Michele Bullock: Financial technology and payments regulation
Keynote speech by Ms Michele Bullock, Assistant Governor (Financial System) of the Reserve
Bank of Australia, at the 5th Bund Summit on Fintech, Shanghai, 8 July 2018.
* * *
My thanks to Chay Fisher, Jiamin Lim, Sean Langcake and Stephanie Bolt who carried out the
work on which this speech is based.
Thank you to the Shanghai Finance Institute for the invitation to speak at this summit. The theme
of the summit - New Finance, New Technology, New Trends - really captures the excitement of
the payments industry at the moment. But it is also a challenging time for regulators who want to
encourage innovation but at the same time ensure that payment systems remain safe for users
and that there is a level regulatory playing field. Today I am going to talk about some of those
challenges and how we are thinking about them at the Reserve Bank of Australia. I will start by
briefly setting out the Australian regulatory framework for payments before talking about the key
forces shaping payments. I will then talk about some of the potential implications for retail
payments and for regulators.
Payments Regulation in Australia
Like in China, the primary regulator of the payments system in Australia is the central bank - the
Reserve Bank of Australia. The Reserve Bank's payments system policy is determined by the
Payments System Board (PSB), which is chaired by the Governor of the Reserve Bank and
includes a number of external members. The key duties of the PSB with respect to the payments
system are to ensure that the powers of the Bank are exercised in a way that best contribute to
controlling risk in the financial system, promoting efficiency of the payments system and
promoting competition in the market for payment services consistent with overall stability of the
financial system.
The Reserve Bank has strong powers to regulate payments systems and in some cases it does.
For example, certain competition and efficiency issues associated with credit card systems
could not be addressed by participants so the Bank introduced regulation that required changes
to certain practices in these schemes. But the Bank's preferred approach is to identify areas
where competition, efficiency or safety could be enhanced and then encourage industry to
address those issues. A good example of this was the development of the New Payments
Platform (NPP).
The NPP is an open access infrastructure for fast payments in Australia. It went live earlier this
year and is gradually ramping up. It allows users of the payments system to send real-time
payments with simple addressing 24/7. It also allows more complete information to be sent with
payments. But this wasn't a spontaneous creation of the industry. It was developed in response
to a number of strategic objectives for the Australian payments system set by the Reserve Bank.
While the industry determined how it would achieve the objectives, the Reserve Bank played a
significant role in encouraging and facilitating the cooperation required to develop and build the
system.
The Forces Shaping Retail Payments
There are three key forces that are introducing innovation and competition to retail payment
systems around the world: new payment channels, new technologies and new participants.
Increasingly, consumers are reducing their use of cash and using electronic payment methods.
But they are also making electronic payments through new channels. One example is payment
using mobile devices. These devices have become ubiquitous and are now being used for
payment at the point of sale, online payments and 'in-app' payments. Wearables and the 'internet
of things' more broadly are also expanding the devices through which payments can be made. In
Australia, most of these new payment channels use the existing payment rails - in particular
those of the card schemes.
New technologies are also shaping retail payments. Distributed ledger technology has been
receiving a lot of attention lately, with suggestions that new payment mechanisms using this
technology might be more efficient (e.g. cross-border payments) and even result in a reduced
role for traditional financial institutions. But other technologies that are likely to facilitate innovation
in the payments system include cloud computing, artificial intelligence and cryptography. These
technologies have the potential to improve payment experiences for customers as well as
support new payment instruments. They are also potentially allowing non-traditional players
without a large physical footprint to compete with the established financial institutions.
Which brings me to the third force shaping the retail payments system - new participants. There
are broadly three types of potential competitors. Most similar to the incumbents are digital banks,
sometimes called neobanks. These banks offer banking services typically by mobile app. They
are unencumbered by legacy systems and physical branch networks and can use newer
technologies, potentially making them more flexible and responsive to consumer needs. Then
there are fintech firms, many of which are using technology to address particular frictions and
gaps in the payments market. Online payments, point-of-sale technology and cross-border
payments are all areas in which fintechs are innovating. And, finally, there are the large global
technology companies that can leverage their already extensive networks to offer proprietary
closed loop payment services. In China there are two at the forefront of this - AliPay and WeChat
Pay. But Google, Apple, Facebook and Amazon all have some payment functionalities within their
networks that they could potentially expand.
