Payments System 3

Interoperability of payment instrument distribution channels

3.1 Introduction

Retail payment systems and their instruments have been targeted for increasing attention by the central of a variety of countries, mainly due to the significant impacts of the technological advances underlying the new systems and methods of making payments.

Basically, the new forms of money and their electronic distribution channels are subjects of intense interest to central banks which, in turn, are charged with the tasks of preserving trust in a country’s currency and maintaining financial stability. For this reason, monetary authorities have begun examining and evaluating the efficiency and security of payment instruments, distribution channels and the infrastructures for the processing, clearing and settlement of these instruments.

A common characteristic of the countries that have gone through processes of modernizing their retail payment systems is the tendency to migrate away from the use of paper-based payment instruments into electronic systems. The reasons for this shift are the increased efficiency and security offered by electronic payment instruments when compared to paper-based instruments.

The social cost of a national payments system – estimated at 2 to 3 percent of GDP12 – can be sharply reduced by making greater use of electronic payment instruments. Aside from this, operational and credit risks, as well as the risk of

12/ David B. Humphrey, Lawrence B. Pulley, Jukka M. Vesala. Cash, Paper and Electronic Payments: A Cross-Country Analysis. Journal of Money, Credit and Banking. Volume 28, 1996.

May 2004 | Financial Stability Report | 75 fraud, can be sharply reduced through utilization of electronic payment instruments since, when compared to paper-based instruments, they have considerably greater potential for incorporating new security elements.

The distribution channels required for electronic payment instruments are the different electronic mechanisms and devices that make it possible to effect payments and perform other banking operations such as withdrawals, deposits, statement issues, balances and other banking services.

In Brazil, the providing of services involving electronic distribution channels and networks is carried out by financial institutions, management companies and bank technology companies. The major distribution channels are the (ATM) terminal networks13, networks of electronic transfer terminals located at sales outlets and known as Electronic Funds Transfer at (EFTPOS)14 and Internet-based financial services networks, normally known as Internet Banking. See Appendix I – “Payment Instruments”.

From the point of view of the utilization of payment instruments, bank branches and service outlets are distribution channels generally associated to checks and credit transfers. The ATM and Internet Banking networks play the same role with respect to credit transfers and direct debits, while the EFTPOS networks make it possible to transactions with payment cards.

The model of the payment instruments supply and distribution infrastructure can be of decisive importance to its utilization. Efficient organization of this infrastructure contributes to reductions in the costs of providing payment solutions and utilizing such instruments, so as to make them more accessible to commercial establishments and clients.

In this context, in mid-2002, Banco Central do Brasil initiated the Payment Instruments Modernization Project, focused on increased utilization of electronic payment instruments and channels and, above all, on efficiency in the processing, clearing and settlement infrastructure for these instruments.

13/ The Automated Teller Machine or ATM is an electromechanical device that allows users to perform one or more types of operations, normally through the utilization of readable plastic cards. These operations can include withdrawals, deposits, issues of bank statement and balances, payment of bills and other papers, fund transfers and others. 14/ EFTPOS (Electronic Funds Transfer at the Point of Sale) are electronic terminals that receive and transmit payments information at the point of Sale, through the use of debit and credit cards.

76 | Financial Stability Report | May 2004 The objective of this study is to discuss the principal features of the current model of the electronic payment instrument distribution channel infrastructure in Brazil, with particular emphasis on the networks of ATM and EFTPOS terminals and their implications on the efficiency of the country’s retail payments system.

3.2 Network goods and services

The payment instruments made available through ATM and EFTPOS networks can be analyzed in light of the economic concept of network goods and services. Basically, what characterizes a network effect is that the value of the good or service made available through some form of access increases for its users when a new client is incorporated into the network.

The importance of the network characteristic for specific goods and services can be seen in various sectors of the economy. The sectors of transportation and telecommunications are the most obvious examples of the influence of network effects or externalities on supply and demand.

Based on the analysis of network effects on payment systems, it is possible to identify a network good or service through two major characteristics: a) the value that an individual associates with a product or service increases with the number of individuals that consume that product; b) the technology that a company chooses for production of a specific product depends on the technology chosen by other companies.

