Banking Framework: How the Banks work.

In this article, you will learn the basic framework in which a bank works. The framework that I have introduced is a very generic model adopted in almost all banks. However, there are exceptions where some banks deviates from the standard I have proposed based upon their operational scale, business needs or regulatory requirements. To start with, please find below a diagram that defines the banking framework in three broad layers.

1. CHANNELS

Channels are the modes through which customers interact with a bank. There is a gamut of instruments that a bank deploys to allow customers to place their banking needs. 

1(a) Branches

A branch is a place where a customer can directly come and use the banking facilities like deposit, withdrawal bill payments, account opening/ closure etc. This is the oldest and most conventional channel of Banking. A branch is located in secured premises and placed at strategically locations so that a bank can reach out to each and every customer in the market.

1 (b) Electronic

This mode of channel has brought a revolution in banking industry. This includes a number of different areas that all have the common theme of the customer dealing directly with bank software rather than bank people like internet banking, ATMS's, Point of Sales (POS), credit and debit cards, online banking, emails etc. There are lots if innovations going across the globe in electronic channels for banking. 

Taken together this is a very important and growing element of service delivery for banks because it can lead to Straight Through Processing (STP) – i.e. without staff manual intervention – this is seriously low cost for the bank and any place- any time banking for the customers.

1(c) Phone

The way the Financial Services Group handles phone calls, both incoming and outgoing. It includes call centers call routing, telesales and interactive voice response as well as computerized response to “push buttons” on the handset. This is another fundamental area of service delivery for banks.

1(d) Mail

Customers still send thousands of letters a week to large financial services organizations and conversely financial groups send millions of letters a week out (statements, letters, etc). The inbound mail is usually a service trigger. The outbound mail (e.g. a credit card statement) is often the principle window for the customer onto the bank’s activities with errors and corrections usually very visible.

1(e) Tied Sales Force

A sales force that works only for the Financial Services Group (or more usually a part of it). They can be employed by the Group or be independent and / or commission only. Normally they are not relevant to service delivery but can be an escalation point for customers with complaints. In the banking area the Relationship Managers that deal with business and high net worth individuals often get involved in service delivery by being the “first point of contact”.

1(f) Brokers and Agents

These salesmen are independent of the bank and work on behalf of multiple Financial Services groups. Although important in service provision in some areas such as insurance, they are not material for service provision in banks at the moment. In the future, this may change (e.g. the use of Post Offices as banking services outlets).

I will update this article to cover the information about other left over banking framework elements.

Innovations in Retail Payments

RETAIL PAYMENTS INNOVATIONS ACROSS THE GLOBE

The article does not cover general technical and business trends, such as cloud computing and outsourcing as well as other strategic approaches in terms of the business behavior of individual banks, since the focus is not on IT developments but on the payment instruments and schemes they.

Retail Payments	Large Value Payments
Mostly in terms of consumer purchase and in retail sector.	These are mostly inter bank payments done on RTGS.
There are a gamut of instruments like card, on line, POS etc.	These are settled on real time gross settlement basis.
They make more diverse use of private sector systems for transactions processing.	They use central bank’s provided secured clearing and settlement systems.
They are smaller in value but large in terms of volume.	They are very large in value though smaller in terms of volume.

To begin with fact findings, let me describe the retail payments in the apposite language.

Typically, the overall payment process or payment scheme is described as four-party system consisting of the payer, the payer’s PSP, the payee and the payee’s PSP.

The payer makes payments by allowing his/her funds to be transferred to the payee.

This funds transfer is made when the payer’s PSP debits the payer’s account, and the payee’s PSP credits the payee’s account, typically by means of clearing and settlement processes.

The use of traditional payment instruments – i.e. credit transfers, direct debits, credit cards and debit cards – is still dominant in retail payments. While cheques are still in use in most of the countries but their usage is now declining every where.

Below mentioned are some trends in habit of retail payments in different geographies:

• Cash continues to be the most frequently used payment instrument for both proximity and P2P payments.
• Credit transfers are frequently used for spontaneous remote payments via the internet as well as for prearranged remote payments and P2P payments.
• Direct debits are the most frequently used instrument for prearranged payments.
• Credit cards are the most frequently used instrument for spontaneous remote payments via the internet and are also frequently used for proximity payments.
• Debit cards have also gained in popularity for proximity payments.
• Cheques are still fairly often used in P2P payments and prearranged payments in some countries.