Moves to require banks to share the data of their customers with other participants (open
banking) have the potential to further promote competition and innovation. In Australia, we are in
the process of implementing an open banking regime that will put consumers in control of their
banking data. It is expected that consumers will be able to use these data to access better
products and services. For example, consumers could ask their bank to share their credit card
transaction history, interest rate, fees and other relevant data with a product comparison website.
Using this information, the website could provide a tailored assessment of the best possible
credit card for that particular individual, including an accurate estimate of potential savings
compared with their current card. While there are a number of challenges in implementing this
ambitious reform, such as ensuring data security and customer privacy, these can be
addressed. The Reserve Bank is confident about the potential of open banking to deliver benefits
for consumers.
Implications for the Retail Payments System
With all this innovation and competition in the financial system, and the payments system in
particular, a logical question is: what are the implications for policy and regulation? I will address
four here:
Challenges in balancing innovation and regulation
Implications for efficiency of the payments system
Security
Resilience
Financial regulation
An important challenge for regulators is how to limit barriers to innovation while maintaining safe
and efficient payments systems. This requires regulators to be alert to any detrimental impact
that regulations might have on innovative new technologies and participants. But new entrants
might also find that it is difficult to get access to the underlying payments infrastructure. And
some innovations might require participants that are otherwise competitors to cooperate, making
it difficult to get an innovative product or system off the ground. The Reserve Bank therefore sees
a need to play a proactive role in facilitating cooperative projects and monitoring potential access
issues.
Most regulators around the world seem to be encouraging innovation while taking a proportionate
approach to regulation. This often involves a graduated approach to regulation, depending on the
activities of the new participants. For example, many jurisdictions have some type of regulatory
'sandbox' in which new participants can develop their services without the full weight of
regulation. Some jurisdictions authorise payment service providers under less onerous
conditions than apply to full financial institutions.
In Australia, the Australian Prudential Regulation Authority (APRA) and the Australian Securities
and Investments Commission (ASIC) are also taking a graduated approach to new entrants.
ASIC has a regulatory sandbox framework that is specifically designed to provide eligible fintech
businesses the flexibility to test new products and services without the need for a licence.
Similarly APRA has established a framework for licencing 'Restricted ADIs', which allows
potential entrants to the banking sector to conduct limited banking business for a period of time
under a simpler prudential framework while they develop their capabilities and resources.
Importantly though, under both these frameworks, new entrants are expected to eventually meet
the same requirements as other financial service providers, ensuring a level playing field.
There are two issues in the Australian payments system that are potentially going to be of
interest to financial regulators. The first is access. New payment service providers will need
access to the underlying payments infrastructure to compete with the incumbent financial
institutions. Non-bank providers of payment services already have access to accounts at the
Reserve Bank for the purposes of settlement. But they will also need access, either direct or
indirect, to payment clearing systems. While they might be able to commercially negotiate an
agency arrangement, this could add to their costs and they might therefore prefer direct access.
If incumbent financial institutions control access, they might seek to put up unreasonable barriers
to entry. Regulators will need to be alert to potential anti-competitive conduct.
The second area is stored value products. Traditionally, payment services have been provided by
regulated financial institutions through transaction accounts. These institutions are prudentially
supervised to ensure that the public can have confidence that they will be able to meet their
financial commitments under all reasonable circumstances. In addition, in most countries,
including Australia, retail deposits would be protected if a bank were to fail. But some of the new
entrants are holding client funds on their books as 'stored value'. This raises a number of policy
questions. Should the funds being held be treated like deposits? If not, do the firms holding the
funds need to be regulated in some other way to protect consumers? If the new entrants are very
large, like the big technology companies, they could potentially hold substantial amounts of value
in their closed systems. What are the implications for systemic risk of such a market structure?
Regulators are still working through these questions.
