The National Payment System and Competition in the Banking Sector A report prepared for the Competition Commission With a research annex by Prof. Olu Akinboade March 2006 FF EE AA SS ii bb ii ll ii tt YY Financial Economic Analysis Strategy F E A S ii b ii ll ii t Y Financial Economic Analysis Strategy A report by: FEASibilitY (Pty) Ltd PO Box 84704, Greenside, 2034 Tel. 011 480 4876 Fax. 011 480 4826 [email protected] This report was researched and written by Penelope Hawkins and Andreas Bertoldi. They were assisted by Christopher Torr, David Llewellyn, Mariana Jansen and Marcia Boys. Special thanks go to Johnny Pienaar, payment system consultant, for his technical advice. His advice was invaluable, although he is clearly not responsible for any remaining errors or omissions. The research annex was written by Prof Olu Akinboade. Contact person: Dr Penelope Hawkins Copyright © 2006 FEASibilitY (Pty) Ltd. All rights reserved. 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Trademarks are implicitly acknowledged. © 2006 FEASibilitY (Pty) Ltd Page i The National Payment System and Competition in the Banking Sector F E A S ii b ii ll ii t Y Financial Economic Analysis Strategy Contents 1 Executive Summary........................................................................1 2 Report synopsis .............................................................................7 2.1 Setting the scene on payment systems....................................... 7 2.2 Introduction to the South African National Payment System (NPS) 12 2.3 Ownership of the payment system ........................................... 14 2.4 Regulation of the payment system ........................................... 15 2.5 Cost of participation in the NPS ............................................... 17 2.6 Pricing, fees and revenue ....................................................... 20 2.7 Anti-competitive outcomes of the NPS ...................................... 27 3 Background to the present study.................................................. 32 3.1 Rationale of the study ............................................................ 32 3.2 Competition in South African Banking: Key findings................... 34 3.3 Terms of reference ................................................................ 39 3.4 Method ................................................................................ 40 3.4.1 Phase I ................................................................................ 40 3.4.2 Phase II ............................................................................... 42 3.4.3 Phase III .............................................................................. 42 4 Historical and cross-country overview.......................................... 44 4.1 The importance of the payment system .................................... 44 4.1.1 Security, efficiency and accuracy of the payment system ........... 45 4.1.2 Regulation of the payment system .......................................... 45 4.2 Payment instruments in historical perspective............................ 46 4.2.1 South African retail payment instruments................................. 47 4.3 The price of payment instruments............................................ 50 4.4 Country variations in payment systems .................................... 51 4.4.1 Regulation model and role of the Central Bank.......................... 51 4.4.2 Membership of payment system.............................................. 53 4.4.3 Ownership of infrastructure .................................................... 58 4.5 Challenges facing payment systems ......................................... 58 4.5.1 Participation of non-bank players in the payment system ........... 59 4.5.2 Pricing and interchange.......................................................... 59 4.5.3 Supervision and oversight ...................................................... 61 4.6 Conclusion............................................................................ 62 5 Regulation of the national payment system.................................. 63 5.1 Defining the NPS ................................................................... 63 5.2 History of the South African NPS.............................................. 65 5.3 The Blue book....................................................................... 68 5.3.1 Introduction ......................................................................... 68 5.3.2 Exclusive domain of banks...................................................... 69 5.3.3 Non-bank participation........................................................... 70 5.3.4 Core proposals for implementation .......................................... 71 5.3.5 Impact to date ...................................................................... 72 5.4 Regulation of the NPS ............................................................ 74 5.4.1 Rationale for regulating the NPS.............................................. 74 5.4.2 Overview of the regulatory landscape ...................................... 76 © 2006 FEASibilitY (Pty) Ltd Page ii The National Payment System and Competition in the Banking Sector F E A S ii b ii ll ii t Y Financial Economic Analysis Strategy 5.5 Legislation............................................................................ 78 5.5.1 General legal aspects............................................................. 78 5.5.2 National Payment System Amendment Act ............................... 80 5.6 Regulatory authorities ............................................................ 86 5.6.1 South African Reserve Bank (SARB) ........................................ 87 5.6.2 Payment Association of South Africa (PASA) ............................. 88 5.7 Conclusions .......................................................................... 97 6 Participation and access to the NPS ............................................. 99 6.1 Payment participants ............................................................. 99 6.1.1 PCH System operators ..........................................................100 6.1.2 Representative bodies...........................................................106 6.1.3 Other NPS participants..........................................................111 6.2 Access to the NPS.................................................................114 6.3 Conclusion...........................................................................115 7 Technical description of the NPS ................................................ 116 7.1 Market activities and the NPS .................................................116 7.2 Description of a payment system ............................................117 7.3 Payment instruments ............................................................118 7.3.1 Debit orders ........................................................................118 7.3.2 ATM cash withdrawals...........................................................119 7.3.3 Cheque processing ...............................................................120 7.3.4 Processing of high value payments .........................................121 7.3.5 Low value credit payments ....................................................122 7.4 A typical payment process .....................................................123 7.5 Authorization, clearing and settlement and fees ........................128 7.5.1 Authorisation process ...........................................................128 7.5.2 Clearing and settlement ........................................................130 7.5.3 Circuit of fees ......................................................................135 7.6 Conclusion...........................................................................136 8 Economics of the payment system.............................................. 137 8.1 The size of the payment system .............................................137 8.2 Pricing and the payment system .............................................140 8.3 NPS participation and transaction costs ...................................141 8.3.1 Entry Costs..........................................................................142 8.3.2 Membership costs.................................................................144 8.3.3 Switching, clearing & settlement costs ....................................148 8.3.4 Cost overview ......................................................................153 8.4 Transaction costs