UNIT 2 PAYMENT MECHANISM IN

CYBERSPACE
Structure
2.1 Introduction
2.2 Objectives
2.3 Electronic Fund Transfer (EFT)
2.3.1 How Electronic Fund Transfer Works?
2.3.2 Different Mode of EFT Mechanism
2.3.3 The Electronic Clearing Services (ECS)
2.3.4 RBI EFT
2.3.5 INFINET
2.3.6 Structured Financial Messaging System (SFMS)
2.3.7 Real Time Gross Settlement System (RTGS)

2.4 Online Payment Mechanism

2.4.1 How Online Payment Mechanism Works?
2.4.2 Electronic Cash
2.4.3 Electronic Wallets
2.4.4 Smart Card
2.4.5 Digital Cheques
2.4.6 Digital Signature
2.4.7 Digital Certificates

2.5 Online Payments and the Information Technology Act, 2000

2.5.1 Online Payments and Negotiable Instruments
2.5.2 Establishment of Public Key Infrastructure (PKI)

2.6 Future of E-money

2.7 Summary
2.8 Terminal Questions
2.9 Answers and Hints
2.10 References and Suggested Readings

2.1 INTRODUCTION
Payment mechanism in cyberspace is all about paying for goods and/or services
ordered or consumed using modern means of information technology. Such payment
mechanism in order to be accepted must have all the attributes of a widely accepted
offline payment system.

2.2 OBJECTIVES
After studying this unit, you should be able to:
z explain the meaning of electronic fund transfer (EFT) and how it works; 15
E-commerce z explain the different modes of EFT mechanism;
z explain EFT as an important tool in online financial and banking networks and
its crucial role in electronic settlement;
z discuss the online payment mechanism in the form of credit cards, smart cards,
electronic wallet, and digital certificates; and
z describe the role of law in shaping the online payment mechanism.

2.3 ELECTRONIC FUND TRANSFER (EFT)

Electronic Fund Transfer means transferring money from one bank account to another
in the same (intra bank) or different bank branches (inter bank). EFT has been in use
since 1960s when banks first started using proprietary EDI network to share banking
information. This was later converted into automated clearing houses. At a global
level, to facilitate faster fund transfer between the remitter and beneficiary, the payment
instructions are sent through telex, SWIFT1 (Society for Worldwide Interbank
Financial Telecommunications), Wire Transfer, CHIPS2 (Clearing House Interbank
Payment System) etc. But when it comes to transfer of funds domestically, the options
have been restricted to demand draft, mail transfer or telegraphic transfer.

2.3.1 How Electronic Fund Transfer Works?

Electronic fund transfer implies transfer of money using Internet technologies. This
involves participation of payer and payee and their respective banks including an
automated clearing house.
Step 1: Payee submits the cheque to his bank
Step 2: Payee’s bank presents the cheque to the automated clearing house
Step 3: Automated clearing house informs the drawer’s bank
Step 4: Drawer’s bank clears the cheque
Step 5: Payee receives the payment

PAYEE DRAWER

PAYEE’s DRAWER’s
BANK BANK

AUTOMATED
CLEARING
HOUSE

INTERNET
16
Figure 1: EFT mechanism using Internet
In India, electronic fund transfer system has got a fillip when the Central Government Payment Mechanism in
Cyberspace
amended the Negotiable Instruments Act, 1881 and brought in forth the Negotiable
Instruments (Amendment and Miscellaneous Provisions) Act, 2002, and introduced
the concept of a “truncated cheque” in section 6 (b) of the said Act:
Section 6(a) “ a truncated cheque” means a cheque which is truncated during the
course of a clearing cycle, either by the clearing house or by the bank whether
paying or receiving payment, immediately on generation of an electronic image for
transmission, substituting the further physical movement of the cheque in writing.
Explanation II. – For the purposes of this section, the expression “clearing house”
means the clearing house managed by the Reserve Bank of India or a clearing house
recognised as such by the Reserve Bank of India.
As evident from the aforesaid section, the truncation process involves replacing
physical cheques with their electronic images, which will travel through the stages of
the clearing cycle. During the whole process of truncation the instrument would remain
with the collecting bank.

