84076 FINANCIAL INFRASTRUCTURE SERIES Payment systems policy and research DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY October 2012 FINANCIAL INFRASTRUCTURE SERIES Payment systems policy and research DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY October 2012 ©2012 The International Bank for Reconstruction and Development / The World Bank 1818 H Street NW Washington DC 20433 Telephone: 202-473-1000 Internet: www.worldbank.org E-mail: feedback@worldbank.org All rights reserved. This volume is a product of the staff of the International Bank for Reconstruction and Development/ The World Bank. The findings, interpretations, and conclusions expressed in this volume do not necessarily reflect the views of the Executive Directors of The World Bank or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. 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All other queries on rights and licenses, including subsidiary rights, should be addressed to the Office of the Publisher, The World Bank, 1818 H Street NW, Washington, DC 20433, USA; fax: 202-522-2422; e-mail: pubrights@worldbank.org. Book cover and interior design by Michele de la Menardiere. FOREWoRD AND ACKNOWLEDGEMENTS Retail payment systems play an important role in the smooth functioning of any economy and inefficiencies in the retail payments market can have cascading effects throughout the economy. The World Bank Global Payment Systems Survey 2010 has shown that inefficiencies persist in many middle-income and low-income countries, with cash still being the most widely used payment instrument for small-value payments. There are a number of issues that are responsible for this, and the lack of a coherent, holistic strategy for the development of retail pay- ment systems is among the most common. The lessons learned in over a decade of technical assistance, and research outputs of other international and na- tional agencies have been merged into a comprehensive “package” for the development and reform of the national retail payments system: 1. “Developing a comprehensive national retail payments strategy” intends to provide public authorities and market players with detailed guidance on how to develop and implement a comprehensive, strategic retail payments reform. 2. “A practical guide for retail payments stocktaking” identifies a methodology for undertaking a detailed stocktaking of a country’s retail payments landscape. 3. “From remittances to m-payments: understanding ‘alternative’ means of payment within the common framework of retail payments system regulation” discusses the development of a normative framework to underpin an efficient retail payments industry, including the so-called innovative payment mechanisms. 4. “Innovations in retail payments worldwide: a snapshot. Outcomes of the global survey on innovations in retail payment instruments and methods 2010” presents the results of the first World Bank survey among central banks that collected information on innovative retail payment products and schemes. This paper has been developed by the Financial Infrastructure Service Line (World’s Bank Financial Inclusion Global Practice) led by Massimo Cirasino. Lead author is Harish Natarajan (World Bank), under the overall guid- ance of Massimo Cirasino and Jose Antonio Garcia (World Bank). The core drafting team for this report included Hemant Baijal (formerly World Bank) and Robert Keppler (World Bank). Alice Zanza, Maria Teresa Chimienti, Ceu Pereira, and Sean O’ Connor (all World Bank) also contributed immensely to the development of this report. This paper has benefited from the comments of a number of World Bank Group colleagues, national central banks and other national and international institutions, as well as private sector entities. Janamitra Devan Vice President & Head of Network Financial and Private Sector Development The World Bank & International Financial Corporation TABLE OF CONTENTS List of Acronyms VII Executive Summary IX I. Introduction 1 I.1 Payment System Modernization Efforts and the Growing Interest in Retail Payment Systems, 1 I.2 Previous Work on Retail Payments by the World Bank and Other International Organizations, 2 I.3 Purpose of the Report, 4 I.4 New Terminology and Definitions Used throughout the Report, 5 II. Overview of Retail Payments 7 II.1 Retail Payment Instruments, 7 II.2 The Evolution of Retail Payment Instruments and Services, 8 II.3 Factors Influencing the Adoption of Specific Retail Payment Instruments, 13 II.4 Clearing and Settlement Processes in Retail Payment Systems, 17 II.5 Different Roles within Retail Payment Systems, 21 II.6 Concluding Remarks on the Observed Trends in Retail Payments, 24 III. Public Policy Objectives in Retail Payments 27 III.1 Overall Safety and Efficiency, 27 III.2 Affordability and Ease of Access to Payment Instruments and Services, 28 III.3 Availability of an Efficient Infrastructure to Process Payment Instruments, 31 III.4 Availability of a Socially Optimal Mix of Payment Instruments, 31 IV. Guidelines for Developing a Comprehensive Strategy for Reforming Retail Payments 33 IV.1 General Framework Underlying the Guidelines, 33 Guideline I: The market for retail payments should be transparent, have adequate protection of payers and payees’ interests, and be cost-effective, 34 Guideline II: Retail payments require reliable underlying financial, communications and other types of infrastructure, 41 iii iv DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY Guideline III: Retail payments should be supported by a sound, predictable, non-discriminatory, and proportionate legal and regulatory framework, 43 Guideline IV: Competitive market conditions should be fostered in the retail payments industry, with an appropriate balance between cooperation and competition, 45 Guideline V: Retail payments should be supported by appropriate governance and risk management practices, 56 Guideline VI: Public authorities should exercise effective oversight over the retail payments market and consider direct interventions where appropriate, 60 V. Implementing Reforms for Retail Payments 65 V.1 Stocktaking, 65 V.2 Establish Appropriate Internal Organizational Arrangements, 66 V.3 Develop an Appropriate Coordination Framework with Key Stakeholders, 66 V.4 Developing a Common Vision of the Desired End-state, 67 V.5 Developing an Implementation Plan, 68 V.6 Monitoring and Evaluation, 69 ANNEX 1: Public Policy Goals, Central Bank Minimum Actions, and Range of Possible Additional Actions for Retail Payment Systems (from CPSS “Policy Issues for Central Banks in Retail Payments”), 71 ANNEX 2: Model for National Payments Council -Terms of Reference, 73 ANNEX 3: Financial Inclusion Initiatives in India, 75 ANNEX 4: Credit and Debit Card Reforms in Australia, 78 ANNEX 5: Key Elements of a Strategic National Payment Systems Development Plan (from CPSS “General Guidance for National Payment System Development, January 2006”), 82 ANNEX 6: SADC’s Guide to Developing a Strategic Framework for Payment System Modernization, 83 ANNEX 7: M-PESA in a Nut Shell, 85 ANNEX 8: Glossary, 86 ANNEX 9: References, 93 Boxes, Figures, AND Tables Box 1: The World Bank Global Payment Systems Survey 2010, 4 Box 2: The Role of Mandates in Direct Debit, 14 Box 3: Enhancements to the ACH to Support Authenticated e-Commerce Transactions, 16 Box 4: Main Results of the World Bank Survey on Innovations in Retail Payments, 26 Box 5: CPSS Public Policy Goals for Maintaining and Promoting Efficiency and Safety in Retail Payments, 28 Box 6: The General Principles for International Remittance Services and Related Roles, 35 DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY v Box 7: The World Bank Remittance Prices Worldwide Database, 40 Box 8: Durbin Amendment – The Dodd-Frank Wall Street Reform and Consumer Protection Act, 51 Box 9: The Welllink Report, 52 Box 10: Guidelines from the World Bank Report “Balancing Co-operation and Competition in Retail Payment Systems”, 55 Box 11: The Payment Cards Industry Security Standards Council, 57 Box 12: Guidelines from the report: “A Practical Guide for Retail Payments Stocktaking”, 61 Figure 1: Non-Cash Retail Payment Transactions Per Capita, 2 Figure 2: Generalized Clearing and Settlement Model, 18 Figure 3: Clearing and Settlement for Mobile Money Schemes, 21 Figure 4: Types of Disputes, 38 Figure 5: Dispute Resolution, 39 Figure 6: Protection of Customer Funds in Innovative Payment Products, 59 Table 1: Mapping of Payment Instruments to Payment Needs, 15 Table 2: Select Banking Infrastructure and Access Metrics, 29 Table 3: Payment Instruments used for Government Payments, 30 Table 4: Key Areas for Standards in Retail Payment Systems, 67 Table 5: Basic Metrics to Assess Progress in Retail Payments Development, 70 Table of Contents LIST OF ACRONYMS ACH Automated clearinghouse MICR Magnetic ink character recognition AML/CFT Anti-Money Laundering / Combating MNO Mobile network operator the Financing of Terrorism MSF Merchant service fee APR Annual percentage rate MTO Money transfer operator ATM Automated teller machines NABARD National Bank for Agriculture and Rural BIS Bank for International Settlements Development CEMLA Centre for Latin American Monetary NFC Near field communication Studies NPC National payments council CGAP Consultative Group to Assist the Poor NPS National payments system CPSS Committee on Payment and Settlement NSP No surcharge policy Systems NSR No surcharge rule ECC Electronic cheque conversion PCI DSS Payment application industry data EFT Electronic funds transfer security standards EFTPOS Electronic funds transfer at point of sale PIN Personal identification number FATF Financial Action Task Force POS Point of sale FDIC Federal Deposit Insurance Corporation PSDG Payment Systems Development Group FIF Financial Inclusion Fund of the World Bank FITF Financial Inclusion Technology Fund RBA Reserve Bank of Australia FPD Financial and Private Sector RBI Reserve Bank of India Development of the World Bank RFID Radio frequency identification GDP Gross domestic product RPSP Retail payments service provider GPs CPSS-World Bank General Principles for RTGS Real-time gross settlement International Remittance Services SADC Southern Africa Development HAC Honor All Cards Community IAT International ACH transactions SEACEN South East Asia Central Banks IC Integrated circuit SEPA Single Euro Payments Area IVR Interactive voice response SHG Self-help group KYC Know-your-customer SME Small and medium enterprise MFI Microfinance institution SMS Short messaging service vii Executive Summary R eforms in the area of retail payments are The second section scans the evolution of retail pay- becoming increasingly important. Given ment systems over the last five to six decades, the the nature of retail payment systems and types of retail payment instruments, the challenges in the structure of the retail payments in- increasing the adoption of electronic payment instru- dustry, there are multiple challenges and roadblocks ments, and finally the various processes and entities that impede those much needed reforms. Navigating that together constitute the national retail payments through these challenges requires a comprehensive system. The analysis of the evolution of retail payments and strategic approach. In this document, the Payment over the last five to six decades shows the following Systems Development Group (PSDG) of the World trends: (i) the successful adoption of advances in tech- Bank presents a framework for countries to use in nology have played a key role in the development of developing a comprehensive retail payments strategy. new channels for payment initiation, improved au- This framework has been developed by synthesizing thentication, and efficient processing; (ii) new and the past studies of the World Bank, the CPSS, and other emerging payment needs at Internet auction sites and international and national bodies, and also the world- social networking sites, among others, and for transit wide experience of the World Bank’s PSDG in support- payments, as well as the need to find efficient mecha- ing payment systems reforms in over 100 countries. nisms for advancing financial inclusion objectives have led to the creation of new payment mechanisms; and, This document is organized into five sections. The first (iii) the payment infrastructure created for one pay- section discusses the importance of retail payments ment product has been successfully leveraged for other and the ongoing efforts by public authorities and in- payment products—one example is the use of the ACH ternational organizations in this area. This section also for online banking-enabled payments. provides working definitions for a few new terms, for some existing terms that need a re-look given the on- The third section analyzes the public policy objectives going developments in the retail payments area, and in the area of retail payments. It builds a case for ex- for other terms commonly used in the industry but panding and elaborating on the range of public policy not yet formally defined by the international standard- goals with respect to retail payments from the general setting bodies. overarching goals of ensuring safety and efficiency of the National Payments System. The additional public policy goals advocated are: ix x DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY • Promote affordability and ease of access to pay- try, with an appropriate balance between co-op- ment services; eration and competition to foster, among other things, the proper level of interoperability in the • Promote development of efficient infrastructure retail payment infrastructure. to support development of payment instruments and mechanisms to meet retail payment needs; • Guideline V: Retail payments should be support- and, ed by appropriate governance and risk manage- ment practices. • Promote socially optimal usage of payment instruments. • Guideline VI: Public authorities should exercise effective oversight over the retail payments mar- The fourth section, and the heart of this report, builds ket and consider proactive interventions where a case for adapting the CPSS-World Bank General appropriate. Principles for International Remittance Services to build a framework for a comprehensive retail pay- Under each of these guidelines, the key issues per- ments strategy. The following guidelines are proposed: taining to them, including, where appropriate, some instrument-specific issues, are discussed. In addition, • Guideline I: The market for retail payments indicative lists of actions that can be envisaged are also should be transparent, have adequate protec- discussed for each of the guidelines. tion of payers and payees interests, and be cost-effective. The fifth and final section of the report discusses the implementation aspects of a retail payments strategy. • Guideline II: Retail payments require reliable This builds on PSDG expertise in implementing na- underlying financial, communications, and oth- tional payments system strategy. This section identi- er types of infrastructure; these infrastructures fies six key steps: (i) stocktaking; (ii) establishing ap- should be put in place to increase the efficiency propriate internal organizational arrangements; (iii) of retail payments. These infrastructures include developing a coordination framework; (iv) developing an inter-bank electronic funds transfer system, a vision; (v) developing an implementation plan; and an inter-bank card payment platform, credit re- finally, (vi) ongoing monitoring and evaluation.1 porting platforms, data sharing platforms, large value inter-bank gross settlement systems, avail- This document is not intended to provide an all-en- ability of robust communications infrastructure, compassing and universal guide to develop a retail and also a national identification infrastructure. payments strategy. It is rather intended to provide a framework that can be used to think through the retail • Guideline III: Retail payments should be sup- payments landscape in a particular jurisdiction and to ported by a sound, predictable, non-discrimi- offer guidance on what the building blocks for a suc- natory, and proportionate legal and regulatory cessful retail payments strategy could be. framework. • Guideline IV: Competitive market conditions 1 The topic of stocktaking is also discussed in detail in an accompanying publi- should be fostered in the retail payments indus- cation – “A Practical Guide to Retail Payments Stocktaking.” SECTION I INTRODUCTION I.1 Payment System ments to large-value payments systems, the area of re- Modernization Efforts tail payments has remained relatively underdeveloped and the Growing Interest in in many countries.2 This is well illustrated in Figure 1. Retail Payment Systems O However, this situation is changing. Indeed, in the last ver the last three decades, payment sys- few years, a renewed interest in retail payments and tem modernization has become a prom- retail payment systems has emerged, recognizing that inent feature in financial sector reform such systems are very important in that they facilitate programs in many countries. In many the conduct of commerce and improve the efficiency cases, central banks have played a leading role in these of both day-to-day transactions among consumers and modernization efforts, which have been mainly driven businesses and the distribution and collection of pay- by increased financial activity as evidenced by growing ments made by and to government agencies. volumes and values of payment transactions, greater appreciation of risks inherent in the use of payment Among other relevant elements, it has been widely ac- systems, technological developments, globalization, knowledged that moving from cash and paper-based and the general realization of the important beneficial instruments to electronic payment instruments is ben- role that stems from active central bank involvement in eficial for the economy as a whole. Recent academic payment systems development and oversight. Central findings based on empirical data reveal that shifting banks tend to become involved because of their uni- from paper-based payments to electronic ones could versal objectives to achieve financial stability through entail yearly savings to a country’s economy of about policies and measures to ensure the safety and sound- one percent of its GDP. This estimate is primarily at- ness of the financial system, and to maintain trust in tributed to savings in back-office operations, reduc- the currency. 2 Large-value payment systems typically process a relatively small number of World Bank research has shown that while a large high-value and time-critical payments. These systems are essential to the proper functioning of the financial system; a failure could trigger disruptions or transmit number of countries have already implemented or are shocks, both at local and at cross-border level. These payments are also referred in the process of implementing successful payment to as systemically important payments and include: interbank money market operations, the cash leg of securities trades, and the cash leg of foreign exchange system modernization reforms focusing on improve- trades. Some customer transactions may also be processed in large-value pay- ment systems. 1 2 DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY Figure 1: Non-Cash Retail Payment Transactions Per Capita (Simple average for each region, 2009) tions in leakages of government benefit transfers and cause the user to have complete trust in the institutions collections, and significant improvements in overall that provide the relevant services and on the payment payment process efficiency.3 It should be noted that mechanisms themselves. Empirical evidence has also cash might still be the most efficient and cost-effec- shown that providing broad-based geographical access tive for a society to pay in certain situations (e.g.) to financial services to all consumers—including those for low-value payments due to faster processing than currently unbanked—can be an important means of other payment methods.4 The ongoing developments addressing poverty issues. like NFC cards and mobile money could however change that. When taken together, all of these factors demonstrate the great importance of an effective retail payment sys- From another perspective, retail payments are usu- tem to a country’s financial outlook and future. ally the point of entry to broader financial services. It is therefore paramount that the integrity of the de- sign and operation of retail payment systems should I.2 Previous Work on Retail Payments by the World Bank and Other 3 For example, a recent study by McKinsey et al. estimated that the Indian Government could save 1.6 percent of the country’s gross domestic product for International Organizations 2009 by moving all government payments to electronic payment mechanisms. In the same vein, a study done by the South East Asian Central Banks (SEACEN) research and training centre in 2008 estimated that the cost of cash handling In an effort to improve the understanding of retail in select Southeast Asian countries ranged from 0.29 percent to 2.23 percent of payments, some international organizations such as GDP. For additional information on these cases see McKinsey et al., 2010, and the Committee on Payment and Settlement Systems Choon Seng 2008. 4 Study by the Reserve Bank of Australia, 2007 - Payment Costs in Australia (CPSS) of the Bank for International Settlements DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY 3 (BIS), the World Bank, and others have produced sev- business service line in the Financial Inclusion practice eral key studies and publications in this field. In ad- of the Finance and Private Sector Development (FPD), dition to providing invaluable input and guidance to has also been intensifying its commitment to promote modernization efforts, some of these publications now and disseminate both policy and research on retail constitute best practice or standards for the design and payments topics, with a special focus on the develop- implementation of payment systems. ment of an effective national retail payments system. In terms of creating a better understanding of retail In 2007, the PSDG published a new study, jointly with payments across G-10 countries, the first step was tak- CEMLA, entitled “Retail Payment Systems to Support en by the CPSS in the mid-1990s, resulting in the 1999 Financial Access: Infrastructure and Policy”.9 This publication of a comparative study for these countries.5 study focused on identifying a set of common issues This was followed by two more publications in 2000 in retail payment systems in Latin America and the and 2003, with the latter drawing attention to policy is- Caribbean, and on this basis, as well as other World sues for central banks with regard to retail payments.6 Bank experience, proposed an agenda for retail pay- ments system reforms in developing countries. Since then, the debate on retail payments has intensi- fied, with focus not only on payment instruments and Moreover, in 2008 the PSDG published the study consumer protection issues like user fees, but also on “Balancing Cooperation and Competition in Retail market trends, customer needs, and other relevant Payment Systems: Lessons from Latin America Case public policy issues. In 2006, the CPSS published Studies” which defined a conceptual framework to the report “General Guidance for National Payment identify the issues pertaining to the development of Systems Development”.7 This report identified 13 retail payments infrastructure, and proposed policy Guidelines that countries could use to plan the devel- guidelines for use by the authorities and other stake- opment of their national payments system. Guideline holders in implementing practical reforms to their re- 11 specifically refers to retail payments, as follows: tail payments mechanisms.10 “Expand availability of retail payment services”. In 2007 the PSDG also launched the first Global In 2007, the CPSS and the World Bank jointly issued Payment Systems Survey, covering retail payment sys- the “General Principles for International Remittance tems as well as several other elements of the national Services”.8 While international or cross-border remit- payments systems. In further work based on this sur- tances are the primary target of the General Principles, vey, countries were ranked according to the level of the report itself envisages applicability of the same to development achieved in retail payments as well as the broader retail payment systems market. in other areas.11 A new version of the Global Payment Systems Survey was launched in 2010 (see Box 1). Apart from the aforementioned effort, the World Bank, through its Payment Systems Development Group Currently, the PSDG has developed a set of documents (PSDG), which is part of the Financial Infrastructure collectively referred to as the “retail package,” which 5 CPSS 1999. 6 CPSS 2003. 9 Cirasino, et al., 2007 7 CPSS 2006. 10 Guadamillas (study coordinator) 2008. 8 CPSS and The World Bank 2007. 11 Cirasino and Garcia 2008. Section I. Introduction 4 DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY Box 1: The World Bank Global Payment Systems Survey 2010 The World Bank’s PSDG launched its second Global Payment Systems Survey in July 2010. In all, 132 central banks have responded, representing 139 countries. As in the first iteration, the survey provided a snapshot of the payment and securities settlement systems worldwide and is also helping in identifying the developments in this field in the last few years. The survey covered the following areas: legal and regulatory framework, large-value payment systems, retail payment instruments and systems, cross-border payments and international remittances, securities settlement systems, and payment system oversight and cooperation. In addition, in recognition of the relevant innovation taking place in the retail payments arena and the interest on this matter expressed by local authorities as well as by international bodies such as the G-8 and the G-20, a dedicated questionnaire to capture developments in this space such as new products or innovations in processing was also included as an annex. This additional questionnaire built on the CPSS Survey on Electronic Money and Internet and Mobile Payments from 2004. The outcomes of the Global Payment Systems Survey 2010 are available at www.worldbank.org/paymentsystems. A separate pub- lication on the specific outcomes of the questionnaire on innovations in retail payments will be released in 2012 as part of the set of documents being prepared by the PSD consists of this document and the following additional to actively examine the scope for improvements in re- documents: “A Practical Guide for Retail Payments tail payments systems. The working group studied the Stocktaking” developed jointly with the Central Bank recent innovations in retail payments and a report was of Brazil and the European Central Bank; “Legal and published in May 2012. The PSDG is a member of this Regulatory Framework for Retail Payments – issues to working group. consider and practical approaches,” which discusses the development of legal and regulatory framework that enables development of an efficient retail pay- I.3 Purpose of the Report ments market; and “Innovations in Retail Payments Worldwide: A Snapshot. Outcomes of the Global The Global Payment Systems Survey 2008 showed that Survey on Innovations in Retail Payments Instruments the disparities between high- and low-income coun- and Methods 2010,” which was prepared in the context tries in the area of large-value payment systems have of the World Bank Global Survey 2010, and discusses been narrowing, mainly as a result of many middle- the results of a specific survey on innovations taking and low-income countries embarking on reforms place in the retail payments arena.12 in this specific area. Based on survey data, a country ranking exercise by Cirasino and Garcia, showed that Also worth mentioning is the fact that the CPSS has many middle-income and low-income countries were recently re-convened a retail payments working group in fact assessed at a high level or medium-high level of development for the large-value payment systems 12 Apart from these studies and research work, since the early 1990’s the PSDG component.13 has assisted more than 100 countries in the design, development and implementa- tion of comprehensive payment system reforms. For more information, visit the PSDG’s website at: www.worldbank.org/paymentsystems. 13 Cirasino and Garcia 2008. DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY 5 On the retail payments front, huge disparities were, Driven by these findings and others obtained through however, noted between the high- and low-income field work, and also drawing on work that has already countries and between developed and developing re- been done in the retail payments arena in many devel- gions. In the aforementioned country ranking study oped countries, the PSDG has compiled this document there were no middle-income and low-income coun- with a view to: (a) analyzing the key obstacles and con- tries ranked at a high level of development on the retail straints faced by countries when promoting and adopt- payments indicators, and the number of these coun- ing a modern retail payments system strategy; and (b) tries rated at a medium-high level of development was providing a basic framework for addressing these con- also lower than for the large-value payment systems straints to promote faster adoption of a comprehensive component. retail payments system improvement strategy. In ad- dition to the analysis of the traditional retail payment These disparities can be attributed to a variety of fac- instruments, this document also takes into account the tors such as: the slow development of infrastructure importance and effectiveness of innovative payment and access channels for electronic payments in most instruments that have emerged in some markets to fill developing countries; limited development of the in- gaps in the existing payments landscape. ternal payments system in corporate, banks, and fi- nancial service providers; limited competition among banks and between the banks and other service pro- I.4 New Terminology viders; and absence of specific strategies for addressing and Definitions Used these issues. Also revealed by the survey is the fact that throughout the Report a significant number of central banks do not actively track the developments and market conditions for re- The CPSS and other bodies have defined various retail tail payments. payments-related terms. To a large extent, this docu- ment embraces these definitions. However, given the A specific thrust of the guidelines stemming from the recent advances in the field, some new terms that have 2008 study on cooperation and competition in retail gained prominence in general discussions on retail payments was a discussion on the measures that could payments by non-payment systems practitioners need be taken to achieve the right balance between com- to be formally defined. This section offers definitions petition and cooperation, especially the benefits that for such terms. A few other terms are discussed in the can accrue through cooperative investments in basic appropriate place in the document and are included in infrastructure and as to how each institution might the glossary (see Annex 8). It needs to be noted that use the common infrastructure while still retaining its these definitions are offered here for consideration by competitive advantage. It also explored two key public the payment systems community and broader stake- policy objectives that arise when designing retail pay- holders, and where there is no real consensus on a ments systems, namely access to and affordability of definition; the definition offered in this document payment services, and extent to which the trade-off should be seen as for the limited purpose of this docu- between cooperation and competition can have an im- ment only. pact on the quality and accessibility of retail payments infrastructures. A retail payment is often defined indirectly as anything that is not a large-value payment. Large value pay- ments are defined as payments typically of a relatively Section I. Introduction 6 DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY high-value and between banks and/or participants in A National Retail Payments System is defined here as a financial market.14 Based on this definition, retail a collection of individual retail payments systems that payments are also commonly referred to as low-value support the practical and efficient use of a range of payments. However, retail payments can also be for payment instruments and payment services. relatively large amounts. In a more general way, for the purposes of this document a retail payment is defined A retail payment instrument is defined here as an in- here as a payment that meets at least one of the follow- strument that facilitates the transfer of funds, for ex- ing characteristics: ample a check, debit card, or credit transfer. A related term is electronic payment instrument, which is defined • The payment is not directly related to a financial here as a payment instrument that uses electronic market transaction; means for initiation, authorization and authentica- tion of a payment transaction. Even though a transac- • The settlement is not time-critical;15 tion might be initiated electronically, the subsequent processes of clearing and settlement might involve a • The payer, the payee or both are individuals or combination of manual and electronic procedures. non-financial organizations; and The common payment instruments in use today are defined and discussed later in this document. • Either the payer, the payee or both are not direct participants in the payments system that is pro- cessing the payment. This definition of retail payment includes person- to-person, person-to-business, business-to-person, business-to-business,person/business-to-government, and government-to-person/business payments. A retail payments system is defined here as a system comprising the technical infrastructure; participants; instruments; arrangements for clearing and settle- ment; business relationship arrangements (such as bank-customer relationships, rules, procedures, the applicable legal framework, and governance arrange- ments) that, put together, provide the overall environ- ment within which retail payments are posted, autho- rized, processed, cleared, and settled. CPSS 2003(b). 