Is India Ready for Real-Time Gross Settlement?
Live since January, will India’s RTGS payment system prompt a switch to electronic payments? As in many other environments, one problem for corporates is the lack of sufficient remittance data when using electronic delivery. Envisaged benefits to working capital management will only be realized in India if banks change their views on float and combine on standards.
India began the pilot of its Real-Time-Gross-Settlement (RTGS) Payments System in January 2004, scheduled to be fully operational by June 2004, thereby joining the World’s developed economies in establishing a domestic payments platform that eliminates systemic risk. Like other RTGS systems, payments are cleared singly and bilaterally as they occur; as a payment message is moved through the clearing house, so the paying bank’s account with the Reserve Bank of India is debited and the receiving bank’s account is credited. Since there are no end-of-day procedures, such systems do not create intra-day exposures between participants. In other words, there is certainty of payment and the receiving bank can credit the beneficiary’s account immediately and allow full use of the funds.
Before RTGS, electronic payments were settled on a net basis at the Reserve Bank, typically at the end of the day. There was therefore a risk that a bank might not be able to settle on their obligations made during the day. This introduced risks into otherwise financially sound banks that may have made commitments themselves or allowed substantial amounts to be paid away in anticipation of receiving funds from another institution. To reduce such risks, banks typically established rules for value and availability of funds that usually allowed clients only to use funds after the payment had been settled. Because the timing of settlement is late in the day, this effectively meant availability was given after the close of business or the next business day. From a corporate cash management perspective, this is not ideal.
An Indian RTGS means bankers, corporates and individuals alike will benefit from more efficient, faster processing of high value payments. But how fast will the take-up be? What will happen with cheques clearing volumes and values over time? And how will this impact bank revenues? To answer these questions, one needs to understand the drivers that might influence a switch from paper to electronic as well as other developments underway in the payments environment.
The first factor influencing take-up is that banks will charge for RTGS payments, in part to recover the considerable investment made in enabling and supporting the platform and also to recover the on-going charges that will be levied by the Reserve Bank for participating in the platform. However, corporate users must weigh the benefits of adopting an electronic payment method against these charges. These benefits are:
These benefits and costs can be discussed from the perspective of both the remitter and the recipient and then we will discuss the implications for bank revenue.
Float cost is defined as the (principal amount x cost of funds x no of days) ÷ 365. Float in respect of a cheque can arise due to: a) the mailcourier time taken between dispatch and receipt by the beneficiary; b) time beneficiary takes in depositing the cheque at their bank; and c) the cheque clearing time for good value to be received on the beneficiaries’ account. Because of the vast geography in India, such float costs can be high. For example, if a corporate with annual sales of INR100 million, makes all payments by cheque – when cost of funds is 10% and the average cheque float days is 10 days – the annual cost to the company is INR273,972 or 0.27% of sales.
If we ignore the bargaining power between payer and beneficiary for the time being, the payer would appear to have some financial advantage in paying by cheque rather than electronic. Firstly, he is probably not incurring any charges for issuing a cheque. (I have always found it counter-intuitive that banks in this part of the world don’t charge for cheques when there is such a high cost involved in processing such items, not to mention the increased risk of fraud versus electronic payments). Secondly, the float cost is actually in the remitter’s favour. That is to say, the remitter may get the use of funds for an additional ten days and if his cash forecasting model is effective he can make use of these funds, even if it is only to the extent of reducing his overdraft and borrowing cost.
But if the remitting company were to solely concentrate on the float cost and ignore the other benefits associated with electronic payments, it may miss the bigger picture and the ‘Holy Grail’ which leads to the next benefit.
A more timely and transparent payment mode can certainly improve supplier relationships and this should also result in improvements in overall working capital management. As counterparties are now able to respond faster to a payment credit, expectations rise goods will be shipped faster, thus facilitating the trend to just-in-time deliveries and thus reduction in overall working capital cost. These savings will be considerably greater than the float costs mentioned above. Indeed, if companies were to adopt electronic mechanisms for both payments and receipts, the float considerations would largely cancel each other out and one could concentrate on improving the working capital cycle.
