Indian banking must switch to electronic payment system

Whether it is bringing banking to the masses or the disbursement of government benefits, the existing systems are clearly unable to keep pace with the needs of India's population. In some cases, the reasons are purely financial - it is expensive to build staff and operate a new bank branch, and the kind of high-volume, low-value transactions that take place in a rural economy might not offset these costs.

As a result, people are denied access to the financial services they need most: credit, so that they can borrow in bad times; savings and investment products, so that they can save in good times; and insurance, so that they can protect them-selves against unforeseen circumstances and acts of nature - an accident, an illness, a crop failure or a flood. If these financial products are to be made avail-able to everyone, the prices of such products must come down, and the associated risks must be offset by spreading them across the entire population.

Technology

Whether it's the printing press or the personal computer, technology has been the skeleton key for enabling access, the great leveller when it comes to making things cheaper and easily available. The ubiquity of the mobile phone in India is a textbook illustration. Why shouldn't this be true of the financial sector as well? In most financial transactions, it is in the last mile - where systems finally meet consumers - that things begin to break down. Here, costs are the problem.

Another is the fact that cheques and cash are expensive to manage. A significant amount of time and effort is expended in shepherding them through the system and finally into the recipient's hands. The only way to bridge the last-mile gap will be through the widespread adoption of electronic payment systems.

The government must be the initial driver, using the heft and reach of its social security schemes to drive the adoption of an electronic payments model. As momentum grows, private players can step in.

We envision electronic payments as the first step on the ladder of financial inclusion. As soon as people have bank accounts, they become eligible for other financial services as well. The next rungs of the ladder are loans, insurance schemes of all kinds - for crops, health, life, accidents - and pension schemes.

As people move upward, they become integrated into India's formal financial sector, with all its attendant benefits. Electronic payments will also help plug the leaks in government disbursement systems that drain precious resources away from the intended recipients. Once money is transferred directly into a beneficiary's bank account, the entire process becomes transparent. Payments can be easily traced and collected, and corruption will automatically drop, so people will no longer have to pay to collect what is rightfully theirs. The estimated savings from such a model are enough to boost the country's welfare spending by 25 per cent, or increase the per capita income of every poor household in India by 15-20 per cent.

Corruption

In his book, The End of Money, journalist David Wolman narrates a story about the unexpected consequences of switching to an electronic payments system. In 2010, local police in the Afghan province of Wardak started receiving their monthly salary electronically. When they checked their bank balances on their cellphones, they were stunned to find that their salaries had jumped 30 per cent overnight. This was not an accounting error - the extra 30 per cent was the amount that corrupt senior officials in the system had been skimming from their cash payments.

For an electronic payments system to work, two major requirements are the ability to identify a beneficiary correctly, and a way to ensure that the money is reaching only the intended recipient. This is where Aadhaar enters the picture. Aadhaar now serves as a link between the government and the people, making it easy both for the authorities to transfer payments to the correct individual's bank account, as well as for people to easily withdraw money using Aadhaar to authenticate their identity.

Money laundering

India is the fourth largest user of cash in the world. What makes cash-based transactions such an attractive prospect for most Indians? For one, there are no extra transaction costs involved when you pay with cash, costs that often make it financially unviable for smaller merchants to switch to electronic payments.

A cash transaction is immediate, as simple as a banknote moving from one hand to another. You don't have to worry about a computer system crashing and losing your transaction. A thousand rupees loaded into Ola's digital wallet allows you to only buy taxi rides; the same thousand rupees as a banknote in your pocket can buy you anything under the sun. On the flip side, it's also easier to launder money and evade paying taxes if you're using cash, since those transactions are much harder to trace.

Financial inclusion is one very good reason to shift from a cash-based system to one that operates on electronic payments, but there are other compelling reasons as well. Cash is a very expensive habit for the nation to cultivate. The cost of printing, managing and moving money around the country is as huge. In the period 2010-11, the RBI spent nearly Rs 24 billion on printing money, and an additional Rs 455 million on distributing that money nationwide.

Cash has other problems too - it can be lost or stolen, and a wet, torn or otherwise damaged banknote is not accepted by most businesses.

Electronic payments, on the other hand, can greatly reduce friction in the economy, since transactions are simpler, faster and easier to trace. If the government were to make the switch to electronic payments, the savings in one year alone would be enough to pay for the entire cost of setting up the system.