14 It needs to be noted that “not time-critical” should not be interpreted to mean 15 not real-time. There are many retail payment transactions that are processed on a near real-time basis, such as a person-to-person funds transfer. However in such cases the settlement agent is the same as the issuer or the settlement is completed at a later time (typically on a deferred net settlement basis) for (example as in the case of a card payment transaction. SECTION II OVERVIEW OF RETAIL PAYMENTS II.1 Retail Payment Instruments fer since the payee originates the payment order for the purpose of collecting payment from the payer. Debit R etail payment instruments that are available transfers are typically used for person-to-business or in most countries today may be classified into person-to-government payments, for example for the four broad categories: payment of utility bills and installment payments, and often need to be set up in advance by the payer by way Paper-based instruments: These include cash, of providing explicit permission to the payee to collect cheques, money orders, travelers’ cheques etc. Cash is funds through a debit transfer payment order (often typically used in face-to-face transactions of low value referred to as a “mandate”). The evolution of informa- between two counterparties. Other paper-based in- tion technology has made it possible that credit trans- struments normally require the involvement of one or fers can now be initiated through a range of channels— more financial institutions to effect the transfer of val- Internet, telephone, interactive voice response (IVR), ue from the payer to the payee. Non-cash paper-based automated teller machines (ATMs), and increasingly instruments are used for both face-to-face as well as through mobile phones—in many countries. The pro- remote payments, usually of value higher than that of cessing of EFT products is generally conducted using cash payments. an interbank network under well-codified rules and procedures. These networks are usually domestic al- Electronic Funds Transfer (EFT)-based products: though there are networks that have an international These include direct credit and direct debit transfers, coverage. and are typically used for remote payments. Credit transfers are defined as a payment order, or possibly a Payment card-based instruments: These include sequence of payment orders, made for the purpose of credit, debit, prepaid and other smart-card based ap- placing funds at the disposal of the beneficiary. Both plications, and typically involve usage of a physical the payment instructions and the funds described card by a payer to discharge the payment obligation to therein move from the bank of the payer/originator the payee. The physical card has the associated account to the bank of the beneficiary. Some common credit information encoded in a magnetic stripe or in an em- transfer-type transactions include payroll, pensions, bedded Integrated Circuit (IC) chip. The information and dividend payments. In processing terms, a debit on the magnetic stripe or IC chip when read by an ap- transfer can be viewed as the reverse of a credit trans- propriate device of the payee triggers a funds trans- 7 8 DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY fer from the payer’s account in favor of the payee.16 mobile phone, or on a computer system. At the time of Payment cards can be used for in-person purchases, as transaction, the stored value is read/accessed through well as for remote payments. Increasingly, card-based an appropriate infrastructure and the value transferred payments are accepted in all standard banking chan- accordingly. nels like ATMs, automated voice response mechanisms like IVR, Internet, through mobile phones, and kiosks. The next sub-section discusses the evolution of these Card-based transactions typically involve the payee payment instruments in the last few decades. being guaranteed payment provided all the acceptance procedures specified by the payment network have been adhered to.17 This guarantee is generally provided II.2 The Evolution of Retail by the payment card network. Payment Instruments and Services Innovative payment products:18 This category in- cludes payment products that are emerging in both Historically, cash has been the dominant retail pay- developed and developing countries. In general terms, ment instrument, especially for face-to-face payment these products involve the payer maintaining a pre- transactions. In the late 19th century, some western funded account with an institution, not necessarily a countries started introducing paper cheques as a sub- banking or financial institution, and drawing down stitute for the use of cash for some retail and person- this pre-funded account to make payments to par- to-person payments. A cheque is defined as a written ticipating payees as well as person-to-person trans- order from one party (the drawer) to another (the fers through a network of business correspondents, drawee, normally a bank) requiring the drawee to pay at participating merchants, or through conventional a specified sum on demand to the drawer or to a third retail payments infrastructure such as ATMs or point- party specified by the drawer. Cheques may be used of-sale (POS) terminals.19 The payment instruction for settling payment obligations or for withdrawing to draw down the pre-paid funds could be initiated money from banks. through the Internet, mobile phone or via specific pay- ment cards issued for this purpose. E-money products Cheques became an effective way to pay instead of us- are one type of innovative payment product. E-money ing cash, particularly in cases where the transactions is a record of funds or value available to a consumer, were not conducted face-to-face. However, in the early stored on a payment device such as chip, prepaid card, days of cheques, the clearing and settlement process was highly inefficient as the banks would typically discount the value of deposited cheques based on the 16 It needs to be noted that payment cards also often have some elements of the account information also printed/embossed on the card face to enable using cost of presenting it to the paying bank for payment this information for initiating remote payments through the Internet or other and some assessment of the latter’s creditworthiness. channels. Geographic attributes further complicated cheque 17 The procedures could delineate, for example, that online authorization should have been obtained, a copy of the charge-slip bearing basic details of the transac- processing. For example, the farther away the banks tion retained, and the transaction submitted for settlement within a particular of the payer and that of the payee, the latter would be number of days. 18 For the purpose of this document, innovative payment instruments include less familiar with the paying bank’s financial condition, all instruments other than cheques, electronic funds transfers and traditional and the greater the transportation cost associated with payment cards. clearing the instrument—therefore the greater the dis- 19 These products can be pre-funded by users themselves or by another entity on behalf of the user (e.g. government, corporation, or person). count applied by the banks. Correspondent banking DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY 9 arrangements helped to address these issues to some Debit transfers are often processed in bulk by the pay- extent. During the first half of the 20th century, driven ee collating the various payment orders and submit- by the need to integrate regional payment systems, im- ting them to their financial institution for collection provements were made when countries began to estab- through the ACH. In contrast, the payer often initiates lish national cheque clearing systems where cheques credit transfers individually, and the payer’s institution could be exchanged at par value. Over time, as the then often batches various credit transfers initiated by volumes grew, central banks as well as correspondent its clients and processes them subsequently in bulk. banks started offering cheque clearing services, driv- As noted earlier, credit transfers and debit transfers ing down the cost and improving efficiencies in the are also commonly referred to as Electronic Funds clearing and settlement process. Transfer (EFT) products, as they typically involve pro- cessing in an automated manner by an ACH. It needs By the 1960’s, some large commercial banks had al- to be noted, however that, credit transfers and debit ready adopted the new technologies that were avail- transfers are also processed in many countries in a able for cheque processing, which increased the effi- non-automated manner, in some cases involving bilat- ciency of their clearing operations. These banks found eral arrangements between the financial institutions in the paper cheque payments business to be profitable, the country. and the consumers had become very comfortable and confident in their use of cheques. In many countries, The adoption levels of ACH as an alternative form of the cheque became the dominant form of non-cash payment was initially mixed. The adoption was slow payment, and there was little incentive for change in in countries where only banks and not individuals the payments system. However, there were concerns at could initiate ACH payments. Over the years, ACH the policy level that the increasing volume of cheques products have become increasingly practical, with would eventually outpace the technology and equip- ever growing possibilities and options for individuals ment used for cheque clearing. to initiate these payments easily and conveniently.20 In some countries (Germany, the Netherlands, Japan, and As an outcome of several initiatives undertaken to Belgium, among others) EFT-based direct credit trans- determine alternative approaches to process small fers and debit transfers became an important electronic value, recurring payments, the electronic Automated payment instrument to replace cash for consumer-to- Clearinghouse (ACH) was born in the 1970’s. An consumer payments and also for consumer to business ACH is defined as an electronic clearing system in payments many years ago. which payment orders are exchanged among financial institutions, primarily via magnetic media or Starting in the late 1990s, countries where paper telecommunications networks, and handled by a data cheques were the dominant form of non-cash pay- processing center. ments, electronic cheque conversion (ECC) applica- tions were developed that further expanded the use of Over the years, ACHs have focused their development to support two distinct retail payment products: credit 20 The Global Payment System Survey 2010 showed that a total of 92 countries transfers and debit transfers, collectively defined ear- were served by at least one ACH. This is a small increase in relative terms to the lier as EFT-based products. 2007 survey which showed 83 countries being served by an ACH. The existence of ACHs is more frequent across the European Union, other developed countries and in Latin America and the Caribbean. They are also more frequent in larger countries. Section II. Overview of Retail Payments 10 DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY the ACH for retail payments. These applications cap- cards during this period.22 During the late 1980s and ture information from the cheque’s magnetic ink char- 1990s, with increased sophistication in technologies acter recognition (MICR) line to create ACH transac- relating to information processing and telecommuni- tions at merchant point of sale, at lock box locations, cations, which among other features allowed online Internet, and over the telephone. transaction authorization by the issuer, credit cards became a widely accepted form of payment in many More recently, a new international format for ACH— countries. As volumes grew, the processing of credit International ACH Transactions (IAT)—was devel- card payments also became more complicated. To ad- oped to facilitate cross-border ACH transactions. dress this need, third-party payment service providers Other recent developments include same-day ACH started to emerge to provide specialized services re- services and the use of devices such as ATMs and lated to both the issuing and the acquiring sides of the smart mobile phones to capture cheque images and business. To address these complexities, the interna- initiate ACH payments.21 tional card associations developed rules and standard- ized procedures for handling transaction flows. They In the last few years, the ACH and RTGS systems in also created international processing systems to handle some countries have also been used to support near re- the exchange of money and established dispute resolu- al-time transfers for low-value transfers and in partic- tion procedures, including arbitration mechanisms to ular person-to-person transfers. This has been enabled handle disputes between consumers and merchants. by advances in processing capacity and the increasing need for cost effective means for near real-time trans- In the 1980s, another form of payment card, the debit fers even for low-value payments. The examples of this card, started to evolve as an important form of elec- include the services in Mexico, India and the UK. tronic payment instrument. Today, in some countries where credit card adoption has been slow due to lim- Whereas ACHs have had some success to convert ited infrastructure for credit information and other certain types of person-to-person and business-to- reasons like cultural preferences, debit cards have be- business payments from paper to electronic, payment come the most popular electronic instrument for mak- cards have proved to be most instrumental in convert- ing retail payments. The growth in debit cards has been ing paper-based payments to electronic at the point of dramatic over the last 25-30 years. At first, debit cards sale. emerged as an enabler for moving customers from bank teller counters to the then newly deployed ATM Credit cards were introduced in the 1950s, and their systems. Over time, instead of using the card to with- use grew rapidly over the next three decades. The in- draw cash from an ATM to pay merchants, bank cus- frastructure of credit cards was developed and man- tomers could simply present the card to the merchants aged mainly by card associations Visa and MasterCard. and have their bank account debited directly. Given Companies such as American Express, Diners Club, this tremendous potential, debit card products evolved Discover, and some other national and regional brands globally and began using the infrastructure that was also introduced payment cards in the form of charge already in place for processing credit card transactions at the point of sale. There are a few variants of debit 21 USAA Bank in the U.S. launched the first iPhone application that allows users to capture the photo image of a cheque and send it to the bank for processing. This development has moved part of the process of cheque processing right down to 22 Charge cards, unlike credit cards, need to be settled in full at designated the beneficiary of the cheque. intervals, typically once every month. DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY 11 cards like “delayed” debit cards, where the payment in- Consumers can use the payment instruments for pur- struction resulting from the usage of the debit card for chases at retailer websites or they can transfer cash to payment results in placing a hold on the funds in the other individuals in some cases identifying the recipi- underlying account, as against, resulting directly in a ent by email-identification. Pre-funded accounts that debit. There were also variants based on whether the consumers can use for online auction payments are authorization was taken online or offline. The offline among the most recent applications. In these applica- authorization cards mostly relied on information re- tions, individuals use a credit card or signature-based corded on the chip. debit card number to pre-fund the web certificate or electronic account, and recipients redeem the value The market for prepaid cards, also commonly called from the issuer at the time of the transaction. PayPal is stored-value cards, has also emerged as one of the fast- the iconic product in this space. est growing segments in the retail payments industry.23 In the 1990s, when prepaid cards were first issued, they The increasing popularity of social networking web- were mostly issued by non-financial businesses and sites is also translating into increased e-commerce ac- used in limited deployment environments such as mass tivity amongst the members of the social network and transportation systems. In recent years, prepaid cards also with external entities who create content such as have grown significantly as financial institutions and games for sale on such sites. This closed user group non-bank organizations target unbanked and migrant kind of environment is creating a demand for efficient remittances segments. Some prepaid cards already use micro-payment solutions. Facebook, one such social the existing infrastructure for traditional credit and network, has created a closed-loop payment product debit cards.24 Technological innovations in the way in- “Facebook credit” which is pre-funded account akin to formation is stored (e.g., magnetic stripe or computer PayPal with the restriction currently that it is used only chip), the physical form of the payment mechanism, for purchases in the Facebook environment. Payments and biometric account access and authentication are and other fees accounted for $557 million in revenue converging to create efficiencies, reduce transaction for Facebook in 2011, up from $106 million in 2010, times at the POS, and lower transaction costs. showing the dramatic growth in payment volumes on such platforms.25 Since the late 1990s, financial institutions and retailers have also been developing electronic payment instru- Mobile telephony started spreading around the world ments for use mainly in the Internet. Using specialized in late 1990’s. The inherent data communication capa- account-to-account services, individuals can trans- bility of mobile phones caught the attention of banks fer E-money value to other individuals or businesses. and they started launching basic inquiry services like account balance inquiry, and slowly starting expand- 23 While the terms prepaid cards and stored-value cards are frequently used ing the range of functions to also include transaction interchangeably, differences exist between the two products. Prepaid cards are services like funds transfer. This set of services col- generally issued to persons who deposit funds into an account of the card issuer. During the pre-funding of the account, most issuers establish an account and lectively started being referred to as mobile banking. obtain identifying data from the purchaser (e.g., name, phone number, etc.). The world-wide subsequent rapid spread of mobile te- Stored-value cards do not typically involve a deposit of funds into an account as the prepaid value is stored directly on the cards. lephony in the 2000’s and the early experiences with 24 These are typically “branded” prepaid card, i.e., supported by an international mobile banking, combined with the experiences with payment network such as Visa or MasterCard. Branded prepaid cards have similar functionality to debit cards, the only relevant difference being that prepaid cards are not linked to a current bank account, as is the case with debit cards. 25 The Economist 2012. Section II. Overview of Retail Payments 12 DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY e-money products, motivated various entities to exper- to one of scanning and uploading the cheque through iment with e-money products designed with transac- an ATM, Internet banking, or mobile banking chan- tion initiation through mobile phones as a key design nel. The development however has a very significant aspect. This is referred to as mobile money in this docu- improvement in convenience to the customer but also ment. As per a recent industry report,26 the first issuer poses a range of security and other risks to the pay- of mobile money in the world was Smart Telecom in ment system. Similarly, mobile payments can be seen the Philippines in 2004 and the 100th mobile money as essentially an additional access channel to a tradi- product was launched in May 2011, with 88 percent of tional or non-traditional account. However the de- them being in developing countries. velopments involving usage of innovative payments mechanisms like mobile payments combined with In the quest to expand access to payment services in the recent developments in the use of business corre- a cost-effective manner, banks and other institutions spondents and non-banking entities becoming issuers evolved a business arrangement of using local entities of payment instruments represent more than just in- like small shops to provide basic payment and bank- creasing convenience. Such services are very quickly ing services on their behalf. Brazil was one of the early becoming a popular substitute in environments where adopters of this model and various countries have be- the infrastructure for card-based or EFT-based pay- gun adopting this in the last few years. This arrange- ments is not adequately developed, and have the po- ment has been referred to as business correspondent tential to dramatically expand the penetration of the or agent in this document. The technological devel- electronic payment instruments by both an increase in opments in payment devices and mobile phones have more accessible service points and the introduction of been leveraged to equip the business correspondent new lower-cost business models. with tools to service customers efficiently and effec- tively, and to a large extent have been able to expand To summarize: an analysis of the evolution of retail the access to banking/payment services dramatically. payments over the last five to six decades shows the A recent report27 by CGAP reported on seven schemes following trends: world-wide which had an agent network of more than 10,000 each—three from Brazil, two from India and • Successful adoption of advances in technology one each from Philippines and Kenya. have played a key role in development of new channels for payment initiation, improved au- Developments in retail payments have typically been thentication and efficient processing; evolutionary, with gradual developments enhancing the scope, efficiency, and scale of existing payment in- • Development of new payment needs like at tran- struments and systems. Many of the developments can sit payments, Internet auction sites, and social be seen as primarily providing an additional channel networking sites recently, and a need for ex- to access and use the same set of payment instruments. panding financial inclusion also have led to cre- For example, remote data capture of cheques builds on ation of new payment mechanisms; and, the existing cheque imaging system, by changing the channel from presenting the cheque at a bank branch • Payments infrastructure created for one pay- ment product have been successfully leveraged for other payment products – like using ACH for 26 GSMA 2011. 27 McKay and Pickens 2011. DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY 13 online banking enabled payments and success- spent commuting to a designated place to obtain cash ful leveraging of infrastructure created for credit to make payments or to be able to use the non-cash cards by debit cards. payment instrument. The trends in innovations in retail payments are dis- Safety and reliability: A payer needs to have a high cussed in the accompanying document: “Innovations level of trust that a payment instrument will work as in Retail Payments Worldwide: A Snapshot. Outcomes expected and discharge the payer’s payment obligation of the Global Survey on Innovations in Retail Payments to the payee as required. This includes aspects related Instruments and Methods 2010,” and also in the re- to system uptime, fraud misuse, correcting processing cently published CPSS report “Innovations in Retail errors, and so forth. Payments”.28 These documents provide a detailed perspective on what constitutes innovation in retail Convenience: The payment instrument needs to be payments. convenient to use. This includes aspects like what the payer needs to remember or what the payer needs to physically carry or use when making the payment, II.3 Factors Influencing the how much time the transaction takes to complete Adoption of Specific Retail when using that payment instrument, and other re- Payment Instruments lated considerations. The adoption of any given retail payment instrument Acceptance: A payer would want the payment instru- by consumers, businesses and governments is influ- ment to be widely accepted for his payment needs. enced by how well-suited that instrument is in ad- For example, a payment cardholder might not find his dressing the specific payment need of the payer and card useful if the card is not accepted at locations like the payee, as well as how each of these perceive the in- grocery shops and restaurants, or for utility payments strument in terms of risk, liquidity, cost, acceptance, and other uses that constitute a significant share of the and convenience. cardholders routine payment needs. For a payer, the choice of payment instruments is typi- Payment confirmation and reconciliation: A payer cally influenced by the following factors: would want a confirmation that his payment has been initiated and will be processed as per a defined time- Cost: Usage of payment instruments entails both ex- line. This is to serve as a reconciliation record and also plicit as well as implicit costs. Explicit costs include as proof that payment has been made. This would help the direct charges paid by the payer for using the in- the payer in managing and monitoring his payment strument, such as per-transaction fees. Implicit costs account. incurred include, for example, the waiting time for processing the payment request or the cost of time For a payee, the factors influencing his choice of pay- ment instruments are similar to those mentioned above, but have some important differences: Cost: The payee incurs in various explicit and implicit 28 CPPS, 2012, “Innovations in Retail Payments”, Report of the Working Group on Innovations in Retail Payments, available at www.bis.org. costs when accepting a payment instrument. Cash, Section II. Overview of Retail Payments 14 DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY for example, has associated handling and safekeeping other payment service provider. In addition, for some costs. One major implicit cost is the time taken for re- instruments the payee will need to deploy certain in- ceipt of funds into their accounts. The longer the delay, frastructure, like POS terminals and the associated the higher the cost in terms of unearned interest and/ telecommunications means. or higher liquidity management costs, among others. Safety and reliability: The payer needs to trust that Acceptance: In general, the payee would want to ac- the payment instrument he has accepted will be pro- cept those payment instruments that a significant pro- cessed as expected and the payment due to him will portion of the payers like to use (i.e., “payer’s choice”). be honored. This includes aspects like assured process- Some payment instruments will require the payee to ing timelines, system uptime, non-repudiation of pay- have some type of deposit account with a bank or an- ment, and settlement finality. Box 2: The Role of Mandates in Direct Debit How characteristics of a payment instrument impact its choice – the case of direct debit. Direct debits, usually require the payer to pre-authorize debit from his account, only after which can the payee initiated a direct debit request. This pre-authorization is commonly referred to as a “mandate.” The issuance, processing, and presentment of this mandate vary across systems. In some cases, the payer provides the mandate to the payee, and the payee, based on this, authorizes his financial institution to process a direct debit to the payers account. In many other cases, the payer and payee have to register the mandate with their respective finan- cial institutions and the mandate is verified during every subsequent direct debit instructions issued by the payee. The requirement of mandates for direct debits makes them difficult to use for unplanned remote payments, such as for e-commerce. This limitation is also strongly influenced by the rules related to dispute resolution related to repudiation of a transaction by the payer. The proof to be produced by the payee in such situations strongly influences whether the payee will accept a direct debit payment. In addition, the lack of guarantee that the direct debit would be processed successfully, due to reasons such as lack of sufficient balance, erroneous account number, or other related reasons also could make direct debits unsuitable for e-commerce. This has been addressed successfully in some systems29 by moving the process of providing a mandate online and at the time of the transaction. In these systems, the payer, while transacting at the Payee’s website, chooses to provide the mandate for the payment online at his bank’s Internet banking website by authenticating himself using his Internet banking password. The successful recording of the mandate is also conveyed electronically to the payee includ- ing an authorization for the underlying amount. The payee then subsequently initiates a direct debit instruction. 29 There are many examples of this worldwide, notably in Germany, the Netherlands, Malaysia, and recently in the U.S. See Box 3. DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY 15 Table 1: Mapping of Payment Instruments to Payment Needs Instrument Payee Payer Instant liquidity Wide acceptance Handling costs and risk of loss Handling costs and risk of loss Cash Safekeeping costs Difficult to maintain audit trails Difficult to maintain audit trails Anonymity Might have limited acceptance Funds not guaranteed* Inconvenient Clearing time required Cheque Susceptible to fraud Costly to handle Suitable for person-to-person and person/business/Government to Highly susceptible to fraud business/person/Government Wide acceptance Convenient to use Funds guaranteed if based on online authorization, Could lead to over-spending if use is not well controlled (credit cards) which enables the sale to be completed immediately Certain usage patterns could lead to high fees31 Reconciliation is easy Suitable for both face-to-face and online payments, as well as for one-time Payment Explicit acceptance costs exist30 and recurring payments, both payee-initiated and payer-initiated cards Fraud and security risks can exist if adequate controls Value added features might be included by issuers as part of product are not in place packaging (e.g. travel insurance) Dispute resolution process is well defined Easy to track usage Fraud and security concerns; but these are actively managed by the payment networks and issuers Clearing timelines Suitable for recurring payments Account maintenance costs Low processing costs May have limited acceptance Easy to reconcile (if banking partner provides details) Debit Suitable for recurring fixed-amount payments Can control initiation transfers Often require pre-registration of the payee, making it unwieldy for In the case of authenticated and pre-approved debit unplanned and online purchases** transfers, suitable for online payments Fraud and security risks can exist if adequate controls are not in place. Account maintenance costs Suitable for recurring payments Can control initiation Low processing costs Suitable for varying amount recurring payments and for person-to-person Credit Easy to reconcile (if banking partner provides payer payments Transfers details) Audit trails and reconciliation is easy Prolongs order processing Low processing costs Cannot control initiation Several channels available like Internet, ATM and mobile to initiate transaction Fraud and security risks can exist if adequate controls are not in place. Funds guaranteed; enables completion of the sale Limited acceptance right away Convenient to use Innovative Reconciliation is easy Easy to track usage payment Processing costs could be low Fraud and security concerns products Fraud and security risks can exist if adequate controls Risk of losing pre-funded amount if operator goes bankrupt*** are not in place Risks related to weaknesses in new technologies Typically accepted by payee for low value transactions Suitable for person-to-person payments Notes: * This often limits the usage for payments between trusted parties. ** This is however addressed in the systems referred to in Box 3. *** While this risk exists for other payment products as well, it is heightened in the case of innovative products, mainly because of their novelty and insufficient maturity and also because many of the issuers are non-banking institutions. This risk can however be effectively managed by instituting mechanisms like having escrow accounts. 3031 30 It needs to be noted that all payment instruments have acceptance costs; in the case of payment cards there are certain explicit costs for the merchants. This should be not be interpreted to mean that acceptance costs are high or low; a detailed contextual analysis taking into account all explicit and implicit costs needs to be done for this. 31 Certain payment card issuers or acquirers could impose specific fees for certain transactions like for (e.g.) online bill payments, transactions at other bank ATMs and inactivity fees. Section II. Overview of Retail Payments 16 DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY Box 3: Enhancements to the ACH to Support Authenticated e-Commerce Transactions In the recent past, in many countries the clearing and settlement features of the ACH have been leveraged to support online e-com- merce transactions as well. ACH by design are deferred settlement systems with no means for online authentication and authorization of the payer. This has generally resulted in ACH being limited to certain types of transactions like bulk payments, person-to-person transfers, and recurring payments. The increasing popularity of Internet banking and mobile banking, has, however, been leveraged in some countries to add on an authentication and online authorization capability to traditional ACHs. A typical transaction sequence in such an arrangement is de- scribed below. 1. The payer is ready to checkout his purchases of goods/services at the payee’s website and clicks on the available payment options. 2. One of the options could be the new payment option—ACH enabled payment. 3. The payer chooses this option and is asked to enter his bank account number and other ACH specific routing information like bank routing identification. 4. This information along with the purchase information is passed onto the additional component added to the ACH, which uses this information to re-direct the payer to the website of the payer’s bank where he can authenticate himself and the payer responds back to the ACH component with the results of the authentication. At this stage, the rules of the ACH are modified to bind the payers’ bank to the transaction when a successful response. 5. Based on the assurance that the payers’ bank has verified and committed to accepting the transaction when presented for settlement, the payee completes the transaction. 