Towards a domestic payment infrastructure for the euro area

ECB conference on retail payments

Conference held at the premises of the ECB,
on Wednesday, 7 February 2001

1. Background

At the end of last year the ECB decided to arrange a conference to exchange ideas on how the euro area could, over time, be endowed with a "domestic" payment infrastructure for retail payments. The idea was to gather market participants representing the current payment infrastructure, which has developed in national contexts and still remains nationally based, with a view to obtaining a picture of current developments and future initiatives to finally close the efficiency gap between domestic and cross-border euro payments. Another objective was to identify the extent to which market participants have already started to think at a euro area-wide level about the strategic development of retail payments and, if they have not, to try to promote such a perspective.

For this purpose, a one-day conference was hosted by the ECB on 7 February 2001. The high turnout of more than 160 participants gave a clear indication of the importance that market participants and central bankers alike attach to retail payments. Credit institutions represented the single largest category of participants, followed by banking associations and payment network operators. In addition, the European Commission, S.W.I.F.T. and the European Committee for Banking Standards were also present. back to top

2. Introduction

The meeting was opened by Mr. Tommaso Padoa-Schioppa, member of the Executive Board of the European Central Bank, who made some challenging statements. Mr. Padoa-Schioppa pointed to the fact that cross-border retail payments are still inefficient compared with domestic payments in terms of speed and cost. He concluded that the banking community has failed to make use of the three years set aside to prepare for the introduction of the euro banknotes and coins to bring cross-border transfer services into line with domestic transfer services. Given that this is likely to lead to increasing dissatisfaction among the general public in connection with the forthcoming introduction of the euro banknotes and coins, he reminded the payment system infrastructure providers of their responsibility to contribute to the acceptance and success of the euro.

In order to enable speakers to think beyond present constraints, Mr. Koenraad De Geest, Head of the ECB's Payment Systems Policy Division and Chairman of the conference, invited them to take a long-term approach, looking up to ten years into the future.

Further challenges were presented to the participants by Mr. Jozef Van den Nieuwenhof of the Belgian Banking Association in his keynote speech entitled "Interbank systems for retail payments in euro. The agenda for 2010".

Mr. Van den Nieuwenhof pointed out that information technology is the key word and that successful companies today realise that change is the new order and innovation is the primary driver. However, he then continued to warn the banking industry against "incrementalism", typified by the attitude that this year's goal is just to do the same as before, only better. This is a dangerous strategy, because competition is not about resting on laurels and the critical mass generated by new networks is being reached at an ever-increasing speed. The law of the network effect says that the value of a network increases exponentially with the number of members. In the end, it is not technology itself which is the main limitation, but rather the extent to which customers will follow change. At the same time, customers are also becoming more and more demanding and the limitations of back offices will not be a good enough excuse for failing to offer straight-through real-time payments with zero errors for customers accustomed to e-mail and internet services.

Furthermore, Mr. Van den Nieuwenhof continued to analyse whether banks are on the right track and concluded that correspondent banking as well as automated clearing house (ACH) linkages imply a long detour between payer and payee and offer no "value chain" integration. Although a global clearing model is better, it still constitutes a disruptive element between payer and payee. The long-term solution should rather be to enable direct communication between payer and payee where financial services could be added, as required, through a payment gateway. Depending on how well banks are able to position themselves in the new infrastructure, they will also have an opportunity to become providers of trust services and workflow management. However, according to Mr. Van den Nieuwenhof the problem for banks is that it is not clear how they can orchestrate this new environment. In the end he concluded that a push from a serious "new" European authority, such as the ECB, is probably necessary to obtain a new infrastructure. With a little bit of "arm twisting", standards that would otherwise take years to implement might come quickly. back to top

3. Euro area payment networks

Three different retail payment networks were presented, namely TIPANET, a network of co-operative banks, Eurogiro, which was set up by postal banks, and S InterPay, which is sponsored by savings banks. These payment networks are club solutions, based on the idea that in order to ensure low cost processing it is important to have only a limited number of participants which can easily reach agreements multilaterally or bilaterally. These agreements, including detailed and strict service level agreements, have resulted in a very high straight-through processing (STP) ratio for all three providers. Mr. Fidel Niggl of S InterPay explained how complex a task it is to define STP rules covering several markets and that a lot of work is necessary to be able to handle all variations. Accordingly, these payment network providers promoted a "small is beautiful" strategy, arguing that small niche players are able to provide a higher quality service at a lower cost than a single payment network. Mr. Henrik Parl of Eurogiro welcomed the ECB's initiative to arrange the meeting and stressed the importance of such gatherings, which allow authorities and the industry to meet and discuss in an open way how to find solutions to future problems. Mr. Niggl felt that the ECB should not become operationally involved in directly delivering actual infrastructure and payment services but should continue to create a competitive environment, promoting the implementation of standards and harmonisation. Furthermore, he suggested that the performance of participants should be measured on an ongoing basis in detailed and large-scale surveys.

