Inclusion, E-payments and

the Payments and Settlement Systems Bill


A.       Introduction and Background

 This note investigates the emerging and proposed regime governing the new electronic payment systems (such as smart cards, multipurpose prepaid cards, mobile-purse, e-wallet, etc).  It recognizes that such payment mechanisms are likely to emerge as a major tool in ensuring the accessibility of the large un-banked masses to the financial system.  It also recognizes that the emerging interaction and communication technologies such as the Internet will only require greater and greater use of such systems.  In such an environment the proposed Payments and Systems Bill achieves special significance.  What vision does it lay out for this sector?  Can it be strengthened?  These issues are covered in this note.  In the process it points out the importance of the legislature laying out a broad vision that can then act as a constant guide to the regulator (the RBI) to ensure growth, equity, accessibility over and above maintaining financial stability. Last, this paper suggests specific points that should be included in the proposed bill.   
A1. Electronic Payment Modes 
The currently prevalent electronic payment systems can be categorised as (i) Stored Value Cards (SVCs), (ii) Smart Cards, and (iii) credit card systems, (v) debit cards and (iv) network money. In addition there are many other variants that may be envisaged currently, but are not yet popular such as mobile-purse, e-wallet etc. SVCs and “smart cards” are debit cards but where the amount stored is not in a linked bank account, instead the prepaid amount is ‘inscribed’ on the card. The purchaser prepays the issuer, who issues a card with the relevant amount stored, and the amount is electronically recorded on the SVC. As the user charges her purchases on the card, the stored value progressively declines. Smart cards are another mechanism that are gaining popularity.  These cards contain programmable microchips, which can be set to identify the total value of the card (in the case of "pre-paid" cards), or the amount of funds on deposit in the user's associated bank or virtual cash account.  E-money or network money also represents a stored value that is pre-paid by the user however the difference with SVC is that the value is stored on devices attached to the Internet such as computers instead of a plastic card. Credit card systems are primarily credit instruments. Bank account Debit Cards are linked to the users’ bank account, and are another mode by which the bank account holder can transact.  IN that sense they are a substitute to checks.   As mentioned there are other modes as well.  These include electronic cheques, mobile based payments, etc. Moreover, many other possibilities, as yet un-envisaged may come up in the future.  The critical difference has to do with the following issues: 
·         Prepaid versus post-paid: Whether the user pays the full value before or after usage
·         Location of value storage: Whether the value is stored on the instrument (magnetic strip/chip/etc) or a distantly located computer/server. Within the above possibilities are a range of other options. 
These include:
·         Amount stored – high or low:  Typically most card/chip options are low value storage.  Computer or mobile-based storage systems can be much higher.
·         Acceptability – the payment can be made to a (a) single or a limited set of service/goods providers (closed loop), (b) to a multiple set of service/goods providers (open loop).  Indeed it is difficult to list out all the various technological options.  But within the above set of possibilities what is most important for financial inclusion of the un-banked and service provision including e-governance initiatives are pre-paid systems that are based on cards or chips.  These are critical as these tend to be the lowest cost options for low value transactions and hence there scalability is most likely.  Here it should be noted that the cost of delivery becomes quite an issue.  Current scales being what they are the smart card approach is quite costly for low value transactions.  Other cost addition factors include extent of user verification before cards are issued, electronic squaring of accounts etc.      
A2. This Paper 
The paper proceeds as follows.  First, it puts in context the importance of e-payments.  For this purpose it reviews the range of experiments and initiatives in the private and public sectors in ensuring the success of the rural Internet kiosks.  The objective is to lay out the criticality of the bill, and why the legislature needs to think through the various ramifications of the bill.  Second the paper reviews the current bill, and finds that it is currently not laying out a general direction for the regulator to follow.  Third, it presents certain principles that a Payments Systems regime needs to incorporate to ensure inclusive growth and financial stability.  