6. There are two options for processing the settlement—either the payee can request his bank to process a direct debit to the payer’s account based on the assurance received in Step 4, or the payer’s bank can be obligated to process a credit transfer to the payee’s bank within a specified period of time. 7. The standard ACH clearing and settlement process then kicks in. There could be other variations where Step 4 can be concluded on a mobile phone by exchange of SMS messages, or by entering a PIN at a POS terminal etc.32 Successful examples of this include the iDeal in Netherlands and proprietary bilateral arrangements of companies like Bill Desk in India. In the USA, NACHA partnered with eWise systems to provide a similar mechanism, Secure Vault Payments. This mechanism has a number of advantages: the payer can use his existing bank account and does not need a payment card; all transactions are authenticated; there are significant economies of scale as existing ACH infrastructure can be used; and this can help in spurring adoption of Internet banking as well. 32 NACHA’s “Secure Vault Payments”, Javelin Strategy and Research, October 2008. DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY 17 Payment reconciliation and audit trails: A payee is typically a consumer but can also be a business or a needs payment reconciliation information to enable government entity. The payee is typically a merchant proper bookkeeping. Payment audit trails are also but can also be another consumer, a business entity crucial, for example when defending repudiation re- or a government entity. Both the payer and the payee lated claims. are represented by their financial institutions and the payment networks, and the clearinghouse plays a role How these aspects play out in the case of direct debit is in routing transactions between various parties and in discussed in the Box 2. determining settlement positions at specific intervals (normally daily). In addition to these payment instrument specific at- tributes, the overall context of the country in terms of Figure 2 below shows a generic clearing and settlement cultural, social, economic development and financial process for retail payments using a standard four-party sector development influences the availability of spe- model. cific payment instruments and also the overall NPS. Cheque Clearing and Settlement Each of the payment instruments described earlier has The typical flow starts with the payee (e.g. an indi- its own specific set of value propositions for payers and vidual or a business) using a cheque to pay for goods payees. Table 1 shows the respective benefits and risks and services. The payee (e.g. another individual or to both the payer and the payee from the use of these a merchant) that accepted the cheque as a means of instruments. payment may opt for cashing the cheque at a branch of the payer’s financial institution, in which case the The general features depicted in Table 1 may vary from transaction is settled with finality at that point.33 country to country, especially with regard to costs. Alternatively, the payee may opt for depositing the Moreover, some instruments may not be widely avail- cheque with its own financial institution for collection. able or widely accepted, due, for example, to the lack of For deposited cheques drawn on other financial insti- the necessary infrastructure like POS terminals. tutions, the payee’s financial institution sends an elec- tronic presentment file with the required cheque data or sends the physical cheque to the clearinghouse.34 II.4 Clearing and Settlement Processes in Retail Payment Based on the information received from or through the Systems clearinghouse, the payer’s financial institution sends back information to the clearinghouse on the cheques Clearing and settlement processes are a vital com- it will honor and those it will not (so-called “return ponent in the processing of any non-cash payment items”) for reasons such as insufficient funds, a closed instrument, either paper-based or electronic. This account, a stop-payment order, fraudulent signature, section describes the typical clearing and settlement or failure of the paying financial institution. models for the various payment instrument groups described earlier. While the clearing and settlement 33 Assuming there are enough funds in the account of the payer to cover the process and the flow of funds and information may amount of the cheque With electronic presentment files, financial institutions exchange the physi- be different for each payment instrument, in general 34 cal cheques at a later stage or do not exchange them at all (that is, the cheque is terms there is a common set of participants. The payer truncated at the point of deposit). Section II. Overview of Retail Payments 18 DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY Figure 2: Generalized Clearing and Settlement Model All the participants of the clearinghouse send this same participants with a multilateral net debit position, and information to the clearinghouse, on the basis of which then credits the account of each of the participants the clearinghouse calculates the amounts financial in- with a multilateral net credit position. Once the clear- stitutions owe to each other. Normally, these amounts inghouse cycle is completed, the financial institution will be subject to some form of netting in order to of the payee will make the funds available to the latter. reduce the gross amounts to be exchanged through offsetting of amounts owed by/due to other financial There are of course many variants to this basic scheme. institutions. In cases where multilateral netting is used, Some of the most relevant include tiered clearinghouse each financial position ends up with a single position participation, the cheque clearinghouse system being (credit or debit) vis-à-vis all other participants in the based on regional clearinghouses rather than on a sin- clearinghouse. gle nationwide clearinghouse, mechanisms by which the financial institution of the payee makes the funds Once all clearinghouse participants know their po- available to the latter before the clearing and settle- sitions, the corresponding transfer of funds takes ment cycle is completed, etcetera. place. In most cases, this is done through a cen- tral settlement agent, normally the central bank.35 Clearing and Settlement for EFT-based In a multilateral net environment, the settlement agent Products first debits the account of each of the clearinghouse EFT based products use the electronic network or au- tomated clearinghouses (ACH) for the exchange of payment instructions among financial institutions, 35 One hundred one of the 106 cheque clearing houses reported in the World Bank Global Payment Systems Survey settled in central bank money DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY 19 typically on behalf of customers. They are typically transaction will not need to undergo the interbank batch-processed, value-dated electronic funds transfers clearing and settlement mechanism earlier described. between the payer’s and payee’s financial institutions. Moreover, in many countries electronic direct credits can also be executed through a real-time gross settle- The flow of an EFT debit transaction is very similar to ment system, in which case the funds are transferred that of a cheque cleared by means of electronic present- directly from the financial institutions of the payer to ment files. Instead of depositing a cheque, the payee, that of the payee. based on a mandate received from the payer, instructs its financial institution to debit the account of the payer.36 Clearing and Settlement for Payment Cards The payee’s financial institution routes this and other For a typical payment card transaction, be it a cred- transactions in batches to the EFT network (or the it card or debit card—for example the purchase of ACH operator). The latter separates the transactions goods and services at a merchant location equipped corresponding to each of the other participating fi- with a POS terminal—once the card is swiped or the nancial institutions and re-routes them also in batch- chip is read, the card’s data is transmitted through es. As in the case of cheques, the financial institution the payments network’s electronic network (called a of the payer sends back information on the transac- payment cards switch) to the card issuer for authori- tions it will honor, and the rest of the clearing and zation. If approved, the merchant receives the autho- settlement cycle is also similar to that of cheques.37 rization to capture funds, and the cardholder accepts liability by signing the credit voucher (can be paper The clearing of a settlement of an EFT direct credit or electronic). The merchant receives payment, net transaction is also similar, with the exception that the of fees, by submitting captured payment card trans- flow within the system is initiated by the payer. The actions to its financial institution in batches at the payer submits the payment instruction to its financial end of the day. The merchant’s card acquirer for- institution, which verifies the availability of funds for wards the sales draft data to the payment network, each of the requested transactions and submits trans- which forwards the data to the card issuer. Once action data files to the EFT network or ACH operator. again, the rest of the clearing and settlement cycle is The transaction is then re-routed to the payee’s finan- similar to that of cheques and EFT-based products.38 cial institution, which confirms that the relevant ac- count can be credited (e.g. account number is correct, Signature-debit transactions are cleared and settled account has not been closed, etc.). The clearing and in the same way as credit card transactions. For an settlement process takes place and then the funds are online, PIN-based, debit card transaction at a mer- made available to the payee by crediting his account. chant POS, the cardholder enters a PIN to autho- rize the transaction. For all prepaid cards, whether There are also several variants for this basic scheme. they are branded prepaid card or affinity, closed If both the payer and the payee hold an account at the loop prepaid cards, a financial intermediary—typi- same financial institution, then the corresponding EFT cally a commercial bank or another third-party pay- ment service provider eligible to issue prepaid cards39 36 The ECC process mentioned earlier is a particular case in which the cheque given by the payee serves the same purposes as the mandate. 38 Of the 165 payment card switches reported as part of the Global Payment 37 The settlement agent is also in most cases the central bank. According to the Systems Survey 2010, around 67 percent of the switches were reported to be set- Global Payment Systems Survey 2010, 97 percent of ACHs reported settling their tling in central bank money and around 31 percent in commercial bank money. transactions in central bank money. 39 These may include non-financial institutions. Section II. Overview of Retail Payments 20 DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY —holds the funds in a pooled account. Each pooled bulk from the MNO or the bank. The consumer then account has various sub-accounts, depending upon uses the mobile phone interface to generate a pay- the characteristics of cardholders and the program to ment instruction to another individual or business, which the cardholders belong. An issuer or its third- which then obtains funds (cash-out) from the network party payments processor maintains a system of re- of agents. There is typically a one-to-one relationship cord, keeping a record of all transactions belonging to between the e-money credit a consumer holds and each sub-account. When a consumer uses a prepaid the real money that is held in their sub-account at the card, the merchant sends a message to the recordkeep- bank. This is illustrated in Figure 3. ing entity to determine whether the balance is suffi- cient to cover the transaction. In the case of branded In large scale agent networks like that used by FINO prepaid cards, the authorization, clearing, and settle- in India and M-Pesa40 in Kenya, additional entities are ment works similar to a traditional debit card. involved to provide cash management services to the agents; these are often referred to as super-agents. The Processing of Transactions in Agent-based super-agents typically hold the accounts of the agents Mobile Payment Services and facilitate conversion of the agents e-money bal- Typically, these schemes rely on the payer and payee ance to cash balance in their regular bank accounts exchanging payment instructions through either cus- and also in certain cases provide overdraft facilities to tom applications loaded onto their mobile phones or the agents. through standard mobile phone messaging services like short messaging service (SMS). In general indus- There are also a few other mobile payment models try terminology these are referred to as “mobile pay- where a separate entity operates the mobile payment ments.” These payment services are typically used for platform integrating with a set of institutions or even person-to-person payments. However, in some coun- in some cases with a payment card switch.41 These try environments mobile payment services are also models mirror the clearing and settlement arrange- being considered or used for various types of bill pay- ment of payment cards. In these models, the mobile ments, government payments, and collections as well phone is used as a channel to send the payment in- as for cross-border remittances. struction instead of a card being swiped at a POS ter- minal, with the payment instruction being handed off There are two predominant models in the delivery to the merchant’s acquiring bank. From there on the of agent-based mobile payment services. In the first process remains the same as for payment cards. The model, a commercial bank holds funds and maintains transaction confirmation is received on either a stan- the customer accounts. It may outsource the manage- dard POS terminal or perhaps at the mobile device of ment of the agent network and transaction processing the merchant. to a third-party payments processor or a mobile net- work operator (MNO). In the second model, a non- The above model also applies to agent-based payment bank payment service provider, typically an MNO services using other mechanisms for transaction initi- leads the effort, including customer management and ownership of accounts. In this scenario, it may partner 40 For details on M-Pesa please refer Annex 8. with a bank to hold funds on its behalf. Consumers 41 These models have been created by existing payment networks in some countries (e.g. Dominican Republic), by the existing global payment networks typically buy (cash-in) e-money credit from the net- Visa and Master Card, and also by independent entities like Obopay, Yellow work of agents, who in turn buy e-money credit in Pepper, and others. DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY 21 Figure 3: Clearing and Settlement for Mobile Money Schemes ation, such as the payer using a smartcard at the agent’s the retail payments value chain are as low as possible, POS terminal to initiate a range of transactions includ- and depends upon factors such as technology, inno- ing remittances, cash deposits, and cash withdrawals. vation, and the level of cooperation and competition within the retail payments market. To fulfill these goals, a central bank typically plays three different II.5 Different Roles within roles: a) an operational role; b) facilitator, acting as the Retail Payment Systems catalyst in provision of retail payment services; and c) overseer and/or regulator of retail payment systems The Role of Central Bank and services. Central banks typically seek efficiency and safety in payment systems as well as stable financial markets. In an operational role, the central bank typically pro- More recently, in addition to safety and efficiency, ac- vides settlement services for some or all retail payment cessibility and the existence of a competitive environ- systems in a country. The settlement is done on the ment are also being considered important objectives. books of the central bank and is common for paper- Safety implies that the system functions smoothly and based systems (usually cheques), EFT-based systems, securely, which is important for the trust in currency/ and some debit card and ATM systems. In some coun- fiat money. Efficiency implies that the costs42 within tries, central banks also play a more direct operational role by provide direct clearing services to various retail payment systems; for example, central banks in coun- 42 Cost is used here broadly and is used to refer to both direct costs like trans- action fees and also indirect fees like costs of access to the system/instrument. tries like Saudi Arabia, Kazakhstan, Kyrgyz Republic, Section II. Overview of Retail Payments 22 DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY Germany, Italy and Belgium provide cheque, EFT, and nomic effects and may undermine the confidence of payment card clearing services. In some other coun- the public in the payment systems and in the national tries the central banks also operate some retail pay- currency. Central banks typically exercise their over- ment systems. The responses received for the World sight powers by monitoring, assessing, and inducing Bank Global Payment Systems Survey-2010 show that change, if necessary, through the issuance of formal central banks operate approximately 55 percent of the regulations. check clearing houses; 35 percent of ACH systems; and, 12 percent of the payment card switches. The Role of Payment Institutions For all EFT and most card-based payment instru- As a facilitator of retail payment services, most central ments, banks44 have the direct relationship with cus- banks maintain close relationships with commercial tomers and hold funds on their behalf (depending on banks and other retail payment service providers in the type of payment product) and are issuers of the order to discuss priorities for payment system devel- relevant payment instruments and operators of the opment within the country and to promote these to underlying current account. In the case of credit and materialize. Through these relationships, central banks debit transfers, they also provide the transaction chan- also pursue development of strategic initiatives aimed nels (e.g. online banking platforms) through which the at benefiting all participants uniformly (e.g., imple- payment instructions are received and processed. mentation of payment systems standards). In many countries, as part of their public policy objectives, For some innovative payment services, some non-bank central banks also pursue important research agendas institutions are playing one or more of these roles. that benefit the wider payments industry in an impar- tial way. In card systems, an additional role is that played by the so-called acquirers. These institutions maintain the re- As an overseer and/or regulator of retail payment sys- lationship with the merchant, provide the infrastruc- tems: the scope of oversight function varies across cen- ture needed for accepting a card payment (e.g. access tral banks, and in some cases depends upon whether to the POS terminal or the payment services support- retail payment systems are considered systemically ing an e-commerce website) and normally operate important or not.43 In the responses to the World Bank the current account in which the proceeds of the sale Global Payments Survey 2010, 64 percent of the cen- transaction are deposited. tral banks surveyed responded that their oversight powers extended to all payment systems operational in Clearing and Settlement Arrangements the country. However, 48 percent responded that they In cases where the payer and payee maintain a rela- actually exercise oversight powers only over systemi- tionship with the same payment institution, then that cally important payment systems. In only a few coun- institution will normally perform all clearing and tries some retail payment systems are considered to settlement functions associated with the transactions be systemically important, while in many others retail between those parties. Likewise, in closed-loop, pro- systems are considered to play a role of “prominent” importance, since their failure can have major eco- 43 Bank of Japan and Bank of Sweden, for instance consider at least one or more 44 Throughout this document, the term banks refers to all deposit taking retail payment systems as systemically important. institutions. DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY 23 prietary payment mechanisms, the payee and payer based transactions and other electronic instructions institutions are by definition the same since one insti- like the ones arising from electronic processing of tution manages the entire payment process. cheques in an automated manner are also referred to as ACHs. Cheque clearinghouses play a similar role In payment mechanisms where the payment institu- and act as a network for exchange of payment instruc- tion of the payer and that of the payee are different, tions for cheques. Financial institutions or third-party an inter-institution network that facilitates authoriza- service providers typically send payment instructions tion routing, clearing, and settlement of transactions is for credits or debits in batches for processing one or necessary. The payment card networks, clearinghouses two days before the settlement date, however there are and clearing associations, play this role.45 several ACHs with same-day settlement.47 Both ACHs and clearing associations set standardized schedules, Payment card networks play an important role in fa- along with rules and procedures for payment sub- cilitation of payment card transactions, including pay- mission, formatting, messaging, and processing that ment authorization and clearing and settlement servic- members are required to follow. es for member institutions. To perform these services efficiently, reliably and securely, the payment card net- The Role of Third-Party Payment Service works define and enforce highly standardized operat- Providers ing procedures and policies, and controls for payment The role of third-party payment service providers has card issuance, acquiring, and settlement activities. become more prominent in recent years due to growth and increasing sophistication and specialization of In some cases, some or all of such services are pro- retail payment systems. Recent technological innova- vided directly by or in close association with the in- tions have further influenced the growth of such spe- ternational card networks like Visa and MasterCard, cialized services. which typically also own the trademarks/logo and grant membership to eligible financial institutions that A third-party payment service provider is a generic use the logo and services to facilitate issuance and ac- term that implies a company providing specialized quiring/acceptance. International card networks like services within the retail payments value chain. This Visa and MasterCard, also set and enforce the inter- company may be contracted by a bank or another pay- change fees that are normally incorporated into the ment service provider to conduct one or more sub- fees charged to merchants or cardholders for point of processes, for example by providing specialized soft- sale transactions. ware or hardware used to create and send ACH files and/or to act as a sending or receiving point for one Clearinghouses and clearing associations46 facilitate of the participants in the ACH system, or to provide both electronic (EFT) and cheque clearing and settle- authorization, settlement, and merchant services. ment services. Clearinghouses that facilitate EFT- In this document, all these three types of players— payment institutions; payment networks, clearing as- 45 For details refer to CPSS, “Clearing and settlement arrangements for retail payments in selected countries”, BIS, 2000. sociations and clearinghouses—along with third-party 46 The difference between a Clearinghouse and Clearing Association is that the former does multilateral clearing and settlement, whereas the latter is a combina- tion of bilateral clearing and a combination of bilateral and multi-lateral netting 47 Examples include the Faster Payments Service in the UK and the NEFT for settlement. system in India, among others. Section II. Overview of Retail Payments 24 DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY payment service providers are collectively called Retail • Consolidation of payment service providers Payments Service Providers (RPSP). These three cat- and emergence of third-party non-bank pro- egories in themselves are not mutually exclusive, there viders for specialized payment services. Recent are significant overlaps and in some cases the same changes to payments technology such as intro- organization could play different roles in different sce- duction of electronic cheque conversion and narios. For example, a bank could offer its own pay- electronic cheque presentment, introduction of ment products and in addition also provide processing prepaid cards, mobile payment services and vir- services in terms of processing clearing and settlement tual wallets have influenced the rapid consolida- of transactions to another bank. tion of retail payment service providers, credit issuers, merchant acquirers, processing compa- nies, and cheque processors. As a result, some II.6 Concluding Remarks on small and mid-sized financial institutions have the Observed Trends in exited the processing business and outsourced Retail Payments certain functions of the retail payments process to larger financial and non-financial institutions. It can be concluded from the discussion in this chapter Non-banks, in particular, are assuming more that finding the “right” solution to a nation’s retail pay- roles in retail payment systems such as the clear- ments needs is not a simple task but one that involves ing and settlement functions, and the issuance a complex interplay of factors that influence both the and processing of electronic payment cards and demand for and the supply of electronic retail payment other devices. instruments. • The shift from paper to electronic payment The demand for a payment instrument is influenced instruments is more pronounced today than by the latter’s effectiveness in satisfying the payment previously, however, paper-based instruments needs of the users, and the ease with which the users and especially cash are still strong in many can adopt and substitute it for the traditionally domi- countries. In many country environments, the nant payment instrument, namely cash. The supply shift from paper to electronic payments has side, on the other hand, in addition to the existence gained significant momentum with technologi- of demand is typically influenced by the extent of co- cal progress and the ever-increasing preference operation and competition in the market, the avail- by consumers, merchants, and other payees for ability of infrastructure and technology, as well as by convenient and low-cost payment alternatives. the legal, regulatory, and payments system oversight The most significant growth is seen in debit and environment. prepaid cards, followed by direct credits and direct debits. For example, the increasing avail- The key trends that are observed to be taking place to- ability of online banking and automated bill pay- day are summarized below. ment, among others, are reducing the number of cheques that flow through the payment system. Likewise, wider availability of modern POS ter- minals has contributed to growth of payment DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY 25 card programs and added to the convenience for vations like the use of biometric authentication consumers. The use of cash, however, is declin- and agent models and also for introducing near ing at a much slower rate.48 real-time payments. • Emergence of innovative payment instruments Several other innovative payment instruments have and services both to expand payment services emerged for very different reasons. For example, new to hitherto unbanked and other under-served payment needs like the ones created with the emer- market segments, as well as to meet new types gence of e-commerce and auction websites or the need of payment needs in mature markets, and, in for transit payments resulted in innovative payment general to improve overall efficiencies in the services like PayPal in the United States and Octopus payments process. Underdeveloped or missing card in Hong Kong. It needs to be noted that even now, payment services infrastructure has resulted in traditional payment cards have a majority share of all relatively high transaction costs and low pen- e-commerce payments; however, innovative payment etration of payment services for lower-income services like PayPal are quickly becoming significant populations in many countries. Very often, fi- players in this space. nancial institutions find it too costly to invest in the expansion of traditional retail payments Improving efficiencies has also been a motivation for infrastructure that is geared towards serving the development of innovative payment services, for ex- needs of low-income people. In recent years, ample the remote deposit capture service—capturing a however, improvements in technology combined cheque image using the payee’s mobile phone and sub- with new product offerings have been adapted mitting it to the presenting bank directly. mostly, though not uniquely, by non-bank pay- ment service providers to satisfy the payment On the other hand, while several innovative payment needs of lower income consumers. A closely instruments have been successful in specific environ- related development is the demand for efficient ments, with very few exceptions their success at the payment services for supporting international global scale has not yet taken place. The results of the remittances and other cross-border payments, questionnaire on innovations in retail payments as part which has led to the development of innova- of the Global Payment Systems Survey 2010 provide tions like inter-ACH linkages and specialized additional insights on the current status of innovative payment service providers. There is similarly a payment instruments and services around the world. demand associated with Government payments The main findings are presented in Box 4.49 and corporate payments which is creating inno- 48 On a worldwide basis, the World Bank Global Payments Survey 2010 showed that debit cards are the most used means for payments in 32 percent of countries, followed by checks. An analysis by income level shows that checks are the most used payment instrument in 65 percent of low-income countries compared to only 13 percent in high-income countries, 19 percent in upper-middle income 49 The accompanying publication, “Innovations in Retail Payments Worldwide: countries and 37 percent in lower-middle income countries. In geographical A Snapshot. Outcomes of the Global Survey on Innovations in Retail Payments terms, check usage is still substantial in Sub-Saharan Africa, South Asia, and Instruments and Methods 2010 (consultative report)”, provides a detailed anal- Latin America. ysis of the responses to this survey. This is available at www.worldbank.org/ paymentsystems. Section II. Overview of Retail Payments 26 DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY Box 4: Main Results of the World Bank Survey on Innovations in Retail Payments This survey was conducted as part of the World Bank Global Payments Survey 2010. There was a separate accompanying questionnaire to collect information on innovations. The questionnaire requested general information on the type of innovative products and on innovative access channels to bank accounts used in a country as well as more specific information on the design features of the relevant innovations (e.g. protection of the monetary value created, involved entities, usage of the product, pricing, clearing and settlement, security, and fraud issues). In addition, questions about the legal and regulatory framework were covered and the provision of statistical data was requested. Finally, central banks were asked about planned reforms in the legal and regulatory framework and about plans to introduce new products and processes. A total of 101 central banks completed the questionnaire and reported 171 innovative retail payment products/product groups. Most of the central banks provided information on a product group basis and not individual products. The main findings are as follows: 1. In terms of usage, innovative payment products are still much less relevant than traditional retail payment products. However, they are important for financial inclusion in over 10 percent of the countries. 2. While non-banking organizations are playing a significant role in the provision of innovative retail payment products/mechanisms, banks remain a significant player in this field. 3. Customer funds are fully protected in around 60 percent of the cases. 4. Innovative payment products appear to have fairly well developed pricing models. 5. Merchant payments, utility bill payments, and person-to-person transfers were the most common transaction types supported by the innovative payment mechanisms. Less than 10 percent of the products supported government-to-person payments. 6. The majority of the innovative products/mechanisms have very limited interoperability. 7. The traditional clearing and settlement infrastructure is in general not used. 8. Security and fraud risks seem to be getting inadequate attention. 9. Central banks identified themselves as the overseers for around 60 percent of the products, however 10 percent of the products were subject to collaborative oversight. 10. In contrast to the detailed transaction data available for traditional retail payment systems and products, the details available for innovative payment products and payment systems are limited. SECTION III Public Policy Objectives in Retail Payments R etail payment systems have been generally overall policy goals for retail payments system (see Box initiated and operated by private entities 5).50 This framework identifies efficiency and safety as that come together to try to address col- key public policy objectives for retail payments system. lectively recognized payment needs in a market. In some cases, it has even been suggested that In the specific context of countries with an underde- public authorities should adopt a hands-off policy as veloped retail payments system, in addition to the pub- direct intervention might hinder innovation. lic policy goals of “safety” and “efficiency” some other public policy goals are typically required to address However, as evidenced by various studies and PSDG both “demand” side as well as “supply” side constraints. field work in over 100 countries, it is clear that signifi- cant public policy objectives relating to retail payments The PSDG’s global experience in the modernization exist and should be pursued by public authorities in and reform of retail payment systems indicates that general and the national central bank in particular. national authorities should have at least three addi- This chapter discusses these key public policy objec- tional policy goals with respect to retail payment sys- tives, based on which it later establishes the need for tem development: a holistic retail payments development strategy to be adopted by any country that lacks a well-functioning 1. Affordability and ease of access to payment retail payments system. instruments and services. 2. Availability of an efficient infrastructure to pro- III.1 Overall Safety and cess electronic payment instruments. Efficiency 3. Availability of a socially optimal mix of payment Standard setters and international financial institu- instruments. tions have already provided a useful framework to guide reforms in retail payment instruments and sys- These are described in further detail below. tems. In particular, in 2003 the CPSS identified a set of 50 CPSS 2003. 27 28 DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY of demand and supply factors, overall there should be Box 5: CPSS Public Policy reasonably affordable and reliable access to a set of ba- Goals for Maintaining and sic electronic payment instruments and services. Promoting Efficiency and Safety in Retail Payments If significant sections of a society do not have access to electronic payment instruments, the use of relatively Policies relating to the efficiency and safety of retail high-cost and potentially growth-limiting paper- payments should be designed, where appropriate, to: based payment instruments payments would remain high. Moreover, adequate access to payment services 1. Address legal and regulatory impediments to can positively impact the provision of other financial market development and innovation; services. Financial services such as provision of credit, insurance, and investment services all depend on the 2. Foster market conditions and behaviors; ability of the institution to disburse funds and/or col- 3. Support the development of effective standards lect periodic payments from their customers. Lack and infrastructure arrangements; and of efficient payment services impacts the ability of fi- nancial service providers to operate in a cost-effective 4. Provide central bank services in the manner most manner, often resulting in that the services these in- effective for the particular market. stitutions intend to provide become unaffordable for some segments of the population. Also, the increased use of payment services by traditionally unbanked and under-banked individuals also may provide banks and other service providers an insight on the financial III.2 Affordability and Ease condition of these persons, potentially making them of Access to Payment eligible for further financial services such as credit, in- Instruments and Services vestment, or insurance services, among others.51 The “demand” for electronic payments is often re- The estimates for world-wide levels of financial inclu- stricted by limited financial inclusion of the country’s sion vary. The World Bank and CGAP estimate that population. Payment services are a basic component there are around 2.7 billion working age adults who do of financial inclusion, which is defined for the pur- not have access to savings, transactions or credit ac- poses of this document as the availability of basic fi- counts.52 While the levels of financial inclusion are cer- nancial products to meet the payment, savings, credit, tainly lower in developing and low-income countries, insurance, and investment needs of a society. The key there are significant extents of population financially requirement for accessing non-cash payment mecha- excluded even in high-income countries. For example, nisms involves the payer entering into a formal rela- in the United States it is estimated that 10 percent of tionship with an intermediary like a bank (or in some households are unbanked.53 In the European Union, cases a non-bank institution) that provides support for electronic payment instruments. While the types of payment instruments and levels of service may vary 51 As an example, Annex 3 describes financial inclusion initiatives undertaken by the Reserve Bank of India. across different segments of society based on a host 52 CGAP and World Bank 2010. 