With regard to the first characteristic, the more a payment instrument is accepted, the greater will be the benefits provided to the consumer who utilizes that instrument and to the establishments that accept it, creating what is known as the demand externality. Moving to the second characteristic, the existence of economies of scale in payment services fosters standardization, sharing and cooperation in the rendering of these services, resulting consequently in supply externality.

The major aspects that should be taken into consideration in a discussion of network goods or services are as follows:

May 2004 | Financial Stability Report | 77 a) complementarity; b) compatibility; c) standardization; d) economy of scale; e) subproduction; f) inertia in innovation.

3.2.1 Complementarity

Complementarity occurs when growth or innovations in a specific market generate increases in the expected value of a particular product or service that originates in another market.

In network markets, complementarities among users or products give rise to network externalities. In retail payment systems, complementarity is an element of significant importance. For example, in systems that operate credit cards, the greater the number of card users, the greater will be the number of merchants willing to adhere to the network that provides access to this payment instrument. The reason for this is that, on providing clients with a more convenient payment alternative, the commercial establishment increases its sales potential. Aside from this, the greater the number of commercial establishments that accept credit cards, the greater will be the value of this payment instrument to the users.

3.2.2 Compatibility

Together with complementarity, compatibility among products is essential to taking advantage of network externalities. This means that, on operating within the same standard or in compatible standards, products or systems can take advantage of the potentiality of the social benefit generated by the externalities.

Thus, for example, for a payment to be accepted, the commercial establishment’s receiving terminal – EFTPOS must be able to read and process the information contained on the card. In this example, if the commercial establishment’s terminal processes only the information of a specific card network, the network externalities generated will benefit only the users of that network. On the other hand, if the terminal is compatible with other card networks, the network effects will be extended to other users.

78 | Financial Stability Report | May 2004 3.2.3 Standardization

The definition of standards for communications and process protocols in networks that operate electronic payment instruments is essential to ensuring compatibility among the network’s participants or even for the participants in other networks who are than able to interoperate on the other system. This compatibility potentializes the network externalities generated by the complementarity that exists among users. In this sense, the systems that operate electronic payment instruments must define certain technical, business and interoperability standards in order to accept and process the payment instructions.

Technical standards define common rules such as, for instance, rules on formatting messages and protocols used in exchanges of payment information. In their turn, business standards are agreements among payment services providers, financial institutions and commercial establishments, determining the technical procedures and standards to be adopted, together with the rules governing the processing, clearing and interbank settlement of these payments.

Payment service providers and financial institutions can opt to cooperate beyond the level of simply applying the same business standards and allow reciprocal use of payment instrument distribution channels through interoperability agreements.

Standardization may have various positive effects from the point of view of efficiency and competition. The cost reductions that result from technical standards agreements may allow for reduction in development and payment processing costs. At the same time, standardization can facilitate compatibility and make it possible for payment service providers and financial institutions to choose the best available technology, thus optimizing their technological development processes.

3.2.4 Economies of scale in production

Payment systems are subject to economies of scale due to the voluminous investments they demand in the infrastructure needed to go into operation. In the pre-operational stage, these systems are characterized by high fixed costs, with relatively low marginal costs for the services provided. The ATM and EFTPOS terminal networks are examples of networks in which these characteristics are quite evident.

May 2004 | Financial Stability Report | 79 3.2.5 Subproduction

Network products and services may also be subject to the subproduction tendency and in general this effect is ignored. For example, when consumers decide to adhere to a network service, they do not take into account the benefits to other users that are generated by the growth of the network. Thus, network equilibrium size is less than the social optimum when the benefits of adhesion to the network exceed private benefits.

In the area of electronic payment systems, in which economies of scale must be present, some authors, such as Gowrisankaran and Stavins15, argue that subproduction is the more significant problem and should be corrected through measures adopted by the regulatory authorities.

3.2.6 Inertia in innovation

The difficulty or inertia found in network service innovation, particularly in the case of retail payment systems, can be understood primarily in light of three aspects: high cost of change, dependence on past infrastructure and the question of critical mass.

3.2.6.1 Costs of change

Markets subject to network effects may also show a tendency to inertia in obsolete standards or technologies. Users tend to prefer an already established technology even when there are benefits that would be provided by the substitution of that technology with a new technology that is incompatible with the former. Payment service providers and final users may be reluctant to adopt a new technology if they have to bear the cost of transition to a new technological generation and, principally, if future users are to take the greatest advantage of the benefits of this evolution (Farrell and Saloner, 198616).

