F EE AA SS Ii Bb Ii Ll Ii Tt YY Financial Economic Analysis Strategy

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

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Note: While every care has been taken to ensure the accuracy and completeness of this report, no liability will be accepted by FEASibilitY (Pty) Ltd, it’s directors, employees or the authors of this document for any loss incurred by any person or entity acting or failing to act as a result of the contents and opinions expressed in this document. The facts, estimates and opinions are taken from sources we believe to be reliable but which we cannot guarantee. The inclusion or exclusion of any organization is not a reflection of judgment on the nature of its activities. Trademarks are implicitly acknowledged.

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

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 & revenue ...... 154 8.5 Industry costs and revenue...... 159 8.6 Banks and the payment system...... 164 8.7 Conclusion...... 166 9 Competition and the NPS...... 167 9.1 Introduction to the key concerns ...... 167 9.2 The institutional legacy of the system...... 168 9.3 Participation of non-banks ...... 168 9.4 Access to an essential infrastructure...... 170 9.5 Governance and ownership of key infrastructure ...... 171 9.6 Bilateral interchange negotiations and their impact...... 173

9.7 Innovation and efficiency trade-offs ...... 174 9.8 Penalty fees...... 175 9.9 Interoperability and Access ...... 175 9.10 Conclusion...... 177 10 The way forward ...... 178 10.1 Questions raised by the research ...... 178 10.2 Questions raised by stakeholders...... 179 10.3 The way forward ...... 180 11 Interviewees...... 181 12 References...... 183 13 Glossary...... 189 14 Research annex: international comparison by Prof Akinboade... 192 14.1 Indicators of payments system development ...... 192 14.1.1 Commercial bank branch and ATM outreach ...... 192 14.1.2 Feasibility of ATM deployment...... 197 14.1.3 Patterns of ATM deployment ...... 198 14.2 Cross country differences in use of payments instruments ...... 200 14.2.1 Retail payments instruments ...... 200 14.3 Clearing and settlement ...... 206 14.3.1 Clearing arrangements...... 206 14.4 Ownership of payments system infrastructure ...... 208 14.4.1 Ownership of ATM payments infrastructure...... 208 14.4.2 Ownership or providers of cheque clearing arrangements ...... 209 14.4.3 Effect of ownership structure on participation in payment systems214 14.5 Cross country comparison of payments system costs and fees ....215 14.5.1 Fees/costs per payments system instruments ...... 217 14.5.2 Retail payments instruments ...... 219 14.5.3 Access pricing of retail payment system ATM clearing houses ....227 14.6 Lessons learned from international comparison of payments systems ownership and costs ...... 229 14.7 Role of regulators/authorities in payments systems ...... 229 14.8 Annex references ...... 234

List of Boxes

Box 1: NPS Vision 2004...... 69 Box 2: International experience on clearing arrangements...... 132

List of Figures

Figure 1: NPS regulatory landscape ...... 16 Figure 2: Debit card transaction cost & revenue ...... 22 Figure 3: Consolidation of the payment operator space, circa. 1990 to 2005 ...... 68 Figure 4: NPS regulatory landscape ...... 77 Figure 5: Regulatory authorities and other representative bodies...... 86 Figure 6: SA payments landscape ...... 99 Figure 7: Bankserv Real-time ATM Switch...... 102 Figure 8: Bankserv shareholding ...... 103 Figure 9: STRATE ownership structure ...... 104 Figure 10: Relationship between market activities and payment processing ...... 116 Figure 11: National payment system scheme ...... 117 Figure 12: Phases of the payment process ...... 124 Figure 13: Authorization process ...... 129 Figure 14: Clearing, netting and settlement ...... 131 Figure 15: Clearing and settlement process ...... 134 Figure 16: Circuit of fees ...... 136 Figure 17: Volume of transactions (year ending June) ...... 138 Figure 18: Annual change in payment stream usage ...... 138 Figure 19: Share of volumes of different payment streams ...... 139 Figure 20: Value share of different payment streams ...... 139 Figure 21: Debit card transaction cost & revenue...... 155

List of Tables

Table 1 Payment instruments...... 13 Table 2: NPS Participation costs ...... 19 Table 3: “Off-Us” ATM Cash-withdrawal transaction ...... 23 Table 4: Typical Consumer Transaction Charges for the first R100 ...... 24 Table 5: Transaction Charges based on Average Transaction Values ...... 25 Table 6: Payment instruments...... 47 Table 7: Supervision of payment systems – international country comparison ...... 51 Table 8: National Payment Systems – Composition of Membership ...... 54 Table 9: Ownership of ACHs – international country comparison...... 58 Table 10: Blue book implementation scorecard...... 73 Table 11: Current PASA council members ...... 90 Table 12: Current payment streams...... 92 Table 13: PCH participants, 2005...... 93 Table 14: Participating entities in the business forums ...... 109 Table 15: Key EasyPay Clients...... 112 Table 16: Cost and capital requirements associated with bank registration ...... 143 Table 17: NPS Participation Costs - PASA...... 144 Table 18: NPS Participation Costs - SAMOS...... 147

Table 19: NPS transaction costs ...... 150 Table 20: NPS participation costs...... 153 Table 21: Off-Us ATM Cash-withdrawal transaction ...... 157 Table 22: Typical Consumer Transaction Charges for the first R100 ...... 158 Table 23: Transaction Charges based on Average Transaction Values...... 159 Table 24: Composition of bank income statements ...... 162 Table 25: Revenue generated by payments activity ...... 163 Table 26: Annual costs of banks’ participation ...... 164 Table 27: Geographic and demographic bank branch and ATM outreach ...... 194 Table 28: ATM deployment by banks and independent cash dispensers in Canada ...... 198 Table 29: Western Europe’s largest card markets, 2004 ...... 201 Table 30: International card schemes in Western Europe (2004) ...... 201 Table 31: Payment card issuers in western Europe (2004)...... 202 Table 32: Volume of non-cash payments in Europe, 2002 (millions)...... 203 Table 33: Number of non-cash payments per inhabitant per instrument in Europe (2003) 203 Table 34: Share of payment instruments in total non-cash payments in Euroland (2002) 203 Table 35: Cheques as a proportion of total non-cash payment transactions in Europe (1998- 2002) ...... 205 Table 36: Clearing and settlement systems...... 207 Table 37: Automated clearing houses owned by commercial banks in Europe (2003) ...... 210 Table 38: Automated clearing houses owned by commercial banks in other countries (2005) ...... 211 Table 39: Automated clearing houses owned jointly by the central bank and commercial banks in Europe (2003) ...... 212 Table 40: Automated clearing houses owned jointly by the central bank and commercial banks in other countries (2005)...... 213 Table 41: Automated clearing houses owned by the central banks in Europe (2003) ...... 214 Table 42: Automated clearing houses owned by the central banks in other countries (2005) ...... 214 Table 43: Number of participants in large value payments system ...... 215 Table 44: Average cost of banking services among 135 retail banks in selected countries 217 Table 45: The cost of ATMs...... 219 Table 46: ATM charges and fees (2005) ...... 221 Table 47: International comparison of personal cheque processing fees and charges...... 224 Table 48: Fees for debit and credit card operations (February 2003)...... 225 Table 49: Fees for large value payments in selected countries...... 225 Table 50: ATM payment system participation fees ...... 228 Table 51: Automated clearing house charges in selected countries...... 228

Abbreviations & acronyms

ABCI Association of Bank Card Issuers and Merchant Acquirers

ACH Automated Clearing House

BASA Banking Association of South Africa (previously known as Banking Council and COSAB - Council of Southern African Bankers)

Big Banks ABSA, FNB, Nedbank, Standard Bank

BIS Bank for International Settlements

Blue book Framework and Strategy Document for the SA Payment system, published by the Reserve Bank in 1995

BSD Bank Supervision Department (of the SARB)

CPSP Customer payment service provider

CSD Central Securities Depository

FSB Financial Services Board

MC Master Card

MFRC Micro-Finance Regulatory Council

NPS National Payment System

NPS Act National Payment System Act No. 78 of 1998

NPS Amendment National Payment System Amendment Act No 22 of 2004 Act

NPSD National Payment System Department

PASA Payment Association of South Africa

PCH Payment Clearing House

PSA Payment Stream Association

SAMOS South African Multiple Option Settlement (System)

SANPAY South African National Payment System Forum

SAPO South African Post Office

SARB South African Reserve Bank

STRATE Originally an acronym for Share Transactions Totally Electronic - the authorised Central Securities Depository for the electronic settlement of securities transactions

1 Executive Summary

The payment system lies at the heart of the banking system. While it is a complex national network, in essence it allows transfers to be made between the accounts of customers who bank at different banks. Transfers can occur between personal customers, between businesses, or between personal and business customers and hence the national payment system (NPS) affects the lives of consumers and firms throughout the economy. The payment system facilitates the transfer of funds between parties who do not know each other and have no reason to trust each other. Quite frankly, we cannot do without the payment system - it plays an essential role in the smooth functioning of the economy.

The payment system is an essential infrastructure in much the same way that an electricity grid is considered to be essential to the functioning of the economy. Scrutiny of ownership and management of the payment system reveals that the high-value real time part of the network - often referred to as the wholesale system - is managed and/or owned by the central bank. The retail part of the system – which involves the banks and the point of sale or ATM interface with which consumers are familiar - is to a large extent privately owned and managed. This at least is the situation in South Africa - ownership and control of the infrastructure varies from country to country.

The payment system has come under the scrutiny of consumer protection agencies around the world, for a number of reasons: • The payment system is the mechanism through which transaction fees and revenue are generated and consumers complain that bank fees are too high • The banks often own and control the essential payment system infrastructure – such as ATMs and the operators or switches which carry payment messages • The payment system appears to be characterised by high entry barriers • Ownership and control of the payment infrastructure may allow banks to further their own business interests to the detriment of other competitors in certain market segments.

This study is a consequence of the 2004 Competition in South African Banking report for the National Treasury and the SARB, which recommended, inter alia, that the Competition Commission investigate the national payment system as a complex monopoly. The Competition Commission engaged, on the basis of open tender, FEASibility and Prof Olu Akinboade1 to undertake this research. The terms of reference are to provide an understanding of the role of the payment system in the South African economy and a technical description of how it

1 Prof Akinboade was commissioned to undertake an international comparison, which appears in the research annex.

operates. In addition, an understanding of the regulation of the system and an analysis of possible anti-competitive outcomes of the system are required. The South African payment system is a national network that embraces the Reserve Bank’s SAMOS system and the National Payment System Department (NPSD); PASA, the industry body with its payment clearing houses (PCHs); Payment clearing house system operators like Bankserv, MasterCard, Visa and STRATE; the registered banks; the Post Office and a number of payment processing providers and retailers.

It might be useful here to distinguish between banks and PCH system operators. PCH system operators run systems which receive, collate and transmit payment messages and push the net positions of banks through to SAMOS. We can refer to this as clearing. In South Africa, Bankserv is the dominant retail payment system operator, clearing more than 90% of the retail volume. A PCH system operator will only be recognised as such if two or more system participants (banks) have agreed to the clearing of payment instructions through the operator.

Given this broad scope of players, one might very well ask if access to the payment system is indeed a concern and it will then immediately become apparent that much depends on what is meant by access. For some, access means access to the clearing and settlement system, an area that has traditionally been the preserve of banks. Access for the NPSD is access to the real-time high-value SAMOS system that it owns and operates, and the department points out that there are no barriers to entry – except of course that to operate in SAMOS one must be a registered bank. For some of the non-bank players, access means being allowed to enable clients to make payment against deposits. For yet others it means having access to bank accounts via their own system operator - rather than Bankserv - which is an operator that is wholly owned by the banks (of which the big banks have a 93 % share). And then of course, for would-be bankers, access is concerned with the problem of gaining entry to a restricted area.

While there are a number of non-bank players hovering in and around the system, the retail payment system has been and continues to be viewed as a privileged banking space since banks are the only organisations with immediate and unmediated access to official clearing and settlement systems. Historically, this has to do with their role in the monetary transmission process, their ability to create credit and the fact that they are regulated as deposit takers.

Banks compete with each other in the provision of retail payment instruments and services to end-users but, at the same time, they also co-operate in shared payment networks. There are hence both collaborative and competitive elements in the network. The co-operative part includes shared infrastructure and central hubs or system operators. While both SAMOS and Bankserv are examples of payment system operators, control or ownership of this shared infrastructure

appears to be important – no-one complains for example at the SAMOS user fees set by the SARB, but Bankserv’s fee structure does come up for criticism. The report brings into focus the need for answers on the questions of whether competition between different infrastructures or competition within one infrastructure is better for society’s welfare. And if the answer is that collaborative infrastructure is best for efficiency, then the question of how the governance and control of such infrastructure can best be handled in the consumers’ interests needs to be considered.

A case in point may be the pricing mechanisms associated with the collaborative activities of the payment system. Traditionally, the banks have set the prices by agreeing between themselves on the appropriate fee to be paid by one bank, when its customer uses another bank’s ATM infrastructure, for example. Generally known as interchange, these fees are compensation for using another bank’s infrastructure. In some jurisdictions these fees have been regarded as very high and indicative of market power rather than cost. The report suggests that further consideration is needed as to whether interchange benefits large banks. For example in the case of cards (debit and credit) interchange is paid to the issuer of the cards, by the bank acquiring the transaction (i.e. the merchant’s banker). In the case of ATM transactions the issuer (of the ATM card) pays the acquirer (who has provided the ATM infrastructure). A big bank that issues debit and credit cards and which has an extensive ATM network is likely to be a net receiver of interchange, relative to a small bank that does not issue cards and has few (if any) ATMs.

In South Africa, where only four banks make up the bulk of the payment activity and where through their vertical holdings these four command much of the revenue generated by such activity, it is perhaps not surprising that there has been increasing consumer pressure and disquiet regarding bank fees. This study has attempted to provide a view on the cost associated with payment system participation and provide a sense of the distribution of payment system revenue. The cost of the system is difficult to estimate as it involves infrastructure cost, staff cost and branch cost over and above the direct costs associated with the payment system. These data are not published by the banks and therefore not accessible to a research process but could well be brought to light through further enquiry. The costs which can be directly attributed to the payment system, such as membership of the Payments Association of South Africa and the card associations (MasterCard and Visa) as well as the account management and other fees payable to the SARB, can be divided into initial membership costs and annual fees. Since the big banks have the most complete membership, they pay considerably more than smaller banks, but they earn proportionately more revenue from payment system activity.

Revenue earned by banks and non-banks directly from payment system activity amounted to almost R31 billion in 2004, or over 2% of GDP. The vast majority of this was earned by the banks, particularly the big banks who dominate the

payments domain. Taken as a whole, the banking industry earned 54% of their income from non-interest activities - such as transactions linked to payments. Transaction-based fee income accounted for 38%, or almost R292 billion of their joint income during 2004. This may even understate the earnings from payment activity. If the existing cost-to-income ratio applies in payment system activity, then the data suggest that the banking industry’s profit for such activity was in region of R10 billion in 2004.

The banks earn the lion’s share of payment stream revenue – some 94% of the total estimated revenue of R31 billion. Cash distribution is an expensive part of the system and makes up 1.6% of the total costs from payment activity – more than the cost of Bankserv, the major switch that serves the banking industry, at around 0.6% of user cost. Since non-banks remain peripheral to the mainstream supply of payment services, they earn relatively little of the payment system revenue.

In many other countries, consumers tend not to be charged directly for payment transactions although these fees may be collected in other ways such as lower interest rates on deposits. This kind of obscure pricing means that consumers have difficulty in making payment service choices as they do not know the associated costs. The South African consumer also experiences such difficulties since although transactions generally attract a fee, there may still be cross- subsidisation which obscures the relative cost of payment instruments. Debit cards, for example tend to attract a fee per purchase, whereas credit cards do not. This obscures the fact that the debit card is a more efficient payment stream. Improvement in disclosure will require not only better information on transaction fees, but also on the cost and interest rates associated with other more traditional services, on comparable terms.

The report suggests that there is little apparent link between the costs directly attributable to making a transaction (such as the Bankserv processing fee, for example) and the fee the customer is charged by the bank. However, it draws this conclusion without full and verifiable information as to as to the costs and the extent of mark-up in levying fees. The question of whether the level of bank charges is cost-related and competitive or whether it is a pricing consequence of the dominance of the retail banking sector of the big banks through their account holding-needs further investigation. The extent to which the establishment of second and third tier banks night alleviate competition concerns also needs further consideration. While proposed legislation on second tier banks was published for comment a year ago, concern has been raised as to the commercial sustainability of the viability of these entities within the current provisions.

Technology has allowed non-bank providers to offer payment services all over the world, but their ability to do so is affected by the rules for membership in

2 The R31 billion mentioned above includes the earnings of non-banks.

their respective countries as well as the general approach of their regulators. In most countries, non-banks have neither a voice nor a vote in terms of the rules of their participation. As the role of non-bank players is growing, the supervision and rules of engagement for non-banks is becoming a pressing issue for regulators. The increasing involvement on non-banks may potentially increase risks which could undermine confidence in the system. In some countries, non- bank players have been allowed into the system as a different class of participant, which means that while they may still be excluded from clearing and settlement activity, they have distinct rules, which diminishes these risks.

In South Africa, there is a wide area of payment activity beyond the clearing and settlement space, which includes companies that facilitate third party payments and IT companies that provide the technology and infrastructure for non-banks and banks alike. They remain unregulated. The regulatory gaps remain in spite of the proposed rules in the Blue book, which set out the strategy for the NPS from 1995-20043. Non-banks may not, by law, be PASA members. Reputational risk for regulated and non-regulated entities exists as a consequence. One may describe the present situation as one where there are high barriers for banks, and non-banks can do as they please, as long as that does not include playing in the clearing and settlement space.

The report presents a comprehensive analysis of the national payment system. It reveals that the South African NPS is a highly efficient and sound system and perhaps more advanced than similar networks in more economically developed countries. But an efficient and sound system may nevertheless lack features which would make it also fair to consumers. What should be of concern to the Competition Commission is the extent to which present arrangements for control over parts of the payment system may be inhibiting competition throughout banking sector. The report raises a number of questions in this regard, and provides some pointers, in particular: • At present the banking industry earns 38% of its revenue (R29 billion) from payment system related fees. At the same any link that there may be the operating costs associated with a transaction and bank charges is not transparent. It thus may be the case that bank fees have less to do with the cost of the payment system and more to do with the market power of banks in setting their fees. • Not only the banks, but all the present participants in the NPS appear to find their activity in this regard profitable – indeed this might be the motivation for the clamour to gain access to the system. Only the SAMOS system operated by the NPSD appears to work on a cost recovery basis. • Apart from SAMOS, the pricing arrangements for each payment stream fall outside the remit of regulation and in the past have been negotiated on a multilateral basis. While some smaller players are concerned that bilateral negotiations may place them at a disadvantage as they wield so little market

3 Towards the final stages of this report, the NPSD informed us that directives dealing with the rules for operators (among others) were being prepared. These are not yet published.

power, it is possible that bilateral negotiations might benefit the consumer. Further inquiry regarding the pricing arrangements in each payment stream is probably warranted. There may well be aspects of the NPS where uniform pricing could give way to competitive pricing without compromising the soundness or efficiency of the system. • While Bankserv costs make up only a fraction of the cost of a transaction, the current profitability of Bankserv and the control and ownership of this essential infrastructure by the banks raises the possibility of broader representation on the board of Bankserv. There is international precedent for this. • There is an absence of market conduct regulation throughout the banking industry and the NPS in particular. Disclosed pricing is often confounded by bundled offerings. In a country where there is an obvious need to improve the access of under-served consumers to financial services, the absence of a market conduct regulator is likely to be particularly keenly felt. • Legislation and regulation have focussed on banks. This has left a regulatory gap in terms of the rules of participation for non-banks and highlights the need for an overall strategy. To the extent that collaborative infrastructure and uniform pricing is necessary for sustaining a sound and efficient NPS for the benefit of consumers, there may also be a need for government oversight.

The report distinguishes between the payment infrastructure at the wholesale level and the payment infrastructure at the retail level and in doing so attempts to highlight the unevenness of the present playing fields. The publication of the report provides an opportunity for industry and consumers to respond, and also to provide further insight on the concerns identified by the report.

2 Report synopsis

2.1 Setting the scene on payment systems

The average consumer in a supermarket might not be aware of what a national payment system is - or even if it exists. If the system breaks down for a while, however, the consumer will immediately become aware that there is a problem. She might observe, for example, commotion around the till.

A national payment system might be likened to an operating system (like Windows) on a computer. If Windows is working well, we are hardly aware of it, but if there are bugs in the system and the computer crashes, we become very aware that there is a problem. Another example is editing – if we see a film which has a good editor, or if we read a book that has been edited sensibly, we are often hardly aware of the editing process. If the editor has been inattentive, however, and we see inexplicable colour changes on the screen (or scenes that last too long) or if we read a book that contains many spelling mistakes - and sentences that seem to lead nowhere – we start questioning the credentials of the editor.

In none of the examples in the previous paragraph is there any mention about the content of the book, or the movie, or the program being run on the computer. A film might have a brilliant editor, but yet leave filmgoers disappointed. We might say, therefore, that a good editor is a necessary, but not sufficient condition for a good movie. So too with a payment system. For an economy to operate efficiently, it requires an appropriate payment system, but such a system will not guarantee that everything else in the economy is okay. A payment system has to operate in a boom or a recession, and in times of inflation or deflation.

For an efficient payment system to be sustainable there needs to be consensus on whether or not it is a fair system. The issue of fairness is what this project is all about. We have a national payment system in South Africa. It appears to work well – in other words it appears to be efficient, but something that is efficient is not necessarily fair. The fairness aspect is bound up with the competitive aspect.

This project seeks to examine whether or not the current payment system in South African contains anti-competitive elements, and if so, what can be done about it. Such an analysis will by its very nature raise issues of the following nature. Suppose we have System A with two highly competitive suppliers. An alternative is System B with many (say 15 suppliers). Will consumers be better off in System A or in System B? While we need to address such a question in the current project, it should be noted that this example raises competitive issues not unique to the payment system.

Conceptually, the project addresses three issues.

In the first instance, it examines what a national payment system is. Let us call this the What-is-it? issue. To get to grips with the functioning of a complex payment system, it will help to analyse simpler payment systems and in the process establish features common to both.

In the second instance, it examines what the payment system looks like in South Africa. This will include discussion of the extent of the payment mechanism and will be labelled the What-does-it-look-like-in-South-Africa? issue. Of necessity this section will need to include some figures and (stylised) facts.

In the third instance, once we know what a national payment system is and once we know what it looks like in South Africa, we can raise the Is-it-fair? question. If the current system is not fair (with due consideration being given to the benefits enjoyed by the consumer) what can be done about it without compromising efficiency and soundness?

For the rest of Section 2.1 we shall address the What-is-it? question and will do so by means of a series of examples.

Sections 2.2 to 2.6 will centre around the What-does-it-look-like-in-South- Africa? question.

Section 2.7 deals with the Is-it-fair? question.

What is a payment system? Suppose that we jump into a time machine and observe transactions taking place in a barter economy – an economy without money. We see a farmer trundling off to market with a pig. After much haggling he swaps the pig for a table. On the way back home he discovers borer beetle in the wood. He returns to the market, and attempts to reverse the transaction. It is conceivable that the other party in the transaction is worried as well - she wonders if she has bought a pig in a poke.

The example so far highlights the necessity for quality checks by both parties to an exchange – an exchange in which neither party has any reason to trust the other. So let us say both parties insist on quality checks. Second and third parties can be brought in to check the pig and the table. The second and third parties need to be trusted by both buyer and seller. Of course, a cursory quality check might not reveal latent defects. The pig might have measles. The table might warp over time. As a compromise both parties might agree to a one year guarantee clause (the kind we are familiar with when we buy a camera or a TV set).

We can imagine that over time, agents start emerging with sophisticated means for checking wood and pork. An X-ray machine is invented that checks wood without breaking it and that tests pigs without killing them. A single agent may be able to check wood and pork. The quicker the agent can assure both parties to an exchange that they can trust somebody whom they feel no apparent need to trust, the quicker the transaction can be consummated. In fact the carpenter may merely assure the pig farmer the table has been tested (via a stamped document, for example) and leave it to the pig farmer to confirm this with the stamper, should he wish to do so.

The agent with the X-ray machine starts making huge profits and other people want to enter the market but the barriers to entry are high. The X-ray equipment is very expensive and the owner may have patent rights. Is it fair that only one person owns such an X-ray machine?

If the presence of the X-ray means that the transaction can take place without any hitches – to a large extent because both parties to the exchange can later pull out of a transaction deemed unfair or fraudulent – then a system has been developed that is dealing with what we may refer to as the SWAP issue. Both sides are reaching Settlement Without Apparent Problems because there is a system in place that enables people who have no reason to trust each other to proceed with the transaction.

Next, our time machine takes us to an economy in which coins are a generally accepted means of exchange. If we continue with the same products, the pig farmer is now happy to exchange his pig for a certain number of coins, and the carpenter is happy to sell her table for a certain number of coins. She may later use the proceeds of the sale to buy a table, but the beauty of the money economy is that the pig farmer and the carpenter do not need to make contact – or to be more formal, a monetary economy does not require a double coincidence of wants. But for the SWAP issue to be resolved, we still need some checking device. The X-ray machine now not only checks the pork and the wood, it checks the coins as well. And it operates best when it is hardly noticed. Pigs, tables and coins are examined to see if the parties can trust people they have no obvious need to trust. The SWAP system is helping to ensure that transactions can be undertaken with almost no hassle.

We now travel through time to an economy in which banks operate. The market participants in this economy can deposit coins in bank accounts. Over time banks realise that they can issue pieces of paper in lieu of coins. The pieces of paper can be swapped back into coins at any time and the banks will be in trouble if they have issued pieces of paper in excess of their coin holdings. To speed up the illustrative process, let us not worry too much about the distinction between notes and coins. For present purposes, the two are interchangeable and let us simply suppose that the X-ray machine ensures stability by guarding not only against counterfeiting but also the over issue of notes on the part of the banks.

We turn our attention to a different issue – the emergence of payment by cheque and the emergence of different banks. If we have many suppliers of goods and services and millions of consumers, we have to take into account that the two parties to an exchange may bank at different banks.

So we are now visiting an economy in which both the farmers, carpenters and other consumers and producers can bank at different banks. To keep it simple, suppose there are only two banks. If Consumer A buys a table from shopkeeper B who also banks at Bank A, then the SWAP issue can be resolved by the shopkeeper phoning the bank to check if the consumer’s bank credentials are okay. If the consumer and shopkeeper are at different banks, the transaction will involve a series of checks and payments. In effect, consumer A is instructing Bank A to pay Bank B and Bank B makes sure the funds reach shopkeeper’s bank account.

How does Bank A pay Bank B? If there is a central bank, both Bank A and Bank B can have accounts at the central bank. Inter-bank payments are facilitated via the deposits at the central bank. It would be time-consuming to undertake such a process every time consumers make payments to suppliers at different banks. At the end of a trading day only net amounts need to be adjusted at the central bank.

How are settlements to take place without any apparent problems? In previous examples we have used X-ray technology, but let us now suppose that the banks themselves are involved in checking the credentials of the market participants. The settlement process will now have to start incorporating some sort of consortium of banks that oversees SWAP. The banking sector vets those payments that are made by cheque.

In order to vet the payments made by cheque, there will have to be administrative systems in place. By the nature of the operation, banks will be involved – watched over by the central bank and other interested parties. If there are only a few big banks, the question of the fairness of the SWAP operation arises. If nothing else, the examples thus far illustrate that the question of the fairness of a national payment system arises before the onset of electronic banking.

Let us now turn to a modern economy in which (as in the previous example) transactions (paid with by cheques) occur between parties who bank with different banks, but in which transactions may also occur by means of debit cards, credit cards and electronic transfers. The sheer multitude of the transactions involved now means that the settlement processes cannot take place without large scale computer systems.

Consumer A moves towards the checkout point of a supermarket B. Consumer A and supermarket B bank at different banks. The details of the items to be purchased are entered at the till and A presents her debit card. The till operator enters the card details which are checked via the national payment system - the conceptual equivalent of our previous X-ray machine. Electronic messages are sent and received by the banks of both consumer and supermarket. (This is discussed in greater detail in Section 1.4.) If the amount of credit allocated to the consumer is sufficient for the transaction, an electronic message is sent back to the supermarket and we hear the familiar chatter of the machine printing out a little piece of paper which is then signed by the consumer. A Settlement Without Apparent Problems has taken place.

One of the factors that ensures a settlement without apparent problems is that both parties have some assurance that the transaction can be reversed – but terms and conditions apply, of course. A furious customer who finds that a camera does not work can come back to the shop and have the transaction reversed on the credit card. The signs in big department shores indicating RETURNS attest to this. On the shopkeeper’s side, a check that reveals that a cardholder does not have sufficient funds is also a type of reverse run – but it takes place even before the consumer leaves the till.

When we consider a monetary economy, the SWAP issues present in a barter economy remain but the X–ray machine (device) changes form, becoming more complicated as more payment instruments (interchangeable with coins) are created and more banks become involved. With the introduction of (for instance) credit and debit cards and electronic transfers, the device – a national payment system – enables the SWAP by enabling the seller herself (or an agent eg a bank instructed by the seller) to check with the buyer’s agent4 (eg a bank, a buy-aid society, or discount card provider), whether or not settlement can take place without apparent problems. The national payment system is not merely a checking device – if settlement can take place without apparent problems, a payment actually takes place5.

The national payment system that we have today in South Africa is highly sophisticated. The latest version of the SWAP machine – the national payment system – is big (ie it handles large volumes and values), complicated and expensive. For historical reasons (including that of the four-pillar policy of government regarding the banking sector), the retail part of the NPS is effectively owned and controlled by four big banks. The fact that it is expensive requires discussion as well. Who ultimately pays the cost? Is it (for example) the consumer? This issue is addressed in sections 2.4 – 2.6.

4The buyer’s agent is the only person or entity that can confirm SWAP provided: - the seller (or its agent) meets criteria set by the national payment system; and - the agent of the buyer is trusted by the seller (or the seller’s agent). 5 Note that the goods or services of the deal are not checked by the national payment system.

In the examples so far we have concentrated on the transaction between the customer and the shop and we have referred to it as the retail part of the payment system. What we also need to examine is the payment mechanism between the bank of the customer and the bank of the shop. Such interbank transactions take place through the accounts held by the banks at the Reserve Bank, and will be associated with the wholesale part of the payment system.

The current project involves examining whether or not a system which has evolved in order to facilitate Settlements Without any Apparent Problems is a fair one. And if it is not fair, what should be done about it?

The fairness issue can be discussed under various headings. For example, is the current system fair to the consumers? Is it fair to the suppliers? In other words if at present there are four main banks involved, is the current system fair to the rest of the banking system? The time element needs to be included as well. Are the consumers’ needs being satisfied in both the short run and the long run? After all, it takes time for new entrants to gain access not only to the banking system, but also to the running of national payment system.

2.2 Introduction to the South African National Payment System (NPS)

The National Payment System (NPS) network affects the lives of consumers and firms throughout the economy. The value of transactions through the South African payment system amounts to four times the value of the country’s gross domestic product6.

In its most familiar form, cash operates as a payment stream of the NPS, allowing for the physical exchange of notes and coin for goods and services. Cheques are a paper payment instrument which may be used as a substitute for cash. Other substitutes include electronic fund transfers (such as debit orders for standing obligations or once-off bill payments and disbursements for payroll or social benefits) and debit and credit card transactions. All of these payments instruments allow for payment and settlement of financial obligations.

Table 1 sets out the common payment instruments in the NPS: cash, cheques, EFTs and debit and credit card transactions. In recent years, the number of cheque transactions in South Africa has declined each year, at the same time that EFT transactions have increased. In terms of number of transactions, EFT transactions are now the dominant. Currently, the EFT share in the volume (or number) of non-cash transactions, represents over 50% of all transactions, with ATM transactions, 17%, cheques 13%, credit cards 10% and debit cards 5%,

6 Excluding the transactions through SAMOS. These are high value transactions, which settle in real- time at the Reserve Bank. Our focus for the moment is primarily on the retail payment system and how it affects consumers, which we shall refer to as the “retail system”. Of course the retail system is still dependent on the SAMOS system and we shall return to it.

respectively. Albeit from very low levels, the usage of credit cards and debit cards has increased in recent years.

The domination of EFT transactions is even more pronounced in terms of the value of transactions: EFTs account for 63% of the value of the transactions with cheques 35% of the value of transaction and the value of credit cards and ATM transactions, 1% each.

