Yves Mersch: Challenges of retail payments innovation
Speech by Mr Yves Mersch, Member of the Executive Board of the European Central Bank,
at the Belgian Financial Forum, organised by the National Bank of Belgium, Brussels,
26 October 2015.
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Introduction
I am sure that almost all of you in this room today have a smartphone in your pocket. With
the smartphone, you feel as if you have the world at your fingertips: you can call or message
anyone across the globe, access up-to-the-minute information and news on the internet, and
stay entertained by downloading music, films or books. You can do all this at any time of day,
wherever you are. This is the smartphone's great innovation: making communication,
information and entertainment available 24/7, on the spot, around the globe.
I am also sure that all of you have a wallet in your pocket, containing banknotes, coins and
some credit or debit cards. You use these to pay for things, but there are limitations. What if
there were none? What if you could pay anyone, anytime, wherever you are? Be it with cash,
by card, online or with your smartphone? And what if all these payments were instant?
In a nutshell, this is what I will talk about today: how we can make this happen. We already
have the euro, making it possible for you to pay with the same banknotes and coins
throughout the euro area. Now we want to make cashless payments as easy, fast, and far
reaching as smartphone services. Users - be they consumers, retailers or businesses - do
not see why payments cannot be instant and boundless like e-mails, text messages or
WhatsApp.
What are the challenges of innovation in cashless payments? How do public authorities
contribute to the process? Who is involved in the market, and how can a level playing field be
ensured? How should innovative payment services be designed? These are some of the
questions I will address.
To give you a broad roadmap, in the first part of my speech I will talk about the key
institutions involved in bringing innovation to the payments arena. The Eurosystem, which
comprises the European Central Bank and the national central banks of the euro area, plays
a key role, as does the European Commission and the European Retail Payments Board.
The second part of my speech will address the supply side of the market, i.e. the retail
payments service providers. Here, we are seeing new payment service providers - i.e.
nonbanks - emerging alongside the traditional providers - i.e. banks. These new payment
service providers have the potential to play an important role in the payments market,
contributing to a wider choice of products and services and increased competition.
The third part of my speech will address the payment services that are ripe for innovation.
One of the central building blocks of payments innovation is instant payments, i.e. electronic
payment solutions that are available 24/7, every day of the year, resulting in the immediate or
close to immediate interbank clearing of the transaction and in the immediate crediting of the
payee's account with confirmation to the payer.
At present, we associate the word "instant" with instant movie streaming, instant messaging
and Instagram. There is still a gap between the instant nature of these services on the one
hand and the non-instant nature of the payments for these services on the other. What is
"normal" for messages, movie streaming and Instagram is not normal for euro payments -
yet. I hope that by the end of my speech, you will see how we can get there.
Part 1: The key institutions involved in payments innovation
Let us return to the wallet in your pocket, containing, most likely, some euro banknotes. This
is the most tangible result of one of the roles of the Eurosystem in payments, namely that of
an issuer of currency. Since the introduction of euro banknotes and coins in 2002, the single
currency has enabled everybody in the euro area to make cash payments across the euro
area countries from a single wallet.
In the payments industry, we use the term "retail payments" to mean all payments made by
private persons, companies, etc., for example to buy goods and services or to transfer
money. For cashless retail payments, the Eurosystem has strongly supported the creation of
SEPA, the Single Euro Payments Area, i.e. a single market for retail payments in euro across
Europe. SEPA was initiated by the European banking industry as a reaction to the
Eurosystem's call for more efficiency in cross-border retail payments1 and to the introduction
of the cross-border payments regulation, which eliminated the differences in charges for
cross-border and national payments in euro. Those of you who were involved in the work
towards SEPA know that harmonising the retail payments market for euro credit transfers
and direct debits was a huge task. More than a year has now passed since full migration to
SEPA and we can conclude that Europe has achieved a Single Euro Payments Area for
credit transfers and direct debits in euro.
