This article deals with ‘Digital Banking / Cashless Economy.’ This is part of our series on ‘Economics’ which is an important pillar of the GS-3 syllabus. For more articles, you can click here.
Indian Case: More Cash in Circulation
India uses too much cash for transactions. The ratio of Cash to GDP in India is one of the highest in the world
- India = 12.4% (2014)
- Whereas in China = 9.4% or Brazil = 4%
Pros and Cons of Cashless Economy
Pros of Cashless Economy
- It will be challenging to evade taxes as all transactions can be tracked in a cashless economy. Money laundering, black money and terrorist financing can be easily controlled.
- No fear of physical theft: In Sweden, where 50% of transactions have gone, cashless robberies have fallen to 30 years because people don’t have any cash.
- Cash transactions in small denominations can happen easily. One can pay even a single paisa (or cent).
- No issue of counterfeit currency and wearing and tearing of currency notes.
- The Cashless Currency is working fine in Sweden & Norway, where 50% of transactions have gone cashless.
- Ratan Watal Committee (in December 2016) quoted that the dependency on cash costs the country about ₹1 Lakh crore on account of the cost of printing new currency, operating currency chests, maintaining supply to ATM networks etc.
- If small vendors start to take payment via digital means in Bank Accounts, their credit history will develop, and they can use this to get credit from institutional lenders.
Cons of Cashless Economy
- Extreme surveillance: Every payment is traceable. The power this hand over to banks & governments is enormous, and the potential scope for Orwellian levels of surveillance is terrifying.
- It can lead to the exclusion of segments of the population who are slow to embrace new technologies, especially the elderly.
- The problem of electronic frauds increases, and the whole system can be hacked.
- Cashlessness may produce a peculiar human problem as people are sentimental about coins and notes.
- For payment to happen cashlessly, infrastructure is required at point of sale destinations that small businesses can’t afford.
- Ultimately, digital payment costs are borne by consumers even when they are charged from producers or vendors. Charges can range from 0.1 per cent to as much as 4 per cent of the value of the transaction.
International Case Study: mPesa
In Kenya, M-PESA in partnership with Vodafone’s local operator Safaricom has ushered Cashless Revolution.
Problems in the adoption of Digital Payment in India
As seen by Chandrababu Naidu Committee & Ratan Watal Committee, problems associated with Digital Payment in India are
1 . Lesser Points of Sale
- India has 160 ATMs per million (UK = 1000 / million)
- India has 1000 Point of Sale (PoS) per million (UK = 30,000 / million)
2. MDR Issue
- MDR = Merchant Discount Rate
- Banks charge around 2% from Merchant for providing Cashless Payment Services. Due to this, the profit margin of merchants decrease. It restricts the the adoption of digital payment by Merchants.
3. KYC norms for Point of Sale Devices
- Vendors cant buy Point of Sale devices as they don’t have any permanent address.
- There is no interoperability between different payment systems (Eg: PayTM to FreeCharge) and between different Financial Institutions (Eg: SBI to PayTM).
5. Regulatory Problems
- The Banking Ombudsman doesn’t have the required powers to deal with Internet Banking Frauds.
- IT Act is not comprehensive enough to deal with such financial frauds.
6. Government doesn’t act as Role Model
- Although the government is promoting a Cashless economy, one cant pay taxes via mobile wallets like PayTM and bidding fees for various e-Tenders are to be paid in cash (only). Hence, the government doesn’t act as a role model.
7. Low Digital Financial Literacy
- People aren’t aware enough to handle a cashless system of payment.
8. Behavioural Issue
- Changing behaviour to use Cashless transactions is a complex process.
- Interoperability is the ability of customers to transact across commercially and technically independent payment platforms.
- Due to legal complications under the payment & settlement system act 2007, users don’t have full interoperability i.e.
- Users can’t transfer money from one wallet to another (can’t transfer money from Paytm to Phonepe).
- Users can’t use wallets to pay all types of taxes, fees, insurance premiums etc.
- It acts as an obstacle to the ‘cashless economy’.
In 2018, RBI issued guidelines for interoperability with the Know Your Customer check, customer grievances redressal mechanism etc., so that transactions can be made between different platforms.
