DAMODARAM SANJIVAYYA NATIONAL

LAW UNIVERSITY

PROJECT ON: ELECTRONIC FUND TRANSFERS AND ITS LEGAL REGIME

PROJECT BY: MAITRAIE REDDY 201130 SEMESTER: VIII SEMESTER

SUBJECT: BANKING LAW

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ELECTRONIC FUND TRANSFER

AND ITS LEGAL REGIME

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CONTENTS

1.INTRODUCTION 2. DEFNITIONS 3. ELECTRONIC CLEARING SYSTEM (ECS) 4. LEGAL REGIME 5. NATIONAL ELECTRONIC FUND TRANSFER (NEFT) a). History b). Objectives c). Coverage d). Definitions e). Procedure for Participation (i) Admission (ii) Suspension (iii) Withdrawal from Participation (iv) Cancellation of Letter of Admission f). Process Flow g). Inter-Bank Settlement h). Rights and Obligations i). Service Charges j). Dispute Resolution Mechanism k). Amendment to Procedural Guidelines

6. BENEFITS OF NEFT 7. LACUNAE IN NEFT 8. DISHONOUR OF ELECTRONIC FUNDS 9. CONCLUSION 10. RECOMMENDATIONS 11.BIBLIOGRAPHY

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1.INTRODUCTION

Electronic funds transfer (EFT) is the electronic exchange, transfer of money from one account to another, either within a single financial institution or across multiple institutions, through computer-based systems.

The term covers a number of different concepts:

Wire transfer via an international banking network. Cardholder-initiated transactions, using a payment card such as

a credit or debit card. Direct deposit payment initiated by the payer. Direct debit payments, sometimes called electronic checks, for which a

business debits the consumer's bank accounts for payment for goods or services.

Electronic bill payment in online banking, which may be delivered by EFT or paper check.

Transactions involving stored value of electronic money, possibly in a private currency.

Electronic Benefit Transfer.

2. DEFNITIONS

"Any transfer of funds that is initiated by electronic means, such as an electronic terminal, telephone, computer, ATM or

"Electronic banking, also known as EFT, uses computer and electronic technology as a substitute for cheques and other paper transactions."1

It is "the use of telecommunications networks to transfer funds from one financial institution, as a bank, to another, or to withdraw funds from one's own account to deposit in a creditor's."2

The use of EFT results in the instantaneous movement of money. The additional time that the funds are available to earn income can more than offset the fees charged by institutions for this service. Its also called wire transfer.3

EFT is "a standard mechanism for electronically transmitting funds between two parties."4 An example of widely used EFT application that it cites is `Direct Deposit', in which pay is deposited straight into an employee's bank account.

"Transactions are processed by the bank through the Automated Clearing House (ACH) network, the secure transfer system that connects all US financial institutions.

1 www.ftc.gov.2 www.infoplease.com.

3 http://dictionary.reference.com, from `Wall Street Words'.4 Glossary of Statistical Terms on http://stats.oecd.org

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For payments, funds are transferred electronically from one bank account to the billing company's bank, usually less than a day after the scheduled payment date," explains the Web site.

The Electronic Clearing System (ECS) is the Indian version of the ACH in other countries for catering to bulk payments.5

3. ELECTRONIC CLEARING SYSTEM (ECS)

The Vision document declares as its mission statement6,

“The establishment of safe, secure, sound and efficient payment and settlement systems for the country.” And its glossary explains ECS (Credit) as credit clearing that ensures "multiple repetitive credits to the accounts of constituents of banks situated at various branches of banks on the basis of a single debit to the account of a corporate customer called the `user'," as for instance in payroll that `Direct Deposit' speaks about.

RBI introduced the ECS credit scheme to reduce the pressures on the cheque clearing and settlement process, and to improve customer service, especially for high volume, low value clearing. "An ECS debit scheme was also brought to market to facilitate payment of charges to utility services."

A common example is of paying one's telephone bills through ECS debit. These are also called “preauthorized transfers”. ECS is the ACH system in India, while EFT is the system for single/individual payments. EFT is safe, secure, efficient, and less expensive than paper cheque payments and collections.

