21. Offline Recurring Payments — NACH, ECS

Note: This is super long article… if you are not interested in offline payment solutions then skip it.

Offline recurring payment solutions evolved over the period of time. A decade ago, post-dated cheques were popular method for merchant to debit customer’s account. If I take bike loan for with 6 months tenure then I had to give 6 post-dated cheques.

That model was not scalable so came the era of paper based mandates with ECS (Electronic Clearing Service). ECS is governed by RBI wherein RBI and selected banks acted as clearing house. ECS fulfils both Credit and Debit requirements of a merchant.

ECS Credit: A merchant/entity has to push funds to other entities or users. (Example: Distribution of dividend to shareholders)

ECS Debit: A merchant/entity will pull funds from other entities or users (Example: deduct my A/C for monthly SIP)

We are interested in ECS Debit, where merchant can pull funds from customer’s account on basis of mandate that is filled by customer and validated by customer’s bank. Even ECS are covered under Negotiable Instruments Act (similar to cheque).

ECS has many problems:

1. A4 sheet mandate form — subjected to wear and tear

2. It took 21+ days for mandate validation (In case of some banks, mandates are validated centrally but for many banks mandate has to reach customer’s branch for validation)

3. Higher failure rates in mandate validation and debit

To overcome these inefficiencies, NPCI launched ACH / NACH (National Automated Clearing House) where NPCI acts as clearing house.

Note: Two leading aggregators (TechProcess, BillDesk) developed Direct Debit solution which is a paper based recurring payment solution and works with 10–15 banks in a bilateral arrangement. Direct Debit is a limited solution and ECS will be phased out so I won’t get deep dive into those. Let’s talk about NACH or ACH in detail.

NACH (National Automated Clearing House):

Solution is governed by NPCI with clear benefits over ECS (Electronic Clearing Service). Although process begins with paper mandate form but the scanned images are used for processing so the time taken for validation is reduced and provides better conversion.

Participants in NACH Process:

• Customer: Provides duly signed mandate form to merchant
• Merchant: Entity that wish to debit customer’s account (E.g.: Utility company, NBFC, Mutual Fund aggregator, Insurance provider etc.). Merchant can avail NACK service from a bank or aggregator
• Sponsor Bank: Banks that are permitted by NPCI to originate transaction in NACH system (a payment aggregator who wish to be part of NACH would need sponsor bank)
• Destination Bank: Customer’s bank and the bank needs to be part of NACH system as well
• Clearing House: NPCI is the clearing house which provides the central system for processing NACH mandates
• Aggregator: An aggregator on-boards the merchant and works with Sponsor Bank (s) for managing mandate life cycle. May charge additional fees for services

There are three stages: Mandate Form filling, Mandate Registration (validation) and mandate debit

A. Mandate Form

Sample Form from LIC

Typically, merchant provides pre-filled mandate form which has basic details such Sponsor Bank Code, Utility Code, Merchant details. UMRN is generated when mandate is processed by NPCI so not applicable in the initial phase but required for mandate modification or cancellation.

Customer has to fill, Account details (beneficiary name, bank name, account number, IFSC/ MICR), and mandate attributes such Frequency (Periodicity), duration (period) and debit amount

Mandate attributes and their implication:

a. Frequency (Periodicity):

It can be monthly, half yearly, yearly, as and when presented and merchant will stage the debit as per the periodicity.

Interest one in is ‘as and when presented’: Customer has given mandate for monthly debit and if debit fails due to insufficient funds then merchant cannot run the debit again. (Customer might not have funds at the time but deposited funds next day). But with ‘as and when presented’ option, merchant can stage the debit file whenever needed. It covers cases of ad-hoc usages as well as re-running debit for insufficient balance cases.

b. Debit Type (Fixed or maximum amount):

Assume you have given mandate for Rs.10,000 ‘fixed amount’ per month for your MF SIP. But after a year, you want to increase SIP amount to Rs.12,000 then same mandate will become useless. But while giving mandate, if you select ‘maximum amount’ of Rs.25,000 then it will cover your current SIP amount and also, future demands as well.

c. Period: Range or until cancelled:

Some mandates are time bound (E.g. EMI payment towards my car loan for duration of 5 years) and some mandates need to run till perpetuity (E.g. MF SIP) until I decide to stop. So depending on situation the period (mandate duration) will be set.

