POLICY BRIEF FINANCIAL INFRASTRUCTURE SERIES 47501 PAYMENT SYSTEMS POLICY AND RESEARCH FINANCE AND PRIVATE SECTOR, LATIN AMERICAN AND THE CARIBBEAN VICE PRESIDENCY FINANCIAL AND PRIVATE SECTOR DEVELOPMENT VICE PRESIDENCY THE WORLD BANK NOVEMBER 2008 BALANCING COOPERATION AND COMPETITION IN RETAIL PAYMENT SYSTEMS 1. Why is retail payments 1. Why is retail payments efficiency and innovation key to efficiency and innovation economic and social development? key to economic and social development? Payment systems and instruments are significant contributors to the broader effective- ness and stability of the financial system, in particular to the confidence in money and to 2. What is the the functioning of commerce. Hence, the efficient and safe use of money as a medium of combination of exchange in payment transactions is an essential function of the currency and, moreover, payment instruments it is also a foundation of the trust people have in it. usage that can be considered socially For these reasons, the efficiency and safety of payment systems (large and low-value ones) optimal? are of interest to central banks and other public authorities. Payment system oversight is a task that central banks undertake to ensure public confidence in money. The scope of the 3. To what extent are oversight function (e.g., large-value payment systems, securities settlement systems, retail efficiency, access and systems, payment instruments) varies among countries. However, there is an increasing innovation determined attention, beyond safety issues and systemically important systems, to the efficiency of re- by cooperation and tail payment systems and their role for the public confidence in money and the economy. competition among market players? Lack of efficiency and innovation in retail payment systems may have important costs. Recent academic findings based on empirical data reveal that shifting from paper-based 4. What are the payments to electronic ones could entail yearly savings to a country's economy of about main drivers of 1 percent of its GDP.1 This is mainly explained by the realization of economies of scale in cooperation and the provision of electronic payments, the overall increase in the total number of payment competition? transactions, savings in back-office operations as well as by the impact of the technologi- cal change in terms of lower telecommunication and processing costs. 5. Lessons Learned from LAC However, in many countries around the world the role of cash and cheques is still strong, country studies acting mostly as preferred payment instruments for smallerand face to face transactions. The socially optimal combination of payment instruments differ from country to country 6. Policy Implications given the particular features of the nation-specific production function (e.g., the balance between fixed and variable costs) and the varying pricing strategies applied by commercial 7. For further reading banks and other payment services providers. Yet, pricing policies by banks and regulatory actions by public authorities are usually visible drivers steering user's preferences. This 8. Acknowledgements Policy Brief looks at the forces shaping retail payments markets. Drawing on an overview of the main issues and four case studies from across Latin American countries (Argentina, Brazil, Colombia and Mexico) and the expertise of the World Bank in payment system projects, it offers a set of policy implications for public authorities to explore in their ef- forts to balance cooperation and competition in retail payment systems in order to bridge the infrastructure gap enhancing economic and social development. 1 In addition, for the case of Europe, Capgemini Consulting has proved that advancing in the modernization of the retail payments market (the so-called SEPA project) could have a significant market potential of up to 123 million in benefits over six years; a figure that could yet rise even further (up until 238 million) should banks be successful in using SEPA as a platform for the automation of business process linked to the business chain (e.g. e-invoicing). BALANCING COOPERATION AND COMPETITION IN RETAIL PAYMENT SYSTEMS 2. What is the combination of payment There is an increasing trend in the use of cash in some coun- instruments usage that can be considered tries (see graph 1). Use of cash in some G-10 countries has been socially optimal? steady in the latter years between 3 and 6 percent of GDP, with the exception of Japan that has traditionally presented a high The socially optimal combination in each country depends on level of cash in circulation, between 14 and 17 percent of GDP. user's preferences that can vary not only among countries but Latin American countries present an increasing trend (in part also within countries for different types of transactions. It also motivated by the establishment of financial transaction taxes) depends on the socioeconomic structure of the country and though levels have been similar to those of G-10 countries, ex- environmental factors (e.g., size, demographics, rural versus cept in the case of Argentina with an increase from about 4 urban, etc.). percent to 9 percent from 2001 to 2006, mainly caused by the financial sector crisis. GRAPH 1 1/ CPSS: Australia, Canada, Euro Area, Japan, U.K., U.S;LAC: Argentina, Brazil, Chile, Colombia, Mexico, Peru Source: WB DDP for LAC and 2006 of CPSS and the rest CPSS from BIS GRAPH 2 Source: World Bank Global Payment Systems Survey 2008 2 WORLD BANK NOvEMBER 2008 The usage of various non-cash payment instruments varies often compete directly in the provision of retail payments in- among countries (see graph 2). In terms of volume, cheques struments and services to end-users but they also cooperate in still represent an important percentage in the American Con- shared payment networks (`upstream cooperation combined tinent despite the reduction of their systemic importance as with downstream competition'). Balancing cooperation and demonstrated by their lower relevance in terms of value. Some competition is not easy, there may be coordination failures G-10 countries still keep a high use of cheques (e.g., Canada, that do not make always possible to cooperate introducing UK, US) though there is an increasing trend in the usage of inefficiencies and duplications. On the contrary, coopera- electronic payment instruments, mainly credit transfers, cards tion could lead to collusive behavior among payment system and direct debits (the latter especially in European countries). providers affecting the accessibility and affordability of retail payment services. 3. To what extent are efficiency, access and Market structure in retail payment systems is character- innovation determined by cooperation and ized by: competition among market players? · Economies of scale in messaging, clearing and The extent to which efficiency and other important policy ob- settlement services due to the fixed costs of the jectives such as access to financial services are attained in retail infrastructure. payments systems is partly determined by a complex interplay of cooperation and competition efforts among market play- · Economies of scope in clearing and settlement as well as in ers. This interplay is influenced by the relative importance and messaging services due to technology flexibility. drivers of costs, risks and market power in the provision of various types of payment services. · Network externalities in messaging, clearing and settle- ment services are produced by complementarities of us- Although the dividing lines among payments services are not ers and/or products and compatibility of products. always clear, the sequence of payment operations can be de- composed generally into: Competition takes place at two different levels: · Access services which provide the payor with the opportu- · Competition across retail payment instruments nity to select a payment instrument of choice. (e.g., cheque vs. electronic transfers). · Messaging services which transmit payment information · Competition across payment system providers for the same in a format that complies with the accepted standards payment instrument: for the entry of that information into the clearing and · among platforms (e.g., different credit card settlement system. providers) and: · within platform between service providers · Specific clearing services and arrangements for the (e.g., cards issuers versus acquirers). processing of payments that vary by the type of pay- ments instrument and the systems' architecture. The retail payment markets are also influenced by a number of dynamics. Some of these are specific to the end users (buyers · The settlement services provided by a settlement bank and merchants), some are specific to the platforms (networks), (e.g., the central bank) which discharge the payment ob- and some depend on the intermediaries (for example, in the ligation and provide finality to the process. case of card payments, the buyers' card issuers and the mer- chants' acquirers): There is increasing centralization of operations as the payment moves from its instrument access stage to the settlement stage · Switching Costs at the platform level (for platform par- due to the natural monopoly features in the provision of some ticipants), at the cross-product level (among payment of these services. For this reason, it is not at all uncommon instruments) and within the same type of product. to see payment platforms being developed through coopera- tion among competitors. Indeed, payments service providers Switching costs may prevent the adoption of better tech- nologies and social optimization. 