B.      Including the Un-serviced through Rural Kiosks

 About 71% of India lives in its villages and though the per capita income at Rs. 21,479 is less than half the per capita urban income of Rs. 49,790, the nation cannot afford to let growth pass by more than 800 million Indians. With balanced and inclusive growth as the vision for the 11th Plan, the government has been instrumental in formulating strategies that will transform the countryside under the National E-governance Plan.   
While the main focus of the NeGP is to link the government to the common man, it proposes to set up one hundred thousand Common Service Centers (CSCs) - one CSC for every six villages in India that will provide world class IT and connectivity at the last mile. CSCs are positioned as the retail extension hubs of rural India. Private corporate firms have already been quick to realise that though the significant constraints of access to infrastructure, markets and information make rural India a formidable marketing challenge, it is a challenge that yields high returns through volume. It is the lack of opportunities that prevents low incomes from being converted into purchasing power. The shampoo and detergent sachets that introduced ‘luxury’ items into villages have proved that innovation in marketing and product positioning enables even the poor to become credible consumers.  The method of creating linkages of markets and information was established by the famous ITC e-choupals in 2000. Though the initiative has been replicated by other organisations, there has been limited impact of rural kiosks and in 2006 there were reportedly 15,000 kiosks spread all over India.  One of the main stumbling blocks for the scalability of this model has been the issue of sustainability. Unless sufficient revenues are generated through the kiosks, entrepreneurs cannot be attracted to these schemes.  With the roll out of the one hundred thousand CSCs, a new model has been proposed, partnership between the government and the public. While this may seem more viable in the long run, it will still need to be supported by provision of sufficient number of revenue generating services.  With India on a high growth path, it is increasingly important to bring rural India into the fold and while CSCs form a vital link in the strategy, it is crucial to look into the future and expand the opportunities available to assure sustainability at the unit level. India will be investing Rs. 26,000 crore through its NeGP; but putting in the necessary infrastructure is merely the first step. Community participation is vital to ensure that the programme achieves its desired objectives. With the focus of the paper on the need to ensure community participation in the kiosks, two possibilities that show potential for the future are the mobile phones and cash cards. Both have gained popularity abroad and recently in India as an instrument to access financial services for all those consumers who are not a part of the banking system.  
This section puts forth the point that without good, cheap, and flexible e-payment systems the CSC initiative will fail and so will most other private initiatives.  
B1.  The Telecentre and Common Service Centres  
There are many different models currently being experimented on the rural kiosks front.  Needless to say the rural kiosk or telecentre approach has been the focus of much debate and discussion. Though highly successful models are currently rare, different learnings have already occurred.  These experiments span a range of activities including education, e-governance, entertainment, etc.  We review some of those experiences in the Appendix.  The objective is to provide to the reader an appreciation of the richness of the experimentation that is occurring both within and outside the government.  While some or many of these endeavours may not eventually be sustainable, their learnings will show us the way for the future.   There are a range of private initiatives being experimented upon such as: 
·         E Governance – The example of Drishtee
·         Agriculture Information Delivery – The example of ITC e-choupals
·         Entertainment – The example of Aksh
·         Health and Agriculture Diagnosis – The example of n-Logue
·         Education – The example of TARAhaat  The experience of most of these initiatives has been that there is great potential, but sustainability remains a big question.  And for this reason various revenue streams are being envisaged and experimented with.  But an economically sustainable model is yet to emerge.  More importantly even a successful subsidy model is yet to emerge in areas where there can be public-private partnerships. 
The critical elements have to do with (i) ability to provide low cost services (ii) ability to create a low transaction cost payment system, (iii) ability to access credible information on usage of services for non-insiders, and the ability to (iv) create strong partnerships both vertically and horizontally. It is well known that a necessary pre-condition for these abilities is a low cost electronic payment system.  These issues are also important from the government’s own initiative – this is discussed next.  
The Common Service Centres 
As mentioned before, the Common Services Centres Scheme is a part of the ambitious National e-Governance Plan (NeGP) with a total budget outlay of Rs. 22,600 Cr. It is a 3-pillar model that incorporates:
·         Enabling e-Government Services through State Data Centres (SDC)
·         Connecting the State Government offices up to Block level through the State Wide Area Network (SWAN)
·         Offering a network of access points for e-Government services at the doorstep of the citizen through the Common Services Centres (CSCs) The CSCs or rural kiosks are the last mile delivery mode of the scheme. About a 100,000 Common Services Centers have been envisaged in Rural India and another 10,000 in urban India.  Each CSC will service a cluster of 6 villages. 
Given an average population size of 1500 per village about 8,000 persons will be serviced through each CSC.  Clearly the potential serviceable population is high enough to ensure economic feasibility.  Provided, or course, that adequate and appropriate services are available. The Service Center Agency (SCA) will build, own and operate the CSCs in a financially sustainable manner; this will require it to (i) set up the CSC locations with the necessary IT infrastructure and branding; (ii) identify, select and train the kiosk operators; (iii) undertake content and services partnerships; (iv) set up back-end data center and a centralized CSC portal; (v) operate and monitor the CSC business, especially the revenue support mechanism (Source: IL&FS documents). As per the ILFS, the range of services envisaged is quite comprehensive. 
E-governance is supplemented by a range of potential services that can be classified as G2C, B2B, and B2C:   
·         E-Government Services –G2C
o         Land Recordso         Birth/Death Certificates
o         Grievances
o         Form downloads and submissions
o         Bill payments –water, electricity, telecom, etc.
o         Licenses, permits, subsidies
o         Property Tax and Registration
o         Buss pass, Railway tickets, Passport, etc.
·         Business to Consumer Services –B2C
o         IT services (Printing, Scanning, DTP, web surfing, etc.)
o         Agri-business services (consulting, testing, information, procurement, etc.)
o         Telecom Services (PCO, Post-paid/pre-paid connections, mobile phone sales)
o         Commercial Services (Matrimonial, Astrology, Bio-data, etc.)
o         Retail Sales & Referrals (FMCG, Consumer Goods, etc.)
o         Education Services (IT, English Speaking, etc.)
o         Health (Tele-medicine)
o         Commerce (Online shopping, airline tickets, etc.)
·         Business to Business –B2B/G2B
o         Market Research
o         BPO Services
o         Advertising, Branding and Promotions 
This is of course more of a wish list related to the various possibilities.  But between the various mission statements, and possible range of services that are being envisaged, one element of the CSC is very clear even at this pre-inception stage – A strong emphasis on the revenue model.  At the scales it is being envisaged the very success of the CSC model hinges on a profitable revenue stream to the kiosk operator.  Smooth and low cost revenue collection mechanisms therefore will be necessary for the economic feasibility of the proposed structure. 
The figures below (sourced from IL&FS) illustrate the complexity of transactional relationships between the various stakeholders.  Central Government, State Governments and their various departments, (potentially) Local Governments, the kiosk operators, the service providers, the infrastructure suppliers, the content providers, etc.  The model depends upon two-way flow of information and would need to have the flexibility for a two-way flow of money.  That is, information would flow from information/service providers through the infrastructure providers to the consumer; the consumer may in turn provide information that then may flow to other consumers, service providers or government departments. Similarly the consumer would pay for some of these services; but some of these relationships also involve subsidies to flow to the consumer. 
The traditional hierarchical organization structure that most of us are familiar with is not being envisaged in the CSC model.  Indeed it should not be.  The CSC organization will be a network, where terms such as upstream and downstream, supplier and buyer, up and down the value chain, will not apply.  The suppliers will also be buyers, the rural consumer may also be the information provider, the seller may also provide subsidies.  
A cash based system would be too costly for many reasons.  One, the typical transaction would be a low value transaction.  Two, it would need to be low transaction cost if the various entities involved are profitable.  Three, it would be spread over a very wide geographical area.  Four a range of transactions would occur from each kiosk.  Cash based systems have the following problem – the physical collection and depositing of cash would need to be combined with account keeping, ensuring books are in order, proper audits, etc.             
B2. The importance of electronic payment systems for Internet kiosks As is apparent from the above, the SCA will not only need to invest, it will need to ensure revenue generation and also build and oversee the revenue support mechanism. In a sense therefore the SCA is an aggregator of content and services and also an aggregator of demand.  This aggregation on the demand and supply side will enable it to benefit from the necessary scale and scope economies.   The critical aspect to bring a vast range of services would of course require it to be able to monitor the transactions being undertaken from the kiosks.  And cash based transactions will be quite costly, if not impossible, to monitor at the scales envisaged.   But monitoring is necessary for two reasons.  The first is of course to ensure minimal leakages.  But that is the less important benefit.  The more important one has to do with the necessity of coming up with credible information on transactions that it can share with its upstream partners.  This information will need to be third party verifiable if partnerships with content and service providers are to be built and sustained. Another aspect that is critical to the model is the wide bouquet of services that are being envisaged.  The SCA will need to tie up with many different content providers. In fact the wider the range of services available the greater is the likelihood of success.  A model where a service/content provider does not tie up with the SCA, but where the SCA gets a share/fee if a transaction occurs through its CSC, will have an even higher likelihood of success. Such issues are discussed in greater detail in later sections. 
In other words, sooner or later, it will become essential for the SCA to introduce electronic payment mechanisms, and base all its commercial services on this mode of payment.  These will be required simply because there will be no other method by which payments can be monitored and verified with the necessary detailed information on service provision on such a complex set of operations. Not just the government backed CSCs.  Even the private initiatives or the other public private partnerships will require to be based on e-payment systems.  This is because there are multiplicities of service providers.  These providers will need a verifiable log of services provides, prices charged, payments and received.  Verifiability is important here as partnerships and collaborations cannot be based purely on trust, they have to be backed by credible information.  And here as well e-payments score over all others.  
A summary note 
This section seeks to underscore three critical elements in the success of delivering on e-inclusion, e-governance, and the delivery of public services either through solely private efforts or by way of public private partnerships (PPPs).  
·         The variety of possibilities that are currently being experimented
·         The search for a yet to evolve financially sustainable model
·         The importance of electronic payments
·         The importance of third party verification  It is therefore clear that electronic payments are the only way; however the specific characteristics of a payment mechanism that will facilitate India’s objectives of inclusive and equitable growth and universal delivery of public services are as of now unknown.  As a consequence whatever be the institutional/regulatory mechanism that is set up, would need to be based on the following principles. 
·         Low cost entry of new parties
·         Availability of various options
·         Flexibility The payment and systems bill needs to be studied in this context.  

