National Payment System Architecture This document discusses India's national payment system architecture. It defines payment systems and describes various payment instruments and infrastructure components like transaction, clearing and settlement systems. It explains processes like cheque clearing and electronic funds transfer. The key objectives of the national payment system are establishing safe, secure, sound and efficient systems. Recent initiatives include expanding electronic payment coverage and introducing innovations like real-time gross settlement, cheque truncation and the national financial switch to improve efficiency.

1. National Payment System
Architecture
AR Joshi

2. Payment System - Definition
• The mechanism, the rules, institutions,
people, markets, and agreements that make
the exchange of payments possible
• The institutional and infrastructure
arrangements in a financial system for
initiating and transferring monetary claims
in the form of commercial bank and central
bank liabilities

3. Consider These Transactions
• Buying vegetables with the local vendor
• Receiving / sending money from / to parents
• Making payment for a vehicle
• Sending registration fee for a national level
examination
• Making railway reservation through internet
• A businessman sending money to branch office
for local payments
• Receiving periodic interest on bonds

4. Modes of Payment
• Paper based
– Cash
– Cheque
– Demand draft
– Postal order
– Money order
• Plastic card based
– Credit card
– Debit card
• Electronic instructions
– Electronic fund
transfer
– Electronic clearing
service
– Real time gross
settlement (RTGS) for
large value transactions
– Using internet banking
facility

5. Elements of Payment System
• Payment instruments
• Infrastructure for transacting, clearing and
transferring funds
• Financial institutions
• Market arrangements such as conventions,
regulations and contracts
• Governance and laws, standards, rules and
procedures

6. National Payment System
Payer PayeeMonetary Claim
Central Bank Money Commercial Bank Money
Cash Deposits
Payment Instruments
Payment Infrastructure
- Transaction Systems
- Clearing Systems
- Settlement Systems
Institutional Framework
-Market arrangements
-Stakeholder consultation
-Legal framework
-Oversight and other
public policies

7. Transaction Infrastructure
• Provides services to create, validate and transmit payment
instructions by:
• Authenticating the identity of the parties involved in the
transaction, sometimes using encryption technologies
• Verifying the payer’s ability to pay
• Validating the payment instrument against system
standards
• Authorising the transfer of funds between the payee’s and
the payer’s financial institutions
• Recording and processing payment information
• Communicating the information between the institutions

8. Clearing Infrastructure
• Provides services to transmit, reconcile and in some cases
confirm payment instructions between financial
institutions and calculate interbank settlement positions by:
• Sorting and matching payment instructions between
institutions
• Collecting, processing and aggregating payment data for
each institution
• Storing payment data reports and transmitting them to each
institution; and
• Calculating gross or net settlement positions (payables or
receivables) for each institution

9. Settlement Infrastructure
• Provides interbank funds transfer services by:
• Collecting and checking the integrity of settlement
claims
• Verifying the availability of funds for settlement
in the participating institutions’ accounts at the
settlement bank
• Settling the claims through funds transfers on
these accounts at the settlement bank; and
• Recording settlement and communicating it to the
participating institutions

10. Cheque Clearing Process

11. MICR Cheque
Cheque
Number
City (3), Bank (3), Branch (3)
Branch Code
Account No.
Instrument
Type
CANCELLED
CANCELLED
124578800
Amount
(Encoded by
Presenting bank)

12. What is a Clearing House?
• An association of banks that facilitates
payments of cheques between different
bank branches within a city / place
• A central meeting place for bankers to
exchange the cheques drawn on one another
and claim funds for the same
• One bank is appointed as in-charge of the
clearing operations

13. Life Cycle of a Cheque Transaction
Payer Payee
Issues cheque (1)
Deposits cheque
with bank (2)
Debit advice (5)
Bank A
(Paying Bank)
PAYMENT SYSTEM
Bank B
(Collecting
Bank)
Clearing house
- processing
Settlement institution
Debit A Credit B
Receives cheque
through or at
Clearing house (4)
Debit advice
Interbank settlement
Credit advice
Presents cheque
through or at
Clearing house (3)
Debit B Credit A
Return item
Return exchange

