Payment system

Topic: Payment Systems and Digital Finance · NCERT: Class 7, Ch 8 "Banks and the Magic of Finance"

Meaning

A payment system is a set-up that handles the clearing (checking who owes whom, and how much) and the settlement (the final transfer of money) of financial transactions, so that people, businesses and organisations can move funds to each other.

• Simple formula: Payment system = Clearing + Settlement
• Legal meaning: under the PSS Act 2007, a payment system is a system that "enables payment to be effected between a payer and a beneficiary, involving clearing, payment or settlement service". This includes credit and debit card operations and money transfers, but it excludes stock exchanges [2].
• Why it matters: payment systems are the "pipes" of financial infrastructure. Roads and railways move goods, and payment systems move the money that pays for those goods. If these pipes are safe and cheap, trade, saving and government transfers become easier.

Explanation

How a payment works: clearing, then settlement

• Step 1: Clearing. Banks exchange and check payment instructions to work out who owes whom, and how much.
• Step 2: Settlement. Money finally moves between accounts. In India, final settlement between banks happens in their accounts with the RBI. The RBI "maintains accounts of other banks and facilitates exchange of funds between them" (Class 7).
• Settlement finality (legal rule): a settlement, whether gross or net, becomes final and irrevocable (it cannot be taken back) as soon as the amount payable is determined [2].
• Suppose a bank fails in the middle of the day.
• Payments that are already settled cannot be undone.

• So one bank's failure does not spread to other banks.

• Positive confirmation: RTGS, NEFT, IMPS and UPI send a message to the sender once the money reaches the receiver's account [3]. Cash and cheques do not do this.

Types of payment systems

Basis	Type A	Type B
Medium	Paper (cheque, demand draft)	Electronic (NEFT, UPI, cards)
Size and user	Retail: many small payments (UPI, IMPS)	Large-value: fewer, bigger payments (RTGS)
Settlement method	Gross: each payment is settled on its own	Deferred net: payments are pooled and only the net difference is settled
Timing	Real-time (RTGS, UPI, IMPS)	Batch (NEFT, cheque clearing)

• Gross settlement: each transaction is settled one by one, "without bunching or netting with any other transaction" [3].
• Real-time settlement: there is no waiting period [3].
• Netting is legally recognised under the PSS Act. The Act also allows loss allocation (sharing losses among the members of a system) if the system's rules allow it [2].
• How payments evolved: barter → coins and notes → cheques and demand drafts → cards and net banking → IMPS → UPI (2016).

Worked example: gross vs deferred net settlement

• Bank A must pay Bank B ₹100 crore. Bank B must pay Bank A ₹70 crore.
• Gross: two separate transfers are made, ₹100 crore and ₹70 crore. In total, ₹170 crore moves.
• Net: ₹100 − ₹70 = ₹30 crore. Only Bank A pays Bank B this amount.
• The trade-off:
• Netting needs much less money, but banks carry risk until the batch settles.
• Gross settlement is safer, but banks must keep more liquidity (ready cash) during the day.

Digital payments: why they grew

• Digital payments are payments made electronically instead of in cash. Examples are mobile or internet banking, cards at POS (point-of-sale) machines, wallets and UPI QR codes.
• Why the government pushed them:
• to reduce the use of cash
• to control corruption
• Class 12 links this push to demonetisation (November 2016) and to financial inclusion (bringing poor and rural people into formal banking).

In India

• Law: Payment and Settlement Systems (PSS) Act 2007
• It received Presidential assent on 20 December 2007 and came into force on 12 August 2008 [2].
• Section 5: nobody except the RBI can run a payment system without RBI authorisation. This applies to both domestic and foreign operators [2].
• Running a system without authorisation, ignoring RBI orders or giving false information can lead to fines and imprisonment [2].

• Rules made under the Act include the PSS Regulations, 2008 and the Payments Regulatory Board (PRB) Regulations, 2025, which came into force on 20 May 2025 [2].

• Regulator: RBI

• Earlier, payment systems were regulated by the Board for Regulation and Supervision of Payment and Settlement Systems (BPSS). It authorised systems, set membership rules, met every quarter and reported every year to the RBI Central Board [3].
• A Payments Regulatory Board (PRB) has now been set up under the 2025 Regulations [2]. In answers, write "PRB (earlier BPSS)".

• The RBI's Department of Payment and Settlement Systems (DPSS) keeps systems "safe, secure, sound, efficient, accessible and authorised". It does this by monitoring them, assessing them and pushing for changes where needed [4].

• Operators

• RBI: runs RTGS, which has worked 24x7 since December 2020, making India one of the few countries with round-the-clock RTGS [3]. It also runs NEFT, which uses batch, deferred net settlement.