3.2.6.2 Dependence on the past

Historic dependence can affect the development of national payment systems, particularly as a result of a slow pace of

15/ Network Externalities and Technology Adoption: Lessons from Electronic Payments, NBER Working Paper 8934. May 2002. 16/ Installed Base and Compatibility: Innovation, Produce Preannouncement and Predation. American Economic Review, vol. 76, 940-955.

80 | Financial Stability Report | May 2004 change in the payment habits of economic agents. Since payment service providers and users want compatibility with the installed base, when new products reach the market they may not be able to take the place of others that have already been standardized in the past, even though the older products may well be less efficient.

Consequently, market innovations subject to network externalities are more easily implemented when those involved are knowledgeable with regard to the technological standards adopted in previous periods. This means that the effects of past decisions are fundamental to current and future decisions.

3.2.6.3 Critical mass and the problem of the “chicken and egg”

Critical mass and the network service infrastructure play a crucial role in the launching and growth of a network. The launching of a new network service presupposes a cause and effect relationship between the infrastructure and the critical mass. Thus, many potential users do not adhere to a network service because of a very small infrastructure. This is a consequence of the absence of critical mass or, in other words, the small number of system users. Therefore, the expectations of potential users with regard to the future size of the network are determining factors of the network’s growth. In technical literature, this problem is known as the “chicken and egg”.

3.3 Infrastructure of retail payment distribution channels

In networks that provide access to payment instrument distribution channels, the concentration of the infrastructure in a single system or in a shared system, as exists in several countries, is basically determined by economies of scale, positive network externalities and the need for determining common standards for communications and process protocols.

Network externalities make it possible for the value of the services and products offered to expand exponentially with the number of users. In this way, an increase in the number of participants in a system will also increase the scale and the level of the service provided to its members.

May 2004 | Financial Stability Report | 81 In this context, the high fixed costs of investment and the occurrence of economies of scale result in the fact that, in general, consideration is given to the possibility of a single infrastructure being more efficient than a fragmented infrastructure, with various provider systems offering the same service. In much the same way, adoption of a standard for communications and process protocols which is ensured by an integrated infrastructure, eliminates the costs and risks associated to the need for users to access different networks, with differentiated and often incompatible standards.

Thus, from the point of view of competition, the world tendency is that only the segments of proprietary networks are treated as natural monopolies and, for this reason, are subject to regulation, while market competition is left to the segment of providers of final services. Even in this approach, a minimum level of concentration of the infrastructure – or a minimum number of users – may be required to allow for optimization of the conditions needed to provide these services, though it is quite difficult to quantify this level. This fact is clearly observed in the areas of telecommunications and rail transportation, in which the segments that provide the network could be separated from the segments that provide the services to final consumers.

The structure of a retail payments system can be classified as either vertical or horizontal. A vertical structure is that in which a same proprietor possesses and operates all of the system’s levels, ranging from reception of the transaction information to clearing and settlement. In a horizontal structure, specialized companies possess and operate only specific niches of the system.

In the context of the horizontal division of a retail payments system, one can identify two markets with distinct characteristics. The first is the market that deals directly with the rendering of services to clients, including banks, offering accounts to clients, or the so-called downstream market, which provides the payment instruments. The upstream market supplies the infrastructure for receiving, processing, clearing and settling retail payments (See Appendix I – “Natural Monopoly Sector”).

The downstream market is potentially competitive, since the participants demand access to the networks in order to meet the needs of final users by providing them with new products. The activities of the upstream market are characterized by economies of scale on the supply side, as well as network externalities on the demand side. This

82 | Financial Stability Report | May 2004 market has the characteristics of a natural monopoly, such as high fixed operating costs and network expansion and, principally, the need for coming to arrangements involving sharing of the clearing and settlement infrastructure.

Thus, in a more efficient retail payments system model, the network infrastructure company is the shared property of a certain number of banks (upstream market). Given that the banks have access to the payments infrastructure, there are a number of competitors for account transactions and individual payment instruments (downstream market).

Another aspect to be analyzed deals with the question of the governance of the companies that provide services of receiving, processing, clearing and settling retail payments. Normally, the companies that are active in these segments belong to banking institutions. For the most part, this is due to the nature of the services provided, which demands a high degree of standardization of procedures and processes among the banks.