Trends in Retail Payments under different situations

   Source: Survey conducted by Working Group 2011, Committee on Payments and Settlements

There have been multiple surveys conducted by different agencies like World Bank, Payments service providers, central banks on the changing trends in retail payments and new innovations in payments, their clearance and settlements. Below are some common findings that can be taken as the bullet points for the common trends in new retail payment products or customized payment services.

There is fairly wide spread adoption of electronic channels for payments initiation using innovative retail payment instruments.

Customer funds are fully protected in 60% of innovative retail payment instruments.

P2P, utility and P2B payments have received maximum degree of innovative instruments.

The majority of innovative payment instruments have very little interoperability. This is an area that attracts a lot of offerings from payments service providers.

Generally, innovative payment instruments are not directly connected to clearing and settlement houses.

Security and fraud issues need adequate attention.

Below are the broad level conclusions on innovative drives in retail payments:

• Most of the innovations are focused on payment initiation stage like near field communication, POS terminal, new advanced cards and mobile applications in Android and I phones have gathered a good momentum.
• e- Commerce is the emerging trend in on line shopping and other payments. Although, skeptics level in terms of security is still high. Increased use of cards and wide spread usage of on line shopping and utility bill payments are now finding their space in retail payments market. Also, new innovations like direct debit, standing instructions, easy bill payments and options of EMI in credit card payments have further stimulated the use of e commerce.
• One important innovation is in banking applications that are easy to use for any payment at any time at any place.
• Cash loaded cards; gift cards and wallet in mobile are also gaining grounds in retail payments.
• Innovative products that allows user to do cross border payments in most convenient way are also becoming fast popular in retail users.

To further understand the innovations in retail payments, below is the list of a gamut of new retail payment products at international level. This list is an attempt to capture the influential products in retail payments during the past decade.

POLi

This is a payment system which directs a payee from its merchant’s web page directly to the internet bank log in page. Now, the payee can directly do a one time payment and will be automatically logged out there after.

 Payclick

               

This payment system provides a user with credit points which he or she can use to transfer

By card swipe or on line credit points transfer to a merchant. The merchant then can redeem   points and credit its account.

PingPing

Mobile micropayment platform that allows users to purchase products and services using their mobile phones (SMS or NFC tag) for proximity payments or on the internet for remote payments up to EUR 25.

Oi Paggo

Mobile payment solution of the Mobile Network Operator(MNO). The MNO grants a credit line to the “cardholder” and acquires merchants to accept the payments. The merchant is paid 30 days after the transaction, while the “cardholder” pays the scheme 25 days later. If the “cardholder” does not pay, the MNO can take out a loan on behalf of the “cardholder”.

Interac e-Transfer

Transfer of funds through online banking to anyone with an e-mail address or a mobile phone number, and a bank account in Canada. It uses e-mail and text messages for fast notification to the recipient that a transfer has been initiated and payment-related information. Funds can be received at both online banking and non-online banking accounts. The limit on the amount that can be transferred is determined by banks.

Reloadable prepaid cards by Visa and MasterCard

Cardholders can make card payments and withdraw cash wherever Visa and MasterCard are accepted, including online and overseas. Cardholders can load additional funds to their cards online, in-branch and through their telephone bill payment system in selected financial institutions or using cash or direct debit from a bank account.

Electronic Commercial Draft System (ECDS)

It caters services for the processing of electronic commercial drafts including acceptance, registering, storage, forwarding and inquiry. Operated by the People’s Bank of

China, and offered to banks and financial companies.

Vingado

Bio metric authentication system that allows registered customers to pay by fingerprint in all stores linked up to the system.

m-pass

Online payments authorized by entering the mobile phone number and a PIN, and verified via SMS. There are plans to extend its service to POS using NFC technology.

Girogo [pilot]

Europe’s largest project for contact less card payments, initiated by German banks and savings banks in 2012. In a first step, the contact less payment function will be available for the German chip-based electronic wallet GeldKarte; in the medium term, contact less payments will also be available for the German electronic cash application on debit cards.

