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The future of payments 2 omfif.org

About OMFIF With a presence in London, Singapore, Washington and New York, OMFIF is an independent With thanks to our memebers forum for central banking, economic policy and public investment — a neutral platform for best practice in worldwide public-private sector exchanges. For more information visit omfif.org or email [email protected]

Report authors Bhavin Patel, Senior Economist & Head of Fintech Research, Kat Usita, Deputy Head of Research, Brandon Chye, Economist, Levine Thio, Research Assistant, Natalia Ospina, Research Assistant

Production Simon Hadley, Director, Production, William Coningsby-Brown, Assistant Production Editor Fergus McKeown, Julie Levy-Abegnoli, Subeditors The future of payments, 2020 3

CONTENTS

Forewords 4 SECTION 4: 38 The state of play Preface 6 Payments systems are invisible – yet indispensable – infrastructures at Executive summary 8 the heart of an efficient, reliable and competitive economy. Innovations have driven the growth of the payments SECTION 1: 10 industry, offering retail users a range of Key trends in payments options to pay, save and transfer value. Advances in technology and changes in consumer behaviour have driven exciting SECTION 5: 50 advances in digital payments systems worldwide. But it has taken a global health Sovereignty crisis to give that transformation further The design of new central bank digital impetus and ensure it has a lasting impact. currencies will determine the extent of the impact they have on payments and, SECTION 2: 18 thereby, on financial inclusion. Consumer focus SECTION 6: 56 Younger consumers thrive in the digital environment. Their behaviour and Policy preferences will shape the future of Central banks and supervisors understand payments. But system providers must also the need for regulatory innovations safeguard consumer rights and privacy, that suit the dynamic nature of digital especially for older consumers. payments. Such innovations will expand the roles of regulators beyond their SECTION 3: 28 traditional focus on formal financial institutions. Infrastructure There have been significant changes in the kinds of payment instruments used, with a shift from cash to cards and mobile payments. Yet the infrastructure for clearing and settling these payments has improved more slowly. 4 omfif.org

FOREWORDS Evolution of money creates prizes and benefits for all

Money is changing fast. As it takes the next step in its digital transformation, this report looks at where that could lead, writes Clive Horwood, managing editor at OMFIF.

Welcome to the ‘Future of Payments’. This is a landmark report for OMFIF, coming at the end of a year in which we launched our Digital Monetary Institute. The DMI was set up to bring together policy-makers, technologists, financiers and regulators to explore the opportunities of digital finance. This ‘Future of Payments’ report does just that. It shows how payments – integral to all our lives – is the area of financial services most ready for transformation. New technology is coming on stream at an incredible pace. What seemed cutting edge only a couple of years ago is already out of date, as distributed ledger technology and central bank digital currencies form the next stage of an inevitable evolution. The prize for the winners of this technological race is huge – the payments industry has revenues of around $2tn. The benefits of this contest will be spread broadly too, enabling far more of the world’s population to access quick, safe, reliable and inexpensive means for moving or spending their money. We thank our sponsors - Algorand, Citi, Cypherium, GrabPay, Mastercard, Novi (from Facebook), PayPal and SWIFT – for their thoughtful and engaging contributions to this report. And we look forward to our readers joining us in further discussions through the DMI in 2021. The future of payments, 2020 5

Digital transition management vital as developments accelerate

Getting the most out of the emerging digital economy requires collaboration between the private and public sectors writes Philip Middleton, chair of the Digital Monetary Institute.

The 2020 pandemic has turbocharged the privacy and transparency, different consumer groups development of a complex global digital economy and the merits of various technology applications, and the sophisticated digital payments systems both old and new, will lead to much scrutiny and upon which it will rely. To many, this offers the debate. exciting prospect of cheaper, more efficient and It is likely that the future digital payments more secure transactions on a global scale. They landscape will comprise of a complex tapestry of see this as having the possibility to extend financial multiple private and fiat currencies with profound inclusion to millions of people, vastly improving the implications for regulation and supervision, and lot of migrant workers and their home economies. To cross-border and domestic interoperability. There others, it spells the loss of personal control, privacy will be critical questions about the balance of co- and sovereignty. operation and competition between public and Managing this transition smoothly and preventing private sectors, and about relationships between disruption of the global financial infrastructure nation states and their currencies. presents a series of massive challenges for This report explores, with both insight and lucidity, consumers, the private sector, governments, these and other issues that will fundamentally central banks and other influential policy-makers. reshape the financial services industry and the lives The competing claims of private and public money, of billions of people around the world. 6 omfif.org

PREFACE PLAYERS FROM ACROSS THE PAYMENTS INDUSTRY OFFER INSIGHTS FOR THE FUTURE

IN THIS REPORT, OMFIF takes stock, describes and We would like to thank the following organisations, evaluates the current payments industry, including individuals and their teams from the payments industry services offered and the infrastructure to support for their contributions and perspectives: them. The study highlights the key trends and Usman Ahmed, Head of Global Public Policy, and innovations that are likely to shape the future ways Ivy Lau, Global Public Policy and Research Manager, in which people will pay, save and transfer value – PayPal domestically and across borders. It focuses on the retail payments industry but also comments on wholesale Tomer Barel, Chief Operating Officer, Novi payments. Raj Dhamodharan, Executive Vice-President The report offers a guide to the problems in the for Blockhain, Digital Asset Products and Digital current monetary set-up. It allows regulators to explain Partnerships, Mastercard their concerns about private solutions and to offer ideas as to how these could be addressed. It is based Sky Guo, Chief Executive Officer, Cypherium on an in-depth survey of 20 central banks, regulators Steve Kokinos, Chief Executive Officer, Algorand and policy-makers, globally. Neha Narula, Director of the Digital Currency Initiative, Contributors’ insights are reflected throughout this Massachusetts Institute of Technology Media Lab paper and summarised faithfully to give an overview of the development of the payments industry. The Harry Newman, Global Head of Payments Strategy, report showcases the potential for new ways forward Swift by examining the changing payments landscape through a regulatory lens. It also explores innovative Huey Tyng Ooi, Managing Director and Head of developments under way in the system of traditional GrabPay, Grab payment providers, technology companies and more Naveed Sultan, Global Head of the Treasury and recent entrants to the financial industry. Trade Solutions Group, Citigroup The future of payments, 2020 7

Never a better time to transform payments services

In a post-pandemic world, it is more crucial than ever that we work together to make payments of all kinds easier to access, less costly to conduct, and faster to process, writes Tomer Barel, chief operating officer of Novi.

DIGITAL technology has transformed nearly every money sent from family and friends abroad to cover aspect of how we live and work. From how we food, housing and healthcare costs. The pandemic communicate, monitor our health, entertain ourselves, only underscores the urgent need for a contactless, learn and more – there is almost no area in which frictionless, simple, fast and inexpensive way to move digital technology has not become integral to the money around the world. experience. In many cases, it has made things work There is no reason that sending money to a better and faster. friend, family member or business partner shouldn’t Many of us already use mobile apps to do our be as easy as sending a text message. With new banking, pay our bills and send money to loved ones technologies like blockchain gaining more mainstream overseas. But sending money from here to there is still traction, there is already the means available to make complicated. it happen. Anyone with a smartphone will be able to Existing money networks are closed systems, and access this new digital financial infrastructure. Of they are not well interconnected. Sending money the 1.7bn people who sit out of the financial system, within one of these systems can be expensive and 1bn have access to a mobile phone. This offers them slow. A single transaction can take days and cost the a path into the digital economy and access to the sender, on average, 7% on top of the amount they are coming system of interoperable digital wallets and sending. currencies. Payment services and wallets are There is no question this digital limited in their effectiveness because transformation is coming soon. China of the underlying infrastructure ‘There is no reason that is developing a central bank digital powering them. You may be able to sending money to a currency, with digital renminbi tests send and receive money from one friend, family member already underway. More countries digital wallet, but you typically can’t or business partner around the world are recognising send and receive money between shouldn’t be as easy as the importance of CBDC and are wallets made by two different sending a text message.’ exploring their own new digital companies. They operate in separate currencies. The continued, global work silos, limiting the reach and efficiency on such technology is essential to the of these kinds of networks. transformation of the world’s digital An innovative technology like blockchain can help financial infrastructure. provide the infrastructure to facilitate fast, cheap and The fragmented global financial structure is not stable money movement across service providers and sustainable. In a post-pandemic world, it is more institutions, and among different people all around crucial than ever that we work together to make the world. The barrier to access modern digital money payments of all kinds easier to access, less costly and financial services would be greatly lowered – to conduct, and faster to process. In doing so, the enabling billions to participate in the world’s economy. lives of billions of people will improve. With broader This could not come at a better time. More than access to affordable and equitable financial systems, 2.5bn people live in countries with poorly developed educational achievements, better nutritional health, financial services and 1.7bn people do not have a and greater employment opportunities will grow bank account. One in nine people globally depend on across the globe.  8 omfif.org

EXECUTIVE SUMMARY THE FUTURE OF PAYMENTS IS HERE

PAYMENTS are not just being disrupted, but utterly age-old reliance on physical cash poses problems transformed by new technology. but also brings benefits in the developing The way we pay for goods and services has world. Innovation in payments must consider evolved constantly over the past 50 years. We accessibility, affordability and inclusion for those swapped cash for cards. Service providers such on the periphery of the financial and payments as Visa and Mastercard became a feature of daily infrastructure. life. We shopped on the internet and paid for items Although many of the payments innovations and electronically. We discovered PayPal, Apple Pay and business models linked to mobile and e-money Alipay, and then found that our mobile phones were originated in developing countries, these now have all we needed to shop. As the means of payment palpable effects in advanced economies as well, changed, whole infrastructures adapted and disrupting the traditional activities of banks and developed around them. other payment providers. Smaller fintechs and The pace of change in payments today is large techfins are injecting greater innovation, unprecedented. A confluence of factors is driving collaboration and competition into the payments the transformation. This OMFIF report examines arena and broader financial services. how the future of payments will look, and surveys The advent of cryptocurrencies and distributed central banks’ and regulators’ opinions as to the ledger technologies has spurred a wave of challenges and opportunities they face. research from governments and central banks. Mobile ownership and telecommunications Apart from the roll-out of fast retail payment technology are driving the digital economy forward. systems that offer near-instantaneous domestic Demand for real-time clearing and settlement clearing and settlement, there is broader potential of high-volume, low-value payments between for profound changes in how central banks can retail businesses and individuals is accelerating. promote better speed, security and access to Consumers value the ability to conduct payments. Consideration of CBDC implementation instantaneous fund transfers around the clock. This and the notion of digital sovereign fiat that can be desire for speed, convenience, ubiquity, safety and transferred quickly and cheaply is sparking further affordability in conducting digital transactions has changes that could transform the execution of been turbo-charged by the need to preserve public monetary transactions. health and reduce dependence on physical cash Regulators need to keep pace with these during the pandemic. innovations. New, non-traditional payment entities The relentless and irreversible shift from the will emerge as systemically important components of the financial system. Proactive central banks and regulators, keen to harness the benefits of payments innovation without undue policy risks, engage more with industry. As many central bank respondents to OMFIF’s 82% survey indicated, their governance and involvement in hybrid systems for payments and money will Main concern of regulators regarding encompass not only a role as issuers of sovereign new entrants in the digital payments digital fiat, but also as standard-setters to protect sector is cybersecurity, according to 82% consumer needs and innovation enablers for of the OMFIF survey respondents greater payments competition. The future of payments, 2020 9

KEY FINDINGS FROM THE OMFIF FUTURE OF PAYMENTS REPORT Central banks see an expanded role for state regulation and innovation policy support to 56% keep pace with rapid evolution in payments Respondents to the OMFIF survey who systems and instruments said that central banks could or should • 94% of central bank respondents identify setting explore direct collaborations with private revised regulatory or technical standards as an entities in designing and managing essential responsibility of the state in the future payments system architectures payments industry.

• Three-quarters (75%) of respondents identify payments systems governance as a key function of the state, with 56% seeing a greater future role for public-private partnerships in payments. 1. Cybersecurity and privacy should be major focus areas for new entrants •Effective payments regulation will also ‘What are your key concerns for new stakeholders offering digital means increasingly involve providing direction on of payments?’, % of responses responsible innovation and industry-level engagement as 88% of respondents select 90 innovation facilitation in payment technologies as 80 an additional key role for the public sector. 70 60 Cyber risk management and the protection 50 of consumer data rights stand out as key 40 regulatory concerns for emerging payment 30 technologies 20 10 • 82% of central bank respondents select 0 cybersecurity as a key regulatory concern in the Data Others Industry Consumer Privacy Cybersecurity sovereignty fragmentation welfare and proliferation of new payment technologies to affordability ensure consumer safety and confidence that data, digital identities and transactions are secure and 2. Public governance of payments will keep pace with private reliable, and to prevent illicit movement of funds. innovations ‘What is the role of the state in the future payments industry?’, % of • 71% of respondents highlight that digital responses payment infrastructures should have measures 100 that safeguard consumer privacy while balancing 90 this with financial integrity and transparency 80 requirements. 70 60 • A comparatively lower proportion (35% of 50 respondents) sees industry fragmentation as a 40 pressing regulatory concern. Given that alternative 30 payment infrastructures and instruments in many 20 jurisdictions have yet to reach a critical mass, central 10 banks see that promoting common technical 0 Public-private Governance Facilitate innovation Set regulatory or standards for payment innovations can help to partnerships technical standards solve or prevent the fragmentation of payment rails before they become systemically important. Source: OMFIF Future of Payments survey 10 omfif.org

1 Key trends in payments The future of payments, 2020 11 12 omfif.org

SECTION 1: THE PAYMENTS REVOLUTION GATHERS PACE

Advances in technology The Covid-19 pandemic has had enabling users to send and receive and changes in a big impact on digital payments, funds through electronic means.’ accelerating the shift away from cash Payments revenues worldwide consumer behaviour to various electronic alternatives. The have doubled in the decade to 2019 to have driven exciting health crisis has changed how people reach $2tn, according to McKinsey’s changes in digital behave and live their lives, whether latest Global Payments Report. payments systems because of a greater emphasis on Even though payments revenues worldwide. But it has hygiene and social distancing, or are estimated to have fallen 22% in because of government-ordered the first half of 2020, the decline taken a global health lockdowns. Rather than risk infection has been accompanied by growth in crisis to give that from physical contact with others, online payments. In the US, online transformation further or even from handling notes and retail spending rose 30% in the first impetus and ensure it coins, more people opted for online or six months of the year relative to the has a lasting impact. digital payments instead. same period in 2019. Credit and debit Many businesses have been hit by card transactions in the UK for July the collapse in demand for inessential 2020 fell 16.4% year on year, but in goods and services, and there is little the same period the share of online indication as to when prospects could transactions increased to 40.7% from recover, if at all. Firms, large and 29.8%. small, had a greater chance of survival The consumer habits formed over if they operated online. This pivot the course of the past year are likely to online shopping and e-commerce to persist even after the pandemic reinforces the growing importance of ends, according to respondents to the digital payments systems. OMFIF Future of Payments survey As one Southeast Asian central of central banks conducted for this bank told OMFIF, ‘The Covid-19 report. Amazon reported a 40% pandemic has elevated the urgency of year-on-year increase in net sales in adopting safe, efficient, reliable and the second quarter of 2020, driven by convenient digital payment services. demand for online grocery shopping, Amid social distancing measures, a platform which it had launched restricted mobility and rising before the Covid outbreak. Just as the uncertainty, digital payment services 2003 Sars epidemic prompted a rise have mobilised retail payments, in e-commerce and digital payments The future of payments, 2020 13

in China, the Covid-19 pandemic is and services ordered online. PayPal installed on their devices, whereas expected to have a lasting impact on was set up in 1998 and started off as digital payment use in the Philippines consumer behaviour across the world. an online money transfer system. is less widespread, accounting for only Users linked their credit cards to their 10% of total volume in 2018. A HISTORY OF PAYMENTS PayPal accounts, or deposited money The evolution of payments systems from their bank accounts. Consumers ALIGNED DEMAND started long before digitalisation. who didn’t have credit cards started Digital payments have grown in Paper money was used in the using it for online shopping, and parallel with e-commerce and other 18th century for domestic and it became the preferred payments digitally enabled services. Online international transactions. Cash platform for online auction site eBay. retail sales are projected to reach continued to play a central role in With the proliferation of $4.1tn in 2020, more than tripling retail payments globally over the next smartphones, particularly after the from $1.3bn in 2014 (Figure 1). two centuries until cards emerged as introduction of the iPhone in 2007, The growth is facilitated by digital an alternative in the middle of the online and non-cash payments payments platforms and vice versa, 20th century. took off. The consumer experience as the digital payments industry is Credit cards originated in the underwent a dramatic change: there also expanding to meet the demand US, initially as store cards issued by was no need for a personal computer created by e-commerce. department stores, hotel chains and or laptop because consumers could China is a notable example, as oil companies in the 1920s. Customers use a smartphone to make electronic it leads in both areas. Online retail could use these cards to pay for payments on the go. spending in the country is expected to transactions with the merchant that By 2012, mobile payments had reach $2tn in 2020. The People’s Bank issued them. Universal credit cards, reached $163.1bn worldwide. Since of China reported an exponential which could be used in a variety of then, non-cash transactions via increase in the volume of mobile stores and transactions, came later, mobile applications, digital wallets transactions to 61bn in 2018 from in the 1950s. The Diners Club Card and QR code payments have increased 1.7bn in 2013. The country’s two was the first of this kind, although steadily, and are estimated to have dominant mobile payments platforms, purchases made on credit had to be topped $1tn in 2019. Alipay and WeChat Pay, account for paid in full by the end of the month. The majority of survey respondents 93% of these transactions. Modern-day credit cards, which allow explicitly noted the growth of One reason why mobile wallets for balances to be carried over to contactless and digital payment in Asia succeeded is because they subsequent months for a fee, soon methods in their respective payments evolved from popular digital services followed. The American Express card, systems, albeit with some variation. that already had a high volume of launched in 1958, was the first of this For example, 75% of Swedes already transactions. Alipay enabled mobile kind. have a mobile payment application payments for the e-commerce giant These cards allowed merchants to settle transactions directly with the cardholder’s bank, removing the need 7 1. Digital 6.5 for payment by cash. The proliferation payments of credit cards meant that consumers 6 5.7 facilitate online could spend ahead of payday and that retail growth 4.9 5 in turn boosted retail businesses. E-commerce Because credit cards are backed by 4.2 sales*, $tn 4 credit, they can be used to pay, but 3.5 *Estimates 3.0 Source: are not true cash alternatives. Debit 3 cards, on the other hand, represent 2.4 Emarketer, OMFIF analysis 2 1.8 actual funds stored in the cardholder’s 1.5 1.3 bank account. 1 Both credit and debit cards contributed to the rise of e-commerce, 0 as they could be used to pay for goods 2014 2015 2016 2017 2018 2019 2020*2021* 2022*2023* 14 omfif.org

How systems that foster trust will usher in a new payments era

Legacy financial systems lack the tools to advance global payments. Blockchain solves this, writes Steve Kokinos, chief executive officer of Algorand.

