– Siddarth Goel (firstname.lastname@example.org)
A payment denotes the performance or discharge of an obligation to pay, which may or may not involve money transfer. Payment is therefore a financial obligation in whatever parties have agreed constituting a payment. A payment and settlement system could be understood as a payments market infrastructure that facilitates the flow of funds in satisfaction of a financial obligation. The need for a payment system is an integral part of commerce. From the use of a payment system in an e-commerce purchase, a debit or credit card fund transfer, stock or share purchase. The payment obligation can also be settled without the presence of any financial intermediary (peer-to-peer). The payment transaction need not always be settled in money, it could be settled in security, commodity, or any other obligation as may be decided by payment system participants.
One of the earlier known payment mechanisms was the barter system. With the evolution of civilisation, the world moved to a system supported by tokens and coins that are still prevalent and are widely used as the mode of payment. The payment mechanism supported by physical currency notes or coins is simple, as it offers peer-to-peer, real-time settlement of obligation between the parties, by way of physical transfer of note or coin from one party to another.
In contemporary electronic payment systems, the manner of flow of funds from one payment system participant to another is central to the security, transparency, and stability of the payment system and financial system as a whole. The RBI’s main objective is to maintain public confidence in payment and settlement systems, while the other function being to upgrade and introduce safe and efficient modes of payment systems. The RBI is also the banker to all scheduled banks and maintains bank accounts on their behalf. All the scheduled commercial banks have access to a central payment system operated by RBI. Thereby banks have access to liquidity funding line with RBI which have been discussed later in this chapter.
Electronic payments usually involve the transfer of funds via money in bank deposits. While securities settlement system involves trade in financial instruments namely; bonds, equities, and derivatives. The implementation of sound and efficient payment and securities settlement systems is essential for financial markets and the economy. The payment system provides money as a means of exchange, as central banks are in control of supplying money to the economy which cannot be achieved without public confidence in the systems used to transfer money. It is essential to maintain stability of the financial systems, as default under very large value transfers create the possibilities of failure that could cause broader systemic risk to other financial market participants. There is a presence of negative externality that can emanate from a failure of a key participant in the payment system.
The payment system can broadly be categorised as; wholesale payment system, retail payment system, and securities settlement system. This chapter is divided into three parts, the first part discusses the netting and settlement of transactions in the payment system and briefly touches upon the concept of central counterparties. The second part covers the institutions in a payment system that form part of wider financial market infrastructure and regulatory principles for financial market infrastructures and approach of RBI in this regard. The third part discusses the broad categories under the payment system namely, the securities settlement system, followed by a wholesale and retail payment system. The fig. below depicts the broad functions that could be performed by payment system participants in a payment system.
Netting and Settlement in Payment Transactions
Section 4 of the Payments and Settlement System Act, 2007 (PSS Act) stipulates that no person other than RBI, can commence or operate ‘payment system’ in India unless authorised by RBI. Surely, RBI has its own payment system (banker to commercial banks) however, it is imperative to understand what is a payment system. The PSS Act defines payment system as:
“2(i) ―payment system means a system that enables payment to be effected between a payer and a beneficiary, involving clearing, payment or settlement service or all of them, but does not include a stock exchange. Explanation.-For the purposes of this clause, -payment system includes the systems enabling credit card operations, debit card operations, smart card operations, money transfer operations or similar operations;”
The entire payment process is nothing but simply an accounting operation in which debt is transferred from one person to another in the payment chain. The payment system is an enabler that affects payment between the payer and the ultimate beneficiary. The participant in the payment system could be a provider of the process which may involve each component or any of the processes in the payment system i.e., clearing, payment, or settlement. The payment in general parlance means funds transfer. The PSS Act defines settlement but does not define clearing. It is essential to understand clearing prior to understanding the settlement of transactions. Nevertheless, both terms are central to an understanding of the payment systems.
The clearing is the process that is necessary prior to executing a settlement trade in the payment system. In simple terms, it is a process of reconciling funds from the account of the payee to the beneficiary. All payment instructions by the payee have to pass through a clearing process for the validation of appropriate funds, records of transactions. The Bank of International Settlements, Committee on Payments and Market Infrastructures (CPMI) defines clearing as;
“The process of transmitting, reconciling, and, in some cases, confirming transactions prior to settlement, potentially including the netting of transactions and the establishment of final positions for settlement. Sometimes this term is also used (imprecisely) to cover settlement. For the clearing of futures and options, this term also refers to the daily balancing of profits and losses and the daily calculation of collateral requirements.”
