RuPay and Paytm's genesis from India's payment clearing system: four-way payments in India

When India is mentioned, what often comes to mind are colourful sarees, vibrant Bollywood cinema dance and music, colourful motorised three-wheelers, the Taj Mahal, Buddhism, Gandhi, and herds of cows ...... These are the stereotypes we have of India, our neighbour. Over the years, with the help of Modiomics, India's economy has indeed grown rapidly - the 2019 GDP figures show that India has become the world's fifth-largest economy, a momentum that should not be underestimated. In the spirit of pragmatism, today we share with you an overview of India's payment and settlement system.

skim through

The payment system in India is categorised by the Reserve Bank of India (RBI) - the central bank of India, as follows:

- Paper tools

- Electronic tools (e-infrastructure)

- Electronic clearing service (ECS) credit

- Regional ECS (RECS)

- Electronic clearing services (ECS) debit

- Electronic Funds Transfer (EFT)

- National Electronic Funds Transfer (NEFT) system: National Electronic Funds Transfer (NEFT) system

- Real Time Gross Settlement (RTGS) System: Real Time Gross Settlement System

- Clearing Corporation of India (CCIL): foreign CCP trading system

- Other tools

- Prepaid payment systems

- Mobile banking system

- Automated Teller Machines (ATMs) / Point of Sale (POS) terminals / Online transactions

Of course, we are concerned with the following:

- Large Payment and Settlement System: RTGS

- Retail Payment and Settlement Systems: NEFT

- Foreign exchange payment and settlement system: CCIL

Next, let us delve into these two areas, which are the pillars of India's payment and settlement system.

Large Payment and Settlement System - RTGS

Until 2004, large interbank settlements in India were based on paper-based instruments. Although RBI claims that settlements can be completed within 30 minutes, this is somewhat unconvincing for a country known for its software technology.

In 2004, RBI developed and operated its own Real Time Gross Settlement System simply named RTGS without any fancy name. However, with over 1,000 cheque-based clearing systems in India, RTGS in India is still not a complete replacement for cheque-based inter-bank settlement. Fortunately, most of the retail settlement systems in India are connected to RTGS. in recent years, the Indian government has been actively promoting a policy of financial inclusion by making RTGS free of charge for banks.

RTGS is an old friend to us and its fundamentals will not be described here. However, there are some unique features of RTGS in India that deserve attention. In India, RTGS participants are categorised into the following four groups:

A: Central banks, large commercial banks

B: Main distributor (the meaning of which is not clear to the author)

C: Ordinary banks

D: Clearing agency

Why is there such a categorisation?RBI has arranged it in this way:

Category A members can submit their internal transfer orders to RTGS and act as correspondent banks to submit orders on behalf of their client banks and are entitled to day-to-day liquidity support from RBI. However, these members are required to meet RBI's infrastructure development needs on an occasional basis.

Category B members can only submit their interbank orders and are also entitled to receive day-ahead liquidity support from RBI.

Class C members do not have direct access to RTGS and must access it through a Class A correspondent bank. Of course, RBI does not provide liquidity support.

Class D members, as clearing organisations, can submit settlement instructions to RTGS in bulk via the API after completing their internal clearing (usually netting).

India requires each bank to open a current account in the IAS system (i.e., the Integrated Accounting System, the unified accounting system for bank clearing accounts), but this account cannot directly participate in RTGS settlements. Banks wishing to access RTGS are required to open another clearing account with RBI called "RTGS Settlement Account".

At the beginning of the trading day, banks must transfer funds from the current account to the RTGS settlement account before they can participate in settlement. At the end of the trading day, any remaining funds must be transferred back to the current account.

The clearing algorithm in the Indian RTGS system is relatively simple and follows the FIFO (first in first out) principle. When there is a shortage of liquidity, the clearing order goes into a queue and waits. If a bank has an IDL-SGL account (i.e. securities account) with RBI, RBI will automatically use the securities held by the bank as collateral to provide liquidity to the bank to ensure that payment orders are processed as quickly as possible. However, at the end of the trading day, the borrowed liquidity has to be repaid to RBI, failing which a penalty will be levied. The funds settlement process is shown in the figure.

An interesting point is that in India, communication between banks and the clearing system uses a self-developed solution called SFMS (Structured Financial Messaging Solution), similar to SWIFT.

Retail Payment and Settlement Systems - NEFT

In the mid-1990s, fund transfers between bank accounts in India were settled through the EFT (Electronic Funds Transfer) system, which was upgraded by RBI in 2005 to NEFT, where "N" stands for "National". Since then, all fund transfers between bank accounts in India have been brought under the NEFT.As a retail payment system, the NEFT uses a netting methodology, whereby the net amount is settled through RTGS every working day. To become a member of NEFT, one must first become a member of RTGS, otherwise settlement cannot take place.

The principle and flowchart are shown below:

NEFT has several significant improvements over its predecessor, EFT:

- Settlement is faster, usually on the same day, whereas previous EFTs usually took T+3 days to settle (later optimised to T+1).