The Chairman questioned whether the original reason for forming those clubs was still valid in a situation with commonly agreed STP standards, International Bank Account Numbers (IBAN) and the likely introduction of a Multilateral Interbank exchange Fee (MIF).

Mr. Friedrich Malz, representing TIPANET, replied that it is not possible at present to set up a clearing house that manages payments better than the club solutions do, because the implementation of standards and validation rules for data files are not sufficient. However, if there were greater adherence to standards, and provided that payers have full information on payees, then the EBA might be used as a clearing house. In addition, Mr. Parl emphasised that retail payment processing is a cost game and that as long as the clubs deliver cheaper solutions than their competitors they will survive. He stressed the importance of members constantly maintaining high service standards and the fact that a limited number of members greatly facilitates this. back to top

4. A global ACH interlinking model versus a single ACH for the euro area

Two different ACH models were described. Ms Priscilla Taylor spoke first, presenting the World-wide Automated Transaction Clearing House (WATCH), which is a proposal to process non-time-critical, relatively low-value, multi-currency batch payments that will be rolled out in 2002. Considering the multi-currency dimension and global approach, Ms Taylor saw the WATCH concept as a compliment to rather than a competitor for a single ACH for the euro area. On the contrary, she described the benefits of developing a single ACH in the United States and said that there is now a marvellous opportunity to create a single ACH in Europe. She concluded that the long-term benefits of standardisation and increased efficiency would justify the time, effort and costs that such a project would require. However, regardless of how complex the task of replacing existing domestic payment systems with a single ACH might be, it would no longer be realistic to envisage doing so over a traditional five-year implementation horizon, since bankers need to react faster nowadays.

Although Mr. Gilbert Lichter of the European Banking Association (EBA) still does not have a specific proposal for a single euro area ACH, he saw this as a possible evolution from the STEP1 low-value payment initiative which was launched at the end of November 2000. In fact, when volume increases in STEP1, and given the developments in technology, the next logical "STEP2" might very well be a pan-European ACH-type arrangement for the settlement of cross-border retail payments. E-commerce could push this development forward by creating new, higher payment volumes as well as a providing an opportunity for banks to share the costs and risks of investment in a new infrastructure. Finally, Mr. Lichter commented that, with respect to facilitating the use of euro in e-commerce, an appropriate infrastructure proposal should be set up as part of a global approach, including the US dollar as well as other major currencies. back to top

5. The euro area: a business opportunity for national ACHs?

Two national ACH organisations were invited to give their views on the changing business environment stemming from the introduction of the euro for ACHs, which have traditionally operated in a purely domestic context.

Dr. Laurenz Kohlleppel took GZS, a German ACH which processes card payment transactions, as an example of an efficient national clearing system where development has been driven by the production side, based on economies of scale. He saw this as a contrast to the club solutions presented earlier, where development has been driven more by the market side. In his view there is a need to separate the business or market side from processing in order to be able to obtain highly efficient payment processing. He predicted that, eventually, this separation of tasks, allowing for an even higher degree of consolidated mass production, would happen when card payment transaction processing merges with direct debit and credit transfer processing. In addition, Mr. Alain Cailleteau, of the French ACH (SIT), explained how the cost of interbank exchanges has been reduced through the highly efficient processing of considerable volumes. In 2002, with the introduction of truncated cheques, SIT will become the biggest ACH in the world in terms of transaction volume.

However, apart from sharing interesting information on the merits of single ACH concepts, including high availability, increased security, etc. no specific proposal was made on how a similar solution for the entire euro area might evolve. Thus, in short it appeared that the business focus of domestic ACHs is still on domestic payments and that involvement in cross-border payments (constituting only 1-2% of total payments) would not be sufficiently justified by the additional business opportunities from their point of view. Furthermore, there seemed to be relatively little enthusiasm for extending domestic processing capacity cross-border or, alternatively, for developing links between ACHs, due to the complexity involved. back to top

6. How could a domestic payment infrastructure for the euro area emerge?

Summarising the presentations given, the Chairman, Mr. De Geest, concluded that the most ambitious outcome that the meeting could have had would have been arriving at a blueprint of the future infrastructure. So far no clear view could be obtained and each area had presented some indications on how evolution could take place on the basis of its current structure. The three main approaches presented were:

• The establishment of a new euro area common ACH (Ms Taylor and Mr. Lichter);
• The evolution of a new infrastructure merging card payment transaction processing with direct debit and credit transfer processing (Mr. Kohlleppel); and
• Continuing with the present set-up, with many different projects under way, allowing competing initiatives to emerge, such as the club solutions in the past (Mr. Parl).