Same day bulk settlement runs

A clearing and settlement service offered by the clearing house in HongKong SAR to help shorten the clearing and settlement cycle (from T+1 to T) for inter bank obligations

arising from electronic money transfers.

Business agents for financial inclusion

Joint ventures between banks and their agents offering innovative payment services based on mobile phones and smart cards to promote financial inclusion and to enable transfer of social benefits.

EBPP

Electronic bill presentment and payment system including services/options such as viewing bills online, paying and        managing bills, auto-pay options, sending reminders, collection of payments, and funds transfer to merchants/utility companies. It provides online platforms run by banks to facilitate consumers’ payments for goods and services, which are then pooled and passed on to merchants/utility companies. Inter bank settlements take place on accounts at the Reserve Bank of India.

Prepaid payment instruments issued by non-banks

Prepaid payment instruments issued by non-banks to be used for the payment of goods and services over the internet and mobile network. Cash withdrawal and funds transfer between instruments are not permitted (however, recently some relaxation has been allowed for funds transfers subject to certain preconditions and limits). For customer protection, prepaid funds are to be kept in an escrow account at a bank. Further security features include limits for the maximum loading amount, limits for individual transactions, and a validity period.

PostePay&Go [pilot]

It is a prepaid product of BancoPosta, developed for users of public transport. Two functions are available in one card: an electronic ticket function (chip/contact less) for local transport, and a prepaid card function (magnetic stripe and chip EMV). The prepaid card function supports all transactions that can be initiated at the POS and via the internet.

There are still many more such innovations in payments, I will continue discuss other revolutionary innovations in my next article. 

Payments and System Settlement Act 2007- Settlement of disputes and dishonor of electronic payments.

In continuation to my previous post posted on 17th February 2013, which aims at providing the insights of Payments, their clearing and settlement in India, in this post, I am giving the insights on how the settlements and disputes like dishonor of electronic payments shall be handled. The PSS Act of 2007 has been intelligently framed to address all kinds of disputes possible in case of electronic payments. The act has also laid down clear and strict guidelines for all the parties involved in a payment life cycle. 

To start with, I would like to detail some terms that will I have used as they have been used in PSS Act 2007.

System Participant:

It refers to any person or organization that has initiated the payment or is a beneficiary of the payment initiated. To illustrate, merchants accepting online or card payments, both end parties in case of NEFT or RTGS shall be treated as system participants.

System Providers:

All the parties and agencies that cater the payments services shall be treated as System providers. This shall involve all the banks catering electronic payments services, card issuing agencies like Visa or Master cards, RBI itself, all payment processing service providers like pay pal.

I would also like to address a question; does the PSS Act 2007 deal with netting and settlement finality? To answer, the PSS Act 2007 defines “netting” and legally recognizes settlement finality. It states that a settlement, whether gross or net, will be final and irrevocable as soon as the money, securities, foreign exchange or derivatives or other transactions payable as a result of such settlement is determined, whether or not such money, securities or foreign exchange or other transactions is actually paid. In case a system participant is declared insolvent, or is dissolved or is wound up, no other law can affect any settlement which has become final and irrevocable and the right of the system provider to appropriate the collateral contributed by the system participants towards settlement or other obligations.

This Act also legally recognizes the loss allocation among system participants and payment system, where the rules provide for this mechanism.

The PSS Act, 2007 lays down the duties of the system provider. The system provider is required to operate the payment system in accordance with the provisions of the Act and the Regulations, the terms and conditions of authorization and the directions given by the Reserve Bank from time to time. The system provider is also required to act in accordance with the contract governing the relationship among the system participants and the rules and regulations which deal with the operation of the payment system.  

The Act requires the system provider to disclose the terms and conditions including the charges, limitations of liability etc., under the payment system to the system participants. The Act also requires the system provider to provide copies of all the rules and regulations governing the operation of the payment system and other relevant documents to the system participants. The system provider is required to keep the documents and its contents, provided to it by the system participants, as confidential and is prohibited from disclosing the same, except in accordance with the provisions of law.

