Financial Stability Report
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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 banks 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, bank statement issues, balances and other banking services. In Brazil, the providing of services involving electronic payment system distribution channels and networks is carried out by financial institutions, payment card management companies and bank technology companies. The major distribution channels are the Automated Teller Machine (ATM) terminal networks13, networks of electronic transfer terminals located at sales outlets and known as Electronic Funds Transfer at Point of Sale (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 access 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 credit card 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