Jon Nicolaisen: Challenges for the payment system
Speech by Mr Jon Nicolaisen, Deputy Governor of Norges Bank (Central Bank of Norway), at
the Finance Norway's payments conference, Oslo, 12 November 2014.
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Introduction
The modern history of payments in Norway began 200 years ago. A clause was included in
the Constitution stipulating that the Storting (Norwegian parliament) should "supervise the
monetary affairs of the realm". Two years later, in 1816, Norges Bank was founded. The
Storting delegated "supervisory authority" over monetary affairs to the Bank. Today, private
banks perform payment services for the general public. Norges Bank has become the
bankers' bank.
According to the Norges Bank Act, Norges Bank shall promote an efficient payment system.
The Bank issues cash and ensures efficient settlement between banks' accounts with
Norges Bank. In addition, the Bank has responsibility for overseeing and supervising those
parts of the payment system located outside of Norges Bank. Finanstilsynet (Financial
Supervisory Authority of Norway) has responsibility for supervising the retail payment
systems.1
Payment services play a unique role in the economy. The payment system can be compared
to the plumbing system in a house. As long as it functions, we do not give it a second
thought. But if it fails, the consequences are immediate and serious.
The Norwegian payment system is efficient and up-to-date. Fast, cheap and reliable
payments save time and provide security to households and the business sector. It gives the
nation a competitive advantage over many other countries. To preserve this advantage,
Norway needs to be a leader. Technological developments pave the way for new possibilities
- new means of payment are introduced and existing means of payment become faster and
cheaper. While most changes result in a more efficient system, they also pose new
challenges. New technology and outsourcing require stricter standards for both the risk
management framework and contingency preparedness. Responsibility rests with system
owners.
As supervisory and oversight authority, Norges Bank has a duty to point out any deficiencies
and weaknesses. There are also challenges associated with the pricing of payment services.
When given a choice of payment solution, customers are not charged prices that reflect
actual costs. Does this make the system more expensive than necessary? Banks operate
most of their payment solutions at a loss. Does this have to be? Are banks' incentives to
invest in secure and forward-looking solutions being weakened?
Risk and costs are drivers of change
The main structure of the payment system has remained fixed for a number of years, but
there have been changes, both to the part of the system customers encounter and to
interbank settlement. Behind many of the changes is a desire to reduce risk or costs, often
both.2
Allow me to give two examples. Just before the turn of the millennium, Norges Bank
introduced a real-time gross settlement (RTGS) system that allowed large payments to be
settled far faster than earlier. This also resulted in less uncertainty and lower risk. Another
example is the introduction of the foreign exchange settlement system CLS just over ten
years ago. Before CLS was established, one party could risk paying his leg of a trade without
receiving anything from the counterparty. With CLS, this counterparty risk was eliminated.
In both cases, the introduction of the new systems increased costs for private participants.
This prompted criticism. But over time, the reduction in risk has more than offset the increase
in costs. The financial crisis in autumn 2008 showed that the gains were real. Where there
were adequate settlement systems without counterparty risk, markets functioned better.
The core of the Norwegian payment system is the Norwegian Interbank Clearing System
(NICS) and Norges Bank's settlement system (NBO). On average, over NOK 200 billion
passes through NBO each day. Without this system, payments in Norway would come to a
halt. This would quickly have serious consequences. Norges Bank therefore has a target of
100-percent availability for the settlement system during opening hours. In recent years, the
Bank has been successful in ensuring this. Almost no disruptions have occurred. We are
steadily working on improvements to ensure a robust and efficient system also in the years
ahead.
Payments often start when an individual or firm makes a payment using an online banking
service or using a payment card. Most payments are relayed from the data processing centre
in the customer's bank to NICS. On the basis of all payments we as customers have made,
NICS calculates a position for each bank vis-à-vis the other banks. The result of this clearing
is sent four times a day to NBO. There the balances of banks' accounts with Norges Bank
are adjusted. When the banks have been notified that the settlement in Norges Bank is in
order, the banks adjust their customers' accounts. All the large banks participate in these
settlements. DNB and SpareBank 1 SMN also participate in the settlement in Norges Bank
on behalf of smaller banks.
Today, Norges Bank has published a new survey of payment costs using data from 2013.
The overall social costs of using cash, payment cards and giro payments amount to just
under NOK 15 billion,3 or 0.6 percent of mainland GDP. The estimate includes the costs for
both providers and users of payment services. These costs have declined since they were
last estimated in 2007. Compared with other countries, the costs of the Norwegian payment
system are low. This is a benefit to customers and represents a comparative advantage for
the Norwegian business sector.
There are several reasons why payment costs are low in Norway. New technology resulted
in an early introduction in Norway of cost-efficient electronic systems. Banks led with new
solutions, and the public adopted them quickly. Banks have collaborated on both the
establishment and the operation of new services. The resulting economies of scale made it
possible to keep costs low. Norwegian and Nordic banks are at the forefront of developments
in this area.
