Notes on Innovations in Retail Payments - A CPSS Report

1. The CPSS published a report in May 2012 that provides an overview of innovations in retail payments around the world.
2. The report defines an "innovation" in retail payment as a new or significantly improved instrument , solution or scheme that has achieved a significant share of the relevant payment market or at least has the potential to take one.
3. Exogenous factors responsible for driving innovation in retail payments
• Technological developments
• User Demand
• Regulation
4. Endogenous factors are
•  Cooperation i.e. creation of shared infrastrcuture.
• Standardization of infrastructure.
• Pricing and price structures.
5.  Some of the general conclusions are 
• Technical advancements are likely to blur product categories
• NFC has potential for future growth.
• E-commerce could further boost the demand for internet payments.
• Globally active players have the advantage in leveraging their coverage and market power when offering payments solutions across borders.
• In many cases innovations in retail payments are only incremental improvements to established payment services. Large leaps can occur, particularly in countries where the payment infrastructure is underdeveloped.
• Distinct changes in retail payments could potentially be triggered by factors such as the emergence of new payment schemes.
• Technology will lead to convergence in payments at the global level although significant differences between regions are likely to persist. 
6. Retail payments are different from large ticket payments in the following ways
• They are used in more varied situations as compared to bank payments
• They are executed using a large variety of payment instruments
• Make more extensive use of private systems as compared to large ticket payments which still operate through central bank operated channels such as RTGS ( Real Time Gross Settlement)
7.  Innovations in retail payments are categorized in two ways
• Process oriented categorization.
• Product oriented categorization.
8. Process oriented categorization is made of the following categories
• Payment initiation ( validation of payment instrument, validation of payer identity, verification of ability to pay) - Push vs. Pull - Payer vs. Payee.
• Overall payment process including clearing and settlement.
• Receipt of payment.
• New schemes ( virtual money etc. )
9. Product oriented categorization is made of the following categories. 
• Card payments.
• Internet payments
• Mobile payments
• Electronic bill presentment and payment ( EBPP)
• Improvements in Infrastructure and security
10. Innovations drive two key purposes - 
• improving efficiency - reduced cash usage, lower processing costs, improved convenience, inclusion of unbanked or underbanked.
• improving security.
11. The following trends have been observed 
• The market is dynamic, but few innovations have significant market impact so far.
• Most innovations are domestic in scope but similar products and categories have emerged worldwide.
• Speeding up of payment processing has gained importance.
• Financial inclusion as the driving force for innovation.
• The role of non-banks is significantly increasing.
12. Characteristics of retail payment market
• Economics of payment production
• High economies of scale , low marginal cost.
• Economies of scope are common because the infrastructure used to process on kind of payment can often be used to process another type.
• Economics of payment consumption
• Network effects - each additional user added to the network increases the value of the network.
• Platform competition - The network externality often leads to the dominance of one platform as users receive more benefits from interconnecting with a large network than with a small one.
• Two-sided markets versus one sided markets - In one sided markets both sender and receiver are part of the demand side of the services. In two sided markets there are two distinct sets of users ( merchants and cardholders) and a critical mass needs to be achieved within both sets of users.
• Economics of club goods
• Social welfare benefits
13. Drivers of innovation
• Technology -  E-commerce, Mobile phones, NFC
• User behavior - 
• Convenience , Ease of use
• Speed of payment process
• Protection against default of parties involved and security breaches.
• Acceptance by merchants
• Low cost of use.
• Enhanced data privacy and anonymity.
• Merchant behavior -
• Speed
• Cost
• Convenience
• Security
• Demand for real time or near real time payment processing.
• Settlement lags give rise to counter-party risk and liquidity risk which forces payment service providers to provide faster services
• Public Transit as a trigger for innovation.
14. Innovation and Financial inclusion
• Special limited service bank accounts 
• Prepaid accounts with non banks
• Business Correspondents or agents
• New means for transaction initiation and authentication.
15. The role of regulation with respect to innovation
• Rationale for regulation
• Ensure market security.
• Increase market efficiency.
• Regulators place a greater emphasis on market efficiency by tasking innovation through
• Improving competition by opening up payments market to non-banks
• Government as a direct promoter of innovative services.
• Financial inclusion as a driver of innovative payments.
• Regulation can occur ex ante i.e. before innovation has occurred or ex post i.e. after innovation has occurred.  Ex ante regulation could end up stifling innovation by imposing artificial barriers to innovation while ex post regulation could lag behind the actual innovations themselves. Both approaches have their own advantages and disadvantages. It is important to note that since innovation is constant and rapid , regulation needs to be reviewed periodically in order to arrive at correct effects.
16. Role of cooperation with respect to innovation - 
• Cooperation is required because it
• reduces costs
• ensures sufficient demand
• Two types 
• Horizontal Cooperation - fostering cooperation between competing parties.
• Vertical Cooperation - fostering cooperation among all stakeholders.
  
