Payment systems in India: PSS Act, RTGS, NEFT, UPI and regulation

A payment system looks simple from a phone: tap, enter a PIN, done. Behind it sit operators, banks, settlement accounts at the RBI, and a law that decides who may run such a system and what happens if a participant fails. Paper III asks about both levels: the customer-facing systems and the plumbing underneath. The regulator's concern is always the same: payments must be safe, efficient, accessible and resilient.

The legal framework

The Payment and Settlement Systems Act, 2007 (in force from August 2008) is the core law.

• Authorisation: no one other than the RBI may start or operate a payment system without the RBI's authorisation (Section 4).
• Regulation and supervision: the RBI can set standards, call for information, audit and inspect, and issue directions.
• Settlement finality: once a payment is settled under a system's rules, it is final and irrevocable, even if a participant later becomes insolvent. This protects the system from a domino effect.
• Netting is legally valid, so net settlement cannot be unwound by a failing participant's liquidator.

Within the RBI, the Board for Regulation and Supervision of Payment and Settlement Systems (BPSS), chaired by the Governor, oversees the area, supported by the Department of Payment and Settlement Systems.

Who runs what

NPCI was set up in 2008 as a not-for-profit company promoted by banks under the guidance of the RBI and the Indian Banks' Association. It is the umbrella organisation for retail payments. UPI, launched in 2016, handles the largest share of India's digital payment transactions by volume.

Gross versus net settlement

• Gross settlement: each payment is settled individually and immediately in central bank money. There is no credit risk between banks, but banks need a lot of liquidity. RTGS works this way.
• Deferred net settlement: payments are collected over a cycle, and only each bank's net position is settled at the end. Liquidity needs fall sharply, but until settlement banks are exposed to each other. NEFT, and the interbank leg of UPI and IMPS, work this way.

Worked example: netting

In one settlement cycle:

• Bank A must pay Bank B ₹100 crore.
• Bank B must pay Bank C ₹70 crore.
• Bank C must pay Bank A ₹50 crore.
• Bank B must pay Bank A ₹20 crore.

Under gross settlement, four transfers move ₹240 crore in total.

Under net settlement, work out each bank's position (receipts minus payments):

1. Bank A receives 50 + 20 = 70 and pays 100. Net = −₹30 crore (pays).
2. Bank B receives 100 and pays 70 + 20 = 90. Net = +₹10 crore (receives).
3. Bank C receives 70 and pays 50. Net = +₹20 crore (receives).
4. Check: −30 + 10 + 20 = 0. Net positions always sum to zero.

Only ₹30 crore needs to move, instead of ₹240 crore. That is the liquidity saving. The cost is risk: if Bank A failed before settlement, B and C would be waiting for money they had counted on. Settlement guarantee funds, collateral and settlement finality rules manage that risk.

Other regulated players and rules

• Prepaid payment instruments (PPIs): wallets and prepaid cards. Small PPIs need minimal KYC; full-KYC PPIs allow higher balances and interoperability with UPI and card networks.
• Payment aggregators and gateways: firms that collect payments for merchants must be authorised by the RBI and meet net-worth and escrow-account requirements.
• Card-on-file tokenisation: since October 2022, merchants cannot store customers' card numbers; a token replaces the card details.
• Merchant discount rate: since January 2020, no MDR may be charged on RuPay debit card and UPI payments to prescribed merchants, which drove adoption but raised the question of who funds the infrastructure.
• Cross-border links: UPI has been linked with foreign fast-payment systems, beginning with Singapore's PayNow in 2023.

Risks the regulator manages

Internationally, payment systems are assessed against the CPMI-IOSCO Principles for Financial Market Infrastructures (2012), which the RBI applies to critical systems.

Model answer outline (15 marks)

Question: Discuss the role of the RBI in the growth of digital payments in India, and the risks it must manage.

1. Introduction: payments as public infrastructure; PSS Act 2007.
2. RBI as regulator: authorisation, BPSS, standards, settlement finality.
3. RBI as operator: RTGS and NEFT, made 24×7.
4. RBI as catalyst: support for NPCI; interoperability; PPIs; tokenisation; Payments Vision.
5. Outcomes: UPI's scale, lower cash use, cross-border links.
6. Risks: fraud, concentration, outages, cyber attacks, funding the zero-MDR model.
7. Measures: authentication, limits, customer liability rules, resilience standards, awareness.
8. Conclusion: growth must be matched by resilience and trust.

Short model answer (10 marks)

Question: Distinguish between RTGS and NEFT.

RTGS and NEFT are both electronic funds transfer systems owned and operated by the RBI, and both now work 24×7. They differ in how they settle.

RTGS (Real Time Gross Settlement) settles each transaction individually, as soon as it is processed, in the banks' accounts with the RBI. Settlement is final and immediate. Because there is no netting, it needs more liquidity, and it is meant for large-value payments, with a minimum of ₹2 lakh and no upper limit.

NEFT (National Electronic Funds Transfer) collects transactions and settles them in half-hourly batches on a deferred net basis. There is no minimum or maximum amount, which suits retail transfers. It saves liquidity because only net positions move, but credit reaches the beneficiary only after the batch settles.

In short, RTGS trades liquidity for speed and certainty on large payments, while NEFT trades a small delay for liquidity efficiency on retail payments. Together with UPI and IMPS, they give India a layered payment system.

Practice questions

1. Which Act gives the RBI power to authorise payment systems?
   • The Payment and Settlement Systems Act, 2007.
2. Who chairs the BPSS?
   • The RBI Governor.
3. What is the minimum amount for an RTGS transfer?
   • ₹2 lakh.
4. Banks X and Y owe each other ₹60 crore and ₹45 crore respectively. What is the net settlement?
   • X pays Y ₹15 crore.
5. Which organisation operates UPI?
   • NPCI.
6. From when did card-on-file tokenisation apply?
   • October 2022.

What to do next

• Fill in the "who runs what" table from memory.
• Redo the netting example after adding "Bank C pays Bank B ₹40 crore".
• Read the fintech and CBDC guide next.
• Then read the financial inclusion guide to see how payments rails reach the unbanked.