Introducing innovative services without re-introducing fragmentation in the market is also
going to be a huge task. On the one hand, we have to be aware that the innovation of retail
payments services has a global perspective. Innovation in the United States, such as the
payment services launched by international giants Google, Apple, Facebook and Amazon,
makes its way over to Europe. In Asia, in China, the companies Alibaba and Tencent, via
their payment arms Alipay and Tenpay, are expanding their platforms for online shopping,
and their internet communication platforms, into complete ecosystems for digital payments
and financial services.
On the other hand, we are seeing that innovative retail payment solutions are often
developed based on local or regional regimes. For example, mobile payment initiatives are
often launched by individual banks, individual mobile operators, individual card schemes or
partnerships between different entities. Where do we position ourselves between these two
opposite ends of the innovation movement?
From the perspective of the Eurosystem, our unique responsibilities in the payments domain
relate to the smooth functioning of payment systems for the euro. Hence, our main focus in
retail payments innovation is on pan-European retail payment solutions in euro. We support
innovation in retail payments because it can increase the efficiency of the market, thereby
promoting economic growth and overall social welfare. We are neutral as to the providers of
such services, be they market incumbents or new players, provided that they fulfil the
applicable regulatory requirements.
Central banks serve three principal roles in relation to market infrastructure and payments:
these are the roles of operator, overseer and catalyst. The Eurosystem is the operator of
TARGET2, the large-value payment system for the euro; of the correspondent central
banking model, which allows the cross-border transfer of collateral in Eurosystem credit
operations; and of TARGET2-Securities, which is a service for the integrated settlement of
securities transactions in central bank money. As the owner and operator of these systems,
the Eurosystem has immediate and powerful tools to ensure their safety and efficiency.
Safety and efficiency are also the main drivers for the oversight of payment systems and
payment instruments. The Eurosystem monitors both existing and planned systems,
assesses them against a set of objectives and, where necessary, fosters change. To give an
example, the Eurosystem, as part of its involvement in international standard setting, for
example through the Committee on Payments and Market Infrastructures, is working
together with the industry to strengthen financial market infrastructure's resilience against
cyber-attacks. Work is also underway to enhance the security of retail payments within
the EU. For instance, the European Banking Authority and the European Central Bank are
closely cooperating in the preparation of regulatory technical standards for retail payments
services.
In its role as catalyst, the Eurosystem is active in helping the industry to find safe and
effective payment, clearing and settlement solutions for the euro area. I have already
mentioned the Eurosystem's contribution to the creation of the SEPA. Another example is its
involvement in the work towards removing barriers to cross-border securities clearing and
settlement in Europe.
The Eurosystem, the European Commission and the European Retail Payments Board have
distinct mandates and responsibilities, but they are also connected to each other. The
European Central Bank has been in regular contact with the European Commission about
their endeavour to harmonise the legal framework underlying payments, i.e. the Payment
Services Directive, which we refer to as PSD 1 & 2, the E-Money Directive, the SEPA
Regulation, the Directive on Payment Accounts and the Interchange Fee Regulation. This
strong cooperation between both institutions has enabled us to get where we are now with
the Single Euro Payments Area.
This brings me to the project currently underway at the European Commission with the aim
of creating a Capital Markets Union, or CMU. CMU has the potential to complement banking
union and strengthen Economic and Monetary Union by improving cross-border risk-sharing
and making the financial system more resilient. CMU will also be key to supporting European
growth by diversifying sources of funding and increasing companies' access to financing.
While the improved access to capital for small and medium-sized enterprises foreseen by the
vision for Capital Markets Union is currently very much in the limelight, we should not forget
that SMEs could also benefit substantially from more innovative retail payments services. Let
me give you some examples here.
First, now that SEPA is up and running, SMEs are able to use one single account for euro
payments throughout the EU.