Thus, the positive effects of the unification or sharing of the retail payments infrastructure depend on such factors as the governance structure of the systems and their guidelines. For example, if the model of governance restricts access, limits the introduction of new services by the system or, simply, implements anticompetitive price systems, general competition will be adversely affected.

From the public utility point of view, the infrastructure of the interbank payments system may be considered an essential service, since it makes it possible to carry out economic transactions and, consequently, contribute to economic growth. Thus, this infrastructure must provide equal access conditions to its users. Determination of competitive effects in a shared system – effects of social well-being – is a complex task that requires an evaluation of the costs and benefits involved, with a clear separation between the payment receiving and processing infrastructure environment and the environment of payment products.

3.3.1 Interoperability of payment instruments distribution channels

The infrastructure of access to electronic payment instruments, which is defined as the distribution channels, has a determining influence on the utilization of these instruments. The interoperability and sharing of ATM and EFTPOS terminal networks have been important factors in

May 2004 | Financial Stability Report | 83 disseminating the use of electronic payment instruments in several countries.

In the case of ATM networks, interoperability can result in benefits for both users and the banks themselves. With respect to the possible effects of interoperability on the modernization of payment instruments and distribution channels, the following benefits should be noted:

a) enhanced ease of access to distribution channels, making increased use of the terminals possible; b) gains of scale and reductions in the costs of logistics, including maintenance of networks and terminals; c) reduction of the fee charged to clients due to the reduction of the system’s fixed costs and, consequently, of the unit cost of transactions; d) increase in the supply of banking services for users, improving their comfort and convenience, with greater agility in accessing new financial products; e) increase in the supply of distribution outlets in localities not currently served, as a result of lower installation and service costs; f) greater organization and optimization of infrastructure investments – hardware, software and network connectivity and reduction in development costs and updating of ATM terminals.

In several countries, ATM terminal networks are shared, though there are different sharing structures. The single network and shared network models are the most common. In the single network model, financial institutions have a high level of standardization and interoperability. In these cases, machines are standardized and access to basic operations – withdrawals, consultations and payments – is open to all users independently of the bank. Operation of the network, maintenance of the machines and development of new platforms and products are carried out by a company that belongs to the banks, thus generating gains in scale and significant reductions in unit cost per transaction. Aside from this, users of the banking system benefits from the network externalities, obtaining greater comfort in utilization of the services.

Generally, in this model, the machine belongs to the banks and the banks receive interbank fees as a result of interoperability. The feasibility of an ATM for a bank is measured by the profitability of the location in terms of interbank fees charged whenever a client of another bank carries out an operation on its ATM terminal. If an ATM is installed by a bank in a specific public space – shopping

84 | Financial Stability Report | May 2004 centers, subways, etc. – and the interbank fee received does not produce earnings that are at least sufficient to cover costs, the machine will be shifted to a different more suitable location.

Countries like Portugal, Switzerland, Belgium, the United Kingdom, Finland and France adopt a single network model for ATM terminals. In the United Kingdom, Sweden and Finland, the single network first appeared as a consequence of a merger among two or more previously existent ATM networks and resulted in complete interoperability among bank terminals. In the case of Portugal, banking system automation from the very start was based on adoption of a single and shared infrastructure for receiving and processing transactions in ATM and EFTPOS terminals.

The model of sharing with more than one network is found in Spain, Italy, the United States and Germany. In this case, basic operations are shared, despite the existence of differentiation in the supply of financial products which can be exclusively offered by each individual network.

In the aforementioned countries, the interoperability of the ATM networks made it possible to cut installation and maintenance costs, generating increasing utilization of this distribution channel. Furthermore, the number of transactions per inhabitant and the number of terminals increased sharply. One factor that can influence utilization of interoperable ATM networks is the question of whether or not to charge user fees for utilization of the shared machines. In general, in those countries in which there are no direct fees charged to users, such as Portugal, Sweden and England, utilization has grown more rapidly than in countries where the direct charging system exists, such as Italy, Finland, Germany, the United States and Belgium.

The process of banking concentration which occurred as of the 90s also stimulated ATM network interoperability in the countries cited. In these cases, the existence of few retail financial institutions or network operators with equivalent dimensions, facilitated the sharing process, since interoperability among networks of varying sizes generally results in asymmetric gains.