Table 1 Payment instruments Payment Description Volumes and value share7 Instrument Cash Notes and coins. R42 billion in the hands of the public by Sept 2005. Cash makes up fewer than 3% of the value of all transactions, but 90% of the volume8. ATM transactions: 1% of the value and 17% of the volume of Bankserv transactions. Cheque A written order from one party (the drawer) to By value, cheques still account for another (the drawee, normally a bank) 35% of non-cash transactions, but requiring the drawee to pay a specified sum on by volume, only 13%. demand to the drawer or to a third party specified by the drawer. Cheques may be used for settling debts and withdrawing money. EFT Electronic EFT Credit is the mechanism by which payer- By value, EFTs account for 63% of funds transfers initiated payments are facilitated (known as all non-cash transactions, and credit-push transactions) wherein the payer around 54% by volume. instructs "their" bank to pay funds to another bank or beneficiary e.g. salary payments, stop orders and internet payments. EFT debit is a mechanism by which the payee draws down specific values, as specified by the payee on authority of the payer. These are credit-pull transactions, an example of which is a debit order. Debit Card Card enabling the holder to have his purchases By value, debit card transactions directly charged to funds on his account at a account for only 0.25% of all non- deposit-taking institution (may sometimes be cash transactions, but 5% by combined with another function eg that of a volume. cash card or cheque guarantee card). Credit Card A card indicating that the holder has been By value, credit card transactions granted a line of credit. It enables the holder to account for 1.2% of the value of make purchases and/or withdraw cash up to a the non-cash transactions, and prearranged ceiling; the credit granted can be 10% of the volume. settled in full by the end of a specified period or can be settled in part, with the balance taken as extended credit. Interest is charged on the amount of any extended credit and the holder is sometimes charged an annual fee.

7 Source: Transactions recorded through Bankserv for the year ending June 2005. Excludes SAMOS (high value real time transactions) and “on-us” transactions where only one bank is involved. 8 See Competition in South African Banking, page 71.

While some of the examples below are given in terms of card transactions, the same principles apply to the other payment streams such as EFT transactions.

2.3 Ownership of the payment system

In most payments systems around the world, there are elements of both private and public sector ownership. Public ownership (through the central bank) is typically of the wholesale system, such as SAMOS in South Africa, where the central bank has developed and owns the infrastructure for wholesale and interbank payments. Cirasano (2005) notes that “Typically, the high value, real- time network (also referred to as the wholesale system) is managed and or owned by the central bank, as this is a systemically important payment system and is seen as the backbone of the NPS”. While the banks using the wholesale system may pay user fees, the tax payer (through the central bank) generally foots the bill for the capital and maintenance costs.

In some countries, the central bank involvement is more extensive and reaches into the retail payments arena. This may include owning and operating a cheque clearinghouse or other operator, such as occurs in Mexico, Italy and Germany. In other countries, such as Greece and France, there is joint ownership between the banks and the central bank. In general, where the central bank owns the payments system infrastructure, the level of direct and indirect participation in the system is higher. For example, in Germany and Italy, where there are many clearing banks, the operating infrastructure is owned by the central bank. In countries where the operators or clearing houses are privately owned by the banks, there are relatively few direct clearing banks (such as in the UK, Canada and South Africa).

For this reason, it is sometimes inferred that private ownership of payment infrastructure may allow the shareholder banks to erect barriers to entry, hence retaining their privileges. Others argue that it is the market structure itself that leads to private ownership of the infrastructure.

Banks compete directly in the provision of retail payment instruments and services to end-users but, at the same time, they also co-operate in shared payment networks. Some have described this as upstream cooperation combined with downstream competition.

The identification of the effect that control of parts of a network (such as the NPS) has on competition is complicated by the collaborative nature of the infrastructure involved. While the efficiency and soundness of the existing system clearly has merit, the report brings into focus the need for answers on the questions of whether competition between different infrastructures or competition within one infrastructure is better for society’s welfare. While the skills learnt in granting credit may predispose banks to succeed at payment

services, these skills are not necessarily exclusive to banks. As has been seen in the credit environment, these skills can be learnt by non-bank firms and indeed, it is these firms that may prove to be the innovators in providing services. The South African micro-lending environment is a case in point, where entities that do not take deposits (and hence are by definition not banks) have proven to be successful grantors of credit particularly to consumers who are not traditional bank clients. In some cases, banks have expanded their operations in this arena by acquisition of such non-bank micro-lenders.

Given the inertia associated with networks, in this case payment networks, it may be that banks are likely to be slow adopters of payment innovations, even where they may generate improvements for consumers at large. In economic terms, adoption of new technology is likely to benefit the relative late comers rather than the incumbents and the continued use of old technology provides a barrier to new entrants. For this reason, incumbents have little incentive to adopt new technology quickly.

The network effects within a payment system are such that innovation is likely to be slow in coming. Such innovation is also likely to be path dependent – based on legacy systems adopted in earlier years. Some have argued that innovations in existing PCHs may be delayed by incumbents for this reason. Given this, new PCHs maybe easier to establish than innovating within a PCH9.

2.4 Regulation of the payment system

In South Africa and elsewhere, two key matters relating to regulation have attracted comment (and concern). The first is the role of non-banks and the second is the issue of self-regulation.

The payment systems of most countries are a “privileged banking space” since banks are the only organisations with immediate and unmediated access to official clearing and settlement systems. Historically, this has to do with their role in the monetary transmission process, their ability to create credit and the fact that they are regulated.

Increasingly, technology has allowed for non-bank providers to offer payment services. Their ability to do so is hindered or enabled by the rules for membership in their respective countries as well as the general approach of their regulators. In most countries, non-banks have neither a voice nor a vote in terms of the rules of their participation. As the role of non-bank players is growing, the supervision and rules of engagement for non-banks is becoming a

9 There are currently a number of new South African PCHs, formed to accommodate new payment innovations, including: the AEDOS/NAEDOS PCH for non-preferential debits on customer accounts; the Mzansi transfer PCH which allows for remittances even where one party does not have a bank account; the money market PCH and a “cash” PCH.

pressing issue for regulators: This is true in South Africa, too, where although the 1995 Blue book (The South African Payment system: Framework and Strategy) allowed for Customer Payment Service Providers (CPSPs), the rules for their participation were never set out. It is clear that such providers do and will provide value-added payment services for customers and firms.

Figure 1: NPS regulatory landscape Nature of regulation Institutions responsible System component Transaction layer

NPS Act Postal Act SARB SAMOS Settlement Legislation Banks Act SAPO Legislated Regulations PASA Rules PASA

PCH PCHs Agreements Agreements BankServ Strate Operator Interbank – Netting & PCHs Clearing Agreements VISA MC Self-regulated Rules PCH Rules PCHs Transaction Initiation

Interchange Banks Agreements sale Service Service Point of Point Provision Customer Contracts Merchant Payment Instruments / Banks CPSPs Agreements Streams, e.g. ATM, Debit card etc. User Commercial Banks CPSPs Agreements

Evident from the research is that the NPS is highly reliant on self-regulation. The largest components of the current NPS framework are either self-governed or entirely in the commercial space and hence subject to commercial transactions and negotiation. Importantly the existing regulations apply only to the core NPS participants – the banks (with the exception of a number of anomalies such as the SA Post Bank).

The concerns around self-regulation can be seen to have two elements: clearing banks tend to set the rules for participation and the clearing banks may own the operating infrastructure which is key to the functioning of the network.

While the participation of the central bank in the banks’ payments associations can be seen to moderate governance concerns associated with private ownership of an essential infrastructure, this is not always seen to be adequate. The recommendations of a task force to implement changes in the United Kingdom are still pending. In South Africa, the National Payment System Department (NPSD) must recognise and oversee a payment system management body in terms of the NPS Amendment Act 2004. The only body currently recognised is the Payment Association of South Africa (PASA). The NPSD has a seat on PASA

without voting rights, but not on any of the privately owned switches (including Bankserv and STRATE).

It should be noted that payment system switches (or operating infrastructures) form an integral part of a national payment system which are the modern reincarnation of our SWAP system introduced in section 2.1. Both SWAPS and national payment systems involve two functions, namely the actual payment after the checking of the integrity of the promise to pay. The national payment system therefore involves more than just a switch however – it is seen as the shared part of an end-to end process that offers an account-based transfer service between two final customers (eg a buyer and seller) and between their respective account-holding agents (eg two banks or a buy aid society and a bank, etc). Since the transactions involve interbank payments, and since interbank payments involve the Reserve Bank’s SAMOS system, no discussion about the NPS can avoid the role of the Reserve Bank even if we ignore for the moment the regulatory role of the Reserve Bank.

The NPS involves both a group of institutions and a set of instruments and procedures. The various components (and some illustrative examples) that make up the national payment system include:

• The legal and statutory framework (eg NPS Act and NPS Amendment Act) • Rules, regulations and agreements (eg PASA rules) • Payment instruments and payment streams (eg EFTs) • Systems, processes and procedures (eg IT communication protocols) • Technological infrastructure (eg SAMOS, ATM network) • Payment and settlement transactions (eg EFT transactions through Bankserv; high-value transactions through SAMOS) • Banks providing financial intermediation (eg ABSA) • Providers of access to payment-related services (eg EasyPay) • End-users of the different products provided by non-bank payment providers (eg Retailers).

2.5 Cost of participation in the NPS

The cost of bank participation in the NPS can be divided into three main categories:

• Regulatory costs • Membership costs • Transaction costs, including: - Switching, clearing & settlement costs - Card association costs - Cash handling costs The discussion refers to the table below.

In South Africa, becoming a bank involves meeting the capital requirements. In the case of a bank, other than a mutual bank, this requirement is set at R250 million.

Regulatory costs refer to the compliance and licensing requirements applicable to banks. These involve an annual fee, and compliance with a number of regulations, only some of which emanate from the Registrar of banks. Once a bank (licensed by the South African Reserve Bank (SARB) in conjunction with the Minister of Finance), registration with PASA and the NPSD is required to gain access to the payment system.

Table 2: NPS Participation costs Cost Description Typical cost Typical cost component (e.g. SMALL BANK) (e.g. LARGE BANK) Rand Rand Regulatory Annual costs: License renewal 3,000 150,000 Costs

Membership Once-off costs: PASA membership 28,000 60,000 Costs Annual costs: PCH membership, PASA 352,000 3,400,000 annual participation fee, SAMOS account management and transaction fees Switching, Once-off costs: Bankserv 1,500,000 2,600,000 clearing & membership, Card association settlement membership costs Annual cost: Bankserv transaction 2,500,000 95,000,000 fees, Bank interchange, Card association fees, Swift, Cash handling fees Total once-off costs 1,528,000 2,660,000 Total annual costs (excl. cash) 2,855,000 98,550,000 Total annual cash cost10 2,000,000 140,000,000

Membership costs primarily comprise of the fees that need to be paid to PASA and the Payment Clearing Houses (PCHs) in order to participate in the various payment streams. Both upfront fees and membership fees are charged and typically, a small bank would pay less than half of a big bank’s initial fee, and only around 10% of the annual fee paid by the big bank. In addition, a payment system provider is required to be a member of SAMOS, which again will cost a small bank somewhere around 10% of the costs facing a big bank. In the case of SAMOS, a cost recovery approach is employed and a flat rate per type of transaction is charged, regardless of the value of a transaction or of the volume throughput. If a sliding scale for number of transaction were employed, this would make real-time, high value transactions expensive for small banks since they have so few of them, and this might involve the migration of transactions out of SAMOS, which is clearly undesirable for the Reserve Bank. An alternative would be for the Reserve Bank to subsidise smaller banks. While it has clearly

10 Cash handling represents an anomaly. While strictly speaking a cost component of most transactions, the bulk of the cost is borne by the large banks who pay SBV (an outdated acronym for Standard, Barclays and Volkskas) for the service. SBV is owned by Standard Bank, First National and ABSA who derive an income from its services). Smaller banks may employ SBV for cash-handling services, or Fidelity Guards.

chosen not to take this route for operating costs, the provision of the SAMOS infrastructure by the SARB does provide some precedent.

Transaction costs involve switching and clearing costs, card association costs11 and cash handling costs. In the case of Bankserv, a sliding scale for volume throughput is employed, which the small banks complain is not sufficiently sensitive for small volumes. The big banks counter that the pricing differential is very small and that they subsidise the smaller banks. Small banks may pay only 3% of what a big bank would pay. Card association fees for smaller banks appears to be around 10% the fees faced by big banks, and the cash handling fees may be between 2% and 6% of the fees facing big banks.

The lack of differentiation in the once-off costs suggest that cumulatively, the start-up costs represent a barrier to entry for small entrants, but that these primarily relate to becoming a bank, rather than a payment system member per se. The small bank pays around 2% of what the big bank pays on an annual basis, but earns only a fraction of its income from payment system activity. (The discussion in section 2.6 takes up this point again.)

It should be noted that the total interchange costs (or revenue) could not be determined in this study. Large banks contend that on balance, interchange (which is intended to compensate the banks for the differential between issuing and acquiring costs) should be neutral in respect of its cost impact. However, the impact of market share of the acquiring infrastructure (such as ATMs and POS devices) on the distribution of interchange between small banks and large banks probably warrants further research.

2.6 Pricing, fees and revenue

The pricing of payment instruments differs, but in general, one rule applies: where more than one bank is involved an interchange fee applies: the acquiring bank will pay the issuer. Hence using the ATM of another bank, using a credit or debit card at a merchant that banks with another bank, etc, all result in interchange fees.

In South Africa, while cash may appear to be a “free” payment instrument at the till, the distribution fees for both banks and merchants is considerable, and banks charge a withdrawal fee at both ATM and counter. Charges for the use of cheques accrue to the consumer only, as do the costs for setting up stop orders. EFT debit orders however, attract a fee on the payer (consumer) side as well as on the payee side. In the case of credit cards, while a merchant discount (or fee) is levied, the customer may see the transaction as free, as typically no transaction fee, only an annual fee and interest, will be charged. A debit card

11 Card association membership is required to issue or acquire MasterCard or VISA cards. The large banks are typically members of both associations.

transaction attracts a merchant discount and as well as a customer charge per transaction.

An illustration of a typical “on them” or “off us” debit card transaction serves to show the exchange of fees between participating banks, merchant and customer. Here, the merchant A banks with bank A, while the customer B banks with bank B. Customer B makes a purchase from merchant A, which involves a customer fee, a merchant discount (fee), and interchange fee and a switch fee through Bankserv.

Shown in the diagram is the typical customer fee12 charged by bank B, which must cover, inter alia, the interchange and the PCH system operator (or Bankserv fee). Bank A charges the merchant a merchant fee. Hence the fees are charged to the consumer and merchant and these accrue to the two banks and the PCH system operator, respectively.

The amounts shown are illustrative values for a R100 debit card purchase. The figure shows the different cost components of the transaction, as well as the distribution of the revenue by various players. The example suggests that there is little apparent link between the switching cost and the fees customers pay. In this example, Bankserv earns only 2% of the revenue generated by the transaction; the rest is earned by the acquiring and issuing bank.

12 Note the customer fee, is derived from the average published cost for a current or transaction account on a pay-per-transaction basis.

Figure 2: Debit card transaction cost & revenue

Bank A Bank B Interchange fee

Switching fee PIN fee or transaction Merchant BankServ charge fee

Merchant a Cardholder b

Value Cost From To (based on R100)

Customer or Pin fee / transaction Consumer Bank B R2.3313 charge

Interchange Bank A Bank B R0.55

Bankserv/Operator Bank B Bankserv R0.0914

Merchant Fee Merchant Bank A R2.50

Total R4.83

Amount earned Share of Institution from revenue transaction

Bank A (Acquirer) R1.95 40%

Bank B (Issuer) R2.79 58%

Bankserv/Operator R0.09 2%

Total R4.83 100%

13 Average charge by big banks for a typical “cheque” or “transaction” type account. 14 Excluding the portion of the annual fixed Bankserv fee allocated to debit card transactions. This will be higher for smaller banks, per transaction, as they have far fewer transactions. All in a big bank might pay between 13 to 20 cents.

In the case of an “off-us” ATM transaction, which involves the customer of one bank (Bank B) using the ATM of another (Bank A), there is no merchant fee involved. In the table below, it is apparent that the cost to the consumer is considerably higher than for the “off-us” debit card transaction, above. For “off- us” ATM transactions, the fee is charged to the consumer only, as there is no merchant involved.

In this case, the issuing bank (Bank B) pays the acquiring bank, Bank A, which provides the ATM infrastructure. Once again there appears to be a 60/40 split of the revenue generated between the banks, with the bulk going to the issuing rather than the acquiring bank that provides the ATM infrastructure (and that carries the cost of ensuring there is cash in the machine). Bankserv earns around 1% of the revenue generated, in this case.

Table 3: “Off-Us” ATM Cash-withdrawal transaction Fee / Cost From To Value (based on R100)

Pin fee / transaction Charge Consumer Bank B R10.00

Interchange Bank B Bank A R3.90

Bankserv Bank B Bankserv R0.13

Total 10.00 ATM Charges: R3.25 + 65 c per R100

Amount Share of Institution earned from revenue transaction

Bank A (Acquirer) R3.90 39%

Bank B (Issuer) R5.97 60%

Bankserv R0.13 1%

Total R10.00 100%

The table below gives some insight into typical consumer transaction charges for different payment streams in South Africa. The data represent average transaction cost from a range of banks for equivalent account types. (The data used here are those for standard cheque account and transaction or savings account data as published on the banks’ websites for pay-per-transaction fees. Clearly this excludes “bundled” account offerings). The typical value assumed in all cases is R100.

Table 4: Typical Consumer Transaction Charges for the first R10015 Payments Cash withdrawals Cheque payments R5.81 Cash withdrawals / Counter R16.74 Debit order (external) R5.33 Cash withdrawals bank's ATM R3.89 Cash withdrawal “off-us” Stop order R5.97 R10.00 Cheque SASWITCH ATM account Banks' ATM (external accounts) R4.03 Branch payment R5.81 Debit card Point-of-Sale R2.33 Bank's ATM R2.90 Cash withdrawals / Counter R16.74 Branch payment R13.03 Cash withdrawals bank's ATM R4.08 Savings Cash withdrawal “off-us” account Debit order (external) R5.85 R9.49 Saswitch ATM Stop order R4.23 Debit card Point-of-Sale R2.48 Source: Various bank web sites: Pay per transaction fees as at March 2006

The data show that while there is some variation between the payment types, there are minimal variations between the charges for account types. Of course, what we cannot show here is the average transaction profile of clients, and one would need this to truly evaluate the relative costs between account types. However, the over-the-counter withdrawals and payments fees and the “off-us” or SASWITCH fee at another banks’ ATM, appear to standout.

It should be noted that the data in the table are simplified. In order to create such a table, we have had to make assumptions about equivalence of account types between banks and in some cases undertake fairly lengthy searches to find comparable data for transactions types. It is fair to say that while there is disclosure on these fees, it is fairly obscure for someone attempting to make interbank comparisons. Charges are typically bundled and dependent on a range of factors such as account type, minimum balance level etc., which affect various rebates and pricing options. It should be noted that the data in table 4 and 5 clearly exclude all other service fees and charges which accrue to account holders – such as cheque book fees, monthly fees, internet banking fees, etc. It is possible that the banks could provide further insights into their pricing for these transactions that would put a different complexion on the data.

15 Note that credit card costs are excluded here as typically there is no transaction fee levied, instead an annual fee is charged.

Table 5: Transaction Charges based on Average Transaction Values

Average Fee as a % of Transaction type Average transaction size the average (Cheque or current accounts) consumer fee in 2005 transaction size Counter Cash withdrawal R 1,000 R 20.90 2.1% ATM cash withdrawal "on-us" R 240 R 4.65 1.9% ATM cash withdrawal "off-us" R 240 R 10.77 4.5% Debit card payment R 220 R 2.46 1.1% Cheque payment R 13,400 R 24.00 0.2% EFT (Credit and Debit) payment R 5,700 R 20.50 0.4% Source: Average transaction sizes for 2005 – Bankserv (except for counter cash withdrawal – which is estimated). Various bank web sites; cheque account pay per transaction fees.

In the table above, the transaction fees customer fees for the average size of transaction are shown. Apart from the counter cash withdrawal, the fee that appears to stand out is the “off-us” SASWITCH16 ATM transaction, representing 4.5% of the value of the transaction. At the other extreme, the cost of cheque transactions appear to be low, and subsidised by other payment streams. This is particularly remarkable as interviewees have pointed to the high costs of cheque processing in the system.

In many other countries, consumers tend not to be charged directly for payment transactions (these fees may be collected in other ways such as lower interest rates). This kind of obscure pricing means that consumers will find it difficult to make the correct payment service choices as they do not know the associated costs. The South African consumer also has difficulties in making rational choices, since although transactions generally attract a fee, there may still be cross-subsidisation which obscures the relative costs of payment instruments. Debit cards, for example tend to attract a fee per purchase, whereas credit cards do not. This obscures the fact that the debit card is a more efficient payment stream. Improvement in disclosure will require not only better information on transaction fees, but also on the costs and interest rates associated with other banking services, on comparable terms.

As already illustrated above, there are a number of fees that may be identified in the payment system which lead to price effects. These fees include:

1. PCH system operator or switching fees. These are fees set by the automated clearing house (ACH) or switch - such as Bankserv, in the case of SA – and paid by the acquiring and issuing banks, depending on the nature of the payment stream.

2. Interchange fees. These include a carriage fee (paid to the acquirer by the issuer to compensate for the costs of acquiring and processing a transaction on

16 This terminology is a little misleading – as one would expect SASWITCH fees to be the fees charged by Bankserv, since the SASWITCH infrastructure is part of Bankserv. In reality, all Bankserv does is ensure hat the agreed interchange fees are correctly assigned to the acquiring bank in this case.

its own infrastructure) and the interchange fee (paid by the acquirer to the issuer for processing the transaction). Generally, the carriage and interchange fees are netted – and referred to as the interchange fee – as it is the latter that dominates. As already noted interchange fees are likely to be cost for small players but are in fact a significant revenue stream for large banks who dominate both the issuing and acquiring of payments.

3. Merchant fees. These are paid by the merchant to the acquiring bank, for its costs of processing, and exist in order to cover the interchange fee that the acquirer has to pay to the issuer. It is widely acknowledged that these fees are passed on to the consumer, not as a transparent fee for the use of debit or credit cards, say, but by the retailer adding a mark-up on all goods or services. This means that cash customers are effectively subsidising card users, as all customers pay the higher prices. Merchant’s fees are negotiated bilaterally between the merchant and the acquiring bank.

4. Customer fees/transaction charge. These are the fees paid by the consumer to the issuing bank for the processing of the transaction. Bank fees may be imposed on consumers for the services associated with payments and are done so on a commercial basis by the banks.

Overall it is important to note that there appears to be little relation between the PCH system operator fee and the charge that appears on the consumer’s statement, for example.

Internationally, investigations into the pricing of the payment system have focused on interchange fees on card transactions. For instance the United Kingdom has declared a dispute with MasterCard and Visa in respect of these fees, while Australia has begun to actively regulate interchange fees. The primary concern is that the interchange fees reflect market power rather than costs. In the United States the major retail associations have initiated a class action anti-trust lawsuit against both card associations and major banks in respect of merchant fees alleging “excessive interchange” fees as well as illegal price fixing of credit card transaction fees.

The report suggests that in South Africa there are also concerns about pricing in the payment system. Non-banks – who may be providers of infrastructure or payment services – or who may be users of the system complain that the big banks wield pricing power through the payment system. This is of particular concern where the large banks compete with non-bank players through their in- house operations in market segments that rely on payments system infrastructure (such as private bureaux and micro-lenders).

The report estimates that the revenue generated from direct payment system activity (by both banks and non-banks) was close to R31 billion in 2004, over 2% of the Gross National Product.

The greatest share of the payment system revenue accrues to the banks (they earn around 94% of the income from the activity) and the biggest share goes, not surprisingly, to the big four banks. While big banks tend not to disclose the operational costs associated with payment system activity, some smaller banks do. For example, one small bank shows that payment system activity costs them in the region of 4% of their revenue, for big banks, it is estimated to be more like 1%-2%.

Taken as a whole, the banking industry earned 54% of their income from non- interest activities (of which transaction based fee income is a significant part) in 2004. Based on the DI 200 returns, transaction-based fee income accounted for 38%, or R28,8 billion17 of banks’ joint income during 2004. Transaction-based fee income is seen as a proxy for payment system activity (although as the report warns, this may understate the income from payment system activity).

Recent research has underpinned the importance of payments as a source of revenue. From the data provided by the banks through the DI returns, it appears that transaction based fee income accounts for 69% of non-interest income and 38% of total bank income. This may be high compared to other countries (CapGemini quotes an average number of 33% of total income for European countries) although the basis of comparison is not entirely clear. The reporting of more detailed information by banks on their non-interest income and costs would be instructive here.

2.7 Anti-competitive outcomes of the NPS

The report identifies a number of features of the current payment system that contribute to anti-competitive outcomes – although there is not necessarily a prima facie case for anti-competitive behaviour. Rather these outcomes appear to be the consequence of uneven playing fields, legislation and regulation as well as the industry structure.

Any proposal on how to level the playing fields, how to introduce appropriate legislation and how to encourage an appropriate industry structure needs to take cognisance of the following:

• How is the proposal likely to affect the welfare of the consumer? While an existing, supposedly efficient system may seem to offer the consumer considerable benefits in that the benefits come at a low price, such benefits may be of a short term rather than long term nature if there are substantial barriers to entry.

17 The R31 billion mentioned above includes non-banks

• Are there identifiable trade-offs between the fairness of the system and administrative manageability? As in the case of a tax system, a very fair system may be difficult to administer. • What impact will the proposal have on settlement procedures, that is will it undermine the efficiency and inter-operability of the payment network and limit the ubiquity (that is acceptance and availability) of payment instruments? • The complexity of the ownership and control of the system. For example, our system has both elements of public and private ownership – such as SAMOS and Bankserv – and the overseer of the NPS also controls and manages the SAMOS system, while Bankserv is owned and managed by the banks. • No single change is a silver bullet to the anti-competitive outcomes. The changes required may be cumulative by nature.

The report underlines that a requirement for a sustainable payment system is that it is efficient. While efficiency may be a necessary condition for sustainability, it may not be sufficient, because an efficient system may be considered unfair by market participants. An efficient payment system enables settlement between market participants without apparent problems because it enables the participants to trust people that they have no obvious reason to trust. In spite of the trust thus generated, the payment system may not be sustainable if the participants consider the way in which the trust is obtained to be unfair. In other words market participants may perceive the system to be unfair because only a few select institutions are involved in the process, and only a few extract excess profits. The excess profits should attract new entrants into the system, but if the barriers to entry are substantial, access (and whittling away of excess profits) will be denied.

The ability of the banks to earn a comparatively high proportion of their revenue from the payment system is largely a consequence of their dominance of the retail banking sector, and speaks of the lack of alternatives in terms of the establishment of second and third tier banks. While proposed legislation potentially enabling new bank entrants was published for comment a year ago, there has been little apparent movement in terms of the enactment of such legislation.

The report suggests that there are barriers to entry for would-be banks and non- banks alike. Trust and systemic concerns preclude a pre-emptive opening of the payments space to all comers. Providing mechanisms for regularisation of those non-banks already participating in the payments space seems crucial, however. The allowance of some unsupervised participants, while prohibiting certain activity is in itself an anomaly. The regulatory authorities appear to have adopted a stance that suggests entry is limited to those whose stake in the system provides sufficient incentive to avoid recklessness. Hence since the reputation of banks is arguably most at stake, entrance is (in theory) restricted

to them. In the short to medium term, regularisation could be addressed by setting rules for the participation of non-banks in the non-settlement space.

Possible legislation which would allow for new bank entry could address participation concerns, without compromising the efficiency or trust considerations of the network. Over time, these changes may begin to affect the costing and consumer pricing involved.

While the banks argue that they price commercially for bank transactions, there appears to be little relation between the identified costs of payment system activity and the prices charged to the consumer. An in-depth evaluation of cost was beyond the scope of this research report and since these data are not published, cannot be accessed by a research process such as this. An in-depth evaluation of costs would require further inquiry. Hence while it is known that transaction-based activity is profitable for the banks, it is not known just how profitable. It may well be that some payment streams subsidise others. It is also likely that a significant component of the payment system cost claimed by the banks bears on their legacy infrastructure, branch network and overall staffing and operating cost rather than payments activities alone. A quick scanning of the press is sufficient to suggest that consumers feel they are being overcharged, but appear to lack ability for redress. This is a concern also held by end-users of the system and big corporations.

The lack of a transparent (and unbundled) price guide for consumers and the lack of an independent banking adjudicator to which consumer complaints can be directed has contributed to the apparent consumer resistance to high banking fees. (The absence of a market conduct regulator for the banks is a long-raised concern by commentators on the system.)18 In a country where there is considerable political pressure to improve the access of under-served consumers to financial services, the absence of these features is likely to be particularly keenly felt. This is an important consideration in improving the fairness of the existing landscape.

Key to the existing debates around pricing is the role of interchange and merchant fees and how they are determined through negotiation. The relationship between bilateral price negotiation and multilateral price setting needs to be probed. The change in the interchange fee for credit and debit card transactions some two years ago is instructive: On the basis of recommendations from a report commissioned by the banks, the interchange fee for both credit and debit card fees were reduced throughout the industry. However, while interchange fees may frequently be cited as a reason for merchants to pass a surcharge onto all their customers, the lowering of the interchange fee did not generate a noticeable change in prices to the consumer from the retailers or a

18 Market conduct falls outside the remit of the Registrar of banks and is not part of the remit of the self-regulator for the Payment system – PASA - or the NPSD.

change in the fees levied by the banks. Hence a reduction in costs attributed to payment system activity does not necessarily reflect in the prices.

Current proposals in respect of sorting at source or multi-acquiring (mainly by large retailers) seek to eliminate the interchange component as far as possible. In effect sorting at source results in all transactions being acquired and routed to the appropriate issuing bank – in effect all transactions become “on us” transactions. While this may in fact eliminate interchange, the international evidence in respect of this practice and its impact on end-prices to consumers remains mixed. In addition there are concerns that removing retail card transactions from the current regulated system may introduce systemic risks. In effect, unless the retail operator is properly regulated and required to undertake appropriate compliance reporting, the NPSD and the SARB in particular, would no longer see the entire retail volume.19

In general, the large banks and the smaller banks already in the system, argue that interchange fees should be set on a multilateral basis, but for different reasons. The large banks argue this way on account of logistic reasons. The small banks argue like this because they have no bargaining power. Other large players – such as the large retailers and the Post Bank argue that bilateral negotiations are best as they allow them to counter bank market power with their own. It is possible that the best outcome in terms of fairness for both consumers and smaller participants (including banks and retailers) would be to allow multilateral price negotiations, and to publish these prices and their changes so that consumers are informed and empowered. A multilateral price set in this way does not necessarily preclude bilateral negotiations, with the multilateral price the de facto ceiling.

The governance concerns about self-regulation of the payment association can be addressed by allowing broader membership of appropriate non-bank participants to PASA. This broader based membership - together with state funding perhaps - would enhance the independence of PASA. Arguably this would address both the uneven playing fields and the regulatory concerns associated with unsupervised participants – the stakes are raised for all participants and risky behaviour discouraged.

There is a need for a forum where a strategic focus on the domestic payment system can be undertaken. In such a forum, the costs and benefits of any innovation on users could be examined, and decisions could be made in a transparent way. Such transparency should improve both trust and fairness.

In terms of ownership of essential infrastructure, the report suggests that private ownership of the switch does not appear to be the primary cause of high

19 It appears that the SARB has lifted the moratorium on sorting at source by means of directive to banks in February 2006. The directive has not been made public however and nor has the reasoning associated with the change in stance.

bank fees – the switch fees appear in most cases to be insignificant cost items relative to bank revenue. In the long term, disruption of this essential infrastructure through ownership directives may dissipate that which contributes to SWAP and efficiency in the system, even though it may provide some short term consumer satisfaction. The proliferation of a number of proprietary systems as an alternative to Bankserv would not necessarily lead to lower prices if it had a negative impact on efficiency. However, the established principle that new operators may be permitted should remain. In addition, expansion of board participation (with voting rights) beyond the big four and Dandishelf to include the regulator or banking adjudicator, at least, could address the some of the governance concerns.

Since the completion of the Competition in South African banking report in 2004, the following have occurred:

• The Dedicated and Co-operative Banks Bills, which will allow for second and third-tier banks, were published for comment. • Barclays PLC, a foreign bank, purchased a majority stake in ABSA, one of the Big Four retail banks. • Provisions relating to the prohibition of preferential payment procedures will be included in the NPS Act once the National Credit Act comes into force. • The Mzansi account, for low-income consumers has been launched by the big 4 banks and the Post bank. However, the impact of these changes has not yet been felt in the market. There is some concern that in its present form, the Dedicated Banks Bill will not allow for sustainable bank entry. There has been no apparent impact on ABSA’s product range or pricing since the announcement of the Barclays deal. The termination of preferential preferences for new contracts will only become effective from the 1 July 2006, with the time period for existing contracts to be phased out by the end of 2007. As for the Mzansi accounts, while they have been marketed competitively, a standard interchange fee has been agreed by the participants for all transactions. In addition, the limited functionality of the account means that until recently low-income consumers with debit orders have had to retain their old account, hence incurring the fees on two accounts.

The discussion above suggests that the issue of competition in the banking industry is clearly neither simple nor one-dimensional. The report has shown that the features of the NPS have generated anti-competitive outcomes. Without impinging on the strengths of the system, regulators need to address the issue of providing level playing fields for all participants. Continued efforts to promote competition in the banking industry remain inextricably linked to efforts to address the issue of fairness in the national payment system.

