India’s status in electronic banking is quite sobering. The acid test of electronic banking is when people pay electronically at merchant shops where cash rules otherwise. On this front, we are woefully behind. Lack of boldness, creativity and local innovation are to blame.

When we are bold and creative, things happen. Let’s look, within Indian banking itself, at automated teller machines (ATMs). The number of ATMs in India has grown very rapidly from 3,000 in 2001 to 160,000 in 2014 at a compound annual growth rate (CAGR) of 36% and it is still growing. Today any bank customer can use ATM of any other bank. As soon as cash is paid out, account of the customer is debited in real time. Customer gets a reassuring instant SMS intimation. 25% of bank account holders are active users of their debit cards at the ATMs. A vibrant vendor industry has evolved to help banks rapidly set up and maintain ATMs. This happened because the network connecting ATMs of all banks in the country was designed elegantly. It ensures everyone in the system is economically sustainable and viable. The Reserve Bank of India (RBI) has intervened several times with very strong measures.

But the good news stops here. The same debit card that is used at the ATM can also be used to pay electronically at merchant shops by swiping the card on the Point of Sale (POS) device. However, in the last financial year i.e., 2013-14, in comparison to the 5 billion ATM cash withdrawal transactions, there were only 620 million debit card transactions on POS devices. As a result, compared to 20 trillion cash withdrawn from ATMs, only R1 trillion was actually spent directly at merchant terminals through debit cards. All this is despite the fact that we have only 160,000 ATMs as against 11,00,000 POS machines. Understandably, the banks, which set up POS machines, do not find them viable. Consequently we have the lowest number of POS machines among all comparable economies.

This is surprising because there is a big win-win opportunity for all concerned in electronic transactions at merchant outlets. The customer does not have to take out cash from ATM before spending. The merchant does not have to handle cash and go to bank branch to deposit cash. The bank saves cost with fewer ATM transactions and, as a subtle (and not fully appreciated) side benefit, enjoys larger float in customer account for a longer time.

At the heart of this colossal failure is poorly designed interbank scheme, which makes it unviable for banks to set up POS units. Just contrasting the scheme of ATMs with that of POS machines is enough to spot the issue. When a customer of Bank A uses her debit card to withdraw money from ATM of Bank B, Bank A compensates Bank B. Bank B has spent money to set up the ATM and to maintain it. Bank A customer is enjoying the benefit. So Bank A pays. Now look at the absurdity of a similar transaction on a POS device. When a customer of Bank A uses her debit card to make a POS transaction at a merchant where the POS device is installed and maintained by Bank B, Bank B effectively makes a net payout to Bank A under the current arrangement. Bank B charges the merchant some money for each such transaction. This is called Merchant Discount Rate (MDR) and has recently been reduced by RBI to 0.75% for transactions upto 2,000 and 1% for transaction value of more than 2,000. Merchants feel uncomfortable having to pay this. They try to avoid taking payment electronically because cash is better for them. Most banks which set up POS machines (like Bank B in the example) make a loss on the business of setting up and maintaining POS machines. So, most banks are going very slow in setting up new POS machines. The situation is absurd since Bank A saves a lot of money when its customers use debit card at POS in form of avoided ATM transaction cost and higher balances in savings account.

The interbank scheme for ATMs is innovative. It is designed for India’s needs. It has an air of frugal innovation about it. It gets the economics right. Results are for all to see. The debit card scheme for POS transactions is out of sync with underlying economics. Its basic architecture is borrowed from the interbank schemes for credit card transactions. The banking industry is paying a huge price in the form of high cost ATM transactions when so much more of customer spending could have been cashless. The scheme for debit cards payment on POS devices should be along the lines of the scheme for ATMs. The Reserve Bank should make a more concerted effort for a fundamental redesign of the system. Bank CEOs should come together to change the state of affairs in their own interest.

Note: This article has been modified from an earlier version to reflect the correct number of POS machines

Saurabh Tripathi is director of Boston Consulting Group.

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