C. Payments and Settlement Systems Bill

 The proposed PAYMENTS AND SETTLEMENTS Bill seeks to enable the RBI to comprehensively monitor and regulate the various payment systems in operation.  As per the ‘Statement of Objects and Reasons’ of the proposed bill, ‘…the payment and settlement systems serve as a backbone of financial system of a country.’  The Bill recognizes that there are a range of systems both electronic and non-electronic that are operation and the lack of comprehensive legislation in the past needs to be remedied. Some of the payment systems currently in operation include:
1.       Manual paper based clearing
2.       Real Time Gross Settlement (RTGS) System for facilitating non cash mode of payments
3.       MICR Clearing,
4.       Electronic Funds Transfer Systems (including the Electronic Clearing Services),
5.       Card Based Payment Systems,
6.       Government Securities Clearing,
7.       Forex Clearing, etc.  
As per the objectives laid out in the bill, it was considered necessary to enact “a specific legislation which would empower the Reserve Bank of India to act as the designated authority with the following powers and functions, namely:
a)       To regulate and oversee the various payment and settlement systems in the country including those operated by non-banks like CCIL, card companies, other payment system providers and the proposed umbrella organization for retail payments;
b)       Lay down the procedure for authorization of payment systems as well as revocation of authorization;
c)       To lay down operational and technical standards for various payment systems;
d)       To call for information and furnish returns and documents from the service providers;
e)       To issue directions and guidelines to system providers;
f)        To audit and inspect the systems and premises of the system providers;
g)       To lay down the duties of the system providers;
h)       To levy fines and impose penalties for not providing information or documents or wrongfully disclosing information, etc.; and
i)         To make regulations for carrying out the provisions of the proposed legislation.
 In other words, the bill does not provide any direction or vision but is an empowering one.  It will enable the RBI to set up a comprehensive regime that would bring together various types of ‘payment systems’ under a single regulatory framework.  But what should be the overall vision of such payment systems, who should it include, what should be provided greater weight – competition, innovation, and growth of coverage, or financial security?  These issues are missing from the law. This is brought out quite clearly “The Bill, inter alia, seeks to provide for the following matters, namely,…to designate the Reserve Bank of India as the designated authority for the regulation and supervision of payment systems in India for their smooth operations…” As such it is difficult to critique the bill, it does not get into any specifics except empowering the RBI to do so. 
Therefore to better understand the status we need to better understand what directions the RBI has been taking.  We briefly review four documents.  The first are the 10 core principles put out by the Bureau of International Settlements.  The second is the RBI's vision document on payment systems.  The third is one related only indirectly – on electronic funds transfer.  And the fourth is the report of the Cama working group by the RBI on E-payments.  The Committee on Payment and Settlement Systems (CPSS), of the Bank for International Settlements (BIS) published 10 core principles for systemically important payment systems.  Moreover, with IOSCO, the (International Organization for Securities Regulators), it has put forth a set of recommendations for securities settlement systems and one for central counter parties. Together, these form a body of standards, codes and best practices that are form the basis of financial architecture worldwide. 
The Core Principles for Systemically Important Payment Systems, published in January 2001 (henceforth BIS, 2001) are not specific blueprints but suggestions of what the key characteristics should be.   
Box: Ten Core Principles 
The following ten principles were published by the Committee on Payment and Settlement Systems (CPSS) of the BIS in January 001. These principles still provide the benchmark by which high value payment systems are judged:
1.       The system should have a well-founded legal basis under all relevant jurisdictions.
2.       The system’s rules and procedures should enable participants to have a clear understanding of the system’s impact on each of the financial risks they incur through participation in it.
3.       The system should have clearly defined procedures for the management of credit risks and liquidity risks, which specify the respective responsibilities of the system operator and the participants and which provide appropriate incentives to manage and contain those risks.
4.       The system should provide prompt final settlement on the day of value, preferably during the day and at a minimum at the end of the day.
5.       A system, in which multilateral netting takes place should, at a minimum, is capable of ensuring the timely completion of daily settlements in the event of an inability to settle by the participant with the largest single settlement obligation.
6.       Assets used for settlement should preferably be a claim on the central bank; where other assets are used, they should carry little or no credit risk and little or no liquidity risk.
7.       The system should ensure a high degree of security and operational reliability and should have contingency arrangements for timely completion of daily processing.
8.       The system should provide a means of making payments, which is practical for its users and efficient for the economy.
9.       The system should have objective and publicly disclosed criteria for participation, which permit fair and open access.
10.    The system’s governance arrangements should be effective, accountable and transparent. * Systems should seek to exceed the minima included in these two core principles.
The BIS 10 core principles are important as they form the basis of much of the future regulations and procedures governing the financial sector.  There is nothing in the principles that one could argue against.  Indeed the key requirement for the success is a part of the core principles as well (see number 8) “The system should provide a means of making payments which is practical for its users and efficient for the economy.  There are two important issues that need to be addressed related to this point. The first is applicability.  By design of its framers, the principles are limited to high value payment systems.  There is a reason for limiting this applicability, and that is recognition that there are significant costs of regulations. A related issue is that of what is systemically important.  If a payment system is not a large enough component of the financial framework of an economy, then it cannot be considered to be systemically important, and therefore the regulatory oversight would need to be on the basis of proportionality.  A complementary note on how these principles need to be implemented (see section 2.4 of BIS, 2001) is quite explicit on this.   “Payment systems consume substantial resources. Accordingly, it is important that the designers and operators of payment systems are conscious of the resource costs of their systems and the charges they will need to pass on to users if resources are to be used efficiently. Cost constraints are likely to require choices to be made about a system’s design, which will have an impact on the system’s functionality and safety. The functionality required will vary from one system to another according to the demands of participants and users. Systemically important payment systems must always achieve a high level of safety appropriate to their potential for triggering or transmitting systemic risk. Little, however, would be gained if a payment system were designed with such extensive safety features that it became so difficult, slow or costly to use that no one was prepared to do so. System operators should keep their choices under review, as financial markets and the local economy develop and as technological and economic advances improve the range of solutions available.” In other words, regulatory oversight should not be at the cost of growth of electronic payments.  And payment systems such as pre-paid cards discussed above should not be included under its aegis as they are not systemically important in this nascent stage of their development in India. 
As per the RBI document (Payment Systems in India – Vision 2005-08) published in 2005, the objective of any payment systems regime is the ‘establishment of safe, secure, sound and efficient payment and settlement systems’. It recognizes that the primary goal of a national payment system is to enable the circulation of money.  The document also states that public policy objectives are to protect the rights of users of payment systems, enhance efficiency and competition, and ensuring a safe, secure and sound payments system.  This can be achieved through four tenets: 
·         Safety will relate to addressing risk, so as to make the systems risk free or with minimal risk
·         Security will address the issues relating to confidence, with specific reference to the users of these systems
·         Soundness will be aimed at ensuring that the systems are built on strong edifices and that they stand the test of time
·         Efficiency will represent the measures aimed at efficiencies in terms of costs so as to provide optimal and cost effective solutions. 
These action points reveal an RBI that is quite forward looking in its interest to expand the usage of newer forms of payment mechanisms.  However the report only mentions smart cards.  Other forms of card based e-payment mechanisms such as stored value cards; prepaid cards etc are not covered.  In other words, some recognition of the importance of newer modes exists, but no sense of RBI’s internal thinking is available.   In the report of the RBI “Study Group on Migration from Paper Based Funds Movement to Electronic Funds Transfer” three of the action points of the group emphasize the importance of keeping costs of electronic modes low and encouraging them vis-à-vis paper modes.  Apart from this aspect there is no mention of importance of prepaid and stored value cards and other types of e-payments.  
 The Report of the Working Group on Electronic Money, 2002, differentiated between the following types of pre-paid stored value cards
1.       Single purpose: where the issuer and the acceptor are identical.  That is, it is designed to facilitate only one type of transaction such as store-specific cards, telephone calls, etc. 
2.       Closed system or limited purpose: where a limited set of very well defined points within well defined locations may accept the card such as in university campuses.
3.       Multi-purpose card: Also sometimes referred to as open-loop cards. 
These are cards that are accepted by several vendors. Credit cards, debit cards, stored value cards are some examples.  These are also the cards that typically are the most used over the Internet. The working group recognizes that the risks are limited where single or limited purpose cards are concerned, and concentrates a large part of its recommendations on multi-purpose e-money.  It states the following: “multipurpose e-money may be permitted to be issued only against payment of full value of central Bank money, or against credit, only by the banks…” The group’s key concerns are the possibility of monetary policy becoming less sensitive to Central bank action, if such payment forms become prevalent.  By placing these instruments solely in the hands of the Banks it felt that RBI would be better able to monitor as well as implement its monetary policy objectives. 
The group goes on to state various reasons for its preference for Banks, these include:
a)       Implication of e-money on accelerating velocity of money
b)       Impact on access by the RBI to the latest monetary statistics
c)       Option to impose reserve requirement on e-money
d)       Concerns on e-money being issued as credit and also technical security. 
This is a highly flawed set of arguments. First, there is no reason why putting e-money only in the ambit of banks will help reduce money velocity, and there is no evidence that lower money velocity will help either the country’s growth or equity objectives or the safety of its financial system.  Second, the fact that e-money is used electronically also implies that there will be more information generated and will be better accessible for the regulating entity to monitor.  (Paper money is always worse at generating information for the regulator than e-money.)  Further, non-banking entities can generate the same information as banking entities. Third, reserve requirements will only increase costs and by extension the range of services available to the consumers. Fourth, if e-money cannot be issued on credit then all the more reason why e-money should not be limited to banks. 
A whole range of entities should be allowed to issue them. But the banker dominated group was quite categorical “non-banks should not be permitted to issue multipurpose e-money… unless other non-bank issuers also confirm to certain prudential norms”.  This author prefers the latter route than prevent non-banks.  That is, have certain norms and make them open to whoever can fulfil these norms. Note that banks have been rather unsuccessful at reaching the underprivileged and rural hinterlands. In other words, the key direction taken by the working group was that preservation of financial stability should not be compromised and it associated the non-banks’ e-money to be more likely to compromise the integrity of the financial system.  However, as long as certain prudential norms are being followed, integrity of the financial system and financial stability can be met even with non-bank entry into e-payments.  