Reduction in Overall Payment Processing and Tracking Costs and Ability to Reconcile Receivables Automatically
Tracking paper remittances – from issuance of a cheque, to dispatch and clearance – is far more costly for both the remitter and the beneficiary than for electronic payments as audit trails are readily available, especially if the transaction is delivered and reported electronically. Electronic payments should also enable straight-through processing and if initiated with a sufficient amount of remittance detail (and such details are passed through the payment chain), this should lead to corporates being able to auto reconcile their accounts receivables, thereby reducing administration expense and improving cashflow forecasting ability. However, discipline is required to enable STP auto reconciliation. Perhaps the best way to explain this is to illustrate how reconciliation typically happens in today’s environment.
If payment is made by cheque, the instrument is usually accompanied by instructions or invoice level details in respect of the application of those funds. The beneficiary is therefore knowledgeable as to the ‘Who’ and the ‘What’ in respect of the payment. Reconciliation still needs to be made manually and this is both time consuming and costly causing some organizations to outsource this to their banks. Now if the payment is to be made by electronic means, the various parties involved in the payment transaction must allow for sufficient and correct information to flow through to the beneficiary for reconciliation. Unfortunately, electronic payment platforms, including India’s RTGS, restrict the amount of information that can pass through the system; to exacerbate the problem further the banks’ own operating platforms can have similar restrictions. Thus the beneficiary could get a credit to his account with little knowledge as to the ‘Who’ and the ‘What’. Clearly what is needed is a process and commitment to pass sufficient data through the payment chain to allow for auto reconciliation. Since there is a limitation on the data that can pass through the payment chain, there needs to be a link between payment and remittance advice by some form of Unique Reference Identifier (or URI) which is of sufficient length to enable unique recognition as well as short enough to pass through the entire payment chain. This URI must enable reconciliaton back to a Full Remittance Advice that can pass outside the payment payment process. The full remittance details can pass by paper or electronic means between the Buyer and Supplier. Indeed it can be outsourced to a 3rd Party, even a Bank.
If banks and corporates don’t recognize and address this problem, reconciliation will be a barrier to adoption of electronic payments:
If we are to make electronic payments successful in India and also enable straight-through processing and reconciliation of accounts receivable, guidelines need to be established and adhered to. To this end, the world’s leading cash management banks, including Standard Chartered, have formed a working committee, along with SWIFT, to work with and respond to the pleas of corporate-led groups (i.e. TWIST and RosettaNet) to usher in common standards. These standards will address both domestic as well as international payments. In due course “The STP Corporate Payment Automation Guide” will be published on the SWIFT Website and can also be made available through cash management banks.
Clearly hard work is required to make the Indian RTGS systemachieve its full potential and the RBI, end-users and banks will all have an important role to play. But let’s understand that bank charges may limit widespread adoption to the higher value and time critical payments associated perhaps with Securities, Foreign Exchange, Funding etc. Therefore, there is still a need to fully develop an alternative lower cost electronic payment platform where payments are cleared, perhaps, in batches and settled on D+1. Such platforms are used typically for direct credit and debits, normally associated with C2B or B2C payments, but we now see these platforms increasingly be used for B2B payments and are rapidly replacing the cheque. Costs are fundamentally lower than for RTGS because there are not the same liquidity issues associated with an RTGS platform and settlement is made on a net basis. Notwithstanding the potential one- or even two-day delay in settlement, there are all the benefits associated with timely and transparent payments discussed above.
What is the bank’s view on this market development? Are they ‘for’ or ‘against’ and will they be rewarded for encouraging electronic payments or lose out because of loss of float revenues? There is a healthy debate surrounding these questions, to which we would like to add our views.
We believe that banks should collectively feel positive toward the adoption of electronic payment systems. There are a number of reasons:
Admittedly, banks in India today derive a reasonable income stream from discounting cheques in the process of being collected. But there are other ways to provide Working Capital financing such as overdraft or invoice or even purchase order discounting/financing. Indeed for both RosettaNet and TWIST, payments STP is the low hanging fruit; next they would like to establish B2B Message standards for STP working capital financing, all of which will link back into the electronics payment platform for settlement.
One development that would certainly encourage the rapid development of electronic payments at the expense of paper cheques is the levy of a bank charge for paper transactions. Charges for paper processing should be higher than for an ACH payment initiated electronically by the client. Some countries have tried this, notably the Scandinavians, and have succeeded dramatically.