A stable regime for the rapid growth  of e-payments

 

   Laveesh Bhandari        

 

A. Introduction and Background

This note investigates the emerging and proposed regime governing the prepaid stored value electronic payment systems (such as smart cards, multipurpose prepaid cards).  It recognizes that such payment mechanisms are likely to emerge as a major tool in ensuring financial systems’ accessibility to the large un-banked masses.  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 this note also looks at the vision laid out by the key actor in this space – the Reserve Bank of India.  It is essential to gauge the RBIs position on this matter as the proposed Bill allows high levels of flexibility to the RBI.  Last, this paper suggests specific points that should be included in the proposed bill, or a completely new bill that is focused on regulation of electronic money issuers needs to be put in place for the RBI to be better able to carry out its assigned task.  

 B. Payments and Settlements 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:  
  • Manual paper based clearing
  • Real Time Gross Settlement (RTGS) System for facilitating non cash mode of payments
  • MICR Clearing,
  • Electronic Funds Transfer Systems (including the Electronic Clearing Services),
  • Card Based Payment Systems,
  • Government Securities Clearing,
  • 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 come across four documents.  The first are the 10 core principles put out by the Bureau of International Settlements.  The second is the RBIs 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.    

 

C. Ten Core Principles for Systemically Important Payment Systems

  

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 counterparties. 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 are not specific blueprints but suggestions of what the key characteristics should be.    These general suggested ‘best practices’ however do not deal explicitly with issues related to pre-paid or stored value electronic cards, in fact they are not really designed to apply to them.  As is stated in the introductory statement of the principles they ‘are a benchmark for high value payment systems’.  Moreover, they are mostly aimed at risk mitigation.  Nevertheless, it is recognized that such mitigation should not be at the cost of ‘fair and open excess’ and ‘a transparent and publicly disclosed criteria for participation’.  In other words, these best practices do not provide further direction as to the principles that will guide the RBIs take on electronic payments.  For that we need to understand the RBIs documents.  These are discussed below.   

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, be 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.

   

 

D. Payment Systems in India – Vision 2005-08

  

 

As per this RBI document 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 are all quite standard points for any payment system, but do not provide any sense of the direction on any specific issues.  Issues of who, how and coverage are all missing.  As far as pre-paid e-payments are concerned there is no explicit vision set out by the RBI.

  

But the vision document does devote a full section on the rural sector.  It states that ‘the benefits of improvements in payment and settlement systems should be fully available for the rural population of the country…[and] the general thrust of all the action points would encompass the requirements of the rural populace…’. It then identifies the following action points:

  

1.      Improve the availability and coverage of the new delivery channels. This will be in the form of extension of facilities such as the Automated Teller Machines for cash payments.

2.      Facilitate large scale deployment and use of multi application smart cards which would also be used for storage and transfer of small value payments in electronic mode. This would be achieved by means of introduction of easy to use, small and cost effective hand held devices for transfer of value between cards in a secure manner.

3.      Increase the reach of electronic modes of funds transfer at rural areas by providing variations of such modes, but with a rural bias. The proposed NEFT system would be modified such that the non-networked branches in rural areas can access the NEFT branches of banks for transfer of fund.

4.      Increasing the reach of payment services by means of tie up and collaboration with other large coverage entities such as the Post Offices.

  1. Providing support for new modes of traditional facilities such as ATM-based Kisan cards.

  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 it only mentions smart cards.  Other forms of card based e-payment mechanisms such as stored value cards, prepaid cards etc are not yet judged to be important enough possibilities.  In other words, some recognition of the importance of newer modes exists, but again no sense of any internal thinking.    If the RBI does not have an internal vision, and a vision is not being explicitly mentioned by the government then the question is still open.  Another RBI initiative provides a better understanding of the RBIs internal thinking on the matter.   

 

E.  Study Group on Migration from Paper Based Funds Movement to Electronic Funds Transfer

 

  

The study group investigated issues related to the migration from paper based funds movement to electronic modes.  The group recommended the following as feasible options:  

  1. Levying a charge for all paper based cheques which will be borne by the customer. Presently the service charges for MICR processing are borne by the banks. Banks may have to educate their customers on the need to migrate to electronic processing and in case the paper based cheques are continued, the service charges relating to the processing of such cheques may be passed on to them.
  2. Providing disincentives to customers for using paper based cheques vis-à-vis electronic modes
  3. Making electronic funds transfers cheaper than paper modes. To begin with ECS based transactions should be free and this could continue for another three years. The payee of a cherub has certain legal protection under Negotiable Instruments Act against dishonor of such instruments. Similar comfort should be available for electronic mode of funds transfer.
  4. For certain transactions which are essentially used for effecting non-paper based funds settlement - such as for reimbursement of credit card dues; payment by banks to card accepting member establishments for transactions settled through the Point-of-sale (POS) terminals etc., it is recommended that such payments should not be through paper based cheques; … A similar approach could be adopted for mobile phone payments as well.
  5. Adopting a differential pricing pattern for paper based Demand Drafts, Pay orders and Bankers’ Cheques issued by banks - these could be priced higher than electronic transactions
  6. Making internet based transactions free of charge for the customers, since banks would be saving on costs involved if these transactions were to be processed by them as paper based transactions or serviced by tellers at the counters of branches.
  

