Erkki Liikanen: Enhancing reliability and efficiency of future payments -
five criteria
Speech by Mr Erkki Liikanen, Governor of the Bank of Finland, at the European Central
Bank/Bank of Finland Retail Payment Conference, Helsinki, 4 June 2015.
* * *
1. Introduction
Traditionally retail payments were made only by notes and coins. Cash-based payment
process required a great deal of physical money transfers. The payment system was
inefficient compared to what it is today.
Today we use more and more debit and credit cards to pay for shopping and online banking
services to pay the bills. The efficiency of the system has increased, but still, it is not
exploiting the full potential of digitalization.
Digitalization will shape the future payment landscape. But it is not necessarily the banks and
other established financial institutions that will dominate this future. They are being
challenged by new entrants and large established companies from non-financial industries.
In Finland, we remember how Nokia became the biggest in mobile phones after it had
challenged incumbents in the industry, such as Motorola, Ericsson, Siemens and others. But
Nokia itself was challenged by new entrants: Android from Google and iPhone from Apple.
Therefore, the next big change in the payment industry may be more than just an evolution -
maybe even a revolution.1
What is the role of central banks in the development of the future payment methods?
Innovation and new development should naturally come from the private sector.
But at the same time, retail payment systems are essential to efficient functioning of the
economy. When we take into account the social costs related to payment systems,2 central
banks can have an important role as a catalyst to facilitate the socially best possible
development. This is our task.3
2. The five criteria for a payment system and the role of central banks
We at the Bank of Finland have defined five criteria which should serve as guiding principles
when assessing the present payment systems and the future developments.
There criteria are: 1) technical efficiency, 2) accessibility and non-discrimination, 3) efficient
and cost-based pricing, 4) operational stability with contingency plans in case of problems,
and 5) international compatibility.
These criteria should not be considered as something that is imposed upon the payment
method providers; they are an essential building block of any sound business case within the
field of payment services.
2.1 Technical efficiency
The first criterion, technical efficiency, states that the payment method providers should take
full advantage of available technical innovations to make the payment process cheaper,
faster and safer for users and providers. Digitalization and innovations are the main drivers
for new payment solutions.
But also user-friendly interface is another dimension that needs to be taken into account.
Users are more likely to start using payment methods that are intuitive and easy to use.
User-friendliness complements technical innovations.
Adapting new technologies will at the start produce costs for the provider of a payment
service but the user base and associated revenue increase over time. A significant risk for
the payment service provider is that the specific technology might not be adapted by anyone
else.
As catalysts that foster discussion between relevant payment system stakeholders, central
banks can alleviate this 'chicken-and-egg problem' associated with the adaptation of new
technologies. Central banks can promote international open standards for the benefit of all.
The recent times have witnessed a shift towards real-time economy. A significant amount of
interest has been expressed regards real-time payments. Some countries have already
implemented or are planning to implement 24/7/365 payment system with the funds being
transferred immediately to the receiver's account. The call for pan-European solutions is
ongoing.4
2.2 Accessibility and non-discrimination
The second criterion defines that different types of users should have access to the payment
infrastructure without disproportionate inconvenience or cost.
The most senior people, for example, might not be familiar with the modern IT tools and
therefore any digital payment method might require unreasonable inconvenience or even
close the access to the services. Still, financial inclusion and access to appropriate payment
methods are extremely important as the ability to make and receive payments related to the
necessities of life is a basic right in our society.
Central banks together with other authorities must see to it that there are proper alternatives
available for those who are not able or willing to use those payment methods, which are
more demanding either technically or in terms of creditworthiness of the citizen. This may be
a problem only for a transition period.
Accessibility and ease of use foster quick adaptation and enable the user base to achieve
critical mass. Larger user base also allows the costs of the system to be borne by many
instead of a few.
Significant factors in attracting users are trust and reputation. Established companies have
credibility whereas start-ups are fighting to get it. If users are not certain that the new system
is secure enough, most of them might be hesitant to start using it. The new entrants could
consider whether submitting oneself to supervision and oversight by authorities would
significantly help a new payment service provider to gain legitimacy in the eyes of potential
users.
2.3 Efficient and cost-based pricing
The third criterion, efficient and cost-based pricing, requires that the pricing of payment
methods is transparent and reflects the costs of producing such services. Prices relative to
production costs give the right signals that should guide users to adopt the most cost-efficient
payment method in any given situation.
Competition is what makes the pricing effective and cost-based. This ensures that the
benefits from technical innovations are distributed throughout the society. Competition
requires a number of independent providers.
We rarely see a multitude of competing retail payment systems in one market at the same
time. Economies of scale is one of the driving forces behind this. Payment methods can be
more numerous but established and widely used methods are a rare breed also.
Authorities play a role in making sure that level playing field can be achieved even in the
presence of dominating payment methods, and that any dominant position in the market is
not misused.5
Cooperation, in relation to adaptation of new technical innovations and security measures,
must still be allowed. This is the competition-cooperation nexus.6 Because payment methods
form a network, cooperation in defining the payment standards and building the underlying
infrastructure should be recognized.
2.4 Operational stability with contingency plans in case of problems
The fourth criteria, operational stability, is critical because payment systems are the
backbone of all economic activity. They must run smoothly and reliably. So providers of
payment methods are faced with a trilemma between usability, costs and security of the
payment system.