Efficiency
The potential for new products to improve payment services will depend on the extent to which
there are gaps or frictions in the payment process. Three areas that are often identified are
micropayments, 'programmable money' and cross border payments.
The concept of micropayments - of, say, one-hundredth of a Yuan or an Australian dollar - is not
new (indeed, the concept has been around for decades). In recent years, demand for a
micropayment service has typically been from internet content providers looking for alternatives
to the advertising or monthly subscription-fee business models. But, looking ahead, the
development of an 'internet of things' potentially greatly broadens the demand for the ability to
make and receive very small payments at low cost. A challenge in addressing this gap has been
how to recover costs - or even be profitable - when the value of each transaction is so small.
'Programmable money', that is, payments that occur automatically if certain terms or conditions
are met, could improve efficiency by minimising the need for human intervention. For example,
online payments for goods could be held as a deposit with an independent third party and
automatically released once goods are confirmed as delivered. Other possible applications
include payments that occur within business supply chains.
Cross-border payments are widely regarded as an area in which significant potential efficiency
gains exist. Current processes are slow and costly, involving significant compliance burden and
a number of different financial institutions in different jurisdictions. New technologies and new
business models could be used to address some of these frictions.
While there are clearly potential efficiency gains from addressing some of these gaps, there are
reasons for regulators to keep an eye on developments that might result in inefficient outcomes.
Some of these arise from the existence of network effects. A very large network that incorporates
payments as one part of its services might be able to lock in the payments business, even if it is
more costly than alternatives, because customers are unwilling to leave the ecosystem.
The trend towards embedding payments in apps or other devices could also lead to inefficient
outcomes. While automated payments are likely to be convenient for consumers and merchants,
they might also make it more difficult for alternative payment methods to compete and reduce the
sensitivity of users to changes in the relative prices of payment instruments.
Security
With increasing commercialisation of consumer data, interest in people's personal banking data
(including payments) is likely to grow. For example, it has been suggested that if individuals could
easily and securely share their personal banking information (while retaining ownership of the
data), new services could be developed to facilitate personalised financial services. More
generally, the advent of 'big data' analytics to generate insights into behaviours of individual
consumers has increased interest in access to data on consumer payments behaviour.
But with more data being stored and shared, data security (and cybersecurity more generally)
will be important ongoing issues for the industry and for regulators. Incumbent financial
institutions invest a lot in securing their customers' data and in managing fraud in payment
systems. Mostly they do this without the need for regulators to be involved because it is in their
interests to ensure that they maintain the trust of their customers. But with new participants and
new technologies, there is a risk that security vulnerabilities and opportunities for fraud will arise.
The strength of the system is only as good as its weakest link so it is essential that all
participants in payment systems and the financial system more broadly manage and mitigate
these risks. Regulators may have a role to play in encouraging the adoption of minimum
standards.
Resilience
The final area I want to focus on is resilience of payment systems. Traditionally, central banks
and regulators have paid a lot of attention to the resilience of high-value payment systems
because of the systemic disruption that would likely occur if such systems were to suffer from an
outage. High-value payment systems are therefore subject to high standards of operational
resilience.
Retail payment systems have not usually been required to meet similarly high standards. But,
with electronic payments becoming increasingly important, the resilience of the electronic retail
payment systems is becoming quite critical to the smooth functioning of economies. With people
carrying less cash, an outage in a retail payment system can mean that customers can't
undertake transactions. In Australia, for example, an outage at a major bank recently meant that
its merchant customers had to turn customers away if they didn't have cash (and many didn't).
These sorts of outages disrupt commerce and erode trust of consumers in payment systems.
Regulators are therefore starting to focus on the operational risks associated with retail payment
systems and whether the operators and the participants are meeting appropriately high
standards of resilience.
Conclusion
There is a lot of change happening in retail payments and it is happening quickly. Financial
technology is facilitating the development of new payment products and the entry of new
participants, and potentially transforming the customer experience. It has the potential to
enhance competition and increase efficiency in the payments system. Recognising this,
regulators in Australia and other countries are encouraging innovation. Nevertheless, regulators
need to keep up with this fast changing world and the implications for efficiency, and safety of the
payments system.