53 FDIC 2009. DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY 29 Table 2: Select Banking Infrastructure and Access Metrics Household penetration Deposit Bank branches ATMs per Region/Countries Deposit accounts per per 100,000 100,000 adults accounts (%) 1000 adults adults High Income Countries 91 2022 32 94 Sub-Saharan Africa 12 163 3 5 East Asia and Pacific 42 1756 15 11 South Asia 22 317 7 4 Middle East and North Africa 42 818 17 28 Latin America and Caribbean 40 1140 14 31 Europe and Central Asia 50 1330 18 50 All Developing Countries 737 10 29 Source: World Bank 2010 there are indications that about seven percent of con- payment services may keep on using cash and other sumers 18 years old and above do not have a bank paper-based instruments on a large scale, thereby fur- account.54 ther undermining the demand for electronic payment instruments. This could be explained by a variety of Regional estimates for the penetration of basic bank- factors, going from the lack of convenient and/or cost- ing services and infrastructure are shown in Table 2. effective alternatives to them, to regulatory environ- As this data shows, the differences in banking service ments and working habits that favor paper-based in- coverage and traditional banking infrastructure be- struments and records, among others elements. Table tween developing countries and developed countries 3 shows data on the main payment instruments used are still very significant. These gaps have a significant for government payments and government receipts or bearing on the low number of per-capita electronic collections, as depicted in the Global Payment Systems transactions in developing countries as shown earlier Survey 2010. in Figure 1. Apart from limited financial inclusion, those individu- als and organizations that do have access to traditional 54 European Commission, Commission Staff Working Paper 2011. Section III. Public Policy Objectives in Retail Payments 30 DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY Table 3: Payment Instruments used for Government Payments Mainly electronic Mainly paper based payment instruments- payment instruments- Mainly cash payment cards, EFT, cheques, payment and other e-payment orders schemes Government to person payments Public sector salaries 11% 24% 76% Pensions and transfer payments 14% 26% 67% Cash transfers and social benefits 22% 31% 52% Person to government payments Taxes 40% 48% 44% Utility payments 55% 33% 42% Payment for services, etc. 54% 35% 34% Government to business payments Procurement of goods and services 2% 50% 61% Tax refunds 2% 49% 50% Business to government payments Taxes 11% 58% 57% Utilities 16% 53% 50% Benefits transfers 9% 52% 46% Note: Central banks were asked to indicate the main payment mechanism used for the specific types of government payments. In certain cases more than one payment mechanism was chosen, hence the total may add up to more than 100 percent. The typical usage patterns of the financially exclud- ditional payment products might not be affordable for ed, which are often erratic and/or small-value, when the financially excluded. It needs to be noted that the coupled with limited ability of these groups to comply costs associated with a payment instrument includes with product requirements like maintaining minimum not just explicit costs like account opening fees and balances and having the ability to bear the standard transaction fees, but also indirect costs like time to transaction fees, make it financially unviable for finan- travel to access a transaction channel. In many cases, cial institutions to service these segments using their indirect costs may be more relevant to the explanation traditional payment products. Seen another way, tra- of financial exclusion than direct costs. DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY 31 III.3 Availability of an Efficient authorization of transactions with cards, quick pro- Infrastructure to Process cessing of payment instructions, or quick posting of Payment Instruments incoming payments to clients’ deposit accounts). The supply or provision of electronic payment instru- The market structure of the financial services indus- ments and services is largely dependent on the avail- try can also play a substantial role in slowing down the ability of certain common infrastructure like payment growth of electronic retail payments. For example, the networks, clearinghouses and ACHs, as well as on cer- market may be characterized by barriers to entry, to tain institution-level infrastructures such as a central- innovation and to effective competition in the provi- ized account management system. sion of retail payment services. Such barriers might have been created by market participants themselves In many low-income and middle-income countries, or in some cases by regulation. Under these circum- commercial banks and other payment service provid- stances, the market arrangements can limit the incen- ers typically face an unviable business case to expand tives of existing retail payment service providers to the traditional payment and banking infrastructure expand their service base for retail payments and, as a beyond major urban areas. In recent years, there have result, to invest in the development of new electronic been many promising innovations that could assist in payment instrument and service infrastructure, which addressing the infrastructure gap. These developments can require significant volumes to be cost-efficient. mainly include: • Using mobile phones on which payment instruc- III.4 Availability of a Socially tions can be initiated and/or received; and, Optimal mix of Payment Instruments • Using business correspondents equipped with mobile phones and/or custom-built POS termi- There is a wide range of payment instruments in use nals to provide banking services, reducing the today. However, the proportion of relative usage varies need to rely solely on traditional banking infra- significantly from country to country due to a variety structure for provision of payment services. of reasons, including those of a socio-cultural nature. Usage of payment instruments also entails costs, with It should be noted, however, that these developments some payment instruments being better suited for will not reach their full potential without availability of certain payment needs than others. For example, for appropriate payment infrastructures for clearing and payments of a somewhat larger value, a credit transfer settlement. might be a better option than a payment card—trans- actions costs are lower for the receiver, and possibly for The supply can also be constrained by limited auto- the sender as well, and the funds can usually be made mation of financial intermediaries and other payment available to the receiver immediately or within a day. service providers. Only with some basic automation of their retail and corporate customer account-man- However, for an individual who does not have suffi- agement systems will electronic payment instruments cient funds in his current account, a credit card pay- be able to reach their full potential (e.g. to allow rapid ment linked to an available line of credit can finance immediate transactions. Also, some incidental costs Section III. Public Policy Objectives in Retail Payments 32 DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY such as account maintenance fees might cause tradi- tional credit transfers and debit transfers to be unaf- fordable for certain types of payment needs (e.g. dis- bursement of some government social benefit transfers to unbanked recipients), whereas a prepaid payment cards might be more cost-effective for this purpose. Therefore, while at a conceptual level the overall pub- lic policy objective could be to promote and encourage usage of electronic payment instruments, the associat- ed costs and other factors such as suitability of specific instruments for a specific type of transaction must be taken into account. In summary, from a public policy perspective, the na- tional payment system should support a range of pay- ment instruments that provide users with choice based on cost, convenience, speed of processing, and safety. SECTION IV Guidelines for Developing a Comprehensive Strategy for Reforming Retail Payments T he overall trends in retail payment systems While there are some differences between an interna- and services and the public policy goals tional remittance transaction and an ordinary retail identified in the previous chapters confirm payment transaction, these differences do not have the need for adopting a comprehensive, much of a bearing on the applicability of the GPs to strategic approach when undertaking a reform of the both. In fact, a remittance can be treated as two sets of national retail payments system; even more so, consid- retail payment transactions—one between the sender ering the many choices that are available and the many and the remittance service provider (RSP), and an- business and technical decisions that need to be made. other between RSP and recipient. Moreover, some of the traditional particularities of remittances vis-à-vis In this chapter, a set of “Guidelines” or “Guiding ordinary retail payments have been disappearing over- Principles” are discussed, with an eye to providing a time. For example, RSPs are increasingly establishing strategic framework for reformers and other stake- account-type relationships with remittance senders holders for the modernization of a national retail pay- and recipients. Or, a growing share of remittances is ments system. now using one or more elements of the retail payments value chain. IV.1 General Framework On the other hand, the proposed expansion of policy Underlying the Guidelines objectives for retail payments beyond safety and ef- ficiency as discussed in Chapter 3 requires a certain In revisiting the numerous studies that have been reformulation of the five GPs, and adding one more. undertaken by the World Bank’s PSDG, the CPSS Also, unlike in the GPs, separate roles for public au- and other international and domestic organizations thorities and private sector players have not been it is clear that, in general, those studies’ key findings elaborated. and especially their public policy implications can be mapped around the CPSS-World Bank General Principles for International Remittance Services (here- inafter the “GPs”). At present, the GPs, shown in Box 6, are the prevailing international standards for a special type of retail payment—cross-border retail payments. 33 34 DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY GUIDELINE I: The market for retail In many cases, the use of the underlying financial payments should be transparent, product also entails a monthly fee or some other have adequate protection of type of “maintenance” fee. Moreover, as part of using payers and payees’ interests, and the product’s payment functionality, consumers be cost-effective. might incur additional costs (for example, per transac- tion fees).55 Description In addition, a major difficulty for achieving proper Transparency levels of transparency is that financial institutions and From an efficiency perspective, adequate transpar- other service providers usually create a variety of an- ency promotes a greater usage of the most cost-effec- cillary services around the financial product, some of tive payment instrument(s). From the perspective of them not directly related to the payment function, for consumers, improving transparency about the vari- example accident insurance coverage. In other cases, ous cost elements and service conditions of payment the consumer is actually rewarded for using the finan- instruments helps promote consumer confidence and cial product and/or associated payment instruments. trust in those instruments. These additional services and benefits by themselves could involve a specific price, though in most cases a Often, however, consumers of retail payment instru- bundled price structure is created. The variety of ser- ments and services are not entirely certain about the vices bundled into the total price makes it very difficult real cost of using a particular payment instrument. for consumers to determine the unitary price they are Moreover, when they wrongly or rightly attribute a paying to their financial institution or service provider higher cost to the usage of a payment instrument, the for their payment transactions. usage of that payment instrument gets restricted. Consumer protection and financial literacy This situation is due in part to the complexity of retail In a non-cash retail payment there are multiple con- payment instrument pricing. Retail payments rarely sumer–provider relationships. A non-cash retail pay- involve usage of a stand-alone payment instrument, ment transaction involves a payer and a payee, both but rather involve using a broader financial product of which are consuming the services offered by their (e.g. a current account), one of the underlying func- payment service provider. In turn, such service provid- tions of which is its usage as a payment instrument. ers might be availing themselves of services from other The financial product would have various levels and service providers. Hence, in the context of retail pay- types of fees. ments, the term consumer is used to mean all consum- ers in all these scenarios. For example, when discuss- Electronic payment instruments used for retail pay- ing card payments, the cardholder and the merchant ments often involve an element of “subscription,” that are both consumers and similarly if the issuer avails is, subscribing to a service which enables a person to itself of services from a payment network then the lat- use a particular payment instrument. For example, to ter is also a consumer. pay using a credit transfer, a payer would need to sign- up for a banking account, or to make payments using a credit card, a customer would need to have signed-up for a credit card. 55 The discussion on pricing is further elaborated under Guideline IV. DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY 35 Box 6: The General Principles for International Remittance Services and Related Roles The General Principles are aimed at the public policy objectives of achieving safe and efficient international remittance services. To this end, the markets for the services should be contestable, transparent, accessible, and sound. Transparency and consumer protection General Principle 1. The market for remittance services should be transparent and have adequate consumer protection. Payment system infrastructure General Principle 2. Improvements to payment system infrastructure that have the potential to increase the efficiency of remittance services should be encouraged. Legal and regulatory environment General Principle 3. Remittance services should be supported by a sound, predictable, nondiscriminatory, and proportionate legal and regulatory framework in relevant jurisdictions. Market structure and competition General Principle 4. Competitive market conditions, including appropriate access to domestic payment infrastructures, should be fostered in the remittance industry. Governance and risk management General Principle 5. Remittance services should be supported by appropriate governance and risk management practices. Roles of remittance service providers and public authorities A. Role of remittance service providers. Remittance service providers should participate actively in the implementation of the General Principles. B. Role of public authorities. Public authorities should evaluate what action to take to achieve the public policy objectives through implementation of the General Principles. In general, it has been observed that consumer protec- Consumer protection attempts to redress those im- tion, transparency and dispute resolution for service balances by giving individuals clear and complete in- arrangements between institutional customers are formation on which to make informed decisions, by typically handled adequately bilaterally as both the en- prohibiting financial institutions from engaging in un- tities are sophisticated and have the necessary skills to fair or deceptive practices, and by providing adequate protect their interests. This, however, is usually not the mechanisms to resolve disputes between individuals case for relationships where either one of the parties is and financial institutions. There are a variety of dis- an individual or small business, as imbalances of in- putes that can arise in the provision of retail payment formation, resources, and power are generally on the services; broadly speaking they can be categorized into: side of financial institutions or other service providers. Section IV. Guidelines for Developing a Comprehensive Strategy for Reforming Retail Payments 36 DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY • Incorrect processing of payment instructions in Issues specific to payment cards terms of the amount or recipient or perhaps even Payment cards are associated with a range of fees that when it was processed; are charged to the cardholder (payer) and to the mer- chant (payee). A card issuer may charge cardhold- • Fraud liability – the liability of customer for ers an annual fee, penalty fees and other transaction fraudulent activities on his account resulting in a specific fees.58 In addition, the merchant is also sub- direct or indirect loss to the customer; and ject to a range of fees by the acquiring bank such as merchant service fees (MSF), account maintenance • Disputes on operational service standards. fees, penalty fees and other transaction-specific fees.59 There are several issues with respect to transparency Consumers who are empowered with information and and consumer protection related to these fees from a basic rights—and who are aware of their rights and re- cardholder’s perspective: sponsibilities—provide an important source of market discipline to the financial sector, encouraging financial • Awareness about these fees; institutions to compete by offering better products and services rather than by taking advantage of poorly in- • Having a good understanding about the scenari- formed consumers. Financial literacy is a complement os in which these fees are charged; to consumer protection, because it helps consumers understand the information and make risk/return • Having adequate assistance and support to avoid choices that optimize their financial wealth. the specific scenarios in which the exceptional fees get charged; Consumer protection also improves governance of financial institutions. By strengthening transparency • Receiving adequate notice of any changes to the in the delivery of financial services and account- fees; and ability of financial firms, consumer protection helps build demand for good governance of the sector and • Changes having no retroactive effect (e.g. in- the strengthening of business standards. In addition, crease in revolving rate not being applicable to consumer protection and financial literacy help pro- balances being carried forward from the past). mote the deepening of the retail financial sector, at- tracting first-time consumers to access financial ser- vices and building public trust in financial institutions. Therefore, consumer protection and financial literacy 58 Annual fees are like a subscription fee to be paid to retain the privilege of us- ing the card. Revolving fees are specific to credit cards and are paid on the balance promote efficiency, transparency, and deepening of carried over (revolved) by the cardholder from a billing cycle to another. This is retail financial markets.56According to PSDG experi- typically a percentage rate and expressed as an Annual Percentage Rate (APR). There are a range of penalty fees associated with cardholders that are typically ence, competition policy alone does not fully address applied on occurrence of specific events such as late payment, short payment, consumer protection issues on its own.57 etc. There is also a range of transaction-specific fees that are typically applied for specific transactions like cash withdrawals, requesting a duplicate copy of a state- ment, or in the case of prepaid cards, charges may be applied for transactions like World Bank Publication 2010 – “Good Practices for Consumer Protection 56 loading money, closing the card account and so forth. and Financial Literacy in Europe and Central Asia: A Diagnostic Tool”. 59 The MSF is the fee paid per transaction by the merchant to the acquiring 57 For additional discussion on this specific issue see Armstrong, “Interactions bank, usually structured as a combination of a fixed fee and a percentage of the between Competition and Consumer Policy”, Competition Policy International, transaction amount. The MSF comprises the interchange fee, which therefore Volume 4, Number 1, 2008. constitutes a floor to the level of the MSF. DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY 37 From a merchant’s perspective, the transparency and In the absence of a confirmation being received, the consumer protection issues are more related to a clear payer would have to use other means such as contact- understanding of when and how the merchant will ing the payee to confirm receipt of payments. get paid for the transaction, the schedule of fees, how EFT debit payments are again deferred payments. The the fees payable are calculated, and the specific proce- payer should receive both a confirmation that an at- dures the merchants needs to follow and the records tempt would be made to collect the payment from his/ he needs to keep to have guaranteed settlement for a her account on a specified date and also the status of transaction. the debit. Erroneous execution, inadequate balance in account due to some other unexpected payout from In addition to the two interactions of cardholder-issu- account and other operational issues could result in er and merchant-acquirer, there are other sets of inter- the payment being unsuccessful. The impact of such actions for payment cards. Transparency and adequate an unsuccessful payment could be beyond the under- consumer protection is important for these interac- lying transaction. tions as well. The most relevant ones are: issuer-ac- quirer, issuer-payment network and acquirer-payment EFT debit payments are often used for recurring pay- network. Given that these interactions are between in- ments. A payer should be able to cancel the general stitutions, the traditional transparency and consumer mandate he has given to the payee to charge his ac- protection issues appear less relevant at a first glance. count. Moreover, whenever there is a discrepancy on However, certain aspects of these interactions have the amount actually debited from the payer’s account, been widely debated and are areas that have seen sev- he should be able to reverse the transaction and get eral regulatory interventions, primarily because these reimbursed even before an investigation is initiated. aspects have been widely believed to influence the fees Ability to easily cancel a recurring payment instruc- for the cardholder-issuer interactions, and the acquir- tion from a designated future date is also an important er-merchant interactions. These aspects are discussed consumer protection feature. in detail in the section on market structure. A payee needs adequate protection for his interest, as Issues specific to EFT-based products well, for unsuccessful payments. In many countries, EFT credit payments by nature are deferred payments; bouncing of a cheque is deemed an offense and there the payer needs to receive a confirmation about receipt are stipulated penalties for the payer. Absence of simi- of the payment request, and confirmation that it will lar protection for ACH debit payments could make be processed as per a defined timeline and if there are them unsuitable for a broad range of payment needs. any problems a notification would be issued. The payer would clearly be in need of information pertaining to: Issues specific to innovative payment when the payee would be paid, the exact amount that mechanisms will get paid to the payee, and finally the process for Prepaid mechanisms, including prepaid cards, have addressing any delays in the processing of this pay- a range of costs associated with them: initial sign-up ment request. fee, account maintenance fee, cash load fee, cash with- drawal fee, balance inquiry fee, and other transaction Increasingly, in many systems the payer has a choice of and event-specific fees, particularly for redemption. receiving the confirmations through various channels. The sign-up process for innovative schemes is often Section IV. Guidelines for Developing a Comprehensive Strategy for Reforming Retail Payments 38 DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY Figure 4: Types of Disputes handled remotely or at locations of an agent of the consumer protections mechanisms applicable to tradi- entity operating the scheme. Ensuring all the details tional payment mechanisms unlikely to apply for the about these fees are communicated clearly to the sub- innovative mechanisms. scriber in this remote channel is critical. Possible Actions Extensive use of agents also brings in the challenge of Creating minimum standards related to transparency ensuring uniform quality, transparency and reliability and consumer protection: These should be applicable of service. to all providers of retail payment services. These stan- dards could be explicitly enforced in the form of a law, The dispute resolution and consumer protection mea- regulation or guideline or where appropriate through sures for many innovative mechanisms might not be an implicit enforcement through self-regulatory mech- formally specified. Traditional payment mechanisms anisms. In some cases, the usage of a service mark to are typically managed by banks, and are in general identify those organizations that are compliant with closely associated with their banking business. Given the standards defined in this area has been an effective this, the consumer protection measures available for strategy to inform consumers in a very practical way. typical banking services get extended to such tradi- tional mechanisms. However, in the case of innova- tive payment mechanisms, the payment mechanisms are often offered by non-banking entities, or when offered by banks they are typically kept separate from their traditional banking business. These make the DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY 39 Figure 5: Dispute Resolution Developing simplified procedures for dispute resolution: the one that meets their needs most effectively. As Ombudsman60 services are becoming increasingly previously discussed, there are many different pricing common for industries like insurance and general elements for a payment product, which could make banking services. Extending these services to payment comparing payment products difficult. However it is services regardless of whether or not the service pro- possible to create some indicators based on standard vider is a bank could provide the consumers an easy, concepts that could enable making some preliminary reliable, and cost-effective mechanism to resolve dis- comparisons. Some of the key indicators include: putes that could not be resolved bilaterally with the service provider. Figures 4 and 5 capture statistics on • Account opening fees; the types of disputes related to retail payment products and prevalent mode of disputes resolution for financial • Account maintenance fees/monthly fees; services. 61 • Per transaction fee paid by payer/payee; Encourage creation of databases to enable easy compari- son of costs: Having access to reliable, comparable, and • Account inquiry fees; consumer-friendly information about the various pay- ment products enables the payers and payees to choose • Account closing fees; and • Interest rate charged and method of computa- 60 For a detailed discussion on banking ombudsman see Thomas and Frizon tion, where credit is provided. 2012.), Resolving disputes between consumers and financial businesses: Funda- mentals for a financial ombudsman, January 2012 61 Source: Financial Access CGAP and World Bank 2010. Section IV. Guidelines for Developing a Comprehensive Strategy for Reforming Retail Payments 40 DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY Box 7: The World Bank Remittance Prices Worldwide Database The World Bank Group’s Financial Sector Strategy of March 2007 set as a goal the reduction of remittance costs, and called for the creation of a remittance prices database. The World Bank launched the remittance prices database in March 2008 – remittancepric- es.worldbank.org. It has been continually upgraded, and is updated every six months; the most recent update was done in October 2011. Currently, the database covers 219 “country corridors” worldwide. The corridors studied comprise 32 major remittance sending countries to 89 receiving countries, representing more than 60 percent of total remittances to developing countries. In most cases, data was captured from the main sending location/area to the capital city or most populous city in the receiving market. Methodology and Data Collection: In the remittances market, in particular, the total cost might not always be clear to customers as there are a number of variables that go into it: the transaction fee, the exchange rate applied and the margin eventually charged, and the speed of the service, among others. Researchers posed as customers and contacted individual firms to collect within each corridor. Data was obtained within each corridor on the same day, in order to control for fluctuations in exchange rates and other changes in fee structures. It should be noted that data in this database is intended to serve as a snapshot of a moment in time, and that pricing may vary over time. The following data is collected from 8-10 major service providers in each corridor including both the primary Money Transfer Operator (MTO) and Banks active in the market, for standard remittance amounts of US$ 200 and US$ 500. Transfer fee: This is the most visible cost component, and can differ significantly among market players. This fee usually represents the charge the sender pays at the initiation point, and usually varies with the amount sent, within set bands. In some cases, there may be fees and taxes charged at the destination that have not been detected in this database. Exchange Rate Fee: An important portion of the remittance cost is the exchange rate spread, which is generally not quoted in the transfer fee. Even though in some receiving countries remittances can be paid in the same currency of the sending country, the major- ity of remittance transactions are paid in local currencies, and, thus, an exchange operation is required. Product: The survey covered mainly cash-to-cash transactions. For some RSPs different products were surveyed. Speed of transfer: The speed of transfer is the time needed for the remittance to be available for the receiver. Network coverage: The following categories are used to describe RSP coverage: nationwide, urban only, rural only, main city, and major cities. DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY 41 The World Bank has developed a price database for in- tions to electronic funds transfers that can be initiated ternational remittances (see Box 7). Some of the key through a variety of channels. Providing such services concepts underlying this price database may be used efficiently requires an appropriate infrastructure of for other retail payments as well.62 access points and for transaction processing. These include payment card switches to enable online au- Develop initiatives to foster consumer education and thorization of card payments, a sufficient number of awareness. The success of the actions mentioned above POS terminals to initiate card payments, or an ACH is based on a certain minimum level of consumer to process EFT-based products efficiently and within awareness. Initiatives to improve consumer awareness standardized service levels, among others. Absence of through education campaigns are therefore critical. such infrastructure components severely hinders the These initiatives should be developed in a format that system from exploiting the potential benefits of mod- is appropriate to the socio-economic context and lit- ern payment instruments. For example, credit card eracy levels of the target populations. payments being manually authorized and manually processed thereafter are not very much different in ef- ficiency terms from paper-based instruments. GUIDELINE II: Retail payments require reliable underlying financial, The provision of safe and efficient retail payment ser- communications and other types vices also relies to an important extent on there being of infrastructure. appropriate clearing and settlement arrangements. A centralized inter-bank clearing and settlement system These infrastructures should be put in place to increase enables the entities providing the payment services to the efficiency of retail payments. These infrastructures focus on their particular transaction authorization ser- include inter-bank electronic funds transfer systems, vices, account management services, and operational inter-bank card payment platforms, credit reporting responsibilities in the payment clearing and settlement systems, data sharing platforms, large-value inter- networks. bank gross settlement systems, a reliable communi- cations infrastructure, and a national identification A safe and reliable clearing and settlement mecha- infrastructure. nism is based on a robust infrastructure as well as on a sound and clear set of rules and procedures for sort- Description ing and exchanging information pertinent to the in- dividual payments and participants involved, and for As earlier discussed, an effective national retail pay- transferring the funds related to these payment trans- ments system should be able to provide users with an actions. In this last regard, a crucial element is a system adequate mix of payment instruments and services to for final settlement with appropriate risk management satisfy a wide variety of payment needs, ranging from mechanisms. Typically, time-critical payments such card payments that can be initiated at merchant loca- as those associated with financial market transactions settle in a system that guarantees finality and has ap- 62 Some central banks have already developed price databases for domestic retail propriate risk management mechanisms to address payment services. See for example Banco de Mexico’s database on maximum fees credit risk and liquidity risks of participants. Very of- and surcharges for payment services as determined by service providers, and the ten, real-time gross settlement (RTGS) systems serve calculator for current account fees, available at www.banxico.org.mx/sistemas-de- pago/sistemas-pago-servicios.html. this function. RTGS systems typically settle transac- Section IV. Guidelines for Developing a Comprehensive Strategy for Reforming Retail Payments 42 DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY tions in central bank money and there are defined risk critical prerequisite for the effective functioning of all management mechanisms like queuing, liquidity op- the various systems supporting and underlying retail timization, and liquidity injection through repos. By payment services. settling the final positions of retail system participants (i.e. usually net positions stemming from the clearing It must be noted that, in order to benefit from the in- cycle) in an RTGS system, retail systems also benefit frastructure components discussed in this section, from RTGS arrangements.63 the participating institutions themselves need to have certain basic systems for their internal operation. Provision of credit cards and other credit services like Financial institutions and other institutions that offer overdraft on debit cards and current accounts, and also payment services need to have automated and central- for merchant acquiring for payment cards involves a ized account management infrastructure, in order to credit decision process by the issuer. The lack of an support electronic payment mechanisms. Electronic effective industry-wide credit reporting system ham- payments involve electronic transmission of the pay- pers an institutions ability to take a view of the credit ment instruction between the payer and his financial risk associated with the applicant. This could result in institution, between the payer’s financial institution denial of the service itself. This is particularly impor- and payee’s financial institution, and finally between tant for enhancing usage of payment services by Small payee and his financial institution. Since these ex- and Medium Enterprises (SME). Studies have shown changes of instructions happen in real-time or near that access to finance is higher in countries with credit real-time, the financial institutions would need an reporting systems.64 The flow of information of pay- automated centralized customer account manage- ment services usage to credit reporting systems could ment system for processing these, because a decen- also enhance the information available for credit deci- tralized system would require additional steps, which sion process. would be inefficient, and if the operations are manual, impossible. A payer or payee wanting to avail non-cash based payment services, needs to have a formal relation- It should be noted that these infrastructures are listed ship with an institution providing payment services. as an illustration of the typical infrastructure compo- Increasingly, because of money laundering and ter- nents that underpin provision of electronic retail pay- rorism financing concerns, the institutions providing ment instruments. These need not be standalone sys- payment services require a robust identity-verification tems: there are successful examples of some of these mechanism. components being integrated into one system for (e.g.) the large-value inter-bank gross settlement system and All the aforementioned systems and infrastructure in- the inter-bank electronic funds transfer system intend- terconnect multiple parties requiring a fast response ed for retail-type payment transactions have been inte- to their requests or enquiries. Therefore, a robust tele- grated into one platform in many countries. In fact the communications infrastructure in the country is a World Bank has actively advocated for such an integra- tion to build efficiencies especially in countries where there are no existing electronic systems of that type.65 63 The World Bank Global Payments System survey 2010 showed that 86 percent of ACH systems worldwide were using an RTGS system for their final settlements. The equivalent figure for payment card switches was 54 percent. 