Cash Management in India
India strides further into the new millennium riding on a wave of
optimism. A decade of reforms has propelled the economy onto a new growth trajectory. Today India is a mature and stable economy. There is now healthy competition among different Indian states to attract foreign investments, and India has joined the league of the fastest growing economies in the world, being next only to China and Korea.
The resurgence of the Indian economy has been sustained in the face of difficult international developments. Even as global growth has declined, India’s gross domestic product (GDP) growth has accelerated in 2002 and is looking set to reach 6% in the current 2003 fiscal year. Despite the worst drought in two decades in 2002, inflation rates have declined further and interest rates have softened. The momentum of the record inflow of foreign direct investment (FDI) has continued and foreign exchange reserves are at all-time highs.
India is a parliamentary democracy with the Union Government functioning out of New Delhi and 29 state governments from their respective states. The executive power is held by the President, who is appointed by the Prime Minister, and the council of ministers. The National Democratic Alliance, a coalition of 22 regional political parties, now comprises the Union Government. The current Union Government is stable and is expected to complete its term of five years. The next general elections, which will elect the new Union Government, are scheduled to be held in September 2004.
The Indian economy is a market-driven economy. Due to the efforts taken by the Securities and Exchange Board of India (SEBI), the equity markets are mature, regulated and offer a wide range of equity- and debt-linked products. India has a well-established legal system with an independent judiciary. Indian corporates have had increased access to global capital markets. This has driven conformity with international accounting standards, greater transparency and a focus on corporate governance. The government has accelerated the disinvestment process, demonstrating its commitment to the economy.
The government policy on FDI has been significantly liberalised. In June 2002, the government gave its assent to 26% FDI in print media. The government has increased the FDI cap on private sector banks to 74% from 49%, and in the advertising sector to 100%. Overseas investors making long-term investments in the country can now hedge their foreign exchange exposures, pending investments, by entering into forward contracts with banks.
The government has made the following concessions for FDI in India:
The above concessions are expected to have a substantial influence on the flow of FDI into India as the easing of controls and the incentives provide a favourable environment for foreign investment in India.
The banking structure in India is complex and spread over a wide geographical area. There are about 65,000 bank branches, and the central bank is the Reserve Bank of India (RBI). The composition of banks in India is:
The Central Board of Direct Taxes (CBDT) is the governing body for direct taxes in India. Similarly, the Central Board for Customs and Excise (CBEC) is the main governing body for indirect taxes. India has in place double taxation avoidance treaties with 78 countries. Taxation rates for companies for the financial year 2003-04 are:
GDP and Trade Issues
India’s GDP has been relatively stable compared to other Asian countries. The rise of transparent, global and shareholder-driven corporates has created a new paradigm of growth. The average GDP growth rate for the past five years has been about 6%. This rate has been maintained due to good growth in the services sector, which has been growing at rates of about 6%. As a result, the GDP share of the service sector has increased to 56%. This phenomenal growth has been achieved due to improved performance by hotels, transport, financing, and real estate.
India’s trade scenario looks very favourable with the government’s trade reform measures, commitment to the World Trade Organization, and increasing share of the services sector in the GDP. Indian reforms are focusing towards liberalising foreign exchange (FX) management and making the Indian economy market oriented.
A notable recent move by the government was the enactment of the Securitisation, Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002. The act defines financial terms in relation to securitisation and acquisition of assets by financial institutions in lieu of debts provided by them. This act will help reduce the non-performing assets of financial institutions.
The average inflation rate for the past five years has been 7.3%. Inflation in India has a direct relationship with the monsoons. A normal monsoon eases agricultural prices of food grains and fibres, leading to a further decline in the inflation rate. Inflation is expected to remain under control.
2003 has seen a steady fall in interest rates, and call money market rates have softened significantly. The overnight call rate is expected to stay with the bank rate. The RBI’s move in the 2003-04 Annual Monetary and Credit Policy of reducing the bank rate – the rate at which it refinances banks – to 6%, the lowest in 32 years, will take the total reduction in the past five years to 5%.
India has traditionally had a paper-based clearing system. As of 2002, India has about 1,047 clearing houses and 65,000 bank branches. The total value of cheques processed through these centres surpassed INR121,000bn in the year 2001-02. The paper-based clearing system poses such inherent issues as a high cost of processing, fragility of the system and security risks. For these reasons, the RBI has been emphasising the need for upgrading the technological infrastructure in India. Following are some of the initiatives in progress.