3 BALANCING COOPERATION AND COMPETITION IN RETAIL PAYMENT SYSTEMS · Path Dependence as the legacy of previous technology Many recent innovations in retail payment systems have been developments, often determined by transient condi- largely supplied by non-banks. Non-banks have proven very tions, does typically influence later choices and out- successful in enhancing existing payment solutions, improving comes, thus, restricting investment decisions that may payments system efficiency and, further, fruitfully identifying negatively affect innovation and adoption of more and servicing new niche markets. efficient technologies. As in other economic sectors (e.g., telecommunication, en- · Tipping points as there is a tendency for one system to ergy), market structure, competition and dynamics in retail end up as the dominant one (payment card systems are payments determine behavioral patterns that differ from the an exception). Since the network externalities dictate situation where a multitude of firms engage in perfect compe- higher utility to each participant by adding more partici- tition with free entry. Economies of scale/scope and network pants, the utility is maximized if everybody participates effects have resulted in natural monopoly features that cause in one single network. a high concentration of payment platforms, sometimes end- ing up in vertical integration. If this is a positive or negative · Multihoming and stickiness. In most cases, both sides in a result is unclear and there is not a definitive answer. Effective payments market use several platforms, i.e. they "multi- cooperation may exploit economies of scale and scope and net- home". Consumers have more than one type of payment work externalities in a cost-efficient way and is likewise crucial instruments, and merchants accept several types of in- for setting standards that will secure compatibility between the struments. This "multihoming" also takes place within various products. However, centrally-agreed common features one type of instruments (e.g., credit cards). Often, how- can sometimes hamper product and/or service differentiation ever, the consumers favor one card over another, i.e. their and innovation at the individual service provider level. A key usage is "sticky". question is what factors should the authorities and key stake- holders consider in balancing cooperation and competition in retail payment systems? (see figure 1). FIGURE 1. RETAIL PAYMENT MARkETS AND DRIVERS OF COOPERATION AND COMPETITION Payment instruments Market conditions Behavioral patterns: Main drivers of cooperation (vehicle to transfer value): · Market structure · No perfect competition and competition: · Cash · Market dynamics (e.g., two sided markets) · Environmental, Legal and · Non-cash · Competition at different · Concentration of platforms: Legacy factors (paper-based, paperless) levels: · Take advantage of · Governance · Across instruments economies of scale/scope · Access Payment services: · Among and within platforms and network externalities · Pricing · Access for the same instrument · May hamper product · Messaging differentiation Policy Response · Clearing · No conclusive evidence on · Oversight and Cooperation · Settlement access, pricing and innovation 4 WORLD BANK NOvEMBER 2008 4. What are the main drivers of cooperation jectivity and contestability normally requires a closer public and competition? scrutiny of the self-regulatory scheme. Some payments services may be more efficiently provided Gaining access to messaging, clearing and settlement services is under competitive conditions (access) versus other that may of capital importance for the ultimate success of new entrants show natural monopoly features (messaging, clearing and in the market. Retail payment instruments and services are a settlement). Vertical integration or joint provision of some of critical part of today's banks portfolio strategies. The increas- these services by competitors may generate conflicts of inter- ing role played by non-banks makes access considerations even est among them resulting in inefficient governance, access or more important nowadays. Players with a dominant position pricing structures. In markets with similar characteristics (e.g., in one infrastructure may have the incentive to create barri- telecommunication), authorities have resorted to services pro- ers for access to new entrants. Moreover, access requirements vision separation by type of service. Those having a natural should be defined as to ensure that all participants enjoy the monopoly feature being provided by entities different from same level of financial soundness and are able to cope prop- those competing with the final client. In the retail payment sys- erly with the technical and operational requirements. Two- tems area this approach may not seem to be a feasible alterna- tiered membership participation models and certain types of tive due to the close relation of retail payment services with the decentralized clearing structures may sometimes be a solution core retail banking activity. to ensure sound access to the infrastructure, but under certain circumstances they may also create access barriers. However, authorities may resort to oversight and regulation to deal with conflicts of interest and balance cooperation and The complexity of pricing structures in retail payment systems competition.This approach has been recently followed by many may be used by some participants to gain a competitive ad- central banks and competition authorities and other relevant vantage. Membership fees accommodate charges depending bodies around the world (see box 1). In particular, through on the type of participation, activity level, market share, assets, oversight and regulation authorities are able to introduce mar- and prospective contribution to the expansion of the current ket corrective measures. These should be targeted to the main network. In addition to entry fees, participants are normally drivers of cooperation and competition (environmental, legal, subject to usage fees. This complexity may increase switching legacy, governance, access and pricing) to achieve the defined costs for the participants and their clients, negatively affecting policy objectives. Lack of oversight and regulation most surely rivalry. Float income earning and cross-subsidization of pay- will end up in sub-optimal availability and affordability of pay- ment services is furthermore a common practice in retail pay- ment instruments (see section 6). ment systems. Thus achieving a neutral and socially optimal level of fees in retail payment systems is not a trivial matter. For Network cooperation and competition is highly influenced by example, in relation to the cards market, interchange fees2 are environmental, legal and legacy issues. In deciding the design typically fixed to serve as a complex balancing mechanism that features of a given payments network, banks and all other rel- aims at maximizing the network overall profits. evant players are typically laying the grounds of the industry's future competition game. Therefore, the final strategic ap- proach chosen is likely to come as a result of the combined influence of such diverse factors as the structure of the banking industry, socio-legal, political and macroeconomic (e.g., high inflation) considerations, demographic dimensions, etc. Governance of the infrastructure has a significant impact on cooperation and competition. Non-proprietary, transparent 2 This study uses the term interchange fee for the cards markets as defined in the CPSS and open standards that do not impair interoperability can glossary, that is, fee applied for a network organization and paid by the card issuing insti- help shift competition to more classic variables such as pricing, tution to the acquiring for the cost of deploying and maintaining ATMs and POS. For the distribution channels, brand, customer service and core value ACH market the study uses the term interbank fee, that is, the one applied among ACH participants (normally banks) to balance costs (mostly associated with cash handling) of propositions. Self-regulation can help keep the infrastructures reaching clients (through bank branches) in different geographical areas. This interbank aligned with the changing needs but ensuring neutrality, ob- fee is normally applied on top of the fee for the infrastructure use. 5 BOx 1. SOME RECENT FINANCIAL SECTOR INqUIRIES ABOUT RETAIL PAYMENT SYSTEMS Country ­ Institution Year Main Payments Systems-Related Findings Conclusions / Proposed Remedies · Cost-based methodologies suggest interchange fees · The interests of end-users of card payment services need should be much lower than current levels to be more directly engaged in the pricing process Australia · No surcharge' rules are undesirable because they · Conditions of entry to card payments networks need to be more ­ Reserve Bank suppress important cost signals to end-users open than at present of Australia · Access restrictions for international credit card schemes Measures taken subsequently: and Australian 1999- lack transparency and objectivity · Elimination of `no surcharge' and `honor all cards' rules on Competition and 2000 · Competitive pressures in card payment networks have merchants Consumer not been sufficiently strong · Establishment of cost-based benchmark (`standard') for Commission · Incentives structure has encouraged growth of credit calculating interchange fees for all payment cards cards at the expense of other payment instruments, · Establishment of transparent access regime such as debt cards and direct debits · Greater disclosure on interchange fees and access · Fragmented infrastructures along national lines · In general, payment card issuing is less concentrated · Antitrust enforcement on access barriers, discriminatory rules, and more profitable than acquiring, and this is fee structures and governance arrangements in some payment European magnified by high interchange fees card networks and in clearing and settlement systems Commission 2005- · Significant competition issues in the payment cards · Regulatory and self-regulatory measures, such as the (EC) 07 market, with entry barriers stemming from network establishment of a pro-competitive Single Euro Payments Area and standardization requirements, regulatory policies, (SEPA) and new EC Directives, can address other competition and cooperative arrangements barriers · The structure