Payment Systems and Customer Protection in Banking: Complete Notes

Two subjects that look unrelated belong together. The law of payment systems decides how money moves, and the law of customer protection decides what happens when it moves wrongly. They are joined by a single fact: an electronic payment is irreversible by design, because a system that could be unwound would be a system no one could rely on. Everything in these notes follows from that. Settlement is made final by statute, and because it is final, the customer who suffers is given a separate and generous set of remedies that operate on the bank rather than on the transaction.

Figure 1: Four layers, from the statute to the remedy

1. The Payment and Settlement Systems Act, 2007

A payment system under Section 2(1)(i) is a system that enables payment to be effected between a payer and a beneficiary, involving clearing, payment or settlement service or all of them, including the operations of card and money transfer systems, but excluding a stock exchange. A system provider operates an authorised system; a system participant takes part in it.

• Section 3 designates the Reserve Bank as the authority and provides for a board through which it acts. The Board for Regulation and Supervision of Payment and Settlement Systems, a committee of its Central Board, has been replaced by a six member Payments Regulatory Board under the Payments Regulatory Board Regulations, 2025, notified on 20 May 2025.
• Section 4(2) lets the Reserve Bank authorise a company or corporation to operate the clearing houses of banks, so as to have a common retail clearing house system for the country.
• Section 7 governs the grant of authorisation, on consideration of the need for the system, its design and security, the netting arrangements, the applicant's standing and integrity, consumer interest and monetary policy. A refusal needs written reasons and a hearing, and the Bank endeavours to decide within six months.
• Section 8 permits revocation after a hearing, except where the Bank must act at once, and the order must protect the interests of persons affected.
• Section 10 fixes standards, Section 17 permits directions where systemic risk is not adequately controlled, and Section 18 permits general directions for regulating payment systems, for their management or operation, or in the public interest.
• Section 24 requires a panel of not less than three participants who are not parties, to resolve disputes between participants, with an appeal to the Reserve Bank, and to the Central Government where the Reserve Bank is itself involved.

Netting and settlement finality

Netting is the determination of the net amount due after setting off the obligations among participants, including the claims and obligations arising out of the termination by the system provider of the transactions of an insolvent participant. Without that last clause a liquidator could collect gross and pay a dividend, which would destroy the arithmetic of clearing.

Figure 2: The six limbs of Section 23

Dishonour, penalties and compounding

• Section 25 punishes the initiator of an electronic funds transfer that cannot be executed for insufficiency of funds or because the arranged amount is exceeded, with up to two years or a fine up to twice the amount or both. The conditions mirror the cheque offence: a legally enforceable debt, compliance with the provider's procedure, written notice within thirty days of receiving information from the bank of the return, and failure to pay within fifteen days. Chapter XVII of the Negotiable Instruments Act, 1881 applies so far as the circumstances admit.
• Section 26 punishes operating without authorisation and defying a direction with imprisonment of one month to ten years, or a fine up to one crore rupees, or both, and one lakh rupees a day; false statements with up to three years and a fine of ten to fifty lakh rupees; and other contraventions with lesser penalties.
• Section 30 lets the Reserve Bank itself impose a penalty up to five lakh rupees or twice the amount involved, for matters under Section 26(2) and 26(6), after a show cause notice, but not where a complaint has already been filed in a court for a contravention under Section 26(2) or 26(4).
• Section 31 permits compounding of any offence other than one punishable with imprisonment only, or with imprisonment and fine. Operating without authorisation, punishable with imprisonment or fine or both, can therefore be compounded; a false statement cannot.

2. The systems and their operator

Cheque truncation replaced the physical movement of a cheque with its image and data, which required the Negotiable Instruments Act, 1881 to be amended to recognise a truncated cheque. The national automated clearing house handles bulk credits and mandate based recurring debits, and the Aadhaar enabled payment system allows withdrawal at a business correspondent on a fingerprint.