4. LEGAL REGIME7

In 1995, the Reserve Bank had set up the Committee for Proposing Legislation on Electronic Funds Transfer and other Electronic Payments (Chairperson : Smt. K.S.Shere). The Shere Committee had recommended a set of EFT Regulations by the Reserve Bank under the Reserve Bank of India Act,1934 and amendment to the Bankers’ Books Evidence Act,1881 as short term measures and promotion of a few Acts like the

Electronic Funds Transfer Act, the Computer Misuse and Data Protection Act etc. as long term measures. The Reserve Bank has already initiated steps for framing of EFT Regulations. The Government of India have also initiated steps for promoting Information and Technology Act, 1999 and consequential amendments to the Reserve Bank of India Act, 1934, the Bankers’ Books Evidence Act, 1881 etc.

5 Payment Systems in India Vision 2005-08' dated May 3, 2005, available onwww.rbi.org.in6 www. rbi.org.in 7 ZeroBase@TheHindu.co.in

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In India there is no separate law regarding electronic fund transfers till date. A few areas of EFT are governed under the Payment and Settlement Systems Act 20078. As a first step, the RBI has recently set up a Board for Payment and Settlement Systems.

There is the Model Law on International Credit Transfers (1992) from UNCITRAL (the United Nations Commission on International Trade Law). The Committee on Payment and Settlement Systems of the G-10 countries (CPSS) set up under the auspices of the Bank for International Settlements (BIS) has formulated best practices in the form of Core Principles for Systemically Important Payment Systems (SIPS)9.

Till a new law is in place to govern EFT, the good old Negotiable Instruments Act, 1881, will hold the fort. In India EFT is in application through the National Electronic Fund Transfer (NEFT)

The Payment and Settlement Systems Act 2007 regulates and oversees the various payments and settlement systems in India. In an era of online transactions, this new law is likely to become a hotbed of litigation in the near future. Law Relating to Electronic Transfer of Money is a commentary on the Payment and Settlement Act 200710. It is a handy and comprehensive reference on all related Acts, Regulations, Notifications, Circulars and Guidelines. The Act makes the dishonour of online transactions punishable in the same manner as the dishonour of cheques under s. 13811.

Admission of electronic files as evidence and preservation of records:

The Shere Committee had discussed the issues of admitting electronic files as evidence and of preserving electronic records and recommended the need to amend the Bankers' Books Evidence Act, 1881 on the lines of the Customs and Central Excise Laws (Amendment) Act, 1988 and Central Excise and Salt Act, 1944 for the purpose. The Government of India is processing the draft Bill amending the Bankers’ Books Evidence Act, 1881. This is a welcome development and would meet the legal requirement of acceptance of contracts, documents etc. in electronic form as evidence.

The Committee considered certain provisions of the proposed Electronic Commerce Bill for admitting electronic records / signatures as evidence. Clauses 9, 10, 11, 12 and 14 of this proposed Bill, which are relevant in this connection, are given in Annexure 16. It is worth mentioning that while clauses 9, 10 and 11 of this Bill are based on the UNCITRAL Model Law, clauses 12 and 14 are based on Singapore Electronic Transactions Act. As and when the Electronic Commerce Bill is passed, these provisions will be made applicable, ipso facto, to electronic funds transfer transactions as well.

8 sec 25, sec 23 etc9Model/Illustrative Payment and Settlement Systems Bill' in a report of the Committee on Payment Systems dated November 28, 2002, last seen: 23rd march 2013 at 3:13 pm10 Act no 51 of 200711 Negotiable Instruments Act, 1881

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Funds Transfer through EFT Systems from Tax Compliance Angle

The Shere Committee had recommended that the Central Board of Direct Taxes (CBDT) may be requested to take up the question of clarifying and, if required, amending the relative provisions of the Direct Tax Laws like Section 40A of the Income-Tax Act, 1961. The Committee however felt that, for according the funds transfer under the EFT system the same status of payment as one made by an A/c payee cheque, suitable technology may have to be developed for treating such transfers as A/c payee transfers. A mere recognition to that effect by the CBDT may not be adequate to treat such transfer as A/c payee cheques. Legal provisions need to be made if such recognition has to be given. The first test would arise when paper instruments like cheques are used along with the use of EFT system. So long as both the systems are in existence at the same time, it would require either amendments to the Negotiable Instruments Act or a separate legislation to deal with the matter.