Three of the action points above 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.  That gets us to the next RBI initiative that has more direct ramifications on the matter at hand.

F. Report of the Working Group on Electronic Money, 2002

 

   

  

This working group was predominantly comprised of persons belonging to the banking sector.  It is differentiates 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 groups 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 statisticsc)      option to impose reserve requirement on e-moneyd)      concerns on e-money being issued as credit and also technical security.  This is a highly flawed set of arguments. First, velocity of money is affected by many factors, it has been increasing consistently and is likely to continue to do so.  Velocity is affected by a range of factors including how long Banks are open, access to ATMs, the availability of notes and coins of different denominations and so on.  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 safety of its financial system.    The fact that e-money is used electronically also implies that there will be more information generated.  Further, since such information would be electronic, it would be much easier to access.  In effect paper money is always worse at generating information for the regulator than e-money.  Again there is no reason why the banks need to be the sole issuers.  Non-banking entities can generate the same information as banking entities.  While all other documents call for a low cost e-money option the group considered imposing reserve requirements on e-payments. The prepaid stored value cards ensure that instead of carrying paper money the individual provides that to the card provider and the card provider then pays to the vendor.  Reserve requirements will only affect the range of services available to the consumers. But again this is not good enough a reason for limiting to Banks.  Moreover, if e-money cannot be issued on credit then all the more reason why e-money should not be limited to banks, and 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.  We prefer to take this route than limit non-banks.  That is, have certain norms and make them open to whoever can fulfill these norms rather than limit to the banks who anyway have been quite unsuccessful at reaching the underprivileged and rural hinterlands.  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.  There are other ways of meeting these objectives.  

A summary discussion

  

In short, the RBI itself has not revealed much on its position on e-payments and specially those related to multipurpose prepaid stored value systems.  When RBI documents do mention these forms of payments it is in passing.  This could mean that either these are not yet considered to be important enough options for the RBI to officially state its position, or the RBI has yet to develop a position on this matter. In any event, what is quite clear is that the proposed Payment Settlement Bill is quite vague and ambiguous 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 RBIs 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.  The only indication is the working group on e-payments that seeks to create Banks’ monopoly in this segment of the financial sector.  Two other issues need to be addressed hat 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.  The only requirement would be the proper identification of the person purchasing the card/service.  Just as is done today with mobile phones.  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.  If the user were to identify himself to the seller who then can potentially share the information with the government,  money laundering can be dealt with better.  But there is a more practical argument as well.  Such cards are typically low value cards.  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 efficient and low effort ways through which money can be laundered.    Given these ambiguities we are left with no option but to ourselves suggest certain principles and specific characteristics of s regulation that is essential for our objectives of growth and equity.   

 

 

G. Proposed Character

of Multipurpose Stored

Value E-payment Bill[1]

  

 

 

The following recommendations 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, the larger the sizes of the market, the greater can regulatory oversight become.    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 secrit and 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.     The Proposed Addition to the Payments and Settlements Bill – Prepaid Stored Value Cards.  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.  Its 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 therefore fear of banks; 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.  As a consequence 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.   Objectives: 

  • Empower the masses to be able to use electronic payments
  • Ensure safety and security
  • Promote efficiency
  Principles: 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.e)      Role of Management: ·         responsible for its activities ·         business is conducted in compliance with regulatory requirements.   

Proposed directions 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
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.
 For limited use e-money options the requirements should be less stringent.  This should include  
ProhibitedGranting of credit through e-money by non-banksMost criticism of non-banks entry into this sector comes from this possibility.  BY removing this we do away with such criticism.  That is, it does away with the fear of monetary authority losing its powers to affect the economy
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 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.
   
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 cross-check 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 regulators 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
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 unprepared entities are also kept out.
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 SecurityMoney Laundering: monitor, training, awarenessBy ensuring that databases can be shared with the regulator real time monitoring of criminal activities as well as money laundering is possible.
User IdentificationDetails of user logged onto central system; no issuance without identificationBy ensuring identification of user as a precondition for its sale/use, many concerns related to misuse can be addressed.
    
H. 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 RBIs powers.  The RBI itself appears to be a bit ambiguous 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 RBIs various documents do not show light on the matter.  But all indications are that, the government and the RBI still do not fully appreciate the possible positive impact of the e-payment systems.  The proposed Payments and Settlements Bill does not contain important questions that need to be addressed.  The first is related to the government’s vision of e-payment and what it seeks to achieve.  This paper therefore calls for a document 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.  

  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.  However it is clear that some legislation will be put in place to ensure completeness of the regulatory regime.  Given that a regulatory structure will come up, the question arises – who should the regulator be?  The answer is quite apparent, it will have to be the Reserve Bank of India.
  2. The next question is: Should this segment which is at such a nascent stage be regulated?  On the one hand regulation will impose costs with little immediate benefits at this point and therefore some may prefer regulation to be delayed. On the other, if regulations ensure entry with safety and security, they will only accelerate the spread of the e-payments system.
  3. 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. 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 these specific principles related to entry, competition, innovation, and growth.  The reason is the regulator will always be most interested in maintaining security and stability and may not give enough weight to the fact that a growing 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  


[1] 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 Borad, New York (Undated).