payment survey presentation 2009 v 0.4

Payments Business in Indian Banks*

Confederation of Indian Industry

2 Payments Business in Indian Banks*

PricewaterhouseCoopers 3

Contents

06 ------------ Executive Summary

Background of the Survey ------------ 07

08 ------------ Objectives of the Survey

Survey Methodology ------------ 09

10 ------------ Macroeconomic Trends in Payments

Payments Business and Technology in Indian Banks ------------ 14

17 ------------ Exploring Enterprise Payments

The Indian Banking industry is in for exciting but challenging times. The current economic turmoil across the globe offers a host of opportunities for the Indian banking industry to grow as the Indian economy is better positioned compared to many economies.

The rising income levels of people are providing ample scope to design and develop a wide range of personal financial products and fee-based services. The focus of the Central Government on infrastructure development and rural economy, health and education, offers exciting business opportunities for the Indian Banks. Similarly, growing international operations of Indian business houses are supporting Indian banks with global opportunities.

Constant design of new products and services and focus on efficient customer service and concurrently pursuing global aspirations has to be the mantra for success for Indian banks in the future. While the recent market turmoil has dampened the mergers & acquisitions climate in the banking space, the upcoming economic upturn in the Indian banking sector should lead to a heightened level of mergers and acquisitions; this will further intensify the competition for the domestic banks. However, the interest rate environment remains somewhat uncertain. Indian banks, having just suffered through the downturn, and experienced the spread crunch (although mild by Western standards), are likely to look for ways to be less dependant on interest income and rely more on fee-based sources of revenue. They are also likely to institutionalize their cost reduction efforts that they have had to master during the economic slowdown. Banks know that technology can be a great enabler in reducing costs as well as in accelerating revenue accretion through opportunities in “Straight Through Processing”, preventing customer churn, and increasing cross sell and up-sell within the existing customer base. Thus, banks will be looking to further automate their processes and integrate technology into their core business and management processes.

Confederation of Indian Industry aims at improving efficiency across all business sectors to improve competitiveness. Banking being a key driver of growth, we look at different aspects of banking for improving services to the economy. In our endeavour to understand the Banks’ technological preparedness for attaining efficiency, and tap into a significant source of fee-based income, we felt there was an imperative need to explore a core area of banking that has, until recently, remained somewhat of an “orphan” within the hierarchy of a typical banking organization. Thus, we felt this was an opportune time to conduct a comprehensive payments survey in India, to understand how equipped Indian banks are to leverage this area of opportunity.

PwC has been our knowledge partner for this study. We express our sincere thanks to the Executive Directors and IT heads of all the Banks, who wholeheartedly supported our endeavour by providing their inputs. We hope this study will help the banks to improve technological efficiency and thus serve the customers in a better way. It would definitely complement our efforts for ensuring “Better Banking for Economic Development”.

With proper strategies and execution processes in harnessing technology and human resources, developing market segments across length & breadth of India, extending banking services to all sections of people, the Indian banking sector will be able to position itself amongst the best in the world and take on the competition from the global banks in a big way.

Mr Mukul SomanyChairman CII Eastern Region

Foreword

At the outset I take this opportunity on behalf of my team to thank all banks who took part in the survey. The insights and views expressed by participating bank have shaped the broad contours of this report.

We at PricewaterhouseCoopers, in our endeavour and mission to help our clients, present our findings on the payments business in Indian banks. We are hopeful that the banking sector would consider these findings to shape the way forward for their payments business.

This report has been prepared under the oversight guidance of Neel Majumder, Financial Services Lead, IT Effectiveness, within the Performance Improvement Group in PwC. Rachna Nath, Harsh Bisht and Sivarama Krishnan, Executive Directors, PwC, provided the organizational and review support to this effort.

The report team included Ranadurjay Talukdar and Susmita Majumder, both Senior Consultants with the Performance Improvement Group of PwC.

They have been ably assisted by Manjari Sogi, Summer Trainee with PwC, in collating and analyzing the primary survey data.

Last, but not the least, was the contribution from CII’s end. We thank Abhishikta Chowdhury and Riddhita Banerjee for their efforts in coordinating the survey and gathering responses from banks.

Although we have tried to be critical in analyzing the various aspects of payments business, we are cognizant of the fact that there might be issues and aspects which may not have been included because of a multitude of reasons. We request the readers of this report to let us know about any issues or aspects which you feel have not been addressed properly in this report. This would serve as an improvement opportunity and ensure that the next time we work on a similar report, it would help us serve you and the community better.

We also thank Confederation of Indian Industries (CII) for giving us the opportunity to present our findings and selecting us a Knowledge partner for the event.

Ambarish Dasgupta Executive Director PricewaterhouseCoopers

Acknowledgements


Executive Summary1 We explore why payments are a big deal for banks. We try to understand how banks in India view payments and how open they are towards taking an enterprise-wide view of the payments business.

The area of Payments is becoming increasingly important for the Indian banking sector. With the volatility in the interest rate regime, and the resulting uncertainty in Net Interest Income for banks, banks are increasingly looking at fee-based products for assured revenue sources. In the midst of this uncertainty, the revenues that banks earn from processing payment transactions stand out as a beacon of light. However, the revenues accruing from such transactions, as well as the underlying costs associated with processing these transactions, can be optimized if the banks start looking at payments as a core “business” of theirs, and mot merely as a panoply of service offerings. As long as the payments business remains an “orphan”, fragmented into different Lines of Businesses with individual owners, with no enterprise perspective to the intricate dynamics between the different products and delivery channels, revenue optimization will remain a far fetched goal. Similarly, when the processing units for the variety of channels and products are distributed across different business units, with no underlying integration architecture, it will be difficult to achieve cost optimization as well. Therefore, the banks need to view payments in a more holistic manner, which brings to us the concept of “Enterprise Payments”, derived from the need to view Payments business across lines of service, across product and channel and even customer group boundaries such as retail and wholesale payments. While the RBI has acted as the wise shepherd in terms of driving modern payments instruments and channels, and ensuring that low-cost, convenient payment instruments are not accessible only by the privileged few, banks also need to reorganize their own houses so that they can profitably meet the challenges thrown at them by the visionary actions of the RBI.

