Strategic Review of Innovation in the Payments System: Conclusions – June 2012
3. Potential Gaps in the Payments System
With the above discussion as background, the Board has identified several areas where it considers there to be existing or potential gaps that need to be addressed for the payments system to continue to adequately meet the needs of end users over the medium term. These are set out in this section. In most cases, these gaps are not new; they have been well known and understood by the payments industry for some time. The task for the Board and the industry is now to find ways in which they can be addressed.
3.1 Real-time Payments
The ability of individuals, government agencies and businesses to make retail payments, with the recipient having visibility and use of those funds in near to real time, is an objective that seems likely to become more pressing. Indeed, one of the key trends identified by the CPSS Working Group on Innovations in Retail Payments was an increased focus globally on speeding up payment processing through faster settlement or payment initiation.
The capacity for real-time retail payments could be used by government agencies to make emergency payments, by individuals to make personal payments and potentially by businesses to make better use of cash balances. Some financial institutions have recently been promoting various elements of real-time payments, including the capacity to make real-time mobile payments to customers of the same bank. To the extent that this is valued by customers, it makes sense that this type of functionality should be available across financial institutions. Some institutions are also now promoting the faster availability of funds to merchants.
The Summary of Consultation paper dealt with the various elements that contribute to real-time payments. These are set out below.
(i) Timing of clearing
Clearing is the exchange of payment instructions between payment system participants. The timing of this activity is important and varies depending on the payment instrument used. In the DE system, payment instructions are batched and exchanged in bulk files between system participants at established intervals. Currently this occurs five times a day, although the largest share of payments occurs late in the day and is processed overnight. These discrete intervals prevent the timely crediting/debiting of funds because the recipient financial institution (for a direct credit) is unaware of the payment until the files are exchanged. Card payment systems, however, are based on real-time clearing, with separate messages exchanged for each payment. Payment instructions are exchanged between the merchant's bank and the cardholder's bank in real-time, confirming that funds or sufficient credit are available before a message is returned to authorise the payment.
(ii) Timing of funds availability in banks' systems
The receipt of payment instructions does not necessarily dictate the timing of funds availability to the recipient of the payment. Historically, funds have not been available until the following business day, although with improvements in financial institutions' systems, within-day availability is becoming more common and a point of competition between institutions. The time it takes the sending institution to submit a payment instruction to another institution is clearly also an important factor.
(iii) Timing of settlement
Traditionally, the availability of funds to the recipient has in many cases been linked to the settlement of funds between financial institutions. The latter has historically occurred on the business day following payment clearing, so that interbank settlement and funds availability were often closely linked in time. With the trend towards within-day availability of funds, funds availability is moving ahead of interbank settlement, meaning that some financial institutions are providing credit to the funds recipient until interbank settlement occurs. This introduces a risk that the paying institution does not settle, or does not settle on time, even though the funds have already been credited to the receiving institution's customers. This risk is most relevant to the DE system, where some high-value payments are sent in preference to using real-time gross settlement (RTGS).
There can also be a lag between interbank settlement and funds availability for the customer. For instance, even in the existing high-value RTGS system, there can be significant disparities in the delay between interbank settlement and funds availability to the customer, with no industry obligation to make funds available earlier than the next day. Lags of this type could reduce the effectiveness of a system that allowed faster interbank settlement of real-time retail transactions.
Given these different aspects of payment timing, there are various ways in which faster retail payments can occur. One partial approach being explored in Australia at the moment is the settlement of DE files when they are exchanged. This would mean that funds could be made available to the recipient soon after the exchange (if the institutions' systems are capable), without the institution taking on credit risk. The industry is currently working towards settling three of the five daily file exchanges in this way, though this does not cover the bulk of the value processed through the DE system. The Board believes that same-day settlement should be extended to all DE exchanges. However, even if settlement occurs with each exchange and funds are made available to the customer immediately, there would typically still be a delay of some hours between initiation of the payment and funds availability because payment instructions are exchanged in batches. Real-time clearing of payment instructions is a necessary condition for real-time payments.
The approach taken in some other systems, including the Faster Payments Service in the United Kingdom, is to provide real-time payments via a combination of real-time clearing, several intraday settlements and the provision of credit by receiving institutions between settlement periods.
Box A: Overseas Systems for Achieving Timely Retail Payments
A number of retail payment systems have been introduced in recent years (or existing systems reformed) to allow funds to be accessed in a more timely fashion by recipients, in some cases within minutes, if not seconds.