3 Background to the present study

3.1 Rationale of the study

The purpose of a payment system is to transfer money - or a legal claim to money - from buyers to sellers. A payment system is a means to an end - a means of settling financial obligations securely and efficiently between debtors and creditors, or between originators and beneficiaries of payments.

An efficient and competitive payment system is associated with the speed, accuracy and security of these transfers, as these factors reduce the transaction costs associated with payments (Frankel and Shampine, 2005). Clearly the payment system affects a multitude of other markets, and “a country’s payment system is what makes its real and financial markets work” (Humphrey, Pulley and Vesala, 1996).

In 2004, Competition in South African Banking, a report commissioned by the National Treasury and the South African Reserve Bank (SARB) and partially funded by the Competition Commission, made the following recommendations with regard to the payment system:

• The principles of interoperability in the payment system and transparency of access requirement to the payment system should be extended. Access by second-tier banks to the payment system on competitive terms should be facilitated. • Penalty fees, charges for essential services or charges for services for services not open to competition should be on a cost-plus basis and open to regulatory oversight. • Government should prohibit any preferential processing mechanism for payments. • The Competition Commission should investigate the existence of a monopoly in the payment system.

Since 2004 the payment system legislation has been amended. Several complaints – either directly or indirectly concerned with the payment system - have been submitted to the Competition Commission.

The Competition Commission concluded that a comprehensive and comparative study into issues around the payment system was necessary. Following a process of open tender, FEASibilitY (Pty) Ltd and Prof Akinboade of UNISA were appointed to provide such a study, with distinct areas of work being specified. This report represents the research efforts of FEASibilitY. The research annex is the work of Olu Akinboade.

A payment system includes cash and non-cash payments instruments, electronic payment instruments and debit and credit cards. Like the banking system itself, the evolution of the payment system in different countries reflects historical and geographic factors. For example, the United States is unusual in its persistently high usage of cheques. Analysts explain this as a consequence of a highly unconcentrated banking system, where until the 1990s, banks were restricted to a single state or to a single office. This together with the sheer geographical size of the United States meant that payors and payees had accounts at different and geographically dispersed banks. In this environment, the only cost-effective way to make non-cash payment was by means of the cheque system (Humphrey, Pulley and Vesala, 1996).

Where countries have concentrated banking systems, a jointly owned and centralized electronic payments network for consumer bill payments, point of sale transactions and payments between businesses is more likely to evolve than where the system is highly unconcentrated with very many participants (Humphrey, Pulley and Vesala, 1996).

International evidence indicates no single international model or Payment System design, but certain trade-offs or compromises may be more appropriate in one setting than in another. The extensive use of cash, for example, tends to be associated with low levels of crime and a well distributed ATM network. Japan and Switzerland, which are generally associated with low crime levels have high cash usage compared to the United States and the United Kingdom, for example (Humphrey, Pulley and Vesala, 1996). Since the most trusted payment stream is likely to be favoured by consumers, this may shift over time and with circumstances. While some point to consumers shifting to non-cash alternatives like cheques20 or cards if they feel vulnerable to incidents of crime when withdrawing money from ATMs, for example, others may say that when the integrity of the Payment System is questionable, only cash will be accepted. Research shows that in general, there has been a growing trend towards electronic and non-paper payment instruments.

The cost of an inefficient or monopolised payment system can distort consumer and merchant choices and can drive a wedge between the total amount paid by the buyer and received by the seller, making underlying markets in goods and services less efficient. Interchange fees are a case in point. These are fees which are paid by the merchant, via his banker, when customers pay for goods by credit or debit card. This adds a cost to the merchant, who may add this mark- up to the price of all goods in the store. This implies that those who pay by cash subsidise those paying by card.

20 Although cheques may be made out as “cash”, in this report they are treated as a payment instrument distinct from notes and coin.

While the resource cost of a nation’s payment system may account for between 3 and 4 per cent of its GDP21, the full cost to the economy may be larger if the payment system is inefficient or controlled in such a way that monopolistic profits can be extracted.

As an essential part of a modern economy, the payment system has come under increasing regulatory scrutiny in a number of jurisdictions, including Europe, the United States and Australia, with major adjustments in the system currently taking place in Australia and the United Kingdom.

The issue of interchange fees has come under particular scrutiny and its effect on retail prices has been investigated by regulators in Australia, Israel, Mexico, New Zealand, Poland, Spain, Switzerland and the United Kingdom in recent years.

South Africa’s payment system works on the basis of same-day clearing and is frequently touted by its proponents as exceptionally efficient. At the same time, the control of key infrastructure is firmly held by the four big banks, and there have been recurring complaints about the barriers to entry. Some have suggested that this control has permitted the development of a sophisticated system that is world class. Yet others have suggested that there are fully functional alternatives to the current mechanisms, but which face barriers to entry.

It is against this international and local backdrop that the study has been undertaken.

3.2 Competition in South African Banking: Key findings

The Competition in South African Banking report provided an overview of competition concerns in the industry. The following section highlights the key findings of the report.

As in other countries, the banking industry in South Africa is the largest component of the financial system, and its functions impinge on all aspects of the economy. It is true that bank failure may impose high direct and indirect costs and banks need protection against systemic failure. However, there is no economic justification to exclude banks from the effects of competition policy. Weak competition in the banking sector will affect the cost of financial intermediation, incentives to save and invest, the pricing of risk and the extent to which risk is shared among players. Weak competition will also enable banks to earn excess returns which may leave potentially viable projects under-funded and allow a transfer of welfare from consumers to banks and their shareholders.

21 This is an estimate based on the cost of a paper-based (cheque) payment system, CapGemini (2005). Electronic Payment System may have lower social costs.

The report considered competition in the traditional way – that is in terms of the number of players and market share – but also examined it in terms of contestability and effective competition. A market is contestable if entry and exit barriers are low, in which case incumbent firms are restrained from exercising monopoly power because of the credible threat of new entrants. Even where there are a number of competitors in a market place, competition will be effective only if the consumer is able to make rational choices and exercise these choices at low transaction costs. The study concluded that the concentrated South Africa banking industry is not adequately contested in the retail and small business market segments and that certain features of these markets undermine effective competition.

The report concluded that South Africa’s profitable banking system is an excellent foundation upon which to encourage effective competition. South African banks have outperformed their peers in the Top 100 international banking fraternity over a sustained period. When compared with other South African non-bank firms, the variability of returns in the South African banking industry is low. This suggests that banks have greater ability to secure margins over the course of the business cycle.

The concentration levels of the South African banking industry are high, but not out of line with other emerging markets. However, it is in the market segments rather than at firm level that concentration is even more marked. For example, while the Big Four (ABSA, First Rand, Nedcor and Standard) accounted for 83% of the total deposits of the public in June 2003, they accounted for 92% of mortgage loans and 89% of bank financed instalment sales. Each of the Big Four has a scale monopoly (25% or more market share) in one or more of the retail market segments (credit cards, current accounts, mortgages or leasing and instalment sales).

The minimum capital requirement for banks is a barrier to entry and does not allow for nuanced business models involving small or regional banks and explains the lack of variety in the banking industry.

Greater participation by new entrants is also blocked by the requirement that only banks are allowed to participate in the clearing house activities of the Payment System and only banks may keep a settlement account with the SARB. A number of mechanisms in the payment-processing procedures favour account- holding banks and related parties. These mechanisms undermine competition and create disincentives for both bank and non-bank competitors to compete with the account-holding banks.

As regards effective competition, the ability of consumers to make rational choices is undermined as the full costs of banking services (including initiation and transaction fees and bundled insurance products) are rarely spelt out, which means the quoted rates for services often understate the costs of financial services. Bundling of products makes it difficult for customers to assess services and disguises cross-subsidisation and differential pricing.

International comparisons reveal that South African banks charge fees on more retail transactions than banks in other countries do and also usually charge higher fees. Although service charges should be covered, competition is key to ensuring correct product pricing and where there is market concentration, the fees charged may not reflect costs.

The access to finance and the quality and cost of service that small businesses receive from banks are key to their profitability and prosperity (and that of the economy). The lack of competition in banking restricts choice for SMEs and increases the cost of access to services. In comparison with individual clients, small firms pay a premium for access to financial services in terms of both interest rates and transaction fees.

The maintenance of a competitive environment is not amongst the stated objectives of the South African banking and payment regulators, yet it is regulatory changes that will determine whether or not the retail and small business markets become more competitive in terms of accommodating new entrants and new distribution channels.

If the lack of competition in certain market segments is to be addressed, improved disclosure will be necessary. On top of this, more and more players need to be active in the industry, and improved and alternative models for access to the payment system need to be available. Moreover, regulators need to promote competition. In particular, the introduction of improved disclosure requirements on banking services; the passing of enabling legislation for second- and third-tier banks; the promotion of entry of and competition by foreign banks and an investigation into the feasibility of implementing a narrow e-money directive enabling electronic transmission facilities by non-banks, would do much to improve the efficiency of the economy and enhance access to financial services.

The Competition in South African Banking report concluded that the national payment system required investigation, as a consequence of two strands of research. First, there appeared to be evidence that there were barriers to entry to an essential infrastructure and second, these barriers contributed to the high costs of banking for low and middle income consumers.

The following is extracted from the final chapter of the Competition in South African Banking (2004) report.

The market segment for lower-income earners and SMEs is generally under-served in South Africa. Low-income earners are usually confronted with high fees and charges and limited choice in terms of providers of basic banking services. The entry of second- and third-tier banks should allow competitors operating with radically different business models to enter the lower-income market.

The report pointed out that roughly half of South African adults do not use financial services and may be seen as financially excluded or unbanked. The unbanked will obviously include those whose income makes them ineligible for banking services, but it will also include some whose income qualifies them for such services. Conservatively estimated, 60% of low-income groups and 80% of the lowest income groups are without access to banking services.

For households, the implications of a lack of access to banking services are severe. It affects the ability of a household to receive government transfers, or to make payments or to accumulate cash surpluses for planned expenses or emergencies. Individuals who have no option but to carry cash are exposed to security risks. Lack of a vehicle for saving may result in low-income households resorting to very expensive short-term debt.

The cost of entry-level banking services together with the negative return on low-value savings accounts discourages the use of banking services and undermines wealth creation. Case studies of smaller banks show that it is possible to serve the low-income segment profitably. Although these initiatives remain relatively small scale, the entry of second and third tier banks should broaden their outreach. The report stated:

It is tempting to conclude that inadequate product design, weak service levels and high fees contribute to low- and middle-income consumers choosing to remain partially or fully unbanked, and the entry of second-tier banks, operating under different business models, may more adequately (and profitably) serve the needs of this group than do the big retail banks.

The report concluded that to provide services to very low-income earners, the Government needs to play both a facilitatory and a regulatory role. Direct involvement and subsidies should be considered only where the market cannot provide necessary services and should not be provided where the lack of outreach is due to high charges and inappropriate products.

The findings of the report in respect of the national payment system are found in Chapter six. These are:

o The South African payment system is a regulated responsibility based on safety and soundness; however, the objectives of risk reduction (and through it consumer protection) and maximisation of efficiency and effectiveness are also important.

o In terms of the National Payment System (NPS) Act only banks are allowed to participate in clearing-house activities and keep a settlement account with the Reserve Bank. o The lack of a tiered banking structure has resulted in a number of non-bank institutions participating in the payment system on a sponsored basis through one of the member banks. While this is an anomaly in terms of the NPS Act, this system is not uncommon in banking systems of the world. o From a value perspective, most payments are credit payments, whilst from a volume (or number of transactions) perspective, cash is clearly still king. o The challenge for the payment system is to develop into one that also caters for the previously unbanked sector of society. The payment networks of the major banks and the post office aim to bring 80% of the population within a 20 km radius of an access point into the payment system by 2008. o The demise of the smaller banks means that by the end of 2003, the Big Four banks accounted for virtually all the throughput of the payment system. o Establishment of second and third tier banks can deal with many of the competitiveness issues, arising from lack of competition in deposit taking, of the payment system.

Two other conclusions from the final chapter are also pertinent here:

o The ownership of and control over the national payment system, which constitutes essential infrastructure, is concentrated in the hands of the four biggest banks. It is possible that a complex monopoly exists, but a detailed investigation of this issue was not within the remit of the Task Group. o There are a number of mechanisms in the payment-processing procedures through which preferences are created in favour of account-holding banks and related parties. These mechanisms undermine competition and create disincentives for both bank and non-bank competitors to enter into aggressive competition with the account-holding banks.

Since the report has been published, there have been some changes within the banking industry which appear to address the concerns raised in the report. These include:

These changes have yet to impact the market. While there was a flurry of interest prior to and after the publication of the Dedicated Banks Bill in December 2004, research suggests that in its current form, the Bill may not contribute to sustained new entry of second tier banks (see, for example, FEASibility, 2005).

As for the Barclays PLC take over of ABSA, there is no apparent change in their product delivery of pricing to the market. The official announcement of the purchase was made in May 2005.

The termination of preferential payment procedures will only begin to take effect for new credit agreements from 1 July 2006, and will only finally be phased out for existing contracts by the end of 2007.

The Mzansi account has been introduced as a low-cost savings account by the big banks and Post Office. The uptake from the public was considerable with some 1 million Mzansi accounts opened within the first year. The Mzansi account has no monthly fee and some free transactions. However, the contribution of the account to better provision of banking services to low-income individuals is not entirely certain. For example, Mzansi accounts currently have no debit order facility (except for accounts opened with the Post Office). Hence customers with existing debit order facilities would have to retain their existing accounts, hence incurring two sets of fees. Through the Banking Association, the participants have agreed to a standard interchange fee for all transactions on the accounts.

3.3 Terms of reference

The aim of this report is to provide:

• An understanding of the role of the payment system in the South African economy. • A technical description of how it operates, the operators and ownership structures of the payment system. • An understanding of the regulation of the system and current and pending changes to the regulations. • An assessment of the pricing method used by operators. • An analysis of possible anti-competitive outcomes of the system. • Recommendations of measures that may be taken to address any anti- competitive effects.

The key components of this report are:

• An introduction An introduction to what a payment system is and what functions it performs in a modern banking industry. • A technical description of the S A Payment System and the regulatory environment A technical description (written in terms understandable by non-technical readers) of how the South African payment system works, who runs it, and who oversees its operation. Recent developments in the South

African regulatory and legislative environment are investigated. This is found in sections 4, 5 and 6. • Comparative Studies A comparison of the South African system with similar systems in other countries. Prof Akinboade has submitted this under separate cover. • An assessment of prices and the economics of the payment system An assessment of the charges levied by the operators of the payment system for particular services and for access is undertaken, and includes a discussion of the occurrence and appropriateness of cross-subsidisation and penalty charges. This is found in section 7. • Competition issues and the Payment System A discussion of the themes of the research and interviews. • Conclusion and possible measures A conclusion is provided on whether or not the payment system has anti- competitive outcomes, and if so, what these are. Possible measures that could be adopted to address anti-competitive behaviour in the payment system are discussed. This will form part of phase two of the project. • Recommendations Discussion here includes various recommendations, justified by reference to experience in other countries, and by reference to the expected benefits that would flow from the suggested policy changes. This will form part of phase two of the project.

With reference to the findings of the Competition in SA banking report, the study will provide an evaluation of the extent to which the banks control essential infrastructure in the payment system and the implications thereof. While this is not a comparative study on bank fees, the study will set out the sum total of payment system fees, such as merchant fees, switching fees and interchange fees.

3.4 Method

The project involved three phases: The first phase involved producing a draft document which was the outcome of broad consultation with the industry and regulators as well as desktop research. The second phase involved a consultative workshop process with the Competition Commission and identified participants. The comments and feedback of the second phase were used to review and amend the final report, the submission of which was the third phase of the process.

The following method was employed to achieve the aims of the study.

3.4.1 Phase I

• Introduction to the payment system

This section provides a review of the literature on the role of the payment system and evaluates whether or not it can be considered essential infrastructure. The discussion highlights different types of payment systems and identifies some of the key features and constraints of each. The section concludes with a discussion of the challenges facing payment systems world wide.

• Technical description of the system This section relies primarily on information gleaned by means of interview, but also makes use of documented descriptions of the national payment system in various reports, including the Competition in SA Banking report (2004). Interviews (based on a questionnaire) have been conducted with:

o The Payments Association of South Africa (PASA) o PCH System Operators: Bankserv, VISA and MasterCard o Payment systems directors in the Big four banks o SA Payments Strategy Association o National Payment System Department (NPSD) o Directors of smaller banks, including those that have recently entered the system as members o “Outsiders” - such as would-be dedicated banks o Those that work around the system, such as “EasyPay” - which facilitates third party payments without being a member o Those to whom clearing is outsourced, such as Direct Transact

Some 30 interviews, with some 45 individuals, have been conducted. These were between one and a half and two hours in duration and were designed to obtain detailed information regarding the operation of the system and the role of different players, the regulations of the system, the mechanisms and terms of access, the benefits of the system and the beneficiaries, an evaluation of possible changes to the system, interoperability and pricing mechanisms.

A questionnaire was designed to provide a framework for discussion at the interviews. Some sections of this questionnaire are universal; others are particular to a particular group of interviewees.

The process provided the information required to map the operation of the payment system and its participants and is described in section 4, 5 and 6.

• Regulatory environment This section comprises an analysis of the respective roles of the regulator of the system from the SARB, the National Payment System Department (NPSD), PASA (the regulator of the participants) and the operators.

A discussion of new (current and pending) legislation affecting the payment system and its regulation, as well as possible new participants are provided. The role of the payment system in ensuring more equitable access to financial services is also highlighted.

• Assessment of prices This section relies heavily on the outcome of interviews and specific questions relating to charges levied and the pricing mechanisms behind these. The inputs of the banks and operators (such as Bankserv) have been key here. Third party suppliers (who offer clearing services to small banks in the system, while adding a mark-up to Bankserv’s fees, for example) have provided additional useful sources of information.

The report sets out the industry costs and revenues of the South African payment system as well as transactions fees and the distribution of payment system revenue.

Phase I is concluded with an analysis of the anti-competitive outcomes of the system and possible recommendations.

• Analysis of whether or not the system has anti-competitive outcomes

This section is the culmination of phase 1. As a consequence of the research conducted, areas which are considered to be anti-competitive are highlighted and justified.

3.4.2 Phase II

Phase II involved consultation on the outcomes of the report by conducting a workshop with regulatory stakeholders. As a consequence of this, comments were received and further questions were identified, which were consolidated into the report.

3.4.3 Phase III

Following the presentation of the report to the consultative workshop, a final report was drafted that took into account comments received. The final report provides:

• An overview of the South African payment system, the role it plays, its participants and key features and constraints • A mapping of the operation of the system • A discussion of the operation and regulation of the system relative to comparator countries

• A description of the regulatory challenges, current and pending that could affect the system – particularly from the perspective of the competitive operation of the system • An evaluation of the pricing mechanism employed within the system and analysis of the key beneficiaries • Possible barriers to entry facing alternative and parallel systems • An analysis of the possible anti-competitive outcomes of the system • Measures to address these should they be identified and recommendations to the Commission.

Phase III was completed and published by the Commission in April 2006.

4 Historical and cross-country overview

The payment systems of most countries are a “privileged banking space” (Lietaer, 2002) as a consequence of the fact that banks are the only organisations with immediate and unmediated access to official clearing and settlement systems. However, much of the theory of banking has paid little heed to payments as an output of banking, along with taking of demand deposits and extending credit (Radecki, 1999).

The following section highlights the importance of the payment system to the functioning of the economy, provides a brief overview of the different retail payment instruments in South Africa and discusses the pricing of the different instruments. The final two sub-sections look at country variations in payment systems and the challenges facing such systems.

4.1 The importance of the payment system

Like many services (or essential infrastructure) in an economy, the importance of the payment system is often only obvious at a time of failure. In the same way that the power supply or a rail network is an important element for an economy’s functioning – its importance rarely comes to light except as and when it breaks down. For this reason it is necessary to spell out how the payment system affects the daily lives of all citizens and firms.

For an economic system to function properly, a payment system is required so that buyers can pay sellers for goods and services. In its most familiar form, cash operates as a payment stream, allowing for the physical exchange of notes and coin for goods and services.

As economies and technologies have developed, payments instruments have evolved, so that for example, cheques are a paper payment instrument which has been used as a substitute for cash. Other substitutes include electronic fund transfers (such as debit orders for standing obligations or once-off bill payments and disbursements for payroll or social benefits); and debit and credit card transactions. All of these payments instruments allow for payment and settlement of financial obligations.

Different payment instruments give rise to different payments streams, for which rules are generally set in terms of operations, items limits and so on, by the participating payment system members. The rules and operation of a payment stream are generally referred to as payment clearing houses (PCHs).

As payment instruments have evolved, so have the systems for clearing and settlement between banks on behalf of their account holders and their creditors. The speed, efficiency and seamlessness of payment system structures mean for instance that a municipal account can be paid by means of an internet banking

instruction or by means of a credit card, and the customer has the assurance that the municipality has received it and attributed it to the correct account, even though the process may take some three days to complete.

4.1.1 Security, efficiency and accuracy of the payment system

Regulatory authorities raise the importance of security, efficiency and accuracy in the payment system – for it is based on this that consumers and firms believe their payments instructions have gone through to completion. While for the most part, payment instructions can be re-issued if they fail, there may be crucial missed opportunities (for example in the case of equity purchase or sale) or a crucial chain of events set in motion by the failure of payment instructions. For example, an individual may believe that he has paid all outstanding traffic fines at his bank’s ATM, but be arrested for non-payment of fines the following evening in a road block. Clearly, the failure of payment instructions to go to completion can have harmful negative effects on the performance of the economy.

If the payment system were vulnerable to security breaches or if it were inefficient or inaccurate, the public would lose faith in dematerialised payment streams and revert to notes and coins. This would introduce a number of risks - as well as transaction costs – into the payment activity and would not be optimal.

4.1.2 Regulation of the payment system

Systemic risk may arise in the clearing and settlement process undertaken by banks. Systemic risk refers to a situation where a liquid and solvent bank can be so negatively affected by the behaviour of another bank and its customers that it can become illiquid. The classic case in banking is where the failure of one bank can lead to a run on other banks – pushing them into illiquidity and even, in some extreme cases, insolvency.

In a payment system, if one bank fails to honour the financial obligations resulting from the payment instructions during the course of a day, the net position of other banks may be so compromised that the clearing and settlement processes of the system can result in the failure of the system. This means that whereas consumers and firms believe their payment instructions have gone through to completion, this would not have been the case.

For the most part, systemic risk arises from within the real time, high value system (often referred to as the wholesale system) rather than for what is known as the retail systems. For this reason, the real-time high value systems around the world tend to be owned, operated and or regulated by central banks.

Retail systems comprise many low value payment transactions, and are the ones most consumers engage with. In South Africa, following the policy of the SARB that credit transactions is favoured above debit transactions, the high value real time transactions are defined as credit transactions greater than R5 million and these transactions are processed through SAMOS. Debit transactions (other than cheques) greater than R500 000 are not accepted for processing in the NPS. Chequest greater than R5 million are manually presented and individually settled ie SAMOS (See section 5).

The mechanisms, procedures and technology to ensure that the payment system does not fail (in clearing and in settlement) are high on the agenda of the regulatory authorities. Surveillance of payment system behaviour provides an early warning mechanism for supervisory authorities – in the case of Saambou, its liquidity problems were apparent in the payment system long before they were apparent in any statutory Deposit-Taking Institution (DI) returns.

It is not surprising that the SARB views a sound payment system as one of the pillars of financial stability. Indeed this view is fundamental to the rationale for regulation of the payment system, which is further discussed in the following section. But it is not only the security, efficiency and accuracy of the payment system that can affect the economy.

The pricing of payments is also important, as will be discussed in subsequent sections.

4.2 Payment instruments in historical perspective

The payment system represents an evolving set of payment streams or instruments that allows the settlement of obligations. While cash (notes and coins) is still widely used, other instruments such as cheques, debit and credit cards and electronic fund transfers (EFTs) can achieve the same outcome. What changes is the technology, the customer interface, the processes and risk involved, the pricing of the instrument and who bears the cost.

Over time, there has been a migration of usage from cash to cheque to electronic instrument (which includes cards and EFTs). Electronic funds transfers may be credit or debit transfers. An example of a credit transfer is a salary payment, and an example of a debit transfer is a debit order.

As technology has evolved, debit and credit cards have become more ubiquitous. Payments made by telephone, cellular phone and internet are also increasingly used and are termed electronic payment instruments. The technological development of payment streams has led to the possibility of non-bank technology companies providing payment services, which has contributed to the debate for access to the payment system and the regulation of non-bank companies.

Table 6: Payment instruments Cash Notes and coins.

Cheque A written order from one party (the drawer) to another (the drawee, normally a bank) requiring the drawee to pay a specified sum on demand to the drawer or to a third party specified by the drawer. Cheques may be used for settling debts and withdrawing money from banks.

EFT Electronic funds transfers may be credit or debit transfers. EFT Credit is the mechanism by which payer-initiated payments are facilitated (known as credit-push transactions) wherein the payer instructs "their" bank to pay funds to another bank or beneficiary e.g. salary payments, stop orders and internet payments. EFT debit is a mechanism by which the payee draws down specific values, as specified by the payee on authority of the payer. These are debit-pull transactions, an example of which is a debit order. Debit Card Card enabling the holder to have his purchases directly charged to either a credit line (similar to a credit card) or funds on his account at a deposit- taking institution (may sometimes be combined with another function, eg that of a cash card or cheque guarantee card).

Credit Card A card indicating that the holder has been granted a line of credit. It enables the holder to make purchases and/or withdraw cash up to a prearranged ceiling; the credit granted can be settled in full by the end of a specified period or can be settled in part, with the balance taken as extended credit. Interest is charged on the amount of any extended credit and the holder is sometimes charged an annual fee.

4.2.1 South African retail payment instruments

The following discussion looks at the retail payment instruments that individuals and households use, rather than large corporations. Hence cash, cheques, EFT and debit and credit card are discussed and the real-time high value SAMOS system, which is used for credit transactions exceeding R5 million22, is ignored for now.

Cash payments

Since 1963 notes have been printed locally by the South African Bank Note Company (Pty) Ltd., a wholly owned subsidiary of the SARB. The sole right to mint, issue and destroy coins was transferred to the SARB by the Act No 49 of

22 SAMOS was preceded by the South African Payment System (ZAPS) which was used to effect large-value rand-denominated interbank transactions in the settlement accounts of banks at the Reserve Bank. It is being phased out although there are still some bank processes that feed into this system.

1989. The South African Mint Company (Pty) Ltd became a wholly owned subsidiary of the SARB. Five note denominations are being printed and nine coin denominations are being minted, namely:

Notes Coin R10 1 cent R20 2 cent R50 5 cent R100 10 cent R200 20 cent 50 cent R1 R2 R5

By September 2005, the value of notes and coin in circulation in the hands of the public amounted to approximately R42 billion. This amount constitutes approximately 8% of the M1 monetary category, which also includes cheques and transmission deposits and other demand deposits. (SARB QB, 2005). It makes up only 4% of M3, which consists of notes and coin in circulation plus cheque and transmission deposits plus other demand deposits plus other short and medium-term deposits plus long-term deposits.

Non-cash payments

Cheque payments

By the mid-1990s, the banked community in South Africa was primarily cheque oriented in payment behaviour. This is no longer the case. The volume of EFT payments is now more than 4 times that of cheque transactions and the value of EFT transactions almost double that of cheques (Bankserv, 2005).

South African cheques are MICR encoded which are read by high-speed MICR reader machines. Payments by cheque accounted for approximately 35% by value and approximately 13% by volume of cashless payments by the end of June 2005. (These Bankserv figures exclude on-us transactions for some banks, which consist of cheques drawn on and deposited with the same bank.)

Cards

There has been a major growth in electronic funds transfer point-of-sale (EFTPOS) terminals, which provide a sophisticated network for electronic-card presentation to clearing banks. In excess of 90% of credit-card payments23,

23 In the text we adopt the general convention by creating the impression that payment can be made by the payment instrument including the credit card, strictly though, the payment instrument such as

previously done using paper slips, have been converted to POS payments. These networks are mainly owned by banks. Card-based payments can be effected by means of credit as well as debit cards. Withdrawals and deposits can also be made at automated teller machines (ATMs) of the major retail banks. When withdrawals are made and the drawer transacts at a different bank from his/her own bank, these ATM transactions are switched through SASWITCH.

Preliminary estimates show that there are approximately 24 million cards in circulation in South Africa of which 5 million are credit cards and the rest account-linked (debit) cards.

Credit cards. Credit cards which are affiliated to either VISA or MasterCard and are issued with a pre-set credit limit. The card account is a normal bank account. Real-time credit card authorisations are also conducted via SASWITCH. Card- holders may choose to settle the total amount of the purchase with the bank before the expiration of 30 days or pay off a portion (normally a minimum of 5- 10%). Interest is paid on the amount if it is not settled after 30 days. A budget facility is also available on certain credit-card schemes with periods to pay off instalments normally ranging from 6-48 months. The interest charges on these credit-card facilities are normally higher retail rates. The volume of credit-card transactions processed through SASWITCH amounted to 95.8 million for the year ending June 2005 which represents annual growth of 19% on the previous year. The value of credit card transactions processed, which amounted to R 53.1 billion over this period is 22% higher than the previous year.

Debit cards. Cash dispensers and ATMs are distributed throughout South Africa and are used extensively to withdraw cash and to effect numerous banking transactions via debit cards – for example, to transfer funds between a customer’s accounts and to deposit funds. Real-time debit card payments are also facilitated. Debit card payments for fuel sales are being introduced via point-of-sale devices at petrol stations.

Electronic instruments

Direct debits and credit

Electronic funds transfer (EFT) direct debits are usually used for payments of a regular nature, for example, insurance deductions, telephone, electricity, water and hire-purchase payments. Direct credit transfers are used for a wide range of applications, from the transfer of low-value amounts for individuals, low-value credit card is merely the instrument via which a payment can be arranged and does not in itself constitute the payment. The payment takes place when the means of payment (M1) is transferred, that is when the bank credits the account of the payee. A month after the consumer has walked out the shop, the cardholder repays the bank the short-term loan granted through the credit card mechanism. The definitions of M1, M2 & M3 make no reference to credit cards. An increased use of credit cards leads to an increase in the velocity of circulation but has no direct effect on the money supply.

retail payments and salary and pension payments. Banks, the government and large corporations normally utilise this form of payment. The volume of EFT transactions processed through BANKSERV amounted to 492 million for the year ending June 2005, which amounted to R2,678 billion in value.

4.3 The price of payment instruments

The price of different payment instruments varies as does the incidence of costs. However, the price of each instrument should be seen relative to its respective risks, as is highlighted below:

• Cash: While cash may appear to be a free payment instrument, it typically costs banks (and firms) to move cash, to ensure that ATMs and other cash dispensing machines are loaded with cash and so on. In South Africa, the costs of cash are exaggerated by the need for insurance and enhanced security as a consequence of frequent and costly cash-in-transit heists. Hence for example, one major retailer indicated that their cash business costs them between 15 and 23 cents per R100 to cover these costs. Hence it is clear that in South Africa, in particular, this is not a costless payment instrument. • Cheques: There is no explicit merchant fee associated with cheques, and the cost accrues to the consumer – either through an explicit charge or lower interest return. However, what makes this a less than perfect payment instrument is the risk of fraud, which undermines the acceptability of cheques. • EFTs: There are charges associated with setting up these credit or debit transfers. They fall on the initiator of the service and represent low risk transactions as they will only be initiated if there are sufficient funds (unless there is an overdraft facility on the account). Penalty fees for insufficient funds fall on the account holder. • Debit cards: Attract both merchant fee and customer charges, but have the advantage that as real time transactions, they carry little risk and are guaranteed, with an audit trail. This clearly makes them less risky than cheques, however, they are not associated with an automatic line of credit (unless an overdraft has been arranged). • Credit cards: Attract a merchant fee, but typically not a customer charge per transaction (although an annual fee is charged24). These are also secure transactions and have the advantage over debit cards that they supply an automatic line of credit.

Research on the relative interchange fees on debit and credit cards, has suggested that debit cards are a much cheaper payment instrument, certainly

24 In countries such as the UK, an annual charge is unusual, as a consequence of competition in the credit card sub-market.

for the merchant. However, the pricing of cards to the customer obscures the actual cost; since the consumer is not charged an explicit fee for a credit card transaction, but is for a debit card transaction, credit cards tend to be favoured by consumers and the perverse outcome results that the more expensive instrument is more widely used. In general the efficiency of the payment instrument is obscured as the underlying costs of producing these services are not reflected in the prices paid (Humphrey, Keppler and Montes-Negret, 1997).

In South Africa, customers are typically charged a fee for each payment transaction (although these are not always explicit when services are bundled). In many other countries, consumers do not explicitly carry the costs of these payment instruments (instead they may earn no or low interest on accounts). For example, in South Africa, a consumer would typically be charged for an ATM withdrawal, whereas a consumer in Thailand would not be. Of course, it is not only the customer that may pay a fee. In most countries, including South Africa, the merchant or store keeper pays a fee for debit or credit card transactions for acquiring the transaction, for example. This charge may be passed on to consumer in the form of higher retail prices.

These themes are further explored in the sections below.

