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Evolution of cheques andpaper-based clearing in India

Thought Paper

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Overview

History of cheque clearing

Features of paper-based clearing

From once being a prized possession and a status symbol to now being on the brink of extinction, the cheque has come a long way.

• During the 1st century AD, banks in Persia and surrounding regions issued letters of credit known as Sakks, which are believed to have been the basis for the modern cheque. At their customers’ request, bankers would issue orders called “Bills of Exchange” to pay money to identified payees, eliminating the need for early merchants to carry large amounts of currency or gold.

• Fully printed cheques were introduced in the early 1700s, and the first personalized cheques were introduced in 1810 in England.

• Daily cheque clearing started around 1770, whereby bank clerks met to exchange cheques and settle their balances in cash.

Features of a cheque:

• A cheque should be in writing and duly signed by the drawer.

• It contains an unconditional order.

• It is issued on a specified bank.

• The amount specified must be clearly mentioned both in figures and words.

• The payee is always specified.

• It is always payable on demand.

• The cheque is invalid if it does not bear a date.

• A cheque must be in order to pay money only.

This paper traces its history, current usage and its future role in the Indian context.

• Section 6 of the Negotiable Instruments Act, 1881, states “A cheque is a bill of exchange drawn on a specified banker, and not expressed to be payable otherwise than on demand.” So, a cheque is a written instruction to a bank (also called the drawee bank) asking it to pay a specific sum of money to the person/company whose name is written on it. The person issuing the cheque is called the drawer and the one to whom it is issued is called the payee.

Types of cheques

Cheques are of basically four types.

a) Open Cheque:

A person holding an open cheque can:

I. Receive payment over the counter at the bank.

ii. Deposit the cheque into his account.

iii. Pass it to another person by endorsing the cheque on the reverse side.

b) Crossed Cheque:

Payment of a crossed cheque cannot be made over the counter at a bank; it can only

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be credited into the payee’s account. Cheques can be crossed by drawing two parallel lines across the top left corner.

c) Bearer Cheque:

A bearer cheque is payable to the person presenting it for payment at the branch; it does not require endorsement and can easily be transferred.

d) Order Cheque:

An order cheque is payable only to a particular person. In this, the word “bearer” may be struck out and the word “order” written. It can be transferred by the payee to someone by simply signing his/her name on the reverse of the cheque.

Introduction of MICR

As cheque usage grew substantially, the Magnetic Ink Character Recognition (MICR) format was first developed by the Stanford Research Institute and General Electric Computer Laboratory in the 1950s for sorting cheques, which by the 1990s had gained prevalence worldwide. These machine-readable nine-digit numbers at the bottom of the cheque identified its postal code/city and state of origin. These codes helped clearing houses in bank- and branch-wise sorting of cheques for delivery to the respective banks on whom the cheques were drawn. While this helped speed up the clearing process, physical movement

of cheques continued even after this partial automation.

Local clearing process

Local Cheque: Both the issuer and receiver banks of a “local cheque” are in the same city.

Clearing House: Each bank sends its representative to a centralized place called the “Clearing House” to exchange cheques drawn on each other. The Reserve Bank of India (RBI) acts as a clearing house. The State Bank of India (SBI) and other banks may act as clearing houses in cities where RBI offices are not present. The clearing house and participating branches usually have a defined distance between them based on the transportation and communication facilities, as cheques have to be physically taken to and from the clearing house.

Local Clearing: Only those cheques drawn on branches of banks within the purview of the local clearing house are handled. The clearing house gives the cheque to the drawer’s bank, which checks if there are sufficient funds in the account and then agrees to pay. The clearing house settles the cheque amount by debiting the drawer’s bank and crediting the payee’s bank. The drawer’s bank then debits the amount from the drawer’s account.

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Outstation clearing process

Here, the cheques have to be moved from the Presentation Centre (the city where cheques have been presented) to the Drawee Centre (the city where cheques are payable), thereby increasing the realization time for “outstation cheques.”

