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Information technology is one of the most important facilitators for the transformation of the Indian banking industry in terms of its transactions processing as well as for various other internal systems and processes. The various technological platforms used by banks for the conduct of their day to day operations, their manner of reporting and the way in which interbank transactions and clearing is affected has evolved substantially over the years.

The technological evolution of the Indian banking industry has been largely directed by the various committees set up by the RBI and the government of India to review the implementation of technological change. No major breakthrough in technology implementation was achieved by the industry till the early 80s, though some working groups and committees made stray references to the need for mechanization of some banking processes. This was largely due to the stiff resistance by the very strong bank employees unions. The early 1980s were instrumental in the introduction of mechanisation and computerisation in Indian banks. This was the period when banks as well as the RBI went very slow on mechanisation, carefully avoiding the use of ‘computers’ to avoid resistance from employee unions. However, this was the critical period acting as the icebreaker, which led to the slow and steady move towards large scale technology adoption.

Computerisation

The process of computerisation marked the beginning of all technological initiatives in the banking industry. Computerisation of bank branches had started with installation of simple computers to automate the functioning of branches, especially at high traffic branches. Thereafter, Total Branch Automation was in use, which did not involve bank level branch networking, and did not mean much to the customer.

Networking of branches are now undertaken to ensure better customer service. Core Banking Solutions (CBS) is the networking of the branches of a bank, so as to enable the customers to operate their accounts from any bank branch, regardless of which branch he opened the account with. The networking of branches under CBS enables centralized data management and aids in the implementation of internet and mobile banking. Besides, CBS helps in bringing the complete operations of banks under a single technological platform.

CBS implementation in the Indian banking industry is still underway. The vast geographical spread of the branches in the country is the primary reason for the inability of banks to attain complete CBS implementation.

Satellite Banking

Satellite banking is also an upcoming technological innovation in the Indian banking industry, which is expected to help in solving the problem of weak terrestrial communication links in many parts of the country. The use of satellites for establishing connectivity between branches will help banks to reach rural and hilly areas in a better way, and offer better facilities, particularly in relation to electronic funds transfers. However, this involves very high costs to the banks. Hence, under the proposal made by RBI, it would be bearing a part of the leased rentals for satellite connectivity, if the banks use it for connecting the north eastern states and the under banked districts.

Development of Distribution Channels

The major and upcoming channels of distribution in the banking industry, besides branches are ATMs, internet banking, mobile and telephone banking and card based delivery systems.

Automatic Teller Machines

ATMs were introduced to the Indian banking industry in the early 1990s initiated by foreign banks. Most foreign banks and some private sector players suffered from a serious handicap at that time- lack of a strong branch network. ATM technology was used as a means to partially overcome this handicap by reaching out to the customers at a lower initial and transaction costs and offering hassle free services. Since then, innovations in ATM technology have come a long way and customer receptiveness has also increased manifold. Public sector banks have also now entered the race for expansion of ATM networks. Development of ATM networks is not only leveraged for lowering the transaction costs, but also as an effective marketing channel resource.

Introduction of Biometrics

Banks across the country have started the process of setting up ATMs enabled with biometric technology to tap the potential of rural markets. A large proportion of the population in such centers does not adopt technology as fast as the urban centers due to the large scale illiteracy. Development of biometric technology has made the use of self service channels like ATMs viable with respect to the illiterate population. Though expensive to install, the scope of biometrics is expanding rapidly. It provides for better security system, by linking credentials verification to recognition of the face, fingerprints, eyes or voice. Some large banks of the country have taken their first steps towards large scale introduction of biometric ATMs, especially for rural banking. At the industry level, however, this technology is yet to be adopted; the high costs involved largely accounting for the delay in adoption.

Multilingual ATMs

Installation of multilingual ATMs has also entered pilot implementation stage for many large banks in the country. This technological innovation is also aimed at the rural banking business believed to have large untapped potential. The language diversity of India has proved to be a major impediment to the active adoption of new technology, restrained by the lack of knowledge of English.