The results of our survey, which we believe is the first of its kind in the public domain, show Indian banks mostly trailing their global counterparts in terms of being organized to seize the opportunities afforded by looking holistically at the payments business.

While in the developed economies, the concept of a “Payment Czar” has existed for some time, at least in the larger banks, such a concept appears not to have reached most of the Indian counterparts. However, most banks still view their payments businesses, not as businesses, but as individual products and channels. Most banks in India do not track the revenues at the payment product level. Thus, banks appear to grossly underestimate the revenue they receive from their payment products and fail to appreciate the complex interplay that can happen between different payment products and channels that could impact their top line and bottom line.

From the cost perspective, we found that although the majority of the banks claim to track payment product costs at the activity level; only 30 to 35 percent of the banks were capable of tracking the unique costs for each type of product.

The rest used standard fixed and variable costs for their payment products, strongly indicating that they might be using gross cost allocations as a substitute for activity-driven costing. With respect to technology architecture, most banks agreed that the disparate payment applications and systems, built on legacy platforms, are unsustainable in the long run, and thus had plans to upgrade their payments architecture. With respect to security and fraud, most banks surveyed felt that they were quite up to the task of controlling the security environment. However, as the section on fraud and security in our document illustrates, the issues and challenges may be more complex than what the banks think. Finally, the bright spot of the survey was the finding that most of the banks surveyed do indeed feel that adopting an enterprise view of payments makes sense due to the positive impact on top line growth, cost reduction, and better service levels for their customer. As one of the largest banks in India has already embarked on this journey, it is anticipated that many of the other large banks will follow suit.


Background of the Survey2 This section explains the reasons why we undertook this survey. it explores the importance of payments in the economic well-being of our nation. It touches upon some of the recent payment initiatives globally. We look at why payments are an important business for banks. We study the key drivers in the payments business in India.

Payments touch everything we do in our everyday lives - from paying our bills, buying goods and services for our household to receiving our salaries. In every payment we make, we make our contribution to the consumption demand in the economy, thereby boosting the GDP of our country. Thus, a robust system that brings speed, convenience and security to our payments is the backbone for the economic well-being of a nation.

Globally, the focus today is on integrating payment platforms that brings a large number of payers and payees under the same umbrella. The Single Euro Payments Area (SEPA) initiative for the European financial infrastructure involves the creation of a zone for the Euro in which all electronic payments are considered domestic, and where a difference between national and intra-European cross border payments does not exist. Another initiative is underway in China, with the formation of China Union Pay, which will be the singular payment network for processing and managing all electronic transactions originating in China. The introduction of Faster Payment Service (FPS) in the United Kingdom will now make it possible for person-to-person or business-to-business payments between banks to happen in near real time. Even in India, efforts are on to create India Pay, which will be an indigenous payment system for India, which is expected to drastically reduce transaction costs for electronic payments.

From a business perspective, payments are increasingly becoming significant for Indian banks. Faced with an uncertain interest rate regime and fluctuating capital markets, Indian banks are understandably looking towards assured fee-based revenue from payment services. There are discernable efforts to migrate customers from availing of traditional methods of making payments like writing a cheque to superior methods like transferring funds online, for the incremental savings that can be accrued in the process is significant.

The last decade has witnessed phenomenal changes in the architecture, technology and strategic initiatives in the payments business in India. The widespread adoption of electronic clearing and settlement networks has provided the foundation for this metamorphosis. The Reserve Bank of India has played a crucial role in this regard, having mandated banks to route high-ticket transfers through RTGS and having introduced NEFT and NECS services. We see a gradual rise in the number of customers who choose to abandon cash and cheques for cards and other electronic payments media.

The economies of scale associated with more efficient modes of making payments has ensured that banks focus on promoting superior payment products.

And of course, technological advancements-while not as disruptive as some initially feared-are clearly spelling out the charter for the financial sector in the long run. Over the next decade or so, we will see millions of devices connected to IP networks, a lot of them payments-enabled. The customer of the next generation will be able to transact anywhere, anytime – via cell phones, PDAs, desktops and remote sensing devices. The challenge for the banks is expected to get tougher as wireless device manufacturers and telecom companies play an increasingly important role in payments.

Traditionally, it has been systemically important payments systems that have garnered greater attention; however, with a gradual focus on financial inclusion, the existence of an efficient retail payment system is being looked upon as a crucial public good. The formation of the National Payments Corporation of India is a step towards bringing the disparate retail payment systems under a single umbrella.

Last year, one of the largest banks in the country initiated a massive exercise that is currently underway, to align its payments business to global best practices and identify redundancies and inefficiencies in its payments products. While the state-run banks were the last to join the payments bandwagon in India, it is significant that the biggest of them has been the first to take the plunge to redesign its payments business. It is only logical to assume that other major banks would follow suit in the next few years, thereby heralding a new way of looking at the payments business in India. While private banks had pioneered the payments revolution in India, public sector banks are becoming increasingly competitive in the payments space, especially in the Debit Card payments market.

In such a backdrop, we felt an imperative need to conduct a comprehensive payments survey in India. We decided to analyze the business and technology issues pertaining to payments and explore aspects of enterprise payments, which would enable banks to view their payments holistically.