Norway is among the world leaders in the use of payment cards. Eight out of ten card
transactions take place using BankAxept, one of the solutions that banks have developed.
According to Norges Bank's estimates, the social cost of using BankAxept is around
NOK 3 per payment. By comparison, payments using international payment cards cost
society NOK 13, or four times as much.
Credit card use is increasing. It is the point of sale, typically a shop, which pays the costs
connected with use, and not the cardholder. While the merchant pays around NOK 0.10
when the customer uses BankAxept, the merchant must usually pay between 1 and
2 percent of the purchase amount when the customer chooses Visa or MasterCard.
Merchants are free to pass on this cost to card users, but this seldom happens in Norway.
Customers are thus not charged correct prices when given a choice of payment solution. The
result can be that an inexpensive solution - BankAxept - is supplanted in favour of more
expensive solutions.
In Denmark, merchants charge a fee to customers who use a credit card. A similar practice
in Norway could keep down payment costs. The profit banks earn on the use of international
payment cards is higher than on BankAxept. It is therefore likely that, in isolation, it is in the
interest of many banks for customers to choose international payment cards. New European
regulations that will set a cap on the fees issuers of payment cards can charge are in the
pipeline. This will likely weaken banks' incentive to promote international payment cards.
Banks continue to lose money on payment services. The cost survey we are presenting
today does show that banks' cost coverage has increased somewhat over time. But income
still amounts to only 76 percent of the costs associated with payment services.
Banks lose money on all main types of payment instruments, except for international cards.
The losses must be covered by income from other banking activities. Pricing that does not
cover costs may be a conscious choice by banks. Some customers may believe that they
should not have to pay for using their own money. At the same time, mispricing and losses
weaken banks' ability and willingness to promote efficient solutions and invest in new
infrastructure. That is not a forward-looking approach.
We must invest now to ensure efficient and secure payments also in the future. The
establishment of the company BankAxept AS is promising in this regard. Norges Bank will
closely follow developments and continue to publish information on costs, prices and market
conditions.
Contactless payments are making their way into the Norwegian payments market.
Contactless payment allows customers to make a payment by holding a mobile phone or a
card over a terminal without entering a PIN.4 While this is a new means of payment, the
underlying payment solution is not new. The solutions are often based on the use of credit
cards, with a low price for users. If contactless payments based on credit cards supplant
payments with BankAxept, the social costs of payment services may rise. Norges Bank has
noted that the new owner company of BankAxept is considering developing a solution for
contactless payments. This may bolster competition and help to lower costs of this type of
payment too.
Efficiency is more than low costs. Payment services have become faster and more
userfriendly in recent years. For example, there has been an increase from two to four daily
clearings and settlements. Contactless payments make small payments faster. Soon, online
bank transfers will also become faster. With the new service "instant payment", funds will be
available in the payee's account within seconds, while interbank settlement does not take
place until afterwards. But there is still a way to go - in this area, other countries have come
further than Norway. Hopefully, payment services in Norway will be even faster in the coming
years.
Assessment of the Norwegian financial infrastructure
The financial crisis was a reminder that increasingly complex financial instruments and
demanding technological solutions have increased risk in the financial infrastructure. In the
aftermath of the crisis, the international recommendations for the financial infrastructure have
been tightened.5
The new principles provide a comprehensive standard for the financial infrastructure across
borders and across various systems. The purpose is to promote a robust and efficient
financial infrastructure6 that supports the stability of the global financial system. The new
principles devote considerable attention to such areas as operational risk, derivate exposure
and the use of central counterparties.
Norges Bank oversees financial infrastructure and supervises interbank clearing and
settlement systems. There are two systems that are licensed by Norges Bank to provide
clearing or settlement: NICS and DNB as a private settlement bank. For these systems,
Norges Bank, as supervisory authority, may require that owners take corrective action for
noncompliance with licence terms or the Payment Systems Act.
In collaboration with Finanstilsynet, Norges Bank has recently conducted an assessment of
important parts of the financial infrastructure in Norway in accordance with the international
principles.7
The main conclusion is that the financial infrastructure in Norway is robust and efficient.
Nevertheless there is a need for some improvements. In particular, two areas are
emphasised:
First, some of the systems have a deficient framework for monitoring and managing risk.
Such a framework is necessary for assessing risk and measures in aggregate. Otherwise,
one cannot be certain whether the measures implemented are appropriate.
The framework should cover all aspects of operations, also the parts outsourced to other
providers. This is an essential tool for controlling the overall risk in the system. It is not
sufficient to indicate that an operating services provider has a separate risk management
framework in place. The board of the owner company has ultimate responsibility.