Multifunctional ATMs

Multifunctional ATMs are yet to be introduced by most banks in India, but have already been recognized as a very effective means to access other banking services. Multifunctional ATMs are equipped to perform other functions, besides dispensing cash and providing account information. Mobile recharges, ticketing, bill payment, and advertising are relatively new areas that are being explored via multifunctional ATMs, which have the potential to become revenue generators for the banks by effecting sales, besides acting as delivery channels. Most of the service additions to the ATM route require specific approval from the regulator.

ATM Network Switches

ATM switches are used to connect the ATMs to the accounting platforms of the respective banks. In order to connect the ATM networks of different banks, apex level switches are required that connect the various switches of individual banks. Through this technology, ATM cards of one bank can be used at the ATMs of other banks, facilitating better customer convenience. Under the current mechanism, banks owning the ATM charge a fee for allowing the customers of some other bank to access its ATM.

Among the various ATM network switches are CashTree, BANCS, Cashnet Mitr and National Financial Switch. Most ATM switches are also linked to Visa or MasterCard gateways. In order to reduce the cost of operation for banks, IDRBT, which administers the National Financial Switch, has waived the switching fee with effect from December 3, 2007.

Internet Banking

Internet banking in India began taking roots only from the early 2000s. Internet banking services are offered in three levels. The first level is of a bank’s informational website, wherein only queries are handled; the second level includes Simple Transactional Websites, which enables customers to give instructions, online applications and balance enquiries. Under Simple Transactional Websites, no fund based transactions are allowed to be conducted. Internet banking in India has reached level three, offering Fully Transactional Websites, which allow for fund transfers and various value added services.

Internet banking poses high operational, security and legal risks. This has restrained the development of internet banking in India. The guidelines governing internet banking operations in India covers a number of technological, security related and legal issues to be addressed in relation to internet banking. According to the earlier guidelines, all internet banking services had to be denominated in local currency, but now, even foreign exchange services, for the permitted underlying transactions, can be offered through internet banking.

Internet banking can be offered only by banks licensed and supervised in India, having a physical presence in India. Overseas branches of Indian banks are allowed to undertake internet banking only after satisfying the host supervisor in addition to the home supervisor.

Phone Banking and Mobile Banking

Phone and mobile banking are a fairly recent phenomenon for the Indian banking industry. There exist operative guidelines and restrictions on the type and quantum of transactions that can be undertaken via this route. Phone banking channels function through an Interactive Voice Response System (IVRS) or telebanking executives of the banks. The transactions are limited to balance enquiries, transaction enquiries, stop payment instructions on cheques and funds transfers of small amounts (per transaction limit of Rs 2500, overall cap of Rs 5000 per day per customer). According to the draft guidelines on mobile banking, only banks which are licensed and supervised in India and have a physical presence in India re allowed to offer mobile banking services. Besides, only rupee based services can be offered. Mobile banking services are to be restricted to bank account and credit card account holders which are KYC and AMC compliant.

With the rapidly growing mobile penetration in the country, mobile banking has the potential to become a mass banking channel, with very minimum investment required by the banks. However, more security issues need to be addressed before banking can be conducted more freely via this channel.

Card Based Delivery Systems

Among the card based delivery mechanisms for various banking services, are credit cards, debit cards, smart cards etc. These have been immensely successful in India since their launch. Penetration of these card based systems have increased manifold over the past decade. Aided by expanding ATM networks and Point of Sale (POS) terminals, banks have been able to increase the transition of customers towards these channels, thereby reducing their costs too.

Payment and Settlement Systems

The innovations in technology and communication infrastructure in recent years have impacted banks in a large way through the development of payment and settlement systems, which are central to the major portion of the businesses of banks.