From the above definition, it is apparent that the clearing could have variety of meanings, dependent upon instrument it is associated with. It is a pre-settlement process, which is by way of authorisation done by a payment participant, to proceed with the payment transaction. For instance clearing of cheques has evolved from a paper-based clearing system to Magnetic Ink Character Recognition (MICR). The MICR has brought standardisation and automation in the cheque clearing process. The MICR has enabled a Cheque Truncation System (CTS), where the presenting bank/collecting bank captures MICR data and scan images of the cheque, thereby eliminating the need for physical movement of a cheque for clearing. Presently, a central processing location (Clearing House) provides the clearing facility by authorising/approving the cheque. The Clearing House facilitates cheque payments between member banks, and also performs a netting function, without having to settle each cheque. Similarly, the clearing process is also involved in electronic payments, where an automated clearing house that enables debit and credit transactions is present. The National Automated Clearing House (NACH) is one such centralised Electronic Clearance Service (ECS) provider by the National payments Corporation of India (NPCI). The NACH provides supports to both NACH Credit and NACH Debit transactions.
Settlement is the post-clearing process, which involves transferring funds from payer to payee. In general terms settlement is the discharge of a payment obligation with reference of the underlying. The PSS Act defines settlement as;
(n) ―settlement means settlement of payment instructions and includes the settlement of securities, foreign exchange or derivatives or other transactions which involve payment obligations;
The settlement involves a reference underlying obligation, which is transferred through payment instruction given by one payment system participant to another. The reference underlying obligation could be in the money (funds), securities, foreign exchange (Forex), or a derivative instrument. A payment instruction means a payment order made by a person or one system participant to another system participant. When a person makes a payment order to the system participant, the clearing and settlement process forms part of the retail payment system. While when a payment instruction is made by a system participant to another system participant the transaction falls into the wholesale payment system. PSS Act defines payment instruction as;
“2(g) ―payment instruction means any instrument, authorisation or order in any form, including electronic means, to effect a payment,— (i) by a person to a system participant; or (ii) by a system participant to another system participant;” (emphasis supplied)
System participant is usually a bank or any entity that is participating in a payment system including a system provider (entity operating an authorised payment system). Thus the settlement transaction could be executed between two settlement participants or a customer and payment participant. In a settlement transaction, there is an offsetting transaction of obligations between or among the payment system participants.
The settlement process is inter-bank debiting and crediting of funds. Settlement can be further sub-categorised into Bilateral VS. Multilateral settlement and Net VS. Gross Settlement. The bilateral settlement is an offsetting of payment obligation between two parties. While multilateral settlement is offsetting of payment obligations that involve more than two parties. Fig. 1 below depicts a bilateral settlement transaction.
The bilateral settlement could be on a gross basis or there could be a net settlement of obligations. In a gross settlement system each payment instruction is settled or transfer of funds occurs individually on a transaction-by-transaction basis for complete value. There is no netting or bundling with any other transaction. The gross settlement could be in real time (continuous) or with a time lag (deferred). In the real-time continuous gross settlement, the risk of default is minimum, but the banks or system participants have to maintain continuous heavy liquidity. Whereas, in the deferred net settlement, transactions are settled on a net basis at end of a pre-defined cycle. The final settlement of transfer instruction occurs usually during a day, on a net basis at one or more discrete, pre-specified times.
In the deferred settlement process be it gross settlement or net settlement there exists a settlement finality risk, since settlement involves a time lag. In net settlement the banks have to hold less liquidity and the transaction cost is low. However, there is implicit credit risk in net settlement, from fig.1 above in net settlement transaction, banks are giving each other unsecured credit on basis of payments that are not immediately settled in final terms. Thus participants in payment systems are exposed to credit and liquidity risk that constitute settlement risk. Similar risk exists where there are cases of deferred gross settlement.
The solution to the bilateral settlement risk problem is a multilateral settlement system that involves more than two parties. Particularly a Central Counter Party (CCP) that takes bilateral exposure to all the other parties in the system. Central counterparty is usually the members self-backed or a government-backed institution that takes on the bilateral credit exposure, of each participant in the system. It allows settlement on a net basis and reduces transaction costs significantly, while the risk of counterparty default is transferred on to the CCP. Fig. 2 below depicts a stylised example of multilateral net settlement.