5. NATIONAL ELECTRONIC FUND TRANSFER (NEFT)

1. History

Mr Bimal Jalan, former governor of RBI for the first time proposed to commence NEFT using the facilities available under the Structured Financial Messaging Solution (SFMS) over the Indian Financial Network (INFINET) in 2002. The Annual Policy Statement of April 2002 emphasized the usage of EFT on a large scale to bring about greater efficiency in the movement of funds, and reduction in risks in funds transfer.

Mr Y.V. Reddy, former RBI governor said, in his Mid-term Review of Annual Policy for 2005-06 that NEFT would be implemented in phases. "By end-December 2005, NEFT would be operationalized in 34 banks. By end-June 2006, the remaining banks are expected to be part of the system."

In the very same year the Reserve Bank of India (RBI) commenced the live operation of the National Electronic Funds Transfer (NEFT) with eight banks are on the NEFT network and only one settlement a day, the system assures instant fund transfer for retail customers, instead of the usual week for inter-city transfers, and half that time for intra-city ones.

2. Objectives12

(1) To establish an Electronic Funds Transfer System to facilitate an efficient, secure, economical, reliable and expeditious system of funds transfer and clearing in the banking sector throughout India, and

(2) To relieve the stress on the existing paper based funds transfer and clearing system.

3. Coverage

12 National Electronic Funds Transfer System Procedural Guidelines, November 2005, revised on September 2008 and April 2011, last seen: 23 march 2013 at 3:39 pm

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This system applies to participating banks/ and branches in the system as notified by Reserve Bank of India from time to time on its official Web site13.

4. Definitions

The guidelines define terms like NEFT Clearing Centre. NEFT SFMS message, NEFT Service Centre, NEFT System, Sending/Originating Bank, SFMS Message etc.

5. Procedure for Participation

i) Admission: To be eligible to apply for admission as a participating bank,

(a) Shall be a bank. Regional Rural Banks (RRBs) can also participate through their sponsor bank in accordance with the guidelines issued by RBI.

(b) Shall be a member of the Real Time Gross Settlement (RTGS) System.

(c) Shall have installed SFMS.

(d) Shall meet the other prescribed eligibility criteria / conditions which are notified by RBI from time to time (eligibility criteria for the present is indicated in Annexure IV).

Provided that, all or any of the above conditions may be relaxed or dispensed with, if so decided by the Reserve Bank of India.

List of participant banks and bank-branches will be displayed on website of Reserve Bank of India.14

Every application shall be accompanied by an undertaking in the specified form to abide by the Procedural Guidelines in the event of admission.

Letter of Admission as specified in Annexure II (Form : NEFT-IB) to every bank admitted to the NEFT System will be issued by Reserve Bank of India.

(ii) Suspension :

(a) If a participating bank has defaulted in meeting its settlement obligations or paying any charges or fees or complying with any procedural guideline provisions or for any reasons specified at paragraph 5(iv), the Letter of Admission issued to it is liable to be kept under suspension for such period as may be specified in the order of suspension.

(b) Every order of suspension shall be notified immediately to all the participating banks and institutions including the bank or institution against which the order of suspension is passed.

(c) An order of suspension may be reviewed and may be revoked at any time by the Reserve Bank of India upon representation received from the concerned bank or on its own. Every revocation shall be notified immediately to all

13 http://www.rbi.org.in/Scripts/neft.aspx.14 http://www.rbi.org.in/Scripts/neft.aspx.

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participating banks.

(d) A participating bank shall not, while any order of suspension is in force against it, be entitled to send or receive any NEFT message or otherwise to affect any funds transfer in the NEFT System.

(e) Provided that a suspension shall not affect the obligations of the suspended bank or institution, whether incurred before or after the suspension.

(iii) Withdrawal from Participation15:

(a) Any participating bank or institution may, by giving a notice of one month to the Regional Director, Reserve Bank of India, Mumbai Regional Office, withdraw from participating in NEFT System.

(b) No notice under these guidelines shall be effective unless it is given in writing and before the expiry of one month from the date of receipt of notice by the Regional Director, Reserve Bank of India, Mumbai Regional Office, Shahid Bhagat Singh Marg, Fort, Mumbai – 400 001.