Issue Analysis: Regulation over Payment Settlement
- 1998: Banking Reforms / Narsimham-II Committee suggested a regulatory framework for e-banking, card payment etc.
- 2007: Payment & Settlement Systems Act enacted according to Narsimham II under which RBI supervises e-banking, card payment, and other digital money-related issues through Board for Regulation and Supervision of Payment & Settlement Systems (BPSS).
- All Payment system providers have to register with RBI’s BPSS – whether a bank, non-bank, wallet-PPI etc.
- 2016: Ratan Watal Committee on digital payment suggested replacing BPSS with a Payments Regulatory Board (PRB) in RBI to regulate Interoperability, Consumer protection, Innovation, R&D in digital payments (as BPSS looks after only Payment and Settlement).
- 2018: RBI opposed the formation of the Payments Regulatory Board due to differences with the government over the issue of who should be Chairman, how many members should be from the Government side etc.
RBI made Ombudsman Scheme for Digital Transactions (OSDT) in 2019 with the following functions
- To look into matters of Digital Payment like Consumer Protection.
- The consumer can make a free complaint about matters up to Rs 20 lakh against Mobile Wallets, Payment Payment Instruments (PPI) and other digital transactions.
- It can charge a penalty of up to Rs 1 lakh to the victim for his mental agony, loss of time etc.
Issue Analysis: Merchant Discount Rate
- MDR is a merchant’s fee to pay to a bank for every credit/debit card transaction.
- MDR hurts merchants’ profit margin and discourages them from adopting Point of Sale terminals, a digital payment system.
- 2017-18: RBI put ceilings on MDR fees to encourage the digital economy.
- WEF 1/1/18: The Government of India started 100 % MDR-subsidy on payments made via Debit card, BHIM or Aadhar enabled payment system for bills up to Rs.2,000. The scheme was valid for 2 years. It will encourage digital payments ecosystem.
- Budget 2019: No MDR will be charged from a firm whose annual turnover is less than Rs 50 crore. RBI and Bank will absorb this burden for not handling so much money.
Developments Related to Cashless/Less Cash Economy
1. Suggestion of various committees to promote the Cashless Economy
1.1 Ratan Watal Committee
- Formed in December 2016.
- To suggest Medium Term Recommendations to strengthen the digital payment ecosystem in India.
Recommendations of Ratan Watal Committee
- Separate Regulator for Digital Payments under RBI known as Payments Regulatory Board.
- The committee envisaged a prominent role for Aadhaar as the primary identification for (KYC) purposes.
- Government departments should levy a cash-handling charge to discourage cash transactions.
- Give incentives like discounts to consumers to make cashless payments.
- It had also suggested interoperability between banks and non-bank digital payment gateways.
- Rewards for government departments, state governments, districts, and Panchayats to promote digital payments.
- Create a fund proposed as DIPAYAN from savings generated from cash-less transactions to expand digital payments.
- Reduce or eliminate import duty on import of ATMs & Point of Sale machines.
1.2 Chandra Babu Naidu Committee
- Formed in Nov 2016 & submitted a report in Jan 2017
- Name of Committee: Chief Minister’s Committee to promote Digital Payment in India by NITI Aayog.
- Tax incentives should be given for domestic production of Point of Sale machines & ATMs.
- Banks should charge 0% MDR from Government Bodies like Railways, Electricity etc.
- Develop a Common QR based payment system for Vendors (led to the formation of BHARAT QR).
1.3 Nandan Nilekani Committee
- In Jan 2019, RBI appointed Nandan Nilekani Committee for suggesting ‘how to deepen the digital payments’.
- Its main recommendations were
- Government should extend the MDR subsidy for two more years.
- Give tax incentives to companies using digital payments.
- Reduce the taxes on devices required for digital payments.
- Raise awareness about BHIM-UPI.
- Setup Computer Emergency Response Team for Finance (CERT-Fin).
- Prepare area-wise ‘Digital Financial Inclusion Index’ to monitor progress.
2. Schemes to promote Cashless System
2.1 Rupay Card
- RuPay is the Payment Gateway started by the National Payment Corporation of India (NPCI).