Institutions and Organisations in payment system
Principles of Financial Market Infrastructure
A Financial Market Infrastructure (FMI) is a multilateral system among participating institutions, including operators of the system. The term FMI is used for the entities that are involved in clearing, settling, or recording financial transactions such as payments, securities, and derivatives. The international standards and best practices are set out by CPSS-IOSCO in principles of FMI (PFMI). The RBI in line with international standards described designated FMIs and released a policy document on regulation and supervision of FMIs in India under its regulation on FMIs in 2013. The PFMI stipulates public policy objectives, scope, and key risks in financial market infrastructures such as systemic risk, legal risk, credit risk, general business risks, and operational risk. Below is the table accommodating CPSS-IOSCO principles applicable to PMIs participating in payment systems.
|Principles of FMI (PFMI)||Scope of Regulation|
|Principle 1: Legal Basis||Legal basis defines foundation for relevant parties to define rights and obligations of the FMI, its participants and other relevant parties such as customers, custodians, settlement banks and service providers.
· FMI should have rules, procedures that provide high degree of certainty for each material aspect of FMI activities.
· FMI able to articulate the legal basis of its activities to participant customers, authorities in clear and understandable way.
|Principle 2 : Governance||It enrolls a set of relationships between owners, board of directors, and management of FMI with other stakeholders.
· Documented set of roles and responsibilities specifying procedures for function of FMI.
· Clear and documented risk management framework
|Principle 3 : Framework for the
Comprehensive management of risks
|FMIs should have integrated and comprehensive view of risks.
· Comprehensive risk policies, procedures and controls
· To have robust information and control systems
· Scenarios that can potentially prevent FMI from critical operations and services as going concern.
|Principle 4: Credit Risk||FMIs should effectively measure, monitor, and manage its credit exposures and such risk arising from payment, clearing, and settlement processes. FMIs should maintain sufficient capital to cover credit risk exposure to other participant.
· FMI to establish robust framework to manage credit risk exposures arising from payment, clearing and settlement processes including current exposures and potential future exposures.
· CCP to cover current and future exposure with high degree of confidence using margin and other financial resources.
|Principle 5: Collateral||Collateralisation protects FMI from credit event of a participant default.
· An FMI guideline on eligible collateral assets and limits in respect to credit, liquidity and market risks.
· Policies concerning valuing collateral, limiting procyclicality, rehypothecation, concentration of collateral and robust management system.
|Principle 7 : Liquidity Risk||It is the risk which arises to FMI from failure of a participant or other entity that cannot settle their payment obligations due during clearing and settlement.
· Robust framework to manage liquidity risks, settlement banks, nostro agents, custodian banks, liquidity providers and other banks.
· FMI should clearly identify its sources of liquidity risk.
· Managing liquidity risk by using real time gross settlement (RTGS) mechanism in place of deferred net settlement (DNS) and use of central bank services.
· Maintaining sufficient liquid resources to effect settlement of payment obligations with a high degree of confidence.
|Principle 8 : Settlement Finality||FMI should have clear and certain final settlement of payment instruction. Final settlement is where transfer is irrevocable and unconditional. It is a legal defined moment (see principle 1: legal basis)
· Rules and procedures defining point of settlement.
· LVPS or SSS should use adopting RTGS or multiple—batch processing settlement.
|`Principle 9 : Money Settlements||This is the money that is in form of deposit with central bank. This involves FMI conducting its settlement in central bank money and obligation is discharged in books of central bank. FMI could also settle its obligation in commercial bank money (commercial settlement bank). FMI’s agreement with settlement banks should stipulate time of settlement and finality in order to enable FMI and its participants to manage credit and liquidity risks.
|Principle 12 : Exchange-of-value settlement systems||This involves settlement of transactions by FMI through two linked obligations. For instance delivery of security against cash or delivery of one currency against delivery of another.
Exchange of value settlement systems eliminate principal risk by way of linking final settlement of one obligation to the appropriate settlement mechanism.
· Timing of settlement could be on gross basis or net deferred basis. The contractual framework ensures that settlement of an obligation is final only of corresponding obligation is settled.
· Modes of settlement; Delivery versus Payment (DvP), Delivery versus Delivery (DvD) or Payment versus Payment (PvP).
|Principle 13 : Participant Default Rules and Procedures||The participant default rules and procedures provides for continued functioning of FMI in event a participant fails to meets its obligations.
Set of default rules that allow FMI to continue in event of default and replenishment of resources following default.
· Public disclosure of key aspects of default rules and procedures.
· Rules should allow FMI to use promptly financial resources fro covering losses and to maintain liquidity pressures.