(c) Notwithstanding its withdrawal, a bank shall discharge all its payment obligations arising out of fund transfers attributable to it, whether effected before or after the withdrawal became effective.

(d) The withdrawal of any participating bank shall be notified to all the participating banks by the Regional Director, Reserve Bank of India, Mumbai Regional Office, Shahid Bhagat Singh Marg, Fort, Mumbai - 400 001.

(iv) Cancellation of Letter of Admission:

Letter of admission issued to a bank may be cancelled by the Reserve Bank on it being satisfied that such bank has

(a) Defaulted in complying with any Regulations / Procedural Guidelines / admission terms and conditions / instructions issued from time to time.

(b) Been placed under an order of moratorium or an order prohibiting acceptance of fresh deposits or an order of winding up or in respect of which a provisional liquidator has been appointed.

(c) Stopped or suspended payment of its debts.

(d) Failed to get the order of suspension passed against it under Regulation 8(e) of the Uniform Regulations and Rules for Bankers‟ Clearing Houses (URRBCH) revoked within a period of three months from the date of order of suspension.

(e) Has conducted its transactions in the NEFT System in a manner prejudicial / detrimental to the interest, integrity or efficiency of the System.

15Sl. 5 (c) of National Electronic Funds Transfer (NEFT) System Procedural Guidelines 2011

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No order of cancellation shall be passed without first giving an opportunity of hearing to the bank concerned.

Every order of cancellation shall be notified to the respective bank and also to all other participating banks in the NEFT System.

Notwithstanding the order of cancellation of Letter of Admission passed against it, such bank shall discharge all its payment obligations arising out of the funds transfers effected in the NEFT System.

6. Process Flow16

The parties to a funds transfer under this NEFT System are the sending bank, the sending Service Centre, the NEFT Clearing Centre, the receiving Service Centre and the beneficiary branch.

The following steps are involved:

a) Request for NEFT by Bank Customer / Any Person

b) Data Entry at the Sending Bank Branch

c) Processing/Data Uploading and Sending to NEFT Service Centre

d) Transmission / Submission of NEFT Message to the NEFT Clearing Centre

e) Processing and Transmission of NEFT Message to the Beneficiary Banks

f) Data Validation at the Receiving NEFT Service Centre

g) Payment to Beneficiary

h) Revocation of Payment Instruction

i) Acknowledgement / Positive Confirmation by the Beneficiary Bank and Return in Case of Non-Credit

j) Sender to be advised in Case of Returns

k) Beneficiary to be Advised of the Receipt of Funds

l) Holidays

7. Inter-Bank Settlement17

16 Sl. 6 of National Electronic Funds Transfer (NEFT) System Procedural Guidelines 201117 Sl. 7 of National Electronic Funds Transfer (NEFT) System Procedural Guidelines 2011

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(i) Inter-bank Funds Settlement at Reserve Bank: Every participating bank and admitted institution shall open and maintain in the NEFT Clearing Centre, a settlement account for settlement of payment obligations arising under the funds transfer executed under the NEFT system.

(ii) Finality of Settlement : The settlement so arrived by through multilateral netting shall be final and irrevocable, in terms of section 23 of the “Payment and Settlement Systems Act, 2007” as soon as the same is determined in terms of the procedures notified by RBI.

(iii) Settlement and Default Handling Procedure: Aspects relating to finality of settlement and default handling in the event of failure-to-settle situations will be in accordance with the Directive on Settlement and Default Handling Procedures issued by RBI and as duly amended from time to time.

8. Rights and Obligations18

Every sender/ originator, sending bank, receiving bank, clearing center and the beneficiary bank will have certain rights and obligations.

General Rights and Obligations of Sender / Originator, Participating Banks or Institutions

Rights and Obligations of the Sender / Originator Rights and Obligations of Sending Bank Obligations of the Sending NEFT Service Centre Obligations of NEFT Clearing Centre Obligations of the Receiving NEFT Service Centre Rights and Obligation of Beneficiary Bank

9. Service Charges

The service charges to be levied by the originating banks would be in terms of the instructions issued from time to time under the framework of charges to be levied by the banks for offering various electronic products

There are no processing charges levied by the NEFT Clearing Centre up to March 31, 2011. The same would be reviewed periodically. The RBI may, if it so desires in future, decide to levy any other charge / fee as also the quantum thereof. Beneficiary Banks would not claim service charge for passing on the credit t the beneficiaries.