Second, the experiences of other markets - particularly the United Kingdom, where instant
payments have been available since 2008 - show that SMEs greatly benefit from faster
payment execution. Receiving and making credit transfers instantly can free up cash flow
and ease working capital needs.
Third, electronic invoicing has long been on the agenda of European policy-makers. By
replacing paper invoices with electronic ones and creating a seamless link between the
invoicing process and the payment process, resources may be freed up and used for other
purposes.
Fourth, as many SMEs are small merchants accepting hundreds or thousands of payments
every day from consumers, at physical points of sale or online, they may benefit from
progress in contactless payments where a payment can be made by simply holding the
mobile device or card above a merchant's terminal.
Last but not least, the technical standardisation of payment cards may contribute to more
competitive card acquiring, i.e. the processing of card payments on behalf of the merchant.
In the longer term, this may lead to significantly lower costs for handling card terminals and
accepting cards, especially for small merchants.
The points I just made illustrate that, despite all the effort that has gone into the integration of
the euro retail payments market in Europe, we are not there yet. Only last month, the
European Commission published a roadmap for an upcoming Green Paper on Financial
Services and Insurance.2 The main purpose of this initiative is to investigate obstacles and
gaps in previous legislation that prevent the supply side from providing services across the
Single Market and the demand side from enjoying the benefits of the Single Market. With
regard to innovation, the European Commission roadmap recognises that the current trend of
digitalisation in retail payment services - i.e. the development of new models and
approaches through technology and the internet - provides a particular opportunity to further
integrate markets and solve a number of pending issues in the retail payments sector.
The European Central Bank very much welcomes this initiative as it should complement the
efforts of the Eurosystem and the Euro Retail Payments Board to further develop open, fair
and competitive retail payments in the EU.
The Euro Retail Payments Board, or ERPB, is the third body working towards innovation in
payments, alongside the Eurosystem and the European Commission. The ERPB was
created by the European Central Bank in 2013 as a strategic body that formulates guidance
and a common starting point for the development of an integrated, innovative and
competitive market for retail payments in euro in the European Union. It also provides
recommendations on work priorities, including standardisation needs. The ERPB is
composed of high-level representatives from both the supply and demand side. On the
supply side, there are representatives of the banking community, payment institutions and
emoney institutions. On the demand side, there are representatives of consumers, retailers
with physical premises, internet retailers, businesses/corporates, small and medium-sized
enterprises and national public administrations. Representatives of national central banks
participate in the board's work on a rotating basis and the European Commission participates
as an observer.
The activities of the ERPB are very much linked to the challenges and priorities for
innovation in retail payments. I will talk about some of these issues, in particular instant
payments, in more detail in the third part of my speech. Next, however, I would like to talk
about the new payment service providers that have been emerging in the market.
New payment service providers
The wallet in your pocket containing euro banknotes and coins and some debit or credit
cards tells you something about payment service providers. The cards you have may be
issued by a bank - if you have for example Visa or Mastercard - but they may also be issued
by a card scheme - if you have for example Amex or Diners. Card schemes and money
transfer service providers such as Western Union or Moneygram are examples of
established non-bank payment service providers. These are new market entrants, different to
the traditional banks, and history shows us that new entrants have long been a part of the
retail payments market. For example, merchants were the initial drivers of the introduction of
payment cards in the US in the 1930s, and, just a couple of years ago, it was a mobile
network operator in Kenya that succeeded in making mobile payments widespread in that
country.
In Europe, it is expected that non-banks will have a stronger role in payment markets in the
years to come. This will contribute to a wider choice of products and increased competition.
One category of non-bank payment service providers is that of payment institutions. Payment
institutions came into being as a result of the enactment of the Payment Services Directive,
or PSD1. Among other things, payment institutions can execute payment transactions for
you. With the revised Payment Services Directive, or PSD2, the list of activities that payment
institutions can carry out is being expanded to include the initiation of payments, i.e. they can
initiate a payment on your behalf. They can also provide account information for accounts
held at other payment service providers.