Considering how heavily the past weighs in the balance and how difficult it is to move beyond the limitations of the existing systems, the Chairman questioned whether a quantum leap triggered by a disruptive technological change was needed to move things forward. The question remained unanswered, but several arguments were made which focused on present limitations rather than on future possibilities. It became clear that the investment in the old infrastructure is far from having been written off and doubts were voiced as to whether customers would be willing to pay for a new, more efficient infrastructure in order to rebuild ACHs. One message to the ECB was that banks are already making sufficient efforts by implementing the IBAN and the Bank Identifier Code (BIC), and that further harmonisation involving different standards, different ACH structures and different reporting schemes would pave the way for additional efficiency gains by reducing mistakes. Several participants defended the right of banks to recover costs for high cost, low quality consumer payments and another argument put forward was that as soon as 100% of these payments are processed using STP the pricing will be close to that of domestic transfers. However, the latter argument was not closely examined to find out whether this theory is already being put into practice somewhere, so that STP retail payments could already be provided at a price level close to that of domestic transfers.

The Chairman made a link to Mr. Van den Nieuwenhof's presentation by asking how payer and payee could be brought closer together to minimise unnecessary bank-related costs? Mr. Van den Nieuwenhof replied himself by saying that this could be achieved through a "bottom-up" approach by linking present ACHs, but that this would take 40 years and there is no time for it. Instead, the faster option would be a "top-down" approach based on card systems. The idea would be to extend an existing national system to be deployed internationally. Again doubts about the business case for rebuilding existing infrastructure were voiced and the only way forward was seen as being more harmonisation of account numbers, legal standards, etc. Furthermore, it was pointed out that, although card payments offer some interesting features, they are not really comparable with credit transfers. For credit cards the routing is easy, because it is clear where the payment must go, by virtue of the exact data and the address of the payee. Thus the level of complexity involved in such payments is different.

Following several requests for the authorities to become more involved, the Chairman asked the delegates what role they see for the ECB and for the Eurosystem and whether it is pushing hard enough for progress. The participants agreed that central banks have an important role to play in ensuring that payment systems work properly. Thus the current approach of promoting standards and continuing to encourage banks to do their best was widely approved. Several participants stressed in particular that they would not wish to see central banks taking a direct operational role. As a consequence of this, one delegate suggested that all customer payments that are handled in TARGET today should be processed via EBA STEP2 or STEP3 in the future.

Finally, Mr. Harry Leinonen of Suomen Pankki reminded the audience about the developments in retail payment infrastructure already taking place, regardless of the legacy systems of the banks. As an example, he mentioned the possible development of payments via mobile telephones ("M-payments") where the initiation of a payment would be simplified to inputting an account number (or possibly just the telephone number itself), a sum, and pressing enter, and the mobile telephone provider would take care of the rest. Once the technology exists, it will be up to the bankers to decide whether to provide this service or whether to leave this to GSM operators to exploit. back to top

7. Concluding remarks

In his concluding remarks, Mr. Jean-Michel Godeffroy, Director General Payment Systems of the ECB, elaborated on the prospects over short (2002) and long time horizons. Mr. Godeffroy expressed his concern that bankers will not be able to meet the expectations of the public. There are good reasons why improvements in cross-border payment systems take time. However, it will be extremely difficult to explain them to the public. For example, a MIF may be necessary to obtain cost reductions, but it will be hard to explain this to members of the public as a reason why they have to continue to pay extra for cross-border transfers in euro.

Mr. Godeffroy continued to argue that the limitations of current systems may be a valid excuse for 2002 but certainly not for 2010. Therefore it is important to start thinking now about the kind of infrastructure that will be needed in the future. The ACH linkages, similar to the current "spaghetti model" in securities settlement systems (SSSs) may not be the first best option because it is relatively costly. Furthermore, the option of linking the present infrastructure together through TARGET might work with 15 participants, but will not work as and when there are an additional 15 EU and/or euro area countries.

Rather, the key question is how to integrate the 2% of payments that are cross-border with the 98% that are domestic. Mr. Godeffroy suggested the following two solutions:

1. cross-subsidisation (applying the same fee for domestic and cross-border payments); or
2. creating a pan-European infrastructure covering the entire euro area .

Comparing the two options, Mr. Godeffroy pointed out that cross-subsidisation constitutes a problem for a public authority because it is relatively inefficient. His conclusion was therefore that a pan-European infrastructure should be fostered. This could be achieved either by creating a new infrastructure or by making use of one or several of the existing infrastructures. back to top