A summary discussion

 In short, the RBI itself has not revealed much on its position on e-payments and especially those related to multipurpose prepaid stored value systems.  This suggests that the RBI has yet to develop a position on this matter. The BIS is quite unambiguous in its recommendations – as long as the payment system is not important enough, keep regulatory oversight to the minimal, and increase it as the system becomes more important.  In other words, the BIS supports the principle of proportionality.  The proposed Payment Settlement Bill is silent on many important issues.  It leaves such issues to the RBI to deal with, but itself provides no direction or grand vision towards e-payments.  On its part as well, the RBI’s grand vision on payment systems also does not include any specific mention on such prepaid and stored value systems.  
The RBI and other monetary authorities will tend to follow the BIS’ 10 core principles.  However those core principles also do not apply to the low value prepaid stored value cards - Another reason why they should not be included under the proposed bill. Two other issues need to be addressed that are not mentioned in the above documents.  The first is related to security issues and the second money laundering.   
Security: Many law breakers have been arrested on the basis of tracking made possible by following their payments trail.  It has been sometimes argued that e-payments would not enable this as easily as was possible through the paper payments trail.  To the contrary, e-payments make it possible to track certain cards on a real time basis and may even better facilitate security agencies in their tasks.  Here, we might be tempted to put in Know Your Consumer (KYC) systems. However the KYC systems tend to be costly.  Identification, documentation, verification, physical and electronic storage, all have significant costs.  Industry estimates of these costs range in between Rs. 100 to 200 per card.  This is too high a cost if our primary target is the underprivileged and un-banked segment of the population. 
Money laundering: Since these cards can be purchased at various points and then used to purchase, many believe that such systems will make it easier to use and even launder illegal money.  This is perhaps one of the more fallacious arguments against e-payments.  Such cards are typically low value.  Money laundering however typically is on a very large scale. Large purchases of pre-paid cards would be a very impractical method of laundering money.  There are far more quite well known, efficient, and low cost methods through which money can be laundered.   

C. Proposed Character of Multipurpose Stored Value E-payment System

We suggest certain principles and specific characteristics of regulation essential for our objectives of growth and equity.  They incorporate the overall objectives of the desired bill, and how they should be put in place.  They include efficiency, economy, innovation, competition and management responsibility.   Efficiency and economy are self-explanatory and need not be elaborated, in that transaction costs of the system should not be inordinately high.  The principle of proportionality essentially ensures that unnecessarily stringent regulations are not put in place relative to the size of the benefits.  This is important as in the initial stages the benefits are unlikely to be high and therefore overly stringent regulations will impede growth.  Of course, as the market size gets larger, regulatory oversight can be increased.   Innovation in this space is essential for it to succeed.  Already many consider smart cards to have been a failure in countries such as Sweden.  The experience in USA of prepaid cards has been one of high costs. In India as well, the experiments are still going on and no unqualified success example has yet been put forward.  As a consequence, system providers will need to experiment before an India relevant model is derived.   Competition is always essential for efficiencies to be sustained.  Competition needs to come in both from incumbents as well as new entrants.  At the same time efficiency should not be compromised and therefore appropriate regulatory oversight would be required on that front.  Last, recognizing that the senior management is responsible for its action will enable to the regulator to not put in too many pre-emptive rules.   We end this monograph with two sets of recommendations.  The first are the proposed additions to the Payments and Systems Bill.  This merely requires the government to set a broad vision for the RBI.  The second are broad directions for the RBI to build its future regulatory oversight upon.  Recommendations for the Parliament:  Changes to the proposed Payments and Settlement Systems Bill  The preamble to the Bill should be changed to include the following.