of the clearing system has inhibited new · Facilitate new members joining payment clearing system Ireland­ The banks offering services · Improve corporate governance structure of the payment system Competition 2005 · Ireland's continued high reliance on paper transactions and increase transparency Authority (such as cheques) raises costs · Promote more efficient payment system · Payments market is characterized by efficient infra · Greater transparency and governance of Interpay structure, but it is dominated by a few large banks and · Banks should introduce a choice of different tariff structures to Netherlands­ a single interbank processor (Interpay) consumers as alternative to current package Dutch National · Consumer usage cost is largely unrelated to actual use · Central bank to intensify oversight of payments systems and to Bank 2002 of payment services offer settlement accounts to non-banks if required (Wellink report) · Interpay's special position raises concerns about tariff · Creation of `consulting group on payment services' to share setting and access conditions information and discuss payments market changes · Dominance of big banks in the payments system, related · Extend interoperability and transparency of access requirements to payments system South Africa­ to concentrated deposits market · Promote competition by allowing second/third-tier banks and National Treasury · Entry restrictions and payment processing procedures entry of foreign banks and South Africa 2004 (including mutual governance arrangements) undermine · Competition Commission should investigate possibility of complex Reserve Bank competition, especially in serving low-income individuals monopoly in operation of payments system (Falkena report) · A big challenge is to develop the payments system so that it caters for the unbanked · Bank and payment regulators should be required to consider the competitive impact of their regulation · Smaller banks have a cost disadvantage in giro and · Commercial management of the payment system infrastructure Sweden­ direct account transfers, and in ATM access should be separated Swedish · `Infrastructure clubs' create potential conflicts of interest · Rules should be developed to ensure appropriate terms of access Competition 2006 due to mutual governance structure to payment systems Authority · Customer switching across banks is currently limited, · Government should introduce measures (including for payments) costly and complex making it easier for consumers to switch banks · Concentrated (and unregulated) market structure and · Introduce new policy framework to address problems mutual governance model create artificial and · Set up independent payment systems commission discriminatory barriers to network access, lack of price · Government should avoid creating regulatory distortions by un transparency and of effective competition across necessarily restricting access to payments systems, and should be intelligent consumer of payment services UK­ Treasury payment schemes, high cost to retailers for card use Measures taken subsequently: (Cruickshank 1999- (interchange fees), slow clearing cycles, excessive · Starting in November 2003, Office of Fair Trading (OFT) given report) 2000 charges (e.g. ATMs), and lack of innovation · Ineffective (competition law) framework enhanced role in payment systems for four years · Lack of competition attributed to network effects that · Establishment of Payments Systems Task Force in 2004, cannot be resolved solely by the "dynamics of the chaired by the OFT, to focus on payments issues marketplace" · 2006 Competition Commission inquiry into store cards confirms competition problems and proposes remedies · The Fed plays a major role in the markets for cheque · The Fed should remain a provider of both cheque collection and USA­ Federal collection services and ACH transactions ACH services in order to enhance efficiency, effectiveness, Reserve (Rivlin 1997- · Per its pricing and cost recovery principles, the Fed does convenience and access committee) 1998 not subsidize cheque collection services · The Fed should play a more active role and work closely with · Growth of ACH hampered by several constraints users and providers of the payments system 6 WORLD BANK NOvEMBER 2008 tions led to some consolidation in the ownership struc- 5. Lessons learned from LAC country studies ture. Provincanje is owned by 15 banks of which 80 per- cent are private banks. ARgENTINA This case study has analyzed cooperation and competition is- · Some prices (e.g., interbank fees) are established by sues in Argentina's Automated Clearing House (ACH) market. the Interbank Committee for Payment Instruments in The market is characterized by the co-existence of four ACH Argentina (Comisión Interbancaria de Medios de Pago platforms with, in theory, overlapping markets as well as by an de la República Argentina, CIMPRA) for both ACH S.A. increasingly salient role of the RTGS system in the context of and COELSA. small-value payments. Interestingly, an implicit specialization of the various platforms seems to have taken place, thus cater- · In order to enhance the financial soundness of the ing for the needs of specific market segments. clearinghouses a collateral pool and other risk control measures have been put in place by a Committee of the A. What are the main drivers of cooperation and Clearinghouses (Comité de Cámaras) comprising rep- competition in ACH market in Argentina? resentatives from all the four clearinghouses, the BCRA and CIMPRA. A.1. Environmental Issues, Legacy and Governance · Two low-value and two large-value clearinghouses are A.2. Access operating in Argentina. Unlike many other countries, · Members of the clearinghouses can be financial the distinction between large and low-value systems entities and other institutions, public or private, is mainly based on the length of the settlement cycle. explicitly authorized by the BCRA. The BCRA is also Thus, the term large-value is used only to define in a member of the ACH S.A. for the clearing of cheque frastructures where settlement occurs within 24 hours. transactions. In any case, as a general rule, no entity Longer processing cycles are typically associated with may control directly or indirectly more than 33 percent low value transactions. of the company. · ACH S.A.and the Compensadora Electrónica S.A.(COEL- · In principle, the rules of the clearinghouses do not SA) are the low-value infrastructures. Both are private- prevent non-banks from becoming participants in the ly-owned companies. ACH has 24 stockholders and ad- national payment system. To this date, however, very ditionally 23 users. The ACH features a broad regional few institutions aside from banks have applied for par- coverage as it was originally founded by banks outside ticipation and most of them are represented by a direct the Buenos Aires area. COELSA has 21 stockholders and participant instead. Among the few exceptions are the 17 clients. Conversely to the previous case, COELSA ini- Postal Office and the National Social Security Adminis- tially provided clearing services only for banks located in tration (ANSES). the Buenos Aires region. A.3. Pricing · Large-value clearinghouses also play a role in the execu- · Common payment products (direct debits, cheques, tion of retail payments.In the absence of a formal thresh- credit transfers) are subject to coordinated pricing poli- old for discriminating low and large value payments, cies at the CIMPRA level. Cost recovery criteria prevail Interbanking and Provincanje (commonly referred to as over other considerations. Instead of allocating the deci- a large-value clearinghouses) have also the potential to sion-making process on interbank fees to the governing accept payments of a small size. Nowadays, Interbank- bodies of each ACH, banks have opted for a collective ing has 10 stakeholders and 36 bank customers, and it price determination in the CIMPRA. was established in 1996 as the result of a merger between Datacash and Newnet (bank-owned companies special- · Nonetheless, discernible differences among the various ized in the provision of e-banking services to corporate small-value clearinghouses are reported to exist regard- customers). Initially, Interbanking had 15 stakeholders ing the pricing of processing services. In the case of but successive mergers in the market and capital reduc- COELSA, fixed monthly fees as well as per transaction 7 BALANCING COOPERATION AND COMPETITION IN RETAIL PAYMENT SYSTEMS ones are levied on all members. On the opposite, ACH S.A. charges each and every single participant a flat fee, · In 1995, the CIMPRA was launched as a forum to help regardless of the volume of transactions. provide private sector input on the modification and modernization of existing payment media, the creation · Large-value clearinghouses apparently apply their own of innovative instruments, and the improvement of "proprietary" pricing structure substantiated by plat- clearing and settlement systems. form-specific features. B. What are the key issues? · Interbank fees do further accrue to transactions pro- · The factual impact on competition of multiple ACHs cessed in the clearinghouses, but they typically come in along with a regulatory/technical framework tailor- different forms and fashions.Interbank fees are normally made to foster rivalry has, however, fallen short of ex- expected to flow from the bank of the instructing party pectations. Small and large-value ACHs have clearly to that of the beneficiary. opted to position themselves in the market differently, hence developing and leveraging, for the most part, from A.4. Oversight and Cooperation a distinctive product portfolio. · The BCRA has a limited-scope oversight function over the four clearinghouses focusing on operational aspects. · Market segmentation due to historical reasons and, The Gerencia de Control de Sistemas de Compensación to some extent, non-trivial switching costs for banks approves the operation of the clearinghouses and con- may further explain