- It will help in financial inclusion indirectly by decreasing the operating cost of Banks to service their customers using debit & credit cards.
How Payment Gateway system work?
Case 1: If there is no payment gateway
- Each bank has to tie up with merchants separately.
- It leads to duplication of effort.
Case 2: In presence of payment gateways
- Each bank can tie up with a payment gateway & the payment gateway will tie-up with the merchant.
Banks are paying ₹300 cr per year to payment gateways (Banks charge them from Merchants as Merchant Discount Rate (MDR) per transaction)
What Rupay will do?
- Rupay will do the same work at 40% lower rates. Hence, the user will have to pay lower Credit/ Debit card charges, and Merchants will have to pay lower Merchant Discount Rates to the banks.
- Rupay is the 7th payment gateway in the world.
- 3 channel payments can be made using this: ATM, PoS(point of sale) and Online.
- They can tie up with any organization: prepaid cards by milk/ grain procurement agencies in Punjab.
- Under Jan Dhan Scheme, Rupay Debit Card is given to the customers.
- FASTags are prepaid rechargeable tags for automatic toll collection at toll collection booths using RFID technology.
- It helps in faster mobility by solving the issue of Jams at toll booths. It is also an issue in the direction of a cashless economy.
- From 15th January 2020, it shall be mandatory for all vehicles passing through tolls to have FASTags.
2.3 Payment Infrastructure Development Scheme (PIDF)
- PIDF aims to strengthen digital payment infrastructure across Tier-3 to Tier-6 cities, focusing on the North-Eastern States.
- PIDF will subsidize banks and NBFCs for deploying digital payment systems like Point of Sale (PoS) terminals, a QR-based payment system, etc. The target is to create 30 lakh new touchpoints every year.
- The scheme will be operational for 3 years, starting from 1st January 2021.
2.4 NEFT System
- Using a bank, a person can settle the amount with another person even if they have a bank account in another bank. The NEFT (National Electronic Funds Transfer) system is used in the backend to settle these payments.
- NEFT settles the net amount between banks at the interval of 30 minutes. After 30 minutes, it will check the lakhs of transactions made between particular two banks throughout the country and settle the remaining amount between two banks.
- RBI operates this system.
- Using this system, transactions of up to ₹10 lakhs can be made.
- According to the 2021 update, even Prepaid Payment Instruments such as AmazonPay, Mobikwick etc. can also use the NEFT system.
2.5 White Label ATMs
- White Label ATMs are operated by private non-banking companies that own & operate their brand of ATMs.
- All the other Bank ATMs can use these White Label ATMs & get service but at a nominal charge.
- It is a step towards financial inclusion. ATM penetration will increase because of this (present = 160/1million compared to US= 1400/1Million)
- E.g., Tata’s Indicash, Muthoot Finance, Srei Infra, Vakrangee Software, Prizm Payments etc.
2.6 Schemes by NPCI
NPCI is a not for profit company made by 10 promoter banks in 2008 to provide cost-effective payment solutions for banks
NPCI is running various initiatives related to high-end technology in Banking & Payment Systems.
Initiatives of NPCI
- UPI = Unified Payment Interface
- It was started in 2016.
- It is a technology for building digital payment apps (i.e. UPI is not an app but technology made by NPCI, which banks use to make their apps).
- 123Pay has been launched for using UPI on basic phones.
- Features provided by UPI
- Scan QR Code and pay directly to merchant’s account.
- Link your bank account to directly transfer money from your bank account without storing it in an e-wallet first (unlike PayTM).
- The facility of ‘push transaction’ (e.g. Sending Remittances to family).
- The facility of ‘pull transaction’ (e.g. Cable operator sending a request for the monthly bill within the app).
- The facility of Bill sharing.
- Examples of UPI based apps: SBI Pay, AxisPay and NPCi’s own BHIM.
2. UPI 2.0
The upgraded version of UPI was launched in Oct 2018 with the following additional features:
- Overdraft facility
- Cash on Delivery
- User mandate for a future date, e.g. DTH
- Invoice in the inbox.
- BHIM = Bharat Interface for Money
- It is an app for iOS & Android-based on UPI (in simple terms, it is an app in which UPI technology).
