Glenn Stevens: Innovation, stability and the role of the Payments System
Board
Address by Mr Glenn Stevens, Governor of the Reserve Bank of Australia, to the Australian
Payments Clearing Association (APCA) 20th Anniversary Symposium, Sydney, 28 May 2012.
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I have not spoken publicly on payments system matters for some time, but it would be hard
to find a better moment and a more appropriate event to take up the issue once more. This
symposium of course marks 20 years of the Australian Payments Clearing Association,
which was set up as a vehicle to coordinate decision-making in relation to clearing and
settlement following the recommendations of the Brady and Martin Reports in the years prior.
It effectively replaced the Australian Clearing House Association, which was largely focused
on cheques - the dominant payment system of the time.
Sharing the stage with APCA in the early days was the Australian Payments System Council,
which had been established in the 1980s as an advisory body to the Government aimed at
promoting and influencing the development of payment systems. The Council was wound up
when the Payments System Board was established in 1998, following the recommendations
of the Wallis Inquiry.
APCA itself has evolved over the years. New clearing streams have been added and it has
moved more into an industry representation role. Its make-up has also evolved; for instance I
note that it was originally chaired by a representative of the Reserve Bank, an arrangement
that ended in 1998.
All this change over an extended period is a sure sign that there has long been recognition of
how critical governance arrangements are to payments systems. The same debates that
have occurred in Australia on these issues are repeated around the world. In fact, while the
institutional arrangements for payments vary enormously from one country to another, it is
remarkable how similar the debates are in each of those countries. I will be dealing with
some of those issues today.
The other reason that it is a good time to be speaking about payments is that, as I am sure
many of you are aware, the conclusions of the Reserve Bank's Strategic Review of
Innovation are due to be released very soon. In fact they will be out within the next couple of
weeks. I cannot pre-empt the detailed findings, but I will share with you some of the major
themes. Naturally, most people will focus on the implications for the payments industry. But
the conclusions will also have implications for the way that the Payments System Board goes
about its business in relation to retail payments issues. That is as it should be. The Board is
not a static entity either and its role evolves over time.
My focus today, then, will be both innovation and the role of the Payments System Board.
But with regard to the latter, I will talk not just about challenges in the retail payments sphere,
but also about the other role of the Board that is probably less known to most of the people in
this room - that is, the regulation of financial market infrastructure in order to preserve
financial stability. This takes up a sizeable and increasing part of the Board's time.
Payments innovation: why is it important?
Why all the focus on payments innovation? It might, on its face, seem strange for the
Reserve Bank to have devoted a considerable amount of time and effort to reviewing
innovation in the payments system.
For one thing, Australia has received great dividends from allowing, in most cases,
commercial imperatives to drive the process of delivering new products, including payment
products. We of course take a more cautious approach when it comes to matters of risk in
the financial sector and we have seen how important those considerations are over the past
few years. But in general, the notion that a regulator should be involved in matters of
innovation might be seen as inconsistent with the regulatory philosophy in Australia.
Certainly the Payments System Board has been reluctant to "pick winners".
The other reason that it may seem slightly anomalous for the Reserve Bank to be
preoccupied with payments innovation is that we see a great deal of it around us and every
sign that there is significantly more around the corner. If we think about the rapid rise of
PayPal, the spread of chip and now contactless card payments, and the enormous amount of
energy that is being focused on mobile payments at the moment, there is clearly no shortage
of innovation in payments.
There is, however, a problem, and one about which the various players in the payments
space themselves have become increasingly concerned. It is that the innovation in the
customer-facing technology is moving at a pace much greater than the underlying
infrastructure. This is a problem because innovation in a network industry is not like
innovation in other industries. No matter how much time, effort and money a financial
institution puts into its own systems and the ways in which customers interface with those
systems, the payments service it can provide is only as good as the arrangements that allow
payments to pass between institutions. These arrangements are in the cooperative space;
not even the most innovative payments provider has the capacity to control these on its own.
It is easy to see how this could act as a constraint on innovation. Cooperative
decision-making between competitors is notoriously difficult. The implications of different
business mixes, strategies and investment cycles can easily derail cooperation, not to
mention the constraints of committee-based decision-making. These are classic coordination
issues, where some external impetus may be required to initiate change.