Objectives of the Survey3 This report aims to identify and understand business and technological issues and aspects pertaining to payments business in Indian banks. It also explores the concept of “Enterprise Payments” .

Survey ObjectivesThe survey was conducted keeping in mind three major objectives, namely: • Business issues and aspects pertaining to the Payments

Business in India

• Technological issues and aspects pertaining to Payments Business in India

• Exploring the concept of “Enterprise Payments” and ascertaining the readiness of banks to migrate towards such a framework in the future

Each of the objectives have been further explained below, where we have explained the various sub-objectives that together give us a perspective on the research objectives

Business Issues pertaining to “Payments”• Analyzing broad structure of payments business

• Method of tracking revenue from payments business

• Method of tracking revenue from payment products

• Cost structure of payments business

• Considerations for pricing payment products

• Understanding of business units responsible for fragmented sections of payments business

• Analysis of transaction volume & value for payment products across delivery channels

Technological Issues pertaining to “Payments”• Understanding of interoperability issues pertaining to

underlying technologies for payments business

• Exploring security aspects of payments and upgradation of payments infrastructure

Exploring the Concept of “Enterprise Payments”• Triggers for migrating towards “Enterprise payments”

• Improvement opportunities across functional areas through “Enterprise Payments”


Survey Methodology4 This section explains how the target sample for the survey was chosen, provides details about the questionnaire used for the survey and details the exclusions and assumptions pertaining to the survey.

Survey ObjectivesTo conduct this survey, a questionnaire was designed which was circulated amongst senior Business, IT and Operations executives of major public, private and foreign banks in India. In addition, we also conducted detailed discussions with the Chief General Manager, Department of Payments and Settlement in RBI.

The primary data gathered through the survey was further supplemented through secondary research from industry sources and PwC knowledge bases. Responses to the questionnaire were collected through emails, telephonic conversations and face to face interviews.

Target SampleThe target sample of banks for the survey was finalized through the following steps:

• Stratification of the population of commercial banks in India in terms of Public Sector Banks, Private Banks and Foreign Banks (28 banks in each stratum)

• Simple Random Sampling of 10 banks from each stratum

Thus, our sample for the survey comprised of 30 banks.

About the QuestionnaireThe questionnaire mostly comprised close-ended questions that were specifically designed to analyze the various aspects detailed in our survey objectives. For most of the questions, we also asked participating banks to offer their opinion on the issue being addressed through the question. This offered us valuable insights on the functioning, and attitude of the banking community.

Exceptions and Assumptions• The findings of the report are based on the analysis

and insights of the survey and are intended to serve as indicators for further discussion.

• Some of the data do not represent the view points of all the respondents because some banks refrained from divulging information regarding certain questions.

Survey ConfidentialityThe identity of all banks which participated in this survey has been kept anonymous. Any reference to the banks’ responses is represented in terms of overall numbers, averages or other pertinent statistical measures and no reference to individual banks has been made anywhere in the survey findings.


Macroeconomic Trends in Payments5 This section talks about the bigger picture – how payment products have evolved in India over the years, the role played by the regulator in shaping the payments landscape and an analysis of business volumes and transaction values of payment products in India.

Evolution of Payments in IndiaAs business needs and available technologies have changed, so has the landscape of payments business in India. The timeline below gives a chronological snapshot of the evolution of payments in India.

• 1995 - EFT• 1996 - ECS Debit • 1998 - ECS Credit

1995 to 1998 • Internet Banking

2001

• 2004 – RTGS • 2005 – NEFT

2004 - 2005• 2008 – CTS• 2009 - Mobile

Banking, Satellite Banking

2008 -2 009

• 1995 - EFT•

1996 - ECS Debit•

1998 - ECS Credit

• 1995 - EFT• 1996 - ECS Debit • 1998 - ECS Credit

1995 to 1998 • InternetBanking

• Internet Banking

2001 • 2004 – RTGS

• 2005 – NEFT

• 2004

– RTGS • 2005 – NEFT

2004 - 2005 • 2008 – CTS• 2009 - Mobile

Banking,SatelliteBanking

• 2008 – CTS• 2009 - Mobile

Banking, Satellite Banking

2008 -2 009

Role of RBIRBI has played a catalytic role over the years in institutionalizing the framework for development of safe, secure, sound and efficient payments system for the country along with initiation of various institutional, procedural and operational measures to strengthen and refine payment systems. The salient developments by RBI chronologically are as shown in the following figure:

Integrated Facilities Scheme

Uniform Regulations and Rules (URR)

Payment and Settlement Systems Act

Board of Regulation and

Supervision of Payment and

Settlement Systems (BPSS)

National Payments Corporation of

India (NPCI)

Guidelines to Prepaid Payment Instruments

Clearing Corporation of India Ltd (CCIL)

1940 1986 2001 2005 2007 2008 2009

-


Paper and Electronic PaymentsThe two subsequent charts illustrate how paper based payments have fared vis-à-vis electronic payments in the recent past, in terms of transaction volume and transaction value. While paper based payments, which are essentially payments made through cheques, still command a lion’s share in terms of volume, electronic payments overtook cheque payments in terms of value in 2006-07 and command a bigger share of the total payments pie today.

However, this has happened almost entirely due to RBI making it mandatory for banks to route high ticket transfers through RTGS. This becomes abundantly clear when we study the share of RTGS transactions amongst total electronic transactions. Just about 1% of electronic transactions are done through RTGS; yet, RTGS accounts for 96% of the value of payments made electronically. This has been illustrated in the subsequent chart.