In order to strengthen the institutional framework for the payment and settlement systems in the country, the RBI constituted, in 2005, a Board for Regulation and Supervision of Payment and Settlement Systems (BPSS) as a Committee of its Central Board. The BPSS now lays down policies relating to the regulation and supervision of all types of payment and settlement systems, sets standards for existing and future systems, approves criteria for authorisation of payment and settlement systems, and determines criteria for membership to these systems, including continuation, termination and rejection of membership. Thereafter, the government and the RBI felt the need for a legal framework dedicated to the efficient functioning of the payment and settlement systems. The Payment and Settlement Systems Act was passed in December 2007, which empowered the RBI to regulate and supervise the payment and settlement systems and provided a legal basis for multilateral netting and settlement.

Important technological innovations in payment and settlement systems introduced by the RBI in recent years are discussed here.

Paper Based Clearing Systems

Among the most important improvement in paper based clearing systems was the introduction of MICR technology in the mid 1980s. Though improvements continued to be made in MICR enabled instruments, the major transition is expected now, with the implementation of the Cheque Truncation System for the processing of cheques.

Cheque Truncation System (CTS)

Truncation is the process of stopping the movement of the physical cheque which is to be truncated at some point en-route to the drawee branch and an electronic image of the cheque would be sent to the drawee branch along with the relevant information like the MICR fields, date of presentation, presenting banks etc. Thus, the CTS reduces the probability of frauds, reconciliation problems, logistics problems and the cost of collection.

The cheque truncation system was launched on a pilot basis in the National Capital Region of New Delhi on February 1, 2008, with the participation of 10 banks. The main advantage of the cheque truncation system is that it obviates the physical presentation of the cheque to the clearing house. Instead, the electronic image of the cheque would be required to be sent to the clearing house. This would provide a more cost-effective mode of settlement than manual and MICR clearing, enabling realization of cheques on the same day. Amendments have already been made in the NI Act to give legal recognition to the electronic image of the truncated cheque, providing for a sound legal framework for the introduction of CTS.

Currently the effort is on increasing the processing efficiency with respect to paper based transactions, and as far as possible, to reduce the burden on paper based clearing. Through the introduction of advanced electronic funds transfer mechanisms, the RBI has been successful in diverting a large portion of paper based transactions to the electronic route.

Electronic Clearing Service

The Electronic Clearing Service (ECS) introduced by the RBI in 1995, is akin to the Automated Clearing House system that is operational in certain other countries like the US. ECS has two variants- ECS debit clearing and ECS credit clearing service. ECS credit clearing operates on the principle of ‘single debit multiple credits’ and is used for transactions like payment of salary, dividend, pension, interest etc. ECS debit clearing service operates on the principle of ‘single credit multiple debits’ and is used by utility service providers for collection of electricity bills, telephone bills and other charges and also by banks for collections of principal and interest repayments. Settlement under ECS is undertaken on T+1 basis. Any ECS user can undertake the transactions by registering themselves with an approved clearing house.

Operating from 74 different locations, ECS handles an average of 20 million transactions per month. It enables easy payments and collections for repetitive and bulk transactions. ECS takes off a lot of burden of paper work from the banks, enabling smooth flow of transactions. The volume of electronic transactions has increased at an annual average growth rate of 32.1% during FY05-FY09. The use of ECS (credit) and ECS (debit), in particular, has witnessed substantial growth in the last few years.

The RBI has recently launched the National Electronic Clearing Service (NECS), in September 2008, which is an improvement over the ECS currently operational. Under NECS, all transactions shall be processed at a centralized location called the National Clearing Cell, located in Mumbai, as against the ECS, where processing is currently done at 74 different locations. ECS system has a decentralised functioning, and requires users to prepare separate set of ECS data centre-wise. Users are required to tie-up with local sponsor banks for presenting ECS file to each ECS Centre. As on September 2008, 25000 branches of 50 banks participate in the NECS. Leveraging on the core banking system, NECS is expected to bring more efficiency into the system.

Electronic Funds Transfer Systems

The launch of the electronic funds transfer mechanisms began with the Electronic Funds Transfer (EFT) System. The EFT System was operationalised in 1995 covering 15 centres where the Reserve Bank managed the clearing houses.