Even if coordination problems could be overcome for an innovation that is in the public
interest, institutions collectively might find it difficult to make a business case to invest. Once
again, this largely seems to be a quirk of the payments industry. Payment systems are
"two-sided markets". In other words, the market must satisfy two distinct sets of customers;
for instance, a point of sale payment system can be successful only if it is adopted by both
consumers and merchants. In two-sided markets the price faced by each set of end-users
may be altered so that the party with the greatest decision-making power faces a low price.
This is most evident in the credit card market, where consumers typically face a low or
negative price while merchants face a relatively high price. The flow of interbank fees to
support this has traditionally made issuing cards profitable for financial institutions. Because
payment systems often do not simply operate on a user-pays model, establishing a business
case can be more difficult than in other industries, even where there is a clear demand from
end-users.
This means there is a case for some kind of mechanism to overcome coordination problems
and to ensure that any disconnect between the public interest and the business case is
properly managed. But any intervention by a regulator like the Payments System Board of
the Reserve Bank must of course be carefully considered.
The Payments System Board will be addressing the issue from two different perspectives.
First, it will be expressing some views about the governance arrangements within the
industry, with the aim of giving those the best possible prospects of successful collective
decision-making and appropriate consideration of the public interest. More details on that will
be included in the conclusions of the Review.
Second, the Board believes that in order to overcome coordination problems, it will need to
take a stronger role in setting some general goals for the payments system, so as to help
provide an appropriate focus for the innovation efforts of the various players. There will need,
in the Board's view, to be greater interaction between the Board and the industry to establish
and work towards shared goals. Our assessment of experience both in Australia and
overseas is that superior industry outcomes have been achieved when there has been a
policy influence promoting public interest goals. Examples range from reform of the ATM
system in Australia to the establishment of the Faster Payments Service - for real-time retail
payments - in the United Kingdom. Therefore, you can expect the conclusions of the Review
to have more to say about a more constructive engagement between the Board and the
industry in relation to payments innovation.
The Board will not be picking winners, nor generally will it dictate the technical details of
systems. The Payments System Board is a policy-making body. It would not seek to impose
the technical details of solutions, unless it was aware of a very clear public policy basis for
preferring one approach over another. In most cases, it is for the Board to provide guidance
as to what outcomes it believes are required in the public interest, but not specific solutions.
The latter are clearly the domain of industry experts, with their knowledge of the technical
and business constraints. But it is important that they be informed by the Board's broader
policy goals.
The Board's thinking about those goals has been informed by two considerations.
First, early in the Strategic Review of Innovation, the Board identified a number of attributes
that were valued by end-users, as well as some that are important in payments system
design. These included such things as: the timeliness of payments; accessibility; ease of
use; ease of integration into other processes (such as business systems); and safety and
reliability. Examining the services the payments system offers in terms of these attributes
strongly suggests the areas where greater innovation in the payments system is needed, and
where the underlying infrastructure might be imposing constraints on innovation.
Second, the Board has considered developments in retail payment systems around the
world. An understanding of what is available elsewhere and whether those things are valued
and adopted by the users of payment systems is a very important common-sense test when
considering what our own system ought to look like. This effort has in part been aided by
interactions with many parties over the course of the Strategic Review, along with the work of
the Committee on Payment and Settlement Systems of the Bank for International
Settlements, which has conducted an examination of innovation in retail payment systems.
On the basis of this information, the Board sees the need to focus on the infrastructure
capabilities of retail payment systems, rather than the specific products that are offered.
Appropriate infrastructure can only be delivered cooperatively, but success in that delivery
will allow payments providers to compete vigorously over the products and services they
offer to customers. That should be true, not just for deposit-taking institutions, but for other
innovative players that have something to offer in the provision of retail payments. I talked
before about customer-facing innovation outpacing innovation in core infrastructure. What
the Board is interested in is lifting the constraints imposed by that infrastructure.
As to the specific areas on which the Board is focused, to those who have followed this
process, and the documents that have been produced along the way, it will be no secret that
one area on which the Board has focused is the timing of payments. It is very clear that both
individuals and businesses are demanding greater immediacy and greater accessibility in all
facets of their day-to-day activities. This includes payments. People expect to be able to
book an airline ticket and choose their seat at any time of the day or night. They expect to be
able to download music or a book while they are sitting on the bus. Our payments system
supports these transactions by allowing the payment to be initiated, and goods or services
exchanged, even though the funds will not be available to the merchant until some time later.
This delivers the immediacy to the transaction itself, as people have come to expect.