0%

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Year

Breakup of Electronic Payments in Terms of Value

Card Payments

Retail ElectronicPayments

RTGS

Transaction Volumes of Electronic Vs Paper Payments

0

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in 0

00s Total Payments

Total ElectronicPayments

Total PaperBased Payments

Transaction Value of Electronic Vs Paper Payments

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ue in

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res Total Payments

Total ElectronicPaymentsTotal Paper BasedPayments

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04-05 05-06 06-07 07-08

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A Deeper Look into Electronic PaymentsWhile RBI’s mandate has ensured that RTGS accounts for 83% of the value of Systemically Important Payments System (SIPS) in India, it is noteworthy that it only commands a mere 21% of the volume of transactions carried out through SIPS, the remaining 79% being done through high value cheques. Increasingly broader coverage of Core Banking Systems across Indian banks will facilitate greater usage of electronic funds transfers. The integration of the RTGS system with the RBI’s internal accounting system (IAS) has enabled straight through processing (STP). Also, with the integration of the RTGS-IAS and the securities settlement system (SSS), automatic intraday liquidity (IDL) is now available. The challenge for RTGS lies with respect to payments between INR 1 lakh and 10 lakhs (above which RTGS is mandatory), a segment where high value cheques continue to be the preferred mode of payment.

On the retail payment front, paper based means of payment is still the preferred choice for a majority of customers, primarily because there has been no mandate from RBI regarding usage of electronic modes for person-to-person (P2P) or person-to-business (P2B) payments. Electronic retail payments account for 27% in terms of volume and 12% in terms of value amongst all retail payment transactions in the country.

Amongst the retail electronic payment services, the growth of the much vaunted NEFT service, which replaced the technologically inferior EFT service in 2005, has been slower than that of ECS Credit. The overall growth in retail payments has resulted primarily from greater off take in ECS Credit transactions, which has seen greater use due to ECS credit becoming the instrument of choice for salary disbursements. In addition, stock exchanges have mandated the refund of oversubscription amount of IPOs through ECS Credit, further contributing to its offtake. The introduction of the technologically superior NECS service is expected to further lower the manual intervention, and consequently, the turn around time, for ECS transactions. However, in sharp contrast to earlier years, NEFT grew by 81% in terms of value in 07-08 over the previous year, an indication of its growing usage. This is expected to further boost retail electronic payments.

Volume of Retail Electronic Payments

0

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04-050 5-06 06-070 7-08

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lum

e in

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s Retail ElectronicPayments

ECS Debit

ECS Credit

NEFT

Retail payments through cards have been in vogue even before any of the other electronic payment options made their appearance in India. While credit cards still constitute the bulk of card payment transactions, the growth in the base of debit cards has been significant over the last few years, primarily due to a majority of Public Sector banks replacing ATM cards of their existing customers with PoS enabled Debit Cards. In fact, the base of debit cards is nearly four times than that of credit cards in India currently. However, usage of debit cards at PoS outlets is still significantly lower than credit cards, contributing a mere 18% of total card transactions, as illustrated in the subsequent chart.

Value of Retail Electronic Transactions

0100,000200,000300,000400,000500,000600,000700,000800,000900,000

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Val

ue in

Rup

ees

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res ECS Debit

ECS Credit

NEFT

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04-05 05-06 06-07 07-08

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Possible explanations for low debit card usage include a greater fear of misuse compared to credit cards, since debit cards link directly to bank accounts. Other factors include low customer awareness (since debit cards are still primarily positioned as ATM cards by a large section of Indian banks) and lesser incentive for card users for using a debit card in place of a credit card.

Thus, the challenge for retail electronic payments primarily lies in bringing a greater share of P2P, P2B and B2P payments under its ambit. The opportunities in cards business are also massive given the low card and PoS penetration in India. The cost of POS terminals is still prohibitively high for a large section of the target retailers. Lower cost hardware and applications such as IP (Internet Protocol) based terminals and mobile devices that could be used as POS terminals themselves can play a large role in expanding the acceptance of POS amongst retailers. In addition, increasing marketing efforts from banks and network associations, coupled with efficient, robust and secure architecture at the back end are expected to charter the future path on the retail payments front

Card Transactions by Value

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res Card Payments

Credit Cards

Debit Cards

04-05 05-06 06-07 07-08


Payments Business and Technology in Indian Banks6 This section brings out the key findings from the survey we conducted and tells us how banks in India view their payments business.

Business StructureWe tried to understand the broad contours of the payment business in Indian banks through our survey. We probed banks on how they structured their payment business, how they tracked revenues and costs and what were the key triggers that shaped business decisions in payments.

Method of Structuring Payment Business

Payment Channel s 34%

Both24%

Payment Products 42%

42

Broadly speaking, banks tend to structure their payments business in terms of payment products and payment channels. This was amply supported through our survey, which revealed that 24% of banks structured their business on both product and channel lines; 42% structured their business on product lines while 34% structured their business on channel lines.

The Revenue AngleWhen it came to tracking revenue from payments business, one-third of the banks revealed that they only tracked revenue at a macro level, i.e., at the level of a broad line of business within the bank, like assets or liabilities. Half of the banks that tracked revenue at a macro level also additionally tracked revenue from payment channels. Significantly, none of these banks tracked revenue from payment products. When probed deeper, it emerged that these banks get MIS reports on volume and value of NEFT/RTGS/Cheque transactions, but do not track the revenues that arise out of these products. However, “Cards” is usually a Line of Business in most banks and hence for cards business, revenue is actually tracked at the product level.

However, 57% of the total number of banks surveyed revealed that they tracked revenue at the product level, while only 10% of the banks tracked revenue in terms of customer segments. Since revenue is rarely tracked at the level of customer groups, it makes it difficult for banks to understand

how specific customer groups respond to individual payment products. Only a handful of the new Private Sector banks and the foreign banks tracked revenue for customer groups.

We also studied the broad heads under which the banks’ tracked their revenue from payments. The chart below illustrates the broad revenue heads.

