malcolm edey : inertia and coordination problems in payment networks remarks by mr malcolm edey, assistant governor ( financial system ) of the reserve bank of australia, at a panel session on “ public policy and innovation ” at the federal reserve bank of kansas city payments conference, kansas city, 30 march 2012 ( to be delivered 31 march 2012 ). * * * the question i have been asked to address is whether inertia ( or coordination failure ) is an obstacle to payments system innovation. and if so, what do we do about it? to begin with, it helps to distinguish between two types of innovation : proprietary and systemic. an example of the first type might be a new piece of card technology, or a new customer platform for an individual bank. an example of the second might be the adoption of a new interbank messaging standard or a system - wide shift to faster payment times. the difference lies in whether the benefit can in some sense be captured by the innovator, or whether the benefits are more dispersed and dependent on coordinated action. payments service providers are good at proprietary innovation, as you would expect – they have an incentive to be good at it. it ’ s in the second area that problems of inertia and coordination failure can come into play. i can think of two general reasons why this is the case. the first is the problem of capturing benefits so as to give a return to the innovator. to give a concrete historical example, think of the question of faster cheque clearing. for a given cost, faster clearing is obviously an improvement, but it can only be achieved collectively. yet doing so confers no competitive advantage to any individual participant in the chequeclearing system, so there is little incentive to agree on costly action to make it happen. to make the example more up - to - date, the same problem exists with incentives to deliver faster ( or real - time ) electronic transfers at the retail level. faster payments can only happen if the system as a whole is set up for it, and then only if a critical mass of the individual participants are set up to provide timely access. but putting this in place will obviously involve some cost, with little or no proprietary benefit to the investor, particularly where it may cannibalise other potentially profitable product lines. this problem would exist even if all the payments industry participants faced identical incentives. without an effective coordinating mechanism, industry will tend to under - invest in this kind of innovation.

as 450 basis points. while the secondary market spread remained this wide, there was likely to be little new primary issuance. investors could satisfy their demand much more cheaply in the secondary market. it is well understood that as a consequence of the demise of sivs, the investor base for asset - backed securities is substantially narrower than prior to the crisis. this is particularly the case in offshore markets. as some of these investors relied on various forms of excessive leverage to be profitable, they are not likely to return. but there are still natural investors, both domestic and offshore, that ought to be attracted to the high quality of the australian rmbs. recent developments rmbs issuance this year has been around $ 18 billion, higher than the $ 14 billion issued last year but well below the $ 50 billion plus annual issuance prior to the crisis ( graph 4 ). however, this comparison exaggerates the situation. the underlying pace of housing credit growth has also slowed from around 15 per cent per annum to around 7 per cent. so given this slowing in system credit growth, comparisons of gross issuance with the pre - crisis period are not very informative. an alternative benchmark is the amount of issuance required for securitisation to hold its own as a share of total housing lending. a rough calculation suggests that annual gross issuance of around $ 25 to $ 30 billion would be required to see securitisation maintain its current share of housing credit. graph 4 all of the issuance this year, with the exception of one tranche in early 2010, has been in the domestic market. the issuance has been mostly by the smaller lenders, regional banks, credit unions and originators, who have limited access to alternative funding sources. these issues have involved some degree of support from the aofm. in total, only $ 3. 2 billion of the rmbs issued have not had aofm support. in thinking about the aofm support for the rmbs market, i believe the aofm program has a number of advantages relative to alternative means of support : it can be easily tailored to help specific types of institutions ; it can be phased out easily ; the likelihood that the government loses money on its investment is very small ; and there is no ongoing contingent liability to the government from providing the support. if instead a government guarantee of rmbs were provided, it would be difficult to phase out, creating a commitment that could generate a large contingent liability for the government. at