· CCPs to have rules and procedures to close out or transfer defaulting participant proprietary and customer positions.
|Principle 15 : General business risk||The FMI should be able to identify general business risks not arising out of credit and liquidity risks, but risks due to financial position as a business concern like decline in revenues, increase in operational expenses, poor business strategies and etc.
· Robust management and control system to identify, monitor and manage general business risks.
· FMI to hold sufficient net assets funded by equity to implement its business plan.
· FMI should have viable plan for raising additional equity, in cases of shortfall in equity.
|Principle 16 : Custody and Investment Risks||An FMI be required to safeguard its assets as well as assets of its participants and minimise risk of loss on delay and access to these assets. Thus FMIs investments should be in instruments with minimum credit, market and liquidity risks.
· FMI should have access to its assets and assets of the participants.
· FMI investment strategy should comprise of claims from high quality assets, with quick liquidation and less adverse effect on prices in stress times.
|Principle 17 : Operational risk||Operational risks deals with risks arising from internal processes, information systems and disruption caused due to IT systems failure.
Robust systems, policies to identify, monitor and manage operational risks.
|Principle 18 : Access and participation requirements||This operation involves an ability to use FMI’s services directly by participants, including trading platforms. The FMI should allow fair and open access. Direct participation has benefits like RTGS, settlement in central bank money.|
|Principle 19 : Tiered participation arrangements||Under this system arrangements occur when indirect participants rely on the services of direct participants to use PMI’s central payment, clearing, settlement or recording facilities.
Credit and liquidity risk between direct and indirect participant.
· FMI to ensure that a default, whether by a direct participant or by an indirect participant, does not affect the finality of indirect participants’ transactions that have been processed and settled by the FMI.
· There is a vulnerability of indirect participants to access to an FMI, their ability to make and receive payments, settle transactions on default of direct participant or direct participant declines to continue business relationship.
|Principle 21: Efficiency and effectiveness||The FMI should maintain appropriate standards of safety and security while meeting the requirements of its participants. Efficiency is resources required by the FMI to perform its functions.
· Designs to meet needs of participants with respect to choice of clearing and settlement transactions.
· Establish mechanisms to review efficiency and effectiveness.
|Principle 22 : Communication procedures and standards||This principle deals with ability of participants to communicate with an FMI in a timely, accurate and reliable manner. This is primary in achieving efficient payment, clearing, settlement and recording of transactions.
· Communication through internationally accepted communication procedures and standards.
|Principle 23 : Disclosure of rules, key procedures and market data
|FMI to provide information to its participants to enable them in identifying clearly and understanding the risks and responsibilities of participants in the system.
· Adoption of written rules and procedure for participants to understand system design and operations and respective rights and obligations.
· Necessary documentation and training to facilitate participants in understanding rules and procedures and disclosure of fees at individual FMI offers.
The FMI Structure in India
The FMIs regulated by RBI currently are Real Time Gross Settlement (RTGS), Securities Settlement System for the government securities (SSS), Clearing Corporation of India (CCIL), and Negotiated Dealing System (NDS), and National Payment Corporation of India (NPCI). FMIs have not been defined explicitly under PSS Act. However, the criteria for declaring a payment system as an FMI is based on its potential to trigger or transmit systemic disruptions. The broad criteria’s for determining system-wide systemic importance of payment system (SWSIPS) are:
- Volume and value of transactions processed/handled
- Share in the overall payment system
- Markets of operation
- Types and number of participants
- Degree of interconnectedness and interdependencies
Centralised Payment Systems (RTGS and NEFT)– Settlement system is a large value payment system that holds total payment transactions of about 77% as of March 2020. As discussed above the settlement system can be classified based on (i) time –designated time (or deferred) settlement systems and real time (or continuous) settlement systems and (ii) amount-gross settlement and net settlement. The RBI has issued its Master Directions on Access Criteria for Payment Systems. The payment system is bifurcated in two access criteria viz., centralised payment systems and decentralised payment systems. The centralised payment system includes Real Time Gross Settlement (RTGS) system and National Electronic Fund Transfer (NEFT). While the decentralised payment systems include clearing houses managed by RBI via. Cheque Truncation System (CTS) and Express Cheque Clearing Systems (ECCS) centers. The decentralised payment system is accessible to licensed and scheduled banks either as a direct member or sub-member. The membership to centralised payment system is open to scheduled/licensed banks/primary dealers/ authorised PSPs. The entities that fulfill the access criteria are eligible for opening current accounts, Subsidiary General Ledger (SGL)/Intra Day Liquidity SGL (IDL-SGL) account, Negotiated Dealing System-Order Matching (NDS-OM) membership facility with RBI.