Actually, payment initiation services provided by third parties have existed in the market
for some time now. They have been emerging in parallel with e-commerce, i.e. online
shopping, offering an alternative to established payment instruments and services that
were - understandably - neither conceived nor wholly suitable for the e-commerce
environment. In particular, these third parties have been serving as an alternative way to
carry out card-not-present payments, i.e. card payments via the phone, internet or other
channels where the cardholder cannot physically present the card to the payee.
This is how it works. When you make a payment online, instead of having to input the
payment details into the online banking tool provided by your bank, typing in the amount, the
recipient's account details, etc., you access your online banking tool via the third party
service provider, which provides the transaction-related data for you. Simultaneously, the
e-commerce merchant, or online retailer, receives an automatic payment notification that the
payment has been completed successfully.
While in some European countries, for example in the Netherlands, banks began offering
these payment initiation services, in other countries, such as Germany, new providers
entered the market. Legally, these third party service providers have been operating in a grey
zone. At the same time, their emergence demonstrates that an actual market need was not
being covered sufficiently by the traditional market.
The rationale behind the regulatory formalisation of payment initiation service providers and
account information service providers with Payment Services Directive 2 has many aspects.
On the one hand, it is meant to increase competition in the market. It should remove
obstacles that have been hindering non-banks from entering the payments service market. In
particular, banks will not be allowed to reject access of third party service providers to the
accounts that they hold.
More indirectly, the provisions in PSD2 may also push banks to innovate in order not to be
forsaken by customers in favour of non-bank payment service providers. Last but not least,
the directive may also stimulate new business models and forms of cooperation between
banks and non-banks.
The need for a level playing field on which to compete goes both ways. All entities providing
retail payment services to end-users within the EU should be licensed and supervised. The
licensing of third party service providers needs to be proportionate, as is currently the case
for banks, for e-money institutions and for payment institutions.
An important follow-up work to PSD2, which was adopted by the European Parliament on
8 October and is expected to be formally adopted by the EU Council of Ministers in the near
future, is the drawing up of so-called regulatory technical standards. This includes, in
particular, the requirements for strong customer authentication3 and for secure and open
communication standards between third party service providers and account servicing
entities. As I mentioned in the first part of my speech, the European Central Bank and the
European Banking Authority are closely cooperating in this area under the remit of SecuRe
Pay. It has to be said, however, that the timeframe for developing regulatory technical
standards is challenging. At the same time, both the third party payment initiation service
providers and the account servicing banks will have to adapt their systems to the new
regulatory requirements.
It is encouraging to see that the market is pro-active in taking up the requirements of
Payment Services Directive 2. For instance, some existing retail payment processors see a
role for themselves in facilitating payment initiation services, thereby assisting banks and
third-party service providers in supplying them to end-users and making them a more
valuable service proposal. Some banks are changing their strategies to become active as
third party service providers or even to set up special purpose subsidiaries. These
subsidiaries will provide their parent bank's services bundled with the services offered by
competing banks, making the increased competition really work for the benefit of payment
service users - be it consumers or merchants.
Instant payments
And now let us return to instant payments, and to the wallet in your pocket. If you went for a
coffee before this meeting and paid for the coffee with coins or banknotes, you made an
instant payment - in cash. If you paid for the coffee with a card, it may take some time before
the merchant actually receives the money in its account and before you receive the
confirmation of the payment in your account statement.
Intuitively, the idea behind instant payments is that cashless payments become as
instantaneous as cash payments, meaning that funds are immediately available to the
payment recipient. Some may say that there is no real need for instant payments, that a
payment guarantee is sufficient in e-commerce. But we have to be aware that we are not
only dealing with customer needs but also with customer expectations. At the European
Central Bank, we receive quite frequently requests and comments from European citizens
and companies regarding retail payments, and one comment that appears time and again
perfectly illustrates my point. This is the comment that in the digital era, it is
incomprehensible why e-payments should take longer than e-mails. People expect instant
payments to be as self-evident as other services delivered via the internet, e.g. instant
messages, movie streaming or Instagram. Nobody would accept an e-mail being delivered
with the same time lag of a letter sent by surface mail. Why then does an electronic payment
still take a full day at least?
