RBI vision document on payments: An evaluation

by Madhavi Pundit and Suyash Rai.

On June 27, RBI published its Payment System Vision Document (2012-15). The document shows RBI's vision and mission for the payment system, and specifies the objectives, approaches and courses of action emanating from the same. It is a laudable step taken by RBI to discuss its plans for payments in India. All regulatory activities, such as banking and capital account liberalisation should have vision documents to similarly show the road map. They bring clarity to market participants, and helps everyone plan better.

A vision document is an opportunity to think from first principles, and to dream about the payments landscape. The document does not do this sufficiently.

Going by the ideas of the vision document, it is difficult to hold RBI accountable to it or to evaluate its role as a regulator, because it is not clear what we should expect the payment system to achieve, say, five years from now. Though the vision itself may be a general, aspirational statement, it should be accompanied by quantifiable goals that can be achieved by Indian payments system (regulator + industry). For example, the regulator can set objectives that by 2015, cash will be x% of transactions, or that cheques will be phased out by 2020. RBI can then, as a regulator, take steps to facilitate the achievement of such goals, with the expectation that other participants will play their part. Such sharp statements are absent in the document.

Once a suitably ambitious, but quantifiable, vision for payments has been stated, achieving it requires looking beyond incremental modifications. This brings us to the kind of steps RBI has proposed in the document; the things that it will do to achieve the vision over the next three years. For a vision document, the proposed steps are rather tactical and operational. From this document, it seems RBI is running all payment systems, with incidental cooperation from the private sector. It is difficult to imagine how industry participants should work towards the vision. For an example of how this can be done, contrast the RBI document with the Strategic Review of Innovation in the Payments System, recently released by the Reserve Bank of Australia. Unlike RBI's document, the focus of this document is purely strategic, and on removing barriers that prevent market participants from innovating.

The document should clearly state what RBI sees as its role in payment systems - which is above all, that of a regulator - and what it sees as the role of market participants. While the document focuses on the development of certain types of electronic payment systems, certain standards, authorisation methods etc., there are a host of other ways the market could innovate. The document's approach precludes other means by which the same goal of higher electronic payments can be achieved.

All regulation must be rooted in market failures that damage the interests of consumers or threaten systemic crises. A specific regulation must address a specific market failure and thus tangibly further consumer protection or systemic stability:

1. In payment systems, consumer protection would entail measures that ensure transparency and disclosure by payment providers, so that consumers receive what they are promised.
2. In addition, providers must be subjected to micro-prudential regulations, such as capital requirements, risk management and investment restrictions that ensure their safety and soundness, based on the risks they take. The risk based approach means that small value systems with real-time payments need less regulation than large value systems that hold clients' funds for a certain amount of time.
3. For systemic stability, enhanced regulation and supervision of systemically important payment systems, especially back-end infrastructure, such as RTGS, is required.

RBI ought to focus on these regulatory objectives, where it would deliver public goods, rather than take on `private goods' functions that can be handled ably by the market. Systems such as NEFT and ECS, which essentially require capabilities that go beyond a regulator's core competence, can be run well by the private sector, under RBI's regulations. In such systems, competition is of essence.

From this perspective, the vision document starts looking less impressive. It is tied to the existing ways of doing things, and intent on incrementally improving them, rather than questioning the existing paradigm. This is unsatisfactory, for a paradigm shift is what India most requires.

Perhaps that is why there seems to be a lack of clarity of purpose. For example, RBI talks about investing in cheque systems and electronic systems at the same time. Developing a grid system to replace clearing houses as suggested is expensive. If the objective is to phase out cheques and promote electronic payments, the revamp of the cheque clearing system has no place in the vision document for electronic payments.

The emphasis on electronic payments is welcome. It is time for India to become a less-cash society, and ultimately a cash-less society. Myriad inexpensive, safe and useful electronic technologies are available, and more are being developed as we write. Hence the extensive use of cash and other paper-based instruments is not acceptable. They are expensive and inconvenient, and cost the most to those with the least - who pay for using these instruments and also face value erosion due to inflation. More needs to be done to move to electronic payments, and soon.

Competition and innovation are both important for this goal. The document talks about the dilemma the regulator faces with regard to pricing. To us, there is no such dilemma. To a large extent, the regulator should not intervene in business decisions such as pricing. In terms of market structure, there are two types of charges in payments - by retail payment providers and by infrastructure providers in the system. At the front end, innovative and cost effective payments products and gateways can develop if there is competition and there is no case for regulatory intervention here. It is a serious issue, and as experience from credit markets would suggest, a cap on pricing usually leads to more exclusion than inclusion.

Anti-competitive actions by players can be taken up to the Competition Commission. At the same time, it is important to note that in industries that are network based, there may be a need for monopolies or duopolies in infrastructure provision which require modification of the standard approaches of competition law (example).

Under these circumstances, if there is evidence of supernormal profits, there may be role for regulating prices. But even here, price determination should be done transparently, based on a full analysis of costs and reasonable returns, and in consultation with industry participants. For example, in the recent announcement of a cap on merchant discount rate on debit cards, there is no explanation from the regulator for how the amount 0.75 per cent was decided, and what are its costs and benefits to the system.

The role for non-banks is conspicuous by its absence in the vision statement. Currently, regulations tie the hands of non-bank payment providers. Take the example of Airtel money, which is a semi-closed mobile wallet. This means money can be transferred to other Airtel customers and transactions can take place with certain merchants, but there is no possibility for cashing out. Vodafone has partnered with a bank, and hence allows cash out from retail points; but these registered points have to be within 30 km of the bank partner.

A key insight that should guide the way forward is that payments is a separate business from banking, and should have its own regulation. Decoupling them could help achieve the twin goals of innovation and inclusion. An electronic payments revolution can take place when small value transactions are done electronically, i.e., customers in every nook and corner of the country can access secure, efficient and low cost retail payments services that can be considered cash substitutes. E-money in many countries has exploded on the backs of non-bank led payments systems such as telecom companies and retail chains, and their reach has been impressive. Easing restrictions on non-bank payments systems in India is required to really take advantage of their vast networks that have already penetrated unbanked areas. There are risks, but nothing that a forward thinking regulator who recognises the immense potential cannot creatively address. (See How to achieve safety in payments for an example.)

Finally, for large value electronic payments systems, RBI's vision should be to bring them up to world standards and integrated with global systems. Cross-border payments are an important facet of international trade and integration, and this can lead to settlement/ Herstatt risks. RBI should address operational and regulatory issues to minimise these risks. For example, RTGS should be brought as close as possible to a 24 by 7 settlement system to ensure overlaps with corresponding systems in other countries and time zones.

Additionally, in light of recent data that shows that the INR is the third most traded emerging market currency, these and other steps should be taken so that the INR becomes an eligible currency for settlement in the Continuous Linked Settlement (CLS) system, alongside the other international currencies already on CLS. In conclusion, it is commendable that RBI has released a payments vision document. Such a document gives an opportunity for us to understand the mind of a government agency, and discuss and debate its priorities and actions. But writing a vision statement is a chance to step away from the familiarity of set ways and ask the big questions. RBI should not squander this opportunity.