Clearing Corporation of India (CCIL) – The CCIL functions as a central counterparty in financial market segments that are regulated by RBI. CCIL was set up and established in 2001 as a guaranteed platform for systemically important payment systems. The CCL acts as a CCP and also as a designated Trade Repository authorised by RBI. It performs CCP platform function in various segments such as government securities, USD-INR and foreign ex-change forwards, collateralised borrowing and lending obligations (CBLO). It also trade repository services, by providing non-guaranteed settlement in rupee-denominated interest rate swaps/Forward rate agreement (rupee-denominated) and cross-currency trade settlement through Continuous Linked Settlement (CLS). While its other function being acting as a trade repository (TR) in OTC derivative transactions. TR facilitates the clearing, settlement, and recording of financial transactions.
Negotiated Dealing System-Order Matching (NDS-OM) – NDS-OM is owned by RBI, operated by CCIL on its behalf. NDS-OM is an anonym screen-based order-driven, screen-based trading system for dealing in government securities. It is a straight-through-processing (STP) as all the trades are directly routed to CCIL for settlement. NDS-OM is assessed as per the methodology prescribed for PFI for critical service providers.
National Payments Corporation of India (NPCI) – NPCI is an umbrella organisation that supports and provides robust technology platforms to customers of all member banks. It was incorporated as a non-profit company in December 2008, as a section 25 company under the Companies Act 1956, with support of RBI and Indian Bank’s Association. The NPCI undertook National Financial Switch (NFS) that operates ATM network of member banks from IDRBT in December 2009. The NPCI share in the entire payment landscape of India was around 64.5% by volumes and 4.07% by value during the month of March 2020. The NPCI is also at the forefront of developing various payment products discussed hereinafter, that has formed the basis of evolving digital retail payment systems.
Important Retail Payment Systems (IRPS) – Based on CPSS-IOSCO principles of (PFMI), the Important Retail Payment Systems (IRPS) are identified on the basis of the respective share of the participants in the payment landscape. The RBI has further sub-categorised retail payments FMIs into Other Retail Payment Systems (ORPS). The IRPS are subjected to 12 PFMI while the ORPS have to comply with 7 PFMIs. The table below summarises the PMFI applicable in IRPS and ORPS. Additionally, the retail payment system operators are also required to undertake / conduct self-assessment as per the assessment template for retail (SAT for retail) prescribed by RBI. SAT is to be filed on an annual basis or as per frequency advised from time to time by the RBI.
|S.NO.||Principles for FMIs||IRPS||ORPS|
|1.||P1: Legal Basis||Yes||Yes|
|3.||P3: Framework for Comprehensive management of risks||Yes||Yes|
|4.||P8: Settlement Finality||Yes||Yes|
|5.||P9: Money Settlement||Yes||No|
|6.||P13: Participant default rules and procedures||Yes||No|
|7.||P15: General Business Risk||Yes||No|
|8.||P17: Operational Risk||Yes||Yes|
|9.||P18: Access and participation requirements||Yes||No|
|10.||P21: Efficiency and effectiveness||Yes||Yes|
|11.||P22: Communication procedures and standards||Yes||No|
|12||P23: Disclosure of rules, key procedures and market data||Yes||Yes|
Messaging Infrastructure– The operations of FMIs are dependent on critical infrastructure, i.e. a communication network. Indian Financial Network (ININET) and SWIFT India Domestic Services Private Limited (SIDSPL) are the two RBI approved networks that provide messaging services for financial transactions. The member banks have multiple options to access RTGS, namely thick-client through Structured Financial Messaging System (SFMS) Interface, Web-API through Indian Financial Network (INFINET), and Payment Originator (PO) Module.
Indian Financial Technology and Allied Services (IFTAS) a wholly owned subsidiary of RBI has recently implemented a Global Interchange for Financial Transactions (GIFT) platform is integrated payment and settlement system. The GIFT supports (inter-bank) payments and messaging between a source bank and a destination bank. The payment processing could be in real-time, batched & bulk payment. The second leg of the payment transaction to receive an outward debit message, settlement of transactions by way of passing real-time inward credit message to beneficiary banks.