• NPCI (2008): a not-for-profit company promoted by banks at the initiative of the RBI and the Indian Banks' Association (IBA). It runs NFS (the shared ATM network), IMPS, RuPay, NACH (bulk payments such as salaries and subsidies), AePS (Aadhaar-based payments), UPI and BHIM, and NETC FASTag. Through subsidiaries it runs Bharat BillPay (NBBL) and takes UPI and RuPay abroad (NIPL).

• Scale (latest data)

• Digital payment transactions in India crossed 18,000 crore in 2024-25 [6].
• In January 2025, UPI handled 16.99 billion transactions worth over ₹23.48 lakh crore [7].
• UPI makes up about 85% of India's digital transactions and nearly 50% of the world's real-time digital payments [8].
• An IMF report (June 2025) found that UPI had about 49% of global real-time payment volume in 2024, which makes it the world's largest real-time payment system [9].

• In FY 2024-25 (till January 2025), P2M (person-to-merchant) payments were 62.35% of UPI volume and P2P (person-to-person) payments were 37.65%. About 86% of P2M payments were worth ₹500 or less [10].

• Measuring spread: RBI Digital Payments Index (DPI)

• Base: March 2018 = 100. It is computed every half year [5].
• It stood at 493.22 in March 2025, up from 465.33 in September 2024 [5]. The rise came mainly from payment infrastructure (supply-side factors) and payment performance [5].
• Growth since the base year: (493.22 ÷ 100 − 1) × 100 = 393.22%, or about 4.9 times the March 2018 level.

• Growth over the half-year: (493.22 − 465.33) ÷ 465.33 × 100 ≈ 6.0%.

• Policy markers

• Payment-data localisation (April 2018): payment data of Indian users must be stored only in India.
• Payments Vision 2025 (released 2022): its five themes are integrity, inclusion, innovation, institutionalisation and internationalisation.

Don't confuse with

• Financial infrastructure: this is the whole network of banks, payment systems, stock markets and other financial institutions. A payment system is only one part of it.
• Stock exchange: it clears and settles trades in securities, but the PSS Act's definition of a payment system excludes stock exchanges. Card operations, by contrast, are included [2].
• Clearing vs settlement: clearing only works out who owes whom. Settlement is the actual, final and irreversible movement of money.
• RTGS vs NEFT: both are run by the RBI. RTGS is real-time and gross, with each payment settled on its own. NEFT settles in batches using deferred net settlement.

Prelims Hooks

• Payment system = clearing + settlement. Under the PSS Act 2007, both gross and net settlements are final and irrevocable [2].
• PSS Act 2007: assent on 20 December 2007, in force from 12 August 2008. Under Section 5, no one except the RBI may run a payment system without authorisation [2].
• Trap: the PSS Act's definition excludes stock exchanges but includes credit and debit card operations [2].
• RTGS is operated by the RBI, not NPCI. It has run 24x7 since December 2020 [3].
• Board change: the Payments Regulatory Board (PRB) Regulations, 2025 have been in force since 20 May 2025. The earlier body was the BPSS [2].
• RBI-DPI: base March 2018 = 100, computed every half year, 493.22 in March 2025 [5]. UPI had about 49% of global real-time payment volume in 2024 (IMF, June 2025) [9].

Mains Points

• Payment systems as public infrastructure (Digital Public Infrastructure)
• UPI is a public rail, and private apps are built on top of it.
• Shared, cheap rails lower entry barriers for small merchants and fintech firms.

• This model became the world's largest real-time payment system [9], and India now promotes it abroad through NIPL.

• The RBI as both regulator and operator: benefits vs risks

• Benefit: settlement in central bank money is the safest possible, and 24x7 RTGS shows the RBI can lead change [3].
• Risk 1: a possible conflict of interest when the RBI also regulates private rails.

• Risk 2: concentration risk. UPI's roughly 85% share means a single outage can hurt the whole economy [8].

• Inclusion vs viability, and sovereignty vs openness

• Zero MDR (merchant discount rate, the fee a merchant pays on each digital payment) keeps UPI free for users. But the government then has to pay banks, for example through the ₹1,500 crore incentive scheme for low-value BHIM-UPI P2M transactions (2024-25) [10]. This raises the question of who pays for the system over the long run.
• Data localisation (2018) and RuPay give India control over its payment data and card network. But they raise compliance costs for foreign firms. The internationalisation theme of Payments Vision 2025 tries to balance these two aims.

Related concepts

• Digital payments

Read more

• Payment systems as financial infrastructure