatives for improving the movement of payment and settlement systems infrastructure in the mid of the 1980s. There was a continued increase in the volume of cheques due to which the banking system found it necessary to have in place a cost-effective alternative system. Various types of clearing systems are as follows:

• Electronic Clearing Service (ECS) credit: This payment system was introduced in the early 1990s in order to handle bulk and repetitive payments such as salary credits, interest credits and dividend payments, etc. for individual and corporate customers.
  
  In ECS, the customer account can be credited on a specified value date with a particular amount of money. The RBI introduced the National Electronic Clearing Service (NECS) in 2008. An NECS transaction can facilitate multiple credits made to multiple accounts across various destination branches against a single debit transaction being made from the sender’s account. NECS is based on the Core Banking Solutions (CBS) of member banks and facilitates the participation of all the CBS bank branches in the system.
  
  
  
• Regional Electronic Clearing Service (RECS): Under RECS, all core-banking enabled branches in a state or group of states can be used by institutions desirous of reaching beneficiaries within the state or the group of states.
  
  In RECS, the clearing takes place at a central location in the region despite customers having accounts across various branches. It is a miniature version of NECS. It is limited to bank branches within the jurisdiction of the regional office of RBI.
  
  
  Under the system, the sponsor bank uploads the validated data with the help of the Secured Web Server of RBI. This server contains credit/debit instructions for the customers of CBS-enabled bank branches spread across the Jurisdiction of the Regional office of RBI.
  
  The RECS centre processes the data, arrives at the settlement, generates destination bank-wise data/ reports and ensures the availability of data/reports through a secured Web server to facilitate the destination bank branches to afford credit/debit to the accounts of beneficiaries by leveraging the CBS technology put in place by the bank. At present, the RECS system is available only in Ahmedabad, Bengaluru, Chennai and Kolkata.
  
  
  
• Electronic Clearing Service (ECS) debit: The ECS debit facility was introduced by RBI to provide individuals and corporates to make faster, periodic and repetitive payments to utility companies such as electricity, natural gas, water and sewage.
  
  Under an ECS debit facility, the customers of utility organisations can authorise their banks to make routine and repetitive payments to the utility company by debiting their account and crediting the account of the utility company. The use of such ECS facilities decreases the use of paper instruments and increases customer satisfaction. The ECS facility is available across the country.
  
  
• Electronic Funds Transfer (EFT): It was introduced in the 1990s. There were banks who agreed to participate in transfers. In this system, an account holder (of a participating bank) could transfer funds electronically to another account holder (of any participating bank).
  
  It was introduced in 15 locations across the country. However, this system has been replaced by a better system known as National Electronic Funds Transfer (NEFT). NEFT has more features and is more efficient than EFT. An EFT transaction can take up to 3 business days to complete.
  
  
• National Electronic Funds Transfer (NEFT): It was introduced in November 2005. It is more secure than the EFT. This system was introduced in order to facilitate the one-to-one transfer of funds between the individuals/corporates. The NEFT transfers operate in larger time windows as compared to EFT. NEFT transactions can be made between 8 am to 7 pm on weekdays and between 8 am to 1 pm on Saturdays (except 2nd and 4th Saturdays). The network of NEFT is very huge and has a pan-India presence.
  
  
  NEFT transfers facilitate one-to-one transfers of funds between an individual/firm/corporate having account in Bank 1 and another individual/firm/corporate having account in Bank 2. However, Banks 1 and 2 must be a part of the NEFT payment system network. Banks 1 and 2 may be different branches of a same bank also. In NEFT, transactions are fulfilled in hourly batches, which enable near real-time transfer of funds.
  
  NEFT transactions can also be made by any walk-in customer who does not have a bank account by visiting an NEFT-enabled bank branch and depositing money along with his/her complete details and the bank account number, bank name, IFSC codes of the receiver. However, in such cases, the maximum amount that can be transferred is `Rs50,000.
  
  NEFT also facilitates one-way transfers to Nepal (Indo-Nepal Remittance Facility Scheme). The individual/corporate who receives money is called beneficiary. The sender is able to view the confirmation of the date/time of credit to the accounts of beneficiaries. There is no limit on the amount of money that can be sent using the NEFT system. However, the maximum amount of funds that can be sent in one transaction.
  
  
• Real-Time Gross Settlement (RTGS): It was introduced in 2004. RTGS is also a payment system that is used for transferring money from one bank account to another bank account. The RTGS transactions are made on real time and on a gross basis. It means that the RTGS transactions are settled on a real time without any lag or waiting period.
  
  Gross settlement means that the one transaction is done alone without bundling it with other transactions as in the case of NEFT transactions where the transactions are bundled and processed in batches. The transactions that are once processed are deemed final and irrevocable. The RTGS payment system can be used for inter-bank transactions above the value of `Rs2 lakhs.
  
  
  
• Immediate Payment Service (IMPS): It has been launched by the National Payments Corporation of India. It can be used by Indian customers to transfer funds on an immediate basis using mobile phones. This service is available on a 24X7 basis. In IMPS, the customer’s mobile phone is authorised to access the customer’s account and carry out the transfer of funds between two accounts.
  
  IMPS allows a secure transfer gateway. The customer has to register with his/her bank in order to use the IMPS facility. Upon registration, the bank grants the customer a Mobile Money Identifier (MMID) and MPIN. The user can login using the request for transfer of funds by SMS to transfer a certain amount to a particular beneficiary.

Other payment systems

Apart from the above mentioned payment systems, there are certain other systems for making and receiving payments. They are as follows:

• Pre-paid payment systems: A prepaid payment system is the one that has an ability to store a certain amount of money and can be used for purchasing goods and services. The value stored in such systems or instruments is the value that has been paid by the holders in cash or has been debited directly from the customer’s bank account or has been paid through the credit card.
  
  The prepaid payment instruments include smart cards, magnetic stripe cards, internet accounts, internet wallets, mobile wallets, etc. The prepaid payment instruments in India are issued and regulated in accordance with the Payment and Settlement Systems (PSS) Act, 2007. These prepaid instruments cannot be used for cross-border transactions. The payment instruments that are approved under the Foreign Exchange Management Act, 1999 (FEMA) can only be used for international transactions.
  
  
  
• Mobile banking system: The RBI laid out guidelines for mobile banking in 2008 due to increase in the importance of mobile banking. According to these guidelines, banks that have physical presence in India and which and have obtained the necessary licence from RBI are permitted to offer mobile banking services.
  
  
  
• ATMs/Point of Sale (POS) terminals/online transactions: Automated Teller Machines (ATMs) can be used by the customers of a bank to withdraw cash from any of the 61,000 ATMs all over India. The savings bank customers can withdraw cash from any bank’s ATM up to five times in a month. After five transactions, the customer has to pay a certain amount of charge per transaction.
  
  The RBI has notified that banks must re-credit the account of a customer from whose account money is debited without actual dispensation of cash at an ATM machine. A Point of Sale (POS) terminal refers to the terminal where a customer can purchase goods and services by using credit/debit cards. There are about 5 lakh POS terminals in India.