Securities Settlement System
CCIL is an FMI under PSS Act, authorised by RBI, which acts as a central counterparty CCP and trade repository (TR) for various financial market product segments. It functions as a liquidity provider and secondary market platform to government securities. CCIL acts as CCP for trades executed on its platform, thereby ensuring guaranteed settlement with multilateral netting benefits. The settlements on (T+0 to T+2 basis) are done through NDS-OM, Clearcorp Repo Order Matching System (CROMS), and Tri-Party Repo Dealing System (TREPS). The CCIL acts as a clearing and settlement agent to the money market securities transactions. It also settles inter-bank cash, spot, and forwards in the USD-INR market. The Forex trades are validated and matched trades are settled, through multilateral member-wise netting procedure whereby net amount payable and receivable by CCIL is arrived. The Forex settlement of net positions is on a payment versus payment (PVP) basis, i.e., INR leg is settled through member’s current account at RBI and USD leg is settled through CCIL’s USD account with its settlement banks. CCPs are to have sufficient net-worth to cover potential general business losses. RBI has stipulated net-worth of INR 300 crore for authorisation/recognition of CCP desirous of operating in India. The trade repository function CCIL has emerged as a new type of FMI post global financial crisis particularly in OTC derivatives markets. In the OTC derivatives market segment the CCIL functions as a clearing and settlement bank. It is to be noted that in repo transactions CCIL acts as a clearing and settlement bank as well as as a tri-party agent. At first, it is primary to establish a difference between clearing bank and triparty agent. A clearing bank here in essence a settlement bank that settles repo transactions on its balance sheet. It maintains separate cash and collateral account for both the parties to the repo (buyer and seller). While a tri-party agent shall be responsible for the revaluation of collateral, margining, income payments on collateral or substitution of collateral. A triparty agent could also function as a clearing bank subject to prior approval of RBI like CCIL.
Wholesale Settlement System
The wholesale payment system or the large-value payment system (LVPS) transactions are supported by banks using gross settlement (RTGS) or multilateral deferred net settlement (NEFT/CTS). The LVPS transactions are relatively higher values and lower volumes. Therefore, the system participants (banks and clearing entities providing settlement) have to hold much more liquidity to process these transactions throughout the day. This explains the logic of only banks and large clearing houses settling LVPS, have access to intra-day liquidity (IDL) facility of RBI. These are entities with relatively large capital and are regulated more stringently.
Real Time Gross Settlement (RTGS) – This does not have a settlement lag, hence there is no settlement risk. The RBI provides this facility to its member banks around the clock on all the days with effect from December 14, 2020. The RTGS is continuous and there is no settlement lag, as settlement is in real time. The liquidity risk is managed by member banks through intra-day liquidity (IDL) available to member banks. IDL is an interest-free liquidity facility against fully collateralised government securities held by the member in their IDL-SGL account with RBI. The member bank has to reverse the transaction by the end of the day. The quantum of IDL, margin requirement and nature of the collateral is communicated by RBI to members. The members can process inter-bank transactions-funds transfer between two RTGS members and can also undertake customer transaction, i.e. funds transfer on behalf of a customer of RTGS member (gross bilateral offsetting). The members can also perform Multilateral Net Settlement Batch (MNSB) from ancillary payment system managed by a clearing house (multilateral offsetting).
National Electronic Fund Transfer (NEFT)– The NEFT is a net settlement system, where transactions are accumulated and offset against each other, either on a bilateral or multilateral basis. The clearing institutions send net transfer information to settlement institutions several time a day in batches and hence the name Multilateral Net Settlement Batch (MNSB). The MNBS files are submitted by clearing banks for settlement that have been granted membership or limited access to RTGS. To access centralised payment system the clearing entities that have been granted membership to the RTGS system (Type C) submits MNBS files that are originated from ancillary payment systems managed by the member clearing entity. Examples of ancillary payment systems managed by member clearing entity are, CTS (managed by RBI or other Banks), NEFT, CCIL, NPCI operated systems and systems operated by SEBI regulated clearing entities. The clearing entity ensures that it maintains adequate liquidity (funds) in the settlement account or current account with the RBI. The member clearing entity can carry out its own account transfers i.e., transfer of funds from the current account to the settlement account and vice versa. The RBI also allows clearing entities to open a limited-purpose settlement account with RBI, but they are not a direct member of RTGS.
The table below summarises four type of member participants in RTGS and facilities available on access to the central payment system:
|Membership Type||Broad Category||Facilities available|
|Type A||Regular Participant (e.g. banks)||IDL, inter-bank, customer transactions, own account transfer|
|Type B||Restricted Participant (eg. Primary Dealer)||IDL, inter-bank, own account transfer|
|Type C||Clearing House||Gross transactions, Multilateral Net Settlement Batch (MNBS)|
|Type D||Regular or Restricted Participant or Clearing House||Customer Transactions, Inter-bank, IDL, own account transfer|
Fig. 3 below depicts the retail payment instruction from a local bank to the clearing entities and the final settlement being undertaken by the settlement bank (type A) RTGS member.