- The hours of operation are much longer, with NEFT running 24/7, and funds can still be settled except on Sundays (as RTGS is also open on Saturdays).

- Higher security with encrypted message transmission using India's self-developed SFMS communication platform.

- To date, NEFT has 220 members, including the Industrial and Commercial Bank of China.

Card Payment and Settlement Organisation - RuPay

In India, the retail card payment space was previously served by card organisations such as American Express, Metro, Visa and MasterCard. Settlement was initiated by the card organisations themselves. For example, transactions using Visa cards in India were settled at the Bank of America (India branch), while MasterCard transactions were settled at the Bank of India.

In 2013, India launched its own domestic card organisation, RuPay (a combination of the words "rupee" and "payment"), and the country rejoiced. With the help of India's financial inclusion policy, RuPay issued more than 500 million debit cards in a few years, accounting for more than 50% of the domestic debit card market share (although these were mainly for low-end customers).

The mobile payments industry in India is growing rapidly, but interestingly, the retail payments industry in India did not skip the industrial and agricultural development stages as the country itself did, but instead focused directly on the services sector. Instead of jumping straight from the bill payment era to the mobile payment era, payments in India gradually made up for missed lessons by developing card payments, leading to the rise of RuPay.

RuPay's parent company is NPCI (National Payments Corporation of India), an RBI regulated legal entity with shareholders in over 50 domestic banks in India. Till date, RuPay has partnered with more than 600 domestic banks to issue various RuPay cards (credit, debit, virtual, etc.) with a cumulative issuance of more than 500 million cards.

As a result of RBI's strong financial inclusion policy, the transaction fees on RuPay cards have been set very low, which has somewhat overwhelmed the traditional card organisations that have been operating in India for decades.

We discussed Visa's operating model in detail earlier. As a domestic card organisation in India, RuPay is doing the same thing as Visa, acting as a four-way organisation, connecting issuing banks, acquiring banks, merchants and cardholders. The operating principles are no different from other card organisations.RuPay dominates the Indian market primarily through the following:

- Cost-effectiveness: Unlike other card organisations that charge merchants a percentage of the transaction amount, RuPay's fee model is a fixed fee, for example, for online purchases or POS card payments, where RuPay charges Rs. 0.06 per transaction, and the issuing bank receives Rs. 0.03 (which translates to less than a penny in Chinese currency).

- Free: There is no charge for Indian issuing banks and acquiring banks to join RuPay.

- Security: This security is relative to India itself as the transaction data is all controlled by India, providing better data security.

- Fast: As a national card organisation, RuPay receives more support for clearing and other aspects than corporate-level card organisations.

RuPay's ambitions go far beyond that. In recent years, it has aggressively moved towards internationalisation, partnering with different regions and card organisations in the hope that one day RuPay cards will be accepted globally. However, one wonders if India really has such a strong overseas spending power ......

Digital wallet par excellence - Paytm

In 2010, Paytm was born. The company didn't become an overnight success as we thought it would. In fact, a few years ago, Paytm was just doing small businesses like online bill payments and rechargeable cards, and there was no indication that it was going to become a market leader.

It wasn't until 2013, after seeing RuPay flourish and learning about China's booming internet and mobile payments, that Paytm couldn't help but think: If China can make internet and mobile payments so successful, why can't India, another country with a huge population, do the same? Imitating China might work, right? Internet payments may not work because India has poor internet infrastructure and no proper internet application scenario. But mobile phone penetration is high and offline transactions are frequent. Why not start with offline mobile payments?

So, in 2014, Paytm "copied" Alipay and launched its own digital wallet (the latest version of Paytm is pictured below).

Digital wallets, like bank cards, are essentially a payment medium. How do you make this medium work smoothly?

In a world where the abstract scenario of money transfers can be summarised into several models: B2B, B2C, C2B, C2C, bank cards have been playing these models for decades, and Alipay, Paytm's 'teacher', has mastered them. However, Paytm has no such ground. It has neither a retail nor a wholesale e-commerce platform. It will be a long road to replicate this.

In this context, Paytm has carefully analysed the situation in India: a country with a poor state of financial inclusion. Until 2013, an average of 4 people had a debit card, 60 people had a credit card, and there were only 20 ATMs per 100,000 people (compared to China, the number was 97, and compared to Japan, it was 128). This resulted in a large amount of people's wealth being in the form of cash.

Does this mean that people are reluctant to use bank cards? Of course not. It is because banks are not serving them. We know that banks must have enough branches, ATMs, POS terminals and other terminals to cover a huge population. Only with these terminals can the money in the bank card flow, and only when the money flows can the bank make a profit. If the value created by serving the population does not cover the cost, the bank, as a profitable organisation, will obviously not spend money on these infrastructural investments.

In Positioning Theory, there is a famous quote, "You have to make an argument that is completely opposite or absurd to your competitors in order to be able to outperform them (because your competitors will never counter themselves with an opposite argument), otherwise, don't bother, it's absolutely impossible."