the perpetuation of the present ducts yearly inspections of them. The BCRA has estab- landscape. lished specific operational requirements (e.g., capacity, security, contingency plans, etc.). Also the Gerencia de · A reported lack of conclusive evidence on the existence Auditoría Externa de Sistemas looks at some aspects re- of increasing returns to scale and other prominent scale lated to the participation in the payments system by fi- effects in the core business of the clearinghouses sub- nancial institutions. Finally, the Gerencia de Sistemas de stantiates the delayed process of consolidation. Pago is in charge of the oversight in general and coopera- tion with other entities (e.g., through CIMPRA) · Moreover, the proliferation of a vast range of services in the clearinghouses other than processing and netting · BCRA's principal tools for the practical exercise of its may be an indication of an excessive fragmentation of the oversight function are regulation and moral suasion, retail payments market, i.e. a critical mass may be hardly in particular in the context of the CIMPRA. BCRA's obtainable at individual level due to a limited market size regulations have proven a fairly useful tool to provide and a multiplicity of competing infrastructures. a formal endorsement and to ensure a wide adoption of industry-supported agreements regarding the struc- · Weak legal foundations, diversity of relevant policymak- ture and future evolution of the national payment ers and limited scope and institutional coordination systems infrastructure. mechanisms have stalled the practical exercise of an ef- fective oversight function. · Under the present arrangements, the operational and business layers of payment products (i.e. the inter- · However, cooperative arrangements (with a limited bank rules, practices and standards for the execution scope) for the payment systems between the central bank of a given payment as well as the commercial frame- and relevant stakeholders do exist in Argentina (e.g., work which enables the authorization, clearing and CIMPRA). Moreover, the BCRA has recently made clear settlement of said transactions) are regulated inde- its commitment to step up its oversight responsibilities pendently from the technology platform on which and, in so doing, to define a plan that helps upgrade the the clearing and settlement process are expected National Payment System. to take place. Therefore, all clearinghouses shall, in principle, be ready to handle the same set of retail payment instruments. 8 WORLD BANK NOvEMBER 2008 holdings of government securities, that were adjusted to C. What are the main policy implications? the inflation. This allowed for huge investments in tech- · In order to take advantage of economies of scale/scope nology and introduced the perception in commercial and network externalities authorities and market players bank management of the competitive advantage that a could consider consolidation of platforms. The particu- broad network could have vis-à-vis the clients. lar strategy, however, needs to be carefully planned as some potential outcomes (e.g., the likelihood of market · These high initial investment costs to set up the infra- conduct problems, a greater operational risk concen- structure (in part caused by the prohibition until 1993 tration, etc.) do have significant downsides. A greater to acquire IT solutions from foreign providers) might emphasis on central bank oversight and payment have been per se another factor inhibiting interoperabil- systems regulation could help reduce these risks. ity and creating segmentation, even after price stability was achieved. In more recent years, market providers · Establishment of institutional mechanisms to promote consider that additional and costly IT investments and coordination and information sharing between the vari- changes in their business model would be needed in or- ous parties: a role that CIMPRA can play. der to reach a compatible infrastructure. · Empower the BCRA to consistently address key payment · Low level of bank concentration might also have di- systems issues, thus further acknowledging the relevance luted the benefits and increased the (actual or per- of retail payments in supporting economic activity and ceived) costs of cooperation. This, coupled with the creating trust in the currency. asymmetric market structure (few large and many small banks) and the high geographical overlap in net- · In this last regard, the formalization of a cooperative works between the main banks (focus on urban areas), framework among regulators and other relevant players may help explain the unwillingness of large banks to should be given a high priority. open up their networks to competitors, particularly small ones. BRAzIL · Inadequate access to financial services, the high inter- This case study has analyzed the implications of cooperation est rates and the customers' poor financial culture have andcompetitionissuesinBrazil'sretailpaymentsinfrastructure been historically some of the principal impeding fac- on two market dimensions: interoperability and infrastructure tors affecting the use of modern payment instruments fragmentation. Idiosyncratic features and the still-evolving in- (e.g., cards, direct debits). In more recent years, how- stitutional framework have restricted interoperability in distri- ever, the usage of electronic payment instruments is butions channels of certain payment services (ATMs, POS and increasing at very high rates, signaling a change in bank correspondents) and further contributed to a segmented consumers' behaviors. retail clearing infrastructure.Although the current institutional set-up is driven by competition and has facilitated innovation, · The high informality rate of the economy has also posed it has adverse efficiency implications leading to segmented in- traditionally difficult challenges to the industry and frastructures that have reduced the exploitation of scale/scope the policy-makers. economies and of network externalities. · The ATM market is primarily dominated by larger banks. A. What have been the main drivers of low interoperability All large banks operate their own proprietary ATM net- and infrastructure segmentation in Brazil? work, while some smaller banks share ATMs in order to benefit from economies of scale. Tecnologia Bancária A.1. Environmental Issues, Legacy and Governance (TecBan) and Rede Verde e Amerela (RVA) are the only · During the hyperinflation of the late Eighties and early non-proprietary shared ATM networks in Brazil. In Nineties, banks were experiencing, on one hand, a de- recent months, agreements are being established be- mand from costumers for faster services available at any tween large banks (e.g. Caixa Economica Federal and time, and, on the other hand, significant returns on their Banco do Brasil) and large banks are also taking an active BALANCING COOPERATION AND COMPETITION IN RETAIL PAYMENT SYSTEMS role in TecBaN. and cannot be accessed by customers of another bank. · The need to protect the card networks (in particular A.3. Pricing ATMs) from frauds and other external attacks forced · Disagreements over interchange fees may have thwarted banks to invest heavily. In most cases, each bank adopted reciprocal accords. For example, the fee structure for us- specific solutions, which makes more difficult and costly ing ATMs belonging to other banks can be prohibitive, to achieve interoperability. which explains the low proportion of shared transac- tions in "open access" ATMs. · Vertical integration and provision of similar product/ services are distinctive features of the largest players in · Also, several middle-sized card issuers have disputed the the POS market: Redecard and VisaNet. Both companies validity of the pass-through levels of merchant discount are in charge of managing the affiliated network of mer- fees. These issuers claim that current allocation of rents chants, of capturing, transmitting, processing and con- extracted from the merchants at the POS is, on average, ducting the settlement of transactions resulting from about 300 basis points below the standard international the use of card transactions and of developing related or levels. As interoperability would possibly imply a greater connecting business to any of the aforementioned items. competition in the marketplace, this aspect might reveal Alongside the international brands, in recent times other a source of conflict that would need to be solved as a players have started to gradually gain momentum in the pre-condition to muster a stable interconnectivity agree- market (e.g., Hipercard, regional cards). ment across the various networks. · The fragmentation observed nowadays in the Brazilian · In addition, the differential pricing between competing fund transfer infrastructure derives from the complex clearing and settlement infrastructure may have impact- path of reform of the Brazilian payments system. To the ed negatively innovation (e.g., direct debit) as well as two existing clearinghouses, Centralizadora da Compen- slowed down the migration towards more efficient, elec- sação de Cheques e Outros Papéis (COMPE) and TecBan, tronic payment instruments. One underlying issue may in 2002 another clearinghouse was added, the Câmara be the lack of an overall normalization of more modern Interbancária de Pagamentos (CIP), parallel to the launch payment instruments in the customer-to-bank domain. of the central bank's RTGS system (Sistema de Transfer- This situation has prevented full end-to-end automation encia de Reservas, STR). Instrument-based specialization from happening and thus, interbank fees for some of and diverse functional clearinghouses have provided a these instruments lie paradoxically well above the ones rationale for the perpetuation of a multifold retail pay- applied to traditional paper-based products. Tax regu- ment infrastructure. lation adds to the complexity of the problem by creat- ing exemptions for cheques and permitting charges over · For some retail payments processing