THE economy functions on complex systems that Implementing trust through legacy methods present challenges and opportunities when it comes and available technology is simply not feasible. The to payment services for consumers, businesses, path to generating trust is through programmable governments and financial markets. Legacy systems and programmable money, or real money financial systems do not have the efficiency, trust or that is represented digitally. accessibility needed to advance global payments. This form of money has rules that can be Blockchains solve this by bringing trust to otherwise enforced by the money itself via smart contracts, untrusted systems. which are coded into the system and replace the To ensure public blockchains operate as need for a trusted intermediary. Advanced smart trustworthy, programmable systems, they require contracts, like those available on Algorand, enable transparency, compliance and security. Consumers programmable money by automatically executing must be able to instantly see transaction settlement, transactions using code stored on the blockchain businesses need to view records and calculate when agreement terms are met. Smart contracts figures easily, and regulators need to offer will replace traditional agreements. As an essential compliance measures. Purpose-built primitives must blockchain functionality that allows frictionless help enable scalable and seamless transaction methods, smart programmable compliance where contracts give end-users more needed. Advanced capabilities must ‘The path to generating control with fewer intermediaries. allow issuers to directly include third- trust is through This new way of handling party regulators in their compliance programmable systems payments and sophisticated operations without the need to invite and programmable transactions paves the way for truly them into the general management money, or real money peer-to-peer transactions and more of issued assets. Blockchains must that is represented financial inclusion. It removes friction provide the highest degree of digitally.’ from financial exchange, providing security through programmable more efficient and accessible ways of consumer controls to protect users transacting between any party. and secure a decentralised network of nodes. Programmable money goes beyond just elegant To be truly scalable, secure and support billions and efficient technology. Critical in bringing all of of users, a foundational blockchain protocol needs this to life are tools and enablement programmes to enable all forms of exchange running at the full that open the doors for developers to easily create speed of the network. This is critical for global simplified financial programming. Lowering the payments as well as the creation of complex financial barriers to entry for those who will develop new products. To make this possible, the Layer-1, or core products, tools and services will represent a major technology rather than something built on top of it, tipping point in the future of payments and financial must be designed to do just that. services. New financial tools, processes, and services Blockchain offers a completely different way to that solve real-world problems are being built with organise and manage payments systems. It provides technology such as Algorand. Unlike other fintech real-time, cross-border payments worldwide – solutions, which still rely on old infrastructure, and even new ways to store value. A platform like Algorand enables the development of a wide range Algorand, paired with fintech’s latest developments of scalable, secure and compliant applications to and simplified developer toolkits, has the potential to power frictionless financial exchange. take the lead in the race for payments innovation.  The future of payments, 2020 15

Alibaba. WeChat Pay facilitated transfers between contacts on a messaging app. Southeast Asia’s A HISTORY OF PAYMENTS GrabPay and GoPay are offshoots of ride-hailing services Grab and Gojek respectively. The growth of these First recorded use of privately issued platforms on the back of other services paper money in China. 618 is similar to PayPal’s earlier success in serving the eBay auction market. Mobile payments also pave the Stockholms Banco, precursor of 1661 Sveriges Riksbank, issues the first way for financial inclusion. Kenya’s central bank banknote.

M-Pesa, a regional and global pioneer Paper money dominates transactions, in this area, had signed up 41.5m facilitating domestic and international subscribers by 2019, up from just transactions. The gold standard is 1800s established to assign uniform value to 20,000 a decade earlier. In 2019 alone, paper currency. there were over 50m new registered mobile accounts in sub-Saharan American department stores, hotel 1920s chains and oil companies begin Africa. In addition to enabling issuing store cards. payments, mobile money services have become a tool for microfinance and Diners Club launches the first charge small businesses. card that could be used in multiple stores. Purchases made on credit had to 1950 Mobile payments have also be paid in full by the end of the month. facilitated remittance flows. The World Bank estimated global remittances American Express launches the first credit card. Balances on the card in 2019 amounted to $714bn, of 1958 could be carried over to subsequent which roughly three quarters months for a fee. are sent to developing countries. Worldwide remittances are expected Visa processes the first online payment. 1994 to decline 19.7% in 2020, reflecting the economic impact of the Covid pandemic on migrant workers in their Seoul issues the first contactless host countries. But mobile payments 1995 payment card for bus and rail services. will probably continue to be an important tool in these cross-border transfers because they offer a low-cost Paypal is set up as an electronic alternative to traditional banking. payments system provider. 1998 A report by the Financial Stability Board found that in the fourth quarter of 2020, the global average cost of The first iPhone is released, and 2007 Vodafone and Safaricom launch remitting $200 was 6.8%, exceeding M-Pesa in Kenya. the G20 target of 5%. Innovations in mobile payments and digital platforms Bitcoin is created, leading the way will be crucial for reducing transaction for other blockchain-based crypto- 2008 assets. costs. Covid-19, which brought about such Apple introduces its mobile payment widespread economic disruption, has and digital wallet service, Apple Pay. 2014 The following year, Google launches led to greater financial and digital Android Pay which it later merges with inclusion. One survey respondent Google Wallet, producing Google Pay. reported that 1.6m individuals gained Sveriges Riksbank starts its access to their country’s formal e-krona project. 2017 banking system during the first half of 2020, while mobile banking The Bank for International transactions rose 192% during the Settlements reports that 20% of central banks are planning to launch same period. The International 2019 a digital currency in the next six years. Monetary Fund reports that mobile Facebook floats proposal for its Diem stablecoin. money networks have enabled some Covid-19 pandemic prompts greater use of digital payment channels. governments, including those of The Central Bank of The Bahamas 2020 Namibia, Peru, Uganda and Zambia, launches the sand dollar, a digital to extend fiscal support to people and version of the Bahamian dollar. Source: OMFIF analysis 16 omfif.org

‘One survey respondent reported that 1.6m individuals gained access to their country’s formal banking system during the first half of 2020, while mobile banking transactions rose 192% during the same period.’

businesses. transformations in financial and allowed to float and fluctuate Another respondent noted how commercial systems within their dynamically against each other. The digitalisation has helped to bridge lifetimes and are better prepared change gave countries flexibility to gaps in the banking system in difficult to adapt to evolving payments cope with the volatility of oil prices. geographic conditions. In Vanuatu, systems. They are also more likely to However, the US dollar remained for example, the global charity understand the benefits, rather than dominant as countries continued to Oxfam partnered with Australian feel threatened by change, as they hold the currency and used it to settle fintech Sempo to deliver post-disaster have grown up with the convenience most international transactions. support. Using a blockchain-based of a digital environment. The dollar’s position was largely platform, they disbursed cash unchallenged in the latter half of the assistance to individuals who had DIGITALISING CURRENCIES 20th century, but the rise of digital been affected by Cyclone Harold and With the digitalisation of payments payments could have implications Covid-19. systems, the retail landscape may for the importance of any currency. Digital literacy is an important be ripe for the introduction of a While central banks are only just factor in the evolution of payments digital currency. Whether publicly or entering the field of widescale digital systems. Younger consumers are able privately issued, a digital currency is currencies, banks and fintechs to adapt to digital payments faster a type of currency in a digital form. have familiarised consumers with than older generations, partly because It can be centralised, with a central the concept of digital money by they are more familiar with newer point of control over money supply, building cashless platforms for technology. Data from the World as is the case with a digital currency existing currencies. As the volume Bank’s Global Findex 2017 database issued by a central bank, because the of transactions they facilitate grows, shows that younger adults are more issuer retains monetary control. It these privately owned and operated likely to make mobile or online can be decentralised, where control systems will radically change payments than older consumers. over money supply comes from payments and banking, potentially In high-income countries, over various other sources. A crypto-asset dominating entire financial systems. 60% of individuals between the is an example of a decentralised The changing payments landscape ages of 15 and 59 have made digital currency, where transactions can take and proliferation of privately issued payments, compared with just above place directly between peers without digital tokens raise the possibility 40% of older consumers aged between intermediaries. of central banks losing monetary 60 and 69. The difference is starker for The development of digital control. Many central banks are low- and middle-income economies, currencies could significantly change now considering the possibility of where about one fifth of younger the existing global monetary system, individuals storing, spending and adults have made digital payments, which has been largely denominated moving value without relying on the compared with only 5% of those in the in – and dominated by – the US fiat currency system. older cohort. dollar for over a century. In the late To mitigate this concern, several Generation Z, the cohort born 19th century, the gold standard institutions are considering whether between the late 1990s and the early initially emerged as a means to assign to issue their own central bank digital 2010s, and millennials, who were uniform value to paper currency, currencies. A study by the Bank for born between the early 1980s and leading to the establishment of International Settlements highlighted the middle of the 1990s, grew up in an early international monetary that 20% of central banks aim to a digital environment. Millennials system. The Bretton Woods system launch a digital currency in the next witnessed the early days of the was formalised in 1944, creating six years. Such CBDCs present an internet, e-commerce and social a mechanism for international opportunity for central banks to media, and experienced the transition exchanges of currency. Participating upgrade the incumbent centralised from cellular phones to smartphones. nations pegged their currencies to the payments and settlement systems. Gen Z, on the other hand, went US dollar, which in turn was linked The shift towards digital straight to the more modern iteration directly to gold. currencies is an important step in the of mobile phones. The system broke down between continuous evolution of payments Aside from their technological 1971 and 1973 as US economic policy systems and instruments. Technology know-how, members of these made it impossible to maintain gold and innovation, driven partly by cohorts are familiar with a faster convertibility. A more liberalised changing consumer behaviour, has pace of change. These younger international monetary system transformed payments systems consumers have experienced rapid followed, where currencies were around the world.  The future of payments, 2020 17

How to help digital payments grow up

Digital payments will soon become the main way money is moved around the world. Hurdles must be overcome to reach that future, writes Sky Guo, chief executive officer of Cypherium.

DIGITAL PAYMENTS are progressing from digital currency/electronic payment project is the most an experimental phase to one of integration, advanced. It has been able to coordinate with tech implementation and development. This transition giants like AliPay, WeChat and Huawei, which is making comes as a result of the technological innovations CBDC compatible phones. of blockchain and smart contract platforms like That coordination solves one problem western firms Cypherium, which are increasingly central to new digital face. As public payments systems reduce the need for payments systems. intermediary services, companies like Mastercard, Visa, Decentralised payments systems prevent data and PayPal are looking for ways to maintain their future breaches, downtime and reliance on intermediaries. market positions. Their role could be as intermediaries Blockchains can process transactions instantaneously between CBDCs and private industry or as point-of- even across borders, unlike any other current system. service systems providers. Smart contracts will enable greater transparency and Moreover, CBDCs are closed systems. They cannot money will become programmable, preventing fraud interact with each other without mediators, creating and tax evasion, and speeding up the application of barriers to exchange. Central banks are unlikely to monetary policy. Mobile banking will allow greater allow access to their systems, for obvious security access for billions of people. Aspects of these systems reasons. Diem and other international initiatives intend and central bank digital currency to become retail digital currencies initiatives highlight what is happening for billions of users. This could be in the digital transition. ‘As public payments impossible, however, as no country Mobile payments systems help systems reduce the need may be willing to allow others to have the financially underserved and for intermediary services, full access to domestic financial enfranchise those excluded from companies are looking transactions and undermine monetary participating in globalised commerce. for ways to maintain their policy. Mobile payments systems also future market position.’ One prominent solution comes attempt to make that participation from Cypherium. It has developed efficient and seamless. its digital currency interoperability Millions of people use mobile money and wallet framework to support the autonomy of central banks services. bKash and M-pesa have the most registered by not having outside parties issue, distribute or subscribers, with 16m and 42m respectively. Much supervise the transfer of CBDC. It is a novel approach innovation has been focused in Africa, where rural that consists of six major bodies: the central bank, economies can be made far more robust through CypherLink (a notary mechanism), Cypherium Connect the democratisation of financial instruments, such (a plug-in module for banking systems), Cypherium as saving and borrowing as well as payments. These Validator (a verification machine), a mediation projects largely precede blockchain, which they are now institution and finally the user. turning to for scalability and safety. A likely scenario will see blockchains adopted Mobile payment hotspots overlap only slightly with as parts of new systems, as go-betweens for both the kinds of national digital banking initiatives that public-private collaborations within national economies are sprouting up across the world. There are a few and international public-to-public interactions. Major CBDCs going live in developing nations, such as the payment corporations and banks, like JPMorgan Bahamas and Cambodia. Most experiments, though, Chase, Square and Facebook, continue to develop are taking place in the developed nations of Europe their blockchain teams. This, ultimately, follows the and Asia. In Europe, there are projects like the Swedish lead of developers working on blockchain networks Riksbank’s eKrona and calls for innovation in France and themselves, such as Cypherium, which are the the Netherlands. In Asia, the People’s Bank of China’s industry’s present authority and at the cutting edge.  18 omfif.org 2 Consumer focus The future of payments, 2020 19 20 omfif.org