 To provide for the regulation and supervision of systemically important payment systems in India and to designate the reserve Bank of India as the authority for that purpose and for matters connected therewith or incidental thereto. Explanation:  The underlined term systemically important needs to be added to the preamble; this is essential as that ensures that regulation does not stifle the growth of systems that are currently not systemically important.  This would make the bill in line with internationally accepted norms of regulation not being at the cost of growth of new transaction technologies.


 Motivation: India has a large segment of its population that is currently deprived of accessing banks.  This un-banked population earns, spends and saves in large numbers.  It’s per household earning, spending, or saving capacities however tends to be quite low. Despite intensive efforts a large part of this population remains un-banked.  This un-banked population remains in urban as well as rural areas and has been deprived of many of the services.  As e-governance and other efforts of the government accelerate, we need to bring such groups rapidly into the banking fold.  However, it is well known that this would be difficult if not impossible for many reasons, three of the most important being – high levels of illiteracy and lack of access to the banking system; problem of access specially in the rural hinterland, and high cost of servicing remotely located customers.  Moreover Internet and other electronic modes of interaction are rapidly becoming more and more important as a source of information on professional as well as personal fronts.  It is the governments desire to ensure that such or other payments systems are able to empower the masses in a short enough period of time.  For this purpose the regulator would aim at ensuring greatest spread through low transaction costs, higher safety and security.  Explanation:  The government will thus ensure that there is a national consensus on bringing in new technologies that can fill the current gap in financial sector penetration among the most underprivileged. 

Broad Directions

 The regulator will seek to achieve the following:·         Empower the masses to be able to use electronic payments·         Ensure safety and security·         Promote efficiency It will do so by following the principles of:a)       Efficiency and Economyb)       Proportionality·         Restrictions imposed on firms and markets should be in proportion to the expected benefits for consumers and the industry. ·         Avoid unnecessarily distorting, entry barriers or impeding competition  c)       Innovation·         Facilitate innovation, for example by avoiding unreasonable barriers to entry for banks and non-banks or restrictions on existing market participants·         Facilitating launch of new financial products and services. d)       Competition·         Facilitate entry of all who can offer services·         Ensure entry along with security and efficiency.  Explanation:  The above additions set the main vision for the RBI without changing the basic character of the current bill.  This will also build into the bill directions for the regulator.     Beyond the above the regulator should also attempt to build a framework for the future.  The broad directions are suggested below. 

Proposed directions for the RBI - Aimed at facilitating progress of the e-payments sector