The National Payments Corporation of India

• A company incorporated in 2008 under what is now Section 8 of the Companies Act, 2013, that is a not for profit company which may pay no dividend, promoted by banks at the initiative of the Reserve Bank and the Indian Banks' Association.
• It is a system provider holding authorisations under the Act of 2007, not a regulator, and its operating circulars bind members contractually rather than as legislation.
• The framework for new umbrella entities of 18 August 2020 permits a competing, for profit operator with five hundred crore rupees of paid up capital and three hundred crore rupees of net worth at all times. A holder of more than twenty five per cent is a promoter, no promoter group may exceed forty per cent, the promoter side must show ten per cent upfront, and the entity must be resident owned, with promoters having three years of experience in payments.

The zero merchant discount rate

• Section 269SU of the Income-tax Act, 1961 requires a business with a turnover exceeding fifty crore rupees to provide the prescribed electronic modes, being the domestic network's debit card, the unified payments interface and its quick response code.
• Section 10A of the Payment and Settlement Systems Act, 2007 forbids any bank or system provider to impose any charge on a person making or receiving payment by those modes.
• Section 271DB of the Income-tax Act, 1961 imposed a penalty of five thousand rupees a day for failure, and both obligations took effect from 1 January 2020.
• From 1 April 2026 the Income-tax Act, 2025 has replaced the Act of 1961, and the obligation to provide the prescribed modes now sits in Section 187 of the new Act, on the same fifty crore threshold.

3. Instruments, tokens and central bank money

Figure 3: Four things that look alike and are not

Prepaid payment instruments

Governed by the Master Directions of 27 August 2021, under the Act of 2007. A non-bank issuer requires authorisation and must keep the money collected in an escrow account with a scheduled commercial bank.

• A small instrument, issued on minimum details and usable only at pre-identified merchants: ten thousand rupees loaded a month, one lakh twenty thousand rupees in a financial year, ten thousand rupees outstanding, and no fund transfer.
• A full know your customer instrument, usable anywhere and permitting transfer and cash withdrawal: two lakh rupees outstanding at any time.
• Cash withdrawal from a full instrument up to two thousand rupees a transaction and ten thousand rupees a month, including from non-bank issuers.
• A gift instrument up to ten thousand rupees each, not reloadable; an instrument for mass transit up to three thousand rupees outstanding.
• Interoperability became mandatory for full instruments by 31 March 2022, through the card networks for cards and the unified payments interface for wallets.

Tokenisation

From 1 October 2022 no entity in the card transaction chain other than the card issuer and the card network may store the actual card number. Everyone else stores a token, unique to the combination of card, requestor and merchant or device, with the last four digits and the issuer's name retained only for reconciliation. Tokenisation requires explicit consent with additional factor authentication, is free, and the cardholder may set limits on a token and delete it. The facility was later extended so that tokens may be generated directly through the issuer's own banking channel.

The digital rupee

• The Finance Act, 2022, notified on 30 March 2022, amended the Reserve Bank of India Act, 1934 so that the definition of a bank note in Section 2 includes a note issued in digital form, extended the sole right of issue under Section 22 to it, and disapplied the provisions that suit only physical currency.
• It is therefore legal tender under Section 26(1), guaranteed by the Central Government.
• The wholesale pilot began on 1 November 2022 and the retail pilot on 1 December 2022. The retail form is token based, behaving like a bearer instrument; the wholesale form is account based.
• It is distributed through intermediary banks, but a holding is not a deposit with the intermediary, earns no interest, and is unaffected by the intermediary's failure, because it is a liability of the Reserve Bank.
• The open questions are privacy after K. S. Puttaswamy, the tension between programmability and legal tender, disintermediation of bank deposits in a crisis, and liability when a wallet fails.

