Jon Nicolaisen: Challenges for the payment system
Speech by Mr Jon Nicolaisen, Deputy Governor of Norges Bank (Central Bank of Norway), at
Finance Norway's payments conference, Oslo, 1 November 2018.
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Please note that the text below may differ slightly from the actual presentation.
Changing payment landscape
The way we make payments is changing. New services and operators are constantly appearing.
The underlying infrastructure, our payment system, must be adapted to the changes. But where
is this all heading? How will we make payments in the future? And what will the future form of
money be?
The forces driving payment market developments are new technology, changes in consumer
behaviour, globalisation, and new regulations, such as the new Payment Services Directive
(PSD2).
PSD2 requires banks to grant third-party providers (TPPs) access to their systems to enable
TPPs to offer payment and account information services. PSD2 is both a response to
developments in the payments market and a catalyst for future developments.
At the same time, a number of large international technology companies are moving into the
payments market. Apple offers mobile payment services to Norwegian customers. Google has
just launched its own mobile payment solution in Norway. Other operators will follow suit. The
role companies such as Facebook, Amazon and Alibaba may take remains to be seen.
Vipps is now the only Norwegian mobile payment solution. A planned merger of the Vipps,
BankAxept and BankID systems was announced towards the end of 2017. The merger was
approved by the authorities in summer 2018. One of the aims of the merger is to be better
positioned to compete with global companies.
New market entrants and lower entry barriers promote competition, but there are other
mechanisms that could weaken competition in the longer term. One example is if one or a small
number of multinationals become dominant payment service providers at the global level. The
key words are digital platforms and network effects.
Marketplaces such as stock exchanges and shopping centres have existed for a long time. But
digital marketplaces, known as platforms, are far more scalable. Well-known examples of digital
platforms are Google, Facebook and the classified ad portal Finn.no. These platforms achieve
competitive advantage by gathering information about customers, eliminating time-consuming
tasks and simplifying users' everyday lives.
Platforms have network effects. Competition can be impaired if platform companies exploit their
market power. A large user base makes it profitable for other service providers to develop
complementary services. Because of network effects, dominant platforms can achieve a
nearmonopoly position.
Operators that control parts of the payment infrastructure can shut out competitors. For
instance, Apple Pay is the only option for contactless payments based on near-field
communication (NFC), using Apple's iPhones. A number of countries are considering whether
this constitutes abuse of a dominant market position. In Norway, this would be a matter for the
competition authorities.
Payment solutions should build on a common underlying infrastructure that enables payments to
be carried out swiftly, safely and at low cost. Providers can compete freely for customers
through various apps and interfaces.
Future payment infrastructure
Norway was one of the first countries to modernise its payment system and still ranks at the top
of international comparisons of payment system efficiency. However, some countries have
caught up with us and have taken the lead in some areas.
With regard to providing real-time payments, we have lagged behind our neighbours. Real-time
payments, or instant payments, provide immediate payment into the recipient's account. Instant
payment is now available through the Vipps system and from many online banks. This is a
positive step, but banks are still exposed to settlement risk, and the solution cannot be used for
all types of payments. It is particularly problematic that the current instant payment solution is not
very suitable for corporate transactions.
Norges Bank has played a catalyst role in bringing about improvements. Just over two years ago,
the Bank expressed the opinion that it was necessary to step up efforts to establish a real-time
payments infrastructure without settlement risk. The financial industry and Norges Bank agreed
on a joint initiative called BRO, Betalinger med Raskere Oppgjør [payments with faster
settlement]. BRO was scheduled to be in place by the end of 2019.
In February 2018, seven large Nordic banks announced their intention to establish a pan-Nordic
payment infrastructure, P27. The aim is to replace existing domestic clearing and instant
payment infrastructures in the Nordic countries with one common system.
When the P27 initiative was announced, the BRO project was put on hold in order to consider
whether a future common Nordic infrastructure as proposed by the P27 banks could be a
satisfactory replacement.