Topic SpecificsNotes
DefinitionE-money: monetary value stored on an electronic device and accepted as a means of payments by third parties Allows for all types of systems, based on cards or other means and removes single purpose cards from the ambit of such regulation
InclusionE-money includes a range of modes and media, specifically including but not limited to value being carried in various types of electronic devices including smart cards, magnetic strip based media, etc.; Can be used to purchase products and services, redeemed for cash, and whose value can be updated; Various new forms are going to emerge that are currently difficult to predict; the definition should be inclusive.   The regulatory framework needs to be technology neutral
IssuerBoth banks and non-banks are allowed to issue; certain norms, reporting and information criteria etc.  Also small issuers should be encouraged to enter.A level playing field between banks and non-banks needs to be established and this needs to be explicitly recognized.
Risk mitigation (tech.)Payment system to build in the following risks and associated costs: unauthorized creation, transfer or redemption; incorrect attribution of funds, etc.Build in monitoring processes of the same in the regulatory framework.   Concerns of risks many times get translated into limiting activity.  Better reporting and associated monitoring mechanism can eliminate many of these concerns.
Use of depositsThe payment from the consumer to the issuer will need to be protected.  There are many ways of doing so including adequacy norms, restrictions on usage of deposits received, etc.This is the key concern for allowing non-banks.  By ensuring better protection of the users non-bank entry will be made easier in this field.
Granting of creditCredit providing entities governed by stricter norms.Currently MFIs are allowed to provide micro-credit facilities by RBI.  Lower norms for systems not based on credit.
Authorization (Entry)Only granted to those who meet the following criteria related to explicit:Legal status and identity, pre-specified threshold conditions, This procedure needs to be as smooth and as open as is possible.  It should explicitly be recognized that small issuers’ entry should be facilitated and not barred in the interest of financial stability concerns.
SupervisionThe laws should allow for supervision including ability of the regulator to examine all transactions of the issuer; all transactions also need to be maintained in clearly laid out uniformly implemented database and data warehousing systems.The regulator should be able to crosscheck various informational claims made by the issuers in case it so desires.
EnforcementEnforcement powers should rest with regulator, which would include cancellation of permissions, fines and censures, prohibition of activities and individuals, initiation of court proceedings etc. In case of non-compliance of the regulator's orders or in case of some disagreement between the regulator and the issuers some arbitration/resolution mechanism would be built in.  A balance would need to be ensured between two forces – the need to provide adequate powers to the regulator.  And the need to maintain some third party oversight over the regulator as well. 
Prudential RequirementsCorporate structure: a formal structure of the entity undertaking this activity should be essentialWith cleanly laid out systems of commands and associated responsibilities
CapitalA minimum initial capital requirement is one such option.  Scales dependent upon the amount of initial capital could be another possibility that would enable both small and large players to enter.The minimum initial capital amount should not be too high; this would ensure that scales are not necessarily high and at the same time unprepared entities are prevented from entering.
Asset-liability managementNon-bank issuers must have investments of an amount not less than outstanding e-money liabilitiesTo ensure both stability and confidence in the system
LiquidityIssuers must have sufficiently liquid assets; such norms can be easily specified.
Safety and SecurityRecognize that low value cards are not viable money laundering options, as other methods are much easier and less costly.By ensuring that databases can be shared with the regulator real time monitoring of criminal activities as well as money laundering is possible.
User IdentificationNone for low value cards, as this will increase costs of delivery and therefore reduce spread.Recognize that e-money is a substitute for cash.  Moreover, user identification one of the primary factors why the poor are kept out of the banking sector.  Large seasonal migrant labour, poor urban migrants are only some examples
D. Summary Conclusion
The proposed Payments and Settlements Bill is a document that is difficult to critique as it merely places the overall payment and settlements regime in India within the ambit of the RBI’s powers.  The RBI itself has not yet explicitly laid out its position on the various options that are likely to be available.  But what is clear is that there is a great need for a framework to be developed.  The proposed Payments and Settlements Bill needs to explicitly lay out a vision that the RBI can then build upon.  The first is related to the government’s vision of e-payment and what it seeks to achieve.  We suggest some specific additions to the bill that do not change the basic character of the bill. Where the regulator is concerned, this paper therefore calls for building a framework that explicitly states what the regulatory system that oversees the consumer e-payment systems should be like. 
It suggests certain important characteristics that ensure:(a)     Stability(b)     Innovation, entry and competition(c)     Entry of small players into e-payment services(d)     Secure and safe e-payment system We are therefore able to answer some important questions that are not addressed adequately by the proposed bill. 
These issues will need to be decided by the regulator 
1.       Whether prepaid cards fit into the definition of System Providers is not clear; but as that flexibility of defining such providers has been given to the RBI in the proposed bill it will only become clear what route the RBI will take later. 
2.       Should this segment that is at such a nascent stage be regulated?  Regulation will impose costs with little immediate benefits at this point and therefore some may prefer regulation to be delayed. However, if regulations ensure entry with safety and security, they will only accelerate the spread of the e-payments system. This should be a critical element for developing a legal framework for emerging transaction technologies.
3.       Who should provide such services and who should not?  The question of entry is important, as undue regulation will prevent entry and therefore competition from the non-bank sector.  Here it is essential that all segments, not just the Bank sector, should be able to provide such payment system services.  Moreover explicit mention should be made on facilitating the entry of small players.
4.       How should issues of safety and security be addressed?  Fears such as money laundering or use in illegal cross border trade are quite unfounded as there are other much easier means to undertake these tasks.  However, as long as basic monitoring and reporting systems are being followed, these can be directly addressed.  With electronic payments it would be easier to trace as well as well as identify both activities as well as persons indulging in such activities.  