SECTION 2: THE CUSTOMER IS RIGHT AT THE FOREFRONT OF DIGITAL CHANGE

Younger consumers Consumers have different demands, and commerce increases. thrive in the digital expectations and preferences in the To these groups, smartphones are digital world, which in turn affect not only communication devices, but environment. Their their use of payments systems. also tools for a plethora of activities behaviour and One of the most important factors integrated in daily life. They use preferences will shape influencing these choices is age, mobile gadgets for socialising the future of payments. because this usually indicates the and entertainment, as well as for But system providers level of familiarity and experience banking, shopping and transport. with technology used for financial The integration of multiple must also safeguard and retail transactions. functions in one device presented an consumer rights and Young consumers tend to be opportunity for payment platforms, privacy, especially for comfortable with all forms of which they captured through digital older users. payment methods, and this is often wallets. Apple Pay, for instance, attributed to their proficiency with enables the use of a single payment technology and digital platforms. channel for multiple applications Older individuals may be slower installed in users’ Apple gadgets. In to adapt to – or prefer to avoid – China, applications such as WeChat modern modes of payments. But and Alipay have bundled together members of the younger generations distinct services into one portal to – Gen Z and millennials – have been create super apps. quick to adopt digital channels. This consolidation has contributed Both of these younger groups to the growth of digital payment grew up during an era of rapid platforms and has encouraged a developments in technology. preference for convenience and When smartphones took off, with streamlined products. In Southeast the launch of the iPhone in 2007, Asia, the popularity of ridesharing millennials were old enough to services Grab and Gojek allowed be students or just starting work, both companies to slowly establish whereas members of Gen Z were their own e-wallets, thanks to their either just starting, or already at, captive markets. GrabPay and GoPay school. Both cohorts are expected to are still small relative to regional dictate consumer trends in the near pioneers WeChat Pay and Alipay, but future as their participation in retail they owe their existence and success The future of payments, 2020 21

to the trend for more integrated, day technology. Had there not streamlined consumer services. been a pandemic, they would have Some digital payment platforms continued using familiar payment are taking integration further by methods such as cash and bank reframing how users approach their cards. However, because the elderly 80% own financial activities. Applications are more vulnerable to Covid-19, specifically designed to facilitate changing their payment habits is Proportion of Indian savings, investment and insurance a matter of greater urgency. They consumers over the have emerged, allowing users to stand to benefit the most: shifting age of 56 saying they manage their finances without the to digital payments can reduce the have used online help of human agents. These apps need to travel, minimise contact can encourage desirable, profitable with other individuals and generally payments more often and responsible financial behaviour, reduce their risk of exposure to the since the outbreak of such as when they can be pre- virus. Covid-19 programmed to force users to save, There has been limited evidence by deducting money and putting it of this shift, prompted by lockdown into a savings account. measures. A consumer behaviour Some apps have integrated social survey by tech consulting firm media features into their platforms, Capgemini found that one-third allowing users to invest and of older consumers increased their trade alongside their friends. The use of digital payment methods convenience and social dimensions at the start of the pandemic. The greater sense of security, especially if of these apps are intended to appeal study, conducted in 11 countries in they fear becoming victims of online to younger consumers, although April, found that 37% of consumers fraud. A more personalised approach older customers who want to reduce between the ages of 61 and 65, may help to get older customers used the burden of financial chores can and 33% of those aged 66 and to digital payments. also benefit. over, reported this change in their Digital literacy may also be Social norms and behaviour are payment behaviour. important for accessing government increasingly reflected in the types of All of the countries covered by the assistance. In the US, pandemic- digital payment channels that have Capgemini survey had imposed some related unemployment support emerged. Venmo, owned by PayPal, form of restrictions on movement was disbursed through prepaid is designed specifically for peer-to- as a result of the pandemic, with debit cards: claimants could apply peer transfers – for example, to split various degrees of severity. The for these online. Individuals who a restaurant bill or share costs – and greatest increase among older are already familiar with card- encourages interaction between users. consumers was in India, where 80% based transactions would find this A key feature of Venmo is that users of consumers aged 56 and over said straightforward, whereas people who can request money, overcoming social they had been using digital payments are used to receiving their wages in and cultural taboos about paying up. more: For all age brackets taken cash or by cheque are more likely to Venmo has grown in popularity and together, the aggregate was 75%. struggle, and may need customer has a user base of more than 40m, To sustain such shifts in support at a time when banks are while total payment volume increased behaviour, traditional banks, closing branches or scaling back to $37bn in the second quarter of fintechs and other payment channels counter services. 2020 from just $8bn two years earlier. need to make sure that their services A report by the Federal Reserve cater to older customers and their Board published in November 2019 DIGITAL LITERACY AND specific needs. For example, older found that more than 40% of rural INCLUSION users may prefer to speak with a counties in the US – which often are Older people are perceived to customer service agent on the phone home to poorer communities and be less inclined to use digital rather than chat online with a bot. people with fewer years of education platforms because of their relative Speaking to a person directly about – lost bank branches between 2012 lack of experience with modern- their questions or concerns adds a and 2017. Altogether, there were 22 omfif.org

DEMOGRAPHICS BY REGION AND ECONOMY

GENERATIONAL disparities in consumer behaviour also presents opportunities for scaling up digital and preferences are evident and fairly consistent payments as the overall consumer base expands. across different economies and cultures, although North America is on a similar path, although the the proportion of younger or older people change is more pronounced in the segment of the varies from place to place. Asia and Africa have population aged between 20 to 59. Millennials and younger populations, indicating a greater share of their parents form a growing share of the consumer consumers who are tech-savvy or fluent. With the base in the region. Europe’s population, in contrast, rise in the number of younger people, especially in is growing older. With a larger portion of the Africa, this trend will continue. The demographic population over the age of 60, banks and payment profile partly explains why certain countries providers face a more urgent need to develop have moved faster in adopting digital payments services that can adequately meet the demands of systems. A sharp increase in the total population older consumers.

1. Younger consumers form a growing share of regional markets Population by age group, millions

Africa Asia 1,600 5,000 4,500 1,400 4,000 1,200 3,500

1,000 3,000

800 2,500 2,000 600 1,500 400 1,000

200 500

0 0 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020

North America Europe 900 400 800 350 700 300 600 250 500 200 400 150 300

100 200

50 100

0 0 1950 1955 1960 1965 1970 1975 1980 1985 1995 2000 2005 2010 2015 2020 1990 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020

0-19 20-59 60+

Source: UN World Population Prospects, OMFIF analysis The future of payments, 2020 23

1,533 closures during this period, representing 14% of the total number of bank branches in these counties. Covid-19 has probably increased the number of bank branch closures – and not just in the US. While the shift away from bricks-and-mortar banking facilities is a consequence of wider digitalisation and reflects changing consumer demand, there is a risk that older or vulnerable customers will be left without access to services.

SAFEGUARDING CONSUMER PRIVACY The benefits and convenience that consumers enjoy from digital financial services come with their own set of risks. The threat to privacy is the most relevant for consumers, as the protection of personal data is important for individual security. Thanks to the digitalisation of payments, firms have been able to systematically collect and store greater amounts of personal data than ever before, enabling them to analyse consumer preferences more ‘The benefits and best. Digital money, on the other effectively and align their products convenience that hand, was well regarded for its speed, and services accordingly. However, if yet generally performed poorly across security is weak, customers become consumers enjoy from all categories, especially safety, wide vulnerable to financial crime, digital financial services acceptance and privacy protection. identity theft and fraud. Data privacy come with their own This suggests two immediate protection is one of the preferred set of risks. The threat priorities for regulators who want to characteristics for any payment to privacy is the most make their jurisdictions more open to instrument, as revealed by OMFIF’s digital currencies. First, broaden the consumer trust survey in 2020, in relevant for consumers.’ scope of possible uses, and second, which 39% of the respondents said design a reliable safety net around they considered privacy protection to digital money to foster consumer be the most important characteristic trust. Data protection measures are when making payments. Respondents essential if digital payments channels felt that cash performed this feature are to be secure. As one Southeast Asian central bank respondent noted, ‘Protecting personal data against 2. European 80 unauthorised alteration, destruction, and American or access is integral to earning public 70 consumers have trust in and facilitating adoption of greater control 60 digital financial services. Standards over personal on security and access controls for 50 data providers, complemented by relevant Countries with online 40 regulatory requirements on data consumer protection protection and governance, need to laws, % by region 30 be in place to [address] issues around Source: United 20 Nations Conference customer consent, data security and on Trade and 10 consumer protection.’ Development, Regulators have issued guidelines 0 OMFIF analysis Europe Americas World Africa Asia-Pacific and laws to safeguard the use of With legislation Draft legislation No legislation No data personal data. In some jurisdictions,  24 omfif.org

Digitalisation can improve financial health

Digital cash has the chance to reach the billions of people without access to the formal banking sector. To do so requires sustained and intentional effort, write Usman Ahmed, head of global public policy and research, and Ivy Lau, global public policy and research manager at PayPal.

FOR most of history, acquiring, managing and time, mobile payments, digital wallets and person- sending money were interconnected in theory to-person payments can help the underbanked take but disparate in reality. We took different actions, more control of their financial lives. For example, used different services and visited different consumers can easily utilise different payment places, depending on where we were in the process options for different circumstances, which is and what funding instruments we were using. important for managing costs. Moreover, one of the However, technology and partnerships can bring features of mobile payments is automatic tracking these practices together and make them more and display of a clear and real-time record of how a accessible and customisable. It is now possible to user is spending money, enabling them to improve receive, manage and send money using apps on decision-making. a smartphone, simplifying tasks that are costly in While technology is creating completely new terms of money, time and mental bandwidth. avenues and channels to democratise financial The Covid-19 pandemic has dramatically services, it is only through partnerships that accelerated the move to digital. The we can truly maximise these payments system is no exception. opportunities. Partnerships Despite this, cash won’t disappear ‘Technological advances, enable us to further digitalise any time soon and there are parts such as artificial cash, the biggest impediment to of the payment process that remain intelligence, blockchain, meaningfully democratising finance outside the digital ecosystem. biometric authentication for consumers. Partnering helps Governments still send out physical and improved analytics, remove friction from the payment cheques to citizens, as do employers will facilitate this experience and push the economy to their employees. Small businesses move towards a digital, further into the digital age. Moving are struggling to meld their physical democratised payment forward, deeper engagement and and digital businesses, dealing with closer partnerships across the public landscape.’ expensive and ill-fitting systems. sector and non-governmental There are 1.7bn people outside the organisation community, around formal financial system. For billions more that system areas like digital identity and central bank digital is too expensive and slow. The future of payments is currency, are needed. This deeper engagement about filling these gaps. could unlock incredible gains for individuals and The opportunity exists to democratise financial businesses when acquiring, managing and sending services and improve the financial health of money and reduce costs across the financial services consumers and businesses. Technological advances, ecosystem. such as artificial intelligence, blockchain, biometric Finally, safe and secure digital payments serve authentication and improved analytics, will facilitate as baseline architecture upon which other financial this move. But we must be intentional in how we services can be offered in an inclusive and prudent design services to ensure they reach and benefit the manner. At PayPal, we can utilise data from mobile underserved. payments, in partnership with financial institutions, A lack of access to institutions, funds and clear to underwrite working capital loans for small account information can disproportionately impact businesses, an example of how integration between poorer individuals. By offering a more convenient payment and other aspects of financial services can and less expensive way of managing and moving help improve financial health and define the future of money, without the constraints of geography or payments.  The future of payments, 2020 25

3. Examples of data privacy laws

Country Law

Argentina The Argentinian Data Protection Authority issues guidelines for the processing of personal data for electoral purposes, setting basic guide- lines to ensure the integrity and protection of personal data.

Privacy Act 1988 and Australian Privacy Principals The mix of federal, state and territory laws applies to private sector entities with an annual turnover of at least Aud3m and all Commonwealth Australia government and Australian capital territory government agencies. Under the Privacy Act, the privacy commissioner has authority to conduct investigations and enforce penalties on those who fail to implement the law.

Brazilian General Data Protection Law Brazil Published on 15 August 2018, the Lei Geral de Proteção de Dados largely aligns with the European Union’s General Data Protection Regulation, providing a comprehensive framework regulating the use and processing of all personal data.

California Consumer Privacy Act California The CCPA empowers residents of California to understand the types of personal information that businesses gather and gives them the right to prevent the sale of their personal data to other parties.

Personal Information Protection and Electronic Documents Act Canada The PIPEDA is one of 28 federal, provincial and territorial privacy statutes governing the protection of personal information in Canada’s private, public and health sectors. It applies to consumer and employee personal information.

Chile Privacy Bill Initiative Chile This initiative establishes the protection of personal data as a constitutional right. It regulates the processing of personal data performed by public and private individuals and organisations. Additionally, Chile has different laws regulating personal data.

There is no single comprehensive data protection law, but there are rules regulating personal data protection and data security. For China example, the PRC Cybersecurity Law was the first national-level law to address cybersecurity and data privacy protection.

India Personal Data Protection Bill India The bill applies to both government and private entities that conduct business, offer goods and services to data principles and conduct activities such as profiling of data subjects in India.

The Privacy Act 1993 and Information Privacy Principles New These laws regulate how agencies collect, use, disclose, store, retain and give access to personal information. Enforcement is Zealand through the privacy commissioner, who has the power to investigate.

Personal Data Protection Act Coming into effect in 2013, the PDPA applies to organisations collecting, using or disclosing personal data in Singapore whether Singapore or not the organisation has a physical presence in Singapore. Separate regulations govern the collection of personal data in the public sector.

Protection of Personal Information Act South Africa The right to privacy is recognised as a fundamental human right in South Africa. The POPIA specifically regulates the processing of personal information. It provides guidelines to help public and private bodies comply with the rules.

Vermont Data Broker Regulation Vermont This law, which came into effect in January 2019, aims to regulate the activities of any business entity that collects and processes information about consumers with the intent of selling or licensing the data. 26 omfif.org

notably in Europe and in North America, consumers have greater control over sharing their personal data. Asia Pacific has the fewest countries with online consumer protection legislation – only 43% of the region, compared to 73% in Europe and 71% in the Americas. Similarly, Asia ranks below the world average in terms of the number of countries in the region that have regulations on data protection and privacy. In the US and Europe, data protection and regulatory constraints have become stricter to establish firm rules on the use of consumers’ personal information. The European Union’s General Data Protection Regulation regulates the use of personal data of all EU citizens, based on the idea that privacy is a fundamental right. Stricter data protection laws present a new regulatory hurdle for businesses that rely on personal data for the growth of their digital payments systems and other services. The GDPR applies to the European Economic Area, which includes EU member states and Iceland, Liechtenstein and Norway. The coverage of this regulatory framework ensures that companies operating in multiple jurisdictions in the region are following a standard set of rules. In the US, different states have their own privacy laws, 4% which means that companies have Companies that fail to countries such as Singapore, India, varying levels of access to personal comply with the GDPR Brazil and Australia have issued their data depending on location. This can be fined up to 4% own regulations. The lack of a single, fragmentation makes it more difficult global framework can hamper the to scale up new payments systems. of their annual global growth of digital payments systems In China, digital payments turnover on an international scale. In August providers were able to leverage 2019, the International Organisation their access to personal data to for Standardisation released guidelines expand their services. WeChat and to help businesses comply with privacy Alipay have become super apps by and data protection regulations in making data-based, personalised different jurisdictions. ISO standards, recommendations that promote the use although useful in aligning with of other services integrated with their existing regulations, highlight the payments systems. Chinese policy- fragmentation across jurisdictions. As makers recognise the dominance of consumers become more concerned these platforms. A comprehensive about how their personal information personal data protection law is being is being used, the need for a globally drafted, and is expected to place harmonised data protection framework greater importance on obtaining will become even more important in consent for the collection and enhancing public trust in digital processing of personal data. Other financial services.  The future of payments, 2020 27

Digital payments are the key to inclusive growth

To ensure people have a fair chance to reap the benefits of Southeast Asia’s economic success, policy-makers and companies must collaborate so that no one is left behind in the digital payments transition, writes Huey Tyng Ooi, managing director and head of GrabPay at Grab.

GRAB’S foray into digital payments took root in 2016 (family-owned businesses – typically restaurants or when the company introduced a cashless stored value cafes – in Indonesia), hawker centres (outdoor food option allowing top-ups to its in-app mobile payment markets), and other heartland businesses whose solution, GrabPay. This provided a more secure way livelihoods have been hit. Offline merchants have of transacting by reducing dependence on physical the option of diversifying their sales channels to cash for public transport, and further expanded the include social media platforms such as Facebook convenience of cashless payments to our unbanked or Instagram, with payment facilitated via a remote customer base in Southeast Asia. GrabPay was the GrabPay link sent to the customer. Rather than first digital payments provider to obtain access to taking steps in isolation, a holistic approach is needed e-money licences in the six major Association of to ensure that support for this segment makes a Southeast Asian Nations countries, allowing a range of difference across the entire value chain. Suppliers services including online acceptance, prepaid top-up, to hawkers and wet markets tend to transact only in remittance, and peer-to-peer funds transfer. cash, therefore the upstream supply chain should be Covid-19 presents an opportunity digitalised. to create a more sustained shift to Public-private partnerships can digital payments. The pandemic has ‘Malaysia’s ePenjana demonstrate the practicality of shown that for most businesses, initiative incentivises digital payments and make them survival depends on digitalisation. accessible to all. Malaysia’s ePenjana citizens through an Digital payments are the foundation initiative incentivises citizens of online commerce. To enable Rm50 handout that through a Rm50 handout that can Southeast Asia to unlock the benefits can be claimed via an be claimed via an e-wallet of their of widespread digital payments e-wallet of their choice.’ choice. This encourages Malaysians adoption, there is much work to be to spend on local businesses, but done. more importantly, it accelerates the Certain consumers, particularly the elderly, are less adoption of digital payments. Four times more senior tech-minded, and reluctant to use digital financial citizens have claimed their subsidies compared to services. They are more familiar with cash and unsure the previous disbursement. Mobile wallets can also of the security of paying online. It is important to be employed to disburse much-needed financial educate them on the benefits and mechanics of relief during a crisis. In the Philippines, employees paying digitally. Governments and the private sector under the government’s small business wage subsidy can drive national education programmes to maximise programme can receive financial relief via multiple results. In 2019, Grab conducted digital clinics in e-wallet providers Singapore’s financial regulator is partnership with the Infocomm Media Development working with consumer banks to promote the use of Authority to help the elderly in Singapore understand PayNow and the Singapore Quick Response Code. how to use the services available on the GrabPay Asean is set to become the world’s fourth largest e-wallet. economy by 2030, but not everyone has the equal There needs to be more support for merchants chance to succeed alongside the region’s growth. and sectors that lack e-payment and digital Shaping the future of payments here must therefore infrastructures, so that they are not left behind. This be driven by a strong desire to advance inclusive particularly applies to traditionally offline businesses, growth, made possible through product innovation such as small independent merchants like warungs and greater public-private collaboration.  28 omfif.org 3 Infrastructure The future of payments, 2020 29 30 omfif.org

