Speech The Path to Innovation in Payments Infrastructure in Australia
Head of Payments Policy
Chicago Payments Symposium
I know there is currently a lot of interest in the Federal Reserve's initiatives to upgrade the US payment system. So as background, today I would like to provide some information on a program that is under way in Australia to bring about a significant upgrade to our retail payments infrastructure. It is aiming to provide users of the Australian payments system – households, businesses and government agencies – access to real-time, data-rich payment services that will be available on a 24/7 basis.
I will speak mostly about the role of the Reserve Bank's Strategic Review of Innovation in the Payments System in initiating this process. This was a review that the Reserve Bank conducted over 2010 to 2012. Chris Hamilton, the CEO of the Australian Payments Clearing Association (APCA) who will follow me, will speak about the progress that the industry is making in working towards the objectives identified in the Review.
The Role of the Reserve Bank in the Australian Payments System
The Reserve Bank has several roles in the Australian payments system:
- it is the principal regulator of the payments system
- it owns and operates Australia's real-time gross settlement (RTGS) system
- it provides banking services to the Australian Government and some of its agencies
- it is responsible for issuing Australia's banknotes.
The issues that we will be discussing in today's session relate mostly to the first two of these functions: the Bank's role as regulator and infrastructure provider.
The Reserve Bank has two Boards. The Reserve Bank Board has responsibility for the general oversight of the Bank and also for monetary policy.
The Payments System Board, which was created in 1998 and consists of a majority of external members, has responsibility for the Bank's payments system powers.
The Bank's broad mandate in this area is to control risk in the financial system and to promote efficiency in the payments system and competition in the market for payment services.
The Bank has powers with respect to both payment systems and clearing and settlement facilities. In the case of payment systems, it has the power to ‘designate’ a system as being subject to regulation if it is in the public interest to do so. It can then impose an access regime for any designated system or set standards that apply to participants in that system.
While the Bank's powers in this area are quite broad, in practice it has exercised them in only a few cases. Instead, the approach of the Board has been to encourage industry to undertake reform, and only use its powers where it judges it to be necessary to ensure stability, manage risk, or promote efficiency or competition, or where the industry has not been able to reach an acceptable self- or co-regulatory solution.
Rationale for the Strategic Review of Innovation
When the Payments System Board announced in 2010 that it would be undertaking a Strategic Review of Innovation in the Payments System, it represented something of a change in direction for the Board.
Previously, the Board had tended to leave issues concerning innovation to the industry. This was based on the presumption that for innovation, similar to a number of other areas such as mobile payments, fraud and security, the industry has the appropriate incentives and is best placed to address issues.
The background to the Board's action was a growing amount of evidence that the services provided to end users in Australia were falling behind the services available to end users in some other countries. It wasn't a problem of Australian financial institutions not being innovators and not competing strongly in the services they offer to their customers – far from it. Rather it was a sense that there were issues in the cooperative elements of some of our payment systems. The development of common rules, standards, communications networks and other infrastructure requires collaborative innovation, where institutions work together. There was a concern that this had proved difficult in Australia and that this was affecting the ability of financial institutions to innovate and provide new and improved services to their customers.
This was a little ironic, because some Australian systems were at the forefront of global innovation when they were first implemented in the 1980s. In part, the emerging gaps reflected the inflexibility stemming from the bilateral, rather than hub-based, nature of many of the longer-standing payment systems in Australia. Ensuring investment and innovation can be difficult in any system, given the different interests and investment cycles of the participants, but it can be especially difficult in a system characterised by lots of bilateral links and no strong central governance.
Accordingly, the Board concluded that there were some market failures that might be preventing, or significantly delaying, certain types of cooperative innovation that would be in the public interest.
The Consultation Process for the Strategic Review
The Review was announced in May 2010 and the Conclusions document was released in June 2012. The Review consisted of a series of formal and informal consultations with a wide range of participants in the Australian payments system. It also drew on international evidence on innovation in payments systems. The Bank also looked closely at different models of industry governance in other countries.
The Review considered the various factors that are valued by users of payment systems, such as timeliness, accessibility, ease of use, ease of integration with other processes, and safety and reliability.
Based on its consultations and these attributes valued by users, the Bank identified a number of specific gaps in the payments system that it anticipated would become increasingly pressing in the years to come. These included:
- The inability 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. For example, at the time of the Review, retail funds transfer systems in Australia could not guarantee same-day funds availability and there were no industry-wide rules covering this issue.