What is this opposite argument in India? Since it is difficult to open a bank card, Paytm has simplified the process and made it easy for everyone to get an e-wallet account. What are the benefits of getting an e-wallet? Enjoy the same payment convenience as a bank card.

Creating an e-wallet is not difficult, but what is difficult is what to do next.Paytm is facing two very serious problems:

How do I deposit money into my e-wallet?

How do you get money circulating?

Since a large number of people in India have their wealth in the form of cash, how do you deposit this cash in an e-wallet? You need a large number of outlets to collect it. Setting up your own outlets is impractical, so Paytm has partnered with convenience stores across India, from large chains like 7-Eleven to small shops on the street, to solve the first problem.

And then, how do you get the money circulating? Personal transfers are possible because they all flow through the same system, it's just a matter of bookkeeping. But commercial payments are key. If you can't handle commercial payments, why should people deposit money into your wallet? Can you provide merchants with collection facilities? That's when Paytm turned its attention to China and discovered a "miracle" - QR codes.

The popularity of QR codes was a key turning point in the reversal of mobile payments. In the past, when paying with a bank card, merchants had to communicate with their bank and receive payments via a POS machine, which was too expensive for small merchants and might not be available even if they had the money. QR codes, on the other hand, are very cheap and only cost a penny to print and scan to receive payments. Humans are rational beings, driven by reason, so of course they will choose QR codes over POS. In countries with weak financial inclusion infrastructure, it is only a matter of time before digital wallets win in the retail space.

So far, Paytm has been fully prepared on the technology front, with everything from recharges and transfers to payments. However, for Paytm to take off, it still lacks a trigger.

In November 2016, good luck fell from the sky. In a nationally televised address, Prime Minister Narendra Modi announced, "In order to combat corruption, money laundering and counterfeit currency, the Government of India has decided that with effect from midnight of 8 November 2016, the 500 and 1,000 rupee notes currently in circulation will no longer be legal tender. This means that these notes will not be available for transactions and will have to be deposited in banks within a stipulated time or they will be null and void."

Indians already have a very small number of bank accounts and a lot of wealth in the form of large denomination notes. Since these notes cannot be deposited in banks or allowed to become waste paper, they have to be deposited in e-wallets.Paytm was ecstatic and sent out a tweet that day:

This decision has given a huge boost to the digital wallet industry in India, which was not anticipated by the Indian government. This dividend has enabled Paytm to grow rapidly and gain a large number of customers, building on the previous years of preparation and readiness. As we all know, Paytm has secured multiple rounds of funding from Alibaba and has grown rapidly to become the third largest digital wallet in the world, supported by Ant Financial's financial cloud technology support and the widespread use of RuPay cards.

We have always maintained that there is no good or bad distinction between bank cards and digital wallets. It's easy to convert a bank card to a digital wallet because the stable payment and settlement logic behind it doesn't need to change. The key is the concept.

Today, there are still more than 1 billion people around the world without access to banking services. In these countries, abandoning the heavy traditional banking infrastructure systems and embracing lightweight mobile payments is an inevitable event, especially in huge countries with weak financial infrastructures. In fact, look at Africa.

However, the world is moving very fast. Recently, a number of countries have launched digitised sovereign currencies, which has alarmed both the bank card industry and the digital wallet industry. Why?

Seventy years ago, there were no bank cards (credit cards), people spent cash, and payments were settlements, where two parties settled debts and credit relationships at the time of the transaction.

For the past 70 years, the processes of payment and settlement have been separated. Although various methods have been tried over the years to reduce the time lag and risk between payments and settlement, since they have always been two separate processes and the glue between them is a bunch of financial intermediaries (banks) and clearing agencies, what could go wrong in the middle is anyone's guess.

Today, with the advent of digital sovereign currencies, it seems that we can go back to the days when payments were settlements - perhaps in the near future, the digital wallets on our mobile phones will actually become "digital wallets", as the bond between money and digital wallets has been The relationship between money and digital wallets has been reinvented as a relationship between money and people. The digital wallet may quickly transform from a financial instrument to a pure e-wallet application.

reach a verdict

We know that India has two industries that are very strong globally: software outsourcing and overseas labour exports. These industries generate consistent foreign exchange earnings for India. In the overseas labour export market alone, India's foreign exchange remittances have been ranked first in the world for nearly 10 consecutive years, reaching nearly $80 billion in 2018, which is a significant source of foreign exchange earnings for India.

In order to serve the foreign exchange market, India launched a service called CCIL (Clearing Corporation of India) in 2002. In fact, CCIL has several functions, foreign exchange settlement being only one of them.CCIL uses CCP (Central Counterparty), which is a central counterparty trading mechanism.The CCP model simply means that an intermediary acts as a buyer for the seller and a seller for the buyer to mediate the transaction, reducing the risk of the other members by concentrating the risk on itself.