17. Role of standardization with respect to innovation - Standardization is required due to the large number of players involved in the payments industry.  
• It affects innovation in a number of ways
• Facilitates achievement of critical mass.
• Creates stable ground for new players to come in.
• Leads to certain efficiencies the gains from which can be used to further innovation.
• It also impedes innovation in the following ways
• Early movers enjoy an advantage when standards are non-existent. Imposing a standard may decrease the incentive to innovate.
• Standard setting can restrict competition by excluding innovation or restricting new business models.
• Existence of obsolete but established and widely used standards could impede evolution in the industry.
18. Role of Pricing and price structure with respect to innovation - Price setting by the participants can have both positive and negative effects
• Positive
• if the Payment Service Providers can set the right price its a driver of innovation
• Negative - if the PSPs cannot set the righ price then
• Prices can turn out to be a barrier to innovation
• PSPs typically use a two part pricing model comprising of fixed periodical fees + per transaction fees. The level of fees will depend on the market power of various players involved and the elasticities of demand and supply.
• Regulatory environment could also influence the pricing strategies.
19. Issues and challenges facing central banks
• To foster security and efficiency of the payments system, central banks
• address legal and regulatory impediments to market developments and innovation
• provide for competitive market conditions
• support effective standards and infrastructure
• make available their own services in a manner that is most efficient for the relevant market.
• play important roles as
• Catalysts
• Overseers
• Facilitators
• Monitoring and Assessment
• Central banks have to rely on voluntary cooperation of market players or use public sources to collect statistical data.
• Improve quality of statistical reporting through periodic reviews but ensure reporting burden does not stifle innovation.
•  Risk assessment of innovative payment products at various stages of development is difficult to ascertain.
• Lack of a core competency in technology within central banks.
• Resource issues in keeping track of new developments.
• Communication, publication and transparency
• Communication of objectives, views and research results, policy stance and work regarding new developments.
• Undertake educational efforts and organize nationwide communication campaigns.
• Interoperability and inter-connectivity between different payment systems
• Participate and ensure participation in different forums and interest groups, organize meetings with stakeholders or publish policy messages in order to foster interoperability and inter-connectivity.
• Effective payments oversight
• Review existing oversight frameworks
• Cooperation with other authorities at a national and international level.

BIS and CPSS

The BIS, Bank for International Settlements, is an international organization that serves as a bank for all central banks and fosters cooperation among them in order to achieve monetary and financial stability around the world.  It conducts research and publish statistics on global banking, securities, foreign exchange and derivatives markets.  It acts as a forum where experts on monetary and financial stability issues as well as on more technical issues such as legal matters, reserve management, IT systems, internal audit and technical cooperation can discuss and provide direction to central bank policy making.

The CPSS, Committee on Payment and Settlement Systems, is the arm of the BIS that serves as a forum for central banks to monitor and analyse developments in domestic payment, clearing and settlement systems as well as in cross-border and multicurrency settlement schemes.

Notes on the RBI Payment System Vision Document (2012-15)

Unlike developed countries, the payment systems industry in India is in its relative infancy. Considering the immense unlocked potential in the country evidenced by the sheer size of the population and the benefits that electronic payments can bring to the entire economy, the RBI has recognized the need to evolve a “safe, efficient, interoperable, authorized, accessible, inclusive and compliant ( with international standards) ”  payment system. In order to streamline the development efforts and to provide a clear policy stance the central bank releases a vision document once every four years with this being the second edition.