14. Clearing
House
Presenting Bank
Service Branch
Presenting Bank
Service Branch
Presenting Bank
Service Branch
Drawee Bank
Service Branch
Drawee Bank
Service Branch
Drawee Bank
Service Branch

15. Timeframe for Cheque Clearance
• Same city (local cheque) – 2-3 days (end-to-end)
• High Value Clearing (Rs. 1 lakh +) – on the same
day
• Coverage of High Value Clearing is very limited
• Outstation cheques – 3 to 10 days
• All the banks to publicise their cheque collection
policy
• For delay beyond the normal period, the banks are
required to compensate the customer

16. Charges for Using Cheque
• Local cheques – no charges are levied
• Outstation cheques – collection charges
depend on the amount of the cheque and the
place
• Charges decided by the Indian Banks’
Association or the banks themselves
• Banks are also required to publicise the
schedule of service charges

17. Payment System Management
Mission and Vision

18. Mission Statement
The establishment of safe, secure,
sound and efficient payment and
settlement systems for the country
Triple S + E

19. Mission Statement
• Safety – to make the systems risk free or with
minimal risk
• Security – will address issues relating to
confidence
• Soundness – ensuring that the systems are built on
strong edifices and that they stand the test of time
• Efficiency – Measures aimed at efficiencies in
terms of cost so as to provide optimal and cost
effective solutions

20. Payment Systems Vision
• New institutional structure for retail PS
• National settlement system
• Sound legal base
• Continuation of risk mitigation efforts
• Efficiency enhancements
• Rural sector facilitation
• Customer facilitation and protection

21. Achievements during 2001-04
• Extension of MICR – 40 centres
• NDS / SSS – 2002
• RTGS operationalisation (2004)
• Establishment of CCIL as CCP for g-sec & Forex
• Implementation of CFMS, SFMS
• Increasing scope of ECS, EFT, etc
• National financial switch (NFS)
• Initiating steps for cheque truncation

22. Current Initiatives and Status
• Expansion of MICR Technology
– Standards of Operational Efficiency for MICR Cheque Processing
System
– Presently at 48 (53 CPCs) centres
– 6 more centres
• Expansion of MMBCS to Non-MICR CPCs
– 35 centres with more than 30 bank / branches
• Extending the coverage of ECS to all IFSC Branches
• Cheque Truncation
– Pilot at the National Capital Region is in progress

23. Reforms in Payment Systems
• Infrastructure Building
– INFINET
– SFMS
– NEFT
– PKI
– Payment Gateway
– National Financial Switch (NFS)
– National Settlement System (NSS)

24. Efficiency Enhancements
• Implementation of cheque truncation
• New clearing houses, expansion of geographical
jurisdiction
• MICRisation of every cheque
• All PSS services to be made available at the
national level – National ECS announced
• Introduction of innovative products – e-purse, etc
• Back-up arrangement
• DR set up / testing at banks

25. Risks Arising in Payment Systems
• Credit risk a party within the system unable to meet its
financial obligations
• Liquidity risk a party within the system will have
insufficient funds to meet financial obligations
• Legal risk legal uncertainties will cause or exacerbate
credit or liquidity risks
• Operational risk operational factors such as technical
malfunctions or operational mistakes
• Systemic risk widespread liquidity or credit problems
could threaten the stability of the system or of financial
markets

26. Continuation of Risk Mitigation
Efforts
• Systemic risk
– Interbank transaction - migration to RTGS (already
achieved)
– High value – guarantee fund (is being examined)
• Liquidity risks
– Implementing the NSS (expected to start at four metros
from march 2006)
• Operational and legal risk
– PKI-based digital signatures
– Credit transfer to be encouraged
– High availability of systems