Net settlement

The RBI, which is the settlement bank (in those centres where it is present), maintains accounts of all the banks participating in the clearing. Net settlement entails transferring only the net differential between banks by accumulating the transactions and then offsetting them against each other.

For example, suppose SBI brings in 1,000 cheques amounting to Rs. 50 lakhs drawn on Axis Bank and Axis Bank brings in 1,000 cheques worth Rs. 45 lakhs drawn on SBI, the net difference of Rs. 5 lakhs is payable by Axis Bank to SBI. In this case, the RBI passes an entry of Rs. 5 lakhs by debiting Axis Bank and crediting SBI. In effect, Axis Bank needs to pay Rs. 5 lakhs to RBI for settling this amount with SBI. This is called “Net Settlement”.

Speed clearing

This refers to processing of outstation cheques in local clearing. It is possible only if these outstation core banking-enabled bank branches have a networked local branch. Speed clearing significantly reduces the time taken for realization of outstation cheques.

If there is no collecting branch at the Destination Centre, then the cheque is sent directly by the Presenting branch to the Destination branch. On receiving the payment proceeds from the Destination branch, the Presenting branch credits the customer’s account, and realization of funds takes about 7 to 21 days.

A cheque drawn on outstation CBS branches can be processed through speed clearing if the drawee bank has a branch at the local centre. If ‘T’ denotes the presentation date of the cheque at the clearing house, local cheques are processed in T+1 days and customers can

withdraw funds in T+1 or +2 days. Also, no service charges are levied on speed clearing of outstation cheques of up to Rs. 1 lakh.

Today, branches are networked by implementing Core Banking Solution (CBS), which eliminates the need for physical transfer of cheques. Speed clearing combines the advantages of MICR clearing and CBS. However, with the advent of the Cheque Truncation System (CTS), speed clearing may well be on the way out.

Reasons for cheque return

Some of the reasons for a cheque to return unpaid are:

• Insufficient balance in the customer’s account.

• Signature mismatch.

• Mismatch of amount in words and figures.

• Too many alterations on the cheque.

• ‘Effects not cleared present again’: Funds not available in the account to clear the presented cheque since the cheque(s) deposited into the account was not yet cleared /available for use in the account.

• Counterfeit, forged or fraudulently altered cheque.

• Post-dated Cheque: A post-dated cheque (PDC) is one, which is drawn on a future date. To illustrate with an example, if a cheque presented on January 10, 2012 bears the date April 2, 2012, it is a post-dated cheque. In this case, the bank can make the payment only on or after April 2, 2012.

• Stale Cheque: A cheque is valid for a limited period from the date on which it is drawn. Once the period has expired, it is called a “stale cheque” and no payment can be made for it. In India, post April 1, 2012, cheques, drafts, pay orders etc. are valid for three months as opposed to six months hitherto.

• Mutilated Cheque: A cheque that is torn into two or more pieces is termed “mutilated cheque.” Banks will not make payments against such cheques without obtaining confirmation from the drawer. However, payment may be made against cheques

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just torn at the corners with no material fact removed or canceled.

• Ante-dated cheques: Such a cheque bears a date earlier than the date of presentment for payment. For example, a cheque that is issued on March 22, 2012 may bear the date March 6, 2012.

If a cheque is not returned within a stipulated time, it is considered “realized” as per the “Return Discipline” established by the clearing house. The collecting bank credits funds to the beneficiary after this scheduled time period.

Advantages of paper-based clearing in India

• Presence of faster cheque clearing infrastructure with more than 1,200 clearing houses in India.

• With implementation of core banking and the resultant “payable in all branches in India” concept, most outstation cheques (through speed clearing) are cleared in T+1 working days.

• Safety: Only the named “Payee” can cash the cheque.

• Trust and Habit: Cheques have long been an alternative to cash, trusted over generations and convenient.

• Buying time: 1) The “time window” between cheque deposit and clearance of cheques gives the payer time to arrange funds in the account. 2) Post-dated cheques allow payment for goods and services in advance, even if funds are not available at the time of issue.