IN conclusion, the current bill should be updated to include broad principles that should be followed by the regulatory entity.  The government needs to specifically mention the broad vision that will then translate into broad principles related to entry, competition, innovation, equity and growth.  The reason is the regulator may be interested in maintaining security and stability and may not give enough weight to the fact that a growing and inclusionary economy needs many different types of providers to meet the demands of the different types of potential users.  The poor and rural users, the un-banked population, small groups, payment over the Internet, etc. all need to be facilitated and coverage growth needs to be accelerated.  This broad vision is currently missing and needs to be incorporated to act as a guide and constant reminder and beacon for the RBI. *** Appendix Some examples of the various private initiatives in the Telecentre space  E Governance – The example of Drishtee This model involves the setting up of kiosks primarily in rural areas that provide a range of services that include agriculture and related information, complementing e-governance initiatives, etc. Transactions include obtaining, filling out and submitting government forms.  The kiosk service suppliers’ fee for this is then set at about 10 percent of the estimated transaction cost, also taking into account ability/willingness-to-pay considerations. The benefits, apart from greater accessibility, include savings from reduced travel and time costs. There may also be benefits in terms of improving the effectiveness of transactions (e.g., if a complaint through this channel s more likely to be addressed), but these are harder to quantify.  The centres also provide other services such as matching buyers and sellers, or providing horoscopes or matrimonial advertising.  Additional services require partners who can provide software, maintenance, content or other components of the complete service. Education is also included in Drishtee’s offerings, though kiosk owners have often used the presence of a computer and peripherals to offer computer training, as well as other offline services such as printing and games. The benefits in these examples are reductions in transaction costs for existing transactions, improved quality of successful matches, and potentially most significant, completion of activities (e.g., training, entertainment, and communications) that would otherwise not take place because of high transaction costs. Currently the model is predominantly based on cash payments where the kiosk provider charges the user, and has synchronous agreements with the service providers.  The transactions costs tend to be high in such models.  These issues are discussed later.  Agriculture Information Delivery – The example of ITC e-choupals ITC has set up a large number of telecentres under the name o ITC e-choupals.  These are currently focussed on specific agri-commodities though they are designed to scale up to cover a range of activities to benefit the farmer.  Take for instance soy-choupals in MP designed to facilitate soyabean transaction between the farmer and ITC.  Soy-choupals are used as registry points for procurement of soybeans. Though procurement occurs at factories and warehouse hubs, initial logging in is done through the soy-choupal. The choupal also provides price information from local mandis, as well as global price information on soybeans and derivative products. The initial benefits include a significant reduction in transaction costs, from 8 percent of the transaction in such agro-transactions, to approximately 2 percent.  Though some of these benefits may be at the expense of traditional intermediaries at mandis (arhatiyas), there are great efficiency gains, including clearer quality guidelines and measurement, greater timeliness and reduced waits, quicker payments, and reduced uncertainties for the farmer.  The organization has been able to expand its range of services by tying up with organizations like Agriwatch that provide a range of agricultural information to farmers including mandi prices. Agriwatch is developing a large-scale Internet portal for farmers, and Drishtee’s role is that of providing last-mile access to this rich information base, through its kiosks.   Entertainment – The example of Aksh The Aksh services model, the revenue model, and pricing structures are currently similar to those of the Drishtee model. With one major difference.  Aksh had initially partnered with Drishtee for the development and maintenance of kiosks that would act as distribution points for cable TV access, as well as Internet kiosks.  The importance of cable TV revenues, points towards the importance of entertainment options - that kiosks can provide a range of entertainment services in addition to utility services such as agriculture-related information or e-governance.  Cable TV is only one entertainment possibility.  With the expected increase in availability of digitised audio, video, gaming, and social networking options, entertainment options have a large role to play in rural India.  Moreover, since delivery costs of conventional modes are quite high the telecentre approach may lead to significant savings in delivery costs and therefore greater scalability.  Health and Agriculture Diagnosis – The example of n-Logue  The n-Logue model is rather different in that it charges the kiosk operator for connectivity; further n-Logue has progressed well beyond being simply a connectivity provider, to delivering a range of services that can be adapted to different connectivity technologies. close links with IIT Chennai have given n-Logue access to a range of software innovations for delivery and implementation of various applications in the fields of education, health and agriculture. For example, web cams have been used for remote diagnostics for diseases of people, animals and plants. A considerable amount of local language software has been created. In other words, audio-visual communications can enable a far richer set f services than is currently envisaged.  Te ability to provide diagnosis services can dramatically reduce health care accessibility issues across rural India.  IN this case as well, low transaction costs payment mechanisms are crucial.  Again these issues are discussed later.  Education – The example of TARAhaat  These kiosks were very much along the lines of those implemented by Drishtee and n-Logue, with a mix of e-governance services, market price information, and so on. TARAhaat’s long-range plans include a comprehensive portal for rural information services and perhaps most important – education.  It has an educational content partner, called TARAgyan. In association with various partners, TARAgyan is developing local language content and software. Basic IT education is an important part of TARAgyan’s actual and potential offerings, but it is not the exclusive focus. In fact, there has been a substantial diversification into developing materials for English language instruction, rural marketing, personality development, and so on.  It is not clear which aspects of the various education offerings will eventually become the most successful, but clearly, educational services are quite expensive to provide especially in the hinterlands.  Electronic media make it less costly and reduce the fixed cost element in that idiosyncratic infrastructure need not be created.  There are of course many different models and range of services that various organizations are experimenting with.  The combination of services that will evolve as the basic service delivery model of telecentres across rural India will be determined in due course.  Moreover, it is likely that depending upon the location the combination of services will also differ across kiosks. But what is clear is that some set of economically feasible models will evolve within the private sector.  If the government’s actions also play out as envisaged the possibilities are even larger. 

