The Evolution of Payments United States
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_' _ ___ S I6 POLICY RESEARCH WORKING PAPER 1676 The Evolution of Payments Lessons from the evolution of Europe, Japan, and the payment systemsin Europe, in Europe, Japan, and the Japan, and the UnitedStates United States providea usefulguide for emergingmarket economies in improving their own Lessons for Emerging Market payment arrangements to Economies foster economic grovth. David B. Humphrey Setsuya Sato Masayoshi Tsurumi Jukka M. Vesala The World Bank FinancialSector DevelopmentDepartment October 1996 IPOLICY RESEARCH WORKING PAPER 1676 Summary findings Some payment arrangements are more efficient than all types of transactions and the United States instead others in promoting economic growth in a market-based relies on checks. Finally, the fact that consumer payment economy. The payment experience of industrial needs were not met within the banking system led to the countries is diverse enough to identify those payment establishment of postal giros in Europe, while untimely arrangements that provide the infrastructure for business payments led to central bank involvement in sustained growth and the emergence of market-based payment processing in the United States. enterprise. Unmet user needs, inefficient payment arrangements, Based on the historical experiences of Europe, Japan, differences in payment instrument costs, and improper and the United States, a number of country attributes pricing of payment services will determine the future have led to the intensive use of different payment structure of payment systems in emerging market instruments and, in some cases, a different mix of private economies just as they have determined the evolution of and public ownership and participation in the payment payment systems in industrial countries. The authors system. Such attributes include country size, population discuss these issues and apply the lessons learned to density, banking structure, legal framework, safety, and payment arrangements in emerging market economies. payment instrument pricing. Although the evolution of payments has taken decades in These attributes explain why Japan relies heavily on industrial countries, emerging market economies hope to cash at the point of sale but uses electronic payments for complete the process in just a few years, and so will bill payments and business transactions. They also are the benefit by having a better "roadmap" for transforming reason Europe relies on credit-transfer giro payments for their payment systems. This paper - a product of the Financial Sector Development Department - is part of a larger effort in the department to promote the development of financial sector infrastructure to support banking and capital market activities. Copies of the paper are available free from the World Bank, 1818 2H Street NW, Washington, DC 20433. Please contactTomoko Ishibe, room G8-136, telephone 202-473-8968, fax 202-522-3199, Internet address [email protected]. October 1996. (44 pages) The Policy ResearchWorking PaperSeries disseminates the findings of work in progressto encouragethe exchangeof ideasabout development issues.An objectiveof the series is to get the findings out quickly, even if the presentations arc less than fully polished. The papers carry the names of the authors and should be used and cited accordingly. The findings, interpretations, and conclusions are the authors' own and should not be attributed to the World Bank, its Executive Board of Directors, or any of its member countries. Produced by the Policy Research Dissemination Center The Evolutionof Paymentsin Europe,Japan, and the U.S.: Lessonsfor EmergingMarket Economies by David B. Humphrey Florida StateUniversity, Tallahassee, U.S.A. SetsuyaSato World Bank,Washington D.C., U.S.A. MasayoshiTsurumi Hosei University,Tokyo, Japan JukkaM. Vesala Bankof Finland,Helsinki, Finland CONTENTS I. Introduction 1 II. Economicactivity, types of transactions,and payment instruments 3 Sizeof economicand paymentactivity 3 Fourtypes of paymenttransactions 4 Matchingtransactions with paymentinstruments 4 IlI. The useof cashin developedcountries 6 Cashholdings as an indicatorof cashuse 6 Changesin the useof cashover time 7 Cashholdings and availabilityof P05 and ATM terminals 8 IV. Thecomposition and growth of non-cashpayments in developedcountries 11 Thecomposition of non-cashpayments 11 Paperversus electronic payments 11 Thetradeoff between cash holdings and non-cashpayments 12 Thegrowth in non-cashpayment instrument use 13 V. Largevalue payments in developedcountries and the roleof thecentral bank 16 Settlementfailure andpolicies to containsystemic risk and daylightoverdrafts 17 Therole of the centralbank 19 VI. Thehistorical evolution of paymentsin Europe,Japan, and