• The beneficiary’s name is the only requirement to pay through a cheque whereas e-payments require many additional details.

• Cheques allow anonymity in payments through bearer instruments.

• Issuing cheques is quite economical to the drawer since most banks offer some cheque leaves free of cost. Collection charges too are waived in many cases. At present in India, there are no charges for local cheque collection and for speed clearing cheques of

up to Rs. 1 lakh. On the other hand, electronic payments attract some charges.

• Limits on transferable amounts constrain online payments; account holders too are at times allowed to set their limits per transaction. Issuing of cheques has no ceiling (apart from some cheques which have a specific upper limit).

• Convenient and Flexible: There is no need to carry cash.

• More secure than cash: If stolen, the bank can be informed immediately and the transaction stopped.

• Certain groups of people still prefer cheques, for instance, visually challenged and home-bound individuals (due to age or illness).

Disadvantages of cheques

• Expenses in cheque usage and issuance towards printing, ensuring security, postage charges, clearing costs, handling costs etc.

• The time lapse before the actual credit or debit of a cheque may lead to accounting errors for the account holder or result in overdrawing of the account. The issuer needs to keep track of his account balance to avoid issuing cheques without sufficient balance.

• Cheques could get stolen or lost. It is necessary to keep cheque books under lock and key.

• Since a cheque is basically paper, it can be easily tampered with, leading to fraudulent transactions.

• Any person handling the cheque has easy access to the account number mentioned on the cheque.

• Cheques will be returned if the signature on the cheque does not match that in the bank’s files. Inadvertent errors by the account holder while signing the cheque may cause it to be returned.

• Bank holidays, system failure, insolvency, strikes etc. can adversely affect the clearing process.

Latest in paper-based clearing in IndiaCheque truncation system (CTS 2010)

CTS 2010 is the prescribed standard by the RBI for cheques issued by all Indian banks to facilitate faster clearing. Instead of the collecting branch sending the physical cheque to the paying bank, an electronic image of this cheque with relevant information like the MICR code, date of presentation, presenting banks etc. is transmitted to the drawee branch by the clearing house, hastening the entire cheque clearing process.

In CTS, the presenting bank/branch captures the MICR band data and cheque images using an Image Capture System comprising a scanner,

Core Banking Solution and/or other applications. Presenting and paying banks have an interface/gateway called Clearing House Interface (CHI), which enables banks to transmit images and data in a secure manner to the clearing house.

The presenting bank sends this digitally encrypted and signed data with captured images to the clearing house, where this data is processed, a settlement figure arrived at and the images and data routed to the paying banks. This is called presentation clearing. The drawee banks receive data and images for processing the payment through their CHIs, which also generate the return file for instruments that are unpaid.

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Source:http://www.bemoneyaware.com

The RBI deadline for all banks to ensure that all non-CTS-2010 standard cheques are withdrawn and replaced with CTS-2010 Standard cheques has been extended to July 31, 2013. Non-CTS- 2010 standard cheques that are presented beyond the extended period will continue to be accepted but will get cleared at less frequent intervals.

The only changes customers need to incorporate while using the new cheques are:

• Use image-friendly, dark-coloured inks while writing the cheques.

• Avoid alterations or corrections and if inevitable, use a fresh cheque altogether.

Cheques for CTS 2010

CTS-2010 standard cheques have been introduced in the country to standardize cheques issued by banks and reduce incidence of fraud.

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The new cheque format must display these security features:

1. The bank logo must be printed with invisible ink (ultra-violet ink) and branch address along with IFSC code printed beside it, on top of the cheque.

2. A photocopy of the cheque should display a pantograph below the account number that reads “VOID/COPY.”

3. Cheque Printer details with CTS-2010 must be displayed on the left side of the cheque.

4. The new rupee symbol should precede the “amount in figures” field.

5. “Please sign above” must be mentioned on the bottom right side of the cheque.

Some others security features include:

• Date in dd/mm/yyyy format with boxes.