In the following, I will discuss the three layers that are required for us to achieve instant
payments: the scheme layer, the clearing layer and the settlement layer.
The scheme layer refers to a set of rules and technical standards that have to be followed by
payment service providers. It can be understood as a common instruction manual on how to
move funds from one account to another.
You may ask why we need a common scheme for instant payments. After all, innovative
payment services based on instant payments are already being implemented by some
national communities in Europe. However, even if they are often based on the same
technical standards, these services lack common rules and the harmonised implementation
of standards and are therefore not easily interoperable. This means that, for example, a
service deployed in Germany cannot be easily used in France. What we want is for electronic
payment means to work for you wherever you are, whether you are paying by card, online, or
using your smartphone.
With the creation of SEPA, we have made huge efforts to integrate the European retail
payments market. Why should we not take advantage of the harmonisation and integration
already achieved with the SEPA project in working towards instant payments? I believe that
payment service users do not want to be swamped by dozens of different solutions, having to
subscribe to different platforms depending on what they want to do. What they want is a
solution that gives them a wide reach, and this can only be achieved by having a common
scheme. If you allow me to take one more analogy from the mobile phone sphere, it is quite
obvious that users expect to be able to reach any person anywhere with a phone. Nobody
would accept having to subscribe to a Spanish mobile operator just to be able to phone a
friend in Spain.
The European Retail Payments Board mandated the payments industry to design a scheme
for instant payment services by November 2015. The European Payments Council, which
represents payment service providers, is working on a proposal for the design of a common
scheme based on the SEPA credit transfer. This proposal is to be delivered in the next
meeting of the European Retail Payments Board in November 2015.
A common scheme for instant payments should harmonise how payment service providers
interact with their users and with other payment service providers.
This leads us to the second layer: the clearing layer, i.e. the process of transmitting,
reconciling and, possibly, confirming payment orders prior to settlement. Here, we have to
consider that, typically, retail payments are processed and cleared in batches. Payment
service providers collect payments and process them one or several times a day through
clearing and settlement infrastructures. After receiving the funds from the payers' banks,
payment service providers credit the funds to the payees' accounts. In this non-instant
payments mode, payment service providers incur no credit risk when processing payments.
They also have sufficient time to comply with checks under Anti-Money Laundering
regulations and regulations combating the financing of terrorism.
As for the third layer - the settlement layer - in instant payments mode, unless instant
settlement occurs, payment service providers may have to provide funds to payees before
they receive the money from the payer, thus incurring credit risk. This credit risk would need
to be covered - for instance by prefunding or collateralisation arrangements. In any case, it
may be necessary to enhance the methods for screening transactions as required by the
applicable law on anti-money laundering and on combating the financing of terrorism.
In Europe, a fundamental question that has to be tackled is what kind of clearing and
settlement infrastructure provides a viable solution for pan-European instant payments
throughout the Single Euro Payments Area. Do we need one or more central infrastructures
for instant payments in euro? Who will build, manage and operate them? Are links between
infrastructures a possible way forward? Could interoperability work, i.e. the establishment of
technical and business procedures that enable the clearing and/or settlement of instant
payments between scheme participants from different infrastructures across SEPA? These
are some of the issues that will have to be addressed.
What is encouraging is that there are several initiatives underway addressing the clearing of
instant payments. What I think is important from the central bank catalyst perspective is that
there will be euro area wide reachability and a fair level of harmonisation. Non-interoperable
island solutions are not the way forward.