SECTION 3: LEGACY INFRASTRUCTURE HAMPERS PROGRESS

There have been The act of making a payment is fast, Transactions happen in real time significant changes in convenient, secure and low cost with delivery and payment occurring in most developed economies. For simultaneously. There is also less the kinds of payment consumers, the experience at the ambiguity when confirming the final instruments used, with a front end has improved over the settlement or agreeing which part of shift from cash to cards decades, thanks to the introduction the transaction occurred first. It does and mobile payments. of new methods of payments that not rely on any digital infrastructure Yet the infrastructure offer real-time settlement, are widely and therefore is not subject to any accessible and accepted, and are outages that can interrupt services. for clearing and settling backed by robust legal and regulatory That is particularly important for these payments has frameworks. These attributes make rural populations, which may not improved more slowly. them more convenient than cash. have adequate access to digitalised Cash as a means of payment is payment infrastructure. limited by its physical properties: With the increasing substitution both parties involved in a transaction of cash, there has been a must be present to confirm payment proliferation in the number of and settlement. Cash must be stored payment solutions arriving in (which usually bears its own costs), the market to fill the gap. Of the there is a risk it could be counterfeit, different payment options available, and its physical properties make it cards and contactless mobile almost impossible to use for high- payments have dominated. However, value purchases. Cash is used less the options available today are still in developed countries and more in largely underpinned by traditional developing countries: paradoxically infrastructures. it is cheaper to distribute cash in developed countries given the LEGACY RELIANCE economies of scale in distribution Typically, commercial bank money and management costs, while in is accessed for payments through developing countries, distribution requests by the deposit holder. These is expensive but demand for cash is payment requests that initialise higher because of the lower financial bank transfers can be authenticated inclusion rates. through, for example, debit cards, Yet cash has important benefits. mobile payment applications or in The future of payments, 2020 31

person with proof of identification. February 2016 using fraudulent Swift and interoperable payment When consumers make a payment messages: They succeeded in getting system infrastructure and related to another agent such as a retailer, the central bank to transfer about system to foster innovation while their respective commercial banks $81m. Given the system’s centralised maintaining the system’s stability settle these transactions against nature, it remains vulnerable to and security. This, it said, ‘will each other through the wholesale single points of failure. A cyber continuously enable future payment payment system, in some cases via attack or system failure would mean systems to cater to the needs of central bank reserves. Commercial that participants are unable to different target groups in the public, bank deposits are not backed one- transact central bank money. private and government sectors to-one with central bank money, Survey respondents also said with appropriate technologies. although they are – in most cases – that the RTGS system presented an For example, promoting pilot convertible at par. additional problem for those new projects in partnership with the A trusted third party conducts players that are eager to enter into public and private sectors for the these transactions between accounts the payments systems. Entrants face implementation of end-to-end from different commercial banks, high regulatory barriers to access e-business processes and digital provided they hold balances core payments infrastructures, which payment to reduce costs and increase between themselves on the same could lead to a lack of competition operational efficiency.’ ledger. This happens at the central and innovation. bank through the real-time gross Smaller, new entrants could ADOPTING INSTANT PAYMENTS settlement system. The RTGS find it difficult to comply because One major issue central banks find facilitates the real-time movement of a mismatch in broad and bulky with RTGS is the lack of support for of funds between accounts held by banking regulations. Non-bank 24/7 payments settling in close- commercial banks at the central institutions, which tend to be to real time. The development of bank. The UK uses the clearing house the innovators in the payments instant payments over the last 10 automated payment system (known market, are the ones most likely years allows for the transmission as Chaps), the US uses Fedwire, and to be affected by these barriers to of payment messages and provides the euro area has Target-2. entry and this, in turn, will reduce availability of final funds to the Survey respondents agreed that competition in the market. payee in real time or nearly real time these systems needed upgrading. Overall, the growth of non- on an almost around-the-clock basis. Central banks have highlighted bank payments service providers These respondents found no that there are inefficiencies in the challenges the legacy of central bank significant shortcomings with these RTGS despite ongoing and costly payments infrastructure and balance instant payments systems. They improvements. The system is still sheet being largely limited to banks. highlighted that one major benefit susceptible to technical faults To address this issue, in 2017 compared with the traditional system and complexities in how certain the Bank of England became the was the ability to overcome time trades are verified and settled. One first G7 central bank to grant access restrictions of transactions between respondent noted that to improve to settlement accounts in RTGS different institutions, as well as RTGS, efforts were needed ‘to make to certain non-bank payments the openness. These open systems it more resilient, to widen its access providers, subject to them meeting subsequently allow end-users to and interoperability, to improve user appropriate regulatory and technical use any number of intermediaries, functionality and to strengthen end- standards. The central bank could such as different payment service to-end risk management’. also consult on the appropriate level providers and banks. The system is prone to errors of access to their balance sheet, The introduction of this central and outages, so backroom manual including necessary safeguards, to infrastructure puts everyday interventions are frequently needed decide whether and how to allow banking on a new foundation, and to correct these. Many incidents go non-bank payments providers to hold with the development of innovative unreported. The Bank of England overnight balances at the Bank of end-user solutions, based on the suffered a major outage in October England. core system, instant payment can 2014. Hackers tried to steal nearly One East Asian central bank be an alternative to cash as a means $1bn from Bangladesh Bank in said it aims to develop an open of payment, even where previously 32 omfif.org

only cash was available. One central ‘One respondent to the retail payments systems and so the bank said, ‘Since all [payment service OMFIF survey noted marginal benefit of adoption is likely providers] had to join the system, that to improve RTGS, to be higher, meaning the decision to all domestic payment accounts have invest may be easier in the absence become reachable, allowing instant efforts were needed ‘to of well-established infrastructures. payments to become the new norm.’ make it more resilient, However, the pace of adoption of One advanced economy central to widen its access instant payments systems globally bank is also planning a major and interoperability, to proved slow (see p. 44). consolidation of its payments improve user functionality architecture. The central bank’s plan CHALLENGES FOR EMERGING is to replace the existing interbank and to strengthen end-to- MARKET ECONOMIES retail payments systems: It aims end risk management.’ The retail payment experiences to develop an infrastructure that in emerging markets have been supports instant settlement with a very different, reflecting various view to ending multiple-day clearing challenges including the lack of cycles and ensuring fast and resilient digital and financial inclusion, the 24/7 clearing. The goal is to establish high cost of making transfers and a system that is easy to access, easy remittances, the absence of advanced to upgrade and make innovations, wholesale payments systems and able to provide new capabilities such as RTGS, the poor network that payment service providers infrastructures and the persistence of (including banks) can exploit for their cash economies. customers’ benefit. Facilitating and securing the However, operational issues operation of payments systems is persist, where high liquidity cost or part of a central bank’s mandate, counter-party risks are transferred as a smooth functioning payments to the payments service provider. system is critically important to These systems require immediate the performance of an economy. clearing between the payments However, in ensuring redundancies service providers of the payer and in payments, central banks face payee, but the settlement of funds real-world constraints. Central bank between providers does not have to survey respondents from emerging occur immediately. The availability markets highlighted that some of of payee funds and inter-provider the key technological pre-requisites settlement can occur either through needed to facilitate the adoption real-time or deferred settlement. of digital financial services revolve In real-time settlement, the around connectivity, identity, data debiting and crediting of funds protection and information security. from the payer to the payee occur at the same time as the debiting and CONNECTIVITY crediting of the respective payment In advanced economies, basic digital service providers. Credit risk is connectivity has become the norm. In removed, but providers are required contrast, central banks in emerging to hold sufficient liquidity to settle in markets underscore the need for real time at all times. digital infrastructures used to enable A deferred system works by fast, reliable and affordable internet batching and executing the connections supported by adequate associated settlements of the mobile network infrastructures payment service providers at a and agents that serve as alternative specified time, while still allowing for touchpoints covering urban and far- real-time debiting and crediting for flung rural areas, especially where the payer and payee. In this model, access to cash and banking services is credit risk arises for the providers, limited. as they would advance funds to the One East Asian central bank payee before interprovider settlement explicitly stated that the high cost takes place. and uneven quality of internet Emerging markets have been early access has been a particular adopters of faster payments systems. shortcoming in promoting the use of These countries lack mature, legacy digital payments. It said, ‘Internet The future of payments, 2020 33

connectivity – the foundation of the digital economy – is limited in rural areas, and where they are available, services are relatively expensive and of weak quality.’ The lack of competition, as well as regulatory restrictions in the telecommunications market, are a hindrance to improving networks. This is mainly due to the lack of open access policies in the ownership of public utility companies that is meant to level the playing field for telecoms, as well as to ensure that market competition is driven by service delivery and innovation rather than exclusive ownership of networks. Smartphones have enabled a technological revolution in digital financial services providing an affordable and mobile way to interact with financial institutions and payment providers. The infrastructure needed to support these devices is crucial to promote the adoption of digital financial services: mobile coverage, low-cost smartphones and affordable data 10GB plans. In low-income populations, if In some developing countries, including Malaysia, the cost of access to a smartphone India and Thailand, the average monthly data usage is a significant barrier, there is a consumption has surpassed 10 gigabytes risk of exclusion. However, falling smartphone and data costs have allowed adoption to rise in developing countries. According to a GSMA report, in some countries, including Malaysia, India and Thailand, the average monthly data usage consumption has surpassed 10 As more and more retail outlets and brands to expand rapidly in gigabytes. The report also noted that begin to accept digital payments, partnership with fintech companies, by 2025, smartphone penetration will consumers benefit from positive which in turn can help fill the gaps reach 80% globally. network externalities, and the utility in banks’ channels, innovations, Once connectivity issues are of joining the network increases. product sets and processing resolved, more should be done to use China offers a good example to capabilities. these online networks. The focus follow, as e-commerce functions have needs to be on targeted solutions that improved in line with the growth of IDENTITY take individuals’ specific needs into scalable and cost-efficient non-bank Another significant challenge for consideration, rather than providing payments providers such as Tencent accessing digital payments is the blanket solutions. and Alipay. need for formal national identity Encouraging supply-side On the demand side, the uptake documents and their translation competition is one effective way to of digital banking services can to digital identity infrastructures. create market-specific solutions. be improved if issues of access Especially in emerging markets, Local vendors and businesses can quality and service affordability the adoption of a national ID benefit significantly from digital are overcome. The partnering of system could make it easier to financial services, especially in incumbent banks and financial open transaction accounts for the economies where account holders are technology companies could unbanked and underserved sectors of more likely to have mobile phones prove fruitful. Banks can leverage the economy. than debit cards. their capital, trust, customer base One emerging market central 34 omfif.org

Consumer demand drives payments revolution

In a challenging environment, financial institutions must be responsive to new conditions and market opportunities, writes Harry Newman, global head of payments strategy at Swift.

CONSUMERS’ DESIRE for instant, secure payments payments account-to-account. For example, in 2019 has driven a revolution in retail payments. Faster we launched a new cross-border instant payments payments systems are changing the game by service, powered by gpi, which enables domestic providing close to real-time credit in more than 50 market infrastructures with instant payment domestic markets. schemes to connect to the gpi Tracker. We have Wholesale payments have undergone an equally successfully trialled gpi payments connectivity with dramatic transformation with Swift Global Payments the European Central Bank’s Target instant payment Innovation, known as gpi. Gpi payments deliver settlement, known as Tips, and Singapore’s Fast and same-day use of funds, end-to-end tracking and Secure Transfers domestic instant payments system. final confirmation of credit – together with full Another strong theme in the data is that gpi is transparency on fees charged. delivering effective solutions for lower value, cross- Since the advent of faster payments systems, border retail payments. This is by far the fastest speed has become a given for domestic growing value segment on gpi. transactions. Gpi often matches this and offers It is now well-established that gpi is effective in transparency via the Tracker and the all-important delivering speed, removing uncertainty and reducing confirmation of payment. The convergence between delays in cross-border transactions. Much has been domestic and international payments is evident from achieved but there is still more to be done. Swift data. Up to 35% of cross-border payments Our data show that regulatory barriers and capital have at least one leg in a domestic clearing and controls are the most significant friction impacting around one-fifth of gpi payments are direct speed and seamless delivery. These are the domain domestic payments. of local regulators and the banking industry cannot Links are being forged between gpi and solve this issue alone. However, the industry domestic and regional systems that are streamlining can speed up responsiveness to requests for

350 35m

300 30m 286 250 25m

200 20m 163 150 154 15m 148 100 10m 50 5m 0 0

0 to <1000 1000 to <10K 10K to <100K 100K and greater Domestic gpi adoption International gpi adoption

1. Low value payments fastest growing segment on gpi 2. Gpi increasingly used for domestic payments Volume of payments, growth from November 2017 Volume of payments, by month – August 2020, % Source: SWIFT Watch Source: SWIFT Watch The future of payments, 2020 35

Within 30 minutes

Payments including Between 30 minutes and 1 hour countries with no barriers or capital controls Between 1 and 2 hours Payments including countries with limited Between 2 and 4 hours barriers or capital controls

Payments including Between 4 and 6 hours countries with significant barriers or capital controls Between 6 and 12 hours

Between 12 and 24 hours

More than 1 day

0 5 10 15 20 25 30 35 40 45 50

3. Impact of regulatory barriers and capital controls on transaction speed Share of gpi payments and its clearing times and reasons of delay, % Source: SWIFT Watch

documentation and try to smooth the path through strengthen transaction screening. the process. This is an area where Swift is already playing an Similarly, time zone differences contribute to important role – providing mutual, non-competitive delays; the data show that payments following the services for know-your-customer processes, sun arrive more quickly than those travelling against sanctions screening and reference data checking local operating hours. While people across the globe that spread the costs of development for the will certainly continue to work and sleep at different domestic wholesale and retail markets – and in which times, technology improvements including enhanced we are exploring going further over the next two straight-through processing and 24/7 real-time years. operating capabilities will reduce the impact of In a challenging environment, financial institutions time-zones on payment delivery. Improved data must be responsive to new conditions and market standards, notably ISO 20022, will ease the flow opportunities, able to connect seamlessly across and hand-off of data across the global payments ecosystems and ready to build a presence in ecosystem and facilitate automation. Here, gpi and high-growth segments, such as small and medium Swift will play a large part. Industry-wide migration to enterprises and consumer payments. ISO 20022 messaging for all cross-border and cash And they must always keep the customer management messages is scheduled to commence experience at the heart of everything they do. from the end of 2022. At the same time, they need to be able to reduce In a world experiencing high levels of financial costs, future-proof their technology investments crime, compliance-based queries represent and reduce dependency on major migrations. a significant block on the speed of cross- With Swift’s new strategy, we are working towards border payments. When it comes to preventing fully-orchestrated transaction management, fraudulent transactions, or stopping funds supported by rich data services. We will help financial flowing to a sanctioned individual or jurisdiction, institutions reap the benefits of a transformed, compliance must not be sacrificed to speed. But by seamless and friction-free payments landscape incrementally harnessing technologies like artificial while reducing costs and increasing efficiency for intelligence we can continue to streamline and themselves and their customers.  36 omfif.org

bank promoted the need to develop 1. Liquidity a National Digital Identity platform, management 3 serving as an infrastructure makes cross- for digital identity verification border and authentication. The survey 613152735 payments respondent said, ‘Biometrics costly technology has been adopted for 2 Cost breakdown e-KYC process to be more secure, for international better prevent possible frauds, and 020406080 100 payment transactions, % also enhance financial services Network management Overhead Source: McKinsey through digital channels.’ Payments operations Compliance Global Payments Another advanced economy Map 2019, OMFIF FX costs Claims and treasury operations central bank highlighted that digital analysis identity could be used not only Nostro-vostro liquidity for KYC procedures, but also for accessing services and authorising payments – and IBAN-mobile phone 2. Mobile 8 number translators – suggesting it money offers could bring significant efficiency and the cheapest 7 safety gains for digital payments. method for 6 In addition, digital identity remittances 5 identification could also help make Average cost, % of 4 security checks smoother, especially remittance amount 3 in cross-border payments. Source: World Bank 2 Data management and information Remittance Prices security are also intrinsic to the Worldwide, OMFIF 1 analysis 0 development of digital identity, as CashBank accountBank account (same Mobile money it requires the availability of both bank) customer data and transactions Q3 2018 Q3 2019 Q3 2020 for electronic processing. Such data management technologies used in the development of these customer identity systems, products and services need to be accessible, affordable, verifiable and accommodate multiple needs and risk ‘Protecting personal data The cross-border payments system levels for a risk-based approach to against unauthorised relies heavily on correspondent customer due diligence. banking networks facilitated by Protecting personal data against alteration, destruction financial intermediaries at multiple unauthorised alteration, destruction or access is essential in levels. A correspondent bank will or access is essential in earning earning public trust and have either a nostro or vostro account public trust and facilitating adoption facilitating adoption of with a counterpart bank in another of digital financial services. In this digital financial services’ country. A nostro is the account of a regard, adoption of standards on local bank held by a correspondent security and access controls for bank in another country, in its providers, complemented by relevant foreign currency. A vostro is the regulatory requirements on data account of a foreign correspondent protection and governance, need bank, held by a local bank in its to be in place to ensure that issues domestic currency. This reciprocal around customer consent, data system of accounts facilitates foreign security and consumer protection, exchange transactions and the flow of among others, are addressed (see funds between countries. p.23). Swift’s network allows participants to exchange electronic transaction CROSS-BORDER PAIN POINTS messages detailing instructions for Survey respondents highlight that cross-border payments. However, cross-border payments are often too it provides neither clearing nor expensive, slow, opaque and can be settlement. Correspondent banks limited in their access. participating in a transaction The future of payments, 2020 37