Four Key aims stand out

1.       Standardize and improve efficiency of the existing payment infrastructure and build capacity for the future i.e.  Evolve from a “fit for current purpose” to “fit for future use” infrastructure.

2.       Recognize and manage potential risks in the payment systems in compliance with international standards.

3.       Incentivize innovation and efforts to move towards a “less-cash” society.

4.       Promote access and inclusion. Improve payment system visibility and literacy.

STANDARDIZATION AND EFFICIENCY IMPROVEMENT

1.       Mandate CTS implementation.

2.       Improve functioning of ECS. Implement an electronic GIRO system.

3.       Develop a policy framework to incentivize arrival of new payment system operators.

4.       Review guidelines for prepaid electronic instruments.

5.       Implement white label ATMs. Consider white label PoS.

6.       Standardize payment instruments, message formats and payment instructions ( Consider ISO20022)

7.       Monitor progress of use of SWIFT as an alternate network.

8.       Strive towards interoperability and portability in all payment systems.

9.       Augment the existing hardware and network resources for payment systems.

10.   Focus on human resource capacity building with respect to the payment systems industry.

11.   Engage with stakeholders for building an integrated payment infrastructure.

RISK MANAGEMENT

1.       Ensure compliance of FMIs to new FMI standards. Emphasize importance of setting up risk management frameworks and perform stress testing and back testing on a periodic basis.

2.       Promote funds settlement of all payment systems beyond a certain threshold through RBI’s books.

3.       Adopt new technology and standards to mitigate concentration risk.

4.       Focus on quasi payment systems and their risk management processes

5.       Focus attention on the role of non-banks and the services that they offer and their risk management frameworks.

6.       Adoption of technology, authentication protocols, security features for safety and security of payment products and channels and start dialogue with stakeholders viz. security, IT, legal experts, legal bodies and government.

7.       Draw up exit criteria for authorized payment system operators including guidelines for managing orderly winding down of operations.

8.       Issue master circulars providing a consolidated view of various guidelines and instructions issued.

9.       Start dialogue about a direct regulatory framework of payment systems.

10.   Focus attention on bringing non-banks and the services they offer including access to payment systems and bring them under the existing regulatory framework.

11.   Prepare self-assessment template for retail payments based on the new PFMI.

12.   Put in place frameworks for Financial Market Infrastructures.

INCENTIVIZE INNOVATION

1.       Encourage further adoption of mobile banking and NFC in payment systems by achieving necessary collaboration between the banking sector and the mobile network operators through a centralized platform.

2.       Promote mobile PoS to increase acceptance across a large base of retailers across the country.

3.       Draw up a policy framework establishing roles and responsibilities of banks and customers in electronic transactions to minimize fraud, fix responsibilities and zero liability protection to increase customer confidence in all electronic transactions.

4.       Examine the feasibility of using Aadhar as authentication protocol for all financial transactions.

5.       Enhance availability and acceptability of alternate payment instruments in lieu of cash.

6.       Promote convergence of all form factors towards mobile making it a single instrument for carrying out financial transactions.

PROMOTE ACCESS AND INCLUSION

1.       Address the issue of identification documents especially in a country where a large section of the population is unbanked ( related to examining feasibility of using Aadhar)

2.       Revisit current KYV norms for various prepaid proudtcs and explore the feasibility of a single, rationalized norm for semi closed prepaid payment instruments.

3.       Fulfill G-20 initiatives on financial inclusion and government payments.

4.       Review the pricing structure in card payments.

5.       Dialogue with stakeholders including the Government for making direct cost of transacting in electronic payments as attractive as transacting in cash.

6.       Promote financial literacy and awareness about payment systems through eBAT ( Electronic Banking Awareness Training) initiative.

Payment And Settlement Systems Act 2007

Regulation and supervision of payment systems in India is governed by The Payment And Settlement Systems Act, 2007 . It designates the Reserve Bank of India (RBI) as the regulatory body governing the system. The RBI exercises its powers of regulation through a committee of its central board known as the Board for Regulation and Supervision of Payment and Settlement Systems.

Board for Regulation and Supervision of Payment and Settlement Systems , India