2.3.2 Different Mode of EFT Mechanism

Over the period of time, the Reserve Bank of India (RBI) has taken various initiatives
to introduce technology to facilitate electronic fund transfer at both corporate and
retail banking level. For example, electronic settlement in the form of the electronic
funds transfer services – Electronic Clearing Services (ECS), i.e., Credit Clearing
and Debit Clearing and retail Electronic Funds Transfer (EFT) system has been a
great success. In 2003-2004, the value of cheque transactions shrunk 16%, while
settlements through the ECS3 jumped 200%.
Further, it has introduced Centralised Funds Management System (CFMS), Securities
Services System (SSS), Real Time Gross Settlement System (RTGS) and Structured
Financial Messaging System (SFMS) to transform the existing systems into a state-
of-the-art payment infrastructure in India.

2.3.3 The Electronic Clearing Services (ECS)

The Electronic Clearing Services (ECS) ‘credit scheme’ and the Electronic Clearing
Services (ECS) ‘debit scheme’ are two activity lines, which have become important
vehicles for furthering improvements in customer services. In ECS – credit, a series
of electronic payment instructions are generated to replace the paper instruments.
The system works on the basis of a single debit transaction triggering a large number
of credit entries. These credits or the electronic payment instructions which possess
the details of the beneficiary’s account number, amount and bank branch, are then
communicated to the bank branches through their respective service branches for
crediting the accounts of the beneficiaries either through magnetic media duly encrypted
or through hard copy. ECS – debit is meant for payment of charges to utility services
such as electricity, telephone companies, payment of insurance premia and loan
installments etc. by customers. ECS – credit, has become popular and is being availed
of by most corporate entities and official bodies.

17
E-commerce Please answer the following Self Assessment Question.
Self Assessment Question 1 Spend 3 Min.
The two activity lines which have become important vehicles for furthering
improvements in customer services are ......................and ......................

2.3.4 RBI EFT

RBI EFT – a scheme introduced by RBI to help banks offer their customers money
transfer service from account to account of any bank branch to any other bank
branch has widened its reach to more than 150 centres in the country. RBI EFT
system is an inter-bank oriented system, wherein RBI acts as an intermediary between
the remitting bank and the receiving bank and effects inter-bank funds transfer. The
customers of banks can request their respective branches to remit funds to the
designated customers irrespective of bank affiliation of the beneficiary.

2.3.5 INFINET
The setting up of the apex-level National Payments Council in May 1999 and the
operationalisation of the Indian Financial Network (INFINET) by the Institute for
Development and Research in Banking Technology (IDRBT), Hyderabad have been
some important developments in the direction of providing a communication network
for the exclusive use of banks and financial institutions. INFINET members include
RBI, Public sector banks, Private banks, Foreign banks, Cooperative banks and
Financial Institutions.

2.3.6 Structured Financial Messaging System (SFMS)

At the base of all inter-bank message transfers using the INFINET is the Structured
Financial Messaging System (SFMS). It would serve as a secure communication
carrier with templates for intra-bank and inter-bank messages in fixed message
formats that will facilitate straight ‘through processing’. All inter-bank transactions
would be stored and switched at the central hub at Hyderabad while intra-bank
messages will be switched and stored by the bank gateway. Security features of the
SFMS would match international standards.

2.3.7 Real Time Gross Settlement System (RTGS)

It is significant to note that the RTGS system in banking sector has the potential to
emerge as a major payment mechanism in India. Through this system both processing
and final settlement of fund transfer instructions can take place in real time. It would
help banks to scale up transactions that they have been processing. When fully
implemented, RTGS would pave the way for a paperless money transfer mechanism.
It would facilitate payment/receipt of funds without going through the traditional mode
of pay order/demand draft/mail transfer/telegraphic transfer, which takes two to seven
days to real time transactions.
RTGS apart from providing a real time funds settlement environment has also become
critical to an effective risk control strategy. The risks inherent in a net settlement
system are well known. Payment system risks in a net settlement system are such
that the default by one bank may lead to a ‘knock-on’ or domino effect to the system.
Gross settlement reduces the risk significantly, as transactions are settled one by one
18
on a bilateral basis in a real time mode.
Presently, RBI is aiming to give legal sanctity to the whole EFT system by bringing Payment Mechanism in
Cyberspace
legislation on the Electronic Funds Transfer and its role in electronic settlement.
Moreover, it has suggested numerous amendments in the: Bankers’ Book Evidence
Act, the Negotiable Instruments Act, the Banking Regulation Act and the RBI Act.