Some systems have facilitated this by making funds available before interbank settlement. Typically, the system will also introduce measures to mitigate interbank credit risk. For example, the UK's Faster Payments Service (FPS), Japan's Zengin system and Korea's Electronic Banking System use net debit caps, which limit each participant's net debit position during a clearing session, and have loss-sharing arrangements backed by collateral. Some systems, such as the FPS and South Africa's Real-time Clearing (RTC) system, place upper limits on the value of individual transactions.
Another means of achieving more timely payments has been to increase the frequency of interbank settlements. In systems that do not provide funds before interbank settlement, such as India's National Electronic Funds Transfer system, more frequent interbank settlement gives recipients faster access to transferred funds. In systems that provide funds before interbank settlement, such as the FPS, more frequent settlement reduces the extent to which interbank credit risk can accumulate. In addition, some countries, such as Mexico and Switzerland, use their high-value interbank payment system to process retail payments. In these systems, recipients have very fast access to transferred funds without interbank credit risk.
3.2 Payments Out of Hours
As noted above, it is desirable that the payments system be available when and where needed by users. There is little doubt that accessibility has increased greatly in Australia over recent decades, starting with the introduction of ATMs and more widespread availability of card payments in the 1970s and 1980s. In 1997, BPAY provided consumers with a means of paying bills out of normal banking hours, initially by phone, and more recently internet banking has enabled consumers to relatively easily initiate BPAY and ‘pay anyone’ payments at any time of day. Some card payments can easily be made from a consumer's home via the internet, albeit with a trade-off in security. The widespread adoption of smartphones means that constraints on the physical location where electronic transactions can be initiated have also been eased.
In the Board's view, the one area of accessibility that is clearly lagging is the availability of low-value payment systems out of hours, particularly during weekends and public holidays. Elements of some systems continue to operate during these times; for instance, the clearing of card payments continues to operate, consumers can initiate ‘pay anyone’ or BPAY payments via online or phone banking, and of course ATMs continue to operate. However, the systems used for the exchange of non-card payment instructions between institutions do not generally operate on weekends, meaning that no DE files are exchanged between banks and no interbank settlement occurs. Banks' accounting systems also do not generally recognise weekends for account posting purposes. Together, these factors mean that the recipient of a DE payment initiated after a bank's cut-off time on a Friday night might not receive those funds until Tuesday. The same might be true for a merchant accepting a payment via eftpos on a Friday night. These delays are of course longer during long weekends.
Some financial institutions have recently begun to settle funds to merchants seven days a week for eftpos transactions. While this is a positive development for merchants, as discussed in the previous section, it is only possible through the provision of credit, given that interbank settlement does not occur until later. This implies an increase, albeit modest, in risk. It also has implications for competition because some participants in the payments system do not have a balance sheet that would allow them to easily extend credit.
The Board considers that this situation is out of step with broader developments in our society and economy, where more and more services are expected to be available seven days a week. Such trends are likely to continue and the retail payments system should be able to support them. The posting of DE payments ought to be possible over weekends and public holidays and merchants' access to the proceeds of card payments would sensibly also be available. Of course any real-time retail payments system, as discussed in the previous section, would be expected to be available continuously. While these types of outcomes have been achieved overseas without requiring interbank settlement during weekends, the Board's view is any solution should be competitively neutral. The Reserve Bank will enhance its RTGS system – the Reserve Bank Information and Transfer System (RITS) – to extend interbank settlement capability as required to support these initiatives.
Some submissions in response to the Issues for Consultation paper have outlined a number of complexities that might result from extended operation of payments systems, including for instance the effect on available maintenance and housekeeping times for financial institutions. These and no doubt other issues would need to be worked through with the industry, but the Board does not anticipate any insurmountable constraints on achieving this objective.
Box B: Extended Availability of Payment Systems
Some real-time retail payment systems, such as the UK's Faster Payments Service (FPS), South Africa's Real-time Clearing (RTC) system, Korea's Electronic Banking System (EBS) and Canada's Interac e-Transfer system, can be used to initiate transactions and make funds available to the recipient 24 hours a day. In these systems, recipients can access funds from transactions whether or not the interbank settlement system is operating. As discussed in Box A, systems use a variety of risk-management techniques to manage interbank credit risk, including net debit caps and transaction limits. The RTC system has an additional safeguard of applying lower transaction limits when the interbank settlement system is not operating.
3.3 Transmission of Data with Payments
The Board considers that providing the capacity to carry additional remittance information with payments could result in a significant improvement to business efficiency. This aligns with the ‘ease of integration’ attribute above.