must still process the messages general decline in their total average individually at their back end, and costs, while post offices have recorded subsequently settle any transactions periodic increases in average costs through foreign exchange markets. since September 2013. This means that cross-border 34% Costs are further differentiated payments are generally more by fee and foreign exchange margins cumbersome and expensive than The bulk of the between digital and non-digital domestic payments due to the costs (nearly 34%) in remittances. The World Bank number of financial intermediaries existing international noted that fees account for a larger involved in the process. Smaller transactions methods proportion of the cost, and that the financial institutions that have are related to nostro- rates for non-digital services are not established correspondent consistently higher than those for relationships with foreign vostro liquidity and digital services, regardless of the counterparts may be disadvantaged. reconciliation region where the recipient is located. The shrinkage and consolidation In the third quarter of 2020, the in the number of correspondent cheapest instruments for sending banking channels have meant higher remittances were mobile phones, costs associated with cross-border with fees representing 5.28% of the payments as institutions seek to remittance amount. Sending money reduce their risk exposures. A World to a bank account at the same bank Bank report in 2018 on the decline technologies are seeing a greater followed, with fees amounting to of correspondent banking noted concentration in their use towards 5.58%. When the recipient account that this trend of de-risking tends to new models for peer-to-peer cross- belonged to a different bank, the costs disproportionately affect financial border payment applications, which increased to 7.24%, and when the institutions in small, developing will probably grow over the short to remittance was sent in cash, fees were countries at the periphery of cross- medium term. 6.42%. However, over the last three border payment corridors. For smaller Lastly, central bank survey years, the average costs have fallen countries, precautionary liquidity respondents said that better for all methods of disbursement, with required tends to be higher in order interoperability is needed at an mobile money showing the greatest to reduce higher transaction risks, international level, especially in the decline (Figure 2). given there is greater opaqueness adoption of standards such as ISO During the current Covid-19 in processes and the overall lack 20022 (an ISO standard for electronic crisis, migrant workers are expected of trust as correspondent banking data interchange between financial to experience a fall in their wages relationships are reduced. institutions), as well as in the further and an increase in unemployment. A study by McKinsey in 2019 on development of common standards The World Bank estimates that cross-border payments found that for digital identity and data-entry international remittances are the bulk of the costs (nearly 35%) in solutions in order to streamline projected to fall by about 20% this existing international transactions processes and encourage competition year. In India and Bangladesh, the methods are related to nostro- for cross-border payments. countries ranking top and ninth- vostro liquidity and reconciliation The high costs arising from the highest in the world in terms of due to a lack of real-time data and operations of making cross-border remittances received, remittances differences in end-to-end payment payments translate into higher costs are expected to fall by 23% and 22% processes. A peer-to-peer model for users. Traditionally, users make respectively. The biggest declines could reduce the need to update remittances through money transfer are expected to occur in Europe and and reconcile multiple accounts organisations such as Western Union central Asia, with an estimated fall in the post-trade cycle. Enabling or MoneyGram that pass on increases of about 27.5% in each, due to the direct transmission of information in costs to their customers. combined effects of the pandemic and and assets between parties could But wider financial literacy, low oil prices. optimise the operational costs of market competition and technology In the short term, it is necessary cross-border payments, as any lack of have steadily reduced the costs of to keep digital remittance channels standardisation could be minimised. remittances. At the end of September open and to work with providers to While there are feasible alternative 2020, the World Bank found that the ensure people can receive remittances solutions to cross-border payments proportion of remittance corridors without the burden of high costs. (e.g. Swift gpi), blockchain and with average costs of less than 5% Solving operational inefficiencies distributed ledger technology, or has increased from 17% in the first and encouraging digital remittance DLT, have proved to be catalysts quarter of 2009 to 34% in the third channels can subsequently create in pushing the financial industry’s quarter of 2020. Banks, mobile cost savings for users and provide outdated infrastructure to the cusp operators and money transfer significant economic benefits for of technological upgrading. These organisations have experienced a remittance recipient countries.  38 omfif.org

4 The state of play The future of payments, 2020 39 40 omfif.org

SECTION 4: MOBILE MONEY ENTERS THE MAINSTREAM

Payments systems INDIVIDUALS, enterprises improvements have traditionally are invisible – yet and financial institutions rely on occurred or been conceptualised payments systems to successfully at an isolated domestic level, and indispensable – settle purchases and pay wages confined to specific economies. infrastructures at the and other bills on a timely basis. However, as global economic heart of an efficient, Digitalisation is changing the activity becomes more integrated, reliable and competitive architecture of payments systems, innovations in payments often have economy. Innovations pushing the frontiers on speed, significant cross-border implications efficiency, cost, security and in multiple jurisdictions. Various have driven the growth of economic safety. The impact of parties or interests from both the the payments industry, digital technologies on payments public and private sectors are closely offering retail users a has accelerated in recent years involved in the innovation of new range of options to pay, due to a confluence of events. technologies and business models save and transfer value. As a survey respondent from a which alter the conduct of economic European central bank noted, rapid transactions. developments in payment systems The most radical proposal in have been underpinned by the existing payment methods is in emergence of new, internet-based the medium of exchange itself, technologies alongside new market with the emergence of alternative participants and growing demand for currencies that could potentially instantaneous payments. become widely accepted as legitimate The global payments industry forms of payment. Crypto-assets is constantly upgrading and (such as bitcoin) and private-sector improving: Advances in technology, stablecoins (such as Diem) are fast accompanied by more streamlined emerging as potential payment rivals regulatory approaches to fintech in to conventional, sovereign-backed payment processes, have paved the fiat accepted by businesses and way for the development of faster, individuals. Separately, central banks cheaper and more inclusive means and governments are exploring the for individuals and businesses to possibility of digital fiat in the form transact. The potential impact of of central bank digital currencies. innovations in payments systems These digital innovations in retail has increased. Payments system payments are changing the way The future of payments, 2020 41

that money can function as an asset: 1. Mobile money 300 money acts as a unit of account, has entered the a store of value, and a medium of mainstream 250 exchange. The shifts in payments Number of live processes and infrastructure lay the mobile money 200 foundations for a long-term migration services of payments into the virtual world Source: GSM 150 which has become all the more Association, OMFIF analysis relevant and necessary because of the 100 Covid-19 pandemic and the need for safer means of conducting economic 50 activities. 0

MOBILE-ENABLED INCLUSION 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 Mobile money emerged in the early 2000s as an alternative to card-based payment. This innovation – of linking mobile phone usage and network 300 2. Acceleration credits as a monetary medium – of mobile originally arose from the practice of 250 penetration transferring pre-paid airtime as a underpins 200 virtual currency in exchange for cash, mobile money growth or other goods and services. This has 150 been very effective in expanding the Number of mobile cellular scope of financial inclusion within 100 subscriptions per developing countries in Africa and 50 100 people Asia, especially in communities Source: World which lack access to formal financial 0 Bank, OMFIF services. A survey respondent from analysis 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 a Latin American central bank noted East Asia & Pacific South Asia Sub-Saharan Africa that innovative electronic retail payment services play an important role in closing financial inclusion gaps and catering to the unbanked. Mobile payments offer several key advantages over cash as a medium used by over 70% of the population. It or physical bank branch. Their pre- of payment, greatly reducing operates in many other countries too, paid mobile accounts function as operational costs and time delays. including Tanzania, Congo, Egypt, current accounts, with the ability to With the rapid rise in mobile internet South Africa, Lesotho, Mozambique, make small consumer payments from penetration and smartphone usage, Romania, Albania and India. The one account to another using mobile mobile payment platforms have M-Pesa wallet allows users to deposit numbers as identifiers for payment become a more convenient and user- cash or transfer funds to other instructions. friendly alternative to cash (Figures M-Pesa customers, and to withdraw Two related trends are shaping 1 and 2). cash from the wallet. These deposit further innovation and regulatory Kenya’s M-Pesa platform is a well- and withdrawal functions are enabled change within the mobile payments known pioneer in mobile payments. by a broad network of Safaricom- landscape. First, non-bank mobile- It was launched in 2007 by the mobile affiliated retailer agents. M-Pesa wallet providers have entered the network providers Vodafone and subscribers can store, transact or send fray. Firms offering non-payment Safaricom and is now the leading money through this network without digital services have been able to digital payments system in Kenya, even accessing a formal bank account establish their own e-wallets and 42 omfif.org

3. Mobile usage been focused on mitigating systemic 1.4 expected to risks from the wholesale payments reach 1.5bn 1.2 sector, which executes high-value, Number of users, high-priority payments between bn 1.0 major financial institutions. Source: Expert 0.8 Cross-border infrastructure such Market, OMFIF as Continuous Linked Settlement analysis 0.6 (CLS) – a platform functioning as an international multi-currency clearing 0.4 system on a payment versus payment

0.2 settlement mechanism – operates by linking together multiple countries’ 0 respective central bank RTGS systems 2016 2017 2018 2019 2020 2021 2022 that are concurrently running. In contrast, retail payment transactions are characterised by a payment channels by leveraging ‘Digital innovations in much higher volume of activity, but their existing distribution network retail payments are are generally of lower value and less and customer base. This includes risky. Unlike high-value interbank e-commerce platforms and other non- changing the way that transactions, driving RTGS in the payment entities offering mobile- money can function as retail space has traditionally been powered services. an asset: money acts as too costly or inefficient to justify Second, mobile financial services a unit of account, a store direct central bank maintenance or have expanded beyond payments to of value, and a medium of management. But the barriers to include lending, insurance, wealth retail payments innovation are now management and credit-based exchange.’ coming down. Bank-based clearing activities. In this respect, attaining and settlement systems that have regulatory approval and licensing to emerged around the world to provide provide digital or virtual banking and timely and efficient retail payment lending services is seen as the next processing include the New Payments step on the path to widespread mobile Platform in Australia, Faster payment adoption. As the growth Payments Service in the UK, Swish of mobile wallet users worldwide is in Sweden, and FAST in Singapore. projected to reach nearly 1.5bn by In a study this year, InfoSys noted 2022 (Figure 3), mobile money-based that there were at least 54 real-time payment platforms are fast becoming payment systems already in operation the most vibrant area in digital globally, with more planned to go live financial services in which incumbent in future. financial institutions and fintechs There are distinct advantages compete and collaborate. to building upon the existing clearing, settlement and payments PICKING UP THE PACE infrastructures of commercial banks. Commercial banks are also First, these institutions already have revamping their existing payments expansive networks of customers infrastructure, either in collaboration and intermediaries. Iterative with, or under pressure from, central improvements to proven payments banks. Co-operation between the two rails can achieve scale and be adopted sides is sparking greater innovation, rapidly. Secondly, in many cases, collaboration and vibrancy in the when interbank transactions are retail payments arena, which had cleared via fast payments systems, conventionally been dominated different banks undertake settlement by large commercial banking of sovereign-backed currency within infrastructure. reserve accounts held at central Jurisdictions that already had banks. That provides a high level well-developed infrastructure for of trust in the process, allowing the clearing and settlement of retail transactions to be settled between payments have had little incentive to account holders across different innovate in the past. Central banks payment services providers and and supervisors had traditionally banks. The future of payments, 2020 43

On the other hand, it is clear that existing fast payment infrastructure operated by commercial banks CLOSED VS OPEN LOOP requires further catalysts for innovation and to encourage PAYMENT ARCHITECTURE adoption. One Southeast Asian central bank noted, ‘Digital One of the key design questions for current and future innovations in transformation of the banking mobile money or e-wallet payment schemes will be where these fall industry is lagging compared to in the continuum of open or closed loop systems. These choices will fintechs.’ As shown in Figure 5, dictate the degree of interoperability and utility that retail users can there is considerable variation in derive from mobile money, as well as their capacity to be substituted the pace of adoption of different for general purpose cash. fast retail payments systems across different jurisdictions. The BIS notes End party End party that rapid adopters such as Sweden Closed loop and Denmark benefit from having End party Payments End party user-friendly mobile applications system and services built into the front end of their fast retail payment End party End party infrastructure. Implementing faster payments also requires the adaptation of services between Open vs closed: commercial banks and central In contrast to established payment intermediaries such as Visa banks. For instance, one of the major and Mastercard that are, for the most part, universally accepted changes required to implement means of payment, the majority of mobile money innovations exist Hungary’s AFR instant payment as closed or semi-closed loop infrastructure. Open loop models are system, which was launched in March distinguished by having higher levels of disintermediation between 2020, was the establishment of new end-party transactors and the core payment service provider. Banks, mechanisms for round-the-clock or other intermediaries connect their respective retail customers and liquidity provision from commercial merchants with the underlying payment system. Closed loop systems banks. tend to be more brand-specific in their operations and governance, and It is increasingly necessary to hence can be more limited in their coverage and ubiquity. Transactions provide a broader range of services can only be conducted with businesses and individuals that are pre- and products via digital channels approved in the issuing entity’s network. that can leverage and support new, There are intrinsic advantages and disadvantages to both payment fast payment infrastructure used arrangements. An open loop model allows for rapid scalability of a by banks. This can be achieved by payments network – as banks or other intermediaries join the platform, developing an open banking system all of their end-party customers are accessible to other intermediary in which third-party fintechs can institutions. On the other hand, a closed loop arrangement requires be interoperable with financial direct ties between end users and the payment platform, which could institutions’ data and software. limit its interoperability. However, as closed loop payments systems Regulators have tended to encourage handle more specific transactions internally with end users, payment greater competition by opening providers have the potential to gain much more detailed insights into up payments to a wider range of transactions, as well as cheaper processing costs from the reduction providers, because the barriers of intermediaries. Nevertheless, as the volume and payment values to entry are high and payments transacted within closed loop payments increase, the systemic processing requires economies of risks of these infrastructures also rise. New regulatory compliance scale. Recent regulations such as considerations imposed on influential closed loop, mobile money the EU’s revised Payment Service schemes may impact the viability of the original business model. Directive and the UK’s Open Banking initiative are promoting the concept End party End party of ‘payments as a service’ (PaaS) by Open loop allowing third-party fintechs greater Bank Bank access to banking data via open APIs End party Payments End party system and open source technology. Bank Bank The implications of open banking on payment processes and the broader End party End party financial services industry are significant. Under an open banking 44 omfif.org

4. Roll-out of new or improved fast payment systems, selected countries Source: Bank for International Settlements, OMFIF analysis

Year of implementation Country System

2001 South Korea Electronic Banking System

Taiwan ATM, FXML, FEDI 2003 Iceland CBI Retail Netting System

Malaysia Instant Transfer 2006 South Africa Real-Time Clearing

2007 South Korea CD/ATM

Chile Transferencias en linea 2008 UK Faster Payment Service

China Internet Banking Payments 2010 India Immediate Payment Service

2011 Costa Rica Transferencia de Fondos

Ecuador Pago Directo

2012 Poland Express ELIXIR

Sweden BiR/Swish

2013 Turkey BKM Express

Denmark Net Real-Time 24-7

2014 Italy Jiffy

Singapore Fast and Secure Transfer

Mexico sPEI 2015 Switzerland Twint

Australia New Payments Platform 2017 Thailand Prompt Pay

Japan Zengin System

Hong Kong Faster Payment System 2018 Philippines InstaPay

Malaysia Real-time Retail Payments Platform

Saudi Arabia ARPS 2019 Netherlands Instant Payments

Norway Straksbetalinger 2020 Hungary AFR

2023/2024 (estimated) US FedNow The future of payments, 2020 45

regime, data that were traditionally only held and controlled by banks can increasingly be leveraged by multiple providers, for example insurance companies, payment services, credit card issuers and mortgage providers, thereby allowing more tailored and individualised financial services to be provided to individual customers. Although incumbent financial institutions and banks could risk being disintermediated from customers when banking, payments and other financial services can be provided by third parties, the ‘Blockchain and DLT have been touted as enabling unbundling of vertically integrated financial services could allow banks technologies that could refine payment processes from to leverage complementary value- account-based systems reliant on data in centralised added services from fintechs. ledgers, to a token-based system in which exchanged In the area of retail payments, items have intrinsic monetary value.’ commercial banks are adopting and integrating certain functions to improve the payments service for their customers: These include providing point-of-sale financing and lending options to streamline new competition from the private DLT have been touted as enabling transactions, and escrow services sector, it is important for banks to technologies that could refine that help to instil trust and mitigate actually catch up with [their] new payment processes from account- security and fraud issues in technologies,’ according to one based systems reliant on data in e-commerce payments. These were southeast Asian central bank. centralised ledgers, to a token-based areas which survey respondents system in which exchanged items said showed great promise as well as OVERCOMING LACK OF TRUST have intrinsic monetary value. benefits for end users. One central WITH DLT The most radical method of side- bank from a developing Asian Banks and fintechs are working stepping the commercial bank and economy said, ‘Advancement in on ways to improve various financial institution-led payment financial technology will encourage aspects of payments, both in the infrastructure is through public bank and non-bank to create value- existing domestic retail payments peer-to-peer networks and crypto- added service for users in term of infrastructure and in the area of assets such as bitcoin. There are convenience, accessibility, safe and cross-border transactions. Some other models which still leverage (and cost-effective service, and fees.’ fintech innovations are exploring are linked to) fiat value, for example For smaller banks with only limited ways to circumvent the established challenger fintech actors such as technological capabilities and capital international payment rails Ripple, which employ DLT to facilitate to invest in IT improvements, PaaS completely by experimenting with movements of fiat currency between could allow them to quickly upgrade blockchain and distributed ledger financial institutions by acting legacy infrastructure and offer value- technology. as bridging digital assets. Other added, third-party services on their The ability of blockchain and DLT developments such as stablecoins (see core platforms. to enable transparent and immutable p.49) are also enabling the wider use Several survey respondents transactions in a decentralised of blockchain and DLT to transform predicted that greater competition and secure environment may open payment processes. from fintechs (as well as collaboration the door to new collaborations and interoperability with these and the streamlining of financial CARD PAYMENT PROVIDERS newcomers), would drive further intermediation between cross- INNOVATE incentives and opportunities for border transactors. Advances in Several large third-party payment improvement and service delivery decentralised data verification and service providers are taking steps among commercial banks. ‘Banks as authentication could transform to revise their business models and incumbent financial service providers how monetary value is exchanged maintain their influence in a fast- compete with the emergence and validated between transacting changing environment. For example, of fintechs which offer several parties. Visa and Mastercard are expanding services provided by banks. With At one extreme, blockchain and and repositioning their portfolio 46 omfif.org

Digital currency that works for all

Payment systems work best as public-private partnerships, and payments with CBDC should not be an exception, writes Naveed Sultan, global head of the treasury and trade solutions group at Citigroup.