Second, it is not always clear how operational risk is managed and controlled. If operational
risk is not managed appropriately, there is a risk that operations are disrupted - and in the
worst case come to a halt. A failure in the delivery of electronic communications is an
example of an operational risk that may have serious consequences. System owners must
ensure that the various operational risks are identified and analysed. The system owner must
implement the necessary measures on that basis.
The assessment is now being followed up. System owners have drawn up plans for
measures. The NICS Operations Office has responded to Norges Bank that work relating to
the principles concerning the risk management framework and operational risk will be
completed by the turn of the year. Norges Bank will ensure that progress and measures are
satisfactory. As the operator of NBO, Norges Bank is also working on measures that will
strengthen the settlement system centrally.
Outsourcing
Today's financial infrastructure is based on advanced technical solutions. This places
considerable demands on system developers and operators. This expertise is costly and
may be difficult to retain. Owners have largely outsourced technical operations. This provides
greater flexibility. At the same time, outsourcing can make it more challenging to manage
operational risk.
The fixed costs associated with operation and development can be high. This allows
operators to exploit economies of scale. A possible result of outsourcing is that several
systems use the same service provider. This may reduce costs. On the other hand, such a
concentration may weaken competition, while risk is concentrated in a single provider. Any
failure in the service provider may then impact large parts of the financial infrastructure.
The systems are vulnerable to technical failure and to external attacks. With several layers of
service providers, risk increases while at the same time becoming more difficult to uncover.
In 2015, Norges Bank will evaluate the outsourced operations of key participants in the
financial infrastructure in Norway. This assessment, too, will be based on international
principles.8
A fundamental prerequisite is that the owners of systems have the ultimate responsibility for
operation. This responsibility also covers backup solutions. The owners' responsibility does
not change because all or parts of system operation are managed by others. Owners must
therefore retain sufficient expertise in-house.
Both for the system owner and the authorities, the ability to set requirements and follow up
activities is more of a challenge the more remote they are. When parts of the financial
infrastructure are operated outside of Norway, system owners should implement special
measures to address these additional challenges. A situation must be avoided where
infrastructure critical to Norway is affected by incidents in other countries. Norges Bank will
give weight to these considerations in its supervisory role.
Contingency preparedness
The consequences of disruptions in a payment system may be more serious for society than
for the individual operator. For that reason, the authorities set strict requirements for
contingency preparedness. Contingency arrangements shall both reduce the likelihood of
incidents and mitigate the consequences if an incident has occurred. The requirements for
contingency preparedness may entail increased costs in the short term. In the longer term,
adequate contingency preparedness is crucial for society. This is reflected in the trade-offs
between long-term risk and short-term costs.
IT systems and websites are vulnerable to attack by criminals. Attacks can put services out
of order and reduce confidence in the systems. Attacks take ever newer forms. This requires
that system owners keep updated on the various kinds of attack. The establishment of
FinansCERT by Finance Norway is a sound measure in this regard. In addition, participants
must ensure robust defences against attack. This will not be any easier in the period ahead.
Nevertheless: if we are to reap the benefits of IT and online services, a substantial use of
resources on monitoring and security is a price we must pay.
Banks and Norges Bank must in the worst case deal with situations where all or part of the
payment system has been put out of action. New technology may in the longer term usher in
new contingency arrangements. Even so, to date no sufficiently adequate alternatives have
been documented to allow cash to be written off as a part of the overall solution.
Finanstilsynet and Norges Bank are now examining closely contingency preparedness for
both electronic payment and banks' contingency arrangements for cash distribution.
Norges Bank shall ensure that society has access to cash as a means of payment. Banks
can make cash withdrawals based on deposits in Norges Bank. The general public go to
their banks to withdraw cash. The Government presented a bill for a new Financial
Institutions Act before summer. The bill states that banks will have an obligation to accept
cash from customers and make deposits available to customers in the form of cash. This is a
further specification of banks' responsibility for cash handling. The bill also gives banks the
freedom to choose how services are to be organised, as long as they are able to meet
customer demand.
Conclusion
Let me sum up: The Norwegian payment system is efficient and up-to-date. It gives the
nation a competitive advantage over many other countries.
The owners must have management systems that enable them to have sound control of
operations. The owners' responsibility also includes backup solutions. This responsibility
does not change if all or parts of operations are managed by others.
Payments can become cheaper, faster and more user-friendly than they are at present.
Banks should price payments so that they achieve acceptable earnings and promote
profitable investments. This will also serve the interest of customers. It is of benefit to us, as
a society, that banks and other operators are now investing in secure and forward-looking
solutions. The aim must be to remain at the forefront of international developments. There is
growing urgency to put in place new solutions. In this respect, the system owners - the
banks - have collective interests that go beyond pure private financial considerations of the
individual bank.
Thank you for your attention.