Box:  A Study of Kiosks, Inclusiveness and Sustainability 

Thus, while we find that roughly 5% of the population in the villages studied have used the kiosk this 5% was clearly not selected “at random” from the village population as a whole; some selection biases drove kiosk use. In particular, we find these diffusion biases along dimensions of gender (more males than females), age (users are usually younger than 30), caste (scheduled caste members are less likely to use the facilities save in those villages where the facility is located in an SC area), … educational attainment (with few illiterate users), and income (users are richer as measured by standard surrogate indicators). We found that of the 77 kiosks that were established in the region by June 2004, 29 of the 35 kiosks run by self-employed entrepreneurs had closed down….The main reasons behind the closure of the kiosks being run by self-employed entrepreneurs were lack of long-term financial viability and lack of adequate operational and technical support by … the internet service provider and organization responsible for coordinating with other entities for delivery of services. The lack of long-term financial viability was mainly due to the inability of the kiosks to diffuse widely within their communities and attract more users. As pointed out in this study, the kiosks continued to attract users mainly from the relatively higher socio-economic strata within their communities and failed to upgrade … to make it more relevant to a wider section of the village population.  … underscore the importance of making the kiosks diffuse more widely among their communities for long-term … sustainability. Source: Social Impact and Diffusion of Telecenter Use: A Study from the Sustainable Access in Rural India Project, Rajendra Kumar, 2007, mimeo 


For an excellent review of these issues and experiments see, Nirvikar Singh, “Information Technology and Rural Development in India” mimeo, University of California, Santa Cruz.
The IL&FS has been appointed as the Program Management Agency for a period of three years to support the Department of IT, Government of India to facilitate the Scheme rollout.
See “The regulation of electronic money issuers”, Financial Services Authority, UK, consultation Paper 117, December 2001.  Also see “A Summary of the Roundtable Discussion on Stored Value Cards and Other Prepaid Products” The Federal Reserve Board, New York (Undated).