4.4 Country variations in payment systems

This discussion provides a brief overview of a few key features of the inter- country differences regarding payment systems.

4.4.1 Regulation model and role of the Central Bank

Table 7: Supervision of payment systems – international country comparison Corporate Governance of payment Role of the Central Bank & other participants in associations. regulation Country/ Source Australia Australian Payments Clearing Association APCA oversees and manages development and APCA is a limited liability company with a operations. board of 11 directors drawn from its shareholders – banks, building societies and The Reserve Bank of Australia (RBA) plays three credit unions and the Reserve Bank. Non- important roles: executive directors’ term of office expire • Regulator. The Bank’s statutory objective is to after two years. Director appoints the promote efficiency and stability of payment chairman. CEO appointed by owner systems and therefore has direct interest in retail members. payment systems. Members’ influences are largely determined • Provides facilities for final settlement on the basis of clearing system volumes • Participates in the system as bank to government. rather than institutional status. RBA works closely with the Australian Prudential The RBA has some influence over some Regulation Authority (APRA). APRA has one systems because of being a shareholder in representative on the RBA Payment Systems Board. some private clearing arrangements. Australian Competition and Consumer Commission (ACCC) & RBA signed Memorandum of Understanding to ensure close coordination.

Corporate Governance of payment Role of the Central Bank & other participants in associations. regulation Country/ Source Council of Financial Regulators is a high-level forum for coordination & collaboration to ensure efficiency and effectiveness of regulation. Financial Sector Advisory Council advises the Federal Treasurer on financial sector developments and policies.

Banking Ombudsman facilitates resolution and disputes among banks and customers that are related to payment systems. Canada Canadian Payments Association (CPA). Board Bank of Canada has regulatory oversight of payment of Directors: 16 members – 6 elected by clearing and settlement systems that pose systemic bank class, 2 by centrals & 4 by other risk, however interprets its authority more in relation membership classes, 3 by Minister of to large-value & not retail. Central Bank participates in Finance. The Chairperson is an official from private clearing arrangements. the Bank of Canada Canadian Payments Act, set out legal framework Framework of Rules and Standards governs the exchange of payment items Payment Clearing and Settlement Act, 1996 gives Bank of Canada responsibility for oversight of clearing & settlement systems. Ireland New recommendations advocate the Payment System characterised by high degree of self- widening of the Irish Payment System regulation on technical standards and operational Organisation (IPSO) Board to include non- matters. financial stakeholders. Current structure raises competition concerns. General oversight lies with the Central Bank & Financial Services Authority of Ireland (CBFSAI) (CB & Clearing companies to be re-established as FSAI merged in 2003). CB does not engage in committees under a single company. detailed or intensive regulation. It does, however, Independent chairman to be appointed and regulate the impact of costs payable to existing non-bank stakeholders will be brought onto clearing company member for facilitating the entry of the Board. These will include consumer new clearing company members. representatives and large-volume users, such as utility companies who bill customers Central bank: Member of IPSO & IPCC Boards. Acts on a monthly or bi-monthly basis. as central clearinghouse for inter-bank payments. Brazil BCB (Central Bank of Brazil) BCB (Central Bank of Brazil) conducts oversight & regulates activities of system operators, authorizes the functioning of the system & applies sanctions. Mexico Banco de Mexico Banco de Mexico responsible for regulating, organizing and controlling own payment systems. Also oversees self-regulated private systems. Have full powers to oversee all payment systems and to impose sanctions. UK APACS (Association for Payment Clearing Bank of England has no regulatory role but has general Services). Members responsible for network oversight to ensure compliance with best practice as development sit on BACS & CHAPS’ Boards. regards robustness and resilience.

Governance structure ensures strong role for The Financial Services Authority (FSA) supervises self-regulation. settlement houses.

Central Bank is a shareholder in some of the Office of Fair Trading in process of investigating private clearing arrangements (same as competition & their role. Australia). Sources: BIS, 1999, APCA website, Reserve Bank of Australia, 2005,Canadian Payments Association, 1997, 2003, 2005. BIS, 2003.Competition Authority, 2005a and b. World Bank, 2004. Central Bank of Brazil website. Central Bank of Mexico.OFT, 2003a and b, 2005a and b.

The above table examines in broad terms the corporate governance of payment associations and the role-players in the regulation of the payment systems. In most cases, the payment associations are made up of participating banks, but the influence of the central bank in the association may be smaller or larger. For example in Australia, Canada, Ireland and the UK, there is central bank

representation on the payment association. In Brazil and Mexico the payment associations are controlled by the central bank.

There is more than one international model for regulation of the payment system operation – those that are regulated, supervised and controlled by the central bank (such as in Brazil and Mexico) and those that share or transfer these responsibilities in part or whole to industry associations, such as APCA, CPA and IPSO in Australia, Canada and Ireland, respectively. These banking member associations exercise self-regulation; although the central bank will have oversight of the payment system, it is not involved in the day-to-day functioning of the retail system. But arrangements in Brazil and Mexico suggest that the powers and potential influence of central banks over retail payment systems is potentially far greater. Australia, Mexico and Thailand are all countries where the central bank or regulator has intervened in terms of interchange fees and pricing, for example.

Where there is high reliance on self-regulation, the member associations such as in Australia, Canada, United Kingdom and Ireland, set rules for participation. The extent to which this might be viewed as a closed shop has much to do with the nature of the membership and the extent to which it extends beyond banks and their associations. In Ireland, this has become an explicit focus.

In terms of the role-players regulating the payment system, the central bank usually has at least an oversight mandate. The oversight role usually includes regulation to the extent that it affects stability. Hence, the central bank will have some control of the real-time high value system in its respective country.

4.4.2 Membership of payment system

In the table below, the membership of the payment system is explored in more detail. It appears that countries can be divided into those that restrict membership of the payment system to banks and those that allow non-bank entities membership.

Examples of the former include South Africa, Zambia, Mexico, the United States and Ireland while Australia, Canada, France, Brazil and the United Kingdom are examples of countries where non-bank entities have membership of the payment system. Membership of non-bank entities is generally reserved for regulated firms – in most cases non-bank financial institutions - such as trust and loan companies and insurers in Canada, finance companies in France and building societies in the United Kingdom. Australia’s membership is somewhat broader than this, including non-bank financial firms such as credit unions and non- financial firms (they currently have one retailer with participating payment system membership).

Where non-banks are permitted, membership is typically graduated in these countries. Examples of this include Australia where there is participating membership (banks, building societies, credit unions and even retailers), owner membership (firms involved in the payment clearing system) and associate membership (other interested parties). There are 88 members in all. Other systems are less nuanced, such as in Canada where there are direct clearers (of which there are 11) and indirect clearers (of which there are 108). The payment clearing houses in the United Kingdom allow for settlement members, which must hold an account at the Bank of England, and indirect members – of which there are some 425 in the high-value clearing house. The table below sets out some of this detail.

Table 8: National Payment Systems – Composition of Membership Country Name of Payment clearing Membership of Payment Association systems / Automated system / clearing system Clearing Houses (ACH) Australia APCA (Australian APCA manages 5 clearing 3 types of membership: Payments Clearing systems: Australian Paper Participating; Owner & Association) Clearing System (APCS); Associate membership. Bulk Electronic Clearing System (BECS); Consumer 88 members in all Electronic Clearing System (CECS); High Value Clearing Members are banks, System (HVCS) & Australian building societies, credit Cash Distribution & unions and other Exchange System (ACDES) institutions and companies participating in APCA's five Payment clearing systems payments clearing systems. independent of APCA include credit cards & BPAY Other interested groups or system individuals may join as associate members. Canada Canadian Payment CPA owns & operates two Current total 119 Association (CPA) major systems: Automated 1 Central Bank, 62 Banks Clearing Systems (ACSS) & 15 Centrals the Large Value Transfer 25 Trust & Loan Companies Systems (LVTS) 16 Other financial institutions The United States Bulk Exchange (USBE) is used Members are: The Bank of for clearing payment item in Canada; all banks; credit US dollars. union centrals, federations of caisses populaires, trust companies, provincial savings offices, life insurance companies, securities dealers and money market mutual funds.

11 CPA member financial institutions, referred to as Direct Clearers, handle the clearing and settlement of payment items for their own customers, as well as for customers that maintain accounts at the other financial institutions, known as Indirect Clearers.

(The Bank of Canada is also included among Direct

Country Name of Payment clearing Membership of Payment Association systems / Automated system / clearing system Clearing Houses (ACH) Clearers.) UK APACS (Association APACS manages the major Any supervised institution in for Payment United Kingdom payment payments industry (Banks, Clearing Services). clearing systems: CHAPS building societies, public Established in 1985 for credit transfers; BACS authorities, government for bulk clearing of owned companies). electronic payments. BACS Membership is open to separated into 2 companies clearing banks, Card ie BACS Payment schemes Payments Group, Cash Ltd and Voca Ltd. Services, City Markets Group. Cheque & Credit Clearing BACS, CHAPS & CCLS have (CCSL) for cheques and two-tiered structures / paper credit clearings – all systems: BACS has two- are member-owned & not tiered structure of for profit. settlement and “indirect” members. Settlement members provide access to “indirect” members through a sponsoring relationship. Banks must hold an account with Bank of England in order to join BACS.

425 indirect members are connected to CHAPS Sterling and 100 to CHAPS Euro.

LINK ATM Network is open to financial institutions that are either Card Issuers or ATM deployers. Ireland Irish Payment ATMS for cash payments. CBFSAI member of both Services OPSO & IPCC. Organisation Cheque payments on a (IPSO) bilateral basis & final Five credit institutions own clearing take place under & operate their own ATM the auspices of IPCC and networks. the CBFSAI respectively. Access to the Laser card Two main international schemes is by means of payment systems are VISA membership of Laser Card & MasterCard. Services Ltd.

Same terminal is used for Laser Card (debit cards) as for credit cards Brazil – BCB (Central Bank Five: Banco de Brazil operates reform is of Brazil) conduct • CIP (Interbank and regulates COMPE. ongoing. oversight & Payments Clearing Participation in the COMPE regulate activities House), non-profit civil is mandatory for institutions of system association. taking demand deposits. In operators, • TecBan (Banking December 2002 there were authorize the Technology 145 such entities. functioning of the Corporation) for CIP: By Dec 2002 system system & apply settlement of was composed of 102 sanctions. transactions for ATM associated banks. network & retail In December 2002, STR operations. (Reserves Transfer System) • RedeCard & VisaNet, was composed of 152 which settle credit and participants that include debit card transactions BCB & National Treasury • COMPE, clearinghouse Secretariat, mandatory for for cheques and credit bank reserve account transfers. holders.

Country Name of Payment clearing Membership of Payment Association systems / Automated system / clearing system Clearing Houses (ACH) Participants are commercial banks, universal banks with commercial bank activities, saving banks, cooperative banks and credit union and PostBank. In December 2002 there were 1612 entities with 77.3m accounts. Mexico Banco de Mexico Banco de Mexico owns & SAIC handles current Reform responsible for operates two electronic accounts that banks & other since 1995 regulating, systems for large-value financial institutions such as & to be organizing and payments – SAIC (Account brokerage houses, mutual completed controlling own Holders Services System & fund management firms, by 2005. payment systems. SPEUA (Extended AFOREs and some insurance Also oversees self- Electronic Payment companies hold at the regulated private Systems). central bank. Payment systems. Have full CECOBAN (Banking transactions made by third powers to oversee Clearing Centre offers parties or on their behalf all payment countrywide clearance of may not be processed systems and to cheques. through SAIC. No clearing impose sanctions. SICAM (Clearinghouse agent, settlement agent is System) operated by Banco Banco de Mexico. de Mexico clears the Only banks have access to payments that CECOBAN the SPEUA. SPEUA has no processed. clearing agent, settlement Visa & MasterCard are agent is Banco de Mexico. principal operators of debit CECOBAN clearing is the & credit cards. Major agent for SICAM and its retailers alo offer payment settlement agent is Banco cards, but can only be used de Mexico. on own premises. CECOBAN belongs to Three ATM network. Two commercial banks by Dec largest banks have own 2001, 44 banks were networks, third is controlled shareholders. by PROSA and used by Payment cards are operated smaller banks. & cleared by three PROSA handles transactions operators (2 major banks & made at EPFTPOS POSA), settlement agent is terminals. participating commercial bank Zambia. In Zambia Clearing Two clearing houses for Transitional Zambia process of House, run and cheques, one for local Clearing House is operated being managed by the currency, the Transitional and managed by the reformed. Bankers Association Zambia Clearing House, Bankers Association of of Zambia. and one for foreign Zambia with ten operating currency, operated by the centres. Bankers Association of Participation & membership Zambia. in the Clearing Houses is set in the Rules of the Clearing system is paper- Transitional Zambia based with a manual Clearing House. exchange of instruments,. All participant banks meet 22 registered banks at clearing centres and commercial banks, one exchange paper. Purpose of Savings Bank, one clearing house is to Cooperative Bank & three facilitate exchange of paper building societies, six multilaterally, determine specialised non-bank and agree upon the net financial institutions and the settlement positions. Post Office. Clearing process is manual. Settlement is through the central bank books under advice from the Controller of the Lusaka Local Clearing

Country Name of Payment clearing Membership of Payment Association systems / Automated system / clearing system Clearing Houses (ACH) House. Source: Country specific websites, BIS

4.4.3 Ownership of infrastructure

Payment system infrastructure may be privately or publicly owned, or some combination thereof. Private ownership of payment system infrastructure would include, for example the ATM machines or POS infrastructure and the network that links ATMs and banks including the automated clearing house or houses (ACHs) – such as Bankserv in the case of the SASWITCH network, for example. Typically, the high value, real-time network (also referred to as the wholesale system) is managed and or owned by the central bank, as this is a systemically important payment system and is seen as the backbone of the NPS (Cirasino, 2005).

Ownership of retail or low-value high volume networks varies from country to country. The number of clearing banks and the ownership arrangement of the retail ACHs appear to be related. In countries with relatively few clearing banks, ACHs tend to be privately owned by the clearing banks, but where there are many direct clearing banks, such as in Germany or Italy, they are owned by the central bank25. In a few countries, there is joint ownership between the banks, the central bank and the payments association.

Table 9: Ownership of ACHs – international country comparison Country Processing by Owner/Manager No. of Automated participants Clearing Houses (Direct in brackets if different) Denmark Retail clearing Banks 166 (63 direct) Germany RPS Central Bank 2 075 DIAS Banks, Central Bank & 35 Payment Association Greece ACO Banks, Central bank & 58 Payment Association France SIT Central Bank, Banks & 640 (15 direct) Payment Association Italy Retail Central Bank 157 Netherlan Interpay Banks 73 ds UK BACS Banks 62000 (14 direct) Bangirot Banks 18 Sweden Dataclearing Banks 18 Source: ECB Blue Book, 2005

4.5 Challenges facing payment systems

There are a number of challenges facing payment system worldwide. While systemic risk remains a key concern for many countries - so that for example large value payments (such as cheques) are still being processed in relatively risky systems, this is not the key area of concern in this report. Instead the

25 Netherland’s Interpay and the UK’s Voca, appear to be exceptions, but their numbers are inflated by the direct connection of corporate entities – with the number of clearing banks still relatively low.

matters highlighted below are those that have to do with issues that relate to barriers to entry, participation and pricing.

A number of trends are apparent, including greater consumer awareness as a consequence of internet services and disclosure. Greater technological ease in delivering payment services has contributed to the debate regarding participation of non-banks. Retailers are becoming increasingly resistant to the fees paid to banks and in some cases they are getting support from regulators. Regulators are increasingly investigating the consequences of the payments space as one of privilege for the banks. These trends are explored in the discussion below.

4.5.1 Participation of non-bank players in the payment system

In a recent World Bank presentation, restricted access of payment systems to few participants, and uncertain exit criteria were highlighted as shortfalls of payment system worldwide. Lack of transparency in governance arrangements and an absence of appropriate fora for system participants to express their needs was also raised as a concern (Cirasino, 2005).

The supervisory or advisory boards of payment systems typically have no representation at all from outside the banking industry and specifically no customer representation, be it corporate or individual (Lietaer, 2002).

Technology has done much to undermine the exclusive preserve of payment services by banks, with IT firms able to mimic these services – often at lower cost. Given the advances in technology, lack of access by non-bank providers in retail systems can inhibit wide availability and efficient distribution of instruments, which in turn may impact negatively on the underserved population (Cirasino, 2005).

4.5.2 Pricing and interchange

Increasing consumer awareness borne of greater ease in comparing bank offerings has been associated with a more active consumer lobby. In more developed countries, this has lead to political campaigns for free payments, but in countries with a less active consumer lobby, lack of transparency and frustration remains the order of the day:

In many cases, conditions applied to payment services are not transparent nor is it clear to the stakeholders and the public the policies pursued by authorities. Banks and other financial institutions are not forced to provide information to the public on the services they offer in the payment system, and nor are the general public able to resort to a bank’s Ombudsman and/or to the central bank and/or the consumers’ protection agencies for resolution of conflicts related to payment services (Cirasino, 2005)

Even in developed countries, lack of transparency in terms of a pricing policy that reflects costs can lead to an inefficient outcome, with consumers misled as to the cheapest and most efficient service. For example, in the Netherlands, cash continues to predominate in terms of the volume of payments made by its citizens. In general, costs involving electronic payment instruments for POS payments are relatively low compared to paper based payments, such as cheques or cash (Jonker, 2005). Dutch consumers have no way of assessing the costs associated with payment behaviour as payments instruments appear to be “free”, with no explicit charge. Banks appear to compensate for this through indirect and hidden costs and cross-subsidisation, but the lack of price disclosure has lead to a less than efficient social outcome as the costs of payment systems is higher than necessary (Jonker, 2005).

Consumers need to understand the nature of the services they are receiving and they need to be more cogniscent of the value of these services relative to their prices. This can only occur to the extent that there is a clearer disclosure of prices to the consumer. In economies around the world, consumers cannot make rational choices regarding payment service choices as they do not know the associated costs and prices.

One commentator writes:

The time for a return to truth in costs and pricing may indeed be nearing. The current patterns of cross-subsidisation are so pervasive that even bank management itself may not know where costs and revenues are really being generated in Payment Systems. Particularly perverse are attempts at recovering costs on legacy paper systems (eg. checks) by penalising the cheaper electronic delivery mechanisms. Such policies give the wrong price signals to consumers, promoting the older inefficient systems that are not favourable for the banks themselves, and that ultimately the consumer has to pay for, even if it is through the back door. Lietaer, 2002

The improvement in disclosure will require not only the better information on transactions fees, but also on the costs and interest rates associated with other more traditional services, in comparative terms. A recent study on pricing of bank products in the UK, suggests that a monopolistic competition model is used with bargains and rip-offs. One of the key reasons it attributes to lack of widespread switching by consumers, even as new entrants offer retail products, is the failure of banks to provide comparable information for consumers. To the extent that consumers’ view payments services as part of their current account package, unless there is an ability to select the account appropriately, transparency in payments services will continue to be undermined.

The merchant lobby regarding the interchange fee is on-going, with merchants complaining about a lack of competition in the banking arena constraining their choices in terms of acquiring banks (CapGemini, 2005)26. Typically, the merchant fee paid to the acquiring bank is passed on to the card issuer on a per- transaction basis, and is set by the credit and debit card networks. While some believe that the interchange fee is unjustified, banks argue that issuers would not issue cards if there was not some form of income to cover the payment guarantee and processing costs involved.

The regulatory authorities in some jurisdictions have become involved in payments pricing. The Reserve Bank of Australia is currently regulating interchange fees. The European Union, the United States, the Netherlands, Mexico and Spain are currently scrutinising and debating fees (Weiner and Wright, 2005).

These investigations may lead to some kind of intervention or moral suasion from the payment authorities. It is this trend which has led some to conclude that payments revenue for banks is likely to shrink, at least to some extent (CapGemini, 2005).

4.5.3 Supervision and oversight

Renewed interest in payment system structures around the world has stimulated debate on the appropriate oversight roles and the institutional structures and responsibilities. The Cruickshank report, for example, felt that the institutional structures within the FSA and the Bank of England were not able to deal with the market failures identified, as consumer protection and competition were beyond its remit (Cruickshank, 2000). It suggested that a licensing regime be established for all participants in the payments arena and the establishment of a Payments Commission charged with supervision of the payment system licensing regime. While these recommendations have not been adopted by the United Kingdom government, there is an increasing sense from the literature that a greater consumer focus in payment system is beginning to dawn.

This has led the World bank, for example, to suggest that:

Central banks do not verify that individual payment systems satisfy user needs as well as risk and efficiency requirements through appropriate interventions both at the development stage and during the on-going system implementation and operational phases… nor does the central bank collect and distribute relevant statistical information to demonstrate the use being made of each system and the extent to which the systems are stratifying end-user and other market needs. Cirasino, 2005

26 An acquiring bank is the bank through which the merchant processes all transactions of a particular type, eg debit cards or credit cards. In South Africa, for example, each merchant is required to have an exclusive arrangement for all Mastercard or Visa payments with a single bank.

Together with lack of co-operation among authorities, between authorities and stakeholders and among stakeholders, and the lack of joint bodies to address problems of common interest, there is a concern that there has been a failure to design reforms according to a strategic approach in the best interests of the economy (Cirasino, 2005).

4.6 Conclusion

The secure, efficient and accurate functioning of the payment system is crucial to all modern economies. At the same time, the possibility of systemic risk in the real time high value payment streams exists. These factors underpin the involvement and regulation of central banks in their respective payment systems.

Given the traditional link between banks as deposit takers and payment providers, the banking industry dominates payments activity throughout the world. However, some variations are evident, with some countries providing for non-bank membership. In some countries the hegemony of banks over operators has been balanced by central bank ownership or interest, or by changes in the governance structures of such entities.

Challenges related to the protection of consumers and to the promotion of competition include: participation of non-bank players, pricing and interchange and supervision and oversight. As will become apparent in the subsequent chapters, these themes have resonance in South Africa.

5 Regulation of the national payment system

Critical to any assessment of competitive implications of the NPS in South Africa is a sound understanding of its history, its components, its participants and the regulatory system in operation.

This section presents an overview of the history, regulation and composition of the national payment system in South Africa. The section concludes with a discussion on the current payment system value chain.

5.1 Defining the NPS

A key issue in much of the current South African debate is the lack of agreement on the appropriate definition of the NPS. Indeed many of the opinions offered in respect of the functioning or competitive nature of the national payment system hinge on a partial understanding of the NPS or on an exclusive focus on only one component or player within the system, most typically SAMOS or Bankserv.

It is therefore essential to establish at the outset that in discussing the national payment system we are dealing with a complex system that comprises a number of technology networks, payment instruments, participants, distribution channels, processes, institutions and rules.

According to the Bank for International Settlements (BIS) a payment system consists of a set of instruments, banking procedures and, typically, an interbank funds transfer system that ensures the effective circulation of money. It further describes a payment as the payer’s transfer of a monetary claim on a party acceptable to the payee. Typically, such claims take the form of banknotes or deposit balances and/or a credit arrangement held at a banking institution or at a central bank. Such claims, however, may also be held against certain non- banks.

In a similar vein, the Blue book (SARB, 1995) defines the payment system as follows,

A payment system consists of a defined group of institutions and of a set of instruments and procedures, used to ensure the circulation of money within a geographic area, usually a country.

A definition that moves away from such a technical view has been offered by the United Kingdom Office of Fair Trade (OFT), in their assessment of the UK payment system:

A payment system is the shared part of an end-to-end process that offers an account-based transfer service between two final customers – and between two different banks. A payment system sits at the heart of what is often referred to as

the banking system. Transfers can occur between personal customers, between businesses, or between personal and business customers. (OFT, 2003b: 3)

Clearly emphasised in this definition is the fact that payment systems are ultimately about monetary transfers between to end-users or parties, whether these are individuals or firms.

The SARB argues that a national payment system is one of the principal components of a country’s monetary and financial system and hence crucial to a country’s economic development. It maintains that a payment system is of central importance for a number of reasons:

• It is through the national payment system that money is transferred between buyers and sellers in commercial and financial transactions • A principal role of money is its medium of exchange function • A payment is the process by which monetary instruments, typically cash and deposit claims, are transferred between the two parties to finalise a transaction • A national payment system is the configuration of diverse institutional and infrastructure arrangements that facilitate the transfer of monetary value between the parties • It encompasses the total payment process including systems, mechanisms, institutions, agreements, procedures, rules, laws etc • It includes the system of banks and the processing capabilities of interbank utilities (e.g. ACHs).

The NPS can be seen as the infrastructure that provides the South African economy with the means for processing payments from various economic activities. As such the NPS supports the full spectrum of financial activity including business transactions in global markets to servicing individual payment requirements.

Central to the NPS is a range of payment service providers as well as the banking system and the interbank fund-transfer process with the Reserve Bank (with ultimate regulatory responsibility) at its apex.

Much of the current regulation and oversight activity has focused on the banking and interbank components. The NPS Amendment Act allows for the regulatory oversight of non-bank participants (primarily through the mechanism of SARB directives). However the rules and guidelines for non-bank service providers and the reporting structures for a significant (in volume and value terms) amount of non-bank payment activity are not in place. This leaves a regulatory gap.

The various components that make up the payment system include:

• The legal and statutory framework • Rules, regulations and agreements • Payment instruments and payment streams • Systems, processes and procedures • Technological infrastructure • Payment and settlement transactions • Banks providing financial intermediation • Providers of access to payment-related services • End-users of the different products provided by customer payment-service providers (CPSPs).

Each of these components will be dealt with in greater deal in the remainder of this section as well as in section 6.

5.2 History of the South African NPS

In its current guise, the NPS is a relatively recent phenomenon in South Africa. Its current formulation can be dated back to the 1995 publication of the South African National Payment System Framework and Strategy Document, the so- called “Blue book”. Effectively, the Blue book lays out the blueprint of the current NPS system.

Prior to the Blue book, the key aspects of trust and interoperability were already integral to cheque processing between banks. The Blue book represents a watershed in terms of Reserve Bank control and oversight, with regulation ensuring both effective risk management and enhanced interoperability27 to the benefit of all participants and ultimately the country as a whole.

In addition, the consolidation and the establishment of the main payment operators (stimulated in large measure by technological developments as well as economic considerations) can be traced back to the 1990s.

Until the early 1990s there were a number of payments service providers or operators in the national payment system, established mainly by the banks, to do the processing and settlement of inter-bank obligations in respect of various payment instruments. In large measure, these historical payment systems concerned paper-based instruments.

27 The Bank of International Settlement defines “interoperability” as “a situation in which payment instruments belonging to a given scheme may be used in systems installed by other schemes. Interoperability requires technical compatibility between systems, but can take effect only where commercial agreements have been concluded between the schemes concerned” (BIS, 2001). Interoperability is a precondition for the ubiquity of electronic payment instruments such as credit cards and ensures that a card is not only widely accepted but also that final payment between various banks can be effected.

The advent of technology and more specifically the shift to electronic payment instruments required a new approach to regulation, risk management and the management of technology. Driven by a range of pressures including this shift towards increased adoption of electronic payments instruments, Bank of International Settlement (BIS) pressure to improve bank and payment system governance, as well as unique South African circumstances (related to problems of cash conveyancing) the SARB and the banking industry were forced to review their approach towards the NPS.

As the SARB notes in its assessment of the NPS in the early 1990s, a number of shortcomings were evident. These included:

o A lack of information and systems to manage the interbank exposures resulting from payment transactions of banks’ customers o Implicit dependence on the financial backing of the SARB to ensure that the clearing banks … [would] be able to settle their daily exposures to one another o Legal uncertainty regarding multilateral netting as the basis for determining interbank exposures o Lack of appropriate mechanisms to make high-value payments. (SARB, 1995)

In order to address these issues the NPS project was launched by the banking industry (represented by the then Council of Southern African Banks - as COSAB) and the SARB. The process of strategy formulation, which lasted 19 months, resulted in the Blue book. This document provides the guidelines and overall strategy for the payment system reforms that have been implemented since 1995.

The reforms and changes to the NPS included the following:

• The establishment of a real-time settlement system in the SARB (to be known as the South African Multiple Option Settlement (SAMOS) System28 • The establishment of management structures including the Payments Association of South Africa (PASA) and specific Payment Stream Associations (PSA’s) • Amendments to the South African Reserve Bank Act in order to enhance and augment the power of the SARB in relation to the NPS.

The consequent reforms of the NPS undertaken in the late 1990s included the establishment of PASA, the promulgation of the NPS Act, the establishment of

28 SAMOS is the South African Multiple Options System, which came into operation in March 1998 that enables banks to settle in real time, high value payments made by them to and received by them from the Reserve Bank, through their settlement accounts held in the books of the Reserve Bank. Daily settlements of retail interbank exposures are also effected through the SAMOS system.

the SAMOS system, the establishment of the SANPAY forum and finally the establishment of the NPSD within the SARB to oversee the payment system. In addition to these legislative, regulatory and settlement system reforms, significant consolidation occurred amongst payment operators, most notably the incorporation of the Automated Clearing Bureau (Pty) Ltd (ACB) and Saswitch (Pty) Ltd operators into Bankserv in 1993. Prior to the establishment of Bankserv, the banking industry in South Africa jointly owned several companies that provided shared services to the banks in a number of different payment channels. The companies in this sector each followed their own direction and operated in their separate silos.

Significant progress has been made in a short period of time in a number of key areas of the NPS, notably in moving from a relatively unregulated space to one which has in place legislation, oversight departments, regulatory and industry representative bodies and the successful establishment of a real-time settlement system (SAMOS).

However, as illustrated in the figure below, this transformation has also been accompanied by the consolidation in the number of payment operators and the absence of an adequate regulatory structure for non-bank participants. While there are 20 registered banks (including two mutual banks), the payment volumes are concentrated within the top four banks.

The figure below compares the main operators in the early 1990s and those in operation today. Bankserv has incorporated ACB and SASWITCH and STRATE/BESA have evolved.

Figure 3: Consolidation of the payment operator space, circa. 1990 to 2005

Circa 1990 NPS Reforms 2005

1996 National The Banks Act The Banks Act Legislation PASA Payment System 94 of 1990 94 of 1990 established Act 78 of 1998

SA Reserve 1998 SA Reserve Bank Act 90 of NPS Act Bank Act 90 of 1989 1989 1998 SAMOS Registered Banks operational Registered Banks Banks 34 (1994) 18 1998 SANPAY established Inter-bank SAMOS NPSD Settlement established

VISA VISA SASWITCH ATM: United & Trust Bank Operators MCI 1993 MCI Bankserv BANKSERV established SWIFT ACB Cheques & EFT IPS STRATE / BESA

Multi-Net SBV Interbank host: Cash Processing: Volkskas, United, Post Standard Bank, Barclays SBV IPS Bank & Standard Bank & Volkskas Operator Consolidation Note: Registered banks here refer only to registered commercial banks and exclude mutual banks. 5.3 The Blue book

5.3.1 Introduction

Much of the current NPS has its origin in the vision and strategy developed in the 1995 Blue book. The Blue book sets out the overall vision for the payment system, the key regulations required as well as the envisaged operating environment. It incorporates the views of a broad spectrum of payment system participants.

Key points from the Blue book are discussed below in order to explain the current payment system, and the extent of the deviation from the original vision. This deviation, we will argue, is, in part responsible for the current concerns and discontent with the NPS.

According to the Blue book, the NPS is an enabler of economic activity and an essential conduit for effecting payments, domestically and internationally. The NPS is a critical component of the financial system. The NPS contributes to and is a prerequisite for a sound financial system. In line with this, the Blue book maintains that the objectives of the NPS are:

o to provide effective mechanisms for the exchange of money between transacting parties o to ensure finality and irrevocability of both payment and settlement; and

o to enable the management, reduction and containment of systemic and other payment-related risks.

The Box below summarises the goals set for the NPS system in the strategic framework. While a number of the goals refer to the requirements of improved systemic risk management, the number of references to fostering a competitive, transparent and open payment system is notable.

The Blue book argues that a key goal is to ensure that the NPS is efficient, open and easily accessible and that there is “healthy competition amongst customer payment-service providers” (SARB, 1995:21).29

Box 1: NPS Vision 2004

The South African National Payment System Blue booksets out the following Vision for the NPS to 2004 …. • NPS is self-regulated • Settlement of domestic interbank obligations is effected on a same-day basis • Banks compete on an equal footing in the provision of interbank clearing and settlement services • NPS is open to both local and foreign participants (not just banks) • There is healthy competition amongst customer payment--service providers • NPS is a national business asset • NPS is easily accessible • NPS is cost efficient • Public is aware of NPS features • Trading and payment domains are separate but integrated • NPS supports electronic delivery versus payment (DVP) and payment versus payment (PVP) • NPS in internationally compatible • Payment settlement time-lags resulting from trading transactions are in line with international practice • International community has an appreciation of the effectiveness of the South African NPS.

5.3.2 Exclusive domain of banks

While the Blue book sets out explicit goals with respect to ensuring competitiveness, openness and efficiency the document is also explicit that in the NPS clearing and settlement of payments is the exclusive domain of banks.

29 As far as the goals of the CPSP are concerned, the document argues: “Customer payment-service providers compete freely in the provision of payment collection and payment delivery services to customers. An extended network of customer payment-service providers exists, which includes banks, corporates, retailers, utilities etc” (SARB 1995: 21).

