The distinguishing characteristics of e-money is that unlike innovations in other retail payments media which facilitate more efficient access to traditional form of central bank money, e-money could have the potential to become an independent medium of exchange. In that eventuality, two extreme views are being offered. On the one hand, one group perceives that in future in a highly technologically advanced networked world, private entities may not require central bank money for settlement and, therefore, there may not be any central bank in future. Some of them also question whether private money is more efficient than central bank money from the point of view of social welfare and if so, under what circumstance, private money can replace altogether the central bank money. On the other hand, there is another group of academicians and practitioners who strongly believe that central banks would continue to be as effective as ever though they may be required to respond differently in the changed environment.

With progress in technology and networking, the modes of payment and settlement would undergo distinct changes, particularly with operationalisation of the real-time gross settlement system (RTGSS), Negotiated Dealing System (NDS) and Clearing Corporation of India Limited (CCIL). These would lead to gradual switchover from the use of paper-based payments media to those based on electronics including electronic money (e-money). Keeping these developments in perspective, it was felt that it is now appropriate to prepare a Policy Paper on e-money so that the challenges it might place in future both on the balance sheet of the central bank as also on the transmission mechanism of monetary policy are appropriately met. In other words, it is instructive to identify the areas of concern from the point of view of the central bank in the context of more wide spread use of e-money so that our conduct of monetary policy is not impaired and at the same time, the integrity of the instrument (i.e., e-money) is also preserved. To this end, a Working Group has been constituted on January 25, 2002 by RBI with representations from both within the Bank and outside under the Chairmanship of Mr. Zarir J. Cama, Chief Executive Officer, HSBC.

The Group submitted its Report on July 11, 2002

Accordingly, the Report is organised in four Sections.

1. Section I deals with the definition and features of e-money and its likely position vis-a-vis other retail payments media.

2. Section II attempts to explore the likely implications of e-money on both the balance sheet of the central bank and the conduct of monetary policy.

3. Based on these discussions, Section III brings to the fore the policy issues for RBI and the likely prudential norms governing operations of the e-money scheme.

4. Section IV gives summary and recommendations of the Report, which alone is reproduced hereunder, covering paragraphs 40 to 52. Those desirous of viewing the full text of the report may do so by accessing website of RBI.

Broadly, e-money is an electronic store of monetary value on a technical device. E-money could be classified as (a) pre-paid stored value card (sometimes called "electronic purse") and (b) pre-paid software based product that uses computer networks such as internet (sometimes referred to as "digital cash" or "network money"). The stored value card could be of three types - single-purpose card, closed-system or limited-purpose card and general-purpose or multi-purpose card. The single-purpose card generally with a magnetic chip recording the amount of fund therein is designed to facilitate only one type of transaction e.g., telephone calls, public transportation, laundry, parking facilities etc. Here, the distinguishing point is that the issuer and the service provider (acceptor) are identical for such cards. The closed-system or the limited-purpose cards are generally used in a small number of well-identified points of sale within a well-identified location such as corporate/university campus. The multi-purpose card on the other can perform variety of functions with several vendors viz., credit card, debit card, stored value card, identification card, repository of personal medical information etc.

While it may not be desirable place any limit on storing monetary value in e-money, it is expected that e-money could be used to substitute central bank notes and coins at least partially. However, the importance of e-money with respect to regulatory oversight, restrictions on issuers and their implications for monetary policy is extremely critical from the point of view of the central bank.

After considering various issues, the Group recommends that multi-purpose e-money may be permitted to be issued only against payment of full value of central bank money or against credit only by the banks. The issuance of e-money on credit basis should, however, be strictly regulated and closely monitored.

It needs to be appreciated that issuers must be under obligation to offer redemption of their e-money liabilities net of service charges, if so required. From monetary policy point of view, such redemption requirement is essential in order to preserve unit of account function of money as also to control money supply in the economy.