4. The Integrated Ombudsman Scheme

The integrated scheme launched on 12 November 2021 merged the Banking Ombudsman Scheme, 2006, the Ombudsman Scheme for Non-Banking Financial Companies, 2018 and the Ombudsman Scheme for Digital Transactions, 2019. Its three reforms are captured in the phrase one nation, one ombudsman: no choice of scheme, no territorial jurisdiction, and no closed list of grounds. A single concept, deficiency in service, replaces the list. The Reserve Bank Integrated Ombudsman Scheme, 2026 replaced it from 1 July 2026, keeping that design; complaints received earlier remain under the Scheme of 2021.

When a complaint is not maintainable

A complaint must be addressed to the Ombudsman directly, lodged personally or through an authorised representative (an advocate only where he is himself aggrieved), complete, and not abusive, frivolous or vexatious. The entity must have been approached first, the complaint to it must have been within the Limitation Act, 1963 period, and the same grievance must not be pending or decided by the Ombudsman's office or by any court, tribunal, arbitrator or other forum, a criminal case or police investigation not counting for this purpose. The excluded matters are a commercial judgment or decision of the entity; a dispute with a vendor; a general grievance against management; action taken under the orders of a judicial, statutory or law enforcing authority; a service outside the Reserve Bank's regulatory purview; a dispute between regulated entities; an employment dispute; a grievance with a remedy under Section 18 of the Credit Information Companies (Regulation) Act, 2005; and a grievance against an entity not covered by the Scheme.

The route, the award and the appeal

• Complain to the entity first; approach the Ombudsman on rejection, an unsatisfactory reply, or thirty days without a reply.
• File within ninety days of the later of the reply deadline or the entity's last communication, in place of the one year allowed by the Scheme of 2021.
• File online, by electronic mail, or in physical form to the Centralised Receipt and Processing Centre at Chandigarh, where maintainability is screened before registration.
• The entity's Principal Nodal Officer represents it, and must file its version within fifteen days or the Ombudsman may proceed ex parte.
• Conciliation first, then an award or a rejection. There is no ceiling on the dispute; compensation is capped at thirty lakh rupees for consequential loss and a further three lakh rupees for loss of time, expenses and harassment, up from twenty lakh and one lakh under the Scheme of 2021.
• The award lapses unless accepted in full and final settlement within thirty days.
• An appeal lies to the Executive Director in charge of the Consumer Education and Protection Department, within thirty days, extendable by a further thirty days for sufficient cause.

5. The consumer remedy

Section 2(42) of the Consumer Protection Act, 2019 names banking as a service. Section 2(11) defines deficiency as a shortcoming in what is required to be maintained by or under any law or undertaken under a contract, including negligence and the deliberate withholding of information. Section 2(7) excludes a service availed for a commercial purpose, with an Explanation saving use exclusively for earning a livelihood by self employment.

• The value that fixes the forum is the consideration paid, not the compensation claimed.
• Section 34(2)(d) permits filing where the complainant resides or personally works for gain, which is the most useful reform of the Act of 2019.
• The limitation is two years from the cause of action, condonable for sufficient cause recorded in writing.
• Appeals lie in forty five days to the State Commission and thirty days to the National Commission, each requiring a deposit of fifty per cent of the amount ordered, and in thirty days to the Supreme Court from an order made by the National Commission in its original jurisdiction, again on a fifty per cent deposit.
• Section 2(46) allows a Commission to strike at an unfair contract, including an excessive security deposit, a disproportionate penalty, unilateral termination without cause and unreasonable charges.
• Section 100 makes the Act in addition to and not in derogation of any other law, so the remedies are cumulative.