Significantly, more than one-third of banks surveyed did not track either float revenue or revenue earned per transaction from their payments business. Most of the banks opined that float revenue that could be attributed to payments were considered, for revenue tracking purposes, under the broad heads of savings or current accounts. Similarly, while per transaction revenue is crucial for card payments and even for RTGS payments, data pertaining to the same was not tracked by banks.

A direct result of not tracking crucial revenue areas under payments resulted in majority (57%) of banks indicating that less than 10% of their total revenues could be attributed to payments. This has been illustrated in the subsequent chart.

Contribution of Payments to Overall Revenue

14%

57%

14%

14%

Less than 10% 10 to 20% 21 to 30% 31 to 40%

Revenue Heads

63%

88%

63%

% o

f Tot

al R

esp

onse

s

0%

20%

40%

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Float RevenueF ee RevenueP er TransactionRevenue

Types of Revenue


A significant proportion of banks do not track revenue for individual payment products. Even among the ones that track, float income originating out of payment products like cards and per transaction revenue earned from electronic transfers are often ignored. Thus, it is not surprising that banks in India have not woken up to the impact that payments have on a bank’s top line and bottom line.

The Cost PerspectiveThe survey touched upon several aspects of costs relating to the payments business. As the subsequent diagram shows, banks still approach the costs for their payments business in a traditional manner, where fixed and variable costs are calculated. In many cases, it is likely that many of the cost components are simply allocate instead of the actual costs relevant to each payment product being tracked.

Unique costs that are attributable to specific payment product or channels are tracked by only 35% and 30% of the surveyed banks respectively. Tracking of these costs would allow the banks to better understand how individual payment products earn revenue vis-à-vis the cost the bank incurs in offering them.

This viewpoint is further supplemented by the chart below, where we have captured the banks’ viewpoint on the following broad parameters:• Whether profit models used by banks for individual

products are linked to the bank’s GL, which would make profitability calculations a lot more robust and reflect the most recent reality

• Whether the costing for payment products is activity-based or allocation-based.

The responses indicate that most banks tend to follow allocation-based costing when it comes to payments, which is the traditional manner of allocating costs into direct and indirect buckets. Thus, banks do not track costs that are specific to activities under each payment business, but instead consider these as direct or indirect costs pertaining to a particular line of business. An activity-based costing exercise for payments would have told banks how costs are distributed across payment products and channels and would have been a better input for shaping strategic decisions.

Pricing ConsiderationsPricing of payments products is a very complex issue and takes into account a multitude of factors. The subsequent chart shows the factors banks consider while taking their crucial pricing decisions.

It is noteworthy that 85% of banks keep the customer in mind while pricing their payment products. However, exactly how the customer relationship is considered while pricing, given that banks do not have databases of price vs. price, is a puzzle. It is also interesting to note that the customer orientation in payment product pricing does not extend to tracking of revenue from payments, as explained earlier.

allocation-basedcosting

activity-basedcosting

productprofitabili tymodel linked

to GeneralLedger

completely disagree

disagree more often thanagree

neither agree nor disagree

agree more often thandisagree

completely agree

Pricing Consideration

65% 60%

95%

50%

35%

85%

Settlement

Time

Settlement

Risk

Transaction

Size

External

Network Fee

Premium

Service Fee

Customer

Relationship

percent of total Responses

Cost Structure for Payments Business

75%80%

35%30%

45%

%

of

tota

l res

po

nse

s

fixed cost

variable cost

unique cost for payment

products

unique cost for payment

channels

shared cost for payment

products and channels


Technology ArchitectureAdvancements in technology have made it possible for banks to offer a multitude of payment products to their customers. However, our survey brought out that there are issues in terms of interoperability of these underlying technologies used for different payment products. For instance, the Core Banking System is usually different from the system used for Cards business in almost all the banks surveyed. Moreover, these disparate systems are seldom interoperable, as indicated by a large number of banks surveyed.

Technology in payments

0% 20% 40% 60% 80% 100%

Are application softwares used inpayments business interoperable

Are banks confident of the security of payments-related data

Do banks intend to upgrade paymentsinfrastructure in the near future

definitely yes yes cant say no definitely no

High rate of technological obsolescence demands regular and continuous upgradation by banks of their infrastructure. This brings in the problem of replicating high-end technology requirement across large user base and also throws up the challenge of ensuring integrity of different systems through their continuous upgradation against money-laundering and financing of terrorism. However, majority of banks showed an inclination towards upgrading their technology infrastructure in the near future.

Financial Inclusion and TechnologyAlmost all banks surveyed emphasised that benefits of superior delivery channels like Internet banking and mobile banking percolated primarily to urban consumers. Adequate infrastructural facilities to reach out to remote rural areas in cost effective manner through the use of smart cards, hand-held devices and other cost effective delivery channels were found to be lacking in most banks. Majority of banks agreed that the current payments infrastructure still has some way to go towards achieving financial inclusion.

Fraud and Security Aspects of PaymentsMost banks surveyed expressed confidence in the security of their payments-related data, as depicted in the previous diagram. However, the issues and challenges may be more complex than what the banks think.

The banking industry has been the darling for fraudulent attempts ever since they came into existence. Over time it just became more sophisticated with the emergence of net-banking, mobile banking etc.

Even India has felt the pangs as several Indian banks have come under more than 400 phishing attacks during the past few months with the number rising sharply in Sept-Oct, 2008, according to industry lobby NASSCOM. It doesn’t matter if it is a state owned bank or a private bank. Criminals using the Internet have attacked banks such as state-owned Bank of India, private lender HDFC Bank, India’s largest private lender ICICI Bank among others.