Retail Payment System
In retail payment systems, are the small value payment systems (SMPS), the frequency of payment transaction is large but the system handles a large volume of low-value payments. While NEFT and RTGS traditionally being supported by banks are also used for retail payments, other modes for retail payment being funds transfer through cheques, credit cards, and direct debit and credit card transactions. The retail payment system in India has witnessed a paradigm shift. The state of the art payment products developed by NPCI, as shown in Fig 4 below, supports new and innovative payment options.
NPCI is instrumental in providing one of its kind payment products that are safe, secure and affordable in line with to give a boost to the Indian electronic payment system. NPCI also launched its one-of-a-kind domestic card payment network ‘RuPay’ having wide acceptance at ATMs, POS devices, and e-commerce websites. Further, after gaining domestic traction to have a global outreach a subsidiary of NPCI International Payments Limited (NIPL) established in April 2020 for internationalisation of UPI and RuPay.
Deferred Settlement Process in Retail Payments: The NPCI serves as a clearing and settlement agency for the ancillary payment system supported by it for processing payments in retail payments ecosystem. In certain retail payment systems processes like Unified Payment Interface (UPI) and Instant Mobile Payment System (IMPS), the funds are credited to the beneficiary after the payment instruction is received by the payment system participant (bank/PPI). While the inter-bank settlement takes at a pre-specified time through NEFT, i.e. can be done 4 times during the day. The remitting bank debits the customer’s account instantaneously, while NPCI acts as a netting and settlement agency (CCP) to the transaction. The destination banks credit the funds to the account of the beneficiary after receipt of authorisation/confirmation from NPCI. The inter-bank settlement is done on a net basis at a later stage. NPCI though it’s various products has paved the way for non-bank entities to act as operators of platforms for payment systems or as a payment system providers (PSPs). The chart. below summarises NPCI retail payment stash and their utility. Chart 2 below summarises all the current retail payment products supported on infrastructure provided by NPCI.
Card (Debit and Credit) Payments
Card payment systems have been one of the most sought-after payment systems. It involves a card issuer bank, merchant, and acquirer bank a typical payment transaction. While debit cards are like pre-paid instruments (discussed later) where the card issuer holds the funds on behalf of its customers. In a typical debit card transaction, there is debiting of funds from a bank account held by a customer, and funds are transferred to the merchant’s bank. The payment transaction is complete once the funds are credited in the account of such a beneficiary. Whereas, credit cards involve a revolving line of credit by the issuer bank to its customers. On a receipt of payment instruction via credit cardholder, the credit card issuer bank debits the credit line of its customer and transfers the funds to the merchant’s bank account.
In card transactions, other market infrastructures are also involved like, ATM, POS machines and card network providers and etc. The customer’s bank functions as a clearing/authoring bank for the customer, and the card network provides the clearing and settlement of the transaction at the inter-bank level. The card network pays the beneficiary’s bank and debits the card issuer bank’s account maintained with it. While the payment transaction settlement between the customer and the merchant takes place instantaneously. The inter-bank settlement transaction takes place in the books of the payment card network on deferred net basis.
Payment System Providers – (Payment Aggregators, Payment Gateways)
Payment aggregators and payment gateways are payment intermediaries in electronic payment transactions. These intermediaries act typically as a bridge between providers of online goods and services (merchants) and customers. The merchant here is a person which accepts payments through a web-based platform. Payment aggregators facilitate e-commerce sites and merchants in accepting various payment instruments for the completion of a payment obligation. The customer may choose any one of the online modes of payment such as debit card, credit card, net-banking, UPI, wallets, and etc. The payment chain depends on the entities involved in the payment cycle, like card networks, NPCI, banks offering net banking services and etc. However, it is to be noted that the role of payment aggregators and payment gateways is akin to the card networks in bank issued card based payment systems.
Payment gateways are the entities that provide technology infrastructure to route and/or facilitate the processing of online payment transactions. There is no actual handling of funds, unlike payment aggregators. Thus payment gateways are the ‘technology providers’ or ‘outsourcing partners’ of payment aggregators. The payment aggregator and payment gateway services could be undertaken by one single entity or as two separate operators in payment systems.
