THE FINANCIAL SYSTEM AND TECHNOLOGY

Financial system
In Iinance, the 1inancial system is the system that allows the transIer oI money between
savers (and investors) and borrowers. A Iinancial system can operate on a global, regional or
Iirm speciIic level.
Gurusamy, writing in Financial Services and Systems has described it as comprising "a
set oI complex and closely interconnected Iinancial institutions, markets, instruments, services,
practices, and transactions."
According to Franklin Allen and Douglas Gale in Comparing Financial Systems:
"Financial systems are crucial to the allocation oI resources in a modern economy. They
channel household savings to the corporate sector and allocate investment Iunds among Iirms;
they allow intertemporal smoothing oI consumption by households and expenditures by Iirms;
and they enable households and Iirms to share risks. These Iunctions are common to the Iinancial
systems oI most developed economies. Yet the Iorm oI these Iinancial systems varies widely."
The implication o1 modern technology on 1inancial system
Modern technology has changed overall liIestyle oI mankind. The progress oI technology
has been accelerated with the development oI the Internet. Financial transaction was not an
exception. The internet has changed the whole perspective oI the world. It allows just about
everything to be completed online, Irom doing your everyday shopping to doing your banking
online. In the past, stock brokers justiIied their high Iees by pointing to the quality oI their
advice; now knowledgeable amateurs as well as industry experts can trade stock Ior no charge in
web sites. Investors can get advice and market inIormation Irom many sources other than Iull-
service brokers, so they are less willing to pay a premium just to trade. Online banking has
revolutionised they way in which most people do their everyday banking. This includes
transIerring money, viewing account balances and paying bills. However there are a lot oI
important issues to take into account when using online banking, such as security issues, privacy
and reliability oI your banks server and website design.

E11ects o1 technology in 1inancial system

This report Iocuses on the relationship between technology and change, both past and Iuture, in the
Iinancial service industry. The roles oI technology as both a motivator and a Iacilitator oI change are
analyzed. Other agents oI change are considered only to the extent that they help deIine the market Ior
new technology or its impact.

Organizations Comprising the FinanciaI Service Industry and Their Products
















Factors Affecting FinanciaI Service Providers





Use o1 1inancial services


FinanciaI service providers:
Banks Data processing
Thrift institutions TeIecommunications
Dry goods merchants Insurance
companies
FinanciaI service Industry products:
Credit Debit cards
Deposit-taking Check authorization cards
Brokerage Information services
Investment Payment
FinanciaI service providers

Use o1 technology in the 1inancial system:

It gives me immense pleasure to be here with Iriends Irom the banking Iraternity. In Iact,
being here is art oI my annual pilgrimage to the Institute Ior Development and Research in
Banking Technology IDRBT). At the outset, I would like to compliment the Governing Council,
Iaculty and staII oI the IDRBT or continuing with their mission with distinction.
The Ioundation Ior large-scale induction oI IT in the banking sector was provided by the
recommendations oI the committees headed by Dr. C.Rangarajan, in 1984 and 1989.
Subsequently, in 1994, the Reserve Bank constituted a committee on Technology Upgradation
in the Banking Sector`. The committee made a number oI recommendations covering payment
systems including setting up oI an autonomous centre Ior development and research in banking
technology. The IDRBT was created as a sequel. The Institute has established and operates the
INdian FInancial NETwork (INFINET), perIorms research in banking technology and provides
consultancy services apart Irom providing educational and training Iacilities Ior the banking
sector.
In my remarks today, I would like to highlight the need Ior concerted eIIorts to enhance
the use oI technology in the Iinancial sector to ensure eIIiciency, stability, competition and above
all service to the common person.
Technology and the RBI
I would like to enumerate Ior record a Iew technology-related initiatives oI the RBI. First,
the establishment oI the mechanised cheque processing systems using the Magnetic Ink
Character Recognition (MICR) technology in India. These have been acknowledged the world
over as systems which have stabilised well with overall reject rates oI around 1 while, I
understand, that the international rates are around 2. Those who operate these systems,
thereIore, deserve to be complimented.
Second, the technological inIrastructure created by the IDRBT since the establishment oI
the INFINET in 1999. This was aimed at sharing expensive IT resources so as to achieve the
economies oI scale. One oI the notable achievements oI the IDRBT has been the implementation
oI Public Key InIrastructure (PKI)-based electronic data transIer with very high security levels.