Under the PSS Act, 2007, dishonor of an electronic fund transfer instruction due to insufficiency of funds in the account etc., is an offence punishable with imprisonment or with fine or both, similar to the dishonor of a cheque under the Negotiable Instruments Act 1881. Subject to complying with the procedures laid down under the PSS Act, 2007, criminal prosecution of defaulter can be initiated in such cases.

The Act lays down an elaborate mechanism for settlement of disputes between system participants in a payment system, between system participant and system provider and between system providers. The Act requires the system provider to make provision in its rules or regulations for creation of a panel to decide disputes between system participants. Where any system participant is dissatisfied with the decision of the panel, or where disputes arises between system participant and system provider or between system providers, such disputes are required to be referred to the Reserve Bank for adjudication, whose decision shall be final and binding on the parties.  

In cases where the Reserve Bank, in its capacity either as a system participant or system provider, is itself a party to the dispute, then there is a provision for referring such cases to the Central Government  for adjudication. 

To conclude the post, I would like to introduce the readers with a new kind of crime that is gaining ground in electronic payments. RBI is continuously receiving complaints of fraud and illegal payment systems in the market. We need to understand that any payment system that is not authorized by RBI under the PSS Act 2007, no prosecution of defaulter can be initiated. However, to avoid such illegal systems, under the PSS Act, 2007, 

• Operating a payment system without authorization
• Failure to comply with the terms of authorization
• Failure to produce statements
• Returns information or documents or providing false statement or information
• Disclosing prohibited information like balances, credit limits and contact details
• Non-compliance of directions of Reserve Bank violations of any of the provisions of the Act, Regulations, order, directions etc.

They all are offences punishable for which Reserve Bank can initiate criminal prosecution. Reserve Bank is also empowered to impose fine for certain contraventions under the Act. 

I hope that readers will definitely gain confidence in new advanced electronic payment systems as they are secure, fast and innovative. In my next post, I will introduce the innovations that are taking birth across the globe in Payments and Banking.

Thanks

H. Sanguri

Payments& Settlements in India

In India, The PSS Act, 2007 received the assent of the President on 20th December 2007 and it came into force with effect from 12th August 2008. PSS stands for Payment and Settlements Systems Act. 

Reserve Bank Of India is the sole proprietor of all the payments systems running in India. We have two types of payments settlements in India. One is gross settlement i.e. RTGS and all other netting settlements like NEFT, card payments etc. A payment cycle involves broadly the below mentioned steps:

a) Payment Initiation

 The party to pay money has to initiate a payment which can be done through a payment instrument like a cheque, demand draft, banker's note, debit card swipe, online payment etc.

b) Payment Clearance

The party given the responsibility to authorize the payment initiated has to clear the that payment in terms of amount available, credentials of payment issuer etc. There are two different modes of clearance, one for paper based instruments and other for electronic instruments. For paper based instruments like cheque, instrument needs to available physically in a local clearing house. Once, that clearing house clears the payment, it is due for settlement. However, modes like demand draft are kind of pre cleared instruments ready to get settled. Today, any institutions allows the feasibility of stop payments in case of paper based instruments after clearing but before settlement of payment. 

The other mode i.e. electronic is much different in terms of getting cleared. They do not need to be present in any physical mode in any clearing house. Instead, once they gets initiated, they gets auto cleared based on the availability of funds in issuer's account. However, financial institutions still have discretion to stop an electronic payment post auto clearance based on grounds like government intervention or if it is a case of fraud or money laundering. Examples of such instruments are card payments, online money transfers and online shopping payments.

c) Payment Settlement

This is the final step in any payment life cycle that involves actual fund transfer from payee account to beneficiary account. Settlement is done on two ways, one is real time gross settlement that do the fund transfer at the time payment gets cleared. The second one is netting which involves accumulation of all payments cleared in a certain interval and finally netting the amount and doing the actual fund transfer after that interval is over. Example of netting settlements are NEFT, card payments etc.

In India, there there are banks national and private who have been vested with power to initiate and clear payments instructions on authorization from their customers. However, settlement can only be done by Reserv Bank of India. Therefore, it is mandatory for all the banks to maintain two sets of accounts one credit and other debit in RBI if they are doing any payments facilitation in India.