In some countries, cheques deposited in banks are scanned and stored with the bank. Instead of sending physical cheques to the clearing house, the scanned copy of the cheques are transmitted. This level of cheque-imaging reduces clearing cycles, enables faster returns-processing, better customer service and availability of images for audit trails.
In India, 15 clearing houses now have cheque-imaging. However, the images are now stored only for reconciliation and resolving clearing house differences. The legal framework is undergoing changes to adopt cheque-imaging. The Negotiable Instruments Act was amended in 2002, and has extended the definition of a cheque to include electronic cheques and the electronic images of truncated cheques. The act now also defines the material alteration of an electronic image of a truncated cheque. Availability of adequate technical infrastructure at clearing houses and banks is a prerequisite for expanding the network and exploiting the full benefits of cheque-imaging.
Real-time gross settlement (RTGS) is a payment mechanism that eliminates settlement risk by settling payments in real time. This is in contrast to the existing net settlement systems, where interbank settlement takes place at the end of the batch. The RBI is implementing a national RTGS system that will allow all banks in India to make secure interbank payments across the country. The RTGS work flow will involve transaction queuing and processing on a first-in, first-out basis. RTGS will provide significant benefits to individuals and businesses by allowing instant transfer of funds between banks, thus expediting electronic payments.
Organisations are migrating from their existing accounting procedures to enterprise resource planning (ERP) systems. This has fuelled the need to integrate the banks’ cash management systems with corporates’ ERP packages, and key cash management providers now offer complete integration of cash management solutions with ERP systems. Such integration offers the following benefits:
Straight-through processing (STP) has historically been regarded as an area focused on by banks for streamlining their processes. Corporates now appreciate the role of STP as an integral part of their internal accounting work flows. Manual practices involve costly multiple data re-entry from paper documents and other sources that are susceptible to errors, discrepancies, delays and possible fraud. STP enables orders to be processed, confirmed, cleared and settled in a shorter time period, more cost-effectively and with fewer errors.
The government has supported the growth of e-commerce in India by enacting the Information Technology Act, 2000. There are more people connected to the Internet in India today (about 13 million users as of March 2003) than in the past owing to improving personal computer penetration, availability of bandwidth, and power. However, despite the growing Internet population, India is still witnessing modest e-commerce activity. E-commerce activity during 2002 was estimated to be in the region of about USD300m, almost half that of China. Business-to-business e-commerce implementation was low except in certain verticals such as the automobile sector, and banking and finance.
With recent technological advancements, the implementation of Internet banking and electronic banking has increased greatly. The private sector and foreign banks in India are at the forefront in offering online banking services on the Internet. This service is in addition to existing offsite delivery channels such as automated teller machines, electronic banking and mobile banking. Reports for collections products are being offered on the Internet by select banks. Customers can now view the clearing status of their cheques and cheque images over the Internet.
Going forward, the utilisation of electronic banking will further increase as technological advances and enabling legislation make the process more secure.
Information Technology Act, 2000
Businesses and consumers are increasingly using computers to create, transmit and store information in electronic format instead of traditional paper documents. Since e-commerce eliminates paper-based transactions, the need for legal changes became a necessity. The Indian parliament gave its assent to the Information Technology Act on 9 June 2000. The act deals with defining the common terminology used in respect of computers, giving legal recognition to electronic records and digital signatures. The act further defines when digital signatures or electronic records can be termed secure for transmission over the Internet.
The government has also framed the Information Technology (Certifying Authority) Regulations, 2001. This regulation primarily controls the activities of certifying authorities (authorised to grant licences to issue digital signatures). India now has four certifying authorities: Safescrypt, the National Information Centre, Institute for Development and the Research in Banking Technology (IDRBT) and Tata Consultancy Services.
Recognising the need for upgrading the country’s financial infrastructure in respect of the clearing and settlement of debt instruments and FX transactions, the RBI initiated the move to set up the Clearing Corporation of India Limited (CCIL). The primary objective of setting up the CCIL has been to establish a safe institutional structure for the clearing and settlement of trades in FX, money, and debt markets so as to bring efficiency into the transaction settlement process, and insulate the financial system from shocks emanating from operations-related issues. The CCIL was incorporated in 2001, and commenced operations from 15 February 2002.
