Banking Operations in Mutual Funds

What this chapter covers

Units 12 to 15 carry 30 marks between them — about 7.5 marks for this chapter.

LEARNING OBJECTIVES: After studying this chapter, you should know about: Different modes of Payments and types of payment instruments · Different types of bank accounts maintained by mutual funds · Efficient Clearing Mechanisms · Role of RTAs in banking operations · Adoption of Standardised, Validated and Exclusive UPI IDs

13.1 Payment mechanism

Payments for mutual fund transactions need to be made through the banking channel modes that have been approved by the regulators. The acceptable modes of payments are through online transactions or different payment mechanisms such as cheque, demand draft and cash.

Payments for any mutual fund transactions are, therefore, made in either of the following forms — Electronic / Online mode · Physical cheque mode · Cash Payments with limitations · E-Wallets with limitations.

Four forms; two of them limited.

13.1.1 Electronic / online payments

Electronic payment instruments are modern facilities, where the clearing process need not be initiated by the mutual fund. The investor completes the transfer of funds, and provides the proof of such transfer to the mutual fund. In order to complete the electronic transfer of funds, investors must know the scheme's account details. AMCs provide this information to investors.

The fund does not chase the money — the investor pushes it.

National Electronic Funds Transfer (NEFT) — a nation-wide payment system facilitating to move funds electronically from one account to another. On opting transfer of funds through NEFT, they get credited to the transferee account in batch processing. There is no limit imposed by the RBI for funds transfer through NEFT system. However, banks may place amount limits based on their own risk perception. To facilitate and encourage electronic payments, NEFT is available on 24/7 basis on all days of the year. Further, RBI has instructed all banks to waive off all charges for NEFT done from savings bank account w.e.f. January 1, 2020.

Batch processing, no RBI limit, 24/7.

Real Time Gross Settlement (RTGS) — a facility to move funds electronically on an instant basis. Funds are immediately transferred from one bank to another. RTGS is used for transactions above Rs 2 lakhs, with no upper ceiling. As in case of NEFT, RBI has instructed all banks to waive off charges for RTGS facility too.

Instant, and for amounts above Rs. 2 lakhs. The third sample question asks which method moves funds instantaneously — RTGS.

Auto Debit and Standing Instructions (SI) — for periodic payments such as Systematic Investment Plans (SIP), investors may issue an auto debit instruction to its bank towards payment to the specified MF scheme. This allows the investors bank to make the payment for specified amount on specified date without repetitive permission or authorisation.

On the specified date, each month, the bank will automatically transfer money from the investor's account to the account of the mutual fund. The bank accepts 'Standing Instructions' (also called 'Direct Debit') if both investor and mutual fund have an account with the same bank.

Note that last condition — a standing instruction proper works with the same bank; across banks the NACH mandate is used.

Application Supported by Blocked Amount (ASBA) — a payment facility available to investors for all mutual fund NFOs, launched on or after October 1, 2010. The investor blocks the required sum of money in the bank account to subscribe to the NFO. The investor account gets debited only on allotment of the units. Banks specified by SEBI provide the facility. Mutual Funds/ AMCs shall make all relevant disclosures in this regard in the Statement of Additional Information (SAI).

Blocked now, debited only on allotment — the money keeps earning interest in the meantime.

E-wallet — a virtual or digital version of the physical wallet. Money is loaded to the E-Wallet and used as required to make payments and transfer funds to other E-Wallets. However, they cannot be used to transfer money to a bank account. Wallets of banks, payment banks and e-commerce platforms are commonly called E-Wallets.

The conditions are strict. MFs/ AMCs ensure that total subscription through e-wallets for an investor is restricted to Rs.50,000 per investor per financial year. This limit of Rs.50,000 is an umbrella limit for investments by an investor through both E-Wallet and/or cash, per mutual fund per financial year.

One umbrella covering e-wallet and cash together.

MFs/ AMCs shall ensure that only amounts loaded into e-wallet through cash or debit card or net banking, can be used for subscription to MF schemes. Any amount loaded into e-wallet through credit card, cash back, promotional scheme etc. are not allowed for subscription to MF schemes. Also, no third-party transactions are allowed through e-wallets. It should be ensured that all e-wallets are fully compliant with KYC norms as prescribed by RBI.