On the other hand, if a business or an individual wishes to receive funds into an account at a
financial institution, that same immediacy is not available. For instance, if a business wishes
to make timely use of the proceeds from a large shipment, or an individual is in need of
emergency assistance from a government agency, options are very limited. This is because
the infrastructure that underpins retail payments assumes that making funds available the
next business day is sufficient. This has served acceptably well to date, but, with systems for
real-time transfers available in countries ranging from the United Kingdom to Mexico,
Australia's approach is starting to look a bit dated. It is our belief that availability of real-time
transfers would fill some important existing gaps, but would also open up enormous potential
for innovation on top of that system. This would contrast with the current situation, where a
significant amount of effort is being put into finding work-arounds for the current constraints
of our systems.
Another element of the timeliness of payments is the availability of the payments system out
of standard banking hours. Some systems, such as card payment systems, give the
impression of operating 24/7, but in reality no funds move between financial institutions out of
hours, constraining the services that can be offered to end-users of the payments system.
Some would argue that anything more is unnecessary and that consumers and businesses
are not unduly inconvenienced by this. But we receive enough complaints about this to
suggest that expectations are changing. It is not that long ago that it was accepted that if a
person wanted to ensure that they had enough cash to see them through the weekend, they
had to make sure that they visited their bank branch by closing time on Friday. But we would
all see that as completely unacceptable these days and I think we have reason to hold the
rest of our payments system to the same standards.
One question that we have come back to during the Strategic Review is what sort of
payments system architecture would best allow us to deliver the features that we think are
going to be demanded by payments system users in the years to come, including improved
timeliness. Australia has had a long-running practice of operating payment systems that are
based on both bilateral business agreements between participants and the bilateral
exchange of payments between those participants. This model presents a number of
problems, not least the complexity and cost of adding a new entrant, which must establish
similar arrangements with each existing participant.
Some of the significant changes we have seen in the payments system over the past few
years have represented partial moves away from those bilateral arrangements. This includes
the move to the industry community of interest network for clearing payments and the
creation of eftpos Payments Australia Limited to centralise governance of the eftpos system.
These changes denote recognition of the constraints of bilateral payment systems. While the
Reserve Bank does not advocate walking away from some of the well-established and
low-cost bilateral systems we have, we can see a strong case for any new architecture that is
established to meet emerging needs to be based on centralised architecture; that is, a hub
and spokes, rather than bilateral, model.
So these are some of the things that will gain attention in the conclusions of the Strategic
Review of Innovation when they are released in the next couple of weeks. I do not mean to
suggest that the issues identified by the Review will be solved quickly, but I think we - the
industry and the regulator - owe it to the users we serve to embark now on the process that
will get us on to the right path. As a first step, in the months following the release of the
conclusions of the Review, I expect there to be a healthy dialogue with the industry on the
sorts of goals that the Payments System Board has in mind for the payments system, along
with more focused discussions on some specific solutions.
Other work of the payments system board
I have been talking about the innovation review and the way it will alter, in some respects,
the role played by the Payments System Board in the future. But it is also worthwhile to talk
briefly about other developments that also have an impact on the direction of the Board more
generally.
The reality is that the Board's mandate of promoting stability, efficiency and competition
requires it to play quite different roles in respect of two quite different sets of players in the
financial system. Most people in this room would think of the Payments System Board as the
body that capped credit card interchange fees and worked with the industry to achieve
reforms in the ATM system. There is another set of players out there who think of the
Payments System Board as the body that seeks to ensure the stability of key financial
market infrastructure, or "FMIs", such as securities settlement systems and, increasingly
importantly, central counterparties - which stand between financial market participants in
order to better manage risk. Much of this role came to the Board later than its initial
payments mandate, when the Corporations Act 2001 adopted licensing arrangements for all
clearing and settlement facilities in 2001. As important as the Board's work on payments
system efficiency is, the stable operation of FMIs has a direct bearing on financial market
and financial system stability. Oversight of FMIs therefore demands a significant proportion
of the Board's time. It is also this work that is expanding most rapidly.
In fulfilling its responsibility for the stability of financial market infrastructure, the Board has
historically focused on the high-value payments system, RITS, with which people in this room
are more than familiar, along with the debt and equities settlement systems operated by the
ASX and the equities and derivatives central counterparties also operated by the ASX. In
addition, the Reserve Bank has for some years been part of an international cooperative
oversight arrangement for the global foreign exchange settlement system, Continuous Linked
Settlement (CLS).