Special EFT (SEFT) scheme, a variant of the EFT system, was introduced with effect from April 1, 2003, in order to increase the coverage of the scheme and to provide for quicker funds transfers. SEFT was made available across branches of banks that were computerised and connected via a network enabling transfer of electronic messages to the receiving branch in a straight through manner (STP processing). In the case of EFT, all branches of banks in the 15 locations were part of the scheme, whether they are networked or not.

A new variant of the EFT called the National EFT (NEFT) was decided to implemented (November 2005) so as to broad base the facilities of EFT. This was a nation wide retail electronic funds transfer mechanism between the networked branches of banks. NEFT provided for integration with the Structured Financial Messaging Solution (SFMS) of the Indian Financial Network (INFINET). The NEFT uses SFMS for EFT message creation and transmission from the branch to the bank’s gateway and to the NEFT Centre, thereby considerably enhancing the security in the transfer of funds. While RTGS is a real time gross settlement funds transfer product, NEFT is a deferred net settlement funds transfer product. As the NEFT system stabilized over time, the number of settlements in NEFT was increased from the initial two to six. NEFT now provides six settlement cycles a day and enables funds transfer to the beneficiaries account on T+0 basis, bringing it closer to real time settlement.

The commencement of NEFT led to discontinuation of SEFT, and EFT is now available only for government payments. With the SFMS facility, branches can participate in both the RTGS and the NEFT System. It is envisioned that all the RTGSenabled bank branches would be NEFT-enabled too, so that the customer would have a choice between RTGS or NEFT, based on time urgency, value of the transaction and different charges applicable on the two systems. Using the NEFT infrastructure, a one-way remittance facility from India to Nepal has also been implemented by the RBI since 15th May 2008.

In order to increase the coverage of NEFT to a wider section of bank customers in semi-urban and rural areas, an enhancement of the NEFT called the NEFT-X [National EFT (Extended)] is also proposed for phase wise implementation. This would facilitate non-networked branches of banks to transfer funds electronically by accessing NEFT-enabled branches for transfer of funds. NEFT (Extended) would work on a T+1 basis and would ensure wide rural coverage of the electronic funds transfer system.

RTGS

The other payment and settlement systems deployed were mostly aimed at small value repetitive transactions, largely for the retail transactions. The introduction of RTGS in 2004 was instrumental in the development of infrastructure for Systemically Important Payment Systems (SIPS).

The payment system in India largely followed a deferred net settlement regime, which meant that the net amount was settled between banks on a deferred basis. This posed significant settlement risks.RTGS was launched by RBI, which enabled a real time settlement on a gross basis. To ensure that RTGS system is used only for large value transactions and retail transactions take an alternate channel of electronic funds transfer, a minimum threshold of one lakh rupees was prescribed for customer transactions under RTGS on January 1, 2007.

RTGS minimizes systemic risks too, in addition to settlement risks, as paper based funds settlement through the Interbank clearing are replaced by the electronic, credit transfer based RTGS system. High systemic risks are posed by high value interbank transfers, so, it is considered desirable that all major interbank transfers among commercial banks having accounts with RBI be routed only through the RTGS system. The RTGS system had a membership of 107 participants (96 banks, 8 primary dealers, the Reserve Bank and the Deposit Insurance, Credit Guarantee Corporation and Clearing Corporation of India Ltd.) as at end-August 2009. The reach and utilisation of the RTGS has witnessed a sustained increase since its introduction in 2004. The bank/branch network coverage of the RTGS system increased to 58,720 branches at more than 10,000 centres facilitating the increased usage of this mode of funds transfer.

Technology Vendors

Many Indian banks handled technological issues in house till the late 1990s. Thereafter, the complications of the business necessitated the engagement of specialized vendors to handle complex issues. Due to the complexities involved, most banks now prefer to engage IT vendors to introduce specialized softwares to help in their risk management systems, retail and corporate banking, card management systems, complete back office support including data management systems.