Instead of looking in isolation at the credit card, debit card, pre-paid card and the online banking frauds, a better perspective emerges if we look at it together as electronic data frauds. Human mind, by nature, will always look for loopholes to exploit the banking system for personal gains. Also, the level of innovation used to perpetuate these frauds is quite mind-boggling.

India wears both the mantle of frauds – as a country swiftly climbing up the ranks in partaking in financial fraud on the Internet as well as falling victim to it. India occupies the 14th position globally in hosting phishing sites. The city of Mumbai accounted for 30% of all phishing Websites in the country, Delhi for 29%, and Chennai and Bangalore hosted 12% each of all phishing Websites as of 2007.

A study done by the CAG on potential trade on the Internet and e-commerce websites had showed that 73 per cent of them allowed several modes of payment, only 7 per cent offered guarantee for products sold and 60 per cent had no mechanism to register complaints. There were very few redress mechanisms, and even their implementation was not enforced. The number of cases (e-fraud) that the Central Bureau of Investigation had registered was less than 50, and only one had reached the prosecution stage.

With an increase in the spate of attempted fraud tools and techniques to collect, protect, store and present, electronic evidences are something that banks have to invest in. This will also impact their organizational policy guidelines and tighter handshake between various departments. Frameworks related to collection of the electronic evidence should be incorporated and ingrained across the organization. Apart from IT and security, the legal team will have to be a major stakeholder in the framework definition so as to protect the various privacy related issues. All the above will help in submitting the electronic evidence in a comprehensible manner in court of law.


Exploring Enterprise Payments7 This section is based on our survey findings and tries to establish a context for Enterprise Payments in Indian banks

Understanding Enterprise PaymentsThe concept of enterprise payments arises from the observation that all payment methods share a common set of data elements and functions. While a cheque and a credit card may seem very different on the surface, they are actually quite similar. Both have a source of funds, a security model, and a clearing and settlement network. Once the check is truncated into an electronic message, it becomes possible to process it through the same infrastructure used for the credit card.

There are also common trade documents that govern the transaction and drive the payment, regardless of method: purchase order, invoice, and remittance advice. These documents may have different names depending on the application, but they maintain the same functions. For example, in consumer bill payments, the invoice is called a bill or statement. These documents can be transmitted as electronic messages just as a payment instruction can be.

Therefore, an enterprise payment system refers to the integration of disparate payment functions and applications, and leveraging the same to achieve higher returns and competitive advantage.

Banks around the world are experiencing profit pressures related to their payment systems, such that continuing with the existing silo infrastructure is increasingly untenable. Among these pressures are lower prices, shifting payment mix, regulations etc.

Hence, it becomes imperative to understand whether the Indian banking system is awake to the possibilities of enterprise payments.

Possible Reasons to migrate to Enterprise

payments

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

Percentage of Banks 63% 53% 47% 79% 11%

Lower Prices

Shifting Payment

RegulationsNew

Payment Others

Triggers for Migrating to Enterprise PaymentsWe asked the banks about the possible reasons that could make them migrate towards enterprise payments. The diagram below encapsulates their responses:

Are Disparate Payment Systems leading to duplication of Work?

No

32%

Yes

68%

Crucially, introduction of newer payment products and channels and lower prices emerged as the primary triggers that might make banks gravitate towards enterprise payments. Newer payment products like introduction of additional variants of card products and introduction of newer payment channels like mobile banking will mean that the disparity in underlying technological architecture will only get wider. Hence, it makes sense if disparate payment systems are integrated, for it will provide banks a common platform for offering a diverse range of payment solutions. Consequently, integration of such diverse systems will lead to significant savings in terms of cost in the long run, which emerged as the second most important trigger in the survey.

Majority of banks agreed that disparate systems were leading to duplication of work, with similar functions being performed by different departments.


Superior Risk Management through Enterprise PaymentsOne of the key benefits of an enterprise payment system is in the introduction of superior risk management measures across the bank. Majority of the banks agreed with this observation.

No

20%

Yes

80%

Will Enterprise Payments Improve Risk Mitigation?

Key Benefits of Enterprise PaymentsBased on the survey responses, the following emerged as the key benefits that could accrue to banks through enterprise payments are:• It would be possible to develop an enterprise payment

financial model, which would tell the bank a consolidated “Profit and Loss” position from all payments-related businesses. The model would also tell banks about the cost structure of their payments business - which costs are fixed or variable over changes in volumes, and which are unique to a particular product or channel (like network or association fees) or shared across multiple products and customers (like branches and payment processing centres).

• Studying the payments P&L would tell the bank about the underlying drivers of payments business. Understanding how to manoeuvre each of these discrete drivers can have significant impact on the profitability of a payment product.

• Simplification of the underlying architecture will lead to reduced transaction costs, benefits of which can be passed on to the end consumer which will consequently drive up usage.

• Integration of underlying systems would allow for superior MIS, which would help the bank understand customer behaviour better. Consequently, it would bring about a greater customer orientation in product offerings.

• Since underlying systems are integrated, it is possible to have an enterprise wise KYC/AML platform which would allow for transaction level and client level flagging if fraud occurs in any of the payment products used by a customer.

The Payments Hub ConceptThe concept of the Payments hub comes in the backdrop of an increasing number of choices for the customers to make their payments, which has led to tremendous complexity of relationships between channels, instruments and customers, as shown in the subsequent diagram.