CITI operates in more than 160 countries and to the centrality of currency and payments in the jurisdictions and is directly connected to over 250 economy, there is the potential for unintended value-transfer systems through which it processes consequences. In order to be effective, CBDC must upwards of $4tn in payments per day. Our global strike the balance between public infrastructure experience as payments practitioners informs our versus private sector solutions; the respective roles views on the emerging topic of central bank digital of central bank money versus commercial bank currency. money; and expanded access to digital money versus The digitisation of currency and payments is financial crime risk. inevitable and central banks will play an important Money has historically existed in both public role in driving innovation. and private forms, and most of the fiat currency in Digital currency in general should be broadly circulation today is commercial bank money. In a accessible, transferrable in real-time and ‘always crisis, universal access to central bank money could on’. It should accommodate the needs of emerging fuel domestic bank runs and cross-border capital forms of commerce like internet of things, support flight. micropayments, enhance wholesale securities Payment systems work best as public-private settlement and integrate with other digital platforms. partnerships, and payments with CBDC should not There should be a thriving private market in digital be an exception. Crowding out the private sector payments with high levels of innovation, competition will stifle innovation and put central banks in the and investment. There are multiple undesirable and onerous position of routes to reaching these objectives. conducting know-your-customer CBDC may help achieve these ‘There should be a processes, enforcing anti-money goals – or detract from them – thriving private market laundering and combating the depending on how it is designed in digital payments with financing of terrorism, and providing and implemented. The potential high levels of innovation, customer support. development of CBDC should be competition and A wholesale CBDC does not have considered alongside other means to investment.’ to be universally versatile. It could be augment payments systems, such as engineered solely for use in domains the development of 24/7 real-time where it would add clear value, such gross settlement systems. as tokenised capital markets, where the alternative Policy-makers are rightly weighing up the would be private stablecoins with greater credit risk potential for technological innovation in the issuance and market risk. of national currency versus the impacts on private CBDC alone, regardless of its design, cannot financial markets. expand access to digital payments. There is a need CBDC may lead to direct access to central bank to update laws and regulations in a technologically money by non-banks and individuals, reducing the neutral way. deposits banks rely on to extend credit and crowding With the above considerations in mind, and in line out private investment and innovation in payments with its responsibilities in the global financial system, systems. Private credit creation is fundamental to Citi actively engages with central banks and policy- economic growth, generating employment, and makers in the discussion of whether, and how CBDC social mobility. Private payments systems foster might further foster, rather than jeopardise, vibrant innovation and ensure greater resilience through private markets in payments and credit. Citi will draw diversification of platforms. attention to the broad range of best practices that There are many design considerations for creating countries can adopt to stimulate the development of a CBDC, both technological and structural. Due effective digital payments systems.  The future of payments, 2020 47

of services to include non-card 60 5. Inconsistent payments, cross-border capabilities, pace of and other financial service areas. 50 adoption for

Card payment networks have 40 fast retail existed in parallel with bank account- payments based payment infrastructures. 30 Number of As improvements in the speed and transactions per 20 reliability of fast bank payments capita, selected countries make it more viable for businesses 10 and individuals to pay directly Source: Bank 0 for International without using an intermediary card, 012345678910 11 Settlements, both Visa and Mastercard have tried Number of years since implementation OMFIF analysis to innovate and shift their services Australia Chile Denmark Mexico Nigeria from physical plastic to digital. India Singapore Sweden UK Mastercard, for example, acquired the UK payment processor VocaLink in 2017, giving it the capacity to handle fast, automated clearing house transactions in multiple markets. ‘As the boundaries of the wary of e-commerce sites. Strategic In September 2020, Mastercard digital economy expand, partnerships and acquisitions announced a collaboration with have broadened PayPal’s reach and ACI Worldwide, a real-time digital platforms – such as PayPal integration with other retail payment payments software provider, to – which originally functioned infrastructures. Its acquisition of expand its fast payment services as payment gateways Venmo and Braintree in 2013 gave globally. Visa has developed Visa for specific e-commerce it a foothold in the P2P mobile Direct, which allows international functions, have payments sector. Other acquisitions, P2P payments with other eligible Visa such as Xoom, iZettle and Honey, cardholders. consolidated their positions have expanded PayPal’s reach into Incumbent card providers are via strategic collaborations retail payment sub-sectors such as also experimenting with potentially and acquisitions.’ remittances and e-commerce. More disruptive new payment technologies recently, PayPal has made inroads and infrastructures. Visa B2B in the Chinese payments sector Connect, a non-card payment by acquiring a majority stake in network, employs DLT for end- Chinese payments processor GoPay in to-end, high-value cross-border December 2019. payments between companies and financial institutions. Mastercard has TECHFINS AND THE POWER OF responded to the interest in CBDCs PLATFORMS by developing a digital currency Large technology companies – or virtual testing environment for ‘techfins’, to use the name coined central banks and private firms to by Jack Ma, Alibaba’s founder – assess interoperability of CBDCs with are yet another important source existing payment rails. of innovation and change in the It is not only card issuers that payments landscape. The emergence are experimenting with business of these influential actors is adding models and technological innovation. impetus for competition and As the boundaries of the digital collaboration in various parts of the economy expand, platforms – payments chain. such as PayPal – which originally While technology has historically functioned as payment gateways been at the core of transformation in for specific e-commerce functions, the payments industry, innovations have consolidated their positions have originated from companies and via strategic collaborations and financial institutions with specialised acquisitions. PayPal’s initial success operations in the sector. Increasingly, was to win the confidence of buyers however, large technology firms and sellers on eBay because it with existing products and services acted as a trusted escrow agent are diversifying their interests into intermediating fund transfers at a the payments industry and the time when consumers were generally financial services sector. In contrast 48 omfif.org 16.53% Volume of big tech mobile payment services as a share of annual GDP in China

to fintechs, which are new market such as credit or insurance, which settlement, including credit cards or participants with high uncertainty feature stricter legal and regulatory fast retail payment systems. Second, costs, large technology companies requirements. Payment activities can there are ‘proprietary systems’ – entering the financial services sector easily be integrated and offer direct such as Alipay and WePay – which have distinct advantages. As well- value-adds to technology companies’ are more closed-loop in nature, known and trusted brands with a core businesses and products. clearing and settling transactions sizable user base and strong financial The expansion of big tech within infrastructures developed position, techfins in financial into payments and banking has and managed by technology firms services could rapidly scale up their been faster and more pervasive themselves. activities. These players can also use, in developing countries where and in turn, benefit from aggregated alternative means of digital DEVELOPING DIGITAL data on consumer behaviour and payments are limited and mobile CURRENCIES preferences gathered from across phone penetration is high. The Although technology companies their existing services and products. role of big tech in mobile payments are making inroads into financial Google and Apple are two of the is especially significant in China, services and the payments sector, giant technology firms that have which has historically been an the expansion is still within the steadily developed capabilities isolated market with only limited bounds of adding or upgrading in payments and other financial penetration by mainstream payment existing payments rails, requiring services. They have developed infrastructures such as international collaboration with banks and mobile payment apps linked to their card providers. incumbent payment network actors. respective operating systems on The Bank for International A more radical transformation in contactless devices. The majority Settlements notes that technology payments systems, catalysed by of techfins have mainly focused firms’ payment platforms fall into several private-sector players in the on entering the payments sector two distinct categories. First, there technology industry, is the concept as a bridgehead for other financial are ‘overlay systems’ – such as Apple of tokenisation and the issuance of services. Payment or e-money Pay, Google Pay and PayPal – which digital currencies to replace account- licences are often obtained with developed around existing payment based infrastructures. relative ease compared to other areas infrastructures for clearing and Linked to the emergence of The future of payments, 2020 49

blockchain and DLT adoption in ‘Innovations in the form of and social impact organisations, various economic sectors, private including Facebook. digital currency issuance is an stablecoin tokens, whose Despite the ambitious original area that has generated immense values are tethered to objectives of the Diem project, interest and debate in recent years. reference assets such as many central banks and financial While bitcoin and other crypto- fiat currencies to trade at regulators are alarmed about assets mark an important step on par with existing monetary the prospect of new monetary the way towards creating a non- instruments from the private sector sovereign currency, their high price instruments, are seen as that could undermine their capacity volatility makes them unsuitable for promising steps to extend for conducting monetary policy and widespread use as a general means of their payments reach and maintaining price and financial payments. Innovations in the form utility as units of account.’ stability. In the words of US Federal of stablecoin tokens, whose values Reserve Governor Lael Brainard, ‘We are tethered to reference assets such have seen the growth of massive as fiat currencies to trade at par with payments networks on existing existing monetary instruments, are digital platforms, such as Alibaba seen as promising steps to extend and WeChat, and the issuance of their payments reach and utility as stablecoins on a smaller scale, such units of account. as Tether, Gemini, and Paxos. What The most prominent proposal for sets Facebook’s [Diem] apart is a private-sector digital currency is the combination of an active-user the Diem stablecoin. This concept network representing more than a was originally floated by Facebook third of the global population with in 2019 as an alternative financial the issuance of a private digital infrastructure that would promote currency opaquely tied to a basket of financial inclusion via a new global sovereign currencies. It should be no reserve currency for domestic and surprise that [Diem] is attracting a cross-border payments. high level of scrutiny from lawmakers According to the initial Diem white and authorities.’ paper, the stablecoin would be backed Subsequent modifications to the by a basket of multiple sovereign Diem stablecoin, for example in currencies, analogous to the IMF’s its design and compliance aspects, special drawing right, and would be sparked regulatory concerns. Under comprised of highly-liquid, short- the revised white paper published term government securities and bank in April 2020, the most significant deposits. The Diem payments system alteration is the replacement of itself is intended to be built upon the original concept of a multi- a permissioned blockchain, whose currency coin linked to a basket operation will be governed by an of fiat currencies with several independent, non-profit association single-currency stablecoins that comprised of global businesses instead serve as constituents for a composite, multi-currency Diem coin. The revisions to Diem also reiterated commitments to closely collaborate with and meet regulatory

16.5 requirements set in place by central 6. China dwarfs 0.7 other big tech banks and monetary authorities. To markets 0.6 ease concerns over its implications for Value of big tech monetary sovereignty and financial mobile payments as 0.5 stability, Diem has proposed that a share of GDP, % digital sovereign fiat, or central bank 0.4 Source: Bank digital currencies, could potentially for International 0.3 be integrated into the Diem network Settlements, OMFIF analysis in future, and eventually replace 0.2 the associated stablecoins. Diem’s

0.1 proposed compatibility with digital versions of major central bank 0.0 currencies could be close on the China US IndiaBrazil Indonesia UK horizon. 

50 omfif.org

5 Sovereignty The future of payments, 2020 51 52 omfif.org

SECTION 5: CENTRAL BANKS JOIN THE DIGITAL RACE

The design of new CENTRAL BANKS have been forced ‘business as usual’. Central bank central bank digital to explore the possibility of issuing money already exists in a digital their own digital currencies because form as electronic bank deposits, currencies will of innovations in payments and the also known as central bank reserves determine the extent of emergence of crypto-assets. A central and, as such, its use is limited to the impact they have on bank digital currency is central qualifying financial institutions. payments and, thereby, bank money in a digital form. Unlike In contrast, retail CBDCs could be on financial inclusion. privately issued crypto-assets, this is used by households and businesses not a parallel currency. It serves as a directly. This form of central bank new means of payment and as a cash digital currency would serve as an alternative. alternative to cash, with e-wallets, CBDCs are denominated in mobile phones, tokens or pre-paid the official monetary unit of the cards providing a means of storage. issuing country and are a direct Closely linked to the decision to liability of the central bank. Besides follow retail or wholesale design maintaining relevance and policy alternatives, central banks will influence within the increasingly also have to choose if their digital digitised payments landscape, the currencies are going to be a direct introduction of CBDCs potentially or hybrid CBDC. In the case of promises to significantly reshape the former, central banks would payment infrastructure at both the handle the issuance, distribution domestic and international levels. and management of the digital There is no ‘one size fits all’ currencies, without any intervention design and underlying technology for by financial institutions. While this CBDCs as these aspects will depend form might favour financial inclusion on how central banks choose to be as a result of the elimination of involved in the national payments fees attached to financial services, environment. With regards to design central banks might not have the and how these risk-free digital infrastructure, the expertise or currencies can be made available, two even the appetite to engage in such distinct possibilities arise: wholesale activities. With a hybrid CBDC, or retail CBDCs. central banks would be freed The former conveys a sense of from handling millions of retail The future of payments, 2020 53

clients and assuming tasks that stored either in digital devices that which allows consumers to have correspond to commercial banks’ can be accessed with an internet access and use their money offline. In day-to-day operations. Under such connection or in pre-paid cards or terms of KYC and AML/CFT, the sand an arrangement, on the one hand, tokens that can be accessed offline. dollar follows a three-tier system central banks would operate the While most central banks around in which the lowest tier does not backup infrastructure to protect the the world are still undergoing entail strict customer screening, but payment system. On the other hand, research or CBDC pilots to test which it does limit the amount of B$ held. financial intermediaries would be the of these designs and technologies The other two tiers have a risk-based ones in charge of making real-time to use, the Bahamas has already approach to KYC and AML/CFT payments and handling every aspect passed to a launching phase. After standards. related to managing customers and completing a pilot during 2019 The People’s Bank of China due diligence, following KYC and on the island conglomeration of launched its Digital Currency/ anti-money laundering/combating Exuma, the Bahamas launched the Electronic Payment project to the financing of terrorism standards. first nationwide retail CBDC, the create a digital yuan, providing the With regards to CBDC’s Bahamian or sand dollar, on October most advanced example of ongoing technological design, accounts 20 of this year. CBDC pilot tests. DCEP trials have and digital tokens are the two The sand dollar is a direct liability been rolled out in the Greater Bay main alternatives that are being of the Central Bank of the Bahamas: Area, Beijing, Tianjin and Hebei considered to grant consumers access It can only be held domestically, province. The PBoC has partnered to CBDCs. With the account-based and it is pegged to the Bahamian with state-owned institutions to run option, consumers will need to have dollar. This CBDC is being released pilot tests of the DCEP in industries an account, either at the central gradually through authorised such as transportation, education, bank (direct CBDC) or a financial financial institutions, or AFIs, and commerce and healthcare. This CBDC intermediary (hybrid CBDC). Token- retail consumers have access to it will probably be fully backed by the based CBDCs will more closely through digital wallets. These wallets central government and pegged resemble a digital form of cash, work with a hybrid wireless network to the Chinese renminbi, with the

’There is no ‘one size fits all’ design and underlying technology for CBDCs as these aspects will depend on how central banks choose to be involved in the national payments environment.’ 54 omfif.org

intention of replacing cash. Like CBDC issuance. Sveriges Riksbank has with the broader digitalisation of Alipay and WeChat Pay, the CBDC can been running a digital currency pilot economic activities, there will be a be stored and accessed by consumers since February 2020. In December corresponding need for central banks through digital wallets. However, 2019, the central bank contracted and financial regulators to configure unlike these networks, the e-yuan with Accenture to test e-wallets, their regulatory mandates to these will not require people to have a distributed ledger technology and changes. Whether they originate from bank account. Another critical aspect interoperability with banks. Other the private or public sector, upgraded of the e-yuan that would further countries in varying stages of CBDC or new retail payment infrastructure advance financial inclusion is that development include Ukraine, must meet financial inclusion and its transactions will not be subject Canada, France, South Africa and stability policy objectives, as well to any fees. Launching its sovereign Brazil. As more countries move away as ensure security, interoperability, digital currency would bolster China’s from cash, more central banks are trustworthiness, resilience, speed and standing in the global political expected to explore the possibility of cost-effectiveness. Regulators have to economy, with the digital yuan CBDC issuance. adequately balance the enforcement potentially challenging the US dollar’s Financial innovations are evolving of these measures while still dominance. and emerging much faster than encouraging continued innovation Sweden, a country with low cash industry regulation. As innovations in and competition in payments from usage, is another frontrunner in payments systems advance in tandem private sector players. 