- The lack of availability of many payments outside of normal banking hours. For example, an internet banking payment made on a Friday night to a customer of another institution would not be available to the recipient until Monday at the earliest.
- The inability to send any significant amount of data with a payment. Our Direct Entry (DE) system – in many ways similar to your Automated Clearing House system – allows only 18 characters of information to be transmitted with a payment. This is especially challenging for businesses, which are limited in their ability to integrate payment processes into their broader business processes.
- The lack of an easy way of addressing electronic payments. A payment to another bank account requires the sender to provide the recipient's BSB and account number, which requires correctly entering up to 15 digits. In contrast, a number of other countries now have systems that allow addressing of payments to identifiers such as phone numbers or email addresses.
Of course, in most cases these gaps were not news to the industry or indeed to many end users of the payments system. For example, the inability to send real-time payments on a 24/7 basis is increasingly at odds with broader developments in our economy and society, where more and more services are expected to be available seven days a week and around the clock.
Conclusions from the Strategic Review
In June 2012, the Bank released the conclusions from the Strategic Review. It concluded that removing some of the barriers to cooperative innovation had the potential to deliver significant public benefits over time. It proposed two means to improve cooperative outcomes.
First, the Payments System Board will be more proactive in setting strategic objectives for the payments system. These will reflect services or attributes that the Board believes the industry should be able to provide by a specific time. The Board will set high-level objectives, not a detailed plan. It will be for the industry to determine how they can be met most efficiently.
The initial set of strategic objectives reflected the gaps identified in the Review:
- same-day settlement of all DE payments (by end 2013)
- the ability to make real-time retail payments (by end 2016)
- the ability to make and receive low-value payments outside of normal banking hours (by end 2016)
- the ability to send more complete remittance information with payments (by end 2016)
- the ability to address payments in a relatively simple way (by end 2017).
The second proposal was the establishment of an enhanced industry coordination body. The intention was that this should take a more strategic view than existing industry governance bodies and have membership from a wider range of institutions than had traditionally been the case for APCA. It should also have high level representation with individuals that will be more able to commit their organisations to any courses of action agreed by the group.
I'm happy to say that we have made good progress on this, together with APCA. The Australian Payments Council has been constituted and will have its first meeting next month. The hope is that the next time the Bank undertakes an exercise looking at what strategic objectives might need to be set it may be able to rely significantly on the Payments Council. Indeed, ideally it might find that there was little need to set new strategic objectives because the industry was already moving to fill any emerging gaps.
The Response of the Payments Industry
Having set the initial strategic objectives, the Payments System Board asked the industry to respond as to how they could best be achieved.
While one of the strategic objectives was for the DE system to move to same-day settlement, the Board indicated that it considered that other objectives were likely to require building a new real-time payments system.
The Bank indicated that it would be prepared to support this by enhancing our RTGS system and building a system for real-time settlement of retail transactions. It also said it would be prepared to expand interbank settlement hours as needed to support innovation.
Furthermore, the Board indicated that there should be a general presumption in favour of more centralised systems when the opportunity arises, given the advantages in terms of facilitating upgrades to the system and entry by new participants. Hence, it suggested the desirability of a hub or hub-like arrangement for the new real-time system. It also suggested the desirability of moving to a modern and flexible messaging standard, ISO 20022, in providing for data-rich payments in a new system.
There were a number of options for how a clearing hub might be provided, one of which was for the Bank to do so. Accordingly, the Board asked the industry for views as to how real-time payments could best be provided. However, it indicated that it was keen for our payments system not to fall significantly behind in this area, so it gave the industry a reasonably short window to come back to the Bank with a proposed path forward.
At that point, we couldn't be sure that the industry would indeed be able to come together with a proposal. One concern was that several different ways forward might be proposed, with no consensus behind any single proposal. However, the industry did come forward with a unified position by the end of August 2012, with much of the credit due to APCA.
In its submission to the Bank, APCA welcomed the Conclusions paper of the Strategic Review and said there was broad acceptance of the Board's strategic objectives. It proposed the formation of the Real-Time Payments Committee (RTPC) to come up with a detailed proposal for new infrastructure that would support real-time payments. The RTPC then worked intensively on a proposal which was welcomed by the Board at its February 2013 meeting. As a next step, the industry established the New Payments Platform (NPP) Steering Committee and invited the Bank to contribute two representatives, one from the policy side and one from the settlements or infrastructure provision side.