In the case of EFTPOS network terminals, which operate with payment cards, interoperability has a direct impact on commercial establishments since it makes it possible to reduce the costs of using the transaction reception infrastructure. For the user, the benefit of interoperability occurs as a result of the greater acceptability of the payment

May 2004 | Financial Stability Report | 85 instrument, since establishments will have lesser fixed costs in accepting different networks.

At the international level, total interoperability of EFTPOS networks and terminals is common. In general, a single company acts as the acquirer and/or processor for all of the different systems, providing the physical infrastructure and the network needed to receive the transactions and process the payments. This is the case of Portugal, Switzerland, Holland, Belgium, the United Kingdom and Sweden.

3.3.2 The Brazilian case

Automation of banking and payment systems in Brazil gained momentum as of the 80s and was based on the development of proprietary or individual networks with sharp technological competition and a low level of interoperability. Financial institutions, in the case of ATM terminals, and payment service providers, in that of payment cards, developed and implemented individual networks for receiving and processing transactions, without concerning themselves with interoperability and sharing.

From the point of view of banking system users, this model offered very few opportunities for the client of one bank to use the terminal of another bank for carrying out operations, except in those cases in which the terminal is connected to a shared network.

In Brazil, there are 28 proprietary ATM terminal networks17 and two shared networks, known as the “Banco 24 Horas” (24 Hour Banking) and the “Rede Verde-Amarela” (RVA), which are operated by TecBan18 and by Asbace19, respectively.

Some proprietary networks possess a certain degree of interoperability or, in other words, allow the clients of a specific bank to carry out operations on a terminal belonging to another bank. The “Rede Verde-Amarela” – RVA (Green and Yellow Network) interconnects the self-service terminals of eleven state and regional banks. The “24 Hour Banking” network not only provides services to the clients

17/ Network that belongs to a single financial institution which can limit its use to the institution’s clients or open it to the clients of other banks, by means of agreements with those institutions 18/ TecBan – Tecnologia Bancária S/A. 19/ Asbace – Brazilian Association of State and Regional Banks.

86 | Financial Stability Report | May 2004 Automated Teller Machine - ATM of the associate banks, but also allows access to the Cirrus/ Access type and Amex international networks.

Description 2001 2002 Whether interoperability exists or not, the self-service Number of ATMs 111 370 129 913 terminals are classified as open access or restricted access, Open access 1/ 43 171 49 813 respectively. In the case of restricted access, the network Participation in the total (%) 39 38 2/ Restricted access 68 199 80 100 is used only by the clients of the proprietor financial Participation in the total (%) 61 62 institution. The open access network does just the opposite and provides access to the clients of more than one financial Sources: Banks, TecBan. institution. 1/ ATMs whose access is not restricted to cards which have been issued by the network owner. 2/ ATMs whose access is restricted to cards which have been issued by the In December 2002, Brazil had 129,913 installed ATM network owner. terminals in bank branches, shopping centers, airports, and

so forth. The pattern of terminal distribution in the different parts of the nation’s territory and within specific regions varies at the convenience of the institution that maintains the network, taking such factors as cost, profitability, publicity and business opportunities into consideration. The distribution of these terminals among open and restricted access was relatively constant in 2001 and 2002. In 2002, 38.3% of all terminals were open access and 61.7% were restricted Automated Teller Machine - ATM access. Networks and number of transactions per terminal

55 In the period from 2001 to 2002, there was an increase of 19.1% in the quantity of operations carried out through 44 ATMs. One of the factors responsible for the increase in utilization of these terminals was incorporation of new 33 services into the terminals, known as “other functions”.

22 Utilization of such functions, including investments and redemptions, checkbook supply and direct consumer credit, 11 increased by 51.1% in the period under consideration. However, most of the operations carried out through ATM 0 n1 n4 n7 n10 n13 n16 n19 n22 n25 n28 terminals – 70.1% - still consist of cash withdrawals and verification of balances and bank statements. Number of transactions (thousand) System average

Sources: Banks and TecBan. When one compares the median number of ATM transactions for each one of the 28 proprietary networks in 2002 with the median number of ATM transactions of the system, one concludes that just five networks have utilization levels above the system median. This demonstrates that the installed capacity of the networks is not being used as much as it could be.