B. Mandate Validation (Registration)

Below is the registration flow if merchant decide to use NACH services by payment aggregator.

• Unique UMRN is created for all mandates that are created in NPCI system. UMRN is used for debit, modification and cancellation of mandate
• Destination banks validate mandate and provide status (Accepted or Rejected) within 5 working. Banks provide reason for rejected mandates
• Mandate that is not validated before 5 working days are considered as Deemed Cancelled
• Aggregator/bank can re-lodge Deemed Cancelled and Rejected mandates (if rejection reasons are not critical such signature mismatch or wrong account details etc.)

C. Mandate Debit:

Once the mandate is validated successfully, merchant can process the debit on that mandate. Below is the standard process of mandate debit.

Merchant has to send file to aggregator/bank at least 1 working day before the actual debit date. Post successful processing of debit, merchant will receive the funds in merchant’s account.

Mandate Life Cycle

• Mandate Modification:

Typically not allowed to modify the mandate because of its paper form. So merchant to make sure periodicity (frequency), debit amount and period cover present and future cases. If need to modify critical information (change in bank account) then user has to cancel previous mandate and provide new mandate.

• Mandate Pause:

I have monthly SIP and due to financial reasons, I want to pause the mandate for 6 months. So it is possible to pause the mandate?

No, there is no automated process for pausing the mandate. But we know the debit will happen only if merchant stages the debit file with aggregator/bank. So if merchant doesn’t stage my mandate for debit for 6 months then it is as good as ‘pause’ on mandate.

• Mandate Cancellation

A customer should request merchant to cancel the mandate and merchant will make sure mandate is removed from its system and won’t do future debits. Also, customer can request destination bank to cancel the mandate.

Operation Details:

• Merchant Settlement: Settlement time is T+1 Working day.

Merchant will receive either gross settlement (if charges are invoiced) or Net-Settlement (if charges are in upfront deduction model)

• Refund: Refunds are typically offline to the system. Merchant has to find alternate way to refund the amount. (it is not similar to online refunds where you simply mark refund against the order)

Commercials:

• Mandate registration fee: Flat Fee for successful registration. The fee is passed on to merchant and also, destination bank may pass the charges to customer
• Mandate Debit Fee: Flat Fee per successful debit
• NPCI Charges: Levied on both sponsor bank and destination bank. Usually passed on to merchant through bank/aggregator. Destination bank charges may be passed to customer.
• All charges attract GST @ 18%

Safeguarding Merchant:

A customer has taken loan from a NBFC and NBFC has validated NACH mandate given by customer. But when NBFC staged the debit for the mandate, the debit failed due to insufficient funds. In another scenario, customer cancelled the mandate by contacting his bank. In both cases, customers are not respond to merchant’s calls/mails/visits. So what should merchant do?

NACH is covered under Section 138 of Negotiable Instruments Act (1881) and Sector 25 of Payments and Settlements Act (2007). Under these acts the frequent dishonour of instructions (NACH) due to insufficient funds attract punishment (similarly, bouncing of cheque).

Note: If is a case where customer has willingness to pay but didn’t have funds on that day then merchant can re-run the mandate or collect payment online (website, payment link etc.)

Benefits of ACH:

• Efficient than ECS and cheques
• Flat Fee structure is economical for merchants
• Can handle large ticket sizes
• Scalable solution due to electronic image of mandate is used for processing
• No restriction on type of merchant that can be on-boarded
• Covered by Negotiable Payments Act, so merchants interests are safeguarded

Drawbacks of ACH:

• Overhead cost in terms of collection of mandate, scanning mandates
• 5 day delay is mandate validation
• File based debit (although companies are moving to APIs)
• Failure rate is still high because of signature mis-match

The advantages of NACH outweigh the drawbacks so ideal solution for Mutual Fund, Insurance, NBFC and B2B industry. NPCI is trying to move NACH to online with e-NACH solution but as systems are not stable and registration process is cumbersome (at present) so I feel NACH continue to thrive couple of more years.

Next: Standing Instruction on cards