The Blue book notes that banks are the “gateway to the payments clearing and interbank settlement facilities” and that only banks may therefore act as principals in central bank settlement (SARB 1995: 25). There is a need to distinguish the role of banks as trading participants and intermediaries in financial markets from the role of banks as customer payment service providers and intermediaries.

Current NPS regulation reinforces the notion of the NPS (at least in its clearing and settlement activities) as the exclusive prerogative of banks. The justification given is that the levels of compliance and monitoring applicable to registered banks provide the soundness of governance and management required. In short banks are more highly regulated and therefore less likely to introduce systemic risk into the NPS. As has been discussed in section 3 above, this is adopted by central banks, however some countries have allowed non-banks to participate as clearing members. 5.3.3 Non-bank participation

While the Blue book considers clearing and settlement the exclusive domain of banks it also mentions that the NPS is not the exclusive domain of banks. In other words, the document acknowledges a role for non-bank institutions in the provision of payment services:

When a non-bank institution accepts payment instructions from a customer on behalf of third party (beneficiary), it assumes the role of customer payment-service provider (CPSP), acting as conduit to the NPS. All CPSPs are subject to an enforceable code of conduct. (SARB, 1995: 26)

Customer Payment-service Providers (CPSP) appear in the Blue book as non- bank firms that provide:

o Collection of payment instructions o Pre-processing of payments in a variety of value-added processes before entry into the NPS o Provision of links to deliver payment instructions to the banks o Receipt of confirmation of payment finality from banks and communication of completion of transactions to its customers o Acceptance of accountability for the integrity of its customers interests at the point of entry into the NPS.

The overall intention of creating framework and regulations for CPSPs was to ensure that the NPS was as open and accessible as possible and to ensure that competition was encouraged.

The Blue book proposes strict entry and compliance criteria including risk management and a code of conduct for potential CPSPs. CPSPs were to be

defined and regulated as agents of banks. In the section devoted to the introduction of a regulatory framework CPSPs the Blue book specifies that:

Legally enforceable rules and regulations, as well as a code of conduct applicable to all participants, will be formulated, published, implemented and enforced, in order to ensure sound payment practices. (SARB 1995: 34)

Such recommendations were, however, never implemented.

5.3.4 Core proposals for implementation

The Blue book sets out a number of core proposals for implementation, with the following opening statement:

It is envisaged that the NPS will serve all the people of South Africa. This will require that the NPS be opened up to encourage effective competition in the provision of payment services to the public and businesses, thereby creating a multitude of access points and a wide variety of payment instruments. This does not mean that the clearing and settlement of payments will be opened up to non-banks, but that non- banks will be able to act as payment-system access points and that all banks will be able to participate on an equal footing. All banks will thus be eligible to have a settlement facility at the SARB and to participate in interbank clearing, on condition that they comply with fair, equitable and transparent entry criteria, applicable to the particular payment stream in which they wish to render services to their customers. (SARB, 1995: 1)

The core proposals are concerned with effective (systemic) risk management and the ensuring of reputational standing. The Blue book envisaged enabling legislation (the future NPS Act), the introduction of an electronic settlement system to support interbank payments and the intraday settlement of interbank obligations (the future SA Multiple Option Settlement system - SAMOS), the establishment of payment clearing houses (PCHs) that assume responsibility for the settlement risk of that PCH, and finally the establishment of management arrangements (the future Payments Association of South Africa).

These envisaged management arrangements would entail three components:

o The establishment of a broadly representative South African National Payment System Discussion Forum (SANPAY) under the chairmanship of the SARB in order to accommodate the payment-processing needs of all stakeholders within the NPS o The establishment of an umbrella body (the Payment Association of South Africa – PASA) by the Council of Southern African Bankers (COSAB) and the SARB to establish and control Payment Stream Associations (PSAs) representing the banks participating in each particular payment stream o Operators (bank and non-bank owned) would be licensed to provide NPS infrastructure and render NPS services.

Central to these proposals was the idea that Payment Clearing Houses (PCHs) would be appointed by the PSAs and it was clearly envisaged that multiple PCHs could be created per payment stream. Proposals were introduced to formalise the participation of banks in the various PCHs.

The overall management structure envisaged, according to the Blue book, is aimed at separating ownership and user interests.

5.3.5 Impact to date

The table below sets out the original strategies envisaged as part of the Blue book and considers whether or not the objectives have been achieved.

Table 10: Blue book implementation scorecard Strategy Description Achieved? No. Systemic risk reduction Introduction of an online central bank settlement system to enable 1 9 (SAMOS) banks to effect interbank fund transfers electronically Introduction of measures to limit exposure build-up in bulk 2 9 clearing processes Implementation of risk-reduction measures in bilateral and 3 multilateral netting schemes ? Introduction of risk-monitoring facilities to assist in the 4 9 management of exposures 5 Introduction of same-day settlement 9 Discouragement of financial sponsorship in the NPS between 6 registered South African banks ? Determining of collateral requirements and related management 7 9 processes Legal frameworks Revision of the statutory powers of the SARB regarding payment 8 9 systems Adaptation of the legal framework to ensure legal enforceability of 9 payment-service agreements and legal certainty in respect of 9 industry practices Introduction of a regulatory framework for customer payment- 10 service providers (CPSPs) X 11 Creation of public awareness of the NPS X Management of the NPS Establishment of an umbrella Payment Stream Association (PASA) 12 9 and individual Payment Stream Associations (PSAs) 13 Introduction of licensing of NPS operators ? Creation of participation agreements for utilization of NPS 14 9 infrastructure Establishment of a South African National Payment System forum 15 9 (SANPAY) 16 Establishment of NPS standards 9 South Africa as a regional financial centre 17 Liaison with banks and financial authorities in the region 9 Interface between the trading system and NPS 18 Review of financial practices from an NPS perspective ? Encouragement of electronic trading and payment mechanisms in 19 9 (STRATE) trading systems Introduction of mechanism to relay information associated with a 20 payment to the beneficiary ? Review of cross-border foreign currency market practices from an 21 NPS perspective ?

Broadly, the strategies have been implemented. However, some strategies (see shaded segments in the table above) have not been implemented, or the strategy has changed over time. A case in point is the sponsorship in the NPS. While point 6 suggests it was to be discouraged, in recent years, there has been far greater emphasis on sponsorship as a mechanism for gaining access to the clearing and settlement space.

5.4 Regulation of the NPS

5.4.1 Rationale for regulating the NPS

The regulation of payment systems is strongly tied to the regulation of the financial system, which ultimately stems from the special economic role of money and the uncertainty associated with it (Dow, 1996). A functionally efficient financial sector is one that deploys, transfers and allocates resources across time and space, under conditions of uncertainty, so that for example, payments between people who have no reason to trust each other can be settled. Appropriate regulation of the financial sector should ensure the sector can play this role.

For Herring and Santomero (1999), a well-functioning financial system is important as it:

o Makes a critical contribution to economic performance by facilitating transactions, mobilising savings and allocating capital across time and space o Provides payment services and a variety of financial products that enable the corporate sector and households to cope with economic uncertainties by hedging, pooling, sharing and pricing risks o Reduces the cost and risk of investment and of producing and trading goods and services o Provides a crucial source of information that helps coordinate decentralised decisions throughout the economy.

It is the experience of bank regulation and supervision that underpins public confidence in money and the monetary system (Dow, 1996). For this reason, regulation is likely to stay with us, which implies that regulatory objectives and their measures need to be regularly evaluated in terms of their trade-offs between costs and benefits.

Falkena et al (2001a) list securing systemic stability in the economy, ensuring safety and soundness and promoting consumer protection as the three prime objectives of financial regulation. Carmichael and Pomerleano (2002) suggest that possible sources of market failure should be the basis for setting regulatory objectives. They give four reasons financial markets may fail to produce efficient and competitive outcomes and may therefore require specific regulatory responses:

• Anticompetitive behaviour: The role of regulation here is to ensure that market forces operate effectively and are not circumvented by participants • Market misconduct: Regulation here is most often concerned with unfair or fraudulent activities and inadequate disclosure. Market integrity regulation seeks to promote confidence in the market

• Information asymmetry: Prudential regulation serves to address the concerns of information asymmetry that cannot adequately be dealt with through disclosure. Carmichael and Pomerleano (2002) note that in substituting the regulators’ judgment for that of a firm and its customers, prudential regulation can result in moral hazard as it may induce greater risk-taking by firms who perceive risk to have shifted to the regulator. Prudential regulation can therefore be costly in terms of economic efficiency if these perverse incentives are not properly recognised. Greenspan (1997) echoes these concerns, highlighting in addition the dangers of a weak regulator in a system where private market participants, believing that their interests are protected by the regulator, diminish their own efforts • Systemic instability: In the financial system, systemic instability arises where the failure of one institution to honour its promises leads to general panic, which could result in contagion and crisis as it spreads and results in the failure of otherwise sound institutions. Systemic instability is typically addressed at the macroeconomic level though monetary and fiscal policy aimed primarily at price stability. Other regulatory interventions include lender-of-last resort facilities, as well as the direct regulation of the payment system30.

These rather broad objectives are most often related to the deposit-taking activities of banks – but can readily be extended to their payments activity. The payment system can be seen as one in which financial promises are inherent – these are related to the difficulty of honouring the promise, the difficulty faced by the consumer in assessing the creditworthiness of the promisor and the adversity caused by promissory breach.

Carmichael and Pomerleano (2002) suggest that prudential regulation should be applied only to institutions that “are judged to have a sufficiently high intensity” in all three of these promise characteristics. It is argued here that at the retail level, payments level regulation should be applied across the board to all participants at least in terms of market conduct. The reason lies in the nature of the monetary system and in the confidence in it.

The regulation of non-banks has typically been neglected by regulators – given the historical role of banks. However, the growing participation of non-banks has raised concerns that they may introduce risks if unsupervised. While the risks associated with settlement risk is very low, concerns about operational outsourcing and legal risks exist (Sullivan, 2005).

Without confidence, the spectre of systemic risk raises its head. While many commentators on regulatory structure do not insist that prudential regulation of

30 Sources of systemic risk include deposit-taking institutions (where the failure to honor promises to transform illiquid assets into liquid liabilities may occur), the payment system (where obligations between financial institutions cannot be met), stock price collapses, and the failure of a single large financial institution.

banks is retained in the central bank, the regulation of the national payment system, together with the lender of last resort function are invariably seen to be within the central bank’s remit.

5.4.2 Overview of the regulatory landscape

The primary regulation of the NPS occurs through the NPS Amendment Act No 22 of 2004 (which superseded the NPS Act No. 78 of 1998) and the Banks Act No. 94 of 1990 – both administered by the SARB. The Post Bank (currently not a registered bank) is regulated by the Ministry of Communication in terms of the SA Post Office Act.

The NPS is regulated by a number of statutory, non-statutory, self-regulatory and other industry bodies.

The core principle underlying both access to and regulation of the NPS is that participation in the core payment system (defined as settlement and clearing) is restricted to registered banks, which is the case in many countries.

The figure below provides an overview of the regulatory landscape that applies to the NPS.

The figure includes the applicable legislation, regulations and the main regulatory authorities. Also indicated are the non-regulatory components such as the various participants, the operators and system components (switches) as well as the transaction layers.

Figure 4: NPS regulatory landscape Nature of regulation Institutions responsible System component Transaction layer

NPS Act Postal Act SARB SAMOS Settlement Legislation Banks Act SAPO Legislated Regulations PASA Rules PASA

PCH PCHs Agreements Agreements BankServ Strate Operator Interbank – Netting & PCHs Clearing Agreements VISA MC Self-regulated Rules PCH Rules PCHs Transaction Initiation

What the analysis indicates is the apparent reliance on self-regulation within the NPS. The largest components of the current NPS framework are either self- governed or entirely in the commercial space and hence subject to commercial transactions and negotiation.

The regulations currently apply only to the core NPS participants - the banks (with the exception of a number of anomalies such as the Post Bank). All components and participants need not, of course, be regulated to the same degree as banks. Rather the concern is to ensure that adequate rules are in place to ensure appropriate risk management of the NPS and to protect its integrity. This requires some attention to the regulation of non-bank participants in the NPS.

In addition a concern (noted in various interviews) is the boundary between what should be considered collaborative (where competition cannot operate) and commercial (where competition can operate) space. In simple terms the success of any payment system relies on its robustness, integrity and its ubiquity – the so-called network effect which requires interoperability and utility-like infrastructure.

The value and success of any payment system will lie in the widespread acceptance and adoption (or ubiquity) of the payment instrument and the ability to quickly and securely affect the transfer of funds. In particular, electronic payments require mutually agreed technology standards as well as market rules that ensure that cards, for instance, are widely accepted and consequently adopted by end-users. Without such interoperability, payment streams remain

proprietary and end-users who can only effect a cash withdrawal from their bank’s own ATMs, for example, are inconvenienced.

The question arises whether commercial agreements (for instance the bilaterals in respect of interchange fees) are the most appropriate mechanism to regulate conduct in the delivery of core or essential payment processing infrastructure and services. This matter is further explored in section 8.

The final issue to note is that the application of the existing regulation and legislation in large measure only impacts the transaction layer from the point at which the inter-bank space proper begins. This is of concern in that current frameworks do not adequately address the customer-interface of the payment system – for instance point of sale and most critically the variety of customer payment service providers (CPSPs) that provide a range of payment services.

The failure to date by SARB and PASA to develop any regulations in respect of CPSPs appears to be an oversight in terms of the Blue book strategy. This regulatory gap is of concern not only because it leaves a significant portion of the NPS un-regulated (and therefore potentially leaves the system open to risk) but also because the overall competitive space may be restricted to the detriment of consumers. In addition, the question is raised as to whether the overseer NPSD, should take a more active role in the rule setting of the self- regulator, PASA.

5.5 Legislation

5.5.1 General legal aspects

Although the payment system is in general terms regulated by commercial law, in view of the requirement that clearing and settlement participants be registered banks, a range of laws, regulations and related legislation in respect of banks also applies.

Specific commercial legislation related to the NPS includes:

• Bills of Exchange Act (Act No. 34 of 1964) • Companies Act (Act No. 61 of 1973) • Insolvency Act (Act No. 24 of 1936) • Electronic Communications and Transactions Act (Act No. 25 of 2002).

From a payment system viewpoint the Bills of Exchange Act deals mainly with the usage of paper-based cheques and bills of exchange. While the Electronic Communications and Transactions Act of 2002 deals with electronically concluded agreements, the legal validity of electronic data, the admissibility of electronic documents in courts of law and the legal status given to electronic

signatures, no specific legislative framework for the handling of electronic payments exists.

The relevant legislation governing activities of banks includes:

• Companies Act, 1973 (Act 61 of 1973) • Banks Act, 1990 (Act No. 94 of 1990) • National Payment System Act, 1990 (Act No 78 of 1998) • South African Reserve Bank Act, 1989 (Act 90 of 1989) • Exchequer Act, 1975 (Act 66 of 1975) • Financial Advisory and Intermediary Services Act • Financial Intelligence Centre Act • Usury Act, 1968 (soon to be replaced by the National Credit Act).

The Banks Act does not apply to:

• The SA Reserve Bank • The Postbank • The Land Bank (Co-operatives Act, 1981 (Act 91 of 1981)) • The Development Bank of Southern Africa • The Corporation for Public Deposits established by section 2 of the Corporation for Public Deposits Act, 1984 (Act 46 of 1984) • The Public Investment Commissioners referred to in section 2 of the Public Investment Commissioners Act, 1984 (Act 45 of 1984) • Any mutual bank • Any co-operative which is a member of an approved self-regulatory organisation • Any other institution or body designated by the Minister by notice in the Gazette.

The Postbank was exempted from the provisions of the Banks Act by Government Notice No. 334, as published in Government Gazette No. 13744 dated 24th January 1992 and is also not registered under the Companies Act. The Minister of Finance, however, retains the discretion to withdraw the exemption from the provisions of the Banks Act.

Registered banking institutions are the main payment service providers to the public. This wide range of services includes money transmission facilities via cheques, cash, credit and debit cards and internet banking services. Banks also issue credit cards which are affiliated to either the VISA or MasterCard schemes.

Certain non-bank institutions also provide payment services to their customers. American Express and Diners Club issue travel cards in South Africa while a number of private sector retailers provide private-label credit cards. The Post

Office provides mail orders and telegram services to facilitate the transfer of money.

5.5.2 National Payment System Amendment Act

The principle legal framework governing the NPS is the NPS Amendment Act No 22 of 2004 (NPS Amendment Act) which must be read in conjunction with the NPS Act No. 78 of 1998 (NPS Act).

The primary object of the 1998 NPS Act is to provide,

for the management, administration, operation, regulation and supervision of payment, clearing and settlement systems in the Republic of South Africa (NPS Act, Section 1)

In terms of the NPS Act “clearing” or “to clear” is defined as “the exchange of payment instructions (an instruction to a system participant to transfer funds or make payment)” while settlement means an “instruction given to the settlement system by a system participant or by a payment clearing house to effect settlement of one or more payment obligations to discharge any other obligation of one system participant to another system participant” NPS Act I(iv); (x) and (xcvi)). Settlement systems are explicitly identified as a system established and operated by the Reserve Bank for the discharge of payment and settlement obligations between system participants (the banks).

The above distinctions are made more explicit in the 2004 NPS Amendment Act, which while introducing the possibility of “limited membership” of the payment system management body PASA), reserves settlement participation (SAMOS) to registered banks.

The NPS Amendment Act provides for a number of key amendments to the NPS Act. Most notably the NPS Amendment Act introduces the following:

o a category of designated settlement system operators to participate in the settlement system o designated settlement systems o a distinction between the SARB’s settlement system (i.e., SAMOS) and other settlement systems o the expansion of the payment system definition to mean a system that enables payments to be effected or facilitates the circulation of money and includes any instruments and procedures that relate to the system o the clear authority of the SARB to withdraw recognition of a payment system management body o to provide for the issuance of directives by the SARB o to enable third party payments in terms of SARB directives to be issued

o to allow for limited membership of the payment system management body by non-bank institutions that are agencies of government (as per Section 2 of the Banks Act) o to explicitly provide for sponsorships of banks that are not Reserve Bank settlement system (SAMOS) participants.

The amendments increase the amount of direct control that the SARB has over the regulator (PASA) in respect of determining the designation of payment systems (understood as PCHs), payment system operators and participants. In addition, the NPS Amendment Act explicitly sets outs the SARB’s authority to withdraw its recognition of PASA.

The amendments appear to enable some degree of participation of state-owned banking entities that are currently excluded from PASA in view of their non-bank status – such as the Post bank- through the sponsorship route.

An overall interpretation of the amendments suggests that in a limited manner the SARB is laying the ground-work for the establishment of multiple payment management bodies, settlement systems and operators that link into SAMOS.

Payment system management body

The NPS Act provides for the establishment of a payment system management body (PASA) with the object of “organizing, managing and regulating the participation of its members in the payment system” (NPS Act 3(1)).

The body is to be delegated responsibility by the SARB on condition that it is fairly constituted, fairly represents the interests of all banks participating in the payment system and has fair, equitable and transparent rules relating to admission criteria. The NPSD can be seen as the overseer of the payment system, and PASA the (self) regulator.

In terms of the 2004 NPS Amendment Act, PASA is the recognised payment system management body and consequently PASA and all its members fall within the oversight of the SARB.

The original NPS Act states that only the SARB and registered banks (banks, mutual banks and branches of foreign institutions) may be members of the payment system management body. However the NPS Amendment Act introduces the possibility of non-bank membership of PASA subject to SARB approval and oversight.

The functions of the payment system management body as laid out in the Act concern the management and control of all matters affecting payment obligations and the clearing and netting of payment obligations.

More specifically the NPS Amendment Act sets out the following as the payment system management body’s objects:

4.(1) The objects of the payment system management body are to manage and regulate, in relation to its members, all matters affecting payment obligations and tie clearing or netting of payment instructions and, in connection with those objects— (a) to provide a forum for the consideration of matters of policy and mutual interest concerning its members (b) to act as a medium for communication by its members with the South African Government, the Reserve Bank, the Registrar of Banks, the Registrar of Financial Institution, any financial or other exchange, other public bodies, authorities and officials, the news media, the general public and other private associations and institutions; and (c) to deal with and promote any other matter of interest to its members and to foster co-operation between them. (2) In addition to any other provisions thereof, the rules of the payment system management body must empower that body— (a) to admit members and to regulate, control and with the approval of the Reserve Bank terminate membership

(b) to constitute, establish or dissolve any body, committee or forum consisting of its members and which has an impact on, interacts with, has access to or makes use of payment. clearing or settlement systems or operations (c) to - (i) recommend for approval by the Reserve Bank, criteria subject to which any person is granted limited membership of the payment system management body or is to be authorised to act as a system operator or a PCH operator within a payment system; and (ii) authorise that person to act as a system operator or PCH system operator in accordance with those criteria; and (d) to recommend for approval by the Reserve Bank criteria subject to and in accordance with which a member that is also a Reserve Bank settlement system participant may be authorised to - (i) Allow a bank, mutual bank or branch of a foreign institution that is not a Reserve Bank settlement system participant to clear; or (ii) Clear on behalf of a bank, a mutual bank or a branch of a foreign institution that is not a Reserve Bank settlement system participant Provided that the member shall settle payment obligations on behalf of such bank, mutual bank or branch of a foreign institution referred to in subparagraphs (1) and (ii). NPS Amendment Act, 2004

Settlement & clearing provisions

The key provisions in the NPS Act in respect of settlement are that where a settlement has been effected by a system participant (currently only banks) with the SARB this settlement is final and irrevocable. This is unaffected by any winding up in the case of liquidation.

In respect of clearing it is noted that no entity may clear payment instructions unless that entity is a system participant that is a bank.

Control of payment intermediation

The NPS Act set out that no entity could accept money or payment instructions from any other entity or person with the aim of making a payment on behalf of that or other entity or person to a third party unless the entity accepting the money is a system participant, was a member of the payment system management body, or was the Post Office or Post Office Savings Bank or a person exempted by the Minister of Finance.

This restriction was not, however, applicable in the case of a “duly appointed agent” of the person to whom the money was due, a company holding company receiving payments from its subsidiary or vice versa, or for purposes of effecting a money lending transaction (in terms of the Banks Act Section1).

The NPS Amendment Act makes provision for payments to third parties by persons who are not registered banks or the SA Post Office. The NPS Amendment Act specifically notes the following:

7. A person may as a regular feature of that person’s business accept money or a payment instruction from any other person for the purposes of making payment on behalf of that other person to a third person whom that payment is due, if – … (c) the money is accepted or payment made ion accordance with directives issued by the Reserve Bank from time to time in terms of section 12.”

It is unclear whether such directives have in fact been provided to enable third party payment service providers.

Netting agreements and rules

Netting agreement sets out the manner in which the positions or obligations by NPS participants will be calculated and dealt with, more specifically the manner in which a large number of individual positions or obligations are consolidated to a smaller number of obligations or positions. In terms of the NPS Act all netting agreement and rules to which a system participant is party are binding upon the liquidator, judicial manager or curator in the case of any payment or settlement obligations where winding-up or judicial management is instituted. This provision is strengthened in the NPS Amendment Act.

Utilisation of assets held with SARB

The NPS Act entitles the SARB to utilise any asset of the system participant held in terms of security requirements for its settlement obligations or in terms of payment clearing house agreements to discharge the obligations in the event of insolvency.

Information

The SARB has the right to access all information relating to volumes or values of payment and settlement instructions or payment and settlement obligations.

Directives by the SARB

The SARB has the authority to issue a directive in writing where it believes that any person is engaging in practices that pose systemic risk. Systemic risk is defined in the NPS Act as:

the risk that the failure of one or more system participants, for whatever reason, to meet their payment obligations within the payment system of their settlement

obligations within the settlement system, may result in any or all of the other system participants being unable to meet their respective payment or settlement obligations (NPS Act 12(1))

Failure to comply with any directive is an offence. The SARB may apply to the High Court to enforce such a directive. Criminal proceedings may also be instituted. The NPS Act provides for fines not exceeding R 1 million or imprisonment for a period of 5 years as a penalty.

The NPS Amendment Act set sets in greater detail the powers and obligations of the SARB to issue directives. Specifically Section 12 of the NPS Amendment Act notes that:

(1) The Reserve Bank may from time to time, after consultation with the payment system management body, issue directives to any person regarding a payment system or the application of the provisions of this Act. (2) In considering whether or not to issue a directive in terms of subsection (I), the Reserve Bank may have regard to any or all of the following aspects: (a) That reasonable ground exist to believe that any person is engaging in or is about to engage in any act, omission or course of conduct, with respect to the payment system, that results or is likely to result in systemic risk (b) that reasonable grounds exist to believe that any person is engaging in or is about to engage in any act, omission or course of conduct, with respect to the payment system that is or will be contrary to the public interest relative to the integrity, effectiveness, efficiency or security of the payment system (c) the public interest (d) the integrity, effectiveness, efficiency or security of the payment system (e) national financial stability; v) any other matters that the Reserve Bank considers appropriate. (3) The Reserve Bank may in writing, over and above any directive contemplated in subsection (I), issue a directive to a person requiring such person, within the period specified in the directive, to- (a) cease or refrain from engaging in the act, omission or course of conduct or perform such other acts as are necessary to remedy the situation; or (b) perform such acts as are necessary to comply with the directive or to effect the changes (c) provide the Reserve Bank with such information and documents, relating or to the matter as specified in the directive. (4) The provisions of this section shall not apply to a designated settlement system. (5) The Reserve Bank may, after consultation with the payment system management body, cancel in writing any previously issued directives. (6) In considering whether or not to cancel a directive in terms of subsection (5), the Reserve Bank must have regard to the factors referred to in subsection (2). (7) No directive issued by the Reserve Bank shall have any retroactive effect. (8) Any person who neglects, refuses or fails to comply with a directive issued under subsection (1) or (3) is guilty of an offence. (9) (a) A directive issued in terms of subsection (1) takes effect three months after it has been issued or on such earlier date as may be determined by the Reserve Bank

(b) A directive issued in terms of subsection (3) takes effect immediately.”. NPS Amendment Act, 2004

It is notable that the NPS Amendment Act gives the SARB considerable powers of intervention in the national payment system. Importantly such interventions extend beyond systemic risk issues and could be construed as responsibility for the regulation of market conduct (for instance the SARB can intervene in the public interest).

5.6 Regulatory authorities

Currently the NPS is governed by two key regulatory authorities. In the first instance final oversight and responsibility rests with the SARB. In addition however the Payments Association of South Africa (PASA) has been appointed by the SARB to act as the (self) regulator of the various payment clearing houses (currently restricted to bank participants).

However, it must be recognised that these regulatory authorities operate in an environment occupied by a number of other entities (both statutory as well as membership-based) that play an important role in the overall management of the NPS and its various components.

Figure 5: Regulatory authorities and other representative bodies

Parliament

Ministry of Trade & Ministry of SA Reserve Bank Ministry of Finance Industry Communications

Standing Committee for Bank Supervision Policy Board for Financial Standing Committee of the Review of the NPS Department / Registrar of Financial Services Board SA Post Office Service and Regulation Company Law Act Banks

Standing Committee for Financial Stability Financial Intelligence the Revision of the Banks Competition Commission Department Centre Act

National Payments MFRC System Department

Banking SANPAY SAMOS Association of Registrar of Companies South Africa

PASA PayStrat

Regulator Management Body Payment Clearing Houses Licensed Self Regulator Statutory Body

Non Statutory Regulator Membership Body

Consultative Forum

Indicated in the figure above are the four main state institutions (including the SARB) that regulate banks and payment system operators. Ultimately, all these institutions are accountable to Parliament.

The main regulatory authority in authorising and registering a bank or mutual bank is the Registrar of Banks or the Bank Supervision Department (BSD). Other role players are the Registrar of Companies from the Department of Trade and Industry (part of the Ministry of Trade and Industry), through whom a person must register as a public company. To gain membership to the clearing and settlement system, a bank (licensed by the SARB in conjunction with the Minister of Finance), must register with PASA.

Banks and mutual banks are regulated by the BSD, which - although housed in the SARB ultimately reports to the Minister of Finance - as well as the Governor of the SARB. Banks are also required to register micro-lending activity with the Micro-Finance Regulatory Council (MFRC). To the extent that banks undertake foreign exchange activity, this is supervised by the Exchange Control Department in the SARB.

To operate in the payment system, registered banks must have a settlement account with the SARB and meet the requirements of the NPSD and PASA – discussed further below. The Financial Stability Department is charged with, among others, systemic stability of the banking industry.

For completeness, the Financial Services Board (FSB) is also shown here as it is taking on a broader role for market conduct across the financial services sector. The Financial Advisory Intermediary Services Act, (FAIS), administered by the FSB, for example, also applies to banks. Banks are also required to comply with the regulations of the Financial Intelligence Centre Act (FICA) administered by the Financial Intelligence Centre.

Consumer credit, including micro credit, falls within the regulatory framework of the Minister of Trade and Industry. Credit Co-operatives and unions are regulated by the Registrar of Co-operatives and to the extent that these undertake micro-lending, they are required to register with the MFRC.

The SA Post Office falls within the jurisdiction of the Ministry of Communications and is currently considered an exempted institution in terms of the Banks Act.

5.6.1 South African Reserve Bank (SARB)

In terms of the NPS Act and the NPS Amendment Act the final authority and regulatory responsibility for the South African NPS rests with the SARB. In terms of this legislation, the SARB has to see that the proper regulations are in place, appropriate supervision is effected and that the overall systemic soundness and integrity is ensured.

Bank Supervision Department (BSD) and the Registrar of Banks

The task of the BSD is to promote the soundness of banks through the effective application of international regulatory and supervisory standards through the Banks Act, 1990 (Act No 94 of 1990) (Banks Act) and the Mutual Banks Act.

The Registrar forms part of the BSD (Section 10(v) of the SARB Act). The Minister of Finance, in consultation with the Governor of SARB, appoints the Registrar. The regulatory responsibility of the Registrar extends to the Minister of Finance (Alant, 1993). This position is unique in that the Registrar is quasi independent from the SARB, as it operates under its own acts (Banks Act and Mutual Banks Act), is appointed by the Minister, consults with the Minister in terms of certain sections of these Acts and reports to the Minister through the submission of annual reports. On the other hand, the BSD is closely aligned with other functions and disciplines of the SARB.

In pursuance of its mission, the BSD has adopted a risk-based management approach. The BSD supervises, on a consolidated basis, 18 banks, 15 local branches of foreign banks, 44 representative offices of foreign banks, and 2 registered mutual banks (BSD, Annual report, 2004).

National Payment System Department (NPSD)

A sound national payment system is one of the pillars of financial stability. The SARB, in terms of Section 10 of the SARB Act, oversees the safety and soundness of the NPS and implements risk-reduction measures in the payment system to reduce systemic risk in terms of the National Payment System Act, 1998 (Act No. 78 of 1998) (NPS Act). The objective of the NPS Act is to provide for the management, administration, operation, regulation and supervision of payment, clearing and settlement systems in South Africa; and to provide for connected matters. The head of the department is appointed by the SARB.

5.6.2 Payment Association of South Africa (PASA)

Currently the only recognised payment system management body in respect of the payment system is PASA – effectively a SARB appointed “self-regulator” for current payment system members. PASA is appointed by the SARB in terms of the National Payment System Act (Act 78 of 1998) and NPS Amendment Act of 2004.

PASA was established in November 1996 to act as the governing umbrella body of all Payment Stream Associations (PSAs). As such, it is an association of banks that provide payment instruments in a specific payment stream to their customers.

The objectives of PASA are to manage, control and regulate all matters effecting interbank payments, payment clearing and netting of interbank obligations within the payment system (PASA, 2003).

Current formal participation in the NPS (that is via membership of PASA) is limited to banks, mutual banks and/or branches of foreign institutions that also hold a settlement account with the Reserve Bank.

The SARB distinguishes between clearing banks and non-clearing banks:

• A clearing bank is a registered bank, a PASA member, operates a SAMOS account and is a member of at least one PSA and PCH31 • A non-clearing bank is a registered bank but it may not provide any clearing or settlement services.32

Payment service is defined (SARB, 2000) as any service whereby a bank enables its clients to:

o make third-party payments to clients of another bank or the other bank itself through direct access to their bank accounts o Receive payments directly into their accounts from clients of another bank or the other bank itself o Withdraw cash at another bank.

PASA has the responsibility to manage the South African payment clearing system in order to:

o provide the South African banking community with safe and efficient o facilities to exchange payments o protect the integrity of the payment system o manage the clearing and settlement risks in the payment system o facilitate access of participants and prospective participants to the payment system on a fair and equitable basis o facilitate communication between participants; and o enable proper understanding of the system and the rules applicable to it.