27. Rural Sector Facilitation
• Availability and coverage – ATMs
• Deployment of multi-application smart card
• Reach of electronic mode of funds transfer
– through variant modes
• Collaboration with post office
• ATM –based Kisan cards

30. Latest Technology in Cheque
Clearing

31. Problems With Physical Clearing
• Processing of paper based cheques constitutes an important
segment of the payment
• Settlement of cheques is arrived on the basis of the
physical presentation of paper based cheques
• Need to transport the paper based cheques and the time
involved in their processing at various intermediary levels
• Physical limitation on processing speeds and capacities
• Outstation cheques typically take longer realization
periods (over a fortnight)
• If the cheque is returned unpaid, it has to re-trace the entire
path back to the presenting branch

32. Cheque Truncation
• The process in which the physical movement of
cheque
– Within a bank,
– Between banks or
– Between banks and the clearing house
• Is curtailed or eliminated,
• Replaced in whole or in part, by electronic records
of their content (with or without the images)
• For further processing and transmission

33. Process of CTS
• Cheques are truncated at the presenting bank itself
– At the branch or at the service branch or outsourced
• Electronic image based cheque truncation to
provide opportunities for signature verification
• Preservation period of paper instruments should be
one year
• Preservation period of the electronic image of the
cheque should be eight years

34. Recommendations for CTS
• Centralized agency per clearing location to act as
an image warehousing facility
• Grey scale technology which helps capture finer
features on cheques and also have relatively lesser
storage and network bandwidth requirements
• There should be no amount based cut-off for
truncation and all cheques should irrespective of
value
• Truncation to be introduced for all banks and all
clearings from a cut-off date for all participants at
that centre

35. Payment without Paper

36. ECS – Debit
• Faster method of effecting periodic and repetitive
payments by 'direct debit' to customers' accounts
• Minimizing paper transactions and increasing
customer satisfaction
• A large number of debits and one credit
• Collection of electricity bills, telephone bills, loan
installments, insurance premia, club fees, etc

37. Present System for Bills Payment
• Customers/subscribers are required to go to
the collection centers
• Stand in long queues for payment of bills
• Time and money spent by the customer
• High transaction cost for many small value
transactions

38. ECS Debit Process
• Initially collect mandates from their customers for
collection of amounts due by direct debit to
customers’ accounts with banks
• User company prepares transaction data on
electronic media and submits the encrypted data to
the local clearing house, through its sponsor bank
• Local clearing house processes the same and
arrives at the inter-bank settlement as also
generates bank-wise/branch-wise reports

39. ECS Debit Process
• Clearing house debits the destination banks’
accounts with clearing house and simultaneously
makes a consolidated credit to the sponsor bank’s
account
• Furnishes the bank-wise and branch-wise reports
to the service branches of destination banks
• Service branches forward the branch-wise reports
to the respective branches for debiting the
accounts of customers with the indicated amounts

40. Benefits of ECS Debit
• Faster collection of bills by the companies and better cash
management by them
• Eliminates the need to go to the collection centers/banks
by the customers and no need to stand in long ‘Q’s for
payment
• Automatic debiting to the accounts once the mandates are
given by the customers, to that effect cuts down the
procedural delay
• Available in about 65 cities presently
• Saving on costly cheque paper and MICR printing
• Manual processing of cheques and cash is also reduced

41. Users of ECS Debit
• Utility service providers
• MTNL, telephone/mobile companies
• State electricity boards
• Banks for collection of credit cards dues
• LIC
• Housing finance companies

42. Bulk Payment Situation
• It requires an expensive administrative machinery for
printing, dispatch and reconciliation
• Bunching of a large number of instruments in clearing
results in operational bottlenecks and pressures on the
cheque processing system
• Chances of loss of instruments in transit and their
fraudulent encashment
• The customer has also to keep track of the receipt/non-
receipt of the instrument and take efforts in depositing the
instrument to the bank on receipt of the same
• Banks find processing of such a large volume of
instruments not only error prone and monotonous, but also
a strain on the cheque clearing system