No credit card money, no cashback money, no third-party payments.

Digital payments such as Net Banking, Debit cards, Unified Payment Interface (UPI) are amongst the accepted modes of payments for mutual fund schemes currently.

13.1.2 Physical payments

Investors may use payment instruments like cheques and demand drafts for purchasing mutual fund units.

Payments through cheques differ in terms of how the funds are collected from the payer's account into the beneficiary's account. This transfer usually involves more than one bank, or more than one branch of the same bank, and sometimes a centralized clearing agency.

Three kinds of cheque:

i. Transfer Cheque: If the investor holds accounts in the same bank as that of the mutual fund, then the cheque only involves a transfer of funds within the same bank.

ii. Local Cheque: If the investor's account is with another bank but in the same city, the collecting bank will have to go through the local clearing house, to get the cheque collected.

iii. Outstation Cheque: If the paying bank account is located in another city, the cheque will have to go through two clearing houses at two different locations. These are not accepted now as it impacts the NAV applicability as realization takes time.

The sixth sample question turns on the last — an outstation cheque is not valid for direct subscription.

Most banks offer multi-city cheques or at par cheques facility to their preferred or current account customers. At par implies that the instrument is as good as drawn on any other branch of the same bank. An at-par cheque is a local cheque when presented at any of the bank's branches and goes into local clearing. In modern banking, there is no practical difference between a local cheque and outstation cheque.

With the introduction of the Cheque Truncation System (CTS), physical cheques do not move between locations for clearing, instead cheque images of requisite quality move in the CTS processing cycle.

Third-party cheques. A cheque issued by any person other than the investor of the mutual fund investment is a third-party cheque. Any cheque which is issued from the bank account where 1st holder/applicant is not one of the account holders, is considered as third party cheque.

The test is the first holder's presence on the bank account — not the relationship of the payer.

Demand drafts. In cases where mutual funds are unable to reach investors in certain locations and are unable to provide for a branch or Investor Service Centres (ISC), they accept Demand Drafts (DDs) and also bear the charges upto the amount as may be specified in SAI. Demand drafts have to be payable on any bank in the nearest ISC or mutual fund branch's clearing area. It is sent by the collection bank for local clearing.

13.1.3 Cash payments

Investors have the option of investing in mutual funds through cash, to the extent of Rs. 50,000 per investor per mutual fund per financial year. Only resident individuals, sole proprietorships and minors (through their guardians), who are KYC compliant, can make cash investments. It may be further noted that, mutual funds do not accept cash (beyond the specified limits), money orders or out-station cheques.

Three categories only, all KYC compliant, up to Rs. 50,000.

And money never goes back the same way: although investment can be made in cash, repayments in the form of redemptions, dividend payments, etc. can be paid only through banking channel. The pay-out bank details have to be provided by the investor in the application form.

Which answers the first sample question — redemption proceeds come by bank transfers or cheques, never cash.

13.2 Third Party Verification and payment to a valid account

For mitigating the risks of third-party payments, the RTAs are required to validate the transactions while accepting/ processing of the investment as per the following:

1. This validation for physical applications would be done with any one of them: 'Penny drop' facility or PAN based account validation facility provided by NPCI · original cancelled cheque with name and matching the name with the investor name · self-certified copy of cheque/passbook, verified with the original by AMC / RTA, which matches the investor name.

Three routes; any one suffices.

2. RTA/AMC shall make sure that the investment amount is accepted through only such modes where independent traceability of end investor can be ensured, and source account details are readily available.

3. For each of the amounts collected through one-time mandate (OTM) and transferred to an Approved Account, the Payment Aggregator (PA) shall provide the bank account number, remitter name, etc. to the respective AMC.

4. For other modes of payment instruments, including net-banking, AMC and PA shall permit payments only from banks which provide real time account validation or banks which provide source bank account information as a reverse feed, not later than the day following the date of payment by investor.

5. In case funds are received from a bank account that is not verified and registered in the investor folio; and such bank account cannot be verified as belonging to the investor, then the subscription transaction shall be rejected and the amount so collected shall be refunded to the same bank account from where the PA had collected the funds.