31 There are currently 21 clearing banks (including the SARB): ABN Amro Bank NV Johannesburg Branch; Absa Bank Limited; African Bank Limited; Capitec Bank Limited; Citibank NV South Africa; Calyon Corporate and Investment Bank South Africa Branch; FirstRand Bank Limited; Habib Overseas Bank Limited; Investec Bank Limited; MEEG Bank (sponsored);Mercantile Bank Limited; Nedbank Limited; Rennies Bank Limited; Societe Generale Johannesburg Branch; The South African Bank of Athens Limited; Standard Chartered Bank Johannesburg Branch; State Bank of India; Teba Bank Limited; and Standard Bank of SA Limited. 32 There are currently 14 non-clearing banks: Barclays PLC, Imperial Bank Limited; Marriott Corporate Property Bank Limited; Regal Treasury Private Bank Limited (In liquidation); Sasfin Bank Limited; Albaraka Bank Limited; Bank of Baroda; Bank Of China Limited; Bank of Taiwan; China Construction Bank Corporation; Commerzbank; Deutsche Bank AG; HSBC Bank plc; and JP Morgan Chase Bank.

PASA governance

PASA Council is responsible for the strategic direction and governance of the Association. Council represents the interests of members and bears the responsibility of ensuring an efficient, reliable and stable payments environment to serve the economy and people of the country.

The council of PASA consists of a chairperson and eight members:

• Five association members (banks) with the highest throughput, as a product of value and volume cleared through the interbank systems during the previous year • Two Association members elected by the rest of the members; and • The SARB, a non-voting member.

The members of Council, on a bi-annual basis, elect the chairperson from their ranks. The bank of the elected chairperson has to appoint an additional representative as the chairperson does not represent his/her bank and has no vote on Council. A schedule of rotation applies to the position of chairperson. No bank may have a chairperson serving for more than four years within a cycle of twelve (12) years.

Table 11: Current PASA council members Current Chairperson ABSA Bank Limited

Five member banks • ABSA Bank Limited with the highest throughput • First Rand Bank Limited • Investec Bank Limited • Nedbank Limited • The Standard Bank of SA Limited

Two member banks • Capitec Bank Limited representing the rest of the members • Mercantile Bank Limited Non-voting member South African Reserve Bank Source: PASA website, 2005

In addition to the Council there is a Settlement Systems Participant Group which is responsible for determining the basis of settlement of the various clearing houses and evaluation of impact of new clearing agreements. The members of the Committee as at the end of 2005, consisted of representatives from:

• PASA - Operations • ABN Amro Bank NV Johannesburg Branch • ABSA Bank Limited • African Bank Limited • Barclays Bank PLC SA Branch

• Capitec Bank Limited • Citibank NA South Africa • Calyon Corporate and Investment Bank South Africa Branch • FirstRand Bank Limited • Habib Overseas Bank Limited • HBZ Bank Limited • Investec Bank Limited • Mercantile Bank Limited • Nedbank Limited • Rennies Bank Limited • Societe Generale Johannesburg Branch • South African Reserve Bank • State Bank of India • Standard Chartered Bank JHB Branch • TEBA Bank Limited • The Standard Bank of SA Limited • The SA Bank of Athens Limited.

PASA have established a Governance Committee which has the responsibility to advise PASA Council on the satisfactory performance of PASA as a body, as well as the various Committees, in terms of the requirements of proper governance.

The Committee performs its function by evaluating the adequacy of the procedures and controls of the various committees constituting PASA. The Committee evaluates the risk management procedures and controls as well as the performance of the Risk Advisory Committee. The Committee also serves the function normally performed by an audit and finance committee by monitoring the financial and administrative practices, controls policies, reviewing the budget and performance against budget.

The Governance Committee is made up of the Deputy-chairperson of PASA, a member from one of the banks representing the "smaller" banks plus one other member and is constituted by Council. The South African Reserve Bank has a standing invitation to participate in the activities of the Committee.

The current committee members as at the end of 2005 are:

• Mercantile Bank Limited • The Standard Bank of SA Limited • Nedbank Bank Limited • South African Reserve Bank (Source: PASA website, 2005).

Payment Clearing Houses

Central to the overall function of PASA and the regulation of various payment streams and instruments are the Payment Clearing Houses (PCHs).

Payment Clearing House (PCH) means an arrangement between two or more system participants governing the clearing of payment instructions between such system participants. Payment Clearing House agreements have been signed.

There are some twelve PCHs in South Africa which offer distinct payment instruments33. However, for the sake of efficient management of PCHs management committees referred to as PCH Participant Groups have been created to manage groupings (payment streams) of PCH agreements.

The current payment streams are summarized in the table below.

Table 12: Current payment streams Payment Purpose / Instruments Stream

1 STRATE The STRATE payment stream is responsible for clearing and settling (Including payments, resulting from equity (share market) transactions between BESA) participating banks. The BESA payment stream does the same for the Bond Market transactions.

2 Code Line The Code Line Clearing PCH is the Clearing House responsible for cheques Clearing & cleared between banks using the Code Line Clearing System. This system Paper enables banks to capture the information of a deposited cheque electronically Credits by reading the magnetic code line and transmitting the information via the PCH System Operator to the paying bank for settlement before the paper cheque is delivered to the paying bank for final approval. The Paper Credit PCH is the Clearing House responsible for clearing paper instruments other than cheques and manual credit transfers between banks. The use of manual credit transfers has reached minimal levels due to the delay in providing value. The two PCHs are managed by one PCH Participant Group as their business is closely related.

3 Credit & The Credit Card products are in most instances linked to one of the two Debit Card major international card associations, Visa and MasterCard, with American Express and Diners Club also being represented. Fleet Card, Petrol and Garage card products bear domestic labels of the individual banks and are not linked to central clearing agencies. A Credit Card is essentially a payment instrument through which purchases can be made utilising credit provided by the issuing bank. A debit card provides the same purchasing capability but purchases are made from funds held by the customer at the bank. A credit card purchase is mandated (approved) by the customer through signature on the card slip, whereas a debit card transaction is mandated through a PIN keyed in by the customer. Garage and Petrol cards are hybrid cards with special application for paying car expenses. The debit cards in South Africa are cleared (exchanged) on a real time basis through payment system Operators and settled one a day in Batch. Credit card transactions are approved through the PCH System Operators on a real time basis but clearing the settlement happens in the largest number of cases in a batch mode directly between the participating banks. The card types described above are all facilitated in one Payment Clearing House

33 There are soon to be three more added: AEDOS and NAEDOS, Money market transfer.

Payment Purpose / Instruments Stream

Participant Group know as the Card PCH

4 EFT The EFT Credit PCH facilitates the exchange of credit payment instructions Credits & for amounts less than R5 million which are delivered on a batch basis to the Debits interbank PCH System Operator for sorting and onward delivering to the receiving bank. EFT debits facilitate the delivery of mandated debit requests limited to less than R500 000 from users of the collecting bank to the paying bank via the interbank PCH System Operator in a similar process to the credits

5 Immediate The Immediate Settlement Payment Stream (IMMS) is denoted as the senior Settlement payment stream as more than 90% of the value of payments flow through & ZAPS this stream on a pre-funded real time basis. This payment stream is aimed at higher value payments but credit payments of any value may be made through it. ZAPS is a delayed batch settled payment stream cleared on a real time basis.

6 NuPay NuPay facilitates debit collections using the debit card infrastructure with a unique mandate to record and presentment methodology for the collection of loan payments from borrowers in the micro-lending market.

Membership of payment-clearing houses is limited to banks, mutual banks and branches of foreign institutions that also hold a settlement account with the SARB. These restrictions have been imposed mainly for systemic risk reasons.

The table below provides a summary of the number of registered banks participating in each clearing house.

There are currently 21 banks who are members of PASA (including SARB) and at least one PCH and two exempted entities (Postbank and Ithala) and one sponsored bank (MEEG). Table 13: PCH participants, 200534 1 2 3 4 5 6 7 8 9 10 11 12

Payment Clearing House Participant Groups BESA BESA (ATM) NuPay NuPay STRATE EFT Debit CLC Debit EFT Credit Debit Card Immediate Credit Card Credit Paper Credit PIN ValidatedPIN Payment ZAPS Electronic DebitElectronic Electronic CreditElectronic Settlement (SAMOS) Settlement (SAMOS)

PASA Member Banks 1 ABN Amro NV Johannesburg Branch 1 1 1 1 2 ABSA Bank Limited 1 1 1 1 1 1 1 1 1 1 1 1 3 African Bank Limited 1 1 1 1 1 1 1 4 Barclays Bank PLC South Africa 1 1 1 1 Calyon Corporate and Investment Cancel 5 1 Bank SA Branch led

34 This table reflects the situation as at the end of 2005. In the first quarter of 2006, Barclays (following its ABSA acquisition) has given up its membership and is no longer a clearing bank. In addition MEEG bank has joined on a sponsored basis. It should also be noted that Ithala and Postbank are not banks but exempted institutions in terms of the Banks Act.

1 2 3 4 5 6 7 8 9 10 11 12

Payment Clearing House Participant Groups BESA BESA (ATM) NuPay NuPay STRATE EFT Debit CLC Debit EFT Credit Debit Card Immediate Immediate Credit Card Paper Credit Paper Credit PIN Validated Payment ZAPS Electronic Debit Electronic Credit Settlement (SAMOS) (SAMOS) Settlement

6 Capitec Bank Limited 1 1 1 1 1 7 Citibank NA South Africa 1 1 1 1 1 1 8 FirstRand Bank Limited 1 1 1 1 1 1 1 1 1 1 1 9 Habib Overseas Bank Limited 1 1 1 1 1 10 HBZ Bank Limited 1 1 1 1 1 Cancel 11 Investec Bank Limited 1 led 1 1 1 12 Mercantile Bank Limited 1 1 1 1 1 1 1 1 1 13 Nedbank Limited 1 1 1 1 1 1 1 1 1 1 1 14 Rennies Bank Limited 1 1 1 1 1 Cancel 15 Societe Generale Johannesburg 1 led 1 16 South African Reserve Bank 1 1 1 1 1 17 Standard Chartered Bank Jhb 1 1 1 1 1 18 State Bank of India South Africa 1 1 19 Teba Bank Limited 1 1 1 1 1 1 South African Bank of Athens 20 1 1 1 1 1 1 1 1 1 Limited Standard Bank of South Africa 21 1 1 1 1 1 1 1 1 1 1 1 1 Limited Total PASA Member Banks 21 10 11 11 9 17 18 5 5 10 10 3 22 Ithala 1 1 23 Postbank 1 1 Sponsored exempted institutions 2 2 Shading – Registered SA Banks Source: Competition in SA Banking, 2004. Updated.

Each PASA member clearing bank is required to have an immediate settlement account with SARB Participation in other PCHs is optional.

In the table above, it is clear that while each bank is a member of the immediate settlement payment clearing house (PCH) agreement (or SAMOS); only a minority have membership of some of the others.

The most popular payment streams among existing PASA members are the EFT Credit and Debit Payment instruments.

New transaction procedures

A dominant concern of a number existing PASA members is the introduction of new payment mechanisms or transaction types. To date the innovating process has been hampered by a lack of clear guidelines and what some see as stonewalling by large incumbents where new transactions are introduced by smaller bank players.

As PASA itself notes, one of the basic principles of participation in any payment stream is that membership of such payment stream obliges all participants to accept all transactions presented to it by any other participant. However, the result of the introduction of some of the transactions was that the counter parties to such transactions were exposed to customer complaints or risk of claims that were not catered for during creation of the PCH and its rules. The new transaction types furthermore created an opportunity for users of the system to arbitrage against both the banks and the customers of the banks by misusing the functionality of the newly introduced transaction types to shift the cost of transactions (and even to gain income in doing so) to the detriment of customers and/or the banks.

This has made incumbents (PCH members, rather than PASA) reluctant to accept the introduction of new payment streams, thereby threatening to cut off the innovation that is required to develop new income producing products for the (expensive) infrastructure that is available.

PASA has consequently adopted an approach that seeks to strike a balance “between the need for constant innovation in a competitive environment that is founded on a co-operative infrastructure and the right to either accept or reject risk, additional workload or obligation that might be introduced by the counter parties” (PASA, website). Further PASA has indicated that some payment transaction types are of a utility nature by virtue of being the backbone of commercial activity in the country and that one may not be allowed to deny access to any qualifying bank to exchange such transactions.

PASA has recently formulated and published a document entitled, Principles and Process for Introduction of New Transaction Types / Devices, which seeks to address the current perceived shortcomings.

The main principles that apply are as follows:

• PASA and its participants will strive for full interoperability, on a fair and equitable basis for all participants, with the intent to support innovation • Participants must always meet technical standards as proven by proper certification of devices • New transaction types or devices may be introduced only after having been declared and approved in terms of a proper transparent process as prescribed by PASA council • If the introduction of a new transaction type or device affects the risk profile or workload of other members that are not party to it they have to either agree to allow it in the existing PCH or a new PCH must be created • All participants will strive for efficiency across the NPS and its PCHs • Any new transaction or device types must be registered with the PCH and PASA prior to introduction of such transaction or device type.

In addition to these principles a set of procedural guidelines for the introduction of new transaction types are provided. The process that needs to be adhered to is as follows:

• The first step would be for the innovating bank to engage other participant banks in order to find a bank/s that would be willing to accept such transactions or transactions from such new devices • The applicant bank/s has/ve to introduce the proposal to the appropriate Business Forum in order to enable the forum to consider the wider industry impact. The applicants may approach PASA ExO and/or SAPSA for guidance as to the most appropriate payment stream for introduction of a new transaction type • The Business Forum forwards the proposal, accompanied by their own recommendation as to the acceptance of and/or concerns as to the industry impact of the introduction of the transaction / device type to PASA ExO via the SAPSA Executive Office in terms of the formal channels established by SAPSA. The proposal will be accompanied by either extracts from the applicable minutes of the Business Forum or a formal letter from the Chairperson introducing the proposal • PASA ExO forwards the proposal and recommendation of the Business Forum to the PCH identified in conjunction with the applicant/s and supported by the Business Forum. If disagreement exists between these parties as to the appropriate PCH the matter would be submitted to PASA Council for a decision • PASA ExO, at the same time as the PCH, considers the proposal and recommendation of the Business Forum in order to assess industry systemic risk and possible negative impact on counter party banks • The PCH performs an impact analysis of the proposal and recommendation of the Business Forum in order to assess industry systemic risk and possible negative impact on counter party banks as well as the operational impact and feasibility. It also considers the fit into the proposed PCH • The proposal is to be accompanied by the proposed Rule changes, drafted by the introducing participant/s that would facilitate the proposed transaction or new device types in the identified PCH • Both the PCH and PASA ExO make recommendation to PASA Council as to acceptance of the new transaction or device type. • If the transaction type is not accepted into a PCH and in the absence of clearly identified industry risks a new PCH will be created. A minority vote against inclusion in the proposed PCH would be presented to PASA Council before a final decision by Council is made. PASA Council will take the objections raised by a dissenting member or members into account in the process of making a decision on the allocation of the new transaction type or transactions flowing from a new device type • All members of a PCH, or in the case of a new PCH all PASA members, will have the right to join such PCH or participate in clearing of such transactions

• If such new transaction type is to be introduced in an existing PCH and some participants choose not to participate in the exchange of such transactions the participants thereto will be recorded formally in a register of participants. (The agreements of some PCHs will have to be amended to cater for such partial participation) • Once all requirements have been met as recorded in terms of signed letters from the various participants PASA ExO will register the transactions indicating which participants are participating therein and inform the PCH and the PCH Operator that the transactions, per registered participant, may be introduced. The record of relationships so registered will form part of the records of the PCH and will be published on the intra-net for benefit of all participants • Upon being informed of the participants by PASA ExO and appropriate technical testing the PCH System Operator/s may allow the transactions to be exchanged between the participants.

Negotiation of inter-bank transaction fees as a result of risk or workload do not form part of the PASA domain and are responsibility of the participating parties. If two parties cannot reach agreement on the fees for the transactions PASA must be informed and the transactions will be registered as not being exchanged between such parties until confirmation is received from both parties that agreement has been reached.

5.7 Conclusions

The four market failures associated with financial regulation - anticompetitive behaviour, market misconduct, information asymmetry and systemic risk – apply to the financial system – as well as the payment system. These market facilities underpin the objectives of regulation.

Market integrity (or conduct) regulation of all players, of banks and non-banks alike, is therefore necessary, given the essential nature of the payments infrastructure and the tendency for market dominance of at least part of the networks by relatively few banks.

Furthermore given the considerable information asymmetry in the system the NPS also requires that participants are technically regulated. Finally, as already noted, the real time high value stream, in particular, may give rise to systemic disruptions.

The analysis of the current regulation of the NPS highlights the historical and evolving nature of the NPS system, most specifically its relative immaturity (about 10 years old) as well as the relatively recent introduction of legislation and regulatory structures. Given this, significant progress has been made to establish a world-class national payment system – in particular in respect of the

central bank settlement system (SAMOS). The NPS has to date achieved considerable ubiquity and interoperability to the benefit of stakeholders.

However, while the current payment system has numerous advantages such as high levels of interoperability and good economies of scale a number of concerns arise.

The first of these is the lack of regulation in respect of non-bank participants. The focus on banks as a consequence of the legislation means that a considerable portion of the participants of the NPS remain unregulated or inadequately regulated. Of additional concern is the inadequate representation of non-banks on the existing structures. With the exception of SANPAY (which is only a consultative forum) all other key bodies (such as PASA, the PCH’s etc.) are the exclusive domain of the banks. Effectively the voice of consumers and some NPS users is not heard. This leaves space for uneven lobbying by those with resources – such as retailers.

The NPSD has oversight of the payments system, whiles PASA is the self regulator. This implies that PASA rules are set by the members (the banks). The question is raised whether the NPSD should play a more active role in providing guidelines for such rules.

6 Participation and access to the NPS

This section sets out the details of the participants of a broadly defined payment system, and the access payment participants have to key infrastructure.

6.1 Payment participants

In addition to the current regulatory structure there are a number of other key payment players – most importantly the (PCH) payment system operators as well as the various membership bodies and forums.

The main players are identified in the figure below. Identified key participants are discussed further below.

Figure 6: SA payments landscape

SARB: SARB: Regulator Registrar NPSD

Payment System PASA Management Bodies

Payment Clearing Houses PCHs

NPS Strat Consultative Forums SANPAY Comm

SA Payments Strategy Business Forums Payment Business Forums Association (PayStrat)

Payment VISA MCI SWIFT CLS associations

PCH System SAMOS BANKSERV VISA MCI STRATE Operators

Other System SBV IPS SWIFT Operators

Banks Clearing Banks Non-clearing banks

Payment service Banks Payment Service Providers Large corporations providers

End-users Individuals Businesses

6.1.1 PCH System operators

SAMOS

One of the main objectives of the Blue book, accepted for implementation by the banking industry on 15 November 1995, was to reduce systemic risk in the South African payment system.

To this end, a number of fundamental principles were formulated, including the following:

• Settlement will be subject to the availability of funds • a balance will be maintained between risk reduction and cost • the Reserve Bank's response to a problem in the NPS will be in the interest of the system, not that of individual participants.

The Blue book furthermore prescribes two strategies specifically aimed at reducing interbank settlement risk, namely the introduction of an online central bank settlement system so as to enable banks to transfer interbank funds electronically, and the implementation of risk-reduction measures in the Payment Clearing Houses (PCHs).

The SARB implemented the South African Multiple Options System (SAMOS) on 9 March 1998. SAMOS is operated by the Operations division of the SARB and is at the heart of the overall national payment system.

SAMOS enables banks to settle in real time, high value electronic payments made by them and received by them through their settlement accounts held in the books of the Reserve Bank. All daily settlements of retail inter-bank exposures are also effected through the SAMOS System.

The SAMOS system provides two primary settlement options to banks, namely: Real-Time Gross Settlement (RTGS), referred to in the SAMOS system as the Real-Time Line (RTL), and the continuous processing line (CPL) settlement.

The Real-Time Line (RTL) is a facility for settling single-settlement instructions immediately on a gross basis. Currently all credit transactions exceeding R5 million must be processed through SAMOS RTL.

The Continuous Processing Line (CPL) is a delayed settlement facility developed to settle single-settlement instructions on a gross basis, utilising net liquidity. The CPL account is funded from the settlement account. Typically such settlement would occur between the various banks at the close of business each day.

The SAMOS system settles on a pre-funded basis. If a bank has insufficient funds available in its settlement account, the SAMOS system will automatically grant a loan to the bank against acceptable collateral. The amount of such a loan is limited to the collateral value of the collateral reserved for this purpose.

The SAMOS system therefore provides for immediate finality and irrevocability of settlement. In effect the SAMOS system is a Payment System operator under the management and supervision of the SARB.

Bankserv

Bankserv is the largest operator (providing infrastructural components) in the South African payment and clearing system. Prior to the establishment of Bankserv in the first half of 1993, the banking industry in South Africa jointly owned several companies that provided shared services to the banks in a number of different payment channels. The companies in this sector each followed their own direction and operated in their separate silos. An Inter-bank task group was appointed to investigate the feasibility of a new operator and in March 1993, the banking industry reached agreement and founded Bankserv. The ACB, BDB and Saswitch (Pty) Ltd were incorporated into Bankserv.

Bankserv’s provides inter-bank electronic transaction switching services to the banking sector. Essentially its role is to ensure that payment instructions (messages) are securely and rapidly switched between the various participants. The figure below illustrates Bankserv’s real-time switching role in respect of ATM transactions.

Figure 7: Bankserv Real-time ATM Switch Bankserv Real-time Acquiring Switch Issuing Bank Bank Non-stopNon-stop AcquiringAcquiring ValidationValidation AcquiringAcquiring BankBank IssuingIssuing BankBank ATMATM AuthenticationAuthentication AutomatedAutomated TellerTeller SwitchingSwitching AuthorizationAuthorization andand MachineMachine AccountingAccounting ATMATM ProcessesProcesses ProcessProcess

Non-stopNon-stop IssuingIssuing BankBank AuthorisationAuthorisation SettlementSettlement SwitchingSwitching SettlementSettlement AccountingAccounting && AccountingAccounting && QueriesQueries QueriesQueries

AuditAudit andand SettlementSettlement ProcessProcess CentralCentral BankBank SettlementSettlement

Source: Bankserv, 2005

Bankserv currently offers the following services:

• Real-time Switching Services (SASWITCH) • Electronic Funds Transfer (ACB EFT) • Code Line Clearing (CLC)35 • Cheque Verification System (CVS Plus) • Inter-bank Credit Payment System (ZAPS) • Fraud Management (FMS) • National Bank Account (NBA) • Mzanzi Money Transfer product (MMT) • Electronic Bill Presentment (EBP) • Web Based Management Information Services (WIS) • Research and Development • Consulting Services.

Bankserv is currently wholly owned by banks. Its current five shareholders comprise the big four banks as well as a consortium of seven smaller banks.

35 Code line clearing involves the capturing of the information of a deposited cheque electronically by reading the magnetic code line and transmitting the information to the paying bank for settlement before the paper cheque is delivered to the paying bank for final approval.

Figure Figure 8: Bankserv shareholding Dandishelf (7 small banks) 8%

ABSA, First Rand, Nedcor Standard Bank 92%

The Board of Bankserv comprise one member each from the Big four banks as well as two representatives from Dandishelf.

Bankserv is currently profitable with an estimated ROI of about 18%.

STRATE Ltd (STRATE)

STRATE (the acronym stands for Share Transactions Totally Electronic) is the authorised Central Securities Depository (CSD) for the electronic settlement of all financial instruments in South Africa. STRATE payment stream is responsible for clearing and settling payments resulting from equity (share market) transactions between participating banks. STRATE currently operates a public unlisted company and has some 1.4 trillion (ZAR) in dematerialised assets under custody.

Figure 9: STRATE ownership structure

Citibank Standard Bank 0.1% 16.8% Johannesburg Stock Exchange 41.0%

Nedbank Bank 16.8%

FirstRand Bank Ltd 12.7% ABSA Bank 12.7%

Currently STRATE is owned by JSE Ltd (41%), the four major South African Banks (ABSA Bank (12.7%), FirstRand Bank Ltd. (12.7%), Nedbank Bank (16.8%), Standard Bank (16.8%)) and Citibank (0.1%).

The controlling body of STRATE is representative of its various stakeholders with five representatives from the JSE, five from the Central Securities Depository Participants (CSDPs) (see below), the chief executive of STRATE and an independent chairperson.

In addition, the board includes a representative of the Investment Managers Association of South Africa and a nominated representative of the Company Secretaries’ Interest Group (CSIG) and 2 independent non-executive directors. The regulator, the Financial Services Board (FSB) enjoys observer status.

In addition to being an operator in terms of the NPS Act, STRATE is also a regulator of CSDPs.

STRATE is South Africa’s Central Securities Depository (CSD) for equities and the CSDPs are the only market players who can liaise directly with STRATE. Most of the current CSDPs are banks. In order to qualify for CSDP status, they have to fulfil the entry criteria set out by STRATE and approved by the FSB. There are currently six CSDPs. They are

• ABSA (ABSA Securities) • First National Bank • Nedbank - SCS Private Clients • Société Générale • Standard Bank • Computershare.

STRATE utilises the SWIFT network (Society for Worldwide Interbank Financial Telecommunications) for the relay of electronic messages. SWIFT is a network owned by all the banks in the world and therefore the provider of choice for all major financial institutions, globally.

SWIFT

SWIFT is an international financial industry-owned co-operative supplying secure, standardised messaging services and interface software to 7,800 financial institutions in more than 200 countries. SWIFT's worldwide community includes banks, broker/dealers and investment managers, as well as their market infrastructures in payments, securities, treasury and trade.

SWIFT provides a number of payment system services. In South Africa the SWIFT network is used by a number of banks as a messaging and clearing services to link to local and international banks as well as SAMOS. Currently STRATE also utilises the SWIFT network for its transactions.

SWIFT is one of three off-shore operators in South Africa.

MasterCard International

MasterCard International (MCI) is a leading global payments solutions company that provides a broad range of services in support of its members' credit, deposit access, electronic cash, business-to-business and related payment programs. MasterCard International manages a family of well-known, widely accepted payment cards brands including MasterCard®, Maestro® and Cirrus® and serves financial institutions, consumers and businesses in over 210 countries and territories.

MasterCard Incorporated is a private, SEC-registered share company whose shares are owned by the principal members or customers of MCI. MCI, a non- stock, membership corporation with more than 23,000 MasterCard, Cirrus and Maestro members worldwide, is the principal operating subsidiary of MasterCard Incorporated.

In South Africa, MCI, together with VISA and Swift is one of three licensed off- shore operators and one of three card operators (the others being Bankserv and VISA). MCI offers switching services for South African MasterCard customers.

VISA

VISA is jointly owned by 21,000 member financial institutions around the globe, and is a private, for profit association. Through its member financial institutions, Visa offers payment solutions for both consumers and businesses. Currently there are more than one billion VISA cards in circulation with acceptance in some

150 countries. In South Africa VISA, together with MCI and Swift is one of three licensed off-shore operators and one of three card operators (the others being Bankserv and VISA). In South Africa VISA offers switching services for VISA customers.

BESA

The Bond Exchange of South Africa (BESA) regulates the market in fixed-income securities and associated derivative instruments. As part of its services, BESA is responsible for clearing and settling payments resulting from bond market transactions between participating banks.

6.1.2 Representative bodies

In addition to the regulatory structures as well as the operators there are a number of key representative or member bodies in the payment system. These typically represent the interests of a particular segment. Notable is the absence of any consumer representation on these bodies.

The South African Payments Strategy Association (PayStrat)

The South African Payments Strategy Association (PayStrat) was originally set up by the payment system member banks (via the Banking Association) to offer a policy formulation and strategy development forum.

In its original formulation (as captured on its Website) PayStrat defined its role as follows:

The South African Payments Strategy Association is responsible for strategy and business development relating to the South African payments industry, in order to ensure that strategic issues are addressed at an industry-wide level.

SA Payments aims to increase the South African payments industry’s awareness and to improve their image in order to make it more accessible, responsive and leading edge.

The objectives of the Association are to:

o align the existing inter-bank business forums to improve industry effectiveness relating to the payment system and identify areas for improving efficiency and eliminating duplication within current inter-bank business forums o undertake research and development to determine whether the business products providing access to accounts that leads to the making of payments, meet international best practice standards o recommend best practice for the business products providing access to accounts that leads to the making of payments through communication and education

o support or influence any strategies that is created for incorporation into Blue Book ii and/or as determined from time to time by the Reserve Bank in consultation with PASA o provide a platform where business products providing access to accounts that leads to the making of payments of national importance can be debated o determine significant strategic issues related to the business products providing access to accounts that leads to the making of payments and the banking industry as a whole, such as the creation and or changing of business practices as well as the co-operation with non-Banks that is also involved in business products providing access to accounts that leads to the making of payments o improve responsiveness to business needs and decision-making in the business products providing access to accounts that leads to the making of payments, thereby ensuring that binding decisions are taken by Members and implemented within acceptable timeframes o foster innovation and execution of industry and other initiatives by engaging non-banks as well as the existing payments business forums and working groups for new initiatives in discussions and projects of common interest o communicate with government as well as risk and regulatory bodies on areas of interest regarding business products providing access to accounts that leads to the making of payments, including future regulation and policies in relation to business products providing access to accounts that leads to the making of payments o design cost effective and efficient business products providing access to accounts that leads to the making of payments for Members by co-ordinating the development of local, regional opportunities and cross-border payments initiatives and o promote the image of the banking industry as being responsive and transparent in relation to business products providing access to accounts that leads to the making of payments o fostering relationships between members to ensure cooperation to the benefit of the payment system o act as a facilitator to resolve differences between members with the aim of resolving matters prior to formal dispute resolution mechanisms being invoked. PayStrat, 2004

More recently PayStrat appears to have been drawn back into the Banking Association fold and no longer appears to operate as an autonomous entity. According to the Banking Association, PayStrat:

is responsible for sStrategy and business development relating to the South African payments industry, in order to ensure that Strategic issues are addressed at an industry-wide level. SA Payments aims to increase the South African payments industry’s awareness and to improve their image in order to make it more accessible, responsive and leading edge. (BASA website)

Specifically, PayStrat provides the primary liaison to PASA for the banks and is also home to the various payments stream business forums. In essence these

policy and business strategy forums are mandated to deal with all commercial / competitive issues that fall outside the technical and risk management responsibility of the respective PCHs. Importantly these business forums were until recently the primary arena for the negotiation of multi-lateral interchange fees. In response to legal advice following the introduction of the Competition Act this practice has ceased. Matter further discussed in section 8.

The business forums that are currently in operation are as follows:

• ABCI Forum (Association of Bank Card Issuers Business Forum): the ABCI business forum has as its purpose business issues and projects relating to debt and credit card payments. Its primary interaction with PASA is in respect of the Card PCH • ATM Forum (Automated Teller Machine Forum): the ATM business forum, also known as the self-service interest group, deals with cash and non- cash transactions in the self service environment. As such its primary interface with PASA is into the ATM PCH, however, this group also deals with the broader cash (notes & coin) management issues • EFT (Electronic Funds Transfer Forum): this business forum considers the business issues and projects pertaining to electronic fund transfer products and business (both debt and credit). The main PCH involved in the EFT PCH • EMV (Euoropay Master Visa Business Forum)36 : the EMV forum is tasked with the business and project issues pertaining o the introduction of the EMV card technology in South Africa. The EMV Forum includes banks, the leading card associations and retailers (through SARPIF - South African Retailers Payments Issues Forum) • IPBF (Interbank Payments Business Forum): this is a broad business forum that deals with all issues pertaining to strategy, new product development and other non-PCH issues in respect of all payments streams.

36 “EMV" is an acronym often referred to mean the specifications issued by EMVCo, LLC covering the operation of Smart card payment cards. Europay International, MasterCard International and Visa International formed EMVCo, LLC (“EMVCo”) in February 1999 to manage, maintain and enhance the EMV Integrated Circuit Card Specifications for Payment Systems as technology advances and the implementation of chip card programs become more prevalent. The objective of EMVCo is to ensure that single terminal and card approval processes are developed at a level that will allow cross payment system interoperability through compliance with the “EMV” specifications. Founders, Europay, MasterCard and Visa, each own a one third interest in EMVCo, LLC. EMVCo have worked for more than seven years to develop specifications that define a set of requirements to ensure interoperability between chip cards and terminals on a global basis, regardless of the manufacturer, the financial institution, or where the card is used. See also www.emv.co.za

The table below sets out the current bank and non-bank members of the five operational business forums.

Table 14: Participating entities in the business forums ABCI ATM EFT EMV IPBF

Absa Absa Absa Absa Absa Bankserv African Bank African Bank Bankserv African Bank FNB Bank of Athens Bankserv Capitec Bank Bank of Athens

Investec Bankserv Capitec Bank FNB Capitec Bank Mercantile Capitec Bank Citigroup Investec Citigroup Nedbank FNB FNB MasterCard FNB Standard Bank Investec Mercantile Mercantile Mercantile Mercantile Nedbank Standard Bank Nedbank Nedbank PASA Standard Chart. PASA PASA Standard Bank Visa International Rennies

Rennies SARPIF Standard Bank Standard Bank Standard Chart. Teba Bank Teba Bank Source: PayStrat, 2005 Shading indicates non-bank participants

Little more than a year ago PayStrat appeared to be repositioning itself as a forum for the development of industry wide payment strategies – in other words extending its purview beyond the narrow mandate of its bank members.