Norges Bank has engaged in joint discussions with the other Nordic central banks since P27
was launched. The central banks have given preliminary feedback on the P27 project and
appreciate the project's ambition to improve payment system efficiency in the Nordic area. At the
same time, there are issues that need to be addressed before the authorities can take a position
on any transition from domestic infrastructures to a common Nordic solution. This process may
take time and will also involve authorities other than the central banks.
Security legislation is one of these issues. If P27 is realised, it will probably be viewed as an
important critical infrastructure for the countries involved. National security concerns may
influence the conditions governing whether a payment system infrastructure can be operated
across national borders. In the case of Norway, one likely condition could be that satisfactory
contingency arrangements must be in place in Norway. Domestic control of the payment system
must be possible in a crisis.
The European Central Bank has launched a European solution for real-time payment settlement
in central bank money called Target Instant Payment Settlement, or TIPS. The system is
scheduled to commence operations this month and may be expanded to include non-euro area
countries. According to Sweden's central bank, the Riksbank, settlement of instant payments in
SEK may be made available on the TIPS platform. If so, this would mean that at least some
Swedish real-time payments will not be cleared through P27, which could affect the profitability of
the project.
Norges Bank is aware that the industry is also assessing other possible Norwegian solutions for
better real-time payments in Norway. In its letter sent in October to Finance Norway and the P27
banks in Norway, Norges Bank called upon the banks to continue this work. The objective must
be to make the necessary adjustments to the Norwegian infrastructure as quickly as possible to
give both businesses and private individuals in Norway access to modern real-time payments on
a 24/7/365 basis. The technological set-up should be adapted to customers' needs, particularly
businesses, while also eliminating interbank settlement risk. As far as possible, the set-up should
also be suitable for use in future solutions, such as P27, including a system for control of reserve
cover at Norges Bank. Reusing a technological set-up will keep total costs down.
Establishing a satisfactory Norwegian solution for instant payments will also decouple P27 work
from any deadlines for the system in Norway, which in time may increase the chances of
success for the P27 initiative.
A common infrastructure for all payments has given Norway an important competitive advantage,
provided economies of scale and facilitated interaction across the banking sector. It is important
to avoid fragmentation of the infrastructure for clearing payment transactions in NOK, otherwise
we will lose the advantages we have today. An efficient and secure common infrastructure must
still be a main feature of the Norwegian payment system, whichever solution the industry
ultimately chooses.
Looking further ahead, a number of broad issues need to be addressed. Norges Bank will initiate
a project to assess the payment and settlement system of tomorrow as a whole. The aim is to
make active and constructive contributions to an efficient and secure payment system, today and
in the future. We will seek long-term solutions to several of the issues mentioned above, in
particular the following two key questions:
Should we continue to have a completely domestic payment infrastructure in Norway, or
could it become more international? How would we then solve issues related to national
security?
How should the infrastructure be changed to facilitate the services needed by end-users in
the future? Should payments still be cleared before they reach the central bank, or is gross
settlement the best option?
The first phase of the project is scheduled to be completed by the end of 2019.
Cyber security
As the payment system is centralised and ICT-dependent, it is vulnerable to cyber attacks. If an
attack were to succeed, payments could come to a halt and financial losses could occur. An
attack could also result in unauthorised access to or manipulation of sensitive information.
The system's vulnerability can be reduced in a number of ways, for example through
wellestablished cooperation within the financial industry and between the industry and the authorities,
sound security procedures and recovery capabilities. System owners are responsible for the
resilience of their own systems. Norges Bank monitors the systems under its supervision to
ensure that satisfactory defence mechanisms are in place.
A number of payment system participants have outsourced the operation of their systems to a
few ICT service providers. This is a source of concentration risk. The failure of key service
providers could bring important parts of the payment system to a halt. The problems at EVRY on
6 October 2017 affected approximately 40 banks in Norway, as well as Norway Post and
Telenor. This incident illustrates the potential broad repercussions of the failure of a key ICT
service provider.
Such concentration risk is difficult for individual system owners to address alone. The entire
infrastructure served by the provider is exposed to risk, not merely the individual system. ICT
service providers are not subject to the same regulation and supervision as licensed banking and
payment system participants. It is Norges Bank's view that the authorities should explore how
key ICT service providers can best be supervised. Such an evaluation must be based on the
work of the ICT Security Commission, which publishes its report in December 2018.