The development of pan-European instant payment services is also an integral part of what
we call the Eurosystem's "vision 2020". Overall, our vision 2020 encompasses three central
areas: first, it aims to explore the synergies between TARGET2 and TARGET2-Securities,
with the ultimate goal of achieving a consolidated Eurosystem market infrastructure for
largevalue payments and securities settlement. Second, it aims to increase the level of
harmonisation of the Eurosystem's collateralisation techniques and procedures, and to
consider whether a common Eurosystem collateral management system would be useful.
Third, it will assess new service opportunities arising from bringing TARGET2 and
TARGET2-Securities closer together. In particular, it will consider the benefits of enhancing
TARGET2 services in the field of instant payments, at least in the settlement layer.
Furthermore, it will review how the Eurosystem could foster the emergence of a competitive
and open clearing solution for instant payments.
In the discussion on innovation in retail payments, instant payments are what everyone is
talking about. Payment service providers will build their service offers around instant
payments, for example when you use their services to shop online or to pay a friend via your
mobile phone. This will foster competition between providers, benefitting the end user.
Of course, when instant payments become a reality, this does not mean that other
noninstant payments will die out. We have seen that, besides e-mails, online news services and
Instagram, there are still letters sent via postal services, people reading newspapers, and
photos put into albums. However, instant payments will be the "new normal".
As a result of digitalisation, payments - and in particular card-not-present payments - are
becoming part of increasingly long and complex value chains. Users expect these value
chains to seamlessly integrate e-commerce, social media and retail payments. The downside
of the gain in convenience may be that users forget about the risks. People often complain
about tedious authentication procedures, about having to memorise passwords and PINs,
about having to generate transaction-specific codes, etc. They would rather payments were
quicker and easier. But there is a trade-off between convenience and risk. And of course,
people also complain if, as a result of this risk, they are subject to fraud or breaches of data
confidentiality.
In order to maintain confidence in payments and trust in the currency, the Eurosystem has to
make sure that the right balance is struck between convenience and security. The
digitalisation of retail payments services means that security requirements need to be
adapted and enhanced. However, innovation brought by digitalisation should not be seen as
the enemy of security. On the contrary, it can actually enhance security, as has been
demonstrated by the introduction of the technical standard EMV4 for cards. In the design of
security features, authorities and payment service providers are well-advised to bear in mind
the users' need for convenience and the proportionality of the security requirements. If the
security features related to a payment service are perceived as being too cumbersome,
users will seek ways to circumvent them - or reject the service.
Conclusion
To conclude, allow me to summarise the three main messages that I would like you to take
home from my speech today.
First, I hope that I managed to explain that for the Eurosystem, the main focus as regards
retail payments innovation is on pan-European retail payment solutions in euro. We should
take advantage of the harmonisation and integration already achieved with the SEPA project
in working towards innovative payment solutions, be they instant payments, mobile payments
or other payment-related services. This does not mean that we should ignore global
developments or prevent local or regional initiatives from emerging. I would like to
emphasise, however, that we should avoid the development of non-interoperable silo
solutions. Rather, the harmonisation of standards and business rules, pan-European
reachability, interoperability and a harmonised legal framework are the foundations on which
innovative payment solutions should be based.
Second, I would like to underline that the market for innovative retail payment services needs
to be based on a level playing field. Hurdles preventing new service providers from entering
the market must be avoided. The Eurosystem welcomes innovation and new market faces.
At the same time, all entities providing payment services to end users should be licensed and
supervised. As for banks, e-money institutions and payment institutions, licensing of new
payment service providers should be proportionate and risk based.
Third, while it is clear that users will go for innovative payment services that are convenient
and inexpensive, they also take it for granted that the regulatory authorities ensure the safety
and efficiency of the products and services. In the end, what is true in other walks of life is
true for retail payments innovation, too - i.e. we have to get the balance right.
Last but not least, as instant payments will be the basis for many innovative services offered
by payment service providers, I expect that, by the end of this year, the course for the
development and adoption of instant payments in Europe will be set. I thank you for your
time.