In general, the larger the network, the larger the level of utilization. In Brazil, the six smallest networks have the lowest utilization levels and the five largest networks are among the six that are most intensely utilized. This occurs because the users of a self-service terminal network tend to utilize the service more frequently as the convenience of

May 2004 | Financial Stability Report | 87 such utilization increases. One large network with a high level of terminal availability stimulates its clients to carry out operations through the terminals instead of going to bank branches. It this way, it has managed to increase the utilization of each terminal.

Despite the gains and benefits consequent upon a shared ATM terminal network infrastructure, there are still some hindrances that make it difficult to achieve a higher level of interoperability.

The first is the high level of asymmetry among ATM terminal networks in the country, resulting in proprietary networks that vary greater in size and technological levels. In the recent past, large retail financial institutions made very large initial investments in the development of individual nationwide networks for their clients. As a result, the technology adopted, service quality and the size of the network have been used as market differentials with the aim of achieving competitive advantages.

The second hindrance is the lack of coordination among financial institutions in standardizing their communications and process protocols, information security requirements and minimum quality levels in their ATM terminal networks. Finally, the third factor is the lack of coordination among financial institutions in defining interbank fees that are compatible with the need for financial equilibrium and the feasibility of investments in infrastructure, systems and connectivity of the proprietary networks in a shared structure.

The low level of infrastructure sharing of proprietary networks and ATM terminals results in the following:

a) low level of utilization of the installed ATM terminal capacity – below the international average and full capacity of the machines; b) overlapping of terminal locations; c) high cost of logistics, development and maintenance of networks and terminals; d) low standardization of communications protocols, environments, methods and processes.

In the case of payment cards – debit and credit20, the infrastructure for receiving and processing transactions is

20/ The so-called private label cards, normally issued by large retail commerce networks, enjoy restricted acceptance and have not been included in this study. In exchange for customer loyalty, large retail companies provide their clients with payment and credit facilities, which accounts for the fact that this type of card is widely used by the lower income population which does no normally have access to credit and debit cards.

88 | Financial Stability Report | May 2004 basically composed of three companies designated the acquirers, which belong to the banking system and to international companies. In this case, on accepting cards, the commercial establishments must adhere separately to each one of the networks and bear the costs of non-sharing – rentals of EFTPOS terminals, acquisition and maintenance of softwares, etc. For the card user, this model can result in a lesser degree of convenience, since a single establishment may decide to participate in just one acquirer network in order to avoid higher costs.

In Brazil, the infrastructure for receiving electronic transactions with the use of credit and debit cards is composed of:

• Redecard, responsible for receiving transactions based on the Mastercard, Diners Club, Maestro and Redeshop companies; • Visanet, responsible for receiving transactions with the Visa and cards; • , responsible for receiving transactions using the company’s own cards; • TecBan, responsible for receiving transactions of the Electronic Check company21. EFTPOS1/ terminals The quantity of EFTPOS terminals is thought to correspond Description 2001 2002 to the total number of existent connections between debit/

Credit function credit card operators and sales outlets. Larger scale Number of terminals 440 451 583 794 commercial establishments commonly operate with their Accepting terminals per million inhabitants 2 555 3 343 own card reading system interconnected to the operator Number of transactions (thosands) 824 995 969 552 by means of a single connection. In much the same way, in Transactions per inhabitant 5 6 cases involving EFTPOS terminals shared by two or more Average of transactions per card 24 23 card administrators, the connections with operators are taken Debit function into account and not the physical terminal. Number of terminals 446 276 595 152 Accepting terminals per million inhabitants 2 589 3 408 At the end of 2002, the infrastructure for receiving payment Number of transactions (thousands) 326 175 451 302 card transactions consisted of 583,794 installed credit card Transactions per inhabitant 2 3 terminals and 595,152 terminals. Compared to Average of transactions per card 3 4 2001, the number of terminals expanded sharply for both Sources: Banks, acquire networks and card associations. credit and debit cards.

1/ Electronic Funds Transfer at Point Of Sale.

21/ The terminals for receiving transactions with the Visanet and Redecard acquirers are able to read both credit and debit operations, depending on whether these functions have been contracted by the commercial establishment. In this case, the counting of the EFTPOS terminals considered the function – debit or credit – and not the physical terminal. The Amex and Tecban – Electronic Check – operators carry out only credit and debit operations, respectively. Consequently, in the period 1998/2003, approximately 90% of the terminals installed in commercial establishments allowed for the use of both debit or credit cards, with no distinction.