Distributed ledger technology
Distributed ledger technology (DLT) offers interesting opportunities. A shared decentralised
digital asset register can enhance efficiency, as business ledgers no longer need to be
reconciled, and can reduce counterparty risk. DLT solutions can also reduce operational risk as
this technology does not rely on a central operator.
DLT has many potential applications in the financial infrastructure, such as in the securities
settlement system. The Australian exchange ASX is replacing the existing system for clearing
and settling trades with a new DLT-based system. Another example is cross-border payments;
several projects have been launched and the potential for improvement is considerable. A
number of Norwegian operators are exploring opportunities for using DLT-based solutions in
Norway's infrastructure.
Central banks have also explored the use of DLT. The European Central Bank and the Bank of
Japan have considered how secure delivery versus payment systems could be organised where
the assets are stored in a decentralised accounting system. Some central banks, such as the
Bank of Canada, have evaluated and tested DLT for use in central bank settlement. At the same
time, the use of DLT poses a number of challenges, including the immaturity of the technology
and how to prevent unauthorised access to confidential information.
New technology also makes new forms of money possible. The functions of money as a medium
of exchange, a store of value and a unit of account are dependent on public confidence in the
currency. Most of our money is in the form of bank deposits or cash. So-called cryptocurrencies
have attracted considerable attention in recent years. Owing to their substantial day-to-day
volatility and the interfaces with money laundering and other criminal activity, cryptocurrencies
are unsuitable as a universal means of payment. On the other hand, cryptocurrencies are
attractive as speculative assets. Crypto-assets is therefore a better term than cryptocurrencies.
Central bank digital currencies
Another possibility is central bank digital currencies (CBDC). A CBDC is a digital form of central
bank money made available to the general public. A number of central banks, including Norges
Bank, are assessing whether introducing a CBDC would be advisable and, if so, in what form.
For the time being, banknotes and coins are the only form of central bank money, with a role to
play both in a contingency and under normal circumstances. Effective electronic contingency
arrangements are crucial for ensuring that the payment system is resilient to disruption. Cash is
part of the overall contingency arrangements, in the role of last resort should the electronic
contingency arrangements fail.
Banknotes and coins will continue to be in use into the foreseeable future. However, the use of
cash is relatively low in Norway compared with other countries and is declining. It is not
impossible that cash usage, at some point in the future, will fall to such a low level that banknotes
and coins can no longer be regarded as a generally accepted means of payment.
We must therefore consider whether cash has any important characteristics that are not shared
by bank deposits and whether there is a need for other forms of central bank money in addition to
cash. Cash has a number of unique characteristics:
It is a credit risk-free alternative to deposit money.
It is an independent back-up solution if electronic systems fail.
It is legal tender that can be used by all.
For Norges Bank, the question is whether a CBDC could supplement cash to maintain
confidence in the monetary system and ensure that Norway's future payment system is safe and
efficient.
A list of factors that should be given weight in an assessment of whether Norges Bank should
issue a CBDC was presented by a Norges Bank working group in May. Phase 2 of the
assessment is now in progress. The working group is focusing on the purposes of a CBDC, the
solutions that best serve these purposes and their impact. The working group's report will be
published in spring 2019. This is a long-term process and it is too early to draw any conclusions.
A premise underlying the work is that a CBDC must not impair the ability of banks and other
financial institutions to provide credit.
Conclusion
The various developments reflect a payment system in change. It is important to look up and
envision the situation a few years ahead. Where do we want to be then? How will we make
payments, what will our means of payment be, and what kind of payment system will we be
using?
Our common goal must be that Norway has an efficient and safe payment system, today and in
the future. That we have confidence in the means of payment we use, that we base our
infrastructure on cost-efficient common solutions, and that we together can safeguard the
interests related to efficient payments, personal privacy and security.
There are numerous challenges to be faced. The best course of action is for businesses to
come together and agree on good common solutions.