platforms, gover- electronic instruments. nance arrangements seem not to have addressed coor- dination failures properly, thus preventing non-banks A.4. Oversight and Cooperation from achieving a stakeholder status, thwarting the as- · The concerns raised by the low levels of interoper- signment of shares or partially limiting the accumula- ability and infrastructure segmentation in Brazil tion voting rights. have already triggered some reaction by the central bank (Banco Central do Brasil,BCB),with the issuance of a A.2. Access circular aimed at foster cooperation in the retail sector. · The pursuit of sustainable network-based competitive · The BCB also signed a memorandum of understanding advantages has proven a recurrent and rational strate- with the main anti-trust authorities to act jointly in this gic behavior. For example, the reluctance of incumbent segment of the financial sector. players to open up the market to competitors and other historical reasons have pushed back the development of B. What are the key issues? a direct debit scheme. Also, hurdles to establish agency · The consequences of low interoperability are overlap- relationships do exist, i.e. correspondent networks with ping coverage and inefficiency. In particular, low in- non-bank agents remain proprietary to individual banks teroperability complicates the exploitation of economies 10 WORLD BANK NOvEMBER 2008 of scale and positive externalities. The cost of deploying is a clear need for a rationalization of the roles played and maintaining ATMs might also have adversely affect- by different stakeholders in the settlement infrastruc- ed the capillarity of bank ATM networks, with the rural, ture. Despite firm direction from the BCB (occasionally lower-income and less populated parts of Brazil being at providing some conflicting signals in different pieces of a comparative disadvantage. regulation aimed at different objectives) and long-lasting discussions at the industry level, the future evolution · Lack of interoperability is obstructing the modernization of the settlement infrastructure for retail payments of the retail payment systems and its potential benefits is still unclear. are being misplaced. A better allocation of the produc- tive resources in the economy would immediately follow · If these measures prove to be ineffective, the BCB might a greater degree of interoperability in the POS market. A have to use"harder"regulation to foster the achievement study from the BCB indicates that a more intensive usage of the public policy objectives.This might include setting of electronic-based instruments can produce a potential up a tight deadline for the interoperability of networks saving to the country of 0.7 percent of the GDP per year. and for the creation of a unified retail clearinghouse. If Such result stems from the economies of scale in the forced to do so, the BCB would certainly maintain its tra- provision of electronic payments, the global increase of ditional stance to minimize interference in the market and payments transactions, and the progressive lowering of ensure that perceived costs of its regulation by financial telecommunication, software and processing costs. institutions be not passed unfairly to final consumers. · Economic efficiency in the provision of payment services is under-optimized by the lack of integrated COLOMBIA payment arrangements. Multiple and not necessarily This case study has analyzed cooperation and competition is- interrelated actors bring in an added layer of complex- sues in Colombia's Automated Clearing House (ACH) market. ity to the retail payments landscape in their condition as The market is characterized by the co-existence of two ACH operators of different infrastructures. platforms, one operated by the central bank (Compensación Electrónica Nacional Interbancaria, CENIT) and the other one C. What are the main policy implications? by the banking sector (ACH Colombia, ACHC). Although the · A more active stance of the BCB in overseeing retail presence of two ACH platforms has increased contestability, it payment systems is starting to activate the development is found that direct competition is inhibited by some discrimi- of interoperable networks and diminish infrastructure natory business practices. In addition, oversight arrangements segmentation. to ensure the right balance between different policy objec- tives are complex because of the multiplicity of relevant policy · Against this background, the central bank should makers and the lack of adequate institutional coordination consider the establishment of a working group or forum mechanisms. with representatives of all stakeholders' groups. A. What are the main drivers of cooperation and competi- · In particular, sufficient time and adequate resources tion in the ACH market in Colombia? should be devoted to the issue of standardization, seek- ing both sector and cross-industry cooperation. A.1. Environmental Issues, Legacy and Governance · ACHC's current shareholding structure stems from the · In addition, the BCB could further strive to team up original allocation of shares between the two with other authorities with a view to promote interoper- pre-existing private ACHs and by subsequent merger ability. The recent memorandum of understanding be- and acquisition activity. Fourteen banks, one trust com- tween the BCB and antitrust authorities is an important pany (fiduciaria) and one cooperative are the current step in this regard. shareholders.ACHC's statute does not accept non-banks as new members (only the trust company and the coop- · Bankers associations have a bigger role to play to fos- erative stay as members for historical reasons). ter cooperation in the banking sector. In fact, there 11 BALANCING COOPERATION AND COMPETITION IN RETAIL PAYMENT SYSTEMS and providing dividends to shareholders whenever pos- · CENIT's operations are based on the legal foundation sible. CENIT aims to charge users on a cost-recovery ba- for central bank (Banco de la República, BR) involvement sis (including opportunity and indirect costs). in the payments system, Central Bank Law 31/1992 (Ley Orgánica del Banco de la República).CENIT's governance · The structure and method of determining interbank fees corresponds to the BR. differs between the two ACH platforms. Although inter- bank fees do not accrue to ACHC and CENIT, both of A.2. Access them act as conduits for notifying such fees to all mem- · CENIT members currently comprise all banks, two fi- bers and for their collection. However, while recipient nancial corporations, two financial cooperatives, the members individually define such fees and communi- National Treasury in the Ministry of Finance (Ministe- cate them to CENIT, it is the ACHC's Board of Directors rio de Hacienda y Crédito Publico, or MHCP), securities that determines fees based on the recommendations of a depository DECEVAL (Depósito Centralizado de Valores committee drawn mostly from Board members (Comis- de Colombia), and all non-bank information operators. ión de Tarifas). · ACHC primarily serves commercial banks (except state- · According to its regulations, CENIT only permits a low owned Banco Agrario) and effectively acts as their `back single interbank fee for direct debits. Its interbank fee office' for funds transfers purposes, leaving each bank structure for direct credits is based on one of two ap- to run its own business and set client fees as it deems proaches: either a flat fee per transaction or a `scaled' appropriate. fee (tarifa escalonada) based on the geographical lo- cation of the recipient's bank branch. The flat fee has · Banco Agrario, which has the largest branch network in been adopted by small and mid-sized Colombian credit Colombia and focuses particularly on rural areas, has institutions, while the `scaled' fee is used by the bigger chosen to work only with CENIT allegedly due to dis- banks that can leverage their large branch networks. By agreements with other banks over the setting of inter- contrast, ACHC's interbank fees are based on a two-tier bank fees when using ACHC. pricing structure. · Thus, membership in the two ACHs has a high degree · Finally, it is worth noting that, while CENIT's pricing of overlap, however CENIT and ACH have traditionally policy (both ACH and interbank fees) is publicly avail- catered to different market segments. This situation is able via the BR's website, ACHC does not disclose its recently changing with some commercial banks increas- prices on the justification that its only clients are banks. ingly using CENIT. A.4. Oversight and Cooperation A.3. Pricing · The function of retail payment systems oversight per se · Revenue growth in the ACH market has been driven by has been only partially implemented through a complex three main factors: i) banking market concentration and intertwine of different authorities' roles. Supervisory re- the degree of internalization of payment orders; ii) the sponsibility for low-value payments systems lies primar- evolution of government payments modernization ef- ily with the Superintendencia Financiera (SF), although forts; and iii) the structure of the Colombia's social pro- it mostly focuses on safety issues. Competition issues in tection system. The cost structure of both ACHs is char- low-value payments systems have recently been taken up acterized by significant economies of scale and scope in by the Superintendencia de Industria y Comercio (SIC). their core business. While the BR monitors and participates in the payments system as part of its role in preserving financial stability, · The revenue/cost drivers and ownership have influenced it has not been responsible for retail payments systems the respective pricing policies. ACHC's pricing policy oversight. Although there are various initiatives relating aims to ensure self-sufficiency by covering costs, financ- to retail payments, there are no formal institutional co- ing any new investments without having to resort to ordination mechanisms. external funding sources (no debt on its balance sheet), 