• Watermark “CTS INDIA” to be visible when cheque is held against a light source.

Effect of CTS 2010 on customers

• Fresh CTS-2010 compliant cheques will have to be issued for all post dated cheques issued previously.

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• All cheques issued after July 31, 2013, need to be CTS-2010 compliant.

Benefits of cheque truncation system

1. Quicker cheque clearance and settlement process with shorter clearing cycles and faster credit of money into an account.

2. Reduced cost of storage – electronic storage is considerably cheaper.

3. No fear of cheques being lost in transit, since cheques will not be physically transferred.

4. Proposal to integrate clearing locations of all banks regardless of their location, resulting in a standard clearing system across India, enabling cheque clearances within 24 hours.

5. Easy detection of fraud by intercepting altered and forged instruments which pass through the electronic imaging system.

6. Improved operational efficiencies of our banking system resulting in better customer service and liquidity position for customers.

In RBI’s words, CTS brings elegance to the entire activity of cheque processing and clearing and offers several benefits to banks in terms of cost and time savings, including human

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Future of paper-based clearing in IndiaWith the increasing usage and popularity of electronic payment modes, a substantial decline in cheque usage is inevitable, all too evident from statistics showing fewer cheques being cleared.

Promote electronic payment modes

Some of RBI’s suggestions to discourage cheque usage and promote electronic payments are:

a) Total stoppage of cheques above a threshold limit: RBI has mandated since August 2008 that payments greater than Rs.10 lakhs between RBI-regulated entities/markets have to be made via electronic modes.

b) Limits set or charges levied on cheque book issue: Free cheque books are to be kept to a minimum and charges levied beyond this fixed number, depending on the customer’s cheque usage history.

c) Levy charges on cheque usage to both the issuer and beneficiary: The drawer can be made to bear charges when he issues cheques. These charges may be at par with

charges for electronic payment systems like NEFT/RTGS etc. Cheque collection charges may also be levied on the beneficiary of the cheque (even local ones) beyond a certain amount. For corporate entities, these charges should be levied irrespective of amount limits, and can be proportionate to the cost incurred by the collecting banks.

i. Repayment of loans should be entirely through electronic payment modes and PDCs completely stopped. Existing ones need to be converted to electronic mandates within a stipulated time.

ii. Credit card payments should be through electronic modes only and card holders paying with cheques penalized heavily.

d) Avoid transition to cash transactions: Ensure that the decrease in cheque usage does not lead to an increase in cash transactions. Frequent, high-value cash withdrawals may also be charged.

e) Widespread awareness and accessibility to electronic payments: Electronic payments

resource rationalization, cost effectiveness and business process re-engineering.

Cheque payments versus electronic payments

Chart 1 below shows that in terms of value, electronic payments have increased in comparison to cheque payments.

Chart 2 shows that even though in terms of volume cheques constitute around 52% of total payments, their share shows a downward trend.

Source: RBI Annual Report

Source: RBI Annual Report

Chart-1: Non-cash Payments Turnover: Paper vs Electronic - Value

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Chart-2: Non-cash Payments Turnover: Paper vs Electronic - Volume

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ConclusionCompletely phasing out cheque usage in the near future is next to impossible. However, the time may be ripe to aggressively promote electronic payment modes over cheques. System providers, payment gateway providers, utility companies, intermediaries, corporate users

including educational institutions etc. need to work together and ensure that electronic payment modes are easy to use, reconciliation and reporting mechanisms along with grievance handling are efficient, with least inconvenience to customers.

Madhumita ShyamSenior Associate Consultant, Finacle-Payments, Infosys

References 1. www.rbi.org.in/

2. www.moneylife.in

3. aitec.usp.net

4. www.bemoneyaware.com

5. m.economictimes.com

should be easily accessible to the public with no disparity in demand and supply of such services.

f ) Liability of customers and banks: Customers need to be made aware of the extent of

liability, protection provided by and obligation of banks in the event of unauthorized transactions using customer credentials. Greater trust in banks would encourage use of electronic payment modes more often.

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