2.4 ONLINE PAYMENT MECHANISM

Plastic money, i.e. credit cards has already made a presence in India and is fast
becoming online shoppers’ choice4. Credit cards have registered a slow but steady
growth in India. All the major banks, both public and private sectors, use the major
international brand names like VISA and MASTERCARD. The most recent trend is
to issue multipurpose cards which function as credit cards, debit cards or Automatic
Teller Machines (ATM) cards. This is essentially to enable the holder to exercise a
choice of payment option.

2.4.1 How Online Payment Mechanism Works?

Online business requires a website (Sub merchant) which acts as a kind of e-shop
for the users. It gives details of products (or services). A customer can buy any of the
products listed on such a website by making payment against the same either in cash
or cheque or through the route of online payment namely credit card/debit card/net
banking. The sub-merchant’s are linked to a Payment Gateway facility provided by
a Master Merchant, which works in association with a Payment Gateway Bank,
which is further linked to VISA or MASTERCARD – the Credit Card Companies.
To illustrate the mechanism, when a prospective customer visits a website (of a Sub-
merchant) on Internet and selects a product he intends to buy, he is redirected to the
website of Master Merchant (Payment Gateway) where the customer feeds all his
details like name, credit card number, billing address etc. and completes the transaction
by making the payment online. The Master Merchant at its end analyse the details of
credit card holder (name, address, phone number, IP address etc.) and forwards the
request to the Payment Gateway Bank and to Credit Card Companies. Depending
on the report generated, the Master Merchant accepts or rejects the purchase order
of the customer. Acceptance would lead to the customer account being debited by
the same amount and the sub-merchant would be required to dispatch the ordered
goods to the customer’s address.
Sub-merchant
www.xyz.com

Master Merchant
www.abc.com

Payment Gateway Bank

Master/Visa Card
Figure 2: Online payment mechanism using credit card 19
E-commerce Apart from credit card based transactions, other online payment systems include:

2.4.2 Electronic Cash

E-cash is a pre-paid system. Consumers buy electronic tokens and build up electronic
funds for use over the Internet. It is stored in an electronic device such as a chip card
or computer memory. The person who has purchased such cash can use it online for
making payments. It is also known as cyber cash5.

2.4.3 Electronic Wallets

E-wallets can be useful for making a series of micro payments online for example,
downloading MP3 music file, paying for an online article etc. A mechanism is necessary
that ensures that the transaction costs of collecting payment for such items do not
exceed the value of the transaction. A software wallet requires a user to set up an
online account to which heads an amount of money. When transactions are
undertaken, the wallet is debited6.

2.4.4 Smart Card

Smart cards use a micro controller chip embedded in the card. The cards can be
purchased and reloaded again and again. It works as an electronic purse storing
digital money, which could be used over public terminals (Websites, ATMs, Telephone
lines) etc. Another example of smart card is the Stored Value Cards (pre-paid SIM
cards for mobile phones).

2.4.5 Digital Cheques

It is a cheque in the electronic form. Here, the consumer uses his digital signatures to
sign an e-cheque. The consumer fills in the cheque online and then sends it via a
secure server to the recipient. The amount specified on the cheque is electronically
withdrawn from the sender’s account and deposited in the recipient’s account.

2.4.6 Digital Signature

It is a mechanism to ensure authenticity, message integrity, non-repudiation and
confidentiality of an electronic record. It is based on asymmetric crypto-system,
which uses a private key to encrypt, and a public key to decrypt messages. A digital
signature regime requires a trusted third party – Certifying Authority (CA) to verify
and authenticate the identity of a subscriber (a person in whose name the Digital
Signature Certificate is issued). These days, even smart cards may contain digital
signatures of a subscriber.
Please answer the following Self Assessment Question.
Self Assessment Question 2 Spend 3 Min.
Define digital signature.
...................................................................................................................
...................................................................................................................
...................................................................................................................
...................................................................................................................
...................................................................................................................
20 ...................................................................................................................
2.4.7 Digital Certificates Payment Mechanism in
Cyberspace
Digital certificates are like trust certificates developed by a consortium led by Master
Card and Visa. These digital certificates provide Secure Electronic Transaction (SET)
to the users. SET allows a purchaser to confirm that the merchant is legitimate and
conversely allows the merchant to verify that a credit card is being used by its owner.
It also requires that each purchase request include a digital signature, further identifying
the cardholder to the retailer.
SET is an improvement over SSL (Secure Sockets Layer) encryption method. SSL
uses a private key to encrypt data that is then transmitted over the SSL connection.
It is used to encrypt customer and credit card information when it is transmitted
across the Internet. The message ‘You are about to view information over a secure
connection’, is an indication that SSL is in use. Websites protected by SSL also
carry a security symbol in the status bar, often in the form of a closed lock7.
A key difference between SSL and SET lies in the allocation of risk. SET makes the
buyer responsible for proving her credentials, whereas, with SSL, the merchant takes
responsibility for checking the buyer’s ability to pay and that the credit card account
being referenced belongs to the user initiating the transaction8.
Please answer the following Self Assessment Question.
Self Assessment Question 3 Spend 2 Min.
The difference between SSL and SET lies in .........................................