Third, the introduction oI the Real Time Gross Settlement (RTGS) System. It has not
only resulted in compliance with the Core Principles Ior Systemically Important Payment
Systems oI the Bank Ior International Settlements (BIS), Basle but has also paved the way Ior
risk-Iree, credit pushbased Iund transIers settled on a real time basis and in the central bank
money. We had an occasion to compare our RTGS system with other RTGS systems Ior placing
beIore our Board Ior Payment and Settlement Systems. It emerged that the Indian RTGS system,
which has the Y` topology, is considered to be the optimal choice and this topology has also
been adopted by several central banks, which have implemented RTGS. Our approach towards
intra-day liquidity and potential gridlock resolution Iollow international patterns. An evaluation
oI the various components oI the RTGS system vis-a- vis the critical evaluation parameters set
by the Bank Ior International Settlements, Basle indicates that we are close to the best on most
oI the parameters.
The Iacility Ior inter-bank Iunds settlement through RTGS is available today across more
than 23,700 branches oI banks spanning more than 500 centres in the country. While it is
reassuring to note that transactions with large aggregate value are being settled through the
RTGS system, with average daily settlement amounting to more than Rs. 60,000 crore, there is
still scope Ior routing many more systemically important payments through the RTGS. For the
purpose, enhancing the customer wareness at the user level would be an urgent imperative. It is
essential that the RBI, banks and large players in the market make concerted eIIorts in this regard
so as to ensure that all large-value customer payments across Iinancial markets, which have
systemic implications, Ilow into the RTGS, such as payments in the equity and debt markets.
Once the system achieves a critical mass oI usage by the participants, a tipping point would be
reached and it should be possible Ior the Iinancial regulators to consider making the RTGS as
the preIerred mode Ior speciIied large-value transactions in the Iinancial markets.
Fourth, creation oI electronic Iund transIer systems. It is not necessary that all the Iund
transactions are settled on a real time basis. It is, thereIore, important to expand the reach oI
other electronic payment mechanisms Ior small-value customer transactions across the country.
Towards this end, the Reserve Bank implemented the Electronic Funds TransIer (EFT) System
in the mid nineties, which was later upgraded as the Special Electronic Funds TransIer (SEFT)

System in 2003 and has now been Iurther enhanced as the National Electronic Funds TransIer
(NEFT) System since November 2005.
The NEFT system, an improved version oI the EFT system, has enhanced security
Ieatures and Iacilitates retail Iunds movement with multiple daily settlements, which enable
customers to receive Iunds within two hours oI the settlement. Today, the NEFT Iacility covers
more than 5000 branches oI 32 banks spread across 200 centres. The Reserve Bank has taken up
as its mission, the expansion oI the reach oI NEFT to cover all computerised / networked
branches oI banks as outlined in the Payment Systems Vision document. The plan is to provide
NEFT Iacilities initially at all the RTGS customer-enabled branches and thereaIter, extend the
same to cover almost all the computerised branches oI banks across the country.
Finally, a major initiative, as Iar as Iunds movement is concerned, is cheque truncation.
In order to improve eIIiciency and substantially reduce the time taken Ior cheque processing, the
Reserve Bank has initiated steps to introduce a Cheque Truncation System (CTS). A pilot project
is scheduled to commence in the National Capital Region in Delhi by the end oI this year.
Over the years, the role oI the Reserve Bank is changing in tune with the increased levels
oI maturity oI the markets and the Iinancial system as a whole. The role oI the Reserve Bank in
Iuture would be oI a catalyst oI change as detailed in the Financial Sector Technology Vision
Document published in 2005. In realising this vision, the need Ior shared eIIorts towards setting
up oI world class IT systems will gain greater signiIicance. As a Iirst step, the Reserve Bank has,
through the IDRBT, Iacilitated the setting up the National Financial Switch, which provides such
an opportunity to the Iinancial sector. I would urge the banks to make extensive use oI this
Iacility. IDRBT is also revamping the entire INFINET structure in consultation with the users to
make it more eIIicient in tune with the international practices. Perhaps, a Iormal benchmarking
oI the Iunctioning oI our system with the global standards and practices may have to be done and
the outcome placed in the public domain.
Technology Challenges 1or the Banking Sector
The entire approach towards technology-based banking has shownsigniIicant
improvement since the initiation oI reIorms in the 1990s. The number oI public sector banks
which has migrated (or are in the process oI migration) to Core Banking Systems (CBS), is an