12 WORLD BANK NOvEMBER 2008 pel mistrust and further promote competition. There is B. What are the key issues? a strong case for greater public disclosure of the oper- · Although the presence of two ACH platforms has in- ating arrangements of ACH platforms (i.e. shareholder creased contestability for some market participants, this structure, decision-making mechanisms, pricing and ac- has been limited by discriminatory business practices. cess policies etc.). One manifestation of partial market segmentation is distinct ACH access and pricing policies, which can be · Strengthening of oversight arrangements, particularly via partly attributed to different governance arrangements. the establishment of robust institutional coordination mechanisms. A stronger oversight framework would pre- · Multiplicity of relevant policymakers and absence of ad- vent potential regulatory gaps and promote a comprehen- equate institutional coordination mechanisms have hin- sive approach to developing a more efficient and accessible dered the development of an effective oversight function. electronic payments systems infrastructure. Oversight is also hindered by the lack of explicit govern- ment objectives and by the relatively minor involvement of the BR. MExICO This case study has analyzed the issue of interchange fees (IFs) C. What are the main policy implications? in the cards market in Mexico. In recent years the Central Bank As it is common in retail payments, multiple public policy ob- of Mexico (Banco de México, BM) has devoted increasing at- jectives to maximize social welfare in this market require cer- tention to the structure of the credit and debit card payment tain trade-offs to be made. Policy-making in this area is also system. Some measures have already been undertaken to pro- made more complex by the multiplicity of relevant policy mote greater competition (e.g., introduction of new transpar- makers. Two high-level policy options to modify the current ency rules for banks' charges, removal of restrictions to access, status quo, driven by different overarching objectives, have abolition of the IF for electronic fund transfers). Despite such been identified. The policy options are: measures, the market for payment cards remains somehow underdeveloped. The industry's view is that IFs are needed to · Strengthening of competition between ACH platforms. balance the interests of issuers and acquirers within card net- Potential advantages of this option would include lower works. In this context, and in order to get a better understand- operational costs and thus better pricing for end users as ing of whether the current situation requires forms of direct a result of stronger incentives to become more efficient regulatory intervention, this case study looked at the role that (X-efficiency), as well as greater product innovation and IFs play in the credit and debit cards industry (see Box 2 for a access (including for non-bank financial institutions) theoretical discussion on IFs). stemming from increased contestability; and A. What are the main drivers of cooperation and · Consolidation into a unique ACH platform. The major competition in the Mexican cards market? advantage of this option would be potentially lower op- erational costs by leveraging economies of scale, which A.1. Environmental Issues, Legacy and Governance would presumably be reflected in lower overall pricing. · The cards market is dominated by the banks. Several This option would almost certainly create some disloca- store chains issue credit cards as well, but these are not tion irrespective of how it is implemented. Strong gover- general acceptance cards. Almost all issuers of general nance arrangements and a robust oversight and antitrust framework would therefore be essential preconditions acceptance cards are banks. All acquirers are banks, and for the successful realization of this option. all issuers and acquirers participate in an interconnected four party system with two switches. Irrespective of the preferred option, there are two additional policy measures that could be taken to improve the function- · In the last few years, several banks have entered both ing of the ACH market: the issuing and acquiring markets. The concentration on both sides of the markets has decreased, although it · Enhancing transparency in the functioning of the ACH continues to be high. The main issuers are also the main market would be a relatively straightforward way to dis- acquirers, and in about one third of the total number of 13 BALANCING COOPERATION AND COMPETITION IN RETAIL PAYMENT SYSTEMS transactions, the issuer is also the acquirer ("on/us"). · The Bankers'Association (Asociación de Bancos de Méxi- · Despite some problems, the BM recognized important co, ABM) governs the pricing structure of credit and advantages in the proposal. It further reduced the IF debit cards market establishing IFs and other pricing scales for credit and debit card payments and, since IFs rules. Thus, the current development of the card market for debit card payments were reduced by a larger extent in Mexico has been strongly influenced by the rules and than for credit cards, the lower costs for debit card trans- regulations set both by banks and card associations. actions reached merchants. Also, the proposed scale is based on type of merchant rather than on merchants' A.2. Access to Payment Instruments transaction value. · Retail payments rely heavily on cash. Among non-cash payments, cheques were the most important instrument · Also, the ABM originally adopted the "no surcharge until very recently. Although the number of both credit rule", the "honor all cards rule", and the "only issuers and debit cards has grown, most operations with cards may become acquirers". These rules, however, have been are still cash withdrawals, especially with debit cards. changing since the early 1990s in part as a response to However, the number of card payments at POS has in- regulators' concerns and demands. creased significantly in the last few years. In turn, the number of POS and of payments at POS is low when A.4. Oversight and Cooperation compared with countries of similar development. · In Mexico, the Central Bank Law establishes among the · Although card payments are more efficient than cash main functions of BM "promoting the sound develop- payments in many transactions, in the early part of ment of the financial system and fostering the proper this decade they were used in relatively few estab- functioning of payment systems". The same law gives lishments. The BM identified IFs at point of sales BM powers to regulate payment systems. To accomplish (POS) as a possible cause for the scant use of payment this mandate, the BM seeks to promote efficient pay- cards, and thus became interested in the mechanism ment systems. that banks use to set these IFs. See Box 2 for a brief description of the discussion on IFs at the international · In 2004, the Mexican Congress issued the Law for Trans- level. parent and Orderly Financial Services (Ley para la Trans- parencia y Ordenamiento de los Servicios Financieros, A.3. Pricing LTOSF). This law, which was amended in 2007 gave BM · The ABM sets the domestic IFs for the four party system, explicit power to assess competition in the banking in- and major card international brands have a very limited dustry and to regulate retail payments systems, in par- role. In 1993, IFs were set as a multilateral charge flow- ticular, IFs. In the last few years, the BM has taken several ing from acquiring to issuing banks. The scheme depen- measures: (1) making banks' charges more transparent; dence on merchants' transaction value seemed especially (2) removing any restriction to market participation and unsuitable to promote the POS network development. entry; and (3) using moral suasion to influence fees. The scheme was also applying same fees for credit and debit operations. Until mid 2004, the levels of IFs re- · Additionally in November 2004,the Federal Government mained almost unchanged. set the Electronic Payments Infrastructure Fund (Fon- do de Infraestructura de Medios de Pago Electrónicos, · The ABM realized that the IF scale was not supporting FIMPE). The FIMPE is a private, non-profit-making either the network development or the use of cards at trust fund formed by acquirers. It aims at promoting and POS and has been applying some changes reducing the extending access to the electronic payments through the average IF and differentiating IFs for credit and debit POS network among small and middle size business, as cards. In 2005 the ABM presented a new methodology well as to increase consumers' usage of them. to balance the weighted issuing and acquiring banks' profits and IFs are then adjusted for several business categories. 