20.10.2020 Date the Bahamas launched the first nationwide retail CBDC, the Bahamian or sand dollar The future of payments, 2020 55

BIS report reinforces principles for CBDC development

Private and public collaboration should be at the heart of the development of digital money. A new testing environment delivers that, writes Raj Dhamodharan, executive vice-president for blockchain, digital asset products and digital partnerships at Mastercard.

CENTRAL banks, financial institutions and tech payment options. Innovation, financial inclusion companies are absorbing the details of a recent and efficient payment flows depend on vibrant report from the Bank for International Settlements. private sector competition. A CBDC should seek It identified the foundational principles and core to preserve those features in its design and features that any publicly available central bank distribution. digital currency must have. Interoperability between payments systems The report outlines three key principles for avoids closed-loop networks that reduce the CBDCs, stating that they must be in ‘co-existence fungibility and portability of money, fragment with cash and other types of money in a flexible and liquidity and limit competition. A growing chorus of innovative payment system… Any introduction (of a economists argues that ensuring interoperability CBDC) should support wider policy objectives and between a CBDC and other payment forms do no harm to monetary and financial stability, and can play an important role in strengthening the features should promote innovation and efficiency.’ domestic payment ecosystem and reinforcing Public and private sectors have a role in creating the role of central bank money. Consumers will be a safe, efficient and accessible more likely to adopt a CBDC if it can system. CBDC payments should be be used on existing infrastructure as easy as existing means and offer ‘Open and competitive and is supported by trusted sufficient interactions with private payment ecosystems payment methods that are linked to sector digital payments systems to are critical to enabling their existing devices and accounts. allow interoperability. access, adoption and Consumer trust is at the heart of Mastercard welcomes this report payment options.’ the payments system. Individuals and believes that the principles must have confidence that they get outlined by the BIS are a promising what they pay for and are protected next step as central banks make decisions about in the event of fraud, dispute or data misuse. issuing CBDCs. Providing cash to the public is a Gaining that trust requires standards and rules that core responsibility of central banks. Mastercard is safeguard the security of every transaction while committed to supporting countries on their path to ensuring all parties are treated fairly and equitably. payments system modernisation. In September, Mastercard announced a For CBDCs to preserve the health of the proprietary virtual testing environment for central financial system and ensure that consumers banks to evaluate CBDC use cases. It can also be continue to have access to robust payment options, used to simulate the issuance, distribution and they must adhere to a set of common principles. exchange of CBDCs. CBDCs are an exciting new device in the central The BIS report argues that the next steps in bank’s toolbox, but that does not mean they are exploring CBDCs must be ‘cautious, incremental right for every job. Tried and tested methods, such and collaborative’. Mastercard’s CBDC testing as a real-time payments system, may be a better platform provides an environment for the fit. Policy-makers should compare a CBDC with collaboration the BIS recommends – a place where other forms of payment to find the approach that central banks and the private sector can work best fits their needs. together in a controlled environment to transform Open and competitive payments ecosystems the way people and businesses transact.  are critical for enabling access, adoption and 56 omfif.org 6 Policy The future of payments, 2020 57 58 omfif.org

SECTION 6: REGULATORS ADAPT TO A NEW LANDSCAPE

Central banks and THE FINANCIAL innovation entities in designing and managing supervisors understand that goes into developing payment system architectures, the payments fintechs often involves survey found a broad consensus the need for regulatory disintermediation and the creation that the public sector must now innovations that suit of credit, which can have an impact proactively encourage innovative the dynamic nature of on the broader financial system and solutions and minimise associated digital payments. Such economy. Central banks and financial risks. As Jens Weidmann, president of innovations will expand regulators are keen to encourage such the Deutsche Bundesbank, says, ‘In a innovation, because of the potential market economy, offering innovative the roles of regulators benefits, while at the same time payment solutions to the public and beyond their traditional containing any risks to consumers, interacting with customers should be focus on formal financial investors and the overall financial a primary task of the private sector. institutions. system. Even as innovation by the Central banks have to ensure that the private sector in payments and fintech payments system runs smoothly and accelerates, governments and central they can act as a catalyst.’ banks – which will continue to play a key role in monetary oversight and HARMONISING CROSS-BORDER payments – are expected to remain REGULATORY STANDARDS relevant in the payments landscape A key regulatory objective is in future, as illustrated by the improving confidence, security and research and implementation of CBDC trust in payments systems. This initiatives. requires understanding, supervising Respondents to the OMFIF Future and, when necessary, intervening of Payments survey were almost to safeguard the interests of retail unanimous in the view that they and and commercial users. However, this their regulatory peers would continue cannot be conducted on a unilateral to play a key role in maintaining basis. As many countries revamp and setting responsible standards the laws and regulations that govern and principles to govern progress in payment infrastructures, survey payments (Figure 1). Although two- respondents point to the compelling thirds of respondents (67%) said that need for greater convergence in central banks could or should explore cross-border payment regulations direct collaborations with private and standards for payments-related The future of payments, 2020 59

products and solutions. In addition, to streamline a sometimes dizzying Commission. In other cases, coin they highlight the need to address legal array of ambiguous and contradictory offerings such as Kik’s Kin or TON’s uncertainties surrounding data and regulations that have failed to keep Gram tokens have been designated as underlying technology infrastructures. up with the hybridised nature of securities, and have been subject to Developing common standards digital payments instruments and regulatory restrictions and penalties and pathways for collaboration in technologies. from the US Securities and Exchanges data management and cybersecurity For instance, the emergence of Commission. is essential. Regulators need to have alternative payment instruments There is an urgent need to access to data on payment transactions such as private tokenised currencies clarify these regulatory and legal to make sure that companies have frequently falls into a grey area in contradictions which have arisen adequate measures in place to protect many regulatory regimes. Depending largely as a result of rapid monetary against data and identity theft or credit on the intended function of tokenised innovation and the emergence of and liquidity risks, thereby ensuring instruments, several regulatory new players and intermediaries in security and stability, and preventing frameworks have determined that in financial services and payments. fraud in payment networks. However, addition to being a means of payment, While retail payments systems due to the increasingly international they could also serve other functions, have traditionally come under the nature of digital transactions, much such as being investible securities umbrella of banking regulations, more attention needs to be paid to or insurance contracts. In the US, fintechs and large technology firms ensuring that cross-border payments the Howey test is used to decide are also increasingly involved as do not compromise the domestic what is a security, based on shared collaborators or competitors within policy priorities of central banks. One common attributes such as ownership the payments industry. As a result, survey respondent noted that although of a collective enterprise’s capital effective supervision over the broad current regulatory frameworks structure and the expectation of profit spectrum of participants involved in tackle domestic risks, they would generated via a promoter or a third payment processes frequently entails probably need updating if found to be party. extending supervisory mandates to inadequate for cross-border risks. As a result, digital currencies in the non-traditional entities. As many financial institutions US have fallen under the regulatory As the overseers of financial system and fintechs employ outsourced mandate of different bodies depending stability and resilience, central banks IT infrastructures from the cloud, on their intended function and and supervisors have the capacity to inevitably some aspects of handling characteristics. For instance, because set important technical standards payment processes may involve data of the decentralised nature of bitcoin, and expectations for the responsible flows across national borders. However, it is considered a commodity and design and operation of payments different jurisdictions have different falls under the oversight of the US systems. One Latin American central standards for data sovereignty in the Commodities and Futures Trading bank noted that a priority for its financial industry, creating disparities. As one survey respondent said, ‘Special effort should be devoted to 1. Public the strengthening of co-operation governance among financial authorities, at the Set regulatory or technical standards of payments international level, in defining and will keep pace applying common rules and standards. with private Facilitate innovation This is a real challenge for authorities, innovations due to the complexity of legislative and ‘What is the role institutional frameworks.’ of the state in the Governance future payments industry?’, % of CLARIFYING REGULATORY responses

AMBIGUITIES Public-private partnerships Source: OMFIF Central banks and financial regulators Future of Payments survey in many jurisdictions are undertaking 020406080 100 regulatory reforms: These are intended 60 omfif.org

government was ‘looking into how to instruments. In addition, many of as a tool for monitoring and better define the legal perimeter for them maintain that greater flexibility overseeing the operation and services the payments ecosystem’. has to be balanced with equitable of payment service providers to Many central banks have expectations and oversight to enhance risk management in specific developed – or are in the process of maintain fair competition and prevent activities. Such a regulatory model drafting – revised legislation and regulatory arbitrage. A Southeast Asian presents several challenges, including licensing frameworks to address and central bank noted in the survey that maintaining systemic financial regulate new and traditional payment the regulation of third-party payments stability while encouraging the businesses. One example is the system providers ‘has to fulfil the simultaneous operation of different Monetary Authority of Singapore’s obligations, among others, to set and kinds of payment providers, banks, Payment Services Act which came implement a sound risk management, and other financial institutions, and into effect in January 2020. This enhance IT security, ensure consumer also limiting the scope for regulatory new licensing framework provides a protection, and comply with applicable arbitrage. progressive and flexible means for the laws and regulations. These obligations In practice, as many jurisdictions central bank to supervise different ensure a level playing field to all embark on initiatives to encourage or payment service providers depending payments system service operators, keep pace with financial innovation, on their specific activities and the while at the same time provide many are referring to the basic risks generated from their operations. confidence to customers in conducting policy principle of ‘same activity, The PSA covers the characteristics of payment transactions’. same regulation.’ As one central various payment developments such as As new firms enter the payments bank in the survey explained, ‘This digital payment tokens, e-money and sector, an important aspect of means that newcomers must be money transfer operators and outlines regulatory reform will be weighing the subjected to adequate AML-CFT specific licensing and operations benefits and efficiency gains of moving security, consumer protection and requirements for businesses in to an activity-based regulatory regime financial stability requirements, different fields. rather than continuing with one that is even when these are ancillary or Several of the survey respondents confined to industry-specific entities. outsourced service providers’. As recognised that payments regulation new technologies and new business must be updated to be more specific ACTIVITY-BASED REGULATION models allow non-traditional and granular with regard to different One survey respondent described the firms to engage in basic financial business models and payment activity-based approach to regulation service activities such as payments, this policy approach is helping to minimise regulatory arbitrage and avoid migration to firms outside the 2. Distinct business areas covered by the MAS Payment Services Act traditional bounds of central bank Source: MAS supervision. However, there are limits to how Payment services areas Activities covered far a purely activity-based approach can be used. Although subjecting all The service of issuing a payment account or any firms involved in regulated activities service relating to any operation required for operating to common expectations is seen as Account issuance services a payment account, such as an e-wallet (including certain multi-purpose stored value cards) or a ‘a prerequisite to a well-functioning, nonbank issued credit card. competitive market’, in one European regulator’s words, some survey Providing local funds transfer service. This includes respondents emphasise that it is also Domestic money transfer services payment gateway services and payment kiosk services. important to customise the precise degree of compliance required from Cross-border money transfer services Providing inbound or outbound remittance service. new payment service providers on the basis of systemic risk. Regulatory Providing merchant acquisition service where the service provider processes payment transactions from frameworks and supervisory the merchant and processes payment receipts on Merchant acquisition services approaches for banks and other behalf of the merchant. Usually the service includes financial institutions are applied to providing a point-of sale terminal or online payment gateway. new fintech players to the extent that they are appropriate for their risk Issuing e-money to allow the user to pay merchants or E-money issuance services transfer to another individual. profiles and systemic importance. Adaptable regulatory approaches Buying or selling digital payment tokens, or providing a that can be gradually customised to Digital payment token services platform to allow persons to exchange DPTs. their risk profiles will help maintain financial stability without unduly Money-changing services Buying or selling foreign currency notes. stifling innovation. As another central The future of payments, 2020 61

bank from Europe noted, ‘Regulation of payments should reflect the financial stability risk, rather than EVOLVING REGULATION FOR the legal form, of payments activities. Firms that are systemically important CHINESE PAYMENTS INDUSTRY should be subject to standards of operational and financial resilience China’s mobile payments sector provides an example of how more that reflect the risks they pose.’ For stringent regulations have been progressively applied to fintechs that example, if payment platforms do not have grown in influence and in systemic importance. engage in deposit-taking or credit- China’s payments sector is concentrated around a few major based activities, some jurisdictions payment service providers, which could impact financial stability and have opted to issue e-money licences consumer welfare. When third-party payment institutions are able to which enable proportionately lower collect large sums of money, it raises the question of whether banks KYC requirements for opening are prepared to offer preferential treatment, or even a lower standard accounts. of financial monitoring, to those third parties in order to retain their custom and accounts. Any failure or lapse in detecting breaches or IDEAL ATTRIBUTES illicit activities in the banking system could have major implications for Regulators acknowledge the need the stability of the system. to review or even overhaul the Payments providers want to expand rapidly, which could encourage ways that digital payments systems them to take risks, for example by reinvesting the money from and currencies are managed and transactions in high-risk, high-return assets in order to maximise monitored, and are in some agreement profits. They have an incentive to focus on advertising and marketing, about the ideal characteristics rather than on improving their products and service, because this is a of robust payments systems and faster way to pull in more users and increase the pool of transactional instruments. While priorities, specific funds. Chinese regulators have used reserve requirements to gradually laws and regulatory mechanisms differ reduce the level of unused consumer funds kept by third-party across jurisdictions, the majority payments institutions. In 2017, payments institutions were asked to of survey respondents emphasise keep at least 20% of unused consumer funds in special non-interest- that the appropriate regulatory producing accounts overseen by the central bank. The mandated and supervisory frameworks and reserve funds ratio increased to 50% in 2018, and from January 2019, prudential tools for payments system all unused funds must be kept in a separate account. Although the design should broadly focus on measures were intended to improve regulatory risk management two main policy objectives: safety and financial stability, this evolving regulatory environment has been and efficiency. The issue of safety criticised by some for stifling innovation and for curbing an important encompasses concerns related to revenue source for third-party payment companies. financial stability and resilience, as well as customer privacy, while efficiency relates to the cost-efficiency, 3. Chinese mobile 5.8 competitiveness and innovative payments sector aspects of payment systems. dominated by As transactions have increasingly duopoly Transaction volume 38.8 involved the use of novel digital 55.4 as market share, %, technologies and infrastructures, Q1 2020 many survey respondents said that Source: iResearch, the focus must be on guaranteeing OMFIF analysis cybersecurity and the integrity of the overall payments infrastructure. Alipay WeChat Pay/QQ Wallet Others

Apart from issues related to data integrity and privacy, survey 4. Stricter 1800 100 regulations for 1600 90 respondents raised other significant Chinese payment 1400 80 regulatory concerns including 1200 70 providers as 60 the affordability and consumer 1000 deposits grow 50 800 protections embedded in the use Non-financial 40 600 of rapidly proliferating payment institution deposits, 30 ¥bn 400 20 systems. 200 10 Source: People’s 0 0 Bank of China, 7 8 CYBERSECURITY 201 201 2019 OMFIF analysis Reserve funds ratio requirement for payment firms, % (RHS) The main concern of regulators regarding new entrants in the digital 62 omfif.org

payments sector is cybersecurity, 5. Cybersecurity according to 90% of the survey Cybersecurity and privacy respondents. They highlighted the should be major focus areas need to incorporate robust features Privacy to guarantee security from cyber ‘What are your key concerns for Consumer welfare and affordability attacks, as well as the ability to new stakeholders withstand such attacks and to recover offering digital full system functionality rapidly. Industry fragmentation means of Both digital currencies and payments?’, % of Others responses payments systems are vulnerable Source: OMFIF to cyber threats. ‘The continuous Data sovereignty Future of development of new payment Payments survey methods and of new tools to access 0102030405060708090 them multiplies the possible vulnerabilities of the system and introduces new types of threats,’ said one European survey respondent. Financial authorities also recognise the fact that a successful attack on make payments in person. any digital payment service can The Bahamas is a case in harm consumers’ confidence in the point when it comes to resilience broader system. Even though some considerations. Like many other differentiation is necessary regarding 90% Caribbean states, the Bahamas is the minimum capital and liquidity The main concern vulnerable to the effects of climate benchmarks required for banks and of regulators change, especially to powerful and digital payment providers, regulators destructive hurricanes that can cause have proposed that there should be no regarding new widespread power losses. Because of distinction with regards to fields such entrants in the digital this, the sand dollar CBDC functions as cybersecurity. payments sector with a hybrid wireless network which In the case of digital currencies, is cybersecurity, allows the digital currency to serve as there is an additional risk of according to 90% of a means of payment offline. counterfeiting and hacking. Over the years, central banks have developed the OMFIF survey PRIVACY VS ANONYMITY sophisticated features to prevent respondents There is constant tension in the counterfeiting. As central banks financial system between the and private sector entities venture consumer’s desire for privacy or into the field of digital currencies, anonymity and the regulator’s or they must pay careful attention to bank’s responsibility for maintaining mitigating counterfeiting and hacking KYC and AML/CFT standards. As risks. with any other token of exchange, Digital currency issuers and digital currencies can be used for payments services providers must illicit activities. There are possible guarantee resilience (to be able to mitigating measures such as requiring withstand attacks) and, in the event payer and payee identification of cyber attacks, must be able to for transactions above a certain ensure rapid recovery and safeguard level, or stipulating some form of data integrity. Payments systems identification for all digital currency must be resilient in the face of other holders. However, like all user external factors such as natural policies, these run the risk of being disasters. One way in which digital circumvented. means of payments have achieved In the case of CBDCs, limits on this is by incorporating features that the amount held might stop the allow the system to function off-line, excessive use of CBDCs as a form of at least temporarily. Granting off-line investment and prevent potential functionality could provide a back- stability issues stemming from bank up payment solution in the event disintermediation and bank runs. of natural disasters which prevent At the moment, CBDC projects are people from having physical access to limiting use to the country’s residents banks or ATMs to withdraw cash or only. But if holders of CBDCs are The future of payments, 2020 63

A universal protocol for value transfer

The internet was built up over decades. It started out as a collaborative project before becoming dominated by a few large companies. That evolution provides a cautionary tale for digital money, writes Neha Narula, director of the digital currency initiative at the Massachusetts Institute of Technology Media Lab.