indication oI the progress in this regard. The unique Ieature oI the CBS is that the concept oI
branchbased banking gives way to the bank-based banking treating the constituent as the
customer not oI a particular branch but oI the bank as a whole. Today, 21 public sector banks
have embarked on the use oI such systems and the number oI CBS-enabled branches exceeds
14,000 as against 14 banks with about 5000 CBS-branches a year ago. Some oI the banks are
reportedly Iacing teething troubles in this area but I trust every eIIort would be made to stabilise
the system to the satisIaction oI all customers. I would urge that an assessment oI the eIIiciency
oI Iunctioning oI CBS in all the banks be attempted to Iacilitate necessary improvements.
The commercial banks have to address various emerging challenges including those
arising Irom large-scale IT deployment. These include the impact oI CBS, more scientiIic risk
management, better asset-liability management, ensuring eIIective anti money laundering
measures, and the security concerns relating to implementation oI IT in banks.
One issue, which oIten gets raised in any discussion on technology implementation, is
the cost it entails. Products such as smart cards, which may not require signiIicant initial capital
costs and which can be easily implemented Ior a large customer base, hold the promise Ior the
Iuture.
Let me highlight some oI the critical Iactors, which need to be adequately addressed
while dealing with IT. Prime amongst them is the need to ensure appropriate security and
integrity oI the system. Security in IT systems is only as eIIective as the weakest link and as
Iinancial intermediaries, the banks have to ensure that security Ieatures incorporated in IT
systems are the best oI the breed. With ever-evolving inIormation technology, the security
concerns do not remain static and a system oI an ongoing critical review oI the eIIicacy oI
security Ieatures and measures needs to be instituted. Integrity oI the data processed and stored
in IT systems has to be ensured by the banks at all times and adequate back up, including real
time replication, to the extent possible, provided Ior.
Another major requirement relates to disaster recovery management and the Iail-saIe
business continuity plans. In today`s world, customer expectations are high and ensuring
uninterrupted availability oI the IT resources, even in the event oI a rather extreme contingency,

assumes signiIicance. The banking community, thereIore, needs to put in place appropriate
contingency plans and test their adequacy at regular intervals.
While the Reserve Bank is providing a common system-wide communications
inIrastructure, the ultimate objective should be Ior each bank to develop its own communications
network so that the movement oI Iunds within the banks is entirely managed through their own
networks. This will avoid excessive dependence on INFINET and improve the overall systemic
eIIiciency. Though a Iew banks have already done so, there is scope Ior Iurther progress in this
regard by others.
There are several co-operative banks too in the system which extend banking services
and some oI them also have relatively large-scale operations. Perhaps, it is essential that the use
oI technology in the cooperative banking sector too is enhanced, as appropriate, to bring them
closerto the level oI the commercial banks.
Technology and Financial Inclusion
We have been highlighting the need Ior Iinancial inclusion which involves the provision
oI banking services to the vast multitude oI population so Iar excluded Irom such services. As Iar
as increasing the scope and coverage oI Iinancial inclusion is concerned, some oI the challenges
which need to be eIIectively addressed include lack oI adequate inIrastructure in rural areas,
relatively low volumes oI transactions, comparatively higher transaction costs, and other Iactors
such as the literacy levels oI target customers.
Technology oIIers an excellent tool to eIIectively address the above challenges. Lack oI
inIrastructure is being addressed in a variety oI innovative ways, leveraging technology. Some oI
these include use oI computer systems which do not require uninterrupted electric power supply,
networking using radio Irequency and other non-conventional methods, centralisation oI
processing systems leading to lower processing costs, provision oI homegrown customised
systems such as the low cost, multi-lingual ATM developed by the IIT, Chennai - all oI which
provide an impetus towards greater Iinancial inclusion.
In South AIrica, technology has been deployed to widen the Iinancial inclusion with the
introduction oI MZANSI account, which is a card-based, limited-service, aIIordable savings

account integrated with the merchant pointoI-sale outlets, ATMs and even Post OIIice outlets. In
Philippines, the cardbased retail money movement system has won great acclaim. In India, the
Reserve Bank, along with the IDRBT, is working on the use oI multiapplication smart-card
systems which can serve as a bank account and also Iunction as a store oI electronic cash, as a
data repository Ior essential inIormation relating to the card holder, with built-in security
Ieatures such as biometric identiIication, and which can also double up as an entitlement
identiIier or as a social security card.
It is gratiIying to note Irom a NABARD report that a pilot project on smart cards has
already been launched with Sri Visakha Grameena Bank in Andhra Pradesh, which has been one
oI the Iront-runner banks in Iinancing SelI Help Groups (SHGs). It is expected that with
enhanced use oI uraloriented technology, the bank would be able to provide value addition to
services oIIered to the rural clients and Iurther expand its outreach in a sustainable manner.
Banks could consider the Ieasibility oI using smart cards Ior the No Frills Accounts` so as to
help expand the coverage oI the banking services and Iacilitate the garnering oI the much-needed
low-cost deposits. Here again, the approach oI sharing oI IT resources would have much to
commend itselI.