64 The World Bank Group 2009. 65 Such a system is normally referred to as an “Automated Transfer System” (ATS) by the World Bank DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY 43 Possible Actions Collaborate with industry players to speed-up the imple- Develop an implementation plan to deploy the required mentation of innovative mechanisms that may help in industry level infrastructure components, anchored in addressing infrastructural gaps: Authorities should use an overall payment system development plan: This has all mechanisms available to promote, in coordination been found to be very successful in addressing the in- with industry participants, the sound expansion of frastructural shortcomings in a rapid manner. Retail access points to electronic payment instruments and payments infrastructure development is a complex services. Authorities should also analyze whether there task typically involving a high degree of collaboration is a business case for developing some basic infrastruc- between various institutions that often are also direct ture (e.g. telecommunications network) to be used col- competitors in the provision of payment services. lectively by small service providers to offer electronic Therefore, infrastructure development needs to be payment services, and also link up their service outlets a well-deliberated and collaborative exercise involv- to provide a virtual large service delivery network.67 ing detailed analysis of the needs, the usage patterns, In some cases authorities may also consider creating pricing levels, risk management, governance arrange- suitable incentives (e.g. some tax incentives) to pro- ments, ongoing enhancements, and evaluation of po- mote private sector investment in infrastructure for tential to reuse and build on existing infrastructure. retail payments. Promote the adoption of common technical and usage standards for payment services to facilitate interoper- GUIDELINE III: Retail payments should ability and thereby widespread adoption of electronic be supported by a sound, predictable, payment instruments: Common technical standards non-discriminatory, and proportionate are a basic requirement for developing interoperable legal and regulatory framework. platforms. Interoperability improves overall efficiency (e.g. by enabling straight-through processing) and in- Description creases convenience to users. Lack of common stan- dards is likely to result in each payment service pro- Payers and payees need to be confident that their inter- vider needing to create its own proprietary systems, ests are protected when a particular payment instru- procedures, and in many cases enter into specific busi- ment is being used for settling their mutual payment ness alignments with payees and payers.66 obligation. These interests include receipt of actual funds as per agreed timelines, protection from opera- tional errors/fraud, and that only the agreed-upon cost is charged. The intermediaries and service providers also need a clear and predictable legal environment, wherein they are clear about their obligations and also In a retail payment system there are multiple levels of standards: (i) customer how any disputes that arise would be settled. 66 to financial institution; (ii) interbank standards; and, (iii) financial institution to customer standards. There have been multiple developments in the area of interbank standards like ISO20022, ISO 8583, etc. focusing on data formats for transaction processing. In addition, there have been standards focused on specific areas like authentication – 3D Secure for e-commerce card transactions, EMV for chip cards; data security – Payment Card Industry Data Security Standards (PCI DSS); and, account numbering – IBAN. There are also standards for specific prod- 67 A good example of this is the establishment of “LA RED DE LA GENTE” by ucts like SEPA credit and debit transfers, and standards for specific card products creating a common infrastructure of credit co-operatives and establishment of a by Visa, MasterCard, and American Express. fund “FIMPE” for rapidly expanding POS terminals. Section IV. Guidelines for Developing a Comprehensive Strategy for Reforming Retail Payments 44 DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY The legal and regulatory environment includes laws, • Adopting a regulatory framework that is propor- regulations issued by the central bank or other regula- tionate to the nature, scale, and risk profile of the tory bodies, and the set of rules, standards, and pro- various types of payment service providers. cedures agreed upon by the participants of a payment system and between providers of payment instruments • Creation of an enabling environment for innova- and services and their subscribers. tion, including provisions guarding against anti- competitive practices and ensuring consumer Increasingly, laws with specific applicability to pay- protection. ment and settlement systems are being developed—as opposite to laws of general applicability to all relevant While laws are normally the appropriate means to en- sectors of the economy—to address in a more precise force a general objective in the payments field, in some way the specificities and particularities of payment sys- cases regulation by the overseers might be an efficient tems and services. Some of the most relevant legal pro- way to react to a rapidly changing environment. In visions supporting a well-functioning retail payments other cases, for example for detailed operational issues market include: and scenarios, specific agreements among participants might be adequate. In this case, an appropriate pro- • Recognition of electronic payments as valid fessional assessment of the enforceability of these ar- means of payments, including the responsibili- rangements is usually required. ties and rights of the parties involved. Possible Actions • Acceptance of digital signatures, digital re- Determine the existing gaps with regard to the legal and cords, and digital exchange of payment instruc- regulatory framework and blend tactical measures with tions as equivalent to their physical equivalents. full-fledged reforms. This should be a cooperative ef- Likewise, recognizing frauds made with or fort between the central banks, other authorities, and through these elements as crimes and typifying market participants to ensure all views and different them. expertise are taken into account. Moreover, it should not be a one-time effort but rather a recurrent one to • Finality of the settlement of positions stem- ensure that the legal and regulatory framework keeps ming from clearinghouses and other clearing pace with new developments. mechanisms. In cases where most of the key provisions do not ex- • A designated authority, usually the central bank, ist at the law level, consider developing an overarching vested with oversight powers. law (i.e. a “Payment Systems Law”) that addresses as many such issues as possible. In some situations adopt- • Recognition of payments as a business service ing new laws could be time-consuming which could that has a number of functions that can be reg- delay developments and implementation of new prod- ulated and overseen separately from some of ucts or systems that are critical for the achievement the other traditional banking functions such as of public policy objectives. In such situations certain lending or deposit-taking. tactical measures which keep in mind the overall legal reforms framework in mind could be adopted. Such measures could include issuing regulations, develop- DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY 45 ing guidelines and also entering into memorandums Environmental, legal and legacy issues of understanding and agreements with system partici- The market for retail payments services is character- pants and payment service providers. ized by: The law should vest the central bank with adequate • Economies of scale in messaging, clearing, and powers to regulate and oversee retail payments: This settlement services due to the fixed costs of the empowerment should be broad enough to allow the infrastructure; central bank to issue regulations and guidelines to rapidly react to specific situations without necessarily • Economies of scope in clearing and settlement as having to amend laws. Moreover, it should allow the well as in messaging services due to technology central bank to propose new regulations and other flexibility; and, types of measures in areas that are not directly under its jurisdiction. • Network externalities in messaging, clearing, and settlement services produced by complementar- The central bank should ensure that payment system op- ities of users and/or products and compatibility erators and payment service providers develop a sound of products. set of system rules and procedures, and that these be re- vised periodically for any required updating. These characteristics have resulted in natural monopo- ly features that cause a high concentration of payment platforms, sometimes due to vertical or horizontal in- GUIDELINE IV: Competitive market tegration in financial infrastructures.69 Whether this conditions should be fostered in is a positive or negative result is unclear—there is not the retail payments industry, with a definitive answer. Effective cooperation may exploit an appropriate balance between economies of scale and scope and network externali- cooperation and competition. ties in a cost-efficient way, and is likewise crucial for setting standards that will secure compatibility be- Description tween the various products. However, centrally agreed upon common features can sometimes hamper prod- The following key issues need to be analyzed in detail uct and/or service differentiation and innovation at the to determine whether any given market for retail individual service provider level. payments operates under competitive conditions:68 Retail payment markets are also influenced by a num- ber of dynamics. Some of these are specific to the end users, some are specific to the platforms (networks), and some depend on the intermediaries: • Switching Costs—at the platform level (for plat- form participants), at the cross-product level 68 This discussion is based on the analysis presented in World Bank document “Balancing Cooperation and Competition in Retail Payment Systems: Lesson 69 See Bustos and Galetovic, U of Chile, 2003, Tapking and Yang, ECB, 2004 and from Latin America Case Studies”, Washington, 2008(a). Lai, Chande and O’Connor, Bank of Canada, 2006. Section IV. Guidelines for Developing a Comprehensive Strategy for Reforming Retail Payments 46 DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY (among payment instruments) and within the erator of one or more retail payments infrastructures.70 same type of product. Switching costs may pre- Under certain circumstances, for example inadequate vent the adoption of better technologies and so- pricing or overly restrictive criteria for participation in cial optimization. the system, such public ownership of retail payments infrastructure may skew the pricing signals and mar- • Path Dependence as the legacy of previous tech- ket structure. nology developments, often determined by transient conditions, does typically influence The legal and regulatory environment may also es- later choices and outcomes, thus, restricting tablish barriers to competition. For example, in some investment decisions that may negatively af- countries the legal framework directly prohibits non- fect innovation and adoption of more efficient banking entities from providing any type of retail technologies. payment services, even those not directly linked to a bank current account. In other cases, a similar effect • Tipping points as there is a tendency for one is achieved through regulations that limit the provi- system to end up as the dominant one (pay- sion of central bank account services to banks. In such ment card systems are an exception). Since the situations, if a retail system settles its final positions in network externalities dictate higher utility for central bank money, then direct participation in that each participant by adding more participants, system by non-banks may not be feasible in practice. the participants’ individual and group utility can be raised if everybody participates in one single Access to the relevant infrastructure and network, and if there are no significant capacity limitations to interoperability limitations that can give rise to serious conges- Gaining access to messaging, clearing, and settlement tion effects. services is of capital importance for the ultimate suc- cess of new entrants in the market. In the absence of • Multihoming and stickiness. In most cases, both appropriate governance arrangements, participants sides in a payments market use several platforms, with a dominant position in a payments infrastructure i.e. they multihome. Consumers have more than may establish strategic barriers to prevent new en- one type of payment instrument, and merchants trants to the system.71 These barriers could be explicit accept several types of instruments. This multi- or implicit in terms of higher pricing terms and access homing also takes place within one type of in- requirements.72 strument (e.g., credit cards). Often, however, the consumers favor one card over another, i.e. their Players with a dominant position in an infrastructure usage is sticky. can alternatively block access to it for the customers Public ownership of retail payments infrastructure is 70 The Global Payment Systems 2010 showed that 51 percent of check clearing another factor that may impact competition. In re- houses and 40 percent of ACH’s were operated by the respective national central sponse to coordination problems or due to legacy bank. Also, around 20 percent of the payment card switches were either operated by the central bank or other governmental bodies. reasons, the central bank may be the owner and op- 71 Guideline V deals with governance issues for retail payment systems. 72 On the other hand, as earlier discussed, the operator of the payment infra- structure often establishes an access policy to ensure adherence to specific rules and also as a risk management measure to ensure overall safety and stability of the infrastructure being operated. DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY 47 of other issuers of the same payment instrument. This promoting competition and also enabling economies situation is known as lack of cross-platform interop- of scale. In general, lack of interoperability could foster erability, and is an important element that hinders anti-competitive practices. However in the case of in- greater competition and efficiency in the marketplace novative payment mechanisms, when and how to im- by impeding lowering of processing costs, duplication pose interoperability is a significant policy issue. of infrastructure, and service providers focusing on competing through larger investments in infrastruc- In the context of retail payment, there could be mul- ture rather than by offering better products and ser- tiple levels of interoperability—system-wide, cross- vices to their customers. While lack of cross-platform system, and infrastructure-level. A system that has interoperability is usually associated with some pay- only system-wide interoperability enables competition ment card systems, it can also be observed for EFT- among the participants of that system, a system that based products, for example co-existence of two or has cross-system interoperability enables competition more ACHs for the same payment instruments that of- between systems; a system that has infrastructure-level fer the same or very similar services to their respective interoperability enables the same infrastructure to be participants.73 used to support multiple payment mechanisms there- by also supporting competition between payment in- There is also the case of infrastructure-level interoper- struments. For example, an acquirer who has deployed ability, whereby the same infrastructure can be used an infrastructure for accepting Visa cards must process to support multiple payment mechanisms. This is all Visa cards (system-wide), and can also addition- especially relevant for innovative payment products, ally use significant components of the infrastructure since without some basic interoperability with more to process transactions of competing payment card traditional payment instruments and systems their brands like MasterCard (infrastructure-level), and also acceptance and/or usefulness for consumers might be Visa and MasterCard networks allow routing of trans- very limited.74 actions among themselves; however an acquirer that is not a member of MasterCard cannot accept a Visa However, in the case of innovative payment products, branded payment card, even though his infrastructure requiring cross-platform interoperability when the in- can support it, (i.e.) no cross-system interoperability. A dividual platforms are not that well developed could bank-operated proprietary payment infrastructure is be onerous. not inter-operable on any of these dimensions. A sys- tem that is inter-operable on all levels would enable an Broadly speaking, an interoperable payments system entity deploying acceptance infrastructure for a par- enables the seamless participation of two or more ticular payment instrument to be confident that cus- proprietary acceptance and processing platforms, and tomers with that payment instrument—irrespective of possibly even of different payment products, thereby their banking/partner affiliation—would be able to use the infrastructure, thereby creating a stronger business 73 In the Global Payment Systems Survey 2010, only 57 percent of the central case for the entity. This would enable the entities in- banks reported that the payment cards system in their country was fully interop- volved in the payment system to compete on quality of erable for ATM transactions, and an even lower number of 45 percent for POS transactions. services, while collaborating in terms of creation and 74 For the Global Payment Systems Survey 2010, 61 percent of the innovative operation of the underlying system. products/product groups reported were proprietary with no interoperability, and only 30 percent had some form of linkage with traditional retail payment instru- ments and systems. Section IV. Guidelines for Developing a Comprehensive Strategy for Reforming Retail Payments 48 DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY There have been arguments that the requirement for at the various payment card infrastructures available interoperability could impact innovation and be too domestically or even internationally. In the context of onerous a requirement for new innovative payment innovative retail payment products, interoperability products. For example, if a bank develops a new inno- is not that straightforward as it could mean not just vative mobile payment service, it might need to invest interoperability in the context of the same payment in- significant amounts in developing an acceptance net- strument but also with other payment instruments, ei- work. To protect its investment the bank might want ther traditional or innovative or both. For example, for to lock in these merchants in an exclusive arrangement a mobile money product interoperability could mean for a long period of time. If this is not allowed, the bank one or more of the following: ability of the customers might not find it viable to make the first move in pro- of one mobile money issuer to use the product to make moting this product, and would wait for an industry- purchases at institutions not directly affiliated with his wide collaborative exercise to take effect. While this is issuer; ability of the customers of one mobile money a persuasive argument, it needs to be borne in mind issuer to use the product to perform transactions like that if the innovation is truly novel, the entity could cash withdrawal at institutions not directly affiliated always seek protection of its interests through seek- with his issuer, either at POS terminals or other accep- ing a patent. That approach with the built-in protec- tance infrastructure like perhaps the merchants mobile tion for ensuring optimal social benefit of innovations phone; and ability of the customer to top-up and trans- would, perhaps, be better than relying on setting up fer the balance in his mobile money account from/to barriers using exclusive arrangements and other busi- various types of accounts, including, for example, an- ness arrangements. other mobile money account operated by another tele- com provider or a traditional bank account.75 Requiring cross-system interoperability when the in- dividual systems are not that well developed could Innovative retail payment mechanisms in general are indeed be onerous, and where the systems are inde- at least initially structured as proprietary solutions, pendently managed with different membership rules typically because they are new developments for which requiring cross-system interoperability might be there are no agreed-upon standards in the domestic unviable. One approach to achieve a significant de- context, though at times it could also be because of an gree of interoperability could be to require, at a mini- attempt to block competition, for example by requiring mum, system-wide and infrastructure level interop- exclusivity from agents. erability, and to make cross-system interoperability necessary for systems that cross a particular scale of Pricing of payment systems infrastructure operations; and also require fair, transparent, and non- services discriminatory membership criteria to promote cross- Pricing and fee patterns for accessing the infrastruc- membership. A sizeable cross-membership com- ture supporting retail payments have an impact on the bined with system-wide and infrastructure level in- teroperability would enable achievement of de-facto cross-system interoperability. 75 There could be other aspects, such as the ability of the mobile money cus- tomer to seamlessly migrate his mobile money account when he changes his In general, when interoperability is discussed, it is in mobile number or when he switches to another mobile phone company. But these aspects should not be confused with interoperability, as they actually refer the context of similar payment instruments, for ex- to the “portability” of access devices and account identifiers. This is akin to bank ample the payment card of one issuer being usable account portability. DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY 49 industry structure and competition. The pricing struc- discourage innovation in technology and services by ture for accessing a retail payments system is often a affecting the pattern and rate of accumulation of sys- complex structure involving: tem development funds.76 • Joining fees—often determined based on size of As previously discussed, public ownership of retail the participant, projected transaction volumes, payments infrastructure may skew the pricing signals, membership type (e.g. direct or indirect), and and as a result affect market structure and competition. other similar factors.; For example, the pricing structure may reflect a lack of urgency to recoup the investment costs and generate • Membership fees—often collected periodically adequate returns. This could hamper both innovation based on transaction volumes and other non- and infrastructure modernization, as well as become usage based parameters; unfair competition for other similar infrastructures owned by the private sector. • Per-transaction fees—typically collected more frequently and directly linked to usage levels, However, it needs to be noted that even with public with tiered pricing in many systems; ownership the pricing structure can be set in a way that it does not impact competitiveness of private • Contributions to various funds like settlement ventures.77 guarantee funds, marketing funds and so forth; and, It should however be borne in mind that pricing mod- els in payment services, as in many other industries, • Exception fees—linked to occurrence of certain need not necessarily be cost-based pricing. Use of elec- events such as, for example, settlement delays, tronic payments brings about a range of benefits to termination of membership, and other similar various stakeholders: events. • Payee: benefits range from reduced operational This complex structure of fees is typically set to arrive expenses to increase in sales arising from cus- at an equitable sharing of investment costs and propor- tomers not being limited by the cash in their per- tional allocation of marginal costs, with an inbuilt rev- son and in the case of credit cards even enhanc- enue generation. The complexity of the fee structure ing the payers ability to pay; can have a series of effects on network participation and development; it can for example: even out average • Payers: more convenience; participation costs between small-volume and large- volume participants, and thus encourage more direct There are also positive effects to non-linear pricing schemes in network 76 industries. See Rochet and others such as Chakavarti on (two-sided) network participation; enable the incumbents to misuse pricing pricing. Also unpublished memos by McAndrews (Federal Reserve Bank of New structures to discourage new entrants; and support or York), Angelini (Banca d’Italia), Green (Pennsylvania State University), O’Connor (Bank of Canada). 77 In the United States, for example, the Reserve Banks operating ACHs follow a pricing policy that requires them to ensure full recovery of all costs and inclu- sion of a private sector adjustment factor to reflect the cost structure of a private operator. This enables the three private sector ACHs to compete with the ACH services provided by the Reserve banks. For additional information see Oliver and Weiner 2009. Section IV. Guidelines for Developing a Comprehensive Strategy for Reforming Retail Payments 50 DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY • Issuers of payment instruments: lower operation- channel through which the transaction is being con- al expenses; and ducted, whether the transaction is domestic or inter- national, the authentication mechanism78 used, and in • Government: operational efficiencies through some cases the amount of transaction. Interchange fees automated funds, accounting and records man- are typically set by the payment network, and enforced agement systems and also increased financial uniformly for all similar type of transactions processed intermediation. through that network. Interchange fees are, in general, meant to balance the interests of the parties involved Each of these stakeholders also experience a particular in a transaction: merchants, acquirer, issuer, and card- set of constraints and legacy inertia factors that im- holder, and to create the right incentives for the parties pact adoption of electronic payments. This gives rise to to maximize the volume and value of transactions pro- various pricing models designed to build in incentives cessed through the payment network. The level of the to increase adoption of electronic payments, some of interchange fee is very relevant because, among other which do not necessarily result in exact apportionment aspects, it sets a floor for the fees charged by card ac- of costs incurred. One such model is that involving in- quirers to merchants (i.e. merchant service fee). If the terchange fees in card payments. In any case, the en- merchants feel that the processing costs are too high, tities involved in the electronic payments value chain possibly because of the higher interchange fees, then should be able to operate in a commercially viable the number of card acceptance points will not develop manner, failing which their capacity to continually in- as fast as it would be desirable. Conversely, if the inter- vest in and their incentive to innovate would be im- change fees were too low, then the issuers would need pacted. At the same time, the users of electronic pay- to suitably adjust the fees charged and incentives pro- ment instruments need to be better off with using the vided to cardholders. electronic payment instrument instead of cash. The so-called Honor All Cards (HAC) rule enforced by Payment cards specific topics most payment networks typically requires the acquir- The pricing structure and specific program rules in ers to ensure that their merchants accept all the cards card payments have for long been argued to be anti- affiliated with the payment network. The affiliation of competitive. The divergent views emerging from the a card to a payment network is typically visually rep- current research on these specific issues is presented resented by a logo of the payment network placed on below. Some regulators have already taken specific in- the face or obverse of a card. In some jurisdictions, terventions in this area. The impact of some of these a distinction is made between accepting all types of actions has been studied but needs to be interpreted cards affiliated with a payment network and all cards in the specific context of that country and it is not yet of a particular type affiliated with the payment net- clear whether some universal policy actions emerge work, irrespective of the issuer. This rule very clearly from the prevalent research. enables greater utilization of the payment network by Interchange fees are arguably the most discussed of For example, interchange fees for ATM transactions are typically paid by the these aspects. Interchange fees are payments between 78 issuer to the acquirer and is a fixed amount irrespective of the amount of with- issuers and acquirers. Their direction and amount is drawal; interchange fees for transactions at merchants are paid by the acquirer to typically a function of the type of transaction, type of the issuer and is usually a percentage of the transaction amount; interchange fee for Internet transactions are higher than interchange for point of sale transactions; card being used, type of merchant accepting the card, interchange fees for transactions authenticated using PIN are lower than transac- tions conducted without PIN, and so forth. DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY 51 Box 8: Durbin Amendment – The Dodd-Frank Wall Street Reform and Consumer Protection Act The Durbin amendment, as it is called, targeted all the three areas—HAC, NSP and interchange fees rules —in the United States market. Some of the most relevant provisions are the following: 1. The Federal Reserve is to ensure that the interchange fees for debit cards be “reasonable and proportional.” 2. The debit cards and prepaid cards used for Government benefit programs and also debit cards issued by banks with assets lower than $10 billion are exempt from the interchange fee limitations. 3. The Act allows merchants to offer discounts for payments for specific cards, cash, or other forms of payments, provided there is no discrimination by issuer or brand. 4. The Act allows merchants to set a floor of below US$10, under which credit cards acceptance can be denied. 5. The Act allows merchants to route transactions over a payment network of their choice, by requiring the payment networks to not impose specific routing requirement. 