Credit cardsATM/

Debit cardsRTGSCheque NEFT

Web site(bank)

MailPhone/

IVRBranch teller/

Drop BoxMobile phone

Web site(Biller or payee)

ATM

Account to Account

Cha

nnel

Inst

rum

ents

Corporate

Retail

Cus

tom

er

ECS

In many cases, these relationships are maintained and serviced by many banks as separate payment silos, with separate processing entities for each payment method. Such disparate payment infrastructure has caused the bank to face significant challenges, some of which are:• Infrastructure duplication, due to hardware and software

systems provided by different vendors, cause huge maintenance problems and cost and redundant back-office staff required to monitor and maintain the infrastructure

• Technology legacy, since outdated or soon-to-be-obsolete technology platforms support the silos that are difficult to support. This means that banks cannot make changes to payment systems quickly and easily, and they are unable to gain an integrated view on the customer over different channels and track payments end to end

• Lack of scalability, since most of the payment systems and architectures were designed at a time before the current volume in electronic instruments and the future growth were not anticipated. The current volumes and the future levels of electronic payments have the potential to overwhelm the payments systems resulting in the failure of the banks to provide guaranteed uptime of its payment systems. A loss of uptime would result in loss of revenues, penalty costs and most importantly, the loss of customers

• Lack of Straight Through Processing (STP), since many of the payment systems cannot provide the high STP rates that are required to run a profitable payments business, banks need to employ a large back office staff to either assist in manual re-keying of transactions, or to repair erroneous entries

• Costs related to payments processing are spiralling due to the silo nature of the payment systems, the duplication of infrastructure, people and processes. It is increasingly getting harder to pass along costs to the customers since customers are becoming savvier and more aware, and regulators are mandating price controls.


Thus, the need of the hour is an IT infrastructure that will help reduce costs by enabling payment efficiencies and decreasing system duplication, improve customer satisfaction with faster market response times, and enhance liquidity management through better monitoring and control.

It is possible to have a solution based on the fact that different payment types share a common set of data elements:• Source of funds

• Security model

• Clearing & settlement network

Moreover, different payments share common process steps, covering the life cycle from messages to settlement. In addition, all payment methods require services such as pricing, limit checking, balance validation, and risk and fraud management.

Within each silo are duplicated services that could be leveraged across silos, such as AML, credit checking, fraud detection, etc. that are candidates for reuse.

These common data elements and process steps make centralized management of payment systems possible because they enable a common message and database schema, as shown in the subsequent diagram.

Receive Payment Request

Transmit to Network

Receiving bank

processes payment

SettlementException

Processing (if applicable)

Check against fraud and compliance filters Risk management

Demand for real - time, accurate information by clients

It is in this context that the concept of a Payments Hub emerges, allowing consolidation of multiple payment systems into one centrally managed mid- office payment system, thereby improving efficiency, reducing cost, enabling more transparency in processing and improving customer service.

The payment hub is built entirely on a Service Oriented Architecture (SOA) delivering common, reusable services consisting of a comprehensive data model; choreographed payment business process and configurable services including parsing, validation, cost based routing, warehousing security, auditing and other services that are typically associated with the payments life cycle.

Architecturally the Payment Hub is positioned between the back office at the core of the bank and the different delivery channels.

Without any direct connections between components, it is possible to modify or replace one component without affecting the others. This allows the bank to focus on areas of maximum benefit with reduced cost and risk.

PaymentDatabase

General Ledger

Reconciliation

Network Access

Channel Management

Enter

prise

Acc

ess

Application Services

Payment Hub• Pricing

• Risk & fraud management

• SecurityUni

que

func

tions

Deposit systems

Mobile Phone

Web Site -B ank

Web Site -B iller or Payee

Branch Teller/ Drop Box

ATM

Phone/IVR

RTGS

ECS

SWIFT

NEFT


The key Components of any Payment Hub are Channel Adapters and Business Process Manager, which have been explained below.

Channel Adapters: Channel adapters form the interface between Bank Payment Hub and outside world. All incoming payments to the system, including payments from customer and payments entering from clearing and settlement systems are handled by these adapters.

Business Process Manager: It defines the core functionality of the Payment Hub system. It makes sure that payments that enter the Bank Payment Hub follow a configurable workflow and defined set of business processes. It allows the alteration of workflow and business processes without affecting the other parts of the system.

• Broadly, the benefits from a payments hub are:

• Strategic benefits:

• Improved visibility in key payment areas

• Lower cost of processing

• Increased flexibility to deal with market conditions

• Improved customer service, higher retention

• Improved ability to respond to increasing regulatory requirements

• Ability to identify new revenue sources

• Operational benefits:

• Increase ability to fix problems faster

• Produce accurate, timely management reporting

• Reduce cost of system integration

• Quicker product development and roll-out

• Reduce cost of compliance through speedy , one-time changes to parameters affecting all payment accounts and methods

• Increase system uptime

• Improved ability to manage intraday liquidity

• Ability to meet processing deadlines confidently

Full service banks offering retail banking through diverse channels and corporate cash management and treasury operations can expect to significantly benefit from a payments hub. Only time till tell whether the concept will find acceptance in India.


Charting the Future8 This section is based on our understanding of the future through discussions with the banks and the RBI.

It is evident that payments will continue to evolve in the years to come, both in terms of how we pay and where we pay. This survey was conducted to understand the bank’s view of how payments are structured today and what developments could be expected in future.

The Banks’ PerspectiveWith speed and efficiency increasingly becoming the buzzwords that shape customer solutions, banks will need to revisit their payments portfolio. It is evident that mobile devices and the Internet will become increasingly popular as delivery mechanisms for payment solutions. However, there will always be customer segments that will prefer to transact through a cheque, or go to a branch to withdraw money. Hence, banks will need to create a mapping of their payment portfolio with their customer segments and decide on the product strategy accordingly.

From the point of view of saving costs, banks will need to increase their efforts in migrating customers from paper-based payments to electronic payments. If a customer pays his phone bills through cheques, a bank spends a few rupees in cost and a few paisa in incremental revenue. If the same customer can be made to pay through his debit card, there will be significant reduction in cost and significant increase in incremental revenue. However, this will require a fundamental change in consumer behaviour, which can happen only if the banks and the regulator offer a secure, robust and efficient network, in addition to incentives in terms of convenience and benefits to the customer.

