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.