14 WORLD BANK NOvEMBER 2008 BOx 2. DISCUSSION OVER IFS IN CARDS MARkETS · The interchange fee (IF) is an inter-bank transfer that occurs every time a card payment is realized in an open network. This transfer typically (but not always) flows from the acquirer to the issuer. It reallocates the total cost of the card payment between the two provid- ers (issuer and acquirer). This fee can be set bilaterally by the two banks or globally at the level of the association of banks. In this case it is known as a multilateral interchange fee (MIF). · In a four party system the payment service is provided jointly by two providers (the issuer of the card and the acquirer of the payment) to the two users (the cardholder and the retailer). There are also proprietary cards that are provided by closed (or three party) systems. By definition, the question of IFs is only relevant for four party systems. · The levels of IFs and their determination mode vary a lot across countries and across systems, but they are often collectively deter- mined at the network level. The collective determination of IFs, as well as rules such as the "honor-all-cards" or the "no surcharge rule," have been challenged by retailers associations, antitrust authorities and regulators. · There is some variation (over time and across systems) in the official doctrine of the card networks, but they essentially view IFs as a way to ensure a "fair" allocation of costs between issuers and the acquirers. Accordingly, a card network is a joint venture between a large number of banks, and that such a joint venture can only function properly if each participating bank gets a fair share of both the costs and the benefits. · Merchants' associations claim that IFs are just an artificial way to put the burden on them. They argue that, for commercial reasons, retailers are somehow forced to accept cards even if merchant services charges are higher that the benefit they (the merchants) obtain. · Networks and merchants are not the only ones to have strong views about IFs, public authorities also do. Indeed, the price structure of card networks has lately become the object of scrutiny of several Regulators, Competition Authorities, and Courts of Justice around the world. While there is no unanimity among Competition Authorities about how to "deal" with IFs, and whether they should be regulated, the dominating doctrine is that card issuers incur costs for some activities that do not benefit (directly) their customers but benefit instead the customers of the acquirers (the retailers). Therefore IFs are viewed by these Competition Authorities as a "justifiable" fee that remunerates these services and compensates the issuers for the costs incurred on behalf of the customers of acquirers. However, regulators are also worried that networks may set excessively high IFs that--by setting a floor to merchant fees--may be instrumental to extract monopoly rents. by issuers to card holders. B. What are the key issues? · What is the relative importance of IFs determination · Given the importance of IFs in determining payments versus other measures in order to promote a broader use instruments usage is there a practical set of "rules of and availability of payment instruments. thumb" that can be developed to reach a socially opti- mum payments instruments usage? C. What are the main policy implications? · Card systems are two-sided markets, and the price struc- · There is also an open question about the impact of IFs ture really matters in cards systems. The balancing act changes on both the merchant service fees (MSFs) that that results from a careful reallocation of costs between acquirers charge to merchants and the benefits provided the two sides of the market is fundamental to maximize network externalities. 15 BALANCING COOPERATION AND COMPETITION IN RETAIL PAYMENT SYSTEMS · There is an asymmetry between the two sides. The fact 6. Policy Implications that retailers internalize some fraction of consumers' Retail payment instruments and circuits are crucial for the de- benefit (because the better quality of service offered to velopment of a market economy and to build a more inclu- consumers by the option to pay by card makes their sive financial system. The standard setters and implementation stores more attractive) implies that they are less resis- agencies have already provided a useful framework to guide re- tance to high fees than cardholders. But this is not nec- forms of retail payment instruments and circuits. In particular, essarily bad for social welfare. A skewed price structure the CPSS identified a set of overall strategic goals and objec- where one side of the market (retailers) pays more than tives for retail payment systems and the World Bank has elabo- the other may be socially efficient. rated a comprehensive Reform Agenda (see Box 3). · Card system operators and bank associations may some- This framework identifies efficiency and reliability as the gen- times have an interest in inflating credit cards IFs. Em- eral public policy objectives for retail systems. In addition, at pirical evidence suggests that higher IFs often result in least three important policy goals should be considered: higher profits for banks (especially for credit cards). This comes from the fact that price reactions to changes in IFs i) Achievement of a socially optimal use of payment seem to be asymmetric. instruments. · IFs are needed even in mature payment card systems. ii) Deployment of an efficient infrastructure to support The need to subsidize membership to internalize net- payment services. work externalities disappears when networks mature and cover a large fraction of potential users. However, iii) Affordability and ease of access to payment payment networks are dominated by usage externali- instruments and services. ties. Even if all consumers hold cards, they need to be encouraged to use them. Price elasticity of card usage by In part, the achievement of these goals is related to an adequate consumers seems to be much higher than that of card balance between cooperation and competition. The main re- acceptance by merchants. sults from the study summarized in this Policy Brief show that some payment services present natural monopoly features · Substitutability between credit and debit cards needs to (messaging, clearing and settlement) while others (access) be considered when determining the IFs level. Some pre- benefit from broad and deep competition. Thus, the intuitively liminary studies indicate a need for capping the differ- and often mentioned statement "cooperation in the upstream ence between credit and debit IFs, in order to discourage market and competition in the downstream market" could the socially inefficient behavior of "convenience users". be considered a general guideline in balancing cooperation In any case, any cost based regulation of IFs needs a fairly and competition. However, this statement needs to be quali- complete understanding of this substitutability and the fied. The four guidelines below provide a set of tools to help incentives of payment card networks to inflate the differ- authorities to adequately balance cooperation and competi- ence between credit and debit IFs. tion and achieve the broader retail payment system objec- tives and goals, ensuring that the institutional framework · IFs discussion should be placed in the context of the (e.g., legal, environmental issues), governance, access and broader retail payment objectives of achieving a socially pricing of the infrastructure are aligned with the mentioned optimal usage of payment instruments. In addition, it objectives and goals. should be taking into account that some payment in- struments also provide other services than payment Guideline 1. Market complexities need to be recognized (e.g., credit cards). and analyzed in detail before any action is decided and implemented · Environmental, legal and legacy factors are important issues shaping the evolution of retail systems. 16 WORLD BANK NOvEMBER 2008 ence of a sufficient number of service providers and lack · Governance of the infrastructure has a significant of interoperability, efficiency might well be the primary impact on cooperation and competition. Ensuring neu- objective to be pursued. On the other hand, the insuf- trality, objectivity and contestability normally requires a ficient access to and excessive cost of payment services, closer public scrutiny. coupled with an insufficient degree of innovation, might be a call for more competition, including on networks · Gaining access to messaging, clearing and settlement and clearing arrangements. services is of capital importance for the ultimate success of new entrants in the market. Players with a dominant · An ex-ante and transparent determination of policy ob- position in one infrastructure may have the incentive to jectives clarifies different actors'roles and avoids mistrust create barriers for access to new entrants. The authori- in the development and operation of the infrastructure. ties' analysis should go beyond traditional payment sys- This is especially important if the public sector is one of tem providers (e.g., banks) and consider the role of new the infrastructure providers. players (e.g., non-financial sector providers) and new instruments (e.g., mobile payments). · Market transparency is key to promote competition and dispel mistrust among market players. · Pricing of some retail payment systems are subject to network economies (e.g., two-sided markets) and tra- · Any policy solution should be considered in a dynamic ditional cost structures are not appropriate to analyze rather than static context as these markets are constantly these markets as pricing structures matter. Interchage changing. fees (e.g., cards markets) and interbank fees (e.g., ACH markets) are mechanisms to balance different interests Guideline 3. Effective Oversight of retail payment systems in payment networks but can also be advantageously by the central bank is crucial to balance cooperation and used by dominant infrastructure players. In order to de- competition issues termine a socially optimum level, competition at three · An effective payment system oversight is the tool author- different levels needs to be considered (across payment ities have to address market and coordination failures instruments, across platforms, across service providers and achieve an appropriate balance between coopera- of the same platform) and, also, the different nature of tion and competition in the National Payments System. payment instruments (e.g., credit cards providing a pay- In particular, the overseer plays the role of a central agent ment and a credit service). who is best placed to solve the coordination problems that typically plague multi-agent decisional contexts by Guideline 2. Policy trade-offs are relevant in this domain. mobilizing efforts from individual participants, prompt- Therefore, policy priorities will have to be determined and ing them, to act collectively when circumstances so re- the type of public intervention should depend on the main quire, and facilitating the development of private sector public objective(s) pursued institutions equipped to deal with these problems.3 · Public policy objectives in retail payments are multiple and none of them is in principle more important than · Central banks are the natural overseers on payment sys- the other. They include efficiency, safety, reliability, com- tems and should persuade themselves (or be persuaded) petition, access, and consumer protection. These objec- to play a central role due to their stake on the confidence tives might need to be reconciled and prioritized, also in money and functioning of commerce and the econo- taking into consideration the policy goals of other seg- my in general. ments of the National Payments System (e.g. the need for a safe centralized system for the settlement of large · Other authorities might have an important role, as well, value transactions). 