Since customer orientation will eventually drive business volumes, migrating to enterprise payments will possibly be an option that banks will not be able to refuse in the years to come. A framework that will reduce costs, bring about superior KYC/AML checks, help banks know customer behaviour better and give an overall idea of the profitability of their payments business does sound like a good idea. However, taking the big leap from legacy systems and traditional business mindsets can only happen if the banks are convinced of the benefits that can accrue to them. For that, a crucial driver would be increased acceptance of electronic payments by consumers across India. The RBI plays a crucial role here, for it is ultimately the entity that shapes the future of any financial offering in India. Formation of the NPCI is a right effort in that direction, for it will bring in a new focus on retail payments, which should also see the electronification that has been brought about by the introduction of RTGS in Systemically Important Payment Systems.

On the aspect of mitigating security risks in payment, it is important to periodically review contracts with technology partners to ascertain whether the contracts are waterproof. Audit authority needs to be established to ascertain auditability of security breach. Application softwares need to be tested against vulnerabilities like backdoor windows. Legal cushion needs to be set up to ensure that the bank is legally protected against the existing compliance framework.

The Regulator’s PerspectiveThrough our discussions with RBI, we got valuable inputs on how the regulator views the future of payments in India.

On the business aspect, RBI revealed that they would shortly be releasing an updated version of the payments vision document, which would chart the path beyond 2009. An immediate area of concern is authentication of cross-border payments, hampered by KYC/AML considerations, which would lead to significant expansion in the realm of payments.

A crucial driver for payments might be the National ID Card initiative currently underway, which would eventually give every Indian a unique identification number. Government payments might largely be driven through the unique ID initiative. However, since banks are the end-users, it is ultimately their prerogative to efficiently use the national ID number for superior payments solutions for their own customers.

An extremely important consideration for the future payments framework would be its efficacy in ensuring financial inclusion. While several public sector banks have taken significant initiatives in this area through introduction of mobile kiosks and the banking correspondent model, there is a lot that is left to be done in the area of financial inclusion. Since mobile penetration is the highest in rural India compared to any other communication channel, mobile banking could possibly be the channel that brings about greater inclusion of the unbanked population in India.


About Confederation of Indian Industry

The Confederation of Indian Industry (CII) works to create and sustain an environment conducive to the growth of industry in India, partnering industry and government alike through advisory and consultative processes.

CII is a non-government, not-for-profit, industry led and industry managed organisation, playing a proactive role in India’s development process. Founded over 114 years ago, it is India’s premier business association, with a direct membership of over 7800 organisations from the private as well as public sectors, including SMEs and MNCs, and an indirect membership of over 90,000 companies from around 385 national and regional sectoral associations.

CII catalyses change by working closely with government on policy issues, enhancing efficiency, competitiveness and expanding business opportunities for industry through a range of specialised services and global linkages. It also provides a platform for sectoral consensus building and networking. Major emphasis is laid on projecting a positive image of business, assisting industry to identify and execute corporate citizenship programmes. Partnerships with over 120 NGOs across the country carry forward our initiatives in integrated and inclusive development, which include health, education, livelihood, diversity management, skill development and water, to name a few.

Complementing this vision, CII’s theme for 2009-10 is ‘India@75: Economy, Infrastructure and Governance.’ Within the overarching agenda to facilitate India’s transformation into an economically vital, technologically innovative, socially and ethically vibrant global leader by year 2022, CII’s focus this year is on revival of the Economy, fast tracking Infrastructure and improved Governance.

With 64 offices in India, 9 overseas in Australia, Austria, China, France, Germany, Japan, Singapore, UK, and USA, and institutional partnerships with 213 counterpart organisations in 88 countries, CII serves as a reference point for Indian industry and the international business community.


About PricewaterhouseCoopers

PricewaterhouseCoopers Pvt. Ltd. (www.pwc.com/india) provides industry - focused tax and advisory services to build public trust and enhance value for its clients and their stakeholders. PwC professionals work collaboratively using connected thinking to develop fresh perspectives and practical advice.

Complementing our depth of industry expertise and breadth of skills is our sound knowledge of the local business environment in India. PricewaterhouseCoopers is committed to working with our clients to deliver the solutions that help them take on the challenges of the ever-changing business environment.

PwC has offices in Ahmedabad, Bangalore, Bhubaneshwar, Chennai, Delhi NCR, Hyderabad, Kolkata, Mumbai and Pune.

Jairaj PurandareExecutive DirectorFinancial Services LeaderTel: +91 22 6669 1400Email: [email protected]

Sivarama KrishnanExecutive DirectorRisk and Regulations, Performance Improvement PracticeTel: +91 22 6669 1350Email: [email protected]

Harsh BishtExecutive DirectorBanking and Capital Markets LeaderTel: +91 22 4007 4602Email: [email protected]

Ambarish DasguptaExecutive DirectorPerformance Improvement PracticeTel: +91 33 2357 3397Email: [email protected]

Rachna NathExecutive DirectorIT Effectiveness, Performance Improvement PracticeTel: +91 33 2357 3199Email: [email protected]

Neel MajumdarManaging ConsultantPerformance Improvement PracticeTel: +91 33 2357 3196Email: [email protected]

Contacts

This publication has been prepared for general guidance on matters of interest only, and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is given as to the accuracy or completeness of the information contained in this publication, and, to the extent permitted by law, PricewaterhouseCoopers, its members, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it. Without prior permission of PricewaterhouseCoopers, the contents of this presentation may not be quoted in whole or in part or otherwise referred to in any documents.


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