the U.S. 20 Theevolution of paymentsin Europeand the establishmentof the giro 21 Giro paymentsmoving to electronics 23 Thesubstitution of cardpayments for cashin Europe 24 Reasonsfor giro dominancein Europe: Bankingconcentration, nationwide networks, and cooperation 24 Theevolution of paymentsin Japanand the benefitsof cashuse 25 Threestages in the evolutionof Japanesepayments 26 Theevolution of paymentsin the U.S.and the reasonfor checkuse 29 Stagesin the evolutionof U.S.payments 29 Thehistorical role of the centralbank in the paymentsystem 32 VIl. Lessonsfor emergingmarket economies 34 Countrycharacteristics and the adoptionof specificpayment arrangements 35 Point-of-salepayments 35 Bill payments 36 Disbursements 36 Financialmarket transactions 36 Evolvingpayment arrangements in emergingmarket economies 37 Therole of the centralbank in the paymentsystem 38 Bibliography 42 TheEvolution of Paymentsin Europe,Japan, and the U.S.: Lessonsfor EmergingMarket Economies 1. Introduction Emergingmarket economies today face the need to upgradetheir payment systems and initiate new paymentarrangements in order better to providethe infrastructurenecessary for sustainedgrowth within a market-basedeconomy. This processrequires an integratedknowledge of enterpriseand consumerneeds, the necessarylegal framework,the applicationof existingas well as new technologies,and an analysisof themonetary policy and riskimplications associated with thevarious paymentsystem design options that are available. The developed countries of Europe,Japan, and the U.S.have had over 150years to transformtheir payment systems from onedominated by the useof preciousmetals (coin) and privatelyissued currency into one which relieson governmentissued currencyand specializedpaper payment instruments and finally into a modernsystem where card- basedconsumer payments and networksof electriccommunication systems have increasingly replacedboth currencyand paperpayment instruments. In transformingtheir paymentsystems, today'semerging market economies have the opportunityto learn from the diversepayment experiencesof developedcountries. TheWorld Bankhas recently been involved in initiativesto modernizethe nationalpayment systemsin countriesof Asia(China, India, Indonesia, Viet Nam), of LatinAmerica (Brazil, El Salvador, Columbia),of Africa (Madagascar,Mozambique, Tanzania, Uganda, Kenya), of EasternEurope (Poland,the CzechRepublic, Slovenia, Albania), and countriesof the formerSoviet Union (Russia, Ukraine). In this paper,the paymentexperience of Japan,the U.S.,and a numberof developed countriesin Europeare outlinedin somedetail and the differingevolution of their paymentsystems are contrasted.The purposeis to identifyimportant country attributes that determinea nation's paymentstructure and illustratethe criticalareas that will affectemerging market economies as they seekto modernizetheir own paymentsystems. These conditions include: (i) Thegeographical size of a countryand its populationdensity (making the communication of paymentinformation easy or difficult); (ii) The concentrationof the bankingsystem and its interconnectedness(permitting greater movementof fundsinternally within a singleentity rather than externally between separate entities); (iii) Thelegal structure concerning rights and liabilities of paymentparticipants (reducing risk for certainpayment instruments but not others)and antitrustlaws (affectingcooperation and competitionamong suppliers of paymentservices); (iv) Theinfluence of culturalfactors such as crime rates (affecting the needfor cashsubstitutes); and 2 (v) The role of economicfactors that affectthe tradeoff betweenrisk and efficiency by type of transactionand paymentinstrument (reflected in relative paymentcosts, user convenience, paymenttimeliness, and the availabilityof paymentalternatives). Theseconditions have combinedin differentways to stronglyinfluence the evolution of the paymentsystems of developedcountries and thus will also importantlyinfluence the restructuringof paymentsystems in emergingmarket economies. Overall, most countriesin Europehave evolved paymentarrangements that tend to rely on electroniccredit transfer giro payments,while Japan continuesto rely heavilyon currencytransactions and the U.S.concentrates on debit-transfercheck payments. Although all developed countries use some amount of all three of these payment instruments,along with credit and debit cards, the proportions used are quite different. The involvementof the central bank in the paymentsystem of thesecountries has also differed. While virtually all centralbanks provide settlementfor all payments,and most either operateor supervise domesticlarge value wire transfernetworks, only a few centralbanks compete with commercialbanks or postalgiros in providingprocessing for relativelylow valueconsumer