6. The issuers are required to be affiliated with at-least two card processing networks to allow the merchant a choice of network routing. Note: Further details are available at the Federal Reserve Board’s website: www.federalreserve.gov. enabling introduction of new types of cards. However, They argue that, taken together, this troika of rules there are drawbacks to this rule, which are discussed forces the merchant to accept all payment instruments subsequently. at par, and either absorb the extra costs or pass them on equally to all payers in the economy, amounting to The No Surcharge Policy (NSP) is another of the con- a cross-subsidy for payers using payment cards and tentious aspects. This rule typically enforced by pay- place the merchant at a disadvantageous position. ment networks requires the acquirer to ensure that the merchant does not surcharge, (i.e. add an additional The contentiousness of the HAC and NSP rules stems fee) for payments made with a card.79 from the merchants’ reluctance to accept certain types Merchants, merchant associations and lobbyists have of cards, typically those that bear higher interchange long argued that the combination of interchange fees, fees, which is believed to directly reflect in a higher the HAC rule and the NSR rule is anti-competitive. merchant service fee charged by the acquirer to the merchant. The HAC and NSP rules force the merchant to absorb the higher costs, as these rules require them 79 In some jurisdiction, for example in the United States, merchants are however allowed by law to offer a discount for cash payments. Section IV. Guidelines for Developing a Comprehensive Strategy for Reforming Retail Payments 52 DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY Box 9: The Welllink Report In April 2001, in the context of the public debate about tariffs charged for the use of payment instruments and the way the payment infrastructure in the Netherlands functioned, the Minister of Finance asked the President of the Nederlandsche Bank (central bank of the Netherlands) to lead an investigation into tariff structures and infrastructure in retail non-cash payments for individual and business users. A working group was established chaired by the President of the Nederlandsche Bank and including the chairmen of the boards of seven banks, the president of Interpay and the chairman and the director of the Dutch Bankers’ Association. At that moment Interpay played an important part in processing electronic POS payments. First, as the agent responsible for transporting the information required for authorization of each transaction by the banks. Secondly, it managed the EFT-POS terminal network. The network linked retailers’ terminals to the banks’ computers, allowing every card holder to pay at any terminal. The network then linked 165,000 EFT-POS terminals, servicing the 20 million debit cards. And thirdly, Interpay also did the clearing of interbank positions resulting from electronic payments; it provided payment information to the banks and was responsible for submitting the settlement instructions to the Nederlandsche Bank, which effected the final settlements. As a provider of network and transportation services for the authorization of debit card payments, Interpay took up a key position in processing electronic payments. Whereas Interpay competed with other banks and nonbanks, such as credit card companies, in many of its activities, it was the sole provider of the network and transportation services mentioned above in the Dutch payments market. The fact that Interpay was the single acquirer who contracted with business users had been the subject of debate. Retailers’ criticism of the tariffs charged by Interpay and of its authority to set EFTPOS terminal specifications had been especially severe. In order to achieve further efficiency improvements in payment systems it would, in the opinion of the central bank, be desirable to stimulate market forces. In this context, it has recommended: (i) the introduction by the banks of the possibility for private customers to choose between different tariff structures; (ii) continued research into the public efficiency of POS payment instruments as a basis for policy aiming at optimum efficiency in the retail payment market; (iii) the creation of a ‘consulting group on payment services’ as a discussion platform to reach agreement on changes in the payments market and for the structured collection and analysis of information on payments and payment systems; (iv) contracting for corporate debit card services, including networking services, to the banks; (v) the creation within Interpay of a users’ advisory group on the use of debit and prepaid cards; (vi) improving the transparency of Interpay by having it provide more detailed information in its external reports; (vii) the inclusion in Interpay’s Supervisory Board of independent experts in order to improve corporate governance. This report was accepted by the Government and all the recommendations were implemented. Interpay now does not contract acquiring services with merchants. Note: Adapted from “Tariff Structures and infrastructure in Dutch Retail Payment Systems” - De Nederlandsche Bank, Quarterly bulletin June 2002. DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY 53 to accept all cards and not dis-incentivize usage of spe- sively on one of these three aspects, though in some cific cards by giving a discount for payment with an- recent cases all three aspects have been focused upon other card or another form of payment. together (see Box 8).82 Some researchers have also argued that the HAC and In countries with underdeveloped payment cards mar- NSP rules result in obfuscating the price signals and kets, the HAC and NSP rules could in particular play a help in promoting payment behaviors which ben- positive role and help in creating an enabling environ- efit only issuers of payment cards and card networks ment for faster introduction and adoption of payment and thereby artificially boost the growth of particular cards and innovations. payment products at the cost of more efficient ones.80 They argue that the dismantling of HAC and NSP rules Another aspect related to competition in relation to would therefore allow the merchants to provide the payment card systems is the way underlying payment right pricing signals related to the processing costs of card infrastructure is setup. A payment card network the payment instrument and thereby encourage a shift is generally established as a four-party model83 in the to more efficient payment instruments and lower in- sense that there are parties involved in a payment card terchange payment cards like debit cards or even spe- transaction – cardholder, issuer, acquirer and mer- cific types of debit cards. chant. In these models the payment card network does not issue cards or acquire merchants and there is a It is however unclear whether the merchants would competition in the provision of cards to card-holders necessarily reflect the processing costs correctly in the and merchant services to merchants. However there surcharges. Card networks, issuers, and other entities are so-called three-party models84 and the parties in- argue that the merchants might not necessarily set the volved are: (i) cardholder, payment card company, surcharges on a cost-recovery basis, and could in fact merchant. In these models, the payment card com- profit from surcharges. There is insufficient research to pany issues cards and acts as the acquirer. There are show how surcharges behave in the long-term. Also, variants of these two schemes, a notable variation of given the large number of merchants, it could be diffi- four-party model is where the card network functions cult to enforce and monitor the surcharge levels. In ad- also as an acquirer however does not issue cards. In dition, these rules provide the ability for card payment situations where four-party and three-party models networks to introduce new products in a more efficient co-exist or there are multiple such arrangements in a way thereby supporting innovation. country, it can be argued that competition is not im- pacted. However in situations where the three-party The regulatory action thus far, has been widely diver- model is the only card network in the country for do- gent and has been guided by different public policy mestic transactions or variants where a lone card net- goals.81 Some of the actions have been focused exclu- work also functions as the lone acquirer in the market there could be competition concerns, the experience 82 The Australian experience with reforms on HAC, NSP and interchange fees rules is also presented in Annex 4. 83 Examples of this include Visa, MasterCard and also many domestic card payment networks. 80 Leinonen 2009. 84 Examples of this model include American Express and Discover. The card 81 For a snapshot of all the recent regulatory actions and a scan of the research company could issue cards or function as an acquirer also through franchisee on these topics, refer to Chakravorti 2009 and The World Bank 2008(a). arrangements. Section IV. Guidelines for Developing a Comprehensive Strategy for Reforming Retail Payments 54 DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY of the Netherlands is presented in Box 9. In the World ers as well as by the different—and sometimes over- Bank Global Payment Systems Survey 2010, operators lapping—scope of their mandates. An ex ante and of 52 switches in 35 countries also functioned as an transparent determination of policy objectives clarifies acquirer. Including in developed payment card mar- different actors’ roles and avoids mistrust in the devel- kets like Brazil, Hong Kong, Singapore and Belgium. opment and operation of the infrastructure. This is es- pecially important if the public sector is one of the in- EFT products specific topics frastructure providers. Interventions should be closely Interchange as an issue applies to EFT-based products related to the public policy objective(s) being pursued as well. However, it has not been that controversial and upon evidence of perceived market failure. For ex- since the interchange fees involved are smaller, and ample, in the presence of a sufficient number of ser- also they do not involve external entities like mer- vice providers and lack of interoperability, efficiency chants. However, interchange fees have been found to might be a primary objective to be pursued. On the impact choice of the EFT-based products versus other other hand, insufficient access to and excessive cost of products like cheques which do not have the same in- payment services, coupled with an insufficient degree terchange structure. of innovation, might be a call for more competition, including networks and clearing arrangements. Innovative products specific topics As mentioned earlier, most innovative products in- Central banks should include the monitoring of aspects volve use of agents or a closed network of acceptance related to anti-competitive behavior as part of their points. In many of these cases, exclusive arrange- oversight function: As earlier discussed, such practices ments are created for these tie-ups, thereby blocking include exclusive arrangements, unjustified denial of an agent/acceptance point of one innovative product access to infrastructure, and unfair pricing mecha- being able to accept another innovative product. In nisms for infrastructure participants, among others. addition, given that many of the issuers of innovative Although, the actual investigation and any regulatory payment products are not banking entities, they typi- actions on these aspects might be the responsibility of cally lack access to traditional clearing and settlement other specific authorities, including the same as part infrastructure. This could directly impact interopera- of a central bank’s oversight activities would help in bility of innovative payment products with traditional identifying such instances faster, and the central bank payment products. would be able to provide specialized feedback to such other authorities. Rules prohibiting certain anti-com- Possible Actions petitive behaviors could also be included as a condi- The World Bank study: “Balancing Cooperation and tion in the licensing of payment system operators (i.e. Competition in Retail Payment Systems” recommend- license could be withdrawn in case of violation). ed a number of guidelines (see Box 10). These have also been synthesized below. Central banks should also use their oversight function to balance other cooperation and competition issues: Central banks and other authorities should determine Identifying the socially optimal level of interchange their policy objectives with regard to competition in the fees and other interbank fees is a very difficult task, market for retail payments, and make them transpar- since competition at three different levels needs to be ent to stakeholders: Policy making is complex due to considered (across payment instruments, across plat- the institutional fragmentation of relevant policy mak- forms, across service providers of the same platform) DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY 55 Box 10: Guidelines from the World Bank Report “Balancing Co-operation and Competition in Retail Payment Systems” Guideline 1: Market complexities need to be recognized 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. • Governance of the infrastructure has a significant impact on cooperation and competition. Ensuring neutrality, objectivity and con- testability normally requires a closer public scrutiny. • Gaining access to messaging, clearing, and settlement services is of capital importance for the ultimate success of new entrants in the market. Players with a dominant position in one infrastructure may have the incentive to create barriers for access to new entrants. The authorities’ analysis should go beyond traditional payment system providers (e.g., banks) and consider the role of new players (e.g., non-financial sector providers) and new instruments (e.g., mobile payments). • Pricing of some retail payment systems are subject to network economies (e.g., two-sided markets) and traditional cost structures are not appropriate to analyze these markets as pricing structures matter. Interchange fees (e.g., cards markets) and interbank fees (e.g., ACH markets) are mechanisms to balance different interests in payment networks but can also be advantageously used by dominant infrastructure players. In order to determine a socially optimum level, competition at three different levels needs to be considered (across payment instruments, across platforms, across service providers of the same platform) and, also, the different nature of payment instruments (e.g., credit cards providing a payment and a credit service). Guideline 2: Policy trade-offs are relevant in this domain. Therefore, policy priorities will have to be determined and the type of public intervention should depend on the main public objective(s) pursued. • Public policy objectives in retail payments are multiple and none of them is in principle more important than the other. They include efficiency, safety, reliability, competition, access, and consumer protection. These objectives might need to be reconciled and pri- oritized, also taking into consideration the policy goals of other segments of the National Payments System (e.g. the need for a safe centralized system for the settlement of large value transactions). • The justification for intervention depends upon the main public policy objective(s) pursued and upon evidence of perceived market failure. For example, in presence of a sufficient number of service providers and lack of interoperability, efficiency might well be the primary objective to be pursued. On the other hand, the insufficient access to and excessive cost of payment services, coupled with an insufficient degree of innovation, might be a call for more competition, including networks and clearing arrangements. • An ex-ante and transparent determination of policy objectives clarifies different actors’ roles and avoids mistrust in the develop- ment and operation of the infrastructure. This is especially important if the public sector is one of the infrastructure providers. • Market transparency is key to promote competition and dispel mistrust among market players. • Any policy solution should be considered in a dynamic rather than static context as these markets are constantly changing. Section IV. Guidelines for Developing a Comprehensive Strategy for Reforming Retail Payments 56 DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY Box 10 (Continued) Guideline 3: Effective oversight of retail payment systems by the central bank is crucial to balance cooperation and competition issues. • An effective payment system oversight is the tool authorities have to address market and coordination failures and achieve an ap- propriate balance between cooperation and competition in the National Payments System. In particular, the overseer plays the role of a central agent who is best placed to solve the coordination problems that typically plague multi-agent decisional contexts by mobilizing efforts from individual participants, prompting them, to act collectively when circumstances so require, and facilitating the development of private sector institutions equipped to deal with these problems. • Central banks are the natural overseers on payment systems and should persuade themselves (or be persuaded) to play a central role due to their stake on the confidence in money and functioning of commerce and the economy in general. • Other authorities might have an important role, as well, due to multiple implications of retail markets (e.g., competition 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 financial institutions and non-financial service providers) be appropriately covered. • There is a broad range of oversight instruments, ranging from regulations and incentives (including those on access and pricing) to moral suasion and policy dialogue, from anti-trust enforcement to structural measures (e.g., government-owned service provision). Guideline 4: Institutional mechanisms to promote cooperation 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 some- times overlapping—scope of their mandates. • Sometimes authorities have already established cooperative arrangements but normally with a narrow scope that has to be broad- ened, other times these arrangements are nonexistent and need to be established. • In particular, it is essential to develop a good cooperative framework between the overseer and the anti-trust agencies that rule against uncompetitive behavior. and, also, the different nature of payment instruments of payment instruments. In this regard, preparing and (e.g., credit cards providing a payment and a credit ser- presenting detailed information on the direct and in- vice). In some cases, regulators may opt for a moral direct savings and revenues associated with migration suasion approach to encourage stakeholders to evalu- of customers from cash and cheques to electronic pay- ate their pricing policies and schemes in light of the ment instruments can be an effective persuasive tool. public policy goal of achieving a socially optimal usage DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY 57 Box 11: The Payment Cards Industry Security Standards Council The Payment Card Industry (PCI) Security Standards Council is an open global forum, launched in 2006, that is responsible for the devel- opment, management, education, and awareness of the PCI Security Standards, including the Data Security Standard (PCI DSS), Payment Application Data Security Standard (PA-DSS), and PIN Transaction Security (PTS) requirements—all created to mitigate data breaches and prevent payment cardholder data fraud. The PCI Security Standards Council operates a number of programs to train, test, and certify organizations and individuals to assess and validate adherence to PCI Security Standards. The Council’s five founding global payment brands—American Express, Discover Financial Services, JCB International, MasterCard Worldwide, and Visa Inc.—have agreed to incorporate the PCI DSS as the technical requirements of each of their data security compli- ance programs. Each founding member also recognizes the organizations and individuals certified by the PCI Security Standards Council. All five payment brands share equally in the Council’s governance, have equal input into the PCI Security Standards Council and share responsibility for carrying out the work of the organization. Other industry stakeholders are encouraged to join the Council as Participat- ing Organizations and review proposed additions or modifications to the standards. The enforcement of compliance with the PCI DSS and determination of any non-compliance penalties are carried out by the individual payment brands and not by the Council. Note: The information in this Box has been adapted from the information in the website of PCI Security Standards Council: https://www.pcisecuritystandards.org/index.php Institutional mechanisms to promote cooperation and GUIDELINE V: Retail payments information sharing are essential: Sometimes authori- should be supported by appropriate ties have already established cooperative arrangements governance and risk management but normally with a narrow scope that has to be broad- practices. ened. In other cases these arrangements are inexistent and need to be established. In particular, it is essen- Description tial to count with a good cooperative framework be- tween the overseer and the anti-trust agencies that rule Good governance arrangements provide incentives for against uncompetitive behavior. an organization’s top management to pursue the long- term interests of the organization, such as continued growth, increased coverage, profitability (where appli- cable), and overall viability. Payment system operators and other infrastructure services providers should be subject to mechanisms of accountability and indepen- dent oversight, including independent audits, to en- sure they are pursuing such long-term interests. Section IV. Guidelines for Developing a Comprehensive Strategy for Reforming Retail Payments 58 DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY All economic activities face a variety of risks, and it physically entered by the payer. This information is is the role of management to determine whether the static throughout the life of the card. This information identified risks should be avoided, accepted, shared or can be compromised at the point of transaction, in transferred to third parties. Major risks in operating transit, at any intermediary processing system, at issu- and using payment instruments and systems include: ers processing system or finally by physically copying card information or extracting card information from • Systemic risks, arising from linkages between the cardholder through social engineering attacks like various national payments system components phishing and vishing. A card prepared using this com- and international payment systems. promised information is called a counterfeit card. A counterfeit card can be used successfully for complet- • Legal risks (e.g. the legal framework not support- ing a transaction if it manages to evade the risk detec- ing some common practices, or the inadequate tion systems at the various levels, for example: or erroneous compliance of the applicable legal and regulatory framework). • Physical inspection of the card for verifying presence of standard physical security features • Settlement risks, arising from liquidity or credit like hologram stickers, issuer specific informa- risk problems of the participants. tion, name of cardholder etc; • Business risks, arising from the general opera- • Fraud detection at acquirer, network operators tion and administration of the various partici- and issuers, using advanced fraud detection soft- pants in the retail payment systems. ware often based on neural networks; and • Operational risks, issues related to operational • Strong authentication mechanisms such as a PIN reliability of the various participants and infra- number or 2-factor authentication for Internet structures including issues such as fraud, data and offline transactions.85 theft, or usage of retail payment for unlawful ac- tivities like money laundering or financing ter- In other cases the risk mitigation mechanism includes rorism related activities. using chip in a card to create dynamic data that varies from transaction to transaction, hence making com- Management will need to establish internal controls to promised information unusable. Box 11 describes a mitigate the risks it decides to accept. recent initiative by the payment card industry to create a data security standard for payment cards. Risks specific to payment cards Payment card infrastructures are for the most part Identity theft is also a significant risk for payment globalized infrastructures and by far the most fraud- cards. Data on the cardholder can be extracted and prone but also with the most advanced fraud risk man- used by either redirecting a replacement card or apply- agement mechanisms. Counterfeit risk is a significant ing for a fresh card which can then be used to conduct risk. However, technology to address this risk is avail- fraudulent transactions. able. Typically, payment card transactions involve ex- change of the information about the card being used 85 3D-Secure is an authentication protocol that enables multi-factor authentica- for payment, read from the cards magnetic stripe or tion for card payments where the acquirer and issuer are not the same institution. DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY 59 Figure 6: Protection of Customer Funds in Innovative Payment Products Source: GPSS 2010 Risks specific to EFT based products count details of the beneficiary—the account number, The EFT payment instructions can be delivered name, branch, bank name, country etc. Any errors in using a variety of channels—walk-in to a branch, these could result in the transaction being misdirected. phone, Internet, ATM, mobile phones, and kiosks. These risks are mitigated by: requiring prior registra- Except in the case of walk-in to a branch, all other tion of beneficiaries to reduce the potential of errors; channels are non-face-to-face and hence are exposed reducing the number of data entries required by pro- to typical authentication, social engineering, and data viding data for bank names, routing codes etc., as stan- security risks. dard drop-down lists; educating the transaction initia- tors to exercise caution, and requiring confirmations However, since the respective financial institution before executing the transaction; providing a cool-off manages these channels, a range of risk mitigation period allowing the initiating institution to retract the measures can be deployed. However, where the payer transaction; and, finally by using robust fraud detec- or payee uses Internet, the computing device is gen- tion and transaction alert systems. erally outside the control of the financial institution, and can be exposed to standard Internet virus, Trojan Risks specific to innovative payment schemes and bots-based attacks. These attacks could harvest Innovative payment mechanisms are basically exposed the authentication information used by the payer or to many of the same risks as payment cards and EFT- payee, and use that to generate fraudulent transac- based traditional products, and probably have height- tions. These risks to a large extent are mitigated by ened exposure to money laundering and terrorist fi- two-factor authentication, requiring prior registration nancing risks. For example, the Financial Action Task of beneficiaries (which could require stringent offline Force (FATF) in its recent report identifies anonymity, verification), fraud detection systems to detect abnor- high negotiability, and utility of funds as well as global mal transaction patterns, and by providing customers access to cash as some of the major factors that can add with robust transaction alerts. to the attractiveness of innovative payment schemes for money launderers.86 Anonymity can be reached EFT transactions are also exposed to data entry error, either “directly” by making use of truly anonymous as the transaction initiator has to provide the account products (i.e., without any customer identification) details of the beneficiaries and transaction amount. EFT transactions require the initiator to provide ac- 86 FATF 2010. Section IV. Guidelines for Developing a Comprehensive Strategy for Reforming Retail Payments 60 DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY or “indirectly” by abusing personalized products (i.e., Fraud prevention is an area where collaboration circumvention of verification measures by using fake amongst all the industry players is particularly impor- or stolen identities, or using straw men or nominees). tant: The central bank and industry players can jointly Additionally, as many of the innovative mechanisms create mechanisms to exchange information about are operated by non-banking entities, their supervi- fraudulent incidents and best practices, and also de- sion might not be as rigorous. Moreover, these schemes velop common repository of previous incidents to might not have other protection measures like deposit serve as a reference against which all future transac- insurance or the operator being able to access short- tions or new applications can be cross-referenced to term funding to mitigate settlement risks. Figure aid decision-making. 6, compiled based on the responses to the Global Payment Systems Survey 2010 (see that survey’s annex on retail payments innovations), captures the percent- GUIDELINE VI: Public authorities age of innovative products/product groups that were should exercise effective oversight reported to have full protection of consumer funds. over the retail payments market and consider direct interventions where Possible Actions appropriate. Ensure that infrastructure operators and payment ser- vice providers have appropriate governance structures Description and mechanisms. These mechanisms should provide for proper accountability of management and, where In general terms, the payment system oversight func- applicable, of board members, and should include in- tion aims to ensure that the infrastructure and the dependent audits or reviews. Moreover, governance market for payment services: arrangements should ensure appropriate identification and management of risks, through a system of sound • Work smoothly, efficiently, and fairly to all par- internal controls and risk management mechanisms. ticipants and users88; In consultation with the industry players, the central • Pursue the level of technological and institution- bank can develop guidelines with respect to risk man- al development necessary to satisfy the payment agement covering key areas: These may include data needs of a growing and open economy; and security and privacy standards, authentication stan- • Minimize the risk of transmitting shocks across dards, settlement risk, incident reporting, protection the economy. of IT and networking systems, data back-up, retention and business continuity procedures, disaster recovery As discussed throughout this document, some of the planning, and anti-money laundering - combating key foundations for exercising oversight over retail the financing of terrorism AML/CFT procedures.87 payment systems include the existence of market fail- Requiring the industry players to demonstrate compli- ures (e.g. externalities, information asymmetries, and ance through an independent assessment can enforce non-contestable markets, among others), coordina- compliance with these standards and guidelines. tion failures among stakeholders, and the existence of 87 There are well developed international standards for most of these aspects, 88 One example of this could be supporting both the payment needs of cor- especially for the data security, IT security, and authentication areas. porate and individuals, and for supporting different segments of customers like banked and unbanked. DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY 61 Box 12: Guidelines from the report: “A Practical Guide for Retail Payments Stocktaking” Guideline 1: The overall scope and structure of the stocktaking exercise shall be driven by the high-level public policy goals set forth in the area of retail payments. The public policy goals would vary from country to country, but in general are associated with the safety and efficiency of retail payment systems in the country. Some other relevant public policy areas in this area may include increased access and affordability, the availability of a socially optimal mix of payment instruments, and the availability of the required industry infrastructure to process such payment instruments. The retail payments stocktaking exercise should be designed so as to enable a clear understanding of the issues and areas of improvements required for achieving the stated public policy goals. The scope should be broad-based and should be developed in close co-ordination with all stakeholders. Guideline 2: Adequate attention needs to be devoted to the planning and organization of the stocktaking exercise. Retail pay- ments stocktaking is a complex undertaking requiring meticulous planning and active involvement of numerous stakeholders. A wide range of information sources should be used, including the information available in the broader payment systems community and also other sources. This information helps in benchmarking the status in the particular country. Where obtaining direct data might be difficult, information from other sources will help in assessing the intended aspects or variables in an indirect manner. Guideline 3: Industry players should be involved from the very early stages. The retail payments industry will require adequate background information and sufficient time to ensure availability of good quality information when the stocktaking exercise is rolled out. In addition, the central bank should actively seek dialogue with industry participants as the latter can provide valuable inputs in structur- ing the exercise, including agreeing on certain common terminologies and helping to determine the appropriateness of the data being required as well as the feasibility of obtaining such data reliably. Guideline 4: Obtaining sufficient, high-quality data and other types of information is at the heart of the stocktaking exercise. The collection, organization, validation and analysis of data is a critical part of the stocktaking exercise, and is probably the most resource-intensive one. Appropriate human and technological resources should therefore be devoted to this element of the exercise, including a strong emphasis on validating the data received from the industry. A retail payments stocktaking exercise is also not a one-off exercise; hence, an approach to enable comparison across iterations to measure evolution should also be considered. Guideline 5: Devote sufficient time to report preparation and to designing the strategy for wide dissemination of the results. Being able to properly document and communicate the results of the stocktaking exercise as well as the alternatives available to address the underlying shortfalls is of outmost importance. A carefully designed strategy for the communication and dissemination of the Diag- nosis Report should be developed to provide useful feedback to the various stakeholders and relevant inforormation to the overall public. Section IV. Guidelines for Developing a Comprehensive Strategy for Reforming Retail Payments 62 DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY dominant positions due to, among other reasons, the infrastructures.90 Apart from the need to prioritize or “natural monopoly” feature of the infrastructures sup- choose among these objectives, transforming them porting retail payment services. into specific policy actions can be a difficult task. It is increasingly accepted that the central bank should First, as discussed under Guideline IV, retail payments play a central role in oversight of all payment systems are usually characterized by certain dynamics, market due to its stake in the confidence in money and func- complexities and particularities for which there is no tioning of commerce.89 In practice, however, there are standard approach or policy response. Moreover, some significant cross-country differences in the extent to of the public policy goals mentioned earlier are not the which central banks have legal authority in the over- sole or even a direct responsibility of the payment sys- sight of retail payment systems and arrangements. tem overseer. For example, while the central bank in its role as overseer is clearly interested in avoiding anti- It is nevertheless a fact that central banks in all re- competitive practices that may lead to lower levels of gions of the world are paying increasing attention to efficiency, the regulatory powers or tools to act upon retail payment systems, and are undertaking certain such practices will more likely be vested in a different oversight activities in this area regardless of their spe- authority, such as the antitrust agency and/or the con- cific legal mandate. For example, central banks with sumer protection agency. Coordination and informa- a weak or non-existent legal mandate for overseeing tion sharing amongst the relevant authorities is there- retail payment systems are opting for so-called “soft” fore crucial, and a key challenge for effective oversight. or less interventionist oversight tools such as monitor- ing and engaging in dialogue with market participants. Possible Actions Many central banks also act as catalyst or facilitators, Given the multitude of objectives and actors involved promoting public policy debate via relevant research, in retail payments systems, a clear oversight frame- by establishing cooperative and consultative arrange- work is required to, among other basic objectives, ensure ments with the private sector, and by driving the adop- proper coordination and resolution of collective action tion of better infrastructure or common operating problems.91 standards and practices. Central banks with stronger legal mandates also have at their disposal more inter- Although the central bank should be expected to lead ventionist oversight tools such as the possibility to is- oversight activities, the overall framework should also sue regulations and sanctions. consider the role of other authorities, where applicable, in attaining the public policy objectives for the retail In the case of retail payments, there is usually a need payments market. The authorities involved vary from to reconcile multiple public policy goals relating to country to country, but in general these authorities in- safety and efficiency, information transparency, reli- clude competition authority, ministry of finance, and ability, infrastructure development, access, and social- ly optimal usage of payment instruments and related 90 For a discussion of public policy objectives in payments systems, see Bossone and Cirasino 2001. 