3See Bossone, B. and Cirasino, M. (2001): "The oversight of payments systems: a frame- · The justification for intervention depends upon the work for the development and governance of payment systems in emerging economies", main public policy objective(s) pursued and upon evi- Payments and Securities Clearance and Settlement Systems Research Series, CEMLA/ dence of perceived market failure. For example, in pres- World Bank, July. 17 BALANCING COOPERATION AND COMPETITION IN RETAIL PAYMENT SYSTEMS due to multiple implications of retail markets (e.g., com- petition authorities, financial supervisors, Ministries of Finance, etc.). The central bank, as primary oversight authority, should ensure all public policy goals are aligned. · The scope of the oversight function should extend over the totality of the payment arrangements to ensure that new instruments and players (such as non-bank finan- cial institutions and non-financial service providers) be appropriately covered. · There is a broad range of oversight instruments, rang- ing from regulations and incentives (including on access and pricing) to moral suasion and policy dialogue, from antirust enforcement to structural measures (e.g., gov- ernment-owned service provision). Guideline 4. Institutional mechanisms to promote coopera- tion and information sharing are essential · Policy making is complex due to the institutional fragmentation of relevant policy makers as well as by the different--and sometimes overlapping--scope of their mandates. · Sometimes authorities have already established coopera- tive arrangements but normally with a narrow scope that has to be broadened, other times these arrangements are inexistent and need to be established. · In particular, it is essential to count with a good coopera- tive framework between the overseer and the anti-trust agencies that rule against uncompetitive behavior. · The public authorities should use Payment Councils, in- dustry associations groups and similar bodies as impor- tant cooperative tools. 18 WORLD BANK NOvEMBER 2008 BOx 3. RETAIL PAYMENT SYSTEMS GOALS AND REFORM AGENDA CPSS Public Policy Goals Legal and regulatory framework: policies relating to the efficiency and safety of retail payments should be designed, where appropriate, to address legal and regulatory impediments to market development and innovation. Market structure and performance: policies relating to the efficiency and safety of the retail payments should be designed, where appropriate, to foster market conditions and behaviors. Standards and Infrastructure: polices relating to the efficiency and safety of retail payments should be designed, where ap- propriate, to support the development of effective standards and infrastructure arrangements. Central bank services: policies relating to the efficiency and safety of retail payments should be designed, where appropriate, to provide central bank services in the manner most effective for the particular market. World Bank Reform Agenda (Defined by the Payment Systems Development Group) The following remarks, stemming from the experience of the reforms implemented in developed countries can be seen as an agenda for developing countries to improve payment system arrangements in a given jurisdiction and across countries. · Central banks and all stakeholders in the retail arena must work together in a clear strategy to promote the intensive use of retail electronic payment instruments and reduce the importance of cheques. · Central banks should take a leadership role to achieve the necessary agreements among banks and other participants so that there is at least one ACH operating in the country that is able to process modern payment instruments such as credit transfers and direct debits. · Central banks should coordinate efforts under way in order to achieve a system that encompasses all relevant players and that processes as many services as possible, avoids duplications and operates on a full scale. · Central banks and other relevant government agencies should foster coordination and communication to ensure that collection and disbursements of the public sector institutions that are major players in the payments system be pro- cessed electronically and in a timely manner. · Central banks, in coordination with other authorities, should ensure customers protection and foster a safe and efficient provision of remittances services in line with the CPSS-WB General Principles for International Remittance Services. In sum, central banks and other regulatory authorities should act as catalyst for the development of market solutions: · Fostering cooperation among market participants and integration/interoperability among circuits and expand access to financial services. · Raising awareness of the general public on new instruments and circuits. · Promoting the intensive use of electronic payments e.g. integrating government and business payments in the retail system infrastructure. · Encouraging the use of high security and technological standards to increase reliability and efficiency. Direct intervention (regulation, operational role) should be considered in presence of: · Strong coordination failures (e.g. inability of the market to develop appropriate arrangements to process electronic pay- ments, failure to reach agreements to perform efficiently payments at cross border level). · Strong information asymmetries (e.g. benefits of security devices such as the microchip on cards, actual cost of paper based transactions). 1 BALANCING COOPERATION AND COMPETITION IN RETAIL PAYMENT SYSTEMS 7. For further reading This Policy Brief is based on the following specific studies: · Guadamillas, M., Stephanou, C., Gorjón S. (2008), Balancing Cooperation and Competition in Retail Payment Systems: Overview and Policy Issues, Financial Infrastructure Policy and Research Series, The World Bank. · Gorjon S., Guadamillas, M., Cirasino, M., Vanasco V., (2008), Cooperation versus Competition in Argentina's Automated Clearing House (ACH) Market, Financial Infrastructure Policy and Research Series, The World Bank. · Cirasino, M., Gorjón S., Stephanou, C., (2008), Cooperation versus Competition: Efficiency Issues in Brazil's Retail Payment Systems, Financial Infrastructure Policy and Research Series, The World Bank. · Stephanou, C., Guadamillas, M. (2008), Cooperation versus Competition in Colombia's Automated Clearing House (ACH) Market, Financial Infrastructure Policy and Research Series, The World Bank. · Castellanos S., Cordella, T., Medina R., Mendoza A., Negrín, J.L., Rochet, J.C., Solís F. (2008), The Role of Interchange Fees in Mexico's Retail Payment System: from Theory to Practice, Financial Infrastructure Policy and Research Series, The World Bank. · Hwang, J.C., Guadamillas M., (2008), Main Trends in Payment Instruments and Infrastructure Usage in Selected Latin American Countries, Financial Infrastructure Policy and Research Series, The World Bank. 8. Acknowledgements The overall study which this policy brief summarizes has been coordinated by Mario Guadamillas (mguadamillas@ worldbank.org), Senior Financial Economist in the World Bank's Latin America and the Caribbean Region (LAC). The coordinators of the different studies have been: · Overview and policy paper: Mario Guadamillas. · Argentina case study: Sergio Gorjón (sgorjonrivas@worldbank.org), Financial Sector Specialist in the World Bank's LAC Region on secondment from the Bank of Spain. · Colombia case study: Constantinos Stephanou (cstephanou@worldbank.org), Senior Financial Economist in the World Bank's Financial and Private Sector Development Vice Presidency. · Brazil case study: Massimo Cirasino (mcirasino@worldbank.org), Head of the Payment Systems Development Group, World Bank. · Mexico case study: Tito Cordella (tcordella@worldbank.org), Lead Economist in the World Bank's LAC Chief Economist Office. · Main Trends in Payment Instruments and Infrastructure Usage: Jane C. Hwang (jhwang1@worldbank.org), Consultant in the World Bank's LAC Region. The team appreciates comments from the reviewers of the study: Bob Keppler (Consultant, World Bank), Fernando Montes-Negret (Director Finance and Private Sector Europe and Central Asia, World Bank), Ignacio Mas (Consulta- tive Group to Assist the Poor, CGAP), Sean O'Connor (Bank of Canada and Chairman of the CPSS Working Group on Guidance for National Payments System Development) and Ceu Pereira (European Commission). The team also ap- preciates comments from Michael U. Klein (Finance and Private Sector Development Vice President,World Bank),Au- gusto de la Torre (Chief Economist LAC,World Bank), Lily L. Chu (Finance and Private Sector Manager Latin America and The Caribbean, World Bank), Peer Stein (Manager Financial Infrastructure and Institutions Building, IFC), Ole Andreassen (former Financial Specialist, World Bank) and José Antonio García García Luna (Senior Financial Sector Specialist, World Bank). Finally, the team also appreciates contributions and comments from the counterparts of the case studies: Julio César Pando (Banco Central de República Argentina, BCRA), Juan Carlos Navas (BCRA), José An- tonio Marciano (Banco Central do Brasil, BCB), Mardilson Fernandes (BCB), Joaquín Bernal (Banco de la República de Colombia, BR), Carolina Merlano (BR), Ricardo Medina (Banco de México, BM), Sara Castellanos (BM), José Luis Negrín (BM) and Francisco Solís (BM). 20