A digital payment is a transfer of information. The their project. effect of the transfer itself, changing balances in a What we saw from the development of internet database, is cheap and easy. Yet estimates indicate protocols is that it is often the ones that are truly free countries spend anywhere between 0.5% to 0.9% and least encumbered that prevail. The internet was of their gross domestic product on retail payment a collaboration between government, academia and transaction costs. industry. Internet protocols had decades to develop In addition to high costs, payments systems have before venture capital started pouring in. Not so not kept pace with technological innovation or the with cryptocurrency. Decentralised cryptocurrency move towards a digital economy. While it is easy and protocols are not mature enough to reach a global cheap to send a photo to anyone in the world, it is scale securely, yet builders are being pressured to slow and expensive to send even small amounts of generate returns to their investors in a short time, money outside of a country or network. usually in the form of ever-growing token prices. Our current payment infrastructure was We also must remember the cautionary lessons designed when settling every transaction in real from the internet. What was a broad, open platform time was unthinkable. We require banks to vouch became dominated by a few large companies that for participants and collect information about now have influence over users’ agency, awareness their customers for even small and attention. When designing transactions. Payments often don’t digital currency, we can protect settle immediately, which requires ‘We must approach users by embedding privacy into new someone to take on settlement risk designing a new protocol protocols. and perform onerous reconciliation. for money carefully, We must approach designing a There are clearly ways to make these with neutrality, and by new protocol for money carefully, systems better, but large changes integrating what users with neutrality, and by integrating require coordination between many need from day one.’ what users need from day one. different partners, some of whom While excitement surrounding digital have a vested interest in protecting currencies is understandably on the high fees rather than improving core technology and rise, we must remember that fundamental research increasing financial ease and access for billions. is required to understand how to best design this Today, central banks are considering the issuance critical infrastructure. of digital currency directly to consumers, providing As we research architectures, evaluate trade-offs, the backbone of a new digital payments system. and design solutions for digital currency, we cannot This is an opportunity to completely rethink the way approach the problem with the same naïveté internet payments are made and build faster, cheaper, and pioneers had. We don’t have that luxury; we know more accessible designs. how easy it is for technology to quickly scale with What’s missing is a universal protocol for value unintended, complex and systemic consequences. transfer, which could form an innovative foundation. Today we have the chance to responsibly redesign Many cryptocurrency advocates pitch central money, informed by the lessons of existing payments banks and hope that their protocol will be the systems and the evolution of the internet. We have ‘winner’. Though their software is open source and the opportunity to create a new story and to design freely available, they often don’t reveal that their a future digital economy that handles trillions institute holds large amounts of their newly issued of transactions securely and includes everyone token and stands to benefit if central banks back equitably.  64 omfif.org

allowed to remain anonymous, it would be impossible to limit the scope ‘Special effort should be devoted to the of users of this risk-free central bank strengthening of co-operation among financial money. authorities, at the international level, in defining and applying common rules and standards. ACCESSIBILITY AND This is a real challenge for authorities.’ INTEROPERABILITY Digital means of payment must be Survey respondent accessible 24/7 and all year round. The technologies built around them should not only have the ability to function around the clock, but also be comprised of back-up power This also supports competition policy would encourage financial generators and a rapid reboot function and innovation by strengthening exclusion, not inclusion. in case of unexpected shutdowns. interoperability. Regulators in many jurisdictions Accessibility also refers to being are raising questions regarding available to the general public – in FINANCIAL INSTABILITY AND monetary policy transmission and other words affordable or low cost. DISINTERMEDIATION private-sector digital currencies. This Regulation can play an important Several financial stability issues has received particular attention in role in this by fostering free-market arise from increased usage of digital recent years because private digital competition and allowing the entry of payment instruments such as mobile currencies can be used by the wider new players to challenge incumbents. money and digital currencies: for public and not just the financial Innovation driven by competition example, these innovations could cognoscenti. can force down prices so that more have an impact on the operation of The substitution of sovereign people have access to the payments monetary policy and the effectiveness currencies by private digital means of system. One survey respondent said of central bank policy instruments. payment could also affect the impact the central bank’s efforts were aimed As a potential substitute for of monetary policy. To control the at ‘fostering innovation and adapting currency in circulation, mobile money demand of money in the economy the regulatory framework to lower can have different impacts on money as well as inflation, market liquidity costs and foster new entrants to supply in the economy depending on and other macroeconomic variables, increase competition’. the country’s banking regulations central banks implement changes Lastly, with new payments and how mobile money is held within in the monetary instruments they systems emerging, and the creation the banking system. Various analyses control, such as the nominal money of stablecoins and CBDCs, regulators have suggested that a high degree stock or the interbank interest rate. have been increasingly interested of substitution, from conventional This transmission of monetary policy in achieving interoperability and currencies or bank deposits to will be impaired if the national standardisation of clearing and mobile money, could diminish a currency is no longer the principal settlement rules and infrastructures. central bank’s control over aggregate means of payment. These features would allow users of money supply, increase the velocity However, private-sector digital different technologies or systems to of monetary transactions and also currencies are not the only cause for interact with one other, improving affect seigniorage revenues for central concern for financial regulators, as the effectiveness and efficiency banks. public digital fiat pose some risks of the payments system. This The increase in the use of mobile of their own. If central banks opt interoperability must be possible money also raises questions about for a direct design for their CBDCs, not only in terms of technology the taxation of economic activities as intervention of financial institutions but also in terms of costs, to avoid transactions shift towards alternative may not be necessary for the issuance, high charges derived from the payments systems. Research in this distribution and management of this interaction and transactions between area is at an early stage. However, state-backed digital currency. systems. Regulators can help to several benefits and risks to the Significant levels of ensure a more seamless payments financial system have been identified. disintermediation could crowd out infrastructure. One central bank from On the one hand, the pervasive use bank deposits and reduce the revenue Europe expanded on how it ensures of mobile money by the informal obtained from the provision of this interoperability as the central bank economy presents an opportunity to financial service. The reduced revenue ‘requires market participants to broaden the tax base in developing could lead to an increase in the develop end-user payment services countries. But imposing taxes on interest rate on bank loans, which based on open data-entry solutions mobile money transactions could have would depress lending and potentially in order to avoid the creation of a negative effect by discouraging the impact economic growth. To avoid closed payment solutions and use of mobile wallets and prompting these adverse effects, central banks the fragmentation of the market’. consumers to revert to cash: The could opt for a hybrid CBDC to make The future of payments, 2020 65

sure banks continue providing their key intermediation role. If, on the contrary, central banks choose a direct CBDC, interest rates might be used to avoid the adverse effects on the banking sector. The holding of CBDCs as a form of investment could be discouraged if central banks decide not to pay interest on their digital currency. Alternatively, a tiered remuneration framework could be used, causing interest rates to decrease when CBDC holdings exceed a specific limit. There is a risk that during times of crisis or stress – when savers tend to have less confidence in the banking sector – the public might turn to CBDCs instead, causing destabilising runs into risk-free central bank money. Since CBDCs are a direct liability to the issuing central bank, they are a risk-free means of payment. Although various ‘Regulators face a difficult balancing act in harnessing mechanisms such as resolution the benefits of fast-evolving payment technologies laws, deposit insurance and the while keeping a check on the potential risks.’ central bank’s role as a lender of last resort protect retail depositors from financial institutions’ liquidity and capital risks, commercial banks deposits are not risk free. As a result, there is a possibility that in times services. Some jurisdictions are technical capacity to craft responsive of economic stress, capital flight to catching up, but generally the lag policies that can accommodate the safety could lead to massive bank has generated market inefficiencies. innovations that consumers want. runs into CBDCs, weakening financial While consumer demand has driven The majority of survey stability: This could be avoided by many technological innovations, the respondents agreed that there should imposing limits on CBDC holdings absence of appropriate regulatory be scope for greater creativity, through regulation. frameworks has caused delays in experimentation and communication their roll-out. to develop the appropriate methods IMPROVING PAYMENTS SYSTEMS The EU’s Second Payments of payments system governance. As a GOVERNANCE Services Directive, which began testimony to this developing culture Central bankers who responded to its phased enforcement in 2018, of innovation, one central bank the survey emphasised the need introduced regulation that clarifies respondent noted that the Bank for for public institutions to be the how existing banking services International Settlements announced setters of standards, supporting the can adapt to new technology. the opening of an innovation centre potential of fintech and innovative Also known as the open banking in collaboration with the European technology through better regulatory directive, it governs newer payment Central Bank in Paris and Frankfurt infrastructure. platforms and sets the requirements this summer. Regulators face a difficult for their operation. The Council of The industry is adapting to a new balancing act in harnessing the the EU approved the directive in environment characterised by new benefits of fast-evolving payment November 2015 and gave member technologies, new players and new technologies while keeping a states two years to adopt it in their activities: Regulators and industry check on the potential risks. Some respective laws and regulations. participants will need to work closely regulatory authorities, which lack While this implementation to make sure that financial services the technical capacity, have failed timeframe is reasonable, considering and payments regulation allow these to keep up both in the formulation the need to amend or introduce new changes to proceed smoothly. Co- of policy as well as in setting up the laws, it shows the importance of operation and coordination in areas infrastructure necessary to facilitate ensuring that regulatory authorities such as regulatory licensing, market the growth of digital financial have the appropriate resources and access, supervision, and recovery and 66 omfif.org

can be encouraged, while ‘ensuring that appropriate prudential standards are observed by market players, hence avoiding potentially good innovations to be constrained by undue excessive regulations’. Typically, businesses that apply to enter a sandbox arrangement would have to demonstrate that they meet pre-determined criteria, and possess appropriate licensing prior to final approval from the regulators. In the next stage, the sandbox would allow for new technologies and business models to operate under set guidelines for a limited duration or context. One Southeast Asian central bank illustrated this, noting that ‘pilot projects may be allowed to run within clear parameters such as specific test time periods, localised markets and limited users’. Finally, testing products and services in ‘Regulation of payments should reflect the financial a sandbox framework allows for stability risk, rather than the legal form, of payments evaluation of the performance, activities. Firms that are systemically important should benefits and risks that can guide further development. As one be subject to standards of operational and financial central bank said, this allows them resilience that reflect the risks they pose.’ to ‘obtain a better understanding Survey respondent of the operating/business models and technical considerations as the product or service is initially being offered in the market’. This resolution will all be required to test of Hong Kong, have also developed enables central banks and regulators and scale beneficial innovations. sandboxes. A recent study from Ross to devise appropriate regulations P. Buckley et al. (2020) estimates customised to the levels of risk that SANDBOXES AND GOVERNANCE that more than 50 jurisdictions have they observe. STRATEGIES introduced financial regulatory In the rapidly shifting payments One mechanism which many sandboxes or similar initiatives. landscape, sandboxes can provide respondents mention as a useful As policy environments, an opportunity for new fintechs to method to develop appropriate regulatory sandboxes are seen as a demonstrate that their underlying models of governance over payments means to adopt a ‘test-and-learn’ technologies and business models and other financial innovations approach for dealing with unfamiliar are viable without generating is the use of dedicated testing financial innovations. Potentially disproportionate risk. For instance, environments such as regulatory beneficial products and services several of the successful applicants sandboxes or innovation hubs. can be tested in a small-scale, live to the UK FCA’s first cohort of Governance of payments increasingly environment, by entities that satisfy firms entering into their regulatory requires governments and regulators sandbox eligibility requirements. sandbox incorporated blockchain or to be much more proactive in On the other hand, innovation DLT to facilitate payments processes. understanding and setting standards hubs provide a way for industry Examples include: Billon, an e-money for new technologies and business players to access and communicate platform based on DLT to enable models. The UK’s Financial Conduct with central banks and regulators, secure transfer and the holding of Authority was the first regulator to gaining guidance or approval funds using a phone-based app; BitX, devise a sandbox model in 2016. Since to navigate different regulatory a cross-border money transfer service then, central banks and regulators requirements. These initiatives are powered by digital currencies and from numerous other countries, seen by respondents as appropriate blockchain technology; and Epiphyte, including Australia, Colombia, ways to balance regulatory needs a payments services provider Malaysia and Singapore, as well as with creative innovation. As one engaging in cross-border payments the Special Administrative Region respondent noted, market innovation using blockchain. The future of payments, 2020 67

Establishing sandboxes is only ‘All firms above a certain threshold carrying out one aspect of creating a conducive the activities that make up payment chains should governance framework to engage with fintechs while being mindful provide sufficient information to support the of regulatory risks. Sandboxes must identification of systemically important payments also be capable of determining the firms as they emerge.’ appropriate criteria and smooth exit Survey respondent processes to introduce successful sandbox entrants to the wider market. For instance, TransferFriend, a cross-border remittance firm, was one of the early entrants into the infrastructures and instruments and testing criteria for how to best MAS’s own regulatory sandbox from (Figure 6). Apart from wholesale manage and integrate new fintech January to May 2018, but it failed regulatory reform or more targeted activities and technologies have to obtain regulatory approval after and differentiated regulations for focused on minimising risks in exiting the sandbox experiment. specific activities, other means areas such as consumer welfare, As regulatory sandboxes are not that can be used include having data protection and management, indicative of a permanent licence to established criteria for licensing and operational resilience. Due to operate, there are also a variety of exemptions or waivers based on the niche take-up of alternative other collaborative tools which can clear criteria, or issuing letters of no payments instruments such as digital be used to enable the responsible objection to specific fintech entities. currencies and crypto-assets, the introduction of new payment The regulatory experiments general opinion is that financial stability risks from many of these innovations will remain limited for now. 6. Regulatory approaches to innovation However, several survey Source: World Bank respondents noted that it will be essential for governance frameworks Wholesale reform to regulations that are conducive to a certain surrounding new payments providers Regulatory policy objective such as fintech competition, innovation, and and instruments to evolve should reform financial inclusion these grow in use and importance. As one central bank said: ‘In order to ensure the information necessary Regulatory framework provides more specific, differentiated Differentiated for regulation and supervision to be and granular guidance for various financial services and regulation effective, all firms above a certain products threshold carrying out the activities More passive regulatory approaches to fintech innovation that make up payment chains should Letters of no Regulators allow on a case-by-case basis certain fintech provide sufficient information objection/ entities to provide products and services with the confidence to support the identification of enforcement that they will not be penalised for unexpected breaches systemically important payments firms as they emerge’. Another respondent noted Regulatory framework clearly sets out that financial services Waiver/ and products which meet certain criteria or are under pre- that governance mechanisms and Exemptions defined thresholds (e.g. number of customers serviced) are platforms to facilitate the exchange automatically exempt from licensing requirements of views and ideas, both informally and within dedicated bodies, would Innovative products and services can apply to be tested in help elaborate upon ‘principles Regulatory a controlled environment under short-term exemption from and regulations that will enable sandbox normal compliance requirements innovation to prosper, rather than block it’. As the use of radically

More proactive regulatory approaches to fintech innovation to approaches regulatory proactive More different payments instruments New innovations can be tested in a live environment such as digital tokens or currencies Test and learn supervised by regulators accelerates and mainstream financial entities increase their exposure to such assets, central banks and supervisors will need to maintain an Regulators allow nascent technologies to develop naturally Wait and see open dialogue with the private sector with no restrictions to reduce risk and reinforce trust in the broader payments system.  $ £

Official Monetary and ¥ Financial Institutions Forum 6-9 Snow Hill ¥ London EC1A 2AY $ [email protected] omfif.org € €

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The future of payments