The optimum for one payment service operator is not necessarily the social optimum. The
commercial operator may be inclined not to take operational risks fully into account. This is
because the parties which suffer from operational disruptions to payment systems are not
able to get full compensation for their damages. Interdependencies within financial markets
mean that there are always a significant amount of externalities hidden from the sight of any
one actor.
In the digital world, cyber threats are the key challenge for future payment systems.7
Therefore, cyber security - or put that more holistically as cyber resilience - is a mandatory
feature of all future payment systems.
Cyber resilience means that it is not only about the technology but the attention needs to be
put also on the processes, people and communication. This all requires a paradigm shift in
the way we think about cyber security: cyber security should not be thought to be only a cost
center, but it needs to be perceived as a business enabler.
It is relatively more straightforward to handle cybersecurity in the interbank payment
ecosystem, since the access points to the payment system are limited and connections can
be made using secure dedicated networks.
In contrast, retail payment systems may have billions of potential access nodes and utilize
standard internet connections. Security solutions for these are different, especially
considering how to make sure that all end user access nodes are secure enough.
Central banks, together with all other stakeholders - banks, supervisors, cybersecurity
companies - can be active in raising awareness of cybersecurity, setting the basic security
requirements, and enabling the flow of best practices from one payment service operator to
another.
Central banks are a natural catalysts for cross-border cooperation to promote cybersecurity
of the whole financial infrastructure. After all, it is an international infrastructure, which
requires international cooperation doing the oversight.
2.5 International compatibility
Finally, the fifth criterion, international compatibility, states that common standards and rules
governing payment systems are needed to promote harmonization and to ensure
interoperability of different retail payment methods.8
In a global economy, fragmented payment system landscape across countries will increase
the costs for individual users and societies as whole. Technical innovations may increase the
fragmentation, unless some common ground has been found through open standards. Either
in terms of interfaces between systems or in terms of payment systems used.
But international compatibility is not only about the interoperability between payment
systems. It is also about the compatibility with the laws and regulations of the society around
the payment system. Future payment systems should not be in a conflict with the laws of the
society in any country where the payment system is operational.
With the future payment systems emerging, international compatibility is again an issue in
the spotlight. SEPA was a step towards international compatibility in the field of payments.
There is again a risk that future payment systems will become fragmented with the
emergence of new payment methods. It would better to set the harmonized guidelines before
this fragmentation actually happens.
The work done by the Euro Retail Payment Board (ERPB) and its national counterparties,
including the Payments Council in Finland, should be highlighted in this relation.9 These
groups bring together the relevant payment system stakeholders to consider how future
payment systems will change the whole financial ecosystem - also at the European and
international levels.
Are the future payment systems already here?
Where are we at the moment in relation to these five standards and innovative payment
methods? Even the most novel and debated virtual currencies do not meet these standards.
So why doesn't Bitcoin meet the five criteria? Bitcoin is not subject to the most basic
principles governing payment systems, starting from the know-your-customer fundamental
principle. Continuity of operations and contingency planning are problematic. And
fluctuations in the bitcoin value will impose additional costs to people who use bitcoins.10
Sometimes you hear a claim that these are not problems of bitcoin, per se, but of the bitcoin
ecosystem. To the general public, these two are the same. It seems that even Bitcoin is for
virtual currencies what MySpace was for social networks.
Digital purses, mobile phone apps and some other niche payment solutions exist, but all in
all, we haven't yet witnessed the emergence of a true future payment system. Bits and
pieces of a future payment system are incorporated in different payment methods of today,
but none such exists yet that would meet all the five criteria. This is by no coincidence.
Banks and other established financial institutions are well entrenched in the payment
landscape. It might not be in their best interest to develop new systems that cannibalize
profits from their existing investments. The new-comers are facing an uphill battle in trying to
establish a bridgehead within the payment landscape. Still, it seems that something
fundamental has changed.
Historically the usage of payment methods has evolved slowly over time. But digitalization
and the emergence of new actors in the field of future payment methods are something new,
not seen in the past. So far the speed of change has been overestimated. But we must
remember that in the short run we often overestimate the change but underestimate it in the
long run. This has happened with many technological breakthroughs.
Conclusions
To conclude, I would like to emphasize that even in the future, the five criteria for a payment
system remain essential. In other words, technical efficiency, accessibility and
nondiscrimination, efficient and cost-based pricing, operational stability with contingency plans in
case of problems, and international compatibility are still important for developing new
payment systems.
The key challenge for developers is how to solve the trilemma between usability, costs and
security of a payment method. The competitors in this future payment race are likely to come
from different directions and their solutions can be very different.
Since payment methods are part of payment networks, no payment service is isolated from
the real world and other financial transactions. The competition-cooperation nexus needs to
be taken into account to enable faster adaptation of innovative solutions without
compromising security, but also to maintain and foster competition between providers of
such payment services. The end-user benefit and transparency are the key points here.
Authorities need to be able to monitor the development and usage of new payment services,
keeping in mind the proportionality principle. This means that it is not in the interest of
authorities to suppress innovation; new entrants should have a fair chance to be able to enter
into the market. Nevertheless, safety of the payments must be ensured in all cases.
The economics of payment networks are highly complex, so there is a need for continued
research in the field. Academic papers and discussion in this conference have shed light on
many important aspects that should be taken into account in relation to future payments.
Conferences such as this are a welcome sign that the necessary exchange of information
and views is going forward. Authorities, users and other stakeholders need to participate in
the discussion about future payments.