As discussed in earlier documents from the Strategic Review, this issue is most readily applicable to the DE system, which is the principal business payment system, although there is no reason that other systems could not seek to meet a similar need. DE messages can currently carry a maximum of 18 characters of additional remittance data with the payment message. This is insufficient for many business purposes, and can also be a constraint for personal use. Businesses might for instance wish to incorporate detailed information about an invoice, for example an indication of which items on the invoice are being paid.
In the absence of a solution to this issue, businesses use other payment methods, predominantly cheques, because they can be accompanied by an unlimited quantity of data in paper form. Alternatively, many businesses separate the payment and the remittance information and these must be reconciled at some cost at a later time.
Potential solutions to allow provision of basic remittance information with payments are set out below. One is to adopt payment messages that allow additional data to be incorporated. ISO 20022 message standards, which provide the flexibility to incorporate a significant quantity of data, are being adopted in many countries around the world and there is a general presumption that they would be considered for any new system. The Australian Payments Clearing Association (APCA) has set out a schema for use with domestic systems
A second option is to handle remittance data separately, but provide a short reference to those data in the message itself, so it can be accessed by the message recipient. This has the advantage that very large quantities of data or other information, such as copies of invoices (i.e. beyond basic remittance information) can also be handled without placing additional loads on the payments system or requiring financial institutions to store and forward this bulky information.
A key problem faced by the Australian system is the starting point. The DE system is very well established, inexpensive and ingrained in business systems. Altering the system to carry additional remittance data could be expensive for both financial institutions and businesses alike, but the additional functionality provided would be of benefit for only a subset of payments. Several approaches for DE payments are possible:
- Incorporating references in the existing 18 character reference field to an external location where a larger quantity of data (potentially over and above basic remittance information) can be stored. This is minimally disruptive and is already being provided on a proprietary basis for some types of payments.
- Establishing of a separate system/clearing stream that would use ISO 20022 messages containing fields for basic remittance information, over and above the basic 18 characters available through the existing DE system. Requirements for larger amounts of remittance information (e.g. copies of invoices) would need to be met by use of external information warehouses.
- Providing a service that could translate between existing DE messages and an ISO message standard incorporating additional data.
These options are not mutually exclusive and given entrenched use of DE, it is probable that progress on this matter may require elements of each, with significant consideration to be given to the migration strategy. The barriers to innovation are typically lower when participants and users can opt-in at a time that suits their needs, although this might make it more difficult to exploit network effects. Staggered migration would be possible in each case, but complexity would be increased by the need for system users to know which parties are capable of sending and receiving enhanced remittance information. Migration to a new ISO 20022 payment message standard would be assisted by provision of a translation service.
An alternative or complementary approach might be to provide the richer data capabilities as part of a new real-time retail payment system. The DE system would continue to service payments that are sensibly batched and require less remittance information. As noted later in this paper, it will be important to maintain investment in this important payment system.
Box C: ISO 20022 Overseas
ISO 20022 messages are increasingly being adopted in retail payment systems overseas. The European Payments Council uses ISO 20022 messages for the Single European Payments Area (SEPA) project; it will be required for all direct debit and credit transfer systems in the coming years as a part of regulations imposed by European legislators. ISO 20022 messages have been an option in Japan's Zengin system since November 2011. Canada, Singapore, Sweden and Switzerland, amongst others, are considering the use of ISO 20022 in upgrading existing retail systems or as the basis for new systems. The International Payments Framework Association is using ISO 20022 to support interoperability of retail payment systems to initiate cross-border payments.
3.4 Addressing of Payments
A key element determining the ease of use of a payment system is the process by which the payee's details are provided by the payer. Currently, in order for a payment to be made into a bank account, the payee's BSB number and account number must be provided. In many cases, individuals will not remember these details themselves and in other cases individuals are reluctant to provide them because they are concerned that they might somehow be used fraudulently. The need to correctly enter up to 15 digits is a further problem. Errors are easily made and the consequences can be uncertain. It is likely that these concerns are the reason that some people are reluctant to make electronic payments and have resulted in significant costs in dealing with payments that have been made incorrectly. The Board therefore believes that an easier means of addressing payments could improve the efficiency of the payments system. It may also have a by-product of increasing competition in the provision of financial services to the extent that it makes it easier for customers to switch accounts between financial institutions.
While other solutions might be possible, one approach to simplifying addressing is to use an identifier – for instance a phone number – that can be associated in a database with a person's full account details. Such a database would most likely be held centrally, although conceptually it could be replicated across multiple financial institutions. There are precedents for both approaches in phone carrier switching arrangements, but the use of a central database associated with a hub is likely to be more efficient. Security considerations would be very important in the design and operation of any account identifier system.