The PSS Act, 2007 provides for the regulation and supervision of payment systems in India and designates the Reserve Bank of India (Reserve Bank) as the authority for that purpose and all related matters. 

 The Act also provides the legal basis for “netting” and “settlement finality”. This is of great importance, as in India, other than the Real Time Gross Settlement (RTGS) system all other payment systems function on a net settlement basis.

Please find below some payments related financial terms laid down by RBI for reference:

“Payment obligation” is defined as what is owed by one participant in a payment system to another such participant which results from clearing or settlement or payment instructions relating to funds, securities or foreign exchange or derivatives or other transactions.

 “Payment Instruction” is defined as any instrument, authorization or order in any form, including by electronic means, to effect a payment  by a person to a participant in a payment system or from one participant in such a system to another participant in that system. The payment instruction can be communicated either manually i.e. through   an instrument  like a cheque ,draft , payment order etc or through electronic means, so that a payment can be made by either a person to the participant in such a system or between two participants.

“Settlement” means the settlement of payment instructions received and these include settlement of securities, foreign exchange or derivatives or other transactions. Settlement can take place either on a net basis or on a gross basis.

"Payment System" is system that enables payment to be effected between a payer and a beneficiary, involving clearing, payment or settlement service or all of them, but does not include a stock exchange. It is further stated by way of an explanation that a “payment system” includes the systems enabling credit card operations, debit card operations, smart card operations, money transfer operations or similar operations.All systems (except stock exchanges and clearing corporations set up under stock exchanges) carrying out either clearing or settlement or payment operations or all of them are regarded as payment systems. All entities operating such systems will be known as system providers. Also all entities operating money transfer systems or card payment systems or similar systems fall within the definition of a system provider. To decide whether a particular entity operates the payment system, it must perform either the clearing or settlement or payment function or all of them.

It states that a settlement, whether gross or net, will be final and irrevocable as soon as the money, securities, foreign exchange or derivatives or other transactions payable as a result of such settlement is determined,  whether or not such money, securities or foreign exchange or other transactions is actually paid. In case a system participant is declared insolvent, or is dissolved or is wound up, no other law can affect any settlement which has become final and irrevocable and the right of the system provider  to appropriate the collateral's contributed by the system participants towards settlement or other obligations.

PSS Act 2007 also legally recognizes the loss allocation among system participants and payment system, where the rules provide for this mechanism.

In my next blog, I will introduce the roles and responsibilities laid down for payment systems to operate in India and the penalties in case of dishonor of payments instructed.

RFP: A bridge between a buyer and a seller

RFP: Request for proposal

This is generally released by an intended buyer as a detailed requirement specification for the potential service providers to submit their business proposals. Different market players have their different formats and contents for RFP’s.  However it should not be confused with Request for Tender RFT.

A RFP process is very vital for both the buyer and seller. In a good RFP where a buyer can put down prudently its requirement and expectations in detail on the other hand a potential supplier can do a fair analysis, if it’s offering can meet all the expectations of buyer. Therefore, RFP favors a client by filtering the vendors and focus on potential and best vendors, where advantage to vendor comes from the gap analysis.

A well documented and nimble RFP should have below mentioned features:

• It informs suppliers that an organization is looking to procure and encourages them to make their best effort.
• It allows for wide distribution and response.
• It ensures that suppliers respond factually to the identified requirements.
• It includes specifications of the item, project or service for which a proposal is requested. The more detailed the specifications, the better the chances that the proposal provided will be accurate. Generally RFPs are sent to an approved supplier or vendor list.
• It has all relevant corporate information of the client and expectations in terms of budget, time and delivery quality.

In today’s competitive environment RFP’s receivable and response is also taken as an indicator of performance of selling parties. RFP’s are also taken as a source to improvise among competitors.

There are many incidences of false responses of RFPS’s where sellers extrapolate and falsify their claims to fulfill the requirements of a buyer to bag the order. In a nutshell, RFP’s are instrumental in making the optimal match between a buyer and a seller in a competitive market however, nepotism and un ethical reporting are two factors that abate the advantages of RFP’s to some extent.