Technology and the Government Sector
It would be appropriate to also outline certain aspects oI application oI technology to the
Government business since RBI is the banker to the Central and State Governments. II we scan
the technology initiatives oI the States, we Iind a large divergence in technology absorption
across the States. While States like Andhra Pradesh, Maharashtra, and Karnataka are generally
ahead oI others in e-Governance, this is just beginning to happen in the States like Madhya
Pradesh, Uttar Pradesh, Bihar and the North East. As Iar as Central Government receipts are
concerned, the Government's tax collection processes underwent a metamorphosis with the
introduction oI Online Tax Accounting System (OLTAS) Ior direct taxes.
Enthused by the success oI OLTAS, the Central Board oI Excise and Customs, in
consultation with the Reserve Bank, has introduced the EASIEST (Electronic Accounting
System in Excise and Service Tax) project which envisages a comprehensive e-payment module

that can be utilised by the banks` corporate customers. The pilot project Ior this is in an advanced
stage oI completion. Acceptance by the Government oI electronic challans, based on Iormats to
be available on their web sites, would make the process tax-payer Iriendly. It would also
substantially reduce paper usage, provide Ior Straight Through Processing and obviate errors
arising Irom the reconciliation process, wrong data entry, etc.
Another signiIicant initiative taken in this sector by the Reserve Bank was the
computerisation oI State treasuries throughout the country. AIter detailed examination oI the
various aspects, steps are now underway Ior the establishment oI electronic linkage amongst the
State Treasuries numbering 3022, agency banks, Finance Departments oI the State Governments,
OIIice oI the Accountant General and the Reserve Bank oI India. This will help in speedier
accounting oI receipts and payments oI the State Government departments, apart Irom serving
as a road map Ior achieving end-to-end connectivity amongst various accounting agencies
involved.
It nee ds to be noted in this context that while use oI the state-oI-the-art technology
within the banking system is an asset, it also poses a challenge to the conventional banker and
government accountants due to increase in the speed and complexity oI transaction processing.
The banks have to ensure that all transactions conducted as agents oI Government are secure
Irom endto-end and are retrievable at any point oI time. A successIul example oI this is the
electronic import-licensing system oI the Directorate General oI Foreign Trade which has an
electronic payment Iacility integrated with the IT systems oI the banks.
I would like to take this opportunity to mention that at a recent conIerence oI the State
Finance Secretaries, the Finance Secretaries oI several State governments expressed the view
that the technological base and eIIiciency oI services rendered by some oI the banks handling
Government business needed to be improved signiIicantly. Relationship banking encompassing
both, lending with a social Iocus and operating as a banker to the Government, is valuable but iI
the quality oI service in handling Governments` transactions is not oI high standards, some oI the
banks may not be able to retain their Government business at the current levels. Concerted
eIIorts are, thereIore, required by the States and their respective bankers in this regard.

Technology and Markets

Technology has played a signiIicant role in improving the eIIiciency oI the Iinancial
markets. The Negotiated Dealing System (NDS) has been Iunctioning well. The introduction oI
Order Matching NDS (NDS-OM), has helped Iurther in securing better price discovery,
transparency in trading, reporting and electronic bidding at auctions. The NDS, implemented
since February 2002, provides a platIorm Ior screen-based trading in government securities to the
member banks and primary dealers with a Iacility to strike online deals anonymously and, thus,
experience more eIIicient price discovery. The process involves the reporting oI deals to the
Clearing Corporation oI India (CCIL) Ltd. which generates the settlement gross Ior the
securities and net Ior the Iunds leg. At the end oI the day, the settlement inIormation is
transmitted to the RBI Ior eIIecting the same in its books. The CCIL also acts as the central
counterparty Ior the trades by guaranteeing the delivery oI securities as well as Iunds.
We are in the process oI Iully integrating the NDS settlements with the RTGS. In order to
improve the Iunctioning oI the corporate bond market, a High Level Expert Committee on
Corporate Bonds and Securitisation has suggested various measures to revitalise the corporate
bond market through setting up oI trade reporting systems, trading platIorms, auction platIorms
and clearing & settlement systems. The trade reporting systems suggested Ior corporate bonds is
on the lines oI Trade
Reporting and Compliance Engine (TRACE) oI National Association oI Security
Dealers (NASD) in the US. Such on-line real-time data dissemination will help the participants
in making eIIicient trading decisions and at the same time, enable the regulators to obtain and
monitor inIormation on the market trends. These recommendations are under examination by
the agencies concerned.
Conclusion
The basic objective oI deployment oI technology in the Iinancial sector should be to
progressively move away Irom paper-based transactions, which include use oI currency notes,
cheques or challans, and to the extent possible, switch over to electronic means using RTGS or
NEFT or any other electronic mode. It is opportune that we are today recognising the valuable
contributions oI the path breakers in the Iield oI banking technology. The identiIication oI

technology leaders and their recognition in the Iorm oI Technology Awards is a pointer that we
are capable oI excelling in our respective Iields. The awards oI today are not a destination but
only mark a good beginning oI a moreexciting and challenging era ahead oI us in our march
towards a technologically advanced and eIIicient, eIIective, progressive and inclusive Iinancial
system.