10. Dispute Resolution Mechanism

The mechanism for resolution of disputes will be in accordance with the Directive on Dispute Resolution Mechanism issued by RBI and as duly amended from time to time.

11. Amendment to Procedural Guidelines

18 Sl. 8 of National Electronic Funds Transfer (NEFT) System Procedural Guidelines 2011

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The Procedural Guidelines can be amended only by RBI. RBI may also, by issuance of a circular, amend the procedure19.

6. BENEFITS OF NEFT

NEFT offers many advantages over the other modes of funds transfer:

The remitter need not send the physical cheque or Demand Draft to the beneficiary.

The beneficiary need not visit his / her bank for depositing the paper instruments.

The beneficiary need not be apprehensive of loss / theft of physical instruments or the likelihood of fraudulent encashment thereof.

Cost effective. Credit confirmation of the remittances sent by SMS or email. Remitter can initiate the remittances from his home / place of work using the

internet banking also. Near real time transfer of the funds to the beneficiary account in a secure

manner.

7. LACUNAE IN NEFT

Lack of legal clarity

Lack of an apposite provision in law for regulation and supervision of these entities.

Lack of a monitoring mechanism leading to apprehension of participants and end-users

Doubts on the safety and security of the payment systems

8. DISHONOUR OF ELECTRONIC FUNDS

Reserve Bank of India vides its circular20 have highlighted that section 25 of the Payment and Settlement Systems Act, 2007 accords the same rights and remedies to the payee (beneficiary) against dishonour of electronic funds transfer instructions for insufficiency of funds in the account of the payer (remitter), as are available to the payee under section 138 of the Negotiable Instruments Act, 1881.

The sub-section (5) of the section 25 of the Payment and Settlement Systems Act, 2007 provides for punishment of two years and twice the amount of electronic funds transfer instruction, or both for dishonour of such electronic funds transfer on par with

19 www.rbi.org20 Circular no. DOC/2011-12/191 DPSS. O.PD.No.497/02.12.004/2011-12 issued on 21 September 2011, last seen: 23rd march 2013 at 4: 47 pm

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the penalties stipulated for dishonour of cheques under the Negotiable Instruments Act,1881.

9. CONCLUSION

Hence it is very clear that the system of electronic fund transfer (EFT) has proved to be beneficial in the Indian baking scenario in reducing the paperwork and increasing the efficiency and the speed of banking system in the country.

The scheme would prove to be even more beneficial when there is a proper statute to govern the system like the Electronic Fund Transfers Act 21 of the United States. There is an urgent need to enact a new law on the e transfers independent of the Negotiable Instruments Act and the Public Settlement Systems Act, with respect to the dynamic Indian society to make the scheme even more effective and successful.

A proper mechanism of guidance and dispute settlement are also suggested.

Legal issues relating to electronic transaction processing at banks are very many and the need to address them by amending some of the existing Acts and by promoting legislation in a few hitherto unexpected areas has assumed critical urgency. Necessary legislative support is essential to protect the interests as much of the customers as of the banks / branches in several areas relating to electronic banking and payment systems.

This is specially required to establish the credibility of ECS and EFT schemes based on the electronic message transfer. Since the Reserve Bank is embarking on large electronic schemes such as the nation wide RTGS, it is time that efforts are made to bring about necessary legislative framework that synchronises and synthesises with the initiatives taken by the Government of India, Department of Electronics for promotion of the Information Technology Bill, 1999 and / or the Electronic Commerce Bill, 1999.

10. RECOMMENDATIONS22

21 Codified to 15 U.S.C. 1601 note

22 http://www.rbi.org.in/scripts/PublicationReportDetails.aspx?UrlPage=&ID=28

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1. The Reserve Bank of India Act, 1934 needs to be amended with a view to providing RBI with the desired regulatory and supervisory powers on payment and settlement systems.

Simultaneously there is also a need to formulate a separate legislation on electronic fund transfer system. This will inter alia facilitate multiple payment system by banks and financial institutions.

2. The RBI and IBA should pursue with the Department of Telecommunications (DoT) / other competent Authority to permit encryption of data files / messages transmitted through communication channels.