The Centralised Funds Management Service (CFMS), introduced by the RBI, enables commercial banks to obtain the funds position of their accounts with the RBI’s Deposits Accounts Department (DAD) at 17 locations in India. Phase I (enquiry mode) of the CFMS now has been implemented. Going forward, banks will not only be able to enquire about their funds balance in DAD accounts, but also transfer funds across their DAD accounts in different cities. CFMS allows banks to reduce their cost of funds by better management of fund flows.
The Structured Financial Messaging Solution (SFMS) is the communication protocol introduced by the RBI for intra-bank and interbank messages within India. It incorporates templates and fixed message formats for affecting STP among member banks. SFMS is broadly similar to SWIFT message formats. These message formats will be used for RTGS and other interbank communication. SFMS protocols will facilitate STP in the Indian banking industry for domestic payments and transactions, reducing transaction costs for customers.
In India, cash management has predominantly been associated with collections products. Subsequently, cash management providers have diversified their product portfolio to include payments, account services and delivery management. This enables corporate treasurers to concentrate on their core functions and outsource non-core activities to banks. Banks are increasingly shifting towards enabling their cash management operations to use more STP.
The RBI introduced the electronic funds transfer (EFT) system in 2001. EFT allows the electronic transfer of funds across 14 locations and 13,000 bank branches in India. It eliminates the burden of writing cheques and allows the transfer of funds within 24 hours anywhere within its current coverage. The system eliminates virtually all incidences of fraud and forgery that are typically involved with paper-based instruments. Current RBI guidelines for EFT stipulate that all banks have to participate in inward EFT (credit to customers’ accounts for EFT payments), but participation in outward EFT (sending payments on behalf of customers) is optional.
In April 2003, the RBI introduced the special electronic funds transfer (SEFT) system, which is the enhanced version of EFT. SEFT now covers 97 cities, 24 banks, and 2,500 bank branches across India. The coverage of SEFT is much larger than that offered by EFT. SEFT gives banks the option to select branches where they can offer SEFT. All branches that participate in SEFT need to be networked with the service branch in Mumbai, which will act as the one point of contact with the RBI for SEFT. Since all banks’ branches participating in SEFT are networked, timely credits will be available to beneficiaries (unlike for EFT, wherein there is a possibility of delayed credit if the beneficiary’s bank is not networked).
Cheques and drafts remain a popular payment method in India but involve time-consuming and laborious manual processes. Payments outsourcing to banks allows corporates to focus on their core competencies, reduce overhead costs, and benefit from speed, accuracy, and enhanced security and fraud control.
Cash management providers in India have started offering electronic invoice presentment and payment (EIPP). EIPP offers the facility of presenting the invoice by suppliers to their clients over the Internet. The product also provides the facility to the client to view, dispute, and pay the invoice electronically through payment gateways.
The continuous linked settlement (CLS) service offered by the CLS Bank provides a global infrastructure for multi-currency payment clearing and settlement services. It is a real-time, cross-border settlement system that eliminates settlement risk caused by delays arising from time-zone differences by the simultaneous settling of FX payment instructions. CLS enables banks to expand their FX business with CLS-participating counterparty banks by making it possible to increase limits due to reductions in settlement risk. Moreover, it delivers the benefits of STP.
Large foreign banks that are settlement banks for CLS have been marketing the service to major Indian banks with cross-border flows. However, CLS has yet to gain momentum in India.
The overall cash management scenario is changing with technological advances and evolving customer needs. STP, facilitated by the integration of banks’ cash management solutions with corporates’ ERP systems, is gaining importance. Electronic banking access on the Internet with account viewing and transaction-initiation capabilities is increasingly critical for technology-savvy customers. The emerging technologies and the payment systems will significantly impact the corporate treasurers’ agenda. New strategies for effective cash management will soon emerge in the Indian market.
In view of the geographic diversity of India, key cash management providers are strengthening their correspondent banking relationships to reduce transaction costs, enhance location coverage and improve service quality. The new payment systems also pose significant challenges for cash management service providers and will require banks to make a shift in terms of earnings (from float to fees) as well as service offerings. Lastly, as a good cash management bank, it will be imperative for a bank to enter into partnerships with customers, listen carefully to their suggestions and provide end-to-end solutions.