With regard to status of issuers of e-money, it may be indicated that there are five reasons which may warrant banks as the issuers of multi-purpose e-money. These include attributes of e-money being closure to demand liabilities of the bank, implications of e-money on velocity of circulation of money and its corresponding impact on monetary statistics, the option to impose reserve requirement on e-money, the need for closure monitoring of e-money when these would be issued as credit and the technical security of e-money. For all these reasons, the Group recommends that only banks should be allowed to issue multi-purpose e-money. However, single-purpose and limited-purpose e-money should be allowed to be issued by any entity including banks.

Non-banks should not be permitted to issue multi-purpose e-money. If they are permitted, they along with banks must conform to seven minimum prudential requirements as laid down by European Central Bank (ECB) in 1998. These are (i) prudential supervision of issuers of e-money by the central bank, (ii) solid and transparent legal arrangements codifying the rights and obligations of issuers, merchants, consumers and the regulators, (iii) adequate technical, organisational and procedural safeguards to prevent and detect threats to the security of e-money, (iv) protection against criminal abuse, (v) supplying of all relevant information to the central bank for the purpose of monetary policy, (vi) legal obligations to redeem e-money against central bank money at par at the request of the holder and (vii) the right of the central bank to impose reserve requirement on issuers of e-money.

E-money could have profound impact on compilation of monetary statistics and money supply unless regulated prudently. E-money could be issued against cash (i.e., 100 per cent backed by central bank money paid upfront). Since e-money are close substitutes of central bank money, these should be explicitly accounted for in monetary statistics. If e-money is allowed to be issued only by banks, then currency would be substituted with demand/time liabilities through e-money. In that eventually, issuance of e-money would be money stock neutral and no change would be required in the definition of money stock. However, if e-money is issued by entities other than depository institutions (i.e., banks), the money creating sector as embedded in compilation of monetary statistics would need to be broadened.

There could be a situation where residents could use e-money supplied by entities outside the country for domestic transactions. In that case, monetary aggregates would lose its predictive power.

It is expected that the proportion of interest bearing liabilities in monetary aggregates would grow in the event of growing use of e-money which would render them more unstable, and information content of monetary aggregates would also change.

If e-money is issued on credit, there is a possibility that the issuers may assume a leveraged position. There is, therefore, a need for continuous monitoring of the behaviour of issuing authorities for balanced growth of their assets and liabilities, particularly liabilities arising out of issuance of e-money. For these reasons, the Group recommends that the central bank should regulate and closely monitor the practice of issuing e-money on credit.

If consumers prefer to use e-money vis-a-vis currency, then for a given stock of currency, the money multiplier would go up which would in turn increase the aggregate money supply in the economy more than what would have been the case without e-money. Also, with large scale use of e-money, it has been apprehended that central bank's balance sheet may shrink to such an extent relative to that of the banking sector that it may be unable to perform its liquidity absorption function on account of non-availability of adequate volume of assets. Apart from constraining its liquidity management function, relative shrinkage in balance sheet may also have serious implications regarding loss of seigniorage revenue for the central bank. As a counter argument, it is maintained that there should always be a lower bound below which the use of currency notes and coins should not go down so that there should also be a limit below which reserve money should not shrink relative to broad money stock.

A review of developments indicate that while considerations of potential benefits of micro-economic efficiency, extension of banking to urban poor and rural communities and facilitation of e-governance demand that there should be increasingly private provision of payment and settlement services in the economy in future, macro-economic stabilisation policy warrants that there should be a case for public regulation over such provision. Also, currency uses are characterised by network externalities in that larger the number of users, larger is the settlement value of the currency concerned implying that currency could at best be supplied oligopolistically. There are, in fact, the fundamental reasons for which the "monopoly right" in the issuance of currency should be in the hands of some public authority, preferably the central bank. Even then, there cannot be any final judgement on this issue at this point of time. In view of all these considerations, the Group, therefore, recommends that the RBI should regularly monitor closely all these developments so that integrity of the financial system is preserved.

The RBI should also periodically review issues relating to legal framework, if any, technical security and the clearing and settlement arrangements of different e-money schemes and the practices of various e-money schemes, both in India and abroad, for preserving integrity of the financial market. On the issue whether entities other than the central bank could issue independent media of exchanges, the Group feels that such a possibility is apparently remote in India at this point of time. However, RBI may continually keep track of these developments for smooth functioning of the financial market.