In broad terms the BPAY system uses an approach similar to that above to allow payment to billers via a six digit biller code. The collapsed MAMBO project would have extended this approach to a much wider range of users.
Box D: Addressing Payments in Other Countries
A number of other countries have implemented systems for easier addressing of payments between bank accounts. For instance, VocaLink is constructing a central database (expected to be completed by the end of 2012) to allow UK consumers who are registered to the service to use mobile phone numbers to address person-to-person payments through the Faster Payments Service or LINK. In the US, clearXchange (a joint venture between several banks) allows person-to-person payments from existing bank accounts at participating institutions using only the recipient's mobile phone number or email address; funds move through the automated clearinghouse system. In India, the Interbank Mobile Payment Service uses a unique identifier, similar to a BPAY code, to link a customer's bank account number to their mobile phone number to facilitate payments through a mobile application or SMS.
3.5 The Way Forward
The Payments System Board considers that the payments industry should be aspiring to address the above four areas over the coming years. It therefore believes that finding solutions to the above gaps should form the basis of an initial set of industry strategic objectives. This will be discussed further in Section 5.
3.6 Other Issues
Many other issues have been discussed during the course of the Strategic Review. Not all can be addressed here and the fact that many have not been does not mean that these are not of interest to the Board. It is to be hoped that the processes established as a result of this Review will provide an avenue to address some of these issues in the future if they become pressing.
There were, however, three issues that had some prominence during the Review, for which no specific additional action by the Bank is proposed – cheques, standards and mobile payments. The Board's conclusions on these issues are set out briefly below.
The Board's consideration of cheques has occurred in parallel with an industry debate on the future of cheques. This debate has covered approaches to declining cheque use that range from naming a date when cheque clearing would cease to making cheque processing more efficient so that the system is sustainable at lower cheque volumes. The debate has moved relatively quickly and the industry is actively pursuing the latter course, along with measures to promote adoption of electronic alternatives to cheques. Details are provided in ‘The Decline of Cheques: Building a Bridge to the Digital Economy’, published by APCA in May 2012. The Board supports this approach given that cheques currently provide some features that are not well replicated in electronic systems, such as ease of addressing. The Board believes that the initiatives discussed in this paper will help electronic payments to bridge that gap.
The adoption of international standards is beneficial to efficiency through the compatibility and interoperability it provides. Standards can cover a number of areas, but the main focus during the Review has been message standards, and in particular the ISO 20022 framework being increasingly adopted internationally. The Board believes that there is now widespread acceptance that any new system should be based on the ISO 20022 framework and supports this presumption.
As discussed in Section 4, the Reserve Bank could provide functionality that may assist migration of DE payments to an ISO 20022 compliant standard.
3.6.3 Mobile payments
The previous papers discussed different models of mobile payments, postulating that in Australia mobile internet and near-field communication (NFC) would be the main channels used for retail payments. While the industry has yet to coalesce around a specific model for providing NFC-based payments, no strong case has been made to the Bank that any intervention is appropriate.
Mobile internet payments are likely to take many paths, with some innovative offerings that provide a much richer interaction between the merchant and the customer already starting to emerge. The Board's key focus is to seek to ensure that the underlying infrastructure of the payments system best supports future innovative products. This includes providing the capacity for real-time retail payments, the transmission of larger quantities of data, and systems for simplifying addressing of payments.
3.7 A Note on MAMBO
The approach taken in this paper will inevitably draw comparisons with ‘Project MAMBO’ which was being developed by the major banks and BPAY until mid 2011. MAMBO had the potential to offer a number of features that have been supported in this document. That does not necessarily mean that MAMBO was the ‘right’ solution nor that the banks were mistaken in withdrawing from the project. It does however illustrate the difficulties with cooperative innovation and building a commercial model that appeals to all players for a major investment project. It is quite possible that benefits similar to those delivered by MAMBO might have been provided at less cost if delivered in a different way, perhaps by different systems. It is also possible that a different business model might be required, or perhaps that such central services are best provided as a utility, rather than on a commercial basis.
- Bank for International Settlements Committee on Payment and Settlement Systems (2012), ‘Innovations in Retail Payments, Report of the Working Group on Innovations in Retail Payments’, May.
- The DE system is the system used predominantly for the exchange of batch or bulk payment files. This may include salary, welfare or dividend credits or direct debits for bill payments. Internet banking transfers are typically also processed through the DE system. Files are exchanged between institutions five times per day (or less frequently, depending on whether an institution uses an agent for file exchanges with payment system participants), with interbank settlement currently occurring the following morning.