91 Some of the main building blocks for an oversight framework are described 89 See Bossone and Cirasino 2001. in CPSS 2006, and Bossone and Cirasino 2001. DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY 63 in some cases or for some specific products also the telecom regulator and/or the ministry responsible for social benefits.92 In order to substantiate the need for public interven- tion, evidence of the type and extent of market failure needs to be documented. One approach in this regard is to conduct a detailed study of the retail payments market through data collection, analysis of relevant lit- erature, and interviews with a broad set of key market players, and to compare the situation in the country to international peers. The PSDG, in association with the European Central Bank and the Central Bank of Brazil, have recently developed a “Practical Guide for Retail Payments Stocktaking Retail Payments Stocktaking” (see Box 12). Any direct intervention should be assessed within a cost- benefit framework: For this purpose, the welfare costs of the identified market failure and the benefits from its partial or full correction should also be estimated. A cost-benefit analysis is also useful to determine pri- orities when several direct interventions are being con- sidered. The rapidly changing nature of retail payment markets should also be recognized and considered in the analysis. Strong cooperative mechanisms are crucial for effec- tive oversight. These include mechanisms whereby stakeholders may voice their views to authorities on the design and evolution of retail payment systems, and mechanisms to coordinate regulatory functions amongst the various authorities. 92 For a detailed discussion please refer to CGAP Focus Note 76 at http://www. cgap.org/p/site/c/template.rc/1.9.56703 Section IV. Guidelines for Developing a Comprehensive Strategy for Reforming Retail Payments SECTION V Implementing Reforms for Retail Payments T he CPSS and the World Bank’s PSDG, • Developing an implementation plan after agree- among others, have developed specific ment on actions that need to be taken and their guidance for the reforming of the national priorities; and payments systems that has been tested suc- cessfully in many countries and under many different • Monitoring progress. circumstances.93 This chapter presents the same over- all framework with the necessary adaptations to reflect Each of these steps is described below. the particularities associated with retail payments and their development. V.1 Stocktaking The implementation of any significant national re- tail payments system development initiative should To get a good understanding of the prevailing state be based on a strategic, well-structured development of retail payments system in a country and to achieve plan. The key components of this plan include: the desired state for retail payment systems, it is im- portant to fully understand the dynamics that prevail • Stocktaking of current situation; in the existing market for retail payments and factors that have shaped the developments thus far so that • Creating appropriate internal organizational appropriate reform initiatives can be designed. arrangements; Stocktaking of the prevailing state of retail payments system would involve: • Developing an appropriate coordination frame- work to involve all stakeholders; • Identifying and unambiguously classifying the various types of instruments available for retail • Developing a common vision of the desired end payments, the institutional as well as the clear- state; ing and settlement arrangements for processing these instruments, and their usage statistics, in- 93 Annex 5 presents the relevant section of the CPSS General Guidance for Na- cluding the typical processing costs; tional Payment System Development. Annex 6 presents a summary of the strategic framework for payment system modernization developed by the Southern Africa Development Community (SADC). 65 66 DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY • The payment needs which are currently met payments system in isolation without consideration to largely through cash-based payments, paper- other aspects of the payment systems may not yield the based payments, and electronic payments; intended results. For example, several structures that are created for the overall reform such as internal and • The general trend in the processing costs, recent external working groups and other cooperation bodies improvements and new features introduced for can be leveraged with some minor rearrangements to these payment instruments; also support retail payments system reform efforts. • The level of customer disputes, frauds and Central banks would also need to ensure appropri- other risks related to usage of these payment ate internal staffing before embarking upon a com- instruments; prehensive retail payments system development plan. For example, a payment systems policy department • Patterns in the usage and adoption levels of these or unit with no operational responsibilities is typical- payment instruments—geographic, socio-eco- ly well positioned to lead the retail payments system nomic, or transaction size; and, reform. Where such a step is not possible right away, as an interim measure, the central bank may consider • The levels of overall population access to the creating an empowered committee comprising senior payment instruments under the overall context central bank officers from the various relevant depart- of financial inclusion objectives. ments such as legal, policy management, operations, and technology. The stocktaking exercise will provide inputs for identi- fying the specific elements of the reform program and in developing the business case for the reforms. V.3 Develop an Appropriate Coordination Framework with Stocktaking exercises should be done periodically to Key Stakeholders measure progress over time and also identify new de- velopments and trends. As discussed under Guideline Comprehensive reforms of retail payment systems re- VI, The World Bank, in association with the Central quire significant coordination with many stakeholders. Bank of Brazil and the European Central Bank/ These include commercial banks, some non-banking Eurosystem, has developed a set of practical guidelines financial institutions, retail payment services providers for effective retail payments stocktaking (see Box 12). including any new players such as telecom companies, the national treasury, and other government ministries involved in social benefit transfers, major billers like V.2 Establish Appropriate utility companies, merchant associations, and repre- Internal Organizational sentatives of final users (including consumers). Arrangements A national payments council (NPC) led by the central A retail payments system development plan ideally banks that includes all the relevant institutions previ- needs to be part of an overall NPS development plan ously described has proven an effective arrangement and hence can leverage the organizational arrange- ments already in place. Moreover, reforming retail DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY 67 Table 4: Key Areas for Standards in Retail Payment Systems Standards area Key elements Consumer protection and Articulation of key product features and pricing terms in an easy to understand format transparency Provision of periodic statement of accounts Simple and time-bound dispute resolution framework Articulation of product operational performance metrics like settlement time etc. with recourse available to the consumer in the event of non-adherence Operating standards and rules. Know your customer and other AML/CFT related requirements Settlement risk management mechanisms Operational risk management requirements Data formats and other technical Device and infrastructure standards like EMV standards for POS terminals standards Account numbering standards like IBAN. Data security standards – PCI DSS, SSL etc. Data formats: IS0 20022, ISO 8583 etc. Device certification requirements Authentication standards POS authentication standards – for (e.g.) requiring PIN based authentication for card transactions at POS, telephone transactions etc. Online remote payments – for (e.g.) 2-Factor authentication for e-commerce transactions for coordination of such a variety of stakeholders.94 V.4 Developing a Common Vision For retail payment reforming, a specialized commit- of the Desired End-state tee within the NPC is normally most well positioned to discuss the specific matters related to this sector. Envisioning the desired state of retail payments sys- Appropriate levels of representation for effective de- tem assists in catalyzing action and serves as a refer- cision-making and the active involvement and leader- ence point for all future endeavors. The desired state ship from the central bank to build wide support for of retail payments systems might vary from country the various reform initiatives are among the key ele- to country/region to region depending on a variety of ments to this committee’s success. factors. In general, developing a vision for retail payments sys- tem should consider the following dimensions: • The desired level of penetration of electronic The existence of a NPC seems to be not too common, in the response to the payment mechanisms; 94 World Bank Global Payments Survey 2010, only around 40 percent of the central banks mentioned existence of NPC in their jurisdictions. Section V. Implementing Reforms for Retail Payments 68 DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY • Reducing the cost of retail payments to the tifying shortfalls in association with the stated public society; policy objectives, and the types of actions required to move from the current state to desired state. • Payment mechanisms being able to meet the payment needs of individuals and businesses; Reform initiatives will need to be prioritized and se- quenced to handle resource constraints and also in- • Appropriate levels of customer satisfaction; and terdependencies. A comprehensive implementation plan incorporating all these aspects should be devel- • Continuous innovation and improvement in the oped and publicized. If necessary, adjustments to the retail payments area. original plan and/or interim measures might need to be developed. The development of the implementa- Creating a set of general objectives to guide the devel- tion plan would benefit from a detailed analysis of the opment of the various individual retail payment sys- business case for the reforms and design of the specific tems might be useful to ensure that each of these is components. positioned to meet the overall vision. In other words, achieving the overall vision for the national retail pay- The implementation plan would be a combination of ments system will be extremely difficult without ensur- discrete components such as development of an ACH ing each of its components individually adheres to the or national payment card switch, and overarching general guiding objectives. These objectives may in- components such as formalization of oversight ar- clude the following aspects: interoperability in design rangements and automation of government payments of retail payment systems that can be broadly adopted related processes. The entity or entities that are expect- by wide customers segments; conformity to all appli- ed to lead each of these components should be clearly cable international standards; adequate use of estab- identified. lished clearing and settlement infrastructures rather than creating parallel processes; and short to medium- One of the most contentious issues in development of term commercial viability. an implementation plan is who should be responsible for developing the core infrastructures of ACH, pay- Adoption of relevant standards would enable develop- ment card switches, and other core payment networks. ment of efficient and reliable national retail payment In the case of RTGS systems, there is in general a con- system. The key areas in which standards could be sensus that the central bank needs to take the lead, and required are shown in Table 4. In many of such areas if it is not the owner and operator of the RTGS systems, international standards already exist. These are men- it must have a very key role in the overall development tioned alongside. and operations of that system. In contrast, for retail payment systems the private sector is usually expected to play a very important role and in fact can take direct V.5 Developing an responsibility for creation of these systems. Implementation Plan However, in certain circumstances, notably when the Analyzing the data and other information gathered private sector is unable to come to an agreement on thorough the stocktaking exercise is critical for iden- developing these systems, the central bank might need to take a more interventionist role, which may include DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY 69 developing and becoming the operator of some re- tail infrastructures. Even in these circumstances the central bank should consider this as a starting point and from the outset design the system in a manner that would enable it to transfer the ownership and operational responsibility to the private sector in the near future. V.6 Monitoring and Evaluation Retail payments system reform should be seen as a continuous process. The progress made needs to be assessed periodically against the vision and objectives established earlier on. A monitoring and evaluation framework should be developed upfront and be an in- tegral part of the overall plan. Developments of specific metrics that are easily mea- surable while at the same time convey the progress to- wards the agreed vision and objectives would greatly enable effective monitoring and evaluation. For exam- ple, the single European payments area (SEPA) project identified indicators like the share of SEPA-compliant credit transfers in total credit transfers. A basic list of metrics that could be collected to assess progress on retail payments development plan is presented in Table 5. Monitoring metrics like these over a period of time could help in keeping the reform process on track and identifying course correction requirements. Section V. Implementing Reforms for Retail Payments 70 DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY Table 5: Basic Metrics to Assess Progress in Retail Payments Development Metric Explanation Per capita cashless transactions This is the number of cashless transactions both inter-institution and intra-institution over a year in relation to the population of the country. Infrastructure metrics This would include metrics like ATMs and POS terminals per 1000 inhabitants and number of branches95 per 1000 adults. To get a more accurate assessment, metric for specific geographic areas could also be considered. Access metrics This would include metrics like number of accounts per 1000 adults, number of credit and debit cards per capita, proportion of Internet banking and mobile banking customers. These set of metrics help in assessing the penetration of payment services. Transactions per ATM/POS This is the number of transactions per ATM, POS or acceptance infrastructure over a period of time. This serves to measure the level of interoperability and usage of infrastructure. Cost of Cash deposit and withdrawal The fees for deposit and withdrawal of a representative amount at a representative frequency across types of institutions, channels and accounts. Percentage of payment instructions This is the share of payment instructions received through electronic means in the total number of pay- received through electronic means. ment instructions (including electronic plus paper-based and face-to-face channels). Percentage of government payment This is the share of government payment transactions made both as a payee and a payer using transactions made through electronic electronic payment mechanisms in the total of government payments (i.e. using all types of payment payment mechanisms. mechanisms). Cost for a domestic remittance between This is the total cost (for the sender and for the receiver) of making a domestic remittance between parties with accounts in different parties maintaining accounts in two different institutions using the available payment mechanisms and institutions. channels. To make it comparable, this should be for a representative amount and shown as a percent- age of such amount, and for different institutions and different modes. Cost to pay a domestic utility bill and a This is the cost to pay a domestic utility bill and a merchant transaction for a representative amount typical transaction at a merchant. through various mechanisms and across institutions. To make it comparable, this should be for a repre- sentative amount and shown as a percentage of such amount. Cost to maintain specific payment product This is the cost for the consumer to maintain specific payment product accounts like a bank account for accounts by institution type. debit cards, prepaid card account for prepaid cards, a mobile money account for mobile payments, etc. Volume and value of frauds and operational This is the count and value of frauds represented in percentage terms for specific categories of frauds errors. and operational errors like late processing of a remittance, debit of a wrong amount, counterfeit fraud, 95 repudiation related fraud, etcetera. 95 Could also include a separate metric for agents/business correspondents per 1000 adults. DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY 71 Annex 1: Public Policy Goals, Central Bank Minimum Actions, and Range of Possible Additional Actions for Retail Payment Systems (from CPSS “Policy Issues for Central Banks in Retail Payments”) LEGAL AND REGULATORY FRAMEWORK • Offering expert advice to other responsible au- Public Policy Goal A: Policies relating to the efficiency thorities, for example in the preparation of rel- and safety of retail payments should be designed, where evant legislation. appropriate, to address legal and regulatory impedi- ments to market development and innovation. MARKET STRUCTURE AND PERFORMANCE The Central bank should, at a minimum: Public Policy Goal B: Policies relating to the efficiency and safety of the retail payments should be designed, (i) Review the legal and regulatory framework to where appropriate, to foster market conditions and identify any barriers to improvements in effi- behaviors. ciency and/or safety; and The central bank should, at a minimum: (ii) Cooperate with relevant public and private enti- ties so that the legal and regulatory framework (i) Monitor developments in market conditions and keeps pace with the changing circumstances and behaviors relating to retail payment instruments barriers to improvements in efficiency and/or and services and assess their significance; and safety are removed, where appropriate. (ii) Cooperate with other public or private entities, The range of possible additional actions could in- as appropriate, to foster competitive market clude, depending on the individual central bank’s re- conditions and to address any significant public sponsibilities, powers and priorities: policy issues arising from market structures and performance. • Altering regulations that currently present bar- riers to improving efficiency and safety, where The range of possible additional actions could in- this is within the central bank’s remit and where clude, depending on the individual central bank’s re- other public interest arguments do not militate sponsibilities, powers and priorities: against such action; • Promoting appropriate standards or guidelines • Introducing or proposing new regulations, as for transparency, in cooperation with relevant the central bank’s remit allows, where the legal public and private sector entities; or regulatory framework is insufficient to sup- port increased efficiency and/or safety; and • Reviewing conditions in the market for cross- border retail payments, with a view to promot- ing improvements, are such action is warranted; and Annex I 72 DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY • Considering and, if appropriate, performing cases where market forces are judged not to have regulatory and/or operational intervention in achieved or not to be likely to achieve and ef- cases where market forces are judged not to have ficient and safe solution. achieved or not to be likely to achieve an efficient and safe solution. CENTRAL BANK SERVICES Public Policy Goal D: Policies relating to the efficien- STANDARDS AND INFRASTRUCTURE cy and safety of retail payments should be designed, Public Policy Goal C: Polices relating to the efficien- where appropriate, to provide central bank services in cy and safety of retail payments should be designed, the manner most effective for the particular market. where appropriate, to support the development of ef- fective standards and infrastructure arrangements. The central bank should, at a minimum: The central bank should, at a minimum: (i) Review and, if appropriate, adapt its provisions of settlement services to contribute to efficient (i) Monitor developments in security standards, and safe outcomes; and operating standards and infrastructure arrange- ments for retail payments which the central (ii) Be transparent in its provision of services. bank judges to be important for the public inter- est, and assess their significance; and The range of possible additional actions could in- clude, depending on the individual central bank’s re- (ii) Cooperate with relevant public and private enti- sponsibilities, powers and priorities: ties to encourage market improvements in such standards and infrastructure arrangements, • Reviewing the relevant non settlement services where appropriate. it provides and considering their adaptation to changing market conditions; and The range of possible additional actions could in- clude, depending on the individual central bank’s re- • Reviewing policies on access to central bank ser- sponsibilities, powers and priorities: vices and on pricing. • Participating actively in reviewing and develop- ing appropriate standards and arrangements, in cooperation with relevant public and private en- tities, where the central bank judges its more in- tensive involvement to be necessary to further- ing the goal; and • Considering and, if appropriate, performing regulatory and/or operational intervention in DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY 73 Annex 2: Model for National Payments Council – Terms of Reference Objectives • The Council plays a key role in endorsing the The National Payments Council aims to support the priority and the schedule of individual projects achievement of sound and efficient payment and secu- to be launched, financed and implemented. rities clearance and settlement systems in a country. It can also serve as a forum for cooperation to maintain • The Council promotes standardization of proce- orderly conditions in regional and international pay- dures and systems. ment systems. • The Council is responsible for promoting knowl- Main Tasks edge of payment system issues in the country. To • The Council works to facilitate the necessary co- this end, the Council uses any means it might operation between all market participants and find appropriate (workshops, seminars, web regulators in the payment area. pages, newsletter, etc.). • The Council promotes common initiatives to- • The Council seeks to promote cooperation wards the implementation of the payment sys- among all institutions active in payment and tem infrastructure. These initiatives should not securities systems within the region and at the impede, and should in fact foster, healthy com- international level. petition among market participants. Methodology • The Council plays a key role in preparing stra- • The Council prepares ad hoc reports on pay- tegic documents for the overall payment system ment system issues. The reports would not have architecture in the country. prescriptive nature. However, they would serve as a reference for the ongoing payment system • The Council plays a key role in monitoring the reforms in the country. implementation of payment systems reforms. • The Council establishes ad hoc working groups • The Council plays a key role in facilitating the on payment matters. Working groups may or sharing of information on economic and busi- may not be composed of the totality of the insti- ness requirements of all parties impacted by the tutions represented in the Council. payment system. • The Council reports on its activities to Steering • The Council helps to identify the impact of dif- Committee on Payment Systems and the Top ferent options on participants business and daily Management of the constituting institutions on operations and on end-user interests. an annual basis. • The Council plays a key role in selecting the main principles and options for system designs. Annex II 74 DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY • Representation and Organizational Structure  In the early stage of its life, the Council might seek, if necessary, assistance from  The Council gives representation to all the other national and international entities stakeholders of payment and securities highly experienced in managing payment clearance and settlement systems. These in- system groupings. clude: the central bank, the capital markets authority, the Ministry of Finance/Treasury,  The Council may invite, if needed, other in- the Association of commercial banks, the stitutions and/or individual experts to par- non bank financial institutions, the clear- ticipate in its meetings. inghouses and payment service providers, the Stock Exchange, the Central Securities Depository(s), the broker/dealers, the end- users, and other regulators (e.g., antitrust authorities), et cetera.  The central bank serves as the secretariat of the National Payments Council.  Appointed representatives of the stakehold- ers are senior managers with an involvement in payment matters. They report directly to the top management of their respective institutions.  The Council is comprised of an appropriate number of experts. The composition of the Council should be consistent with the ob- jective of having effective discussion in the meetings.  The Council has an internal governance structure with a chairperson and deputy(s), an executive body, formal rules to determine the terms and conditions for the appoint- ment of the executive positions, and formal rules to govern the activity of the executive body. DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY 75 Annex 3: Financial IncluSion Initiatives in India India faces enormous challenges for financial inclu- The Reserve Bank of India (RBI) defines financial in- sion. Recent estimates for outreach by the formal clusion as “the process of ensuring access to appropri- financial sector are summarized below:96 ate financial products and services needed by vulner- able groups such as weaker sections and low income groups at an affordable cost in a fair and transparent manner from mainstream institutional players.”98 As Financial product Number per 1000 adults this definition indicates, the RBI is focused on ensur- ing wider access using existing banks.99 Deposit accounts 815 Accordingly, the RBI has made a series of regulatory interventions. These include: Loans 147 • In the early 1990s, the RBI allowed banks to Life Insurance 100 provide deposit and loan services to self-help groups (SHGs).100 By March 2010, 97 mil- ATM or Debit Cards 291 lion low-income households had been reached through SHGs.101 Credit Cards 87 • All domestic commercial banks are required to direct 40 percent of their lending to designated Non-life insurance 6 “priority sectors,” including micro and rural lending, either directly or through loans to SHGs and regional rural banks. Any shortfall below 40 percent must be restituted through deposits into a fund for development of rural infrastructure. These figures are a simple ratio of the corresponding As of March 2009, this program covered 51 mil- metric and number of adults. For example, they do not lion accounts. indicate that 81.5 percent of adults in India have ac- counts, as many adults have multiple accounts, which • Additional licenses for banking branches are tied this ratio does not capture. By means of comparison, in to progress made in financial inclusion efforts. 2009, the number of deposit accounts per 1000 adults was 2022 and 737 for high-income countries and de- veloping countries, respectively.97 RBI 2010. 98 It is estimated that only about five percent of villages have bank branches, and 99 outreach by microfinance institutions and self-help groups varies by state—from 96 Source: Speech by Dr. K.C. Chakraborty, Reserve Bank of India Deputy less than four percent of the adult population in northern and low-income states Governor, at 20th SKOCH Summit, July 2009, Mumbai. Estimates by extrapola- to more than 40 percent in southern states and relatively higher-income states. tion based on RBI Report on Currency and Finance; and CGAP and The World 100 SHGs are not regulated or licensed; they are informal groups of 15 or more Bank 2010. members coming together to manage their financial needs by pooling resources. 97 Source: CGAP and The World Bank 2010. 101 National Bank for Agriculture and Rural Development 2009-10. Annex III 76 DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY • In 2005, the RBI enjoined banks to create sim- • In January 2010, the RBI required all commer- ple, low-cost banking accounts—the “no-frills” cial banks to develop three-year financial inclu- account—with simplified KYC procedures. By sion plans and required their boards to track June 2010, 35 million such accounts had been progress on implementation of the plans. opened. • The RBI has set a target of achieving at least one • In 2006, the RBI enabled banks to extend their financial services point within a four-kilometer reach using business correspondents. Guidelines radius of all villages with populations of more for this approach have been progressively sim- than 2,000 households by 2012. There are 8,947 plified. Today, banks are free to appoint a wide such villages in Bihar. The RBI has required that range of individuals and entities to act as busi- state-level banker committees track progress.103 ness correspondents. Since 2007 the RBI has allowed non-bank entities to provide payment These initiatives have generated strong momentum for services. financial inclusion in India. Several commercial banks have made significant progress, with multiple pilots • As recommended by the 2008 Rangarajan and solutions under way.104 Almost all solutions have Committee on Financial Inclusion, the involved a combination of opening no-frill accounts Government of India, RBI, and National Bank and servicing clients through business correspon- for Rural Development (NABARD) have jointly dents, with some differences in the technology used. constituted two funds managed by NABARD, The three variants have been widely piloted, with some each with INR 6 Billion: the Financial Inclusion showing promising results: Fund (FIF) and the Financial Inclusion Technology Fund (FITF). As of March 2010, • Kiosk model: Clients are provided with smart- projects totalling INR 195 Million from FIF and cards, cards with magnetic strips, or passbooks INR 218 Million from FITF had been approved, and are serviced at kiosks run by business covering 50,225 villages.102 correspondents. • In 2008 the RBI launched a programme to com- • Smartcard-POS model: Clients are provided pensate banks issuing smartcards for govern- with smartcards and are serviced using POS- ment payments at the rate of INR 50 a card, equipped business correspondents. provided the concerned state government also contributed by paying a mutually agreed fee to • Mobile mode: Clients or business correspondents banks processing the payments. This scheme use their mobile phones to conduct transactions. lapsed in June 2010, and though many banks in Andhra Pradesh and other states availed of this scheme, no banks in Bihar did. But banks in Bihar are planning to request an extension of Source: Various RBI publications and transcripts of speeches on the RBI 103 website www.rbi.org.in this scheme. 