However, this appears to have recently been reversed and PayStrat’s independence has been curtailed as it has been brought back as a division into the Banking Association.

SANPAY (South African National Payment System Forum)

SANPAY is meant to be the main forum where the interests of all NPS stakeholders (including non-bank participants) are discussed.

SANPAY is open to all officially constituted associations and bodies that represent both individual and corporate participants within the South African NPS.

SANPAY was established by the SARB and falls under its mandate and management.

The purpose of SANPAY is to provide a discussion forum to foster and facilitate collaboration between the various stakeholders in the national payment system, with the aim to:

• contribute to an efficient and effective national payment system in South Africa

• ensure that the interests of all participants and stakeholders within the national payment system are considered • provide a collective forum for stakeholders within the national payment system to discuss and debate issues of mutual interest • provide input relating to payment system issues to the SARB as overseer of the national payment system.

In light of these aims SANPAY performs the following functions:

• identify and consider payment system issues for further discussion and debate within SANPAY • research payment system issues • debate and propose solutions to payment system issues, practices, processes and development • determine the most suitable channels to take action in order to address payment system issues and problem areas • facilitate the exchange of information between stakeholders • monitor progress in addressing the identified payment system issues or problem areas and provide feedback thereon to affected stakeholders and • assist with the information dissemination and education process on payment system issues.

SANPAY is open to all system participants, but it remains at the level of a discussion forum with the mandate to advise the SARB. It does not have any statutory or enforcement capabilities.

In recent interviews, many participants have expressed dissatisfaction with the operation of SANPAY and the quality of the discussions.

Banking Association of South Africa

The Association of Mortgage Lenders (AML), Merchant Bankers Association (MBA), Clearing Bankers Association (CBA) and Association of General Banks (AGB) merged into establishing The Council of South African Banks (COSAB) in March 1992. The name changed to The Banking Council of South Africa in March 1998.

The Board resolved on 7 March 2005 that the name be changed to The Banking Association of South Africa (BASA).

BASA is the industry body whose role it is to establish and maintain the best possible platform on which banking groups can do responsible, competitive and profitable banking. As the representative body, BASA continuously interacts with various government departments, consumer bodies and other interest groups regarding banking issues.

SWIFT Users of South Africa

The mandate of the SWIFT Users of South Africa (SUSA) is to represent the interests of banks and participants who belong to the SWIFT network (see Operators section above).

Treasury Operators Forum

The mandate of the Treasury Operators Forum (TOF) is to discuss treasury and international banking issues which are of mutual concern and to set market practices where appropriate. The executive committee consists of the four major banks, the Reserve Bank (as a treasury operator) and two representatives from the other banks. The members of this body are responsible for the largest portion of large-value payments.

Association of Bank Card Issuers

The mandate of the Association of Bank Card Issuers (ABCI) is to discuss technical issues of mutual concern in the bank card industry, specifically technical issues related to bank cards affiliated to VISA and MasterCard. The ABCI also sets industry rules, undertakes research and involves itself in legal matters pertaining to the bank card industry.

6.1.3 Other NPS participants

While from a legal point of view only banks may participate in the clearing and settlement system of the NPS, the reality is that there are a large number of other participants who provide customer payment services or interface with the NPS.

The recent Competition in SA banking report (2004) indicated some 60 institutions that participate in the NPS - of which at least 19 were not banks and included retailers and other customer payment service providers.

A large number of these non-bank participants are linked to the NPS through specialist service providers and other payment operators.

In addition it should be noted that a number of smaller banks and foreign bank branches are currently not direct clearing and settlement participants but utilise the services of a specialist operator to provide them with banking IT services as well as clearing.

EasyPay

EasyPay (Pty) Ltd is a division of Prism Holdings. Currently, EasyPay controls the largest bank-independent financial switch in Southern Africa, processing more than 260 million transactions last year. Its infrastructure connects into all major South African banks and switches both debit, credit and fleet card transactions for the country’s leading retailers and petroleum companies.

The company has enjoyed substantial growth over the last five years. EasyPay currently processes a considerable number of South Africa’s point of sale- originated debit and credit transactions, in addition to processing over 1 million bill payments and over 3 million prepaid transactions per month.

EasyPay switches credit, debit, fleet, staff and private label card EFT transactions for some of South Africa’s leading retailers and petroleum companies (see table below).

Table 15: Key EasyPay Clients

• ABSA & ABSA NuPay • Pick ‘n Pay Group • Blue Label Investments incorporating • SABC The Prepaid Company, Kwikpay and • Shoprite Holdings CGS • Telkom • BP • Total • Caltex • Traffic Departments • Cell C • Vodacom • Edcon Group • All major Local Authorities • Eskom • An increasing number of users of • JD Group EasyPay Licences service • Lewis Group • Organisations across a variety of • Makro industries requiring consumer • MDD Group payments – these include Insurance, Medical, Cosmetic, Financial, • MTN Legal, Funeral Homes, Mail Order etc.

Key to this offering is the reconciliation, settlement and 24 x 7 monitoring service provided around the core switching of transactions between merchant’s POS infrastructure and the acquiring institution’s back-end system.

As part of its value-added-services offering, EasyPay developed and operates the consumer bill payment service introduced at retail point-of-sale over 10 years ago. Known and marketed as EasyPay, the service is integrated into a large number of national retailers, mobile channels and is available on www.easypay.co.za.

EasyPay processes monthly account payment transactions for close on 200 different bill issuers including major local authorities, telcos, utilities, medical services, traffic departments, mail order companies, banks and insurance companies.

EasyPay Prepaid Electricity enables the vending of prepaid electricity for electricity utilities such as Eskom and a growing number of local authorities on a national basis. The vending of prepaid electricity is done in full compliance with Rationalisation Standard (NRS) and the Common Vending System (CVS) standards. EasyPay is also a member of AMEU (Association of Municipal Electricity Undertakings SA).

EasyPay is a member of SARPIF (SA Retailers’ Payment Issues Forum) which forms part of SANPAY (SA National Payment Forum) (see section 6.1.2). EasyPay is also a member of SARPA (SA Revenue Protection Association) and has representatives on both the implementation and master EMV forums.

Net1 Applied Technology Holdings

Net1 is another major local player in the payments space offering a range of products and services. Currently Net 1 offers:

• Transaction-Based Activities: these consist primarily of the distribution of social welfare payments in South Africa (believed to have about 45% of the market share) through its subsidiary Cash Paymaster Services (Proprietary) using smart card technology. These transaction services also include introduction of POS devices at merchants. This system allows their card holders to load their social welfare grants or salaries onto their smart cards at any participating merchant. Once their smart cards have been loaded, card holders have the flexibility to either purchase goods or receive cash offline • Smart Card Accounts: This involves the provision of smart card accounts to its card holders, which currently primarily consist of social welfare grant beneficiaries • Financial Services: This business segment concerns the provision of financial services to card holders through their smart card delivery channel. These financial services consist primarily of short-term loans (micro-lending) and life insurance products. Net1 have about 100 branches in the micro-lending business throughout South Africa • Hardware, Software and Related Technology Sales: This involves hardware, software and related technology sales including hardware for the back-end switching and settlement system; customization of the smart-card software to suit local conditions, including management system, automated teller machine, or ATM, integration and POS device integration etc. Its largest customer in this segment is Nedbank Limited. Net1 have an arrangement with Nedbank relating to the outsourcing of its entire POS device management system, front-end switching Stratus computer platform, software development, smart cards and POS device maintenance. Net1 also supply hardware to Nedbank in the form of POS devices and card readers.

6.2 Access to the NPS

Access to the NPS, in the sense of participation in clearing and settlement, is regulated and restricted to registered banks37. The current regulations in respect of access indicate the following:

• Only those institutions that are regulated by the SARB (i.e. banks, mutual banks, and branches of foreign banks) are eligible to become members of a payment clearing house and keep a settlement account at the SARB • The NPS Act obliges the Reserve Bank to oversee the payment system from a systemic risk perspective • The Blue book detailed the strategy for the payment system to 2004 (“Vision 2004”), including 13 fundamental principles, one of which is “2.5.9 All banks are eligible to clear payments in their own name.” This states “A bank, providing payment services to its customers, should preferably participate in the interbank clearing process under its own name, thereby ensuring that all exposures are visible”.

The current regulations allow registered banks to participate in two ways in the NPS – either as direct clearing and settling banks (that is with direct access to the real-time clearing and settling system – SAMOS), or as a members of a payment clearing house (PCH) without a settlement account.

This latter arrangement is referred to as sponsorship and requires that the member’s obligations are settled by another bank under a sponsorship arrangement.

A number of non-banks have become members of the payment system on a sponsored basis, e.g. the Postbank, is a sponsored financial institution in the payment system. It has no settlement account at the SARB.

Sponsorship can take three forms, namely:

• Sponsorship of the settlement of obligations that stem from clearing • Clearing and settling on behalf of a smaller player by a larger player • Technical sponsorship where the smaller bank uses systems of the larger bank but clears and settles in its own name.

These relationships are negotiated on an individual basis between the bank requiring such a service and the bank providing it.

37 While there are some non-bank sponsored entities, such as Postbank and Ithala, the NPS Amendment Act still restricts clearing and settlement activity to registered banks.

Difficulties associated with accessing the payment system by smaller banks has been documented in recent reports (SMEs Access to finance in South Africa 2001b and Competition in South African Banking, 2004). The difficulty has frequently revolved around perceived or real barriers regarding non-price criteria, such as meeting the interoperability requirements of existing players, or lack of transparency regarding the processes involved, etc.

During the interview process for this report, both regulators and banks appeared to feel that some of these non-price barriers had been fully or partially addressed. Certainly, there were indications that the regulators were aware of potential problems and were prepared to intervene if necessary. For example, the question was raised as to how a would-be dedicated bank could persuade a clearing bank to become its sponsor. The response of the regulator was that should no clearing bank be prepared to volunteer their services, the regulator would identify the bank with the best fit and facilitate the process leading to such sponsorship.

6.3 Conclusion

The landscape reveals a high degree of concentration amongst operators. While a number of operators exist, typically these serve only a single payment stream (e.g. STRATE). The core NPS payment processes in respect of EFT and card transactions are dominated by Bankserv which is owned by the large banks who constitute the major users of its infrastructure. While the two card operators (Master card and Visa) have introduced some competitiveness into the debit and credit card markets, the EFT space remains largely uncontested. While the concentration has resulted in a high degree of interoperability and likely economies of scale, it eliminates the possibility of any competitor emerging and limits the possibilities of switching.

Various anomalies already set precedents in respect of possible future approaches to the regulation of the NPS. These precedents include the fact that multiple operators exist in some PCHs (for instance card) which would suggest that there is no reason further licensed operators should not be encouraged. Secondly the fact that some non-bank participants (specifically State owned financial institutions) are able to participate in the NPS without the same levels of oversight as the bank participants, suggests that the current hostility to all non-bank participants in direct clearing and (if not) settling may be unfounded.

7 Technical description of the NPS

This section sets out the main technical features of the NPS and its operation. The intention is not to provide an exhaustive account of the various nuances that exist in respect of the technology and structure of the various payment processes, but rather to assist the reader in understanding the core function and process associated with any payment.

7.1 Market activities and the NPS

Payments originate in trade between buyers and sellers in a market. The common denominator of trade in the various markets is the fact than an agreement is reached as a first step. This is referred to as deal making. Thereafter the deal must be completed, or finalised in accordance with the agreement. This includes both payment and, where applicable, delivery (for example where scrip is involved).

Illustrated in the figure below are some of the possible market activities that would give rise to the need for a payment transaction and payment system.

Figure 10: Relationship between market activities and payment processing Retail Wholesale (Corporate) Foreign Exchange Market Commodities Market Capital Market Money Market Trading BuyerBuyer Deal Making SellerSeller

Delivery

Deal Completion Payment

Market-related Trade Reporting Systems Banks: Clearing & Delivery System – Ownership Transfer Settling

Infrastructure Payment System

Source: SARB, 1995

7.2 Description of a payment system

Various market activities give rise to the need for different payment instruments and systems. Historically different payment systems have evolved in each market. This has given rise to proprietary networks, multiple payment instruments and, in some cases, limited inter-operability. Recently increased emphasis has been on establishing integrated payment networks in order to improve inter-operability and efficiencies and also to establish improved centralised risk management and oversight.

As such a national payment system is the configuration of diverse institutional and infrastructure arrangements that facilitate the transfer of monetary value between the parties and ideally seeks to integrate multiple payment networks or facilitate their improved interoperability.

The figure below illustrates the major components, technological, institutional and other, that comprise a national payment system.

Figure 11: National payment system scheme

Payer Monetary claims Payee

Central bank money Commercial bank money

Cash Deposit

Non-cash payment instruments

Network systems Payment infrastructure Oversight • Transaction • Clearing Participating Laws financial & non- • Settlement Standards financial institutions Procedures

Market arrangements Securities systems

The payment system comprises of a number of key elements, notably:

• Payment instruments • Transaction flows (payment flows) • Clearing • Settlement.

Each of these is dealt with in more detail below.

7.3 Payment instruments

Currently PASA determines the specific rules that pertain to the various payment instruments. These rules determine the manner in which a transaction must be performed.

7.3.1 Debit orders

Debit orders are payment instructions directed by a third party to the account of a paying customer of a bank in terms of authority granted by the paying customer to such third party. In simpler terms, it can be described as a facility whereby somebody can collect money from your bank account without your having to do anything other than having given such person a written or recorded voice approval to do so. Debit orders are widely used to collect monthly premiums on life and investment policies, mortgage and hire purchase payments, medical aid subscriptions, magazine and TV subscriptions, etc. It provides the payer with a relatively cheap and very convenient means of making recurring payments.

The collector/beneficiary of the debit order, commonly referred to as a user by the banks, must obtain authorisation from the customer to collect the funds from the customer account through a signed or voice recorded debit order mandate. The mandate given by the customer typically authorises the collections on a specific date, or repeatedly, on a fixed date every month, for a fixed amount or a variable amount with an upper limit or for example increased by 10 percent each year. A user is a party who has been approved by a participating/collecting bank and is facilitated by such bank into the EFT payment system to be able to collect funds, mandated by customers of the paying banks.

Paying banks accept collection instructions to debit their customer’s account that includes the collection information / reference provided by the user. The information normally reflects on the customer’s bank statement to enable the customer to identify the source of the debit. If the customer is not in receipt of regular bank statements, details of the EFT debit transactions may be obtained from the customer’s bank.

Customers are responsible for ensuring that the correct account numbers are provided to the user as banks processing is based on customer account number and not the name or other reference information. The maximum value of a debit order is currently set at an amount of R500 000 (Five Hundred Thousand Rand). Transactions mandated by customers are sent by the user to the paying bank via the inter-bank operator for collection from the account of the customer. Such transactions are processed overnight by the paying banks against the accounts of their customers and unsuccessful transactions are returned to the collecting bank/user the next day.

In the process of clearing, the account of the customer is debited and the account of the collecting user is credited with the transaction amount. The transaction will reflect on the bank statements of the customer along with the reference information provided by the user.

7.3.2 ATM cash withdrawals

This section deals only with transactions performed using Automated Teller Machines (ATMs) that dispense cash directly to the customer and not other types of terminals or transactions.

A withdrawal by a customer, using an Automated Teller Machine (ATM), constitutes a real time withdrawal by such customer out of his/her own account38. ATMs may either belong or be contracted to the bank holding the account of the customer or another bank. In the first instance, the transaction will be performed entirely through the customer’s bank. In the second, the transaction will be forwarded to the account holding bank by SASWITCH, the inter-bank operator.

A customer initiates the transaction by inserting his/her ATM enabled card into the ATM, after which the ATM will request that the Personal Identification Number (PIN) be keyed in to verify that the transaction is in fact being initiated by the customer. This requirement protects the customer from the system being misused to obtain funds fraudulently from the customer’s account as most bank accounts of individuals in South Africa are or can be linked to the SASWITCH system enabling fund withdrawals at ATMs across the country.

As the customer is responsible for safekeeping of both the ATM card and the PIN any transaction initiated, using both the card and PIN, will be deemed to have been initiated by the customer. A transaction initiated at an ATM is immediately passed on to the bank where the customer’s account is held together with the PIN in encrypted format. The paying bank (customer’s bank) has the capability through its security system to verify the correctness of the PIN without the PIN

38 This means that the ATM must always be “on-line”. This contributes considerable telecoms cost to the overall cost of distributing ATMs. SmartCards, which store information on the card itself would be one way of reducing operation costs and facilitate withdrawals in remote areas.

ever being exposed to anybody during the process. All transactions are uniquely referenced to facilitate easy identification of the transaction where subsequent enquiry or audit is needed.

Having verified the PIN and ensured that the customer has sufficient funds to cover the requested withdrawal, the customer’s bank (authorising bank) will debit the account of the customer, then send a message, via SASWITCH, through the bank controlling the ATM, authorising the amount requested be paid out. The ATM would then pay the authorised amount if it contains sufficient bank notes to make the payment.

Normally, if any one of the required messages or actions fails to be executed, the ATM and or the system/s of the bank/s and operator will record such error with a code indicating the type of failure, send an error message to the other parties to indicate that the action has failed and the system will reverse any entries that could not be completed. The records of successful or failed transactions are recorded in log files by the various parties to assist in resolving any queries that might arise. In conjunction with the daily balancing of the cash in the ATM a clear picture can be obtained as to whether payments were actually made correctly by such ATM.

All banks involved in the exchange of ATM transactions are required to reconcile the records of transactions on a daily basis so as to ensure that the system is kept in balance and any incomplete transactions can be rectified speedily. A bank receiving a query regarding anomalous transactions has four working days to resolve a query.

In the unlikely event that a customer’s account is debited with the withdrawal without the customer actually having received such funds, the two banks involved will communicate with each other, having identified the error during the daily reconciliation processes or when a customer complaint is received. The funds involved will be returned to the affected customer and the service providing bank.

7.3.3 Cheque processing

A cheque written out, signed and handed to the receiving customer starts a physical journey, in the same way that corresponding electronic transaction is generated and processed.

The receiving customer will deposit such cheque at his or her bank and expect to receive credit on the same day, even though a cheque is judged to be a promise to pay that is only fulfilled when the paying bank has confirmed the correctness and legality of the cheque as well as whether the paying customer has adequate funds to cover the amount of the cheque. In South Africa, a customer is credited

with the value of a cheque deposited on the date of the deposit. In most other countries, credit is applied only once the paying bank has cleared the cheque.

Banks normally withhold access to the funds credited in this manner to safeguard against the possible rejection and return of the cheque by the paying bank. To speed up the process, the information on a cheque is sent via an electronic information stream through an inter-bank operator and the physical cheque follows to serve as final confirmation of the mandate.

Upon receipt of the cheque at the branch of the paying customer’s bank, the cheque will be inspected to confirm the correctness of the details and the signature of the cheque. If a cheque is found to be flawed in terms of signature (mandate), the paying bank will return the transaction electronically to the depositing bank and the cheque will follow.

The maximum value payable per cheque is currently set at R5 000 000 (five million Rand). In instances where cheques for higher values are issued it will be cleared manually between the banks and the beneficiaries account will be credited only on completion of this process.

7.3.4 Processing of high value payments

Payments made through this system take place instantaneously and the funds for each transaction are transferred between the two banks involved in the books of the SARB before confirmation of completion of the transaction is given. Depending on the functionality provided by a bank to its customers the immediacy of processing via this system may vary. Such transactions are final and irrevocable. This means that a transaction cannot be reversed. Any errors have to be corrected by way of a new transaction.

Payments of more than R5 million can be made only by using this instrument.

These transactions are performed through the Immediate Settlement Payment Clearing House (IMMS PCH) and payments of any amount may be processed through this mechanism as long as the customer and the paying bank have enough funds available in the books of the SARB at the point of initiating the transaction.

In the payments industry these transactions are settled on a Real Time Gross Settlement (RTGS) basis. Each individual transaction is settled (transferred between the accounts of the two banks in the books of the SARB) immediately.

Some banks have integrated their customer systems in such a way that transactions over R5 million are automatically routed through this system. Funds received via this medium are automatically applied to the account specified in the transaction although not all banks have automated their systems and manual intervention is required before funds are credited to the specified account.

7.3.5 Low value credit payments

The maximum value of a low value credit payment is currently set at five million Rand. Any electronic payment more than five million rand can only be done through the High Value Payment System.

Low Value Credit Payments, also referred to as EFT Credits, originate whenever a customer of a bank issues a payment instruction to his/her bank via various delivery channels to make an electronic payment to a third party, accepting that such payment will not be made immediately but either later that day or on a future date. This instrument may be also be used where a customer issues an instruction to his/her bank to make a series of recurring payments in the future. Such payments are commonly referred to as electronic account payments or bill payments and sometimes as stop orders or standing orders.

Low value credit payments are widely used by employers to make salary payments and are used more and more by customers to replace cheque payments, especially by issuing the instructions through use of the Internet or Call Centre services of his/her bank. Customers must ensure that the correct beneficiary account number is provided to their bank when issuing the payment instruction as all processing/transfer of funds is performed solely based on this account number.

Transactions mandated by customers are sent by the paying bank to the receiving/beneficiary bank at the close of the day in a batch via the inter-bank operator to be credited to the account of the customer. Such a transaction is final and irrevocable. The transaction cannot be reversed once processed by the receiving bank. Any mistake may only be corrected by way of a new transaction initiated with full approval of the recipient of the funds. Batches of transactions received from other banks are processed overnight (after 00h00) by the receiving bank to the account of its customer and unsuccessful transactions are returned to the paying bank the same business day.

In the process of clearing, the account of the paying customer is debited and the account of the receiving customer is credited with the transaction amount. This transaction will reflect on the bank statements of the customer along with the reference information provided by the user. Depending on the functionality provided by the paying bank to its customers the availability of funds via this system may vary. The paying customer may select for same day or deferred

processing. The capability of a bank to present a transaction for value the same day would be affected by the time of day that the transaction is initiated by the paying customer, as specific cut-off times, which vary from bank to bank, are applied by the banks to facilitate the processing of the batches in time for the industry cut-off.

Some banks have integrated their customer systems in such a way that transactions under R5million are automatically routed through this system and the customer may also specifically request processing through the high value payment system. In some banks, funds received via this medium are automatically applied to the account specified in the transaction. Not all banks have automated their systems and as such require manual intervention before funds are credited to the specified account.

7.4 A typical payment process

Set out in the figure below is a description of the stages of a typical non-cash payment process. In broad terms a payment process would involve the following key steps:

• Payment instruction triggered by end-user • Payment initiation involving acceptance and assumption of responsibility by bank to facilitate transfer of value • Clearing – exchange of payment instructions between banks; determine “on- us ” vs. “on-them”39 • Interbank settlement (where required) via SARB • End-user receives payment confirmation.

39 The terms “on-us” and “on-them” refer to the relationship between the acquiring bank and the issuing bank. An on-us transaction means that the for instance the merchant who accepts a credit card banks with the same bank as the customer presenting the credit (which is also issued by that same bank. In effect this becomes an intra-bank transaction that does not need to be switched through an operator (such as Bankserv) and SAMOS. In short no obligations arise to another bank. In contrast an on-them transaction requires the payment to be routed via an operator in order to obtain final settlement from another bank. As will be noted further on, these two types of transactions carry different costs

Figure 12: Phases of the payment process

Real economy Purchase and sale of goods and services

Banking System Provision of payment services

Interbank Fund-Transfer Systems Clearing and settlement processes

Payment Payment Payment Payment Clearing Settlement instruction initiation finality confirmation

Source: SARB, 1995 (modified)

Let us consider the typical transaction process in a bit more detail. The flow of payments through the payment system can be described for debit instruments and credit instruments, as follows:

1. Debit instrument payments such as cheques, debit orders and debit cards

(a) The buyer, a person wanting to buy goods or services, walks into a shop, chooses what he or she wants and discusses payment with the seller (shop owner).

(b) The shop owner evaluates the form of payment presented ie, cheque, debit order, debit card, etc and its payment risks. The shop owner can refuse certain types of payment. Increasingly, cheques are declined.

(c) Upon reaching agreement with the buyer, the shop owner will release the goods or provide the service indicated in (a) to the buyer.

(d) The shop owner transmits payment instructions to its banker, normally in the form of a deposit, with the understanding that, should its banker (collecting banker) not be able to collect the payment, the shop owner’s account will be debited with such un-collected payments.

(e) The collecting banker, depending on its arrangements in a PCH agreement with the banker of the buyer (paying banker), will either transmit all relevant payment instructions directly to the paying banker or

will transmit all payment instructions to a PCH system operator, which will deliver the relevant payment instructions to the paying banker. (f) The PCH system operator utilised in this manner will receive payment instructions from collecting bankers, sort all such payment instructions received and deliver it to the applicable paying bankers. Concomitantly with the receiving, sorting and delivering process, the PCH system operator calculates the gross bi-lateral payment obligations that each paying banker owes to each receiving banker, after which a settlement instruction are delivered together to the Reserve Bank on behalf of each paying banker to transfer funds from the account of the paying banker to that of the collecting banker to settle the payment obligation.

(g) The Reserve Bank, upon receipt of these settlement instructions, will validate the instructions and if the accounts of the paying banker are funded (i.e. is in credit or collateral is available for a loan), will transfer the funds to the account of the collecting banker. In cases where a settlement instruction, due to an account not being funded, cannot be effected, none of these settlement instructions are settled until internal management processes of the Reserve Bank takes the process of settlement to a logical conclusion.

(h) Upon receipt of any payment instruction the paying banker may honour only a client’s mandate, which means that the paying bank is only allowed to debit a client’s account based on an authentic payment instruction received from such a client40. The paying banker will therefore, within the ambit of the PCH agreement and clearing rules, authenticate the payment instruction and -funds or credit prevailing- either makes the payment by debiting the payer’s account or decline to make the payment. A decision to make payment may be taken after settlement was effected in the books of the SARB (depending on the rules and process of the relevant stream). In the case of debit cards (due to the real time nature of the system) the decision is taken before effecting settlement.41

(i) The paying banker, when declining to make payment, will present the transaction not paid to the collecting banker as a new transaction (following a process similar to the process described in (e) to (h) effectively reversing settlement and payment in the same manner as it happened initially.

40 All credit payment instructions are irrevocable regardless of whether the paying banker has authenticated and/or received information to enable it to authenticate the payment instruction. 41 In respect of various payment streams the following payment and settlement priorities apply: • CLC (cheques): settled before (or after) effecting • EFT debit orders: settled after effecting • EFT credits: settled after being credited to the account • Credit cards: settled before being effected to the account • ATM cash: settled after having been paid out.

2. Credit payments done via telephone, stop order42 or internet. (a) The buyer, a person wanting to buy goods or services, walks into a shop and chooses whatever he or she wants and then discusses payment with the seller (shop owner).

(b) The shop owner evaluates the form of payment presented i.e. credit payment into its account and furnishes the buyer with the account number and information regarding its (the shop owner’s) banker (beneficiary banker).

(c) The shop owner, upon reaching agreement with the buyer, will release the goods or provide the service indicated in (a) to the buyer. This normally only happens after receipt of confirmation from the beneficiary banker that payment has been received from the buyer.

(d) The buyer instructs its banker (the paying banker), by internet or telephone, or by signing a stop-order within the branch with the understanding that, should the account number and information provided by the payer regarding the buyer and the beneficiary bank be incorrect, the paying banker or the beneficiary banker cannot be held responsible for effecting an incorrect payment.

(e) The paying banker upon receipt of any payment instruction may honour only a client’s mandate which means that the paying bank is only allowed to debit a client’s account based on an authentic payment instruction received from its client43. The paying banker will therefore, upon the receipt of the payment instruction from its client (or on the due date of the stop order instruction) within the ambit of the PCH agreement and clearing rules, authenticate the payment instruction and (funds or credit prevailing) either make the payment by debiting the payer’s account or decline to make the payment. Due to the delivery of the payment instruction by the payer to his/her banker a decision to make payment is taken before clearing takes place and settlement is effected in the books of the SARB. In the case of EFT credits, where the payer transmits the instructions directly to the PCH system operator rather than his banker, the paying banker updates its client’s account before effecting settlement. The paying banker may not however decline to effect these instructions received via the PCH system operators, since all credit payments are irrevocable in terms of clearing rules.

42 A stop order is held by the paying banker and a credit transfer is initiated based on the stop order to the bank of the beneficiary. A debit order instruction, however, is held by the beneficiary. 43 In the EFT credit order system due to the delivery of the instruction to the PCH system operator, payment instructions are received that are not accompanied by information, such as a Personal Identification Number or the signature on a cheque, that the paying banker can use to authenticate whether the payment instruction was issued by the payer. Should a payer therefore, after payment has been made, declare (in writing) that the payment instruction was not issued by the payer self or by a properly appointed agent of the payer, then the paying banker will refund the amount involved to such payer.

(f) The paying banker, depending on its arrangements in a PCH agreement with the banker of the shop owner (beneficiary banker), will either transmit all relevant payment instructions directly to the beneficiary banker or will deliver all payment instructions to a PCH system operator, which will deliver the relevant payment instructions to the beneficiary banker.

(g) The PCH system operator, when utilised, will receive payment instructions from paying bankers, sort all such payment instructions received and deliver them to the applicable beneficiary bankers. Concomitantly with the receiving, sorting and delivering process, the PCH system operator calculates the gross bi-lateral payment obligations that each paying banker owes to each beneficiary banker, after which a settlement instruction are delivered to the SARB on behalf of each paying bankers to transfer funds from the account of the paying banker to that of the beneficiary banker to settle the payment obligations.

(h) The SARB, upon receipt of these settlement instructions, will validate the instruction and if the account of the paying bankers are funded, will transfer the funds to the account of the beneficiary bankers. In cases where a settlement instruction, due to an account not being funded cannot be effected, none of these settlement instructions are settled until internal management processes of the SARB takes the process of settlement to a logical conclusion.

(i) The beneficiary banker, upon receipt of the payment instructions, will credit the account of the shop owner and inform the shop owner of the payment as arranged between the shop owner and its banker (the beneficiary bank). In the case of high value payments that are settled on a payment instruction by payment instruction basis through the books of the SARB, the agreement between the banks is that the account of the shop owner will be credited only after settlement has taken place. In all other cases, the funds are credited to the account of the shop owner upon receipt and before settlement between the paying and beneficiary bank was affected.

The system guarantees account holders, within reason and by arrangement with the account-holding bank, that money will not be lost (especially due to fraud). The same cannot be said for cash. It therefore follows that fee structures of banks have to include a risk premium to cover the guarantee on non-cash payments.

From the moment of initiation of a non-cash payment until its settlement with finality, the participants in a transaction (payer, payee and one or more financial institutions) may be exposed to certain risks. These risks arise at the level of the

individual payment, and, where payments are netted, at the aggregate level as well. These risks include:

• Risk of fraud: wrongful or criminal deception • Operational risk: human or technical error • Legal risk: legal uncertainty (eg bankruptcy) • Settlement risk: comprises credit and liquidity risk preventing settlement • Systemic risk: failure of one participant prevents others from meeting their obligations.

Payment system networks are designed to minimise these risks, through authentication and regulation.

7.5 Authorization, clearing and settlement and fees

Any payment transaction comprises three layers. These layers include an authorization process (essentially a messaging or information process), a settlement and clearing process and finally a circuit of fees which determines what each participant obtains from the transaction.

As noted earlier the permutations of these three layers are multiple and dependent on particular regulations, technology issues, negotiation between key players as well as the nature of the payment instrument itself. Most importantly in South Africa the circuit of fees is determined by whether a transaction is intra- or inter-bank (on-us versus on-them).

7.5.1 Authorisation process

Different procedures may be used for authenticating and authorising payments. They vary depending on the different payment instruments used: for example, a debit card transaction at the point of sale (POS) with the use of a PIN code generally involves both authentication (by keying in the PIN) and authorisation (confirmation of the transaction and initiating the online approval by pressing the OK key).

Figure 13: Authorization process

3 Authorise Authorise

Bank A Bankserv Bank B

Message Message

Authorise Message 2 2

POS 1 3 VISA Authorise PIN 4 Master Card Cardholder b

The following key steps are indicated in the figure above, which illustrates a typical debit card transaction which is an “on them” (sometimes also referred to as “off us”) transaction.

1). Cardholder b (who banks with Bank B), enters his PIN at the merchant’s POS. The Merchant banks with Bank A 2). A message is sent from Bank A to Bankserv and from Bankserv to Bank B, seeking authorisation 3). Since Cardholder b has funds in his account to cover the purchase, authorisation is delivered via the same route to the POS 4). Alternative authorisation route may also occur through VISA or MasterCard that by-passes Bankserv.

With respect to the timing of these activities, two broad categories exist:

• Immediate authentication and authorisation: given by the payer’s financial institution at the initiation of the payment transaction process (e.g. credit transfers and card payments) • Deferred authentication and authorisation: given by the payer’s financial institution at the end of the transaction process following the request of the payee’s financial institution handling the payment information (e.g. cheques and direct debits).

In the figure above, the authorisation process is shown. Debit card transactions require immediate authentication and authorisation. If the transaction were a credit card one, then transactions up to the pre-approved threshold would be automatically approved; larger transactions require authorisation. In order to show the role of the switch, Bankserv, we have assumed that the transaction is an “on them” or “off us” transaction. As mentioned before if the customer and merchant both deal with the same bank, this would be an “on us” transaction, which would be processed wholly within the systems of the bank concerned.