6. Quick Revision

1. A stock exchange is outside the definition of a payment system; an agent of the payee and an intra group arrangement need no authorisation.
2. Settlement finality attaches on determination, not payment, and survives insolvency.
3. Gross settlement eliminates exposure; net settlement creates it, which is what Section 23 protects.
4. The national payments corporation is a not for profit system provider, not a regulator, and its circulars bind contractually.
5. Zero merchant discount rate works through two statutes: one compels acceptance, the other forbids charging.
6. A prepaid balance is not a deposit and is not insured; the escrow is the protection.
7. A token is bound to the card, the requestor and the merchant or device and is useless elsewhere.
8. The digital rupee is a liability of the Reserve Bank and legal tender; a bank balance is a claim on the bank.
9. The Ombudsman Scheme replaced a list of grounds with a list of exclusions.
10. A commercial judgment of a bank is not a deficiency in service.
11. Under the Act of 2019 the complainant may file where he lives, and the forum is fixed by the consideration paid.
12. Neither summary forum can decide fraud, forgery or disputed contents.

7. Frequently Asked Questions

Why can an electronic settlement not be reversed?

Because the general law of insolvency would otherwise reopen it. A liquidator's ordinary duty is to collect everything owed to the estate and to pay only a dividend on what it owes, which applied to a netted clearing would turn a settled net figure into a one sided demand. Section 23 removes that risk by making a settlement under the approved procedure final and irrevocable at the moment the amount is determined, by providing that an order of insolvency does not affect it, and by letting the provider appropriate the failed participant's collateral under the system's own rules. Every participant may therefore treat a settled position as money, which is what makes same day and instant settlement possible at all.

What is the difference between money in a wallet, a bank balance and a digital rupee?

Whose liability it is. A wallet balance is a claim on the issuer, which makes the holder an ordinary creditor; it is not a deposit, carries no insurance, and is protected only by the requirement that a non-bank issuer keep the float in an escrow account. A bank balance is a claim on the bank, insured up to the limit in force and backed by the whole prudential and resolution framework. A digital rupee is a liability of the Reserve Bank itself and is legal tender, so the intermediary's failure does not touch it, but it earns no interest. A token is none of these: it is not value at all, only a substitute number standing in for a card.

Should a customer go to the Ombudsman or to a consumer commission?

The Ombudsman is free, quick, needs no representation and has no ceiling on the amount in dispute, so it suits an ordinary service failure such as a wrong debit, a delayed reversal or an uncorrected credit record. A consumer commission suits a claim for compensation beyond what the Ombudsman may award, a case where an unfair contract term should be struck down, or a complainant who wants a reasoned order capable of being appealed through a judicial hierarchy. Both are summary and neither can decide seriously disputed facts. Having chosen one, a complainant may not run the other in parallel on the same cause of action, since the Scheme excludes a matter pending or decided elsewhere.

Is the unified payments interface governed by a statute written before it existed?

Yes, and that is a feature of the drafting rather than a gap. The Act of 2007 regulates the category, a system that enables payment between a payer and a beneficiary involving clearing, payment or settlement, rather than any named instrument. The interface falls squarely within that definition, is operated under an authorisation under Section 7, and every operational rule that governs it, from transaction limits to dispute resolution, takes effect as a condition of that authorisation or as a direction under Section 17 or Section 18. The same architecture absorbed prepaid instruments, payment aggregators and the tokenisation framework without any amendment to the statute.

Does a customer who loses money to a fraud have a consumer remedy?

A limited but real one, and the framing decides the outcome. Where the complaint is that the bank failed to follow the framework for unauthorised electronic transactions, by not providing a reporting channel, not sending alerts, not making the shadow reversal within ten working days or not resolving within ninety days, that is a deficiency in service provable on documents and either forum can decide it. Where the complaint asks the forum to find who committed the fraud or whether a signature was forged, it is beyond a summary jurisdiction and belongs in a civil court with a criminal complaint beside it. The burden of proving customer liability in an unauthorised electronic transaction lies in any event on the bank.

8. Related Topics and Provisions

• Electronic banking and customer liability for unauthorised transactions
• Reserve Bank regulation of non-banking financial companies and payment systems
• Cheques, crossing, the paying banker and the collecting banker
• The duties of a banker: secrecy, care and honouring cheques
• Small finance banks and payments banks
• Cyber security, outsourcing and operational risk in banks
• Reserve Bank note issue, legal tender and currency management