May 2004 | Financial Stability Report | 89 ATM1/ - International comparative Just as occurred in the case of the ATM network Transactions per capita and terminals2/ infrastructure, it is important to stress that, in the case of the EFTPOS networks, there are multiple infrastructures. 1 300 USA This vertical structure between the supply of a payment

1 090 instrument and the processing of transactions made through

Japan the use of this instrument results in a situation in which one 880 Switzerland Brazil UK does not attain the maximum economic and social benefits Italy 670 that can be drawn from competition among networks. In France Belgium Germany Finland Brazil, each acquiring company is tied to trademarks and 460 Netherlands specific products. Thus, a commercial establishment that Sweden 250 desires to receive payments through the use of credit or 0 1020304050debit cards linked to a specific company has no other option Sources: Brazilian Banks, TecBan, BIS/CPSS e BCE. but to formalize a contract with the exclusive acquirer/ 1/ Automated teller machine. processor of that company. Therefore, the competition that 2/ Million inhabitants. exists among the different international companies is reproduced in the operations of the acquirers, consequently

ATM1/ - International comparative making it difficult to reach interoperability agreements. Transactions per terminal (thousand) in 2002 2/ Nº In a framework of competition based on infrastructure or 1 300 USA technology in which each acquirer effectively operates a

1 090 monopoly for a particular company, this model generates difficulties that have been stressed by the acquirers Japan 880 themselves. The most important is that of the “market Brazil Switzerland UK position” of each payment service provider, with a quantity Belgium 670 Italy France of operations below potential, which is a factor that clearly Germany Netherlands Finland 460 impacts the provider’s business performance.

Sweden 250 0 25 50 75 100 125 3.3.3 International comparison Sources: Brazilian Banks, TecBan, BIS/CPSS e BCE.

1/ Automated teller machine.

2/ Terminal / million inhabitants. 3.3.3.1 ATM terminal network

Cards with debit function and EFTPOS1/ terminals The productivity of the ATM terminal infrastructure can be measured by considering the number of terminals per million inhabitants and the per capita number of transactions. Based Description EFTPOS terminals / Transactions / on this criterion, Brazil occupies an intermediate position, million inhabitants inhabitant 2001 2002 2001 2002 with approximately thirty transactions per inhabitant and eight hundred terminals per million inhabitants. The United France 14 845 15 620 60 67 States is an example of a large network and high utilization Belgium 14 047 13 136 45 52 level. Finland and Sweden, on the other hand, have a small United Kingdom 13 078 13 691 47 52 Italy 12 918 14 109 8 10 network and a high level of utilization, while Japan has a Finland 12 914 14 228 53 70 large network and low level of utilization. In Brazil, the low United States 12 257 12 128 44 54 level of interoperability and the geographic overlapping of Netherlands 10 333 10 972 60 66 individual networks clearly hinder the efficient use of Switzerland 10 174 10 976 28 31 installed capacity, leaving the country in an intermediate Sweden 9 917 11 439 37 57 position. Germany 5 291 5 584 15 17 Brazil 2 589 3 408 2 3

Sources: Acquire networks, card associations, BIS/CPSS, European Central Bank

1/ Electronic Funds Transfer at Point Of Sale.

90 | Financial Stability Report | May 2004 Electronic Funds Transfer System - 2002 3.3.3.2 EFTPOS terminal network Cards with a debit function - transactions per

capita Nº 1/ 17 In the case of debit cards, when one analyzes the number France Italy of EFTPOS terminals per million inhabitants and the per Belgium 14 UK Finland capita number of transactions, Brazil generates rather low Switzerland USA Netherlands 11 indicators when compared to the group of selected countries: Suécia 3,408 terminals per million inhabitants and 2.6 transactions 8 per inhabitant.