Refunded to the source account — the money goes back where it came from, not to the applicant.

6. Detailed information at each stage of the relevant transaction, including rejection, shall be made available at the same time to all the stakeholders involved in the transactions, as applicable, including investors, RTAs, MFDs, IAs, etc.

7. Payment Aggregators (PA) shall provide access to the relevant documentations to a third-party auditor appointed by AMC/ AMFI to verify compliance with the provisions of the AMFI guidelines on process for mitigating risks of co-mingling of funds at the level of payment aggregator and payment gateway... AMFI may require such audits to be carried out at least on an annual basis.

8. Redemption proceeds shall be credited only to a verified bank mandate. AMC/ RTAs shall ensure that payment is credited directly to the registered and verified bank account of the investor mapped with the concerned folio, after due verification. The process carried out by AMC/ RTAs to verify bank account details i.e. investor name, bank account number, bank name, etc. shall be available as audit trail.

9. In case of subscription or redemption of units, Two-Factor Authentication (2FA) (for online transactions) and signature method (for offline transactions) shall be used for authentication. One of the Factors for such Two-Factor Authentication for non-demat redemption shall be a One-Time Password sent to the unitholder at his/ her email/ phone number registered with the AMC. In case of demat redemption, process of authentication as laid down by the Depositories shall be followed. Two factor authentication was earlier required only for redemption. W.e.f April 1, 2023 two factor authentication is also required for subscription transactions. For SIP and other recurring transactions, two factor authentication shall be applicable only at the time of registration of such recurring mandate.

2FA online, signature offline; redemption always, subscription from 1 April 2023; and for SIPs only at registration.

13.3 Bank accounts maintained by mutual funds

A mutual fund scheme has several bank accounts through which it receives and pays out money for various purposes.

Why the balances are managed actively. A mutual fund does not keep money in the bank accounts idle. Idle funds do not earn any return. At the same time, it is also important to make all payments that become due, on time. Mutual funds therefore need to manage their cash balances efficiently. Banks enable mutual funds to efficiently use their cash balances by providing a facility called Cash Management Service (CMS).

The collecting banker. A mutual fund scheme may appoint one or more collecting bankers. The names of such banks and their branches are listed in the new fund offer (NFO) application form. Since the NFO price applies uniformly to all purchases during the NFO period, there is no time stamping requirement. Therefore, the branches of the collecting bank are also available for collecting NFO applications and payment instruments.

No time stamping during an NFO because the price does not vary.

Investors use various payment options offered by the banking system for buying mutual fund units. These payment instruments collected at ISCs and AMC offices are also deposited into the collecting bank. Deposit into the collecting bank account is done by using manual pay-in slips or pay-in slips generated from the system using scheme CMS codes.

The collecting banks provide a CMS code for each scheme. Its bank branches upload the soft copy of the pay-in details into its CMS. The collecting banker notifies the AMC and the R&T agent about the status of the deposited instrument.

Three functions of collecting bankers:

They collect payment instruments through the clearing process to realise the funds paid by the investors.

They provide reverse feeds showing the cleared or bounced status of the instruments.

The NFO collecting bankers accept NFO applications. After the NFO, they provide a 'collections confirmation certificate'. The bank's collection figures are reconciled with the R&T agent's records before allotting units to investors.

13.4 Electronic clearing mechanisms

13.4.1 NPCI and NACH

National Payments Corporation of India (NPCI) is an umbrella organization for all retail payments and settlement system in India. It was set up with the guidance and support of the Reserve Bank of India (RBI) and Indian Banks' Association (IBA).

The core objective is to consolidate and integrate the multiple systems with varying service levels into nation-wide uniform and standard business process for all retail payment systems. The other objective was to facilitate an affordable payment mechanism to benefit the common man across the country and help financial inclusion.

NPCI was incorporated as a Section 25 Company in December 2008. The aim is to create infrastructure of large dimension and operate on high volumes resulting in payment services at a fraction of the present cost structure.