Two developments mean that the Bank's and the Board's workload in this area is increasing.
First, while most financial market infrastructures serving Australian markets are currently
operated by one entity, cross-border competition is increasing, particularly for central
counterparty clearing services. It is likely that the Bank's oversight responsibilities will
increase and become more complex as it has to deal with new entities offering services in
the Australian market.
The other development affecting the Board's role is the global push to strengthen financial
regulation in the wake of the global financial crisis. That includes the push for OTC
derivatives to be cleared through central counterparties and reported to trade repositories, as
embodied in the G-20 commitments from Pittsburgh in 2009. All this means financial market
activity that is important to Australia will be increasingly reliant on centralised financial market
infrastructure.
The logic of this reform is that it will reduce and simplify bilateral exposures between
counterparties. But it will also increase the systemic importance of the financial infrastructure,
because we will in effect be creating a small number of "single points of failure". Hence the
resilience of that infrastructure will be critical, and the obligation of the official sector to
provide proper oversight to ensure that resilience will correspondingly increase.
These trends have been recognised in a number of areas that will affect the Payments
System Board's work in the period ahead.
•
The international standards used by central banks and securities regulators around
the world as the cornerstone for oversight of FMIs have been comprehensively
rewritten to reflect the lessons of the crisis and the increased importance of central
counterparties and trade repositories. The revised standards were released just last
month and it will be a substantial task for the Bank to reflect those changes in its
own regulatory framework.
•
The Council of Financial Regulators has made a number of recommendations
regarding the framework for regulation of FMIs in Australia, including that the
Reserve Bank - along with ASIC - be given the power to, in extremis, "step in" and
operate an FMI in the event that it suffers financial or persistent operational
problems. The Bank has long had this capacity in regard to Austraclear, because of
the systemically important nature of that system for the operation of the domestic
money market. Domestic work in this area is occurring in parallel with international
efforts to develop principles for the recovery and resolution of FMIs. Over the
coming year, the Board will need to devote increasing attention to establishing how
step-in and other recovery and resolution tools for FMIs would operate in Australia.
•
Following further work by the Council of Financial Regulators, the Treasury is
consulting on a legislative framework to support mandating of central clearing,
exchange trading or reporting of OTC derivatives transactions, should this be
warranted. Initially, however, the Council intends to rely on existing market and
regulatory incentives to promote central clearing. The Payments System Board is
likely to have a central role in the new regime, such as overseeing new central
counterparties entering the market to clear these products, as well as input into
decisions about when mandates for central clearing might be appropriate.
•
It is inevitable that the Bank will become increasingly involved with cooperative
oversight arrangements for financial market infrastructure that operates on a global
basis.
The upshot of all this is that the financial stability element of the Payments System Board's
role is only going to increase. This is a continuation of a trend that has been under way for
some time, and to which we have already responded with a significant boost in the resources
we devote to these issues within the Bank. The work of the Payments System Board on the
regulatory framework complements the Bank's broader focus on financial stability, which is of
course overseen by the Reserve Bank Board.
Conclusion
There is a clear sense within the Payments System Board that our work over the next few
years will in some respects take us into some different activities. The work for which the
Board has mostly been known has focused on addressing problems or distortions in
individual systems, albeit with knowledge that these distortions had significant effects on
other parts of the system. The solutions have tended to be focused on the rules of those
systems. Payments innovation requires something quite different because it is more clearly
about solving coordination problems, which by their nature are likely to be ongoing and do
not necessarily occur within the confines of an existing system. Addressing this issue will
require a change in the nature of the conversation between the Board and the industry. That
conversation began with the innovation roundtable earlier this year, and will continue in the
period ahead, stimulated, hopefully, by the release of the conclusions from the innovation
review. At the same time, the Board's mandate in relation to financial stability remains a key
focus, and the global response to the financial crisis dictates that we take on a greater, and
probably more complex, role as the global focus shifts to centralised financial market
infrastructure.
This doesn't mean that the Board will be paying less attention to the payments system
efficiency matters for which it is perhaps best known. Much as we might want to live in a
world where that type of regulation is not necessary, unfortunately the issues do not become
any fewer or any less complex, and the Board is committed to continuing to meet its
legislated responsibilities in this area. In fact, one challenge from innovation is that old
tensions about competition might emerge in new ways. The Board will need to remain just as
vigilant in these areas in the years to come.