2.5 ONLINE PAYMENTS AND THE INFORMATION

TECHNOLOGY ACT, 2000
The Information Technology Act, 2000 is a facilitating as well as an enabling Act. It
facilitates e-commerce by enabling a digital signature regime. It is important to note
that a digital signature regime not only authenticates electronic records but also plays
an important role in electronic fund transfer.

2.5.1 Online Payments and Negotiable Instruments

When the Information Technology Act, 2000 came into effect on October 17, 2000
it was non-applicable to the negotiable instruments, like promissory note, cheque
and bill of exchange but subsequently to facilitate e-commerce related transactions,
the Central Government amended the Negotiable Instruments Act, 1881 and brought
in forth the Negotiable Instruments (Amendment and Miscellaneous Provisions) Act,
2002 to recognise “a cheque in the electronic form” (e-cheque) and “a truncated
cheque”. Therefore, to facilitate e-commerce related transactions, creation and
acceptability of ‘e-cheque’ (a signer uses his digital signatures to sign an e-cheque)
and payment or receipt on the basis of an electronic image of a ‘truncated cheque’
are now legally valid. Still, the negotiable instruments, like promissory note and bill
of exchange are considered non-applicable under the Act.
Further banking transactions in India are being regulated by the Indian Central Bank
– the Reserve Bank of India (RBI). Banks, which are going for e-cheque and truncated
cheque facilities, have their secured proprietary IT networks in place conforming to
the guidelines issued by the RBI from time to time on network banking. 21
E-commerce For example, “Punjab National Bank” (PNB) was among the first banks to deploy
the first image-based cheque clearing system in India. This provided clearance of
inter-city cheques within 48 hours after the cheque is presented, at selected centres
using cheque truncation, where there is image based cheque clearing system. Earlier
it took about 15-20 days for clearance of outstation cheques. PNB was the first
bank to launch the Intra Bank Inter City Cheque truncation project by using NCR’s
ECPIX (Electronic Cheque Presentment with Image Exchange) technology. After a
successful pilot run the system was introduced by connecting MICR Centres located
at Lucknow, Nagpur, Jaipur, Kanpur, Ludhiana, Chandigarh, Jalandhar, Agra,
Allahabad and Varanasi.

2.5.2 Establishment of Public Key Infrastructure (PKI)

The Information Technology Act, 2000 gives a legal mandate to the use of digital
signatures to protect confidentiality of data protection. It is based on “asymmetric
crypto system” [Section 2(1)(f)], wherein two different keys are used to encrypt
and decrypt the electronic records. A private key is used to encrypt an electronic
record and a public key is used to decrypt the said record. Private key is kept
confidential and is to be used by the signer (subscriber) to create the digital signature,
whereas the public key is more widely known and is used by a relying party to verify
the digital signature and is listed in the digital signature certificate. The subscriber’s
public key and private key constitute a functioning key pair. In an asymmetric crypto
system, a private key is mathematically related to public key and it is computationally
impossible to calculate one key from the other. Hence the private key cannot be
compromised through knowledge of its associated public key.
It calls for establishment of a Public Key Infrastructure (PKI), which is based on
mutual trust involving subscribers, Certifying Authorities and the Controller of
Certifying Authorities (CCA). Public Key Infrastructure (PKI) represents a set of
policies, processes, server platforms, software and workstations used for the purpose
of administering Digital Signature Certificates (DSCs) and public-private key pairs,
including the ability to generate, issue, maintain, and revoke public key certificates.
The Information Technology Act, 2000 provides for a statutory environment for
establishment of a PKI to administer DSCs. It has provisions related to powers and
functions of the Controller of Certifying Authorities [Sections 17-34 of The Information
Technology Act], Certifying Authorities [Sections 35-39 of The Information
Technology Act] and Subscribers [Sections 40-42 of The Information Technology
Act]. The Controller of Certifying Authorities is a public body and acts as a regulator,
whereas the Certifying Authorities could be any person, who fulfills all the licensing
conditions put forth by the Controller of Certifying Authorities.
The success of this PKI model can be gauged from the fact that presently, in India
there are seven licensed Certifying Authorities, namely, Safescrypt, Institute for
Development & Research in Banking Technology (IDRBT), Tata Consultancy Services
(TCS), National Informatics Centre (NIC), Mahanagar Telephone Nagar Limited
(MTNL), (n) Code Solutions Ltd. and Department of Customs and Excise.
Moreover, it is important to note that most of these Certifying Authorities are quite
active in both businesse-to-consumer (B2C) and business-to-business (B2B) domain.
For example, TCS is issuing DSCs for online Tax Filing, Northern Railway e-
procurement, ONGC e-procurement etc.; MTNL is issuing free DSCs to MTNL
22 Broadband customers; Safescrypt is issuing DSCs for EXIM (Export-Import)
purposes to vendors dealing with the Directorate General of Foreign Trade and (n) Payment Mechanism in
Cyberspace
Code Solutions Ltd. is issuing DSCs to Northern Railway vendors (e-procurement).
Please answer the following Self Assessment Question.
Self Assessment Question 4 Spend 2 Min.
PKI is based on ............................... system.