Germany 5 In the same way, in the case of credit cards, Brazil has the Brazil 2 lowest number of terminals for every group of one million 0 1020304050607080 inhabitants. In 2002, the country registered an average of six transactions per inhabitant. This is higher than the Sources: Acquire networks, card associations, BIS/CPSS, European. average registered in Holland and Germany, but much lower 1/ Terminals / million inhabitans. than the average of 22 transactions registered in the other Cards with a credit function and POS accepting terminals - countries. EFTPOS1/

Description EFTPOS terminals / Transactions / Comparing the size of the terminal network for credit card million inhabitants inhabitant payments in the selected countries and total transactions, 2001 2002 2001 2002 one concludes that, in general, the large networks process United States 46 227 47 124 60.0 61.9 a larger number of transactions. However, in the case of Spain 21 186 ... 6.4 ... Germany and Sweden, while the networks are large, they France 14 845 15 620 ...... process a low number of transactions. Brazil was the country United Kingdom 13 078 13 691 29.6 31.8 that turned in the highest rate of growth in the number of Finland 12 914 14 228 23.1 14.2 transactions and terminals in relation to the previous year, Portugal 10 057 ... 24.3 ... even though the average number of per capita transactions Sweden 9 917 11 439 8.3 7.8 Japan 6 426 ... 17.6 ... remains below the average of the selected countries. Germany 5 809 5 736 7.3 7.5 Brazil 2 555 3 343 4.8 5.6 Switzerland ...... 11.1 11.1 3.4 Conclusion Belgium ...... 5.9 5.5 Italy ...... 5.4 6.2 Netherlands ...... 3.0 2.8 Among the major aspects that have characterized the process of developing retail payment systems in Brazil, the Sources: Acquire networks, card associations, BIS/CPSS, European Central Bank. most important has been low levels of interoperability in the infrastructure of the payment instruments distribution 1/ Electronic Funds Transfer at Point Of Sale. channels – ATM and EFTPOS terminal networks. This EFTPOS1/ Terminals in 2002 specific aspect has, therefore, generated inefficiencies for Cards with a credit function - transactions per 2/ the banking sector and for payment service providers, with capita Nº 50 negative repercussions for users. USA 40 The interoperability of the ATM and EFTPOS terminal networks is a factor of essential importance to the 30 modernization of payment instruments and can directly or 20 indirectly generate the following benefits: Finland UK Sweden 10 Germany a) greater expansion of the network that accepts payment Brazil 0 cards – the increased capillarity of the network makes it 0 10203040506070 possible to reduce processing costs by optimizing Sources: Acquire networks, card associations, BIS/CPSS, ECB. equipment use and reducing terminal overlapping; 1/ Electronic Funds Transfer System.

2/ Terminal / milion inhabitants.

May 2004 | Financial Stability Report | 91 b)reduction in the costs to which commercial establishments are subject when they join the system – a single EFTPOS terminal to be used for transactions in a store would clearly make it possible to reduce rental, maintenance and training costs, while simplifying operations and controls; c) more efficient organization and optimization of investments in the technologies needed to expand networks, as well as reductions in the unit cost of processing; d) expanded user access to payment channels, enhancing the capillarity of the service networks, resulting in gains of scale and reduced logistical, operational and development and maintenance costs for networks and terminals; e) possibility of reducing the fees charged to clients as a result of lower fixed costs for the system and, consequently, lower unit costs per transaction; f) increase in the options available to users of banking services, enhancing the comfort, convenience and agility of access to new financial products.

Notwithstanding the benefits indicated above and the international trend toward ATM and EFTPOS terminal network sharing, the banking system and payment service providers in Brazil still must cope with barriers to adoption of improvements that could lead to increased interoperability in their infrastructures. These barriers are basically a consequence of the model adopted in the creation and expansion of these networks.

The inefficiencies indicated in this study demonstrate that retail payment systems must cope with the risk that market forces will not satisfactorily achieve the objectives of security and efficiency. The underlying reason for this is that system operators and participants do not generally have adequate incentives that would lead them to act in a cooperative manner, particularly when the model adopted in the past creates added difficulties for adoption of more efficient practices.

In fulfilling its role as the catalyst of retail payment system modernization in the country, Banco Central do Brasil must encourage cooperation among participants in the system, clearly defining retail payment system guidelines, publicly disseminating information on its role in the system and announcing the major policies to be followed in relation to payment instruments.

92 | Financial Stability Report | May 2004 Furthermore, Banco Central do Brasil must act in a cooperative manner with the banking system, payment service providers and representatives of the real sector of the economy, with the ultimate aim of eliminating the barriers to adoption of a more efficient and secure payment instrument utilization infrastructure model, expanding access to the various payment services and ensuring the trust of the population in these new forms of money.

May 2004 | Financial Stability Report | 93 Appendix I

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