#43 A Black Box

RBI's strange regulations, NEFT 101 and Lending Updates...

Apr 03, 2021

Hey everyone!

A lot of subscribers mailed asking for more details about the job update last week, so here it is:

Personal update + hiring: I'm super excited to share that I have joined @RaiseTheBarHQ as their first Product Manager! Raise is building everything that I'm passionate about. Hope to learn and contribute to the best I can! Wish me luck! 🤓

On to this week’s round of updates:

What’s up with RBI?

I’m sure you’re aware about the recent hullabaloo over “recurring payments”. If not, here’s a recap (skip to the end if you’re aware):

If you’ve ever used auto-pay recurring transactions, you’ll know that the current state does not require you to approve the transaction each month. It also does not remind you before the amount is debited.
It is expected that once the consumer has submitted the mandate (approval), he/she is aware of the transaction. However, starting April 1st, 2021, as per RBI, banks were supposed to not only remind you 5 days prior to the debit, but also ask for an OTP each month! (for transactions above ₹5,000)

I pay each month for my email ID (anirudha@bankonbasak.com) through my credit card. Here’s what Google sent me on the morning of 31st March:

Email sent by Google Payments Team asking me to manually pay for my monthly paid email service

This was primarily because implementing RBI’s desired changes required a complete overhaul of the current system processes. Due to covid, banks were not able to complete them. And RBI wasn’t budging. In the end, companies threw their hands up in the hair and plainly asked customers to face the brunt.
Now remember, RBI always thinks about the customer first. So it was kind of expected they’d roll it back. However, they waited till the last moment. On 31st March, around 3pm, they extended the deadline by another six months. Of course, RBI was not happy. At all.

Here’s an excerpt from the RBI notification:

Read the highlighted section. RBI is gangsta!

Now that you’re up to date, here’s the good and the bad:

The Good:

As a customer, I will certainly love to reminded about an incoming transaction, at least once. I had subscribed to BQ Blue last year and completely forgot about it. For four months, I tried to understand who was deducting 700 bucks from my account each month. The cryptic detail (MSI/Quintillion) didn’t help either.

I might be bothered about inputting a OTP each month though.

The Bad:

The regulations might be good for customers, but it’s definitely bad for businesses and expensive for banks. A 2014 article from Quartz India explains how Indian software companies (a.k.a. SaaS), which relied on monthly payments from their users, such as FreshDesk and Practo, had to register themselves abroad to bypass the stringent regulations that selectively disallowed dynamic recurring transactions or required two-factor authentication for credit cards, a step which other credit cards from around the world did not have. I say “selective” because:
1. Hotels were suddenly allowed, but not software companies.
2. Flipkart was given a certification to bypass this step, but others were not.
Despite all the comprehensive data that it has, RBI is not being transparent about the figures this time. According to multiple sources, the entire industry for recurring transactions is worth ₹2,000 crores. However, how much of this susceptible to fraud? If it is not much, is it even worth it? A lot of customers prefer the convenience anyway.
All these measures display a bias for NPCI. For instance, mutual fund SIP payments are automated through NPCI's NACH platform which wasn’t going to be affected. Many also believe that this move was indirectly going to benefit UPI Autopay (same recurring transaction concept, but using UPI Pin, instead of OTP), which was launched last year. While the technology is great, there has been a higher incidence of fraud in UPI compared to credit/debit cards. So who exactly is RBI protecting?

Just like the government, RBI has also helped platforms like UPI and Rupay proliferate. While good for users, does it really help businesses and banks? For a more detailed journey through RBI’s steps leading up to this, I suggest you read today’s article by The Ken.1

How does this work?

Bank processes are a black box. Even though RBI literature is quite comprehensive, the actual method could be quite different. A better understanding will help you understand why banks fail (or succeed) in certain areas.

So starting this week, this is going to be a new segment. Whenever I read about/find a good explanation on a particular process, I’ll try to highlight it here.

Today we will understand NEFT, courtesy Srikrishnan’s tweet:

Deepak Shenoy @deepakshenoy

Thread. Banks keeping less cash in their rbi accounts causes settlement delays..

Srikrishnan @GeistNoetic

@mkart72 @deepakshenoy 1/n Although we say payment systems it is actually a 3 step process, pymnt, clearing and settlement. Payment is what we as customers initiate, clearing is the interim process which identifies which bank owes how much to other banks (can be favorable or adverse net effect).

Like I said, RBI has already explained the NEFT mechanism in their website:

As you can see, the detailed Step 1 is more to do from the consumer end. But how does it play out on the banks’ end?

For starters, NEFT, unlike claimed by RBI to be 24x7, is actually a half-hourly batch process.
It is not a direct bank account to bank account transfer - although it does appear that way to a consumer. It is a actually a three-step process:
- Payment (from the consumer end)
- Clearing (initiating bank calculating how much they owe to or are owed from recipient bank) - done by NCC (NEFT Clearing Centre) or NPCI
- Settlement (when banks finally pay each other) - done through nostro account kept with RBI
Banks need to maintain balances in these nostro accounts kept with RBI (just like you have a minimum balance in your savings account)
The second step, i.e., “clearing” is the process that happens every half hour. Once done, settlement is “triggered” - the available balance in the nostro account is used to complete the process.

Why is this important?

Because now you know why many NEFT transactions were pending since 31st March, even though this is supposedly a “real-time” transaction process.

During extended holidays or important dates like quarter-end or financial year-end, banks have little incentive to let their precious funds lie idle in these clearing nostros and hence the settlement fails and their customers face the brunt!

If you’re curious about a bank process as well, do mail me and I’ll try my best to simplify it.

More from this week…

Corporate Lending in India Awaits its Moneyball Moment (Mint): This article, by a visiting faculty at IIM Calcutta, talks about the current state of decision-making while disbursing large corporate loans. His argument is that all bad loans can’t be attributed to corrupt borrowers or corrupt bankers. Some of them are due to a gap at the loan approval stage. You see, these large loans are not approved exclusively based on the financials. There’s some (actually, a lot) of human judgement involved as well. So loans are at a risk of being disbursed based on mood, targets or even the weather! How do you measure human emotions? Like in the movie Moneyball (great watch, btw), can we use analytics to improve this?
Retail And Industry Loans Come Neck And Neck For The First Time Ever (BQ): I’ve previously highlighted in this newsletter how personal (and other retail) have grown at a break-neck speed since the coronavirus. Well, it seems they’ve finally caught up with the big guys:

So a few factors that led to this:

Bad loans problems at the corporate side (compare their GNPA ratios), which has made bankers averse to this segment, even before covid hit.
Improved credit-scoring, faster authentication through Aadhaar and PAN cards, better data availability and digital reach on individuals - all of this has been an enabler.

Experts believe that retail GNPA may rise to 4% in the coming quarters (quite believable as covid has impacted this segment severely). Let’s just hope bankers don’t burn their fingers again, in the quest for growth.

I love feedback. If you want me to cover a particular news, want to get featured, write a guest post or wanna simply say hi, do reach out to me at anirudha@bankonbasak.com or LinkedIN or Twitter. Meanwhile, like this post and share it around?

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