As I noted, it was not clear at the time that the Conclusions document was released that the industry would be able to agree on a way forward towards real-time payments. Our consultations with participants suggest a few major factors influencing the industry's response:
- There was broad acceptance that the gaps identified by the Bank were ones where there was genuine end-user demand – informed not just by analysis of Australian end users but also drawing upon experience in other countries. Even where some institutions were not convinced of the immediate business case for building a new real-time system, there was acceptance that a growing case would emerge in coming years.
- A new payments system built to fill these gaps was likely to bring in new revenues and reduce costs by displacing cash and cheques. While a new system might also ‘cannibalise’ some existing revenues coming from other payment types, many end users would be willing to pay a premium for improved services, especially those involving richer remittance data. Furthermore, there was a realisation that if the existing major players in the payments system chose not to address those gaps for their customers it was likely that new entrants would find innovative ways to do so.
- On its own, the cost of building a new system was not expected to be particularly large in the context of the overall profitability of the industry and the expected life of the new infrastructure. The major cost to institutions is likely to come from modifying their internal systems to connect to the new infrastructure. While most institutions accepted that expenditures to modernise their systems to fill such gaps was inevitable, the Board's strategic objectives may well have brought forward the timing of that spending. The Board's four to five year timetable for achieving the strategic objectives was viewed as ambitious, but achievable.
I will leave it to Chris Hamilton to take you through how the industry worked together to come up with their proposal and how that proposal is now being implemented.
Ongoing Reserve Bank Involvement
Before finishing, I will touch on two issues regarding the Reserve Bank's ongoing involvement in promoting a faster and more innovative payments system.
As I noted earlier, the Board considered that it would not be possible to modify the DE system to provide real-time payments. However, it was recognised that the system was well suited to its use for the exchange of bulk files of non-time-critical retail payments and that it would be useful to move to same-day settlement of DE transactions.
While the industry was already working towards same-day settlement of three of the five DE exchanges the Board's view was that it should move quickly to same-day settlement of all exchanges. However, there were liquidity management issues associated with this, given that the last two exchanges, which represent much of the daily value exchanged, occur after the money market has closed. Hence, banks could be hit with unexpected drains on their liquidity.
The Bank worked on this issue and proposed a solution that involves the use of open-dated repos, which are available to holders of Exchange Settlement (ES) Accounts – the equivalent of Federal Funds accounts – at no penalty relative to the Bank's policy rate. These new arrangements, and the successful commencement of same-day settlement of all five DE exchanges, took effect in November 2013. The achievement of same-day settlement has meant that it is easier for financial institutions to provide funds to their customers immediately after each DE batch without incurring settlement risk.
More broadly, the Reserve Bank is involved in the NPP at three levels.
At the policy level, the Payments System Board is taking a close interest in the industry's progress and remains very committed to the achievement of the Bank's Strategic Objectives.
In addition, the Bank is one of 17 financial institutions that are participants in the NPP. The Bank has two members on the NPP Steering Committee and has indicated that it will commit to its share of the funding of the build and the first two years of operation of the system.
Finally, our Payments Settlements Department has had a project team in place for two years working towards delivering the Fast Settlement Service (FSS). The FSS will allow for settlement of transactions from the clearing hub on a line-by-line basis (i.e. without batching). NPP participants will still have a single ES Account at the Reserve Bank, but the funds in their account will be allocated between the FSS and RITS, our existing high-value RTGS system. Participants will be able to transfer funds between the two systems, including on an automated basis using preset liquidity trigger points. ES Account funds will be shared between the two systems during opening hours for RITS and will all be available to the FSS when RITS is closed (including over weekends). The FSS will be open on a 24/7 basis, supported by the new open repo liquidity arrangements, and will be able to operate even if RITS is down. Testing to date has indicated that the FSS will be able to deal with high transactions-per-second throughput and very short response times.
To conclude, the Bank is very supportive of the NPP program's objectives and looks forward to continuing to work with the industry to deliver this important piece of new infrastructure for the Australian payments system. We have been watching the experience of other countries closely and we hope that our experience working as a catalyst for innovation can be relevant for other countries, including the United States, as they also look to move towards real-time retail payments.
See RBA (2012), Strategic Review of Innovation in the Payments System: Conclusions, June. 
For more information, see Fraser S and A Gatty (2014), ‘The Introduction of Same-day Settlement of Direct Entry Obligations in Australia’, RBA Bulletin, June, pp 55–64.