The process involves a message requesting authentication from the cardholder’s bank. The transaction switches through Bankserv, as the customer’s bank and the merchant’s acquiring bank differ. If there are funds in the account, the payment is authorised via the same routing, and from the customer’s and merchant’s perspectives, the purchase is now concluded, although clearing and settlement are still to be completed.

As the figure shows, MasterCard and VISA are alternative switches which by- pass the Bankserv infrastructure, but generate the same result.

7.5.2 Clearing and settlement

Clearing, netting and settlement are three distinct processes pertaining to the payment system environment.

Clearing process

During the clearing process two main functions may be performed: • the exchange of the payment instruction (which may or may not include the payment instrument or relevant payment information) between the payer’s and the payee’s financial institutions, and • the calculation of claims for settlement. The outcome of this process is a fully processed payment transaction from payer to payee as well as a valid claim by the payee’s institution on the payer’s institution.

The procedures for the exchange of payment instructions (including instruments or payment information where applicable) may consist of a number of more detailed steps:

• matching of the transactions • sorting of the transactions • data collection (including integrity checks) • data aggregation, and • sending of the relevant data.

Such processes vary considerably according to the operational and legal features of the different payment instruments.

Figure 14: Clearing, netting and settlement

Clearing Settlement

Post- Pre- clearing Netting Settlement Netting Netting

Clearing Netting Settlement

z The physical z An agreement off-setting of positions z An act that exchange of payment or obligations between participants. dischargers instructions between obligations in respect z Netting reduces a large number of the payer’s bank and of funds between two obligations to a smaller number of the payee’s bank (or or more banks. obligations or positions. their agents). z Netting as a means to minimise liquidity required for settlement, can be applied either as a post-clearing operation or a pre-settlement operation.

Procedures for the calculation of claims for settlement consist of:

• calculation of gross claims and • calculation of net or aggregated claims to be settled.

These procedures are less affected by peculiarities of different payment instruments.

Therefore, in principle and in some countries in practice, claims associated with instruments exchanged through different exchange procedures may be aggregated so as to determine one single balance to be settled per institution participating in settlement.

Box 2: International experience on clearing arrangements Combinations of different arrangements in respect of clearing are possible, for instance:. • A correspondent may submit payment instructions to a clearing house on behalf of its client financial institutions. • More complex arrangements involve cross-membership in clearing houses, e.g. a participant in one clearing house acts as a correspondent for clearing house members with respect to the exchange of payments in a second clearing house. Alternatively, a clearing house may itself be a member of another clearing house or, more likely, enter into exchange or interchange agreements with other clearing houses. Linkages between correspondents and clearing houses, and cross-membership or interchange agreements between clearing houses, can expand the availability of clearing house services to a wider group of financial institutions and their customers. The volume (i.e. the number) of payments to be cleared as well as the number of financial institutions involved represent the major factors in determining the relative convenience of the various types of clearing arrangements: • Bilateral arrangements - except for the experience of Germany - have not typically represented efficient solutions when large volumes of payments need to be processed for a large number of delivery points. • Multilateral arrangements make the processing of payment instructions more efficient by coordinating the exchange of payment instructions, operating communications networks and providing processing services. Multilateral netting allows participants to minimise the liquid balances necessary for settlement.

There are four types of arrangements for the clearing of payment instructions. The first arrangement takes place within one and the same financial institution; the other three types require interbank arrangements:

• when the accounts to be debited and credited are held in the same financial institution - termed in-house transactions (or “on us”) - the exchange of information and the calculation of balances that characterises the clearing process can be performed within the single financial institution • in a bilateral arrangement, the sorting and processing of payments flowing between two financial institutions is handled by the institutions themselves • alternatively, financial institutions may employ a common third party - a separate financial institution known as a correspondent (system operator) - for clearing, with one or more institutions forwarding payment instructions to the correspondent for sorting and processing. • multilateral clearing arrangements are based on a set of procedures whereby financial institutions present and exchange data and/or documents relating to funds transfers to other financial institutions under a common set of rules. One example of such an arrangement is a clearing house: an organisation that operates central facilities and which may also act as a central counterparty in the settlement of the payment obligations under a multilateral netting arrangement. Alternatively, multilateral arrangements may be based on a clearing association that is a coordinating body organising and facilitating clearing among institutions

but which does not operate central processing facilities or act as a principal for settlement.

Settlement process

In the settlement process, the valid claim from the payee’s institution is discharged by means of a payment from the payer’s institution to the payee’s institution.

The steps in the settlement process are:

• collection and integrity check of the claims to be settled • ensuring the availability of funds for settlement • settling the claims between the financial institutions, and • logging and communication of settlement to the parties concerned.

Settlement balances resulting from clearing arrangements may be posted to two types of settlement accounts:

• correspondent accounts that pairs of financial institutions hold with each other. These are typically used when payments due to or due from the correspondent banks are to be settled bilaterally • accounts held with a third-party financial institution acting as a settlement bank.

In large-value systems settlement generally takes place as an entry in the books of the central bank.

In retail payment systems, however, settlement is performed by either the central bank or a another private bank, which means that settlement takes place as an entry in the books of the central bank or the private bank. This is also know as settlement in central bank funds (money) or in commercial bank funds (money).

Access to settlement accounts at the central bank may be either open to all institutions participating directly in clearing arrangements; or limited to financial institutions satisfying specific criteria (e.g. institutional type, minimum payment volumes).

The clearing and settlement process finalises the payment process for the acquiring and issuing banks.

During the clearing process two main functions may be performed:

• the exchange of the payment instrument or of relevant payment information between the payer’s and the payee’s financial institutions, and

• the calculation of claims for settlement. The outcome of this process is a fully processed payment transaction from payer to payee as well as a valid claim by the payee’s institution on the payer’s institution.

In the settlement process, the valid claim from the payee’s institution is discharged by means of a payment from the payer’s institution to the payee’s institution.

The steps in the settlement process are:

The clearing and settlement process is best illustrated through a more practical example as indicated in the figure below. Again this is a typical debit card transaction which is “on them”.

Figure 15: Clearing and settlement process

SARB SAMOS 4 4

Gross positions of each PCH participant 3 for settlement in SAMOS 2 2 PCH Bank A Bank B System Operators Payment e.g. Payment 2 instruction Bankserv 2 instruction 2 MasterCard 2 or Visa Merchant A Merchant B

1 Purchases 1 Purchases

Cardholder b Cardholder a (client of Bank B) (client of Bank A)

1). Cardholders a and b make purchases though merchants A and B 2). Banks A and B send matching payment instructions to the PCH system operator 3). The PCH system operator sends the net position of each PCH member to SARB 4). SAMOS ensures (by means of an EFT instruction) that the net positions of the bank for each PCH are squared and settled

In the case of the “on them” or “off us” debit card transactions, it is assumed there will be “on them” transactions affecting both banks (as in the figure above), which generate payment instructions in Bankserv. Bankserv sends the net position of each debit card PCH member to the Reserve Bank’s SAMOS. SAMOS in turn ensures that the net positions of each bank, for each PCH are squared and settled. While the figure indicates transactions through Bankserv, MasterCard and VISA are alternative switches.

In multilateral netting systems (involving multiple banks), settlement risk is used to refer to the possibility that one or more participants in the system will be unable to settle. If one participant’s failure to settle were to have implications for the settlement of other transactions, this could give rise to systemic risk. In South Africa, settlement is effected only through registered banks.

7.5.3 Circuit of fees

The authorisation process is paralleled by a process by which fees pass through the network. Again, we consider an “on them” or “off us” debit card transaction in the figure below.

In this case, the cardholder and the acquiring bank A (that acquires the debit card transactions on behalf of the merchant) both transmit fees to the issuing bank B (the bank that issued the debit card to the customer). The issuing bank B pays Bankserv a switching fee and the merchant pays an interchange fee to the acquiring bank A.

Figure 16: Circuit of fees

Bank A BankServ

Interchange fee Switching 2 Merchant 4 fee fee 3 Bank B

Merchant a PIN fee or transaction 1 charge

Cardholder b

1). Cardholder is charged a transaction fee for the Debit card transaction, paid to Bank B 2). Bank B pays Bankserv a switching fee 3). The Merchant pays his bank (the acquiring bank) a merchant fee 4). Bank A pays Bank B an interchange fee – acquirer pays issuer 5). Bank B (the issuing bank) pays an annual licence fee to the card company (not shown).

7.6 Conclusion

The processes involved in the payment system are revealed to be a series of messages, be they those associated with authorisation, fees or clearing and settlement. For the customer and merchant, a payment may appear to have been concluded well before such transactions are cleared and settled through their respective banks.

8 Economics of the payment system

This section provides an overview of the economic characteristics of the payment system, its size and importance, the fees and pricing associated with the system and finally the social cost and benefit of the system.

8.1 The size of the payment system

By September 2005, the value of transactions through the retail payment stream via Bankserv (i.e. excluding the high value real-time SAMOS stream) amounted to R386 billion per month. For the year ending September 2005, the value of transactions amounted to R4.1 trillion. This is three times the value of the Gross Domestic Product of the country (R1.3 trillion) in 2004 and the value of banking assets in the country (R1.4 trillion in 2004). Together, there were almost one billion EFT, ATM, credit card, debit card and cheque transactions for the year ending September 2005.

The value of transactions can be inflated by about another 30% to account for “on us” transactions, or transactions where the payer and payee have the same bank. (These transactions do not pass through Bankserv and are not captured in “total” transaction figures. This procedure increases the value of non-SAMOS transactions to close to R5.4 trillion for the year ending September 2005 or around 4 times the value of GDP).

The data in the figure below show the annual number of transactions (in millions) per payment stream44. The data show the decline in the number of cheque transactions each year, at the same time that EFT transactions increase. In terms of number of transactions, EFT and ATM transactions are now the dominant payment instruments. Albeit from very low levels, the usage of credit cards and debit cards has increased in recent years.

For example, in 2002, only 2.2 million debit card transactions were made through Bankserv. By the year ending June 2005, this had increased to 50.3 million.

44 These are Bankserv data and exclude “on us” transactions

Figure 17: Volume of transactions (year ending June) Millions of transactions per payment stream 600 500 400 300 200 100 0 2001 2002 2003 2004 2005

EFT ATM Credit Cards Debit Cards Cheques

Source: Bankserv, 2005. Year to June

Figure 18: Annual change in payment stream usage Annual change in volume of transactions 300%

250%

200%

150%

100%

50%

0% 2002 2003 2004 2005 -50%

EFT ATM Credit Cards Debit Cards Cheques

Source: Bankserv, 2005. Year to June

The data in the figure above show the dramatic increase in debit card usage since 2002 with an average annual growth rate of 194%, although by 2005 the annual rate of growth of debit transaction appears to be slowing down. In June 2005, debit card transactions represented 10% of the volume of EFT transactions, up from 0.6% in 2002. Credit cards grew at an average annual rate of 22% over this period and EFTs 10%. ATM growth was roughly in line with real economic growth of GDP over this time (at 4%), while cheque usage fell on average by 17% per year during this period.

Figure 19: Share of volumes of different payment streams Share of volume of transactions 60%

50%

40%

30%

20%

10%

0% 2002 2003 2004 2005

EFT ATM Credit Cards Debit Cards Cheques

Source: Bankserv, Year to June

Currently, the EFT share in volume of transactions represents over 50% of all non-SAMOS transactions, with ATM transactions, 17%, Cheques 13%, Credit cards 10% and debit cards, 5% respectively.

The domination of EFT transactions is even more pronounced in terms of the value of transactions. In the figure below, the value share of payment system transactions is shown. The share of EFTs has grown each year, so that now EFTs account for 63% of the value of the non-SAMOS transactions with cheques making up 35% of the value of transactions and the value of credit cards and ATM transactions, making up 1% each.

Figure 20: Value share of different payment streams Share of value of transactions 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 2002 2003 2004 2005

EFT ATM Credit Cards Debit Cards Cheques

Source: Bankserv, Year to June

8.2 Pricing and the payment system

Recent research has underpinned the importance of payments as a source of revenue, with banks’ annual statements typically not reflecting the full value of payments (Radecki, 1999). However, it appears that in the US alone, the top 25 Bank holding companies may earn between one third and two fifths of their revenue from payments services.

There are a number of fees that may be identified in the payment system which lead to price effects.

These include:

1. PCH System Operator or switching fees. These are fees set by the automated clearing house (ACH) - such as Bankserv, in the case of SA – and paid by the acquiring and issuing banks, depending on the nature of the payment stream. The point is frequently made that these fees are dependent on economies of scale, so that an efficient ACH or switch with a large volume of transactions would be able to charge less per transaction than a similarly efficient producer with a small volume of transactions.

2. Interchange fees. These include a carriage fee (paid to the acquirer by the issuer to compensate for the costs of acquiring and processing a transaction on its own infrastructure) and the interchange fee (paid by the acquirer to the issuer for processing the transaction). Generally, the carriage and interchange fees are netted – and referred to as the interchange fee – as it is the latter that dominates. Interchange fees include what are referred to as SASWITCH fees for “on them” ATM transactions – which in this case are paid to the bank that has provided the ATM infrastructure – the acquirer. In the past interchange fees have been set by multilateral agreements, between the banks, but in recent years some of these fees have been negotiated bi-laterally between two banks.

3. Merchant fees. These are paid by the merchant to the acquiring bank, for its costs of processing, and exist in order to cover the interchange fee that the acquirer has to pay to the issuer. It is widely acknowledged that these fees are passed on to the consumer, not as a transparent fee for the use of debit or credit cards, say, but by the retailer adding a mark-up on all goods or services. This means that consumers paying in cash, for example, will be subsidising the fee payable on other payment instruments. The argument goes that interchange fees inflate merchant fees and in turn elevate retail prices. This argument and its counter are elaborated further below. Merchant’s fees are negotiated bilaterally between the merchant and the acquiring bank.

4. Customer fees/charges. These are the fees paid by the consumer to the issuing bank for the processing the transaction. Bank fees may be imposed on

consumers for the services associated with payments and are done so on a commercial basis by the banks. In some countries customer fees are kept to minimum and transactions may appear to be largely free. There appears to be little relation between the switching fee and the charge that appears on the consumer’s statement, for example.

International investigations into the pricing of the payment system have tended to focus on interchange fees. There are a number of reasons for this:

• The switching or operator fee is a very small part of the payment service price and contributes relatively insignificantly to the actual merchant or customer fee. Hence it appears there is little to investigate • The existence of the merchant fee appears to be motivated by the need to cover the interchange fee payable by the acquirer to the issuer. This has raised the debate as to whether such fees are necessary: if all payments were made through one financial intermediary, there would be no interchange fee • In the countries in which these investigations have been undertaken, there are few customer fees, generally only penalty fees. In these countries, transaction costs associated with payment streams have been compensated for by lower interest paid on current accounts, or other indirect charges to the consumer.

For these reasons, it is the interchange fee which is seen as main culprit in creating price effects which impact on retail prices.

There is concern by regulators in other jurisdictions that the interchange fees reflect market power rather than costs. Indeed this is the most powerful argument against bilateral negotiation of interchange or merchant fees, as small players – be they banks or others - clearly lack the negotiating power of large players who are able to ensure larger discounts.

8.3 NPS participation and transaction costs

Participation in the NPS is expensive in respect of both transactional as well as compliance costs. These direct NPS costs, as detailed below, are in addition to the very significant staffing, information technology and other infrastructure costs that are required to support an effective payment system. One need only think of the extensive ATM or PoS terminal networks that exist to appreciate the magnitude of the investment required to ensure that access points are widespread and inter-connected. BMI-T (2002) for instance estimates that in 2005 the finance sector in South Africa spent some R13,5 billion on IT hardware, software and services. The bulk of this expenditure came from the banks (some 61%).

Equally it should be noted that in order to be a SAMOS participant (that is a core clearing and settlement player), registration as a bank is a prerequisite in terms of the NPS Act. At present the capital requirement for a bank licence is R250 million.

For those entities that do obtain their banking licence the next hurdle is NPS access, either directly or on a sponsorship basis with a large bank. Discussions with recent entrants suggest that the cost of installing the necessary technology infrastructure cost, meeting regulatory requirements and other prescribed standards (such as interoperability, security etc.) are somewhere in the region of another R1 million to R2 million. In one case it was noted that a participant has spent in the region of half a million Rand to merely test their systems to meet Card Association requirements. Players that wish to install their own switch would incur at least another R500,000. Options do however exist to outsource banking IT infrastructure (such as account hosting and a banking switch) at significantly reduced upfront costs.

Nevertheless a consensus view appears to exist which suggests that a minimum of R 1 million is required to become a player in payment system.

All of the above having been said however it needs to be noted that the direct cost of the NPS remains opaque, with few players willing, or able to divulge the cost elements. Naturally this raises concerns (and suspicions) as to the relationship between the end-user prices being charged and the underlying costs that are being incurred by players in the NPS.

Returning to the costs of NPS participation as well as the broad transaction costs, the following costs could be identified:

• Entry costs • Membership costs • Transaction costs, including: - Switching, clearing & settlement costs - Card association costs - Cash handling costs - Merchant fees.

8.3.1 Entry Costs

These costs concern the regulatory compliance and licensing requirements applicable in respect of banks. Currently, access to the core payment system, that is settlement, is restricted to licensed banks. While it is noted that the current proposals in respect of the Dedicated Banks Bill may relieve the overall bank licensing costs and requirements, this is currently not in effect.

To become part of the payment system, a registered bank must register with PASA through the NPSD in the SARB. Currently the registration of a first tier bank is prescribed in Chapter III of the Banks Act, while the Mutual Banks Act allows for registration of mutual banks. The Banks Act however does not apply to a number of entities including the SARB itself, the Post bank; the Land Bank; the Development Bank of Southern Africa; the Public Investment Commissioners and any mutual bank (of which there are currently two) or co-operative.

The table below presents the prescribed fees as set out in the Banks Act and Regulations to the Banks Act. By themselves they do not appear to be a constraint to entry. However, registration currently requires capital of R 250 million.

Table 16: Cost and capital requirements associated with bank registration PROCESS LEGISLATION DESCRIPTION COST (R) Application for authorization as company Registration as public Companies Act • Basic registration fee 461 company* (Registrar of • Registration of Memo 2,746 Companies). Chapter IV of association or articles Banks Act, 1990 [S. of association of bank 11(1), s. 15 & s. 18] • Other ad hoc fees 2,000 Application for authorization as a bank Authorisation for the Banks Act, 1990 [S. • Application for 10,260 establishment of/and 12(1); s.16(1)] authorisation to establish registration a bank is a bank: conducted by the • Registration fee 3,420 Registrar of Banks45 (Regulations, Chapter V, s. 55) Annual Fees Annual licence46 Banks Act, 1990 [Sect Based on value of assets 3,000 to 35] 150,000 per annum Capital requirement 250,000,000 TOTAL

Capital requirement 250,000,000

Once-off costs 18,887

Annual costs 3,000 to 150,000

45 Above applications must be made in a manner and on a form with accompanied statements containing such information as prescribed by the Registrar; and any other additional information or documents as deemed necessary. The Registrar may grant, revoke or refuse any application for authorisation or registration provided that all information and documents, etc had been carefully considered. The Registrar may cancel, suspend or restrict the registration of a bank. 46 A registered bank or foreign branch will be issued with a business licence against payment of the prescribed licence fee. Fee will be based on size of assets.

In addition to the above there are considerable ongoing compliance and reporting costs which include meeting the requirements of monthly, quarterly and annual SARB returns, as well as meeting the requirements of a range of other legislation such as FICA and FAIS.

These costs are by and large in respect of personnel and IT system, with most significant one being Basel II (anticipated to cost the banking industry in excess of R2 billion).

In summary it will cost a large player at an absolute minimum of R150,000 per annum to remain registered as bank, with a capital requirement of R250 million. Should the Dedicated Banks Bill be promulgated under current proposals this is likely to reduce the latter to R50 million.

8.3.2 Membership costs

The second core cost component concerns the regulatory costs associated with membership in the payment system, including the cost of self-regulation.

These costs primarily comprise of the fees that need to be paid to PASA and the Payment Clearing Houses in order to participate in the various payment streams. In addition, the requirement to settle via SAMOS (which in part a technology cost) could also be seen as being part of the overall regulatory structure costs.

PASA costs

Table 17: NPS Participation Costs - PASA AUTHORITY DESCRIPTION OF FEES AND THEIR COST (R) COST (R) / DETERMINATION (e.g. SMALL (e.g. LARGE REGULATOR BANK) BANK) PASA Once-off joining fee: 12,000 12,000 Membership PCH Once-off membership fee per PCH (minimum 16,000 (2 48,000 (6 Membership membership is 2 PCH’s – RTC and one other) – PCH’s) PCH’s) R8,000 per PCH Annual Annual PASA participation cost comprises an 114,804 (2 1,032,200 (6 participation apportionment of the annual PASA running cost PCH’s) PCH’s) fee (budget). TOTAL PASA COSTS Once-off costs 28,000 60,000

Annual Costs 112,806 1,032,000

Currently the annual PASA participation cost comprises an apportionment of the annual PASA running cost (budget) as follows:

• 30% of the budget is shared equally amongst all members of PASA • 20% of the budget is shared equally across all six PCH’s. This share is then paid for equally by all members in the PCH, i.e. the smaller the number of PCH participants the higher the cost. • 25% of the budget is shared pro rata by all PASA members according to their volume throughout (i.e. number of transactions). • 25% of the budget is shared pro rata by all PASA members according to their value throughout (i.e. total ZAR value of transactions per annum).

As indicated above the initial PASA membership fee (including full PCH membership) is some R 160,000. In respect of annual participation fees these are impacted by the number of PASA members, PCH members and overall transition volumes. The costs here range between R 112,000 to R 1 million per annum for a small and a large bank respectively. The current PASA rules are such that in subsequent years following initial joining, the annual fees (calculated on the apportioned cost as noted above) may never be less than the original joining cost.

In addition one respondent indicated that the cost to obtain technical compliance in respect of a payments stream in a PCH was in the region of R 6 to R7 million.

SAMOS Costs

All NPS settlement and clearing participants are required to be SAMOS members. SAMOS charges are divided into three distinct categories namely; an account management fee, instruction processing fee and exception charges (SARB, 2003).

The SARB levies an annual account management fee on all settlement banks at the beginning of the financial year.

The charge for processing an instruction is based on the operational costs associated with the processing capacity required by each instruction and not on the value of the instruction. The SAMOS system is subject to severe peak- processing periods during operational hours. In order to address the impact that this has on both processing capacity and the risk profile of the payment system, different charges may be levied for different periods of the day. The different charges are calculated by application of a discount or surcharge to instructions processed during a specific processing window.

One of the fundamental principles agreed upon in the Blue book is that payment- related risks should be visible and controlled. Instructions that cannot be processed owing to errors in the instruction format, or the paying bank not

having sufficient funds and/or collateral available in the system, can increase the payment-related risks of the NPS as a whole. Exception charges are levied on instructions that cannot be processed, in order to encourage the accurate preparation of instructions as well as diligent management of funds and/or collateral. In case of defaults that occur owing to circumstances beyond the control of the participant, that participant could lodge an appeal, which, if successful, would lead to repayment of the charge.

The following general principles are applied in the formulation of the cost- recovery policy:

• All operational costs pertaining to the provision of the SAMOS system must be recovered within a financial year.

• Uniform cost structures will apply to all participants in the calculation of the instruction processing charge and exception charge regardless of the size or volume of transactions or any other distinguishing characteristic. These transaction charges are reviewed annually and remain fixed for a year.

• Participants are charged a differentiated account management fee. This fee is based on the average settlement instruction amount that the participant settled in the previous year as well as the number and types of Payment Clearing houses in which they participate.

The account management fee is payable quarterly, while the instruction processing fees as well as exception charges are calculated for all participants at the end of each settlement cycle day (SCD). A settlement instruction (SI) is generated by the SAMOS system at the beginning of the next SCD in order to pay the SARB. Although the SI is generated by the SMOS system, the participating bank is responsible for ensuring that there are sufficient funds in its settlement account to pay the charges.

These enumerated costs clearly exclude the significant capital expenditure associated with establishing the SAMOS infrastructure - which was borne by the SARB.

Table 18: NPS Participation Costs - SAMOS AUTHORITY DESCRIPTION OF FEES AND COST COST (R) COST (R) / THEIR DETERMINATION (e.g. SMALL (e.g. LARGE REGULATOR BANK) BANK) Account Annual membership fees that are 100,000 per Value Management payable per PCH, but differentiate annum per high dependent All 11 PCHs: Fees between high-value and low value value PCH Approx. steams. Fee includes a value-add Low value, 1 400,000 per pricing component based on the 12,000 per annum PCH: annum total transaction value over the per low-value PCH 37,000 per total volumes per annum. (Min: 12,000 per annum annum one PCH is the minimum High value, requirement) PCH: 112,000 per annum Instruction Comprise two components: processing 130,000 per 2 million per fee Network (messaging) fees Approx. 2 per annum annum Comprises the cost of utilising the transaction Sub Link network - flat fee irrespective of the value of the transaction.

Application fees SAMOS processing cost - a flat fee Approx R3.67 per calculated on an apportionment of transaction the SAMOS budget according to number of transactions. This fee is only paid by the payer in the settlement process. TOTAL SAMOS COSTS

Annual Costs Annual account 170,000 per 2,4 million management annum (low fee value) to Plus instruction 240,000 processing fee per annum depending on (high volume value)

Currently the SAMOS also has in place penalty fees of R5,000 per failed transaction and R20 000 if a failed transaction affects other players.

8.3.3 Switching, clearing & settlement costs

These costs comprise two key elements, switching cost and interchange fees.

The switching cost consists of membership as well as transaction-based fees payable to operators and third-party payment service providers who provide switching services. From a retail perspective in South Africa this involves predominantly Bankserv, although MasterCard and Visa provide such services for international transactions and a limited number of local bank transactions47 and a range of specialist providers provide switching services for their bank and retail customers (for instance Direct Transact and EasyPay). Other operators also include STRATE /Besa and CLS, and of course SAMOS is the wholesale system operator.

The current membership costs in respect of Bankserv comprise an apportionment of the operating costs based on the number of participants in any payments stream. These are estimated to be in the region of R500,000 per annum for typical participants. This is volume-based pricing comprises a per transaction fee based on the overall volumes that each participant puts through the switch.

In respect of Bankserv transaction fees, participants are required to contract at the beginning of a year (in advance) on the basis of their projected volumes. The fee structure is on a sliding scale with higher volumes attracting lower fees and are differentiated across the different payment streams. To the extent that a participant miscalculates the projected transaction volume and these are significantly less than projected, Bankserv will recover the difference in the fees. This does not however apply where the actual volume exceeds the projection. In respect of the Bankserv fees it is notable that the current pricing model rewards higher volumes through reduced per transaction costs. (This is different to SAMOS, where a flat fee is charged irrespective of volume).

Interchange fees are intended to off-set the cost and revenue differential between acquiring and issuing banks in the payment system. Interchange is also a contentious area in respect of pricing, both in South Africa and internationally where regulatory interventions have focused their attention.

Historically interchange was set multi-laterally by PCH participants in each stream. The introduction of Competition legislation has however seen participants revert to bi-lateral negotiations to determine the fee, to a large extent the historical interchange agreements still appear to be in effect.

47 VISA switches for Investec and Mastercard for some Nedbank transactions.

The available data in respect of interchange fees is that determined four years ago on a multi-lateral basis by Edgar Dunn and Company for card PCHs48. These were calculated utilising the weighted average of combined cost and risk of all players in the credit and debit card PCH to determine a standard card interchange rate. There are:

• Credit card: 1.99% of transaction value, subsequently reduced to 1.71% • Offline debit card: 0.55% of transaction value • Online (pin-based) debit card: 0.75%, subsequently reduced to 0.71%.

This is an example of multi-lateral pricing being used to reduce the interchange fee. In international terms, these fees are comparable to the UK and Australia.

The card association costs relate to participation in either VISA or MasterCard for the issuing and acquiring of credit or debit cards. Although it was difficult to obtain disclosure some cost indicators for the card association were obtained.

MasterCard has two forms of membership – principal members (9 in SA) and affiliate members (1 in SA). The once-off membership (joining) fees that are applicable are as follows: • Principal members (irrespective of size) pay a once off $50,000 • Affiliated members (irrespective of size) pay $10,000.

MasterCard charges a per transaction fee on a tiered basis dependent on the volumes of the participant. Typically the transaction fee reduces as volumes increase. This fee is paid by both issuing and acquiring banks. A minimum fee of US$ 30,000 per quarter is applicable in developed markets (which includes South Africa). This transaction fees comprise three components:

• An assessment fee: Based on reported local and international cardholder volumes. These fees are based on a tiered basis and decrease as the reported volume increases. This is a quarterly fee • Acquiring fees: These are merchant fees based on an intra-country interchange currently set at fee per US$1000. In respect of international merchants this is a fee per US$ 1000 on outgoing inter-country interchange volume • Transaction Fee: This fee is levied per transaction and it is paid quarterly by the issuer based on the members reported domestic and international interchange transaction.

In addition there are a number of monthly and quarterly fees applicable in respect of connectivity and maintenance payable to MasterCard.

VISA also has principal and associate memberships with differing fee structures. The once-off membership fee for principal members in 2002 was $60,000 for

48 This includes credit and debit card transactions.

principal and US$ 35,000 for associate members. In addition VISA have introduced an Acquirer membership priced at US$ 50,000 to obtain this membership however a participant must have issued at least 15% of total cards in a country.

The VISA per transaction charge is volume based and in 2002 was US$4c for domestic transactions and US$33c for international transactions where monthly volumes were less than 26,000 transactions.

Other costs indicated include: A once-off member readiness fee of $4,000 and VISA Net service (implementation, software etc) of about $96,000.

Table 19: NPS transaction costs ENTITY DESCRIPTION OF FEES AND THEIR COST COST (R) COST (R) DETERMINATION (e.g. (e.g. SMALL LARGE BANK) BANK) Bankserv Joining fee Once-off membership fee 150,000 R150,000 R150,000 Monthly Estimated to be in the region of R 500,000 per R 500,000 R500,000 R500,000 membership annum for typical participants. per annum per annum per annum fee Transaction Contracted per transaction fee based on Range: 7c Approx. Approx. fee projected volumes (sliding scale) to 62c per R1 million R40 million transaction per annum plus per annum STRATE / BESA (Equities settlement System) Membership Once-off memberships fees : R57,000 to nil R780,000 fees • STRATE: R750,000 for Central R780,000 once-off Securities Depository Participants – once-off currently 6 including big 4 banks R66,000 • STRATE: R57,000 for business partners R36,252 to per annum R66,000 plus a • BESA front end licence: R29,355 per annum custody fee Annual / monthly fees: monthly • SAFE costs of R 66,462 for CSPs pa Custody • SAFE cost of R36,252 for business fees based partners pa on value • BESA custody fees of 0.0113% per 10 billion – 0.0092% for <50 billion in custody paid monthly. Transaction STRATE settlement fees: R14.94 per leg R8.24 per nil R30 million costs BESA settlement fees: R17.51 per R1000 value leg (BESA) plus per – R14.42 per R5000 value and R11.33 per leg R14.94 per annum (first 100 trades) and R8.24 per leg (after 250 leg trades) (STRATE) Connectivity BESA: Approx. R30,000 per month R120,000 nil R120,000

ENTITY DESCRIPTION OF FEES AND THEIR COST COST (R) COST (R) DETERMINATION (e.g. (e.g. SMALL LARGE BANK) BANK) fees per annum per annum

CLS (Forex settlement system) Participation Shareholding and participation cost na nil R2,5 million cost plus per annum

SWIFT Connectivity BIC charge of Euro 1250 Approx. R400,000 R400,000 fees Once-off logical terminal charge EURO 500 R400,000 once-off once-off Dedicated port connection (once off) EURO minimum 3000 and annual charge of EURO 875 once-off R8,000 per R8,000 per R8,000 annum annum annual minimum minimum charge minimum Message Lowest tier US$0.7 per message R4.20 per R250,000 R5 million costs message per annum per annum Bank interchange fees Interchange Except for EFT and ATM all PCH’s have historical Credit NA- volume NA- volume fees interchange agreements that are still in effect. Card: dependent dependent The available data in respect of interchange R1.71 per fees is that determined four years ago on a R100 multi-lateral basis by Edgar Dunn and Company for card PCHs. There are: Debit Card: • Credit card: 1.71% of transaction value R0.55 per • Offline debit card: 0.55% of transaction R100 value Online • Online (pin-based) debit card: 0.71% of Debit Card: transaction value. R0.71 per R100

ENTITY DESCRIPTION OF FEES AND THEIR COST COST (R) COST (R) DETERMINATION (e.g. (e.g. SMALL LARGE BANK) BANK) Card association costs Membership MasterCard once-off membership fees: MasterCard MasterCard MasterCard fees • Principal – US$50,000 Principal: Principal: Principal: • Affiliate – US$ 10,000. R300,000 R300,000 R300,000 Affiliate: Affiliate: Affiliate: R60,000 R60,000