National Automated Clearing House (NACH) is a centralised clearing system launched by the National Payments Corporation of India (NPCI). NACH aims to replace and consolidate multiple existing Electronic Clearing Service (ECS) systems across India and create a faster and more efficient clearing platform. It is a web-based solution for Banks, Financial Institutions, Corporate and Governments, to facilitate interbank high-volume electronic transactions which are repetitive and periodic in nature. This has been introduced in place of ECS for repetitive payments. NACH have same day presentation and settlement, including returns processing.

Repetitive and periodic — which is why the fourth sample question answers Systematic Investment Plans (SIP), not one-time lump sums.

The various facilities offered by NACH include standardisation and digitisation of mandates, overall simplification, reduction of operational cost, and minimisation of activation time. Existing ECS mandates are now been moved to the NACH platform, in partnership with the participating banks. However, no intervention from investors will be necessary in this regard.

The service is now active in all Indian banks with core banking facility. It comes in two variants – NACH Credit and NACH Debit. The significant benefits to bank customers include automatic debits from their account for bill payments (telephone, electricity, etc), loan instalments, insurance premiums, SIPs and more. Not only this, NACH is useful for corporate and financial institutions that make payments in bulk like dividend distributions, salaries, interests, pensions, etc.

Debit for collections, credit for bulk payouts.

13.4.2 Cheque Truncation System

CTS is a project of the Reserve Bank of India (RBI), commenced in 2010, for faster clearing of cheques. Cheque truncation means stopping the flow of the physical cheques issued by a drawer to the drawee branch. Instead of the physical instrument, an electronic image of the cheque is sent to the drawee bank for payment. This eliminates the need to move the physical instruments across branches resulting in an effective reduction in the time required for payment of cheques, the associated cost of transit and delays in processing, etc., thus speeding up the process of collection or realization of cheques.

The image travels; the paper stops.

13.5 Role of RTAs in banking operations

RTAs play an important role in banking operations for mutual fund transactions. It helps in efficient handling of cheque receipt or return, reconciliations and verification of cut-off time for NAV applicability.

On electronic payments: RTA is required to reconcile the receipt of funds with the applications and highlight discrepancies, if any, in the same. If any mismatch is found, the transaction is flagged as 'Not in Good Order' (NIGO) and units are not issued to the investors.

The fifth sample question asks what NIGO stands for — Not in Good Order.

On physical payments: the RTA sends the payment instruments for clearing in stipulated time and to reconcile the same for cheque return. The RTA ensures that units are not issued to any investors in case of cheque return.

On liquid funds: RTA has to ensure that clear funds are available at the time of allotment of units.

On payouts: for redemptions and dividend (IDCW) pay-outs, RTA ensures that the payee details are captured properly in the system for electronic payment; where electronic payments are not possible, RTA issues payment instruments and sends the same to the investor through registered mail.

13.6 Standardised, validated and exclusive UPI IDs

Unified Payments Interface (UPI) has become a popular and convenient mode of money transfer. With an objective to enhance accessibility and safety in the securities market, SEBI proposes to offer structured Unified Payment Interface ('UPI') option for investors making payments to market intermediaries. The transfer of funds through this mechanism will assure investors that their payments are being made to the verified and registered market intermediaries. A verified UPI ID is linked to a validated bank account of the user thus ensuring secure transactions.

RTAs are required to make this facility available by October 1, 2025. The investor shall be at liberty to use UPI or any other payment mechanism.

Available, not compulsory.

Responsibilities of the Registrar to an Issue: create investor awareness about UPI payment handles and "SEBI Check" functionality through modes like SMS, e-mail communications, social media posts and audio-visual messages, and create awareness and educational content for investors by placing relevant FAQS on respective websites.

The eighth sample question asks the purpose — to enhance safety and traceability of payments.

The chapter's sample questions confirm that redemption proceeds come through bank transfers or cheques; that cash, demand draft and bank transfer are all accepted for investing; that RTGS moves funds instantaneously; that NACH is used by retail investors for SIPs; that NIGO means Not in Good Order; that an outstation cheque is not valid for direct subscription; that redemption to NRIs must comply with the source of investment account and RBI regulations; that standardised UPI IDs enhance safety and traceability of payments; and that a cash deposit beyond Rs. 50,000 per year is not an acceptable electronic mode.