This would facilitate easier access to remotely located branches to the INFINET network. The standardized financial messages would also get necessarily encrypted irrespective of the type of network used - private or public.

3. As recommended by the Committee for Proposing Legislation on Electronic Funds Transfer and other Electronic Payments, amendments to the Bankers’ Books Evidence Act, 1881 and other relevant Acts would need to be carried out.

This would facilitate recognising computer print-outs and records stored on electronic media used in banking transactions as primary evidence within the definition of the Bankers’ Books Evidence Act, 1881.

4. The provisions made in the proposed Electronic Commerce Bill, 1999 and the Information and Technology Bill, 1999 seek to clarify the legal position on several issues in electronic transactions which would equally apply to banking transactions carried out on computer and communications networks.

To firm up the responses of banking industry to the initiatives taken by the Government of India and for bringing about a new legislation on electronic funds transfer as also to examine legal issues that arise in the course of development of electronic banking, a Standing Committee to examine all legal issues on Electronic Banking with members drawn from the Legal Departments of the RBI, IBA, a few banks and Department of Electronics may be set up by the Reserve Bank.

5. CBDT would need to take up the question of amending the relative provisions of the Direct Tax Laws like Section 40 A of the Income Tax Act, 1961 to accord electronic funds transfer the status of crossed cheques / drafts for the purpose of payment of income tax and other taxes.

Simultaneously, it should be ensured that the account payee transactions are put through the electronic fund messages to the stipulated account in the same manner as account payee crossed cheques are treated.

6. To facilitate the introduction of cheque truncation in India, the definition of presentment in the Negotiable Instruments Act, 1881 would have to be amended to permit electronic presentment of data or image of the cheque.

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The Reserve Bank may be empowered to frame Regulations on Cheque Truncation by suitable amendment to the Reserve Bank of India Act, 1934. Appropriate changes may accordingly be incorporated in the Clearing House Regulations and Rules as well.

7. As already recommended by the Shere Committee, there should be a clear distinction between the role of a service provider and that of a regulator and supervisor.

Since low value and high volume payments require a good deal of servicing of the participating institutions, it is recommended that such payment and settlement systems may be managed by a group of banks with only the net clearing positions being settled at the Reserve Bank or the settlement bank as notified by the RBI.

The Reserve Bank may restrict its electronic funds transfer services only for large value transactions and essential Government securities transactions.

Suitable amendment may be carried out to the Reserve Bank of India Act, 1934 empowering the RBI to frame regulations on operating its own electronic funds transfer services as an extension of the Remittance Facilities Scheme, 1940 and to implement model regulations for electronic funds transfer, payment and settlement systems to be operated by group of banks.

8. The proposed Standing Committee on legal issues on Electronic Banking may, among others, consider the need for appropriate regulation/ legislation on netting of inter-bank payment obligations arising out of the EFT systems which would operate on deferred/ discrete/ netting basis.

The need for a model Posting Rules which would determine the time of posting of the net position and time gap after which withdrawal would be permitted by the bank acting as the Settlement Bank, may form part of the netting regulations/ legislation.

The Standing Committee may examine the need for incorporating for model risk management practices as part of the netting regulation / legislation.

9. The issue of confidentiality and sharing of data among the users need to be examined in view of the banks secrecy obligations. The Standing Committee may also examine the legal aspects which would enable sharing of confidential data between the user agencies.

BIBLIOGRAPHY

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BOOKS

Law Relating To Electronic Transfer of Money- M A Rashid, 2nd edition, 2010, , Lexis Nexis Publications

WEBSITES

www.ftc.gov. www.infoplease.com

http://dictionary.reference.com

http://stats.oecd.org

www. rbi.org.in

ZeroBase@TheHindu.co.in

GUIDELINES

National Electronic Funds Transfer System Procedural Guidelines, November 2005, revised on September 2008 and April 2011.

Model/Illustrative Payment and Settlement Systems Bill' in a report of the Committee on Payment Systems dated November 28, 2002.

NEWSPAPERS

The Hindu Business line, November 23, 2005

STATUTES

Payment and Settlement Systems Act 2007

Negotiable Instruments Act, 1881

Reserve Bank of India Act, 1934

Bankers’ Books Evidence Act, 1881

Information and Technology Act, 1999

Singapore Electronic Transactions Act

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