43. ECS Credit Process
• User which has to make payments prepares the payment
data on a magnetic media and submit the same to its bank
• Sponsor bank would present the payment data to the local
clearing house
• Clearing house will process the data and work out an inter-
bank funds settlement
• Clearing house will furnish to the service branches branch-
wise credit reports indicating the beneficiary details
• Concerned branches will credit the beneficiaries’ accounts
on the appointed date

44. Benefit a Corporate Body
• Savings in administrative cost presently being incurred for
printing of paper instruments in MICR format and
dispatching them by registered post
• Loss of instruments in transit or fraudulent encashment
thereof totally eliminated
• Reconciliation of transactions is made automatic. By the
time the ECS cycle is completed, the user institution gets
an electronic data file from its bank with the date of
payment and banker’s confirmation thereon
• Cash management becomes easier as arrangement for
funds is required to be made only on the specified date
• Ensuring better customer/investor service
• Centralised data submission for 15 centres

45. Benefit the Customer
• Payment on the due date
• Effortless receipt - no need for visiting the
bank for depositing the dividend/interest
warrant
• Loss of instrument in transit or fraudulent
encashment thereof and consequent
correspondence with the company are
completely eliminated

46. Payer Beneficiary
Payment instruction
Bank A
Debit Payer’s
account
Bank B
Credit beneficiary’s
account
Credit advice
V
a
l
i
d
a
t
i
o
n
Check
available
funds /
collateral
/ credit
Debit A
Credit B
Clearing /
Processing
Systematically important payment system
Financial
Risk
Controls
(caps,
limits)
Confirmed payment
Settlement
Payment
message
Life cycle of a payment (credit transfer)

47. National Electronic Funds
Transfer (NEFT)
• Electronic funds transfer system
• Introduced by Reserve Bank of India
• To transfer funds electronically
• From one customer account of a participant bank
branch
• To another customer account of any other
participant bank branch
• Funds can be transferred from one bank to another
bank

48. Geographical Coverage
• Available all over India
• Uses the concept of centralised accounting system
• Bank's account gets operated at one centre, viz,
Mumbai only
• Individual branches participating in NEFT could
be located anywhere across the country
• The beneficiary gets the credit on the same Day or
the next Day
• Six settlements in a day

49. NEFT Process – 1
• The remitter fills in the NEFT Application form
giving the particulars of the beneficiary
• Authorises the branch to remit the specified
amount to the beneficiary by raising a debit to the
remitter's account
• This can also be done by using net banking
services offered by some of the banks
• The remitting branch prepares a Structured
Financial Messaging Solution (SFMS) message
and sends it to its Service Centre for NEFT

50. NEFT Process – 2
• The Service Centre forwards the same to the local
RBI (National Clearing Cell, Mumbai) to be
included for the next available settlement
• The clearing centre sorts the transactions bank-
wise and prepares accounting entries of net debit
or credit for passing on to the banks participating
in the system
• Bank-wise remittance messages are transmitted to
banks (to service branch)

51. NEFT Process – 3
• The receiving banks process the remittance
messages received from RBI
• Messages are forwarded to respective
branches
• Credit is given to the beneficiaries' accounts

52. Infrastructure required for NEFT
• Branches are to be computerised
• Connected to the central server and to service
branch
• Each participating bank has to identify a branch as
the link point for transmitting all outward
messages and receiving all inward messages
• This branch is called Service Centre
• SFMS infrasturcture to be installed at all the
branches

53. Benefits of NEFT
• Banks can now provide inter-bank TT service
• Reconciliation is automatic
• Banks can make use of the NEFT infrastructure
for introducing new payment/cash management
products to their customers
• The number of outstation cheques issued by
customers and consequent service load on banks
may decline considerably over a period of time
• Customers can remit money quickly to the
intended beneficiary