2.6 FUTURE OF E-MONEY

The growth of e-commerce depends on effectiveness and acceptability of online
payment mechanisms. Newer technologies are making online world a safer, convenient
and cost effective medium to do monetary transactions.
What would be the result of these technological advances, replacing money with
digital cash? This gradual e-monitisation can shrink cash demand and may affect the
money supply and rate of interest in the long term. It will also restrict RBI’s ability to
conduct open market operations. The current trends, involving e-monitisation
transactions through credit cards and Internet will require monetary policy to take
not of the ongoing revolution in the payments and settlement system9. According to
RBI the spread of e-monitisation does not require monetary and financial aggregates
to be redefined, as long as transactions take place through the banking channel.
However, e-money instruments, like credit cards, debit cards and stored-value cards
have a potential to bypass the banking channels altogether and serve as parallel
money suppliers.
Let us now summarize the points covered in this unit.

2.7 SUMMARY
z Online payment is fast emerging as a good alternative to physical mode of
payments.
z Electronic fund transfer mechanisms are a reality now.
z Financial institutions and banks have transformed themselves into huge financial
networks providing real time facilities to their customers.
z The traditional ‘brick-and-mortar’ banking model has given way to ‘click- and-
mortar’ banking model which has made many online payment options available
to a consumer.
z Significantly, the law also grants legal validity to such online payment instruments.

2.8 TERMINAL QUESTIONS

1. It is said that technology has made online world a safer, convenient and cost
effective medium to do monetary transactions. Do you agree with this statement?
Give reasons.
2. What is the role of public key infrastructure in creating trust in an online medium?
3. Explain the working of online payment mechanism?
23
E-commerce
2.9 ANSWERS AND HINTS
Self Assessment Questions
1. Electronic Clearing Services (ECS) ‘credit scheme’ and Electronic Clearing
Services (ECS) ‘debit scheme’.
2. It is a mechanism to ensure authenticity, message integrity, non-repudiation and
confidentiality of an electronic record.
3. The allocation of risk.
4. Asymmetric crypto system.
Terminal Questions
1. Refer the unit and analyse the problem in your own way.
2. Refer to sub-section 2.4.2 of the unit.
3. Refer to section 2.4 of the unit.

2.10 REFERENCES AND SUGGESTED READINGS

1. SWIFT is a reliable. Secure. high-speed. global telecommunications network

owned by its bank participants and used to transmit financial instructions in

machine-readable formats worldwide.

2. CHIPS are a computerised funds transfer system operated by the New York

Clearing House Association. It is used primarily for high-value, cross-border

payments.

3. www.rbi.org.in

4. According to Power Shopper Report - IOAI Ecommerce Report 2005. 62%

of online shoppers have used ‘credit cards’ for online purchase.

5. See: www.cybercash.com

6. See: www.ecoin.net

7. Rowley Jennifer. “E-business – Principles & Practice”. p.249. Palgrave. 2002.

8. Ibid. p.252

9. Sharma Vakul. 2004 “E-commerce: A New Business Paradigm”. in Legal

24 Dimensions of Cyberspace. Ed. Verma. S.K. and Mittal Raman. ILI Publications.