104 In parallel and sometimes in collaboration, microfinance institutions (MFIs) and self-help groups (SHGs) are playing a key role in promoting financial inclu- sion in India. Several MFIs are linked to banks or other payment service providers for remittances and payments for their clients. But because few MFIs and SHGs 102 NABARD 2009-10 play leading roles in payment services, they are not specifically discussed. DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY 77 • An inter-ministerial group constituted by the Government of India has proposed a framework for providing basic banking services to custom- ers by using an interoperable, shared-services infrastructure linking business correspondents equipped with mobile phones to service no-frill bank accounts. It has been proposed that the shared services infrastructure be linked to the national unique identification infrastructure for client authentication. The client no-frills bank accounts are linked to client mobile phone num- bers, and clients exchange payment instructions initiated from their mobile phones with a proxi- mate business correspondent to operate their no-frills bank accounts. Annex III 78 DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY Annex 4: Credit and Debit Card Reforms in Australia The Payments System Board’s Mandate and points and an interest-free period) but faced a posi- Objectives tive cost to make an EFTPOS transaction, despite the The Payments System Board (the Board) of the fact that credit card transactions had a significantly Reserve Bank of Australia (Reserve Bank) oversees higher resource cost than EFTPOS transactions. This the payments system in Australia. The responsibilities was largely driven by the structure of interchange fees of the Board are set out in the Reserve Bank Act 1959. in the respective systems. Prior to the reforms, inter- In particular, the Act requires the Board to determine change fees for MasterCard and Visa credit and debit the Reserve Bank’s payment system policy so as to best cards were around 0.95 per cent of transaction value contribute to controlling risk in the financial system, (paid to the issuer, and typically passed on to the card- promoting the efficiency of the payments system, and holder via rewards points), while bilateral EFTPOS promoting competition in the market for payment ser- interchange fees were around 20 cents per transaction vices, consistent with the overall stability of the finan- (paid to the acquirer). In addition, the Board was con- cial system. cerned that there was a tendency for competition be- tween card schemes to drive interchange fees higher, In order to give effect to these responsibilities, the to provide additional incentives for issuers to promote Reserve Bank has powers that are set out in two Acts: each scheme. The interchange fee regulations, as they the Payment Systems (Regulation) Act 1998 (PSRA) currently apply, are as follows: and the Payment Systems and Netting Act 1998. Under the PSRA, the Reserve Bank has the power to designate • MasterCard and Visa credit card systems: payment systems and to set standards and access re- Weighted-average interchange fees must not ex- gimes in designated systems. The Act also sets out the ceed 0.50 per cent of the value of transactions. matters that the Reserve Bank must take into account when using these powers. • Visa Debit system: Weighted-average interchange fees in the Visa Debit system must not exceed $0.12 per transaction; MasterCard has also un- The Board’s Reforms: Interchange Fee dertaken to meet this requirement voluntarily. Regulation and Removal of the ‘Honour-All- Cards’ and ‘No-Surcharge’ Rules • EFTPOS system: Bilateral interchange fees in Since 2003, the Reserve Bank has regulated to reduce the EFTPOS system (paid to the acquirer) must interchange fees in the MasterCard and Visa credit be between $0.04 and $0.05 per transaction. card systems, the Visa Debit system and the domestic Multilateral interchange fees in the EFTPOS sys- debit card system (referred to as EFTPOS). These regu- tem must not exceed $0.12 per transaction (paid lations reflected the Board’s concerns that differences to the issuer). in interchange fees were resulting in pricing to card- holders that that did not properly reflect the relative Interchange fee regulation has therefore resulted in resource costs of different payment systems, leading to lower levels of interchange fees, as well as a significant- inefficient use of the payments system. For instance, ly smaller differential between the fees in the various many consumers faced a negative cost to make a credit systems (Graph 1). card transaction (e.g. through the receipt of rewards DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY 79 Graph 1 As well as the reforms to interchange fees, the Reserve Bank has removed various merchant restrictions that had previously been imposed by the card schemes, including: • No-surcharge rules: rules that prevented mer- chants from surcharging for credit card and scheme debit card transactions. • Honour-all-cards rules: rules that required a merchant to accept a scheme’s debit card if it ac- cepted its credit card and vice versa. • No-steering rules: rules that prevented mer- chants from steering customers to other forms of payment. Effects of the reforms The Reserve Bank also introduced a number of re- When the Board reviewed the reforms in 2007/08, it forms to access arrangements in all the card payment concluded that they have delivered substantial benefits systems in order to promote competition. improving efficiency and competition in the payments system. One of the main effects of the regulations has Overall, the reforms have aimed to improve efficiency been an improvement in price signals that consumers of the overall payments system and to promote com- face when choosing between use of credit and debit petition by seeking to: increase the transparency of cards. For credit card transactions, lower interchange the system; remove or modify restrictions that hinder fees have resulted in a reduction in the value of reward competitive forces; liberalize access arrangements; and points and higher annual fees, increasing the effective promote price signals to consumers that are conducive price of credit card transactions faced by many card- to the efficient evolution of the payments system. holders. The reduced cost to issuers of EFTPOS trans- actions have been reflected in them offering customers The reform process was undertaken with ‘a whole-of- unlimited free EFTPOS transactions with a transac- system’ perspective, given the interrelationship be- tion account (with a fixed monthly fee applied for all tween different card payment systems. However, the account services), compared with issuers’ limit on the individual reforms have occurred at different times number of fee-free transactions before the reforms. due to legal considerations and the Board’s willingness Consequently, the relative prices consumers now face to allow industry to explore solutions before consider- for credit and debit card transactions more closely re- ing regulatory solutions. flect relative costs than was the case prior to the re- forms. In line with this, growth in the number of credit Annex IV 80 DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY Graph 2 Graph 3 card transactions has slowed since the reforms, while As with credit cards, however, increased competition growth in the number of debit card transactions has in acquiring has lowered the margin of EFTPOS mer- accelerated (Graph 2). chant service fees over interchange fees. The changes in interchange fees have also been passed The removal of the no-surcharge rules has also played onto merchants, and appear to have also contributed a role in improving price signals to cardholders. to increased competition in acquiring. The average fee Although surcharging was slow to develop among paid by merchants for transactions (merchant service merchants in the first few years following the removal fees) on MasterCard and Visa cards declined signifi- of the no-surcharge rules, the rate of surcharging has cantly after the introduction of the reforms in 2003 picked up significantly in recent years. (Graph 3). Moreover, the margin between merchant service fees and interchange fees for these schemes has According to a survey of the merchant acquiring mar- also narrowed. Merchant service fees charged by both ket, in June 2012 around 36 per cent of merchants sur- American Express and Diners Club have also fallen, veyed applied a surcharge on at least one of the credit albeit more gradually, as merchants have reviewed cards they accepted (Graph 4).105 Surcharging is more their acceptance of these cards given the increase in common among very large merchants, with over half their relative costs compared with the other cards. In now surcharging credit cards. the EFTPOS system, the debit card reforms initially led to an increase in merchant service fees as acquir- ers sought to recover some of their lost fee revenue. 105 East & Partners (2012), “Australian Merchant Acquiring and Cards Markets: Special Question Placement Report prepared for the Reserve Bank of Australia”, June. DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY 81 Graph 4 However, while merchants that apply surcharges are becoming increasingly commonplace, consumers ap- pear to respond to the price signals by avoiding sur- charges where possible. According to the Reserve Bank’s 2010 Consumer Payments Use Study, consum- ers paid a surcharge on just 5 per cent of their credit card transactions over the one-week diary period, with this proportion little changed from a similar study conducted in 2007 despite the greater prevalence of surcharging. Annex IV 82 DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY Annex 5: Key Elements of a Strategic National Payment Systems Development Plan (from CPSS “General Guidance for National Payment System Development, January 2006”) The CPSS “General Guidance for National Payment • A description of: the procedures for ongoing co- Systems Development” report states six key elements operation and coordination among the relevant of a NPS development plan. These are presented below: stakeholders; the processes for resolving con- flicts and disputes that arise during program im- plementation and thereafter; and the procedures Components of a Strategic Development Plan for communicating progress and achievement over the implementation period. • A vision of a desired end state over the planning horizon that articulates the consensus view of key stakeholder groups regarding the high-level objectives, guiding principles, properties, bene- fits, risks and costs of the future payment system. • A statement of the roles, commitments and re- sponsibilities of the key public and private sector stakeholders in the development process. • Observable milestones that can be measured against critical and objective success factors. • A presentation of the conceptual design of the planned infrastructure for retail payments sys- tems, which could include the relation to the ex- isting system with reference to its structure, key characteristics, functionality, and potential for further expansion and re-engineering as future financial developments warrant. • A statement of the implementation strategies, which includes the specific implementation pri- orities and procedures, along with timelines, budgetary allocations and financing schemes, critical milestones, and observable measures of achievement for public progress reports. DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY 83 Annex 6: SADC’s Guide to Developing a Strategic Framework for Payment System Modernization106 The Guide to Developing a Strategic Framework for Payment System Modernization, was developed by the South African Development Committee (SADC), Payment System Project Team with the following ob- jectives: to provide developing countries with a system- atic approach to modernizing their national payment systems (NPS); and to serve as a means of enhancing payment system skills in developing countries. The guide identifies that NPS reform should be seen from multiple perspectives, follow a strategic process for reform and be supported by various support struc- tures. These three dimensions are depicted in the be- low figure. The SADC guide further discusses three methodolo- gies for implementation: immediate attention in the current NPS. Funds and ef- fort are expended on enhancing the efficiency of the Pure strategic approach: The pure strategic approach current system. At worst, this approach may even lead focuses on the future by designing the ideal NPS. The to the automation of a manual system, without first approach assumes that everything is possible and that considering users’ needs and requirements. there are no constraints or limitations. Problems in the current NPS are not allowed to influence the design of The guide states that the three approaches are not mu- the ideal system. This approach is often referred to as tually exclusive, and that a country can: i) use the stra- a “blank paper” or “blue sky” approach. There are no tegic approach to address the present and future needs fixed checklists, guidelines, or models. of all NPS users by identifying the characteristics and critical success factors of the ideal NPS; ii) use the Model-based approach: The model-based approach model-based approach to learn from other countries investigates the modernization models adopted by with systems similar to the envisaged NPS, or; iii) use other countries. A fact-finding team will generally the operational approach to resolve the most serious visit different countries to learn from their experi- problems in the current NPS so that the system can ences. Models from different countries are collected meet the minimum user requirements of timeliness, and studied, demographic features of different coun- security and reliability; tries are analyzed, and the most compatible model is adopted and adapted for local circumstances. Combining these three approaches in this manner en- sures that the most pressing problems in the current Operational approach: The operational approach is NPS are resolved in a time-bound manner and that driven by the desire to resolve problems that require the envisaged NPS takes into account the unique con- 106 SADC 2002. Annex VI 84 DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY ditions, circumstances and requirements of the local environment. In this way the envisaged NPS will not be unduly influenced by inappropriate external mod- els. Short-term problems are therefore resolved within a long-term vision of the NPS and the modernization process is not derailed through short-term expediency. DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY 85 Annex 7: M-PESA in a Nut shell107 M-PESA was developed by mobile phone operator foregone interest is paid into a not-for-profit trust fund Vodafone and launched commercially by its Kenyan controlled by Safaricom (the purpose of these funds affiliate Safaricom in March 2007. M-PESA (“M” for has not yet been decided).108 mobile and “PESA” for money in Swahili) is an elec- tronic payment and store-of-value system that is ac- In their working paper, “Mobile Money: The cessible through mobile phones. To access the service, Economics of M-PESA.” William and Suri,109 estimat- customers must first register at an authorized M-PESA ed that M‐PESA had reached nearly 40 percent of the retail outlet. They are then assigned an individual elec- adult population in Kenya after a little more than two tronic money account that is linked to their phone years of operation, and that now, approaching only number and accessible through a SIM card-resident the fourth anniversary of its launch, it is used by more application on the mobile phone. Customers can de- than two‐thirds of households. Part of this success is posit and withdraw cash to/from their accounts by ex- due to a rapidly expanding network of M‐PESA agents, changing cash for electronic value at a network of re- who now number over 23,000. tail stores (often referred to as agents). These stores are paid a fee by Safaricom each time they exchange these two forms of liquidity on behalf of customers. Once customers have money in their accounts, they can use their phones to transfer funds to other M-PESA users and even to non-registered users, pay bills, and pur- chase mobile airtime credit. All transactions are autho- rized and recorded in real time using secure SMS, and are capped at $500. Customer registration and deposits are free. Customers then pay a flat fee of around US$0.40 for person-to- person (P2P) transfers and bill payments, US$0.33 for withdrawals (for transactions less than US$33), and US$0.13 for balance inquiries. Individual customer ac- counts are maintained in a server that is owned and managed by Vodafone, but Safaricom deposits the full value of its customers’ balances on the system in pooled accounts in two regulated banks. Thus, Safaricom is- sues and manages the M-PESA accounts, but the value in the accounts is fully backed by highly liquid deposits at commercial banks. Customers are not paid interest on the balance in their M-PESA accounts. Instead, the 108 For more detailed accounts of the M-PESA service, see Hughes and Lonie (2009) for a historical account, Mas and Morawczynski (2009) for a fuller descrip- tion of the service, and Mas and Ng’weno (2009) for the latest accomplishments of M-PESA. 107 Mas and Radcliffe 2010. 109 William and Suri 2011. Annex VII 86 DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY Annex 8: Glossary The following list of terms is not exhaustive; only the most relevant terms used throughout this report are defined. Some of the definitions were taken directly from the CPSS Glossary.110 In some cases, the definition provided in that Glossary was adapted (those terms are marked with “*”). Terms not included in the CPSS Glossary, or terms that have a different meaning in other contexts and which are relevant for the purposes of this report are also defined herewith. Term Definition 3D-Secure An XML-based protocol used as an added layer of security for online credit and debit card transactions. This enables multi-factor authentication even for transactions where the issuer and acquirer are different institutions. It was devel- oped by Visa to improve the security of Internet payments and is offered to customers as the “Verified by Visa” service. Services based on the protocol have also been adopted by MasterCard, under the name MasterCard SecureCode, by JCB International as J/Secure, and by American Express as SafeKey. Acquirer The entity or entities that provide services to the card acceptors (merchants) related to, clearing and settlement of the accepted transactions. In general the services include receiving and processing the data relating to the transaction for authorization, clearing and settlement, though some provide only services for only clearing and settlement. Some ac- quirers also hold(s) deposit accounts for card acceptors (merchants). . Agents An entity that provides certain retail payment services on behalf of a retail payment services provider. The type of ser- vice provided by the agent could vary from direct processing of transactions like disbursing cash or accepting deposits, to ancillary non-transaction related services like collection of documents or addressing customer service queries, among others. Authorization The process of receiving and recording the issuers’ confirmation of accepting the liability for a transaction. Typically associated with card payments. Authorization is typically processed through the exchange of messages between the initiator and the issuer of payment instrument being used. See also offline authorization. Automated Clearing An electronic clearing system in which payment orders are exchanged among financial institutions, primarily via mag- House (ACH)* netic media or telecommunications networks, and then cleared amongst the participants. All operations are handled by a data processing center. An ACH typically clears credit transfers and debit transfers, and in some cases also cheques. See also clearing/clearance. Automated Teller An electromechanical device that permits authorized users, typically using machine-readable payment cards, to with- Machine (ATM) draw cash from their accounts and/or access other services such as balance inquiries, transfer of funds, or acceptance of deposits. ATMs may be operated either online with real-time access to an authorization database or offline. Automated Transfer An integrated payment system that combines Real-Time Gross Settlement and ACH-style deferred net settlements into System (ATS) one common platform. Bilateral Netting An arrangement between two parties to net their bilateral obligations. The obligations covered by the arrangement may arise from financial contracts, transfers or both. See also Multilateral Netting. 110 CPSS 2003(b). DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY 87 Term Definition Business An entity that provides direct transaction services on behalf of a principal, typically a bank. The transaction services Correspondent include cash withdrawal and deposit from/into an account maintained with the principal, loan disbursements, loan re- payment, bill payment services, etc. In many countries, agents and business correspondents are used interchangeably. See also agents. Card payment Payment transactions using payment cards as the payment instrument. Charge Card* A type of payment card indicating that the holder has been granted a line of credit. It enables him to make purchases but does not offer extended credit, the full amount of the debt incurred having to be settled at the end of a specified period. The holder is usually charged an annual fee. Also called Travel and Entertainment card. Cheque A written order from one party (the drawer) to another (the drawee, normally a bank) requiring the drawee to pay a specified sum on demand to the drawer or to a third party specified by the drawer. Cheques may be used for settling debts and withdrawing money from banks. Referred to as Check in some countries. See also bill of exchange. Cheque Truncation Process of replacing the exchange of paper cheques as part of the clearing process with exchange of their images or digital substitutes instead. Chip Card* Also known as an IC (integrated circuit) card. A card containing one or more computer chips or integrated circuits for identification, data storage and/or special purpose processing used to validate personal identification numbers (PINs), authorize purchases, verify account balances and store personal records. In some cases, the memory in the card is updated every time the card is used (e.g. account balance is updated). Clearing / Clearance The process of transmitting, reconciling and, in some cases, confirming payment orders or security transfer instructions prior to settlement, possibly including the netting of instructions and the establishment of final positions for settlement. Sometimes the term is used (imprecisely) to include settlement. Clearinghouse A central location or central processing mechanism through which financial institutions agree to exchange payment instructions or other financial obligations (e.g. securities). The institutions settle for items exchanged at a designated time based on the rules and procedures of the clearinghouse. In some cases, the clearinghouse may assume significant counterparty, financial, or risk management responsibilities for the clearing system. See also clearing/clearance. Contactless card* Payment card where the IC chip bearing account details can be read by a suitable proximate card reading terminal without requiring physical contact. Correspondent The entity holding accounts of another institution for providing payments and other services to that institution. See also correspondent banking and business correspondent. Correspondent An arrangement under which one bank (correspondent) holds deposits owned by other banks (respondents) and Banking provides payment and other services to those respondent banks. Such arrangements may also be known as agency relationships in some domestic contexts. In international banking, balances held for a foreign respondent bank may be used to settle foreign exchange transactions. Reciprocal correspondent banking relationships may involve the use of so-called nostro and vostro accounts to settle foreign exchange transactions. Annex VIII 88 DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY Terms Definition A type of payment card, indicating that the holder has been granted a line of credit. It enables the holder to make pur- chases and/or withdraw cash up to a prearranged ceiling; the credit granted can be settled in full by the end of a speci- Credit Card* fied period or can be settled in part, with the balance taken as extended credit. Interest is charged on the amount of any extended credit and the holder is sometimes charged an annual fee. See also Payment Card, Charge Card, Prepaid Card and Debit Card. A payment order or possibly a sequence of payment orders made for the purpose of placing funds at the disposal of the beneficiary. Both the payment instructions and the funds described therein move from the bank of the payer/originator Credit Transfer to the bank of the beneficiary, possibly via several other banks as intermediaries and/or more than one credit transfer system. Cross-Platform A situation of full interoperability. See interoperability. Interoperability Payment card where the funds are debited in full for every transaction. Some issuers of debit cards could provide an Debit Card overdraft feature, allowing the payer to use the card even without sufficient balance in the underlying account. A payment order or possibly a sequence of payment orders made for the purpose of collecting funds from the payer and Debit Transfer placing at the disposal of the payee. The payment instructions move from the bank of the payee/originator to the bank of the payer, possibly via several other banks as intermediaries and/or more than one debit transfer system. Electronic Funds Another term for an Automated Clearinghouse, but unlike an ACH could also be for clearing of payments within an insti- Transfer system tution. Electronic Purse / Same as Electronic wallet. ePurse* E-Money product, where the record of funds is stored on a particular device, typically in an IC chip on a card or mobile Electronic Wallet* phone. E-money is a record of funds or value available to a consumer stored on a payment device such as chip, prepaid cards, mobile phones or on computer systems as a non-traditional account with a banking or non-banking entity. E-Money E-Money* products are further differentiated into network money, M-Money, electronic purse, electronic wallet and network money. Payment instructions that enter a payments system via the Internet or other telecommunications network. The device used to initiate the payment could be a computer, mobile phone, POS device, or any other device. The payment instru- E-Payments ment used could be an E-money product, payment card product, credit/debit transfer or other innovative payment products. The availability of basic financial products to meet the payment, savings, credit, insurance and investment needs of a Financial Inclusion society at a reasonable cost. DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY 89 Terms Definition Infrastructure-level A situation where the infrastructure is fully interoperable in terms of being able to accept payment instruments of other Interoperability schemes. See also Interoperability In general terms, these products involve the payer maintaining a pre-funded account with an institution, not necessarily a banking or financial institution and drawing down this pre-funded account to make payments to participating payees Innovative payment and person-to-person transfers through a network of business correspondents, at participating merchants, or through products conventional retail payments infrastructure such as ATM and POS terminals. The payment instruction to draw down the pre-paid funds could be initiated through the Internet, mobile phone, or specific payment cards issued for this purpose. E-Money products are one type of innovative payment products. Banking services that customers may access via the Internet. The access to the Internet could be through a computer, Internet Banking mobile phone, or any other suitable device. A type of E Payment. Payment instructions which enter the payment system via the Internet. The device used to initiate Internet payment the payment could be a computer, mobile phone or any other device. The payment instrument used could be an E- Money product, payment card product, or direct credit transfer, among others. A situation in which payment instruments belonging to a given scheme may be used in platforms developed by other Interoperability schemes, including in different countries. Interoperability requires technical compatibility between systems, but can only take effect where commercial agreements have been concluded between the schemes concerned. Institution that issues the payment instrument. Typically used to refer to the institution issuing a payment card or E- Issuer* money instrument. Payments, generally of very large amounts, which are mainly exchanged between banks or between participants of Large-value Payment financial markets and that usually require urgent and timely settlement. Mobile Payments A type of E-Payment, where the payment instrument used is an M-Money product. Also known as M-Payment. E-money product where the record of funds is stored on the mobile phone or a central computer system, and which Mobile Money can be drawn down through specific payment instructions to be issued from the bearers’ mobile phone. Also known as M-Money. Authentication mechanisms typically use a combination of three factors to ensure that the person participating in a transaction is the person who he claims to be. These factors are: i) something a person has, such as a payment card; ii) something a person knows, for example a password, PIN number, token, etc.; and, iii) something a person is, typically a Multi-Factor biometric information like fingerprint, but could also be non-biometric like keystroke patterns. Authentication systems Authentication that use more than one of these factors are called multi-factor authentication systems. Those that use two—something a person has and something a person knows—are specifically referred to as two-factor authentication mechanisms. It needs to be noted that in some contexts, inclusion of out-of-band authentication could also constitute multi-factor authentication. Annex VIII 90 DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY Terms Definition An arrangement among three or more parties to net their obligations. The obligations covered by the arrangement may Multilateral Netting arise from financial contracts, transfers or both. Multilateral netting of payment obligations normally takes place in the context of a multilateral net settlement system. See also Bilateral Netting. An agreed offsetting of positions or obligations by trading partners or participants. Netting reduces a large number of Netting individual positions or obligations to a smaller number of obligations or positions. Netting may take several forms that have varying degrees of legal enforceability in the event of default of one of the parties. Network Money E-money that is transferred via telecommunications networks such as Internet. Authorization processed by exchanging financial messages between a card reader and chip card without exchange of Offline Authorization online financial messages with the issuer of the card. See also Authorization. Payment transaction using a standard banking account, with the transaction being authorized by the payer’s bank at Online Banking- the time of transaction, typically through introducing a standard Internet banking authentication as part of the payment enabled Payment transaction. In general, in this step the payer’s institution also provides an authorization and a commitment to honor a (OBeP) subsequent direct debit for this or alternatively committing to process a credit transfer. The payment transaction is then processed as a direct debit from the payer’s account or a credit transfer by the payer’s bank. Authentication mechanisms where a different channel than the one used for the transaction is used to conduct au- thentication or in some cases to conduct an additional authentication. For example, in an Internet banking transaction, Out-of-band sending a one-time password to a person’s mobile phone and requiring that password to be entered for completion of Authentication the transaction; or, in the course of a mobile phone-initiated transaction, triggering an automated call to the persons registered landline phone and seeking confirmation of the transaction. Paper-based Payment instruments that require physical exchange between payer and payee and also require manual clearing. Instruments Payment product where the payer is provided with a physical card with required account information encoded in a magnetic stripe and/or on an embedded IC chip. The information on the magnetic stripe or IC chip being read/accessed Payment Card by an appropriate device of the payee triggers an authorization request to ensure availability of funds in the payers account. Cards issued by retailers for use within their premises or at a limited set of locations are not included in this definition. Payment Card A company that owns trademarks of payment cards (credit, debit or prepaid cards) and may also provide a number of Company marketing, processing or other services to institutions issuing its cards. Also called card company. DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY 91 Terms Definition A payment card switch is defined as a mechanism that connects various institutions allowing interchange of payment cards transactions of participating institution cardholders at other participating institution merchants, ATMs and other card acceptance devices. A payment card switch is typically used for routing authorization and authentication-related messages between participating institutions, and can also generate and distribute clearing and settlement files. In some settings, the individual institutions could themselves have payment card switches to connect their own ATMs and POS Payment Card Switch terminals to their own internal card processing systems, and these payment card switches are then connected to a central inter-institution payment card switch. Payment card switches are also beginning to be used for processing of card transactions initiated through other channels like internet and mobile phones. This is often used interchangeably with payment card network but there are important differences. A switch in general refers to the technical infrastructure whereas a payment card network encompasses operational arrangements, payment products, rules, procedures, ac- ceptance brands etc. and essentially is a payment system. Also referred to as switch or payment switch. An order or message to transfer funds (in the form of a monetary claim on a party) to the order of the beneficiary. The Payment Instruction order may relate either to a credit transfer or to a debit transfer. A payments system that connects various member institutions enabling interoperability of payment instruments issued by a member at other members’ acceptance infrastructure. Commonly used to refer to payment card systems like Visa Payment Network and Master Card. This is at times used interchangeably with Payment Card Switch or Switch, but there are important differences, please see the definition of Payment Card Switch for a description of the differences. Payment Order Same as payment instruction. This term refers to the use of payment cards at a retail location (point of sale). The payment information is captured either by paper vouchers or by electronic terminals, which in some cases are designed also to transmit the information. Where this is so, the arrangement may be referred to as “electronic funds transfer at the point of sale” (EFTPOS). In the POS Terminal* latter case, the terminal reads the account information from a payment card’s magnetic stripe and/or embedded IC chip and in some cases also accept cardholders PIN entry; prepares a transaction authorization request based on transac- tion; transmits the authorization request to the acquiring institution; receives the authorization response; displays trans- action completion status; and prints a transaction record. Prepaid card Payment card provided in exchange of prior deposit of funds specifically for use through this card product. Real Time Gross The continuous (real-time) settlement of funds or securities transfers individually on an order-by-order basis (without Settlement netting). A payment that meets at least one of the following characteristics; (i) the payment is not directly related to a financial market transaction; (ii) the settlement is not time-critical; (iii) the payer, the payee, or both are individuals or non-finan- Retail Payment* cial organizations; and (iv) either the payer, the payee ,or both are not direct participants in the payments system that is processing the payment. This definition of retail payment includes person-to-person, person-to-business, business-to- person, business-to-business, person/business-to-government, and government-to-person/business payments. Annex VIII 92 DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY Terms Definition A system comprising the technical infrastructure, participants, instruments, arrangements for clearing and settlement, Retail Payments business relationship arrangements such as bank-customer relationships, rules, procedures, the applicable legal System framework, and governance arrangements that, put together, provide the overall environment within which retail pay- ments are posted, authorized, processed, cleared, and settled. Settlement An act that discharges obligations in respect of funds or securities transfers between two or more parties. Stored-value cards are a type of E-Money product that do not involve a deposit of funds into an account. Rather, the Stored-value Card* prepaid value is instead stored directly on the card in the embedded IC chip. E-Money products which employ specialized software on a chip card, mobile phone or any other personal computing Stored-value Product device and which can typically be used to transfer electronic value via telecommunications networks, Internet, or using technologies like Near Field Communication (NFC), RFID, Bluetooth etc. Time-critical payment A payment transaction that needs to be executed by a specified time. Two-Factor See Multi-factor Authentication. Authentication DEVELOPING A COMPREHENSIVE NATIONAL RETAIL PAYMENTS STRATEGY 93 Annex 9: References Armstrong, M. 2008. “Interactions between Competition and Consumer Policy.” Competition Policy International, Volume 4, Number 1. Bergman, M. A. 2005. “A welfare ranking of two-sided market regimes.” Working Paper Series 185, Sveriges Riksbank. Bossone, B and M. Cirasino. 2001. “The Oversight of payment systems: a framework for the development and governance of payment systems in emerging economies.” Bradford.T, 2007. 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