The presence of payment aggregators and payment gateways eliminates the need for merchants to set up a separate payment system for integration and it facilitates connecting with acquirers. The payment aggregators and payment gateways provide services like settlement via netting of funds received by the merchants on-boarded by them. Non-banks payment aggregators maintain escrow accounts with scheduled commercial banks and the settlement with merchants is usually within a predefined settlement time period.
Pre-paid Instruments (PPIs) /Wallets
PPIs are the instruments that facilitate purchase of goods and services, fund transfers and etc. against the value of funds stored in such instruments. The PPIs issued can be further categorised under three variants; closed system PPIs, semi-closed system PPIs, and open system PPIs. These instruments are to be loaded only from bank account by debiting bank accounts of users and loading reloading is not be done via cash but through payment instruments issued by regulated entities in India. PPIs can be issued as cards, e-wallets, and any such form except in form of physical paper vouchers.
Closed System PPIs: These are PPIs that can be used in facilitation of purchase of goods and services from the issuer entity only. These instruments cannot be used for fund transfers and neither there is cash withdrawal nor there is payment or settlement with third parties. Therefore, technically these instruments do not fall under payment system and hence do not require approval/authorisation from RBI. Gift cards are the best-suited example of closed-system PPIs, however, they are not reloadable.
Semi-closed System PPIs: These PPIs are issued by banks and non-bank entities and can be used for purchase of goods and services at with the issuer or clearly identified merchant locations. The issuer has a specific contract with such merchants to accept PPIs as payment instruments. The payments are routed through payment aggregators/payment gateways. The issue of such instruments requires prior RBI approval.
Open Systems PPIs: These are issued by banks and are similar to debit card issuances. These can be used at any merchant and can be used for cash withdrawals.
The payment and settlement system in India has been witnessing the wave of evolution, having one of the foremost payment products word-wide. The legal and regulatory underpinning of the payment system has been best in line with international standards. The NPCI with its state-of the art payment products has changed the ecosphere for retail payment systems, making them more affordable, accessible, convenient and efficient. NPCI has been instrumental in India’s growth story for digital payment landscape along with the creation of avenues for non-bank entities to participate in the payment system. A robust and efficient payment and settlement system is central to the functioning of financial system at institutional level. The participation of large institutions and entitles in payment space will enable consolidation of the system at the wholesale level. However, there is a need to building a few other parallel FMIs akin to NPCIs for clearing and settlement to reduce payment concentration risk in large-value payment systems.
 Section 2 (p) and 2 (q) of PSS Act.
 The Bank for International Settlements (BIS), Committee on Payment and Settlement Systems (CPSS) and International Organisation of Securities Commissions (IOSCO) published 24 principles for financial market infrastructures and and responsibilities of central banks, market regulators and other authorities. April 2012 < https://www.bis.org/cpmi/publ/d101a.pdf>
Regulation and Supervision of Financial Market Infrastructures, June 26, 2013 https://www.rbi.org.in/scripts/bs_viewcontent.aspx?Id=2705
 RBI, Oversight Framework for Financial Market Infrastructures (FMIs) and Retail Payment Systems (RPSs), June 2020 https://rbidocs.rbi.org.in/rdocs/Content/PDFs/OVER13062020_FF0CC640BA0CC434C83A1E847B4FB3FD6.PDF
 Banks are the primarily the institutions issuing cheque in payment system.
 Master Directions on Access Criteria for Payment Systems, January 17, 2017 https://www.rbi.org.in/scripts/FS_Notification.aspx?Id=10833&fn=9&Mode=0
 CBLO was replaced by tri-party repo under securities segment w.e.f. November 05, 2018
 Section 34 A (2) PSS Act; Provisions apply to Trade Repositories operating in OTC interest rate, credit and forex derivative transactions.
 By the end of December 2020, the network has grown to 112-member banks connecting 2.3 lakh ATMs across India. See RBI, ‘Journey in the Second Decade of the Millennium’ available at < https://rbidocs.rbi.org.in/rdocs/Publications/PDFs/PSSBOOKLET93D3AEFDEAF14044BC1BB36662C41A8C.PDF>
 RBI, Oversight Framework for Financial Market Infrastructures (FMIs) and Retail Payment Systems (RPSs), June 2020
 For detail discussion on Payment Aggregators and Payment Gateways- Refer to our write up titled ‘Understanding regulatory intricacies of Payment Aggregator business’, available at http://vinodkothari.com/2021/04/understanding-regulatory-intricacies-of-payment-aggregator-business/
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