- BHIM has been developed by NPCI
- No need to install multiple apps for each bank account (SBI Pay, AxisPay etc.). The single BHIM app can be used for using all bank accounts.
- App has a 3-factor authentication system.
- Your money stays in a bank account. It is not stored in an e-wallet outside a bank like PayTM. Hence, a person can earn interest on his money.
- No cards involved. Hence, no MDR or such hidden charges need to be paid.
4. Bharat QR Code
- It was started in Feb 2017
- Bharat QR code has been developed jointly by the National Payments Corporation of India (NPCI), Visa, MasterCard and American Express under instructions from the Reserve Bank of India (RBI).
- Note – QR is a two-dimensional machine-readable matrix. QR Code can store up to 7089 digits compared to conventional bar codes that can store a max of 20 digits.
- It eliminates the need of using card swiping machines for digital payments. There is no need to have ‘Swiping Machines’ in shops. Just have QR printed & payments can be easily done via that.
- Interoperability: Using the BharatQR code, the merchants will be required to display only one QR code instead of multiple ones.
- For the buyer, there is no need to carry a card. Payment can be made via mobile.
5. Aadhar Enabled Payment System (AePS)
The customer has to tell the Aadhar number and name to the merchant or Bank Business Correspond, who authenticate it using the customer’s fingerprint. Following this simple step, his transaction is completed.
6. Cheque Truncation System (CTS)
- If somebody from Delhi gives a Cheque from the Delhi Bank Branch to a person in say Chandigarh. Earlier, that cheque was physically sent to Delhi Branch for settlement.
- Under CTS, a Scanned image of the cheque can be sent to Delhi Branch, and settlement can be done rapidly.
7. National Financial Switch
- ATM Card of one Bank can be used in another Bank too. The system that is working in the backend to make this possible is NFS.
- NFS helps re-route transactions to the Core Banking Solution Network of the Bank whose ATM card is being used.
8. NACH (National Automated Clearing House)
- NACH help in Automated Payments, which are to be paid periodically like each month or year like salaries, bills, EMI etc.
- NACH is finding great attraction among customers, companies and government departments to pay bills, EMIs, salaries, pensions etc.
- IMPS = Immediate Payment Settlement System
- It is available 24X7.
- It is used for real-time settlement of all online payments up to Rs. 5 lakh.
- It is not free. A service fee is charged on the transactions.
- e-RUPI is a QR based purpose-specific digital voucher where it is not required for the customer to have a bank account and is operable on basic phones, even in areas that lack an internet connection.
11. Offline Retail Payments using Card and Mobile Devices
- RBI has allowed offline payment using the card and mobile devices to deal with the issue of internet connectivity.
- The maximum transaction allowed under the scheme
- Rs. 200 per transaction
- Subject to an overall limit of Rs 2000 (after that person will have to go online to settle the transactions)
Side Topic: ATM security features introduced to prevent frauds
1. ATM Card Technology changed to EMV Technology
- Magnetic Technology used in the ATMs has been used since the 1960s.
- In this, data is stored on the magnetic strip. But it is insecure as the data can be duplicated, cloned, skimmed while swiping the card, which increases the chances of fraud.
- So, RBI stopped such cards from 1/1/2019 using the Payment & Settlement Act powers.
- Full form: Europay + Mastercard+ Visa
- It is based on chip infrastructure with encryption.
- RBI had ordered migration in 2013. It has become operational on 1/1/2019.
- Two sub-types
- EMV-Contact: cards must remain in the Point of Sale (PoS) Terminal during the transaction.
- EMV-contactless cards: Tap the card on the terminal using RFID technology.
2. Card Tokenisation
- When we shop on sites like Amazon, Flipkart etc. or pay bills using PayTM, they allow us to store our Debit or Credit Card information like Card Number, Expiry date etc., for future convenience. But this thing has security implications in case the server of such a company is hacked, and user information is leaked.
- To prevent such incidents, Card Tokenization was introduced by RBI in Jan 2019
- Tokenization = Token number is generated for a given credit/debit card.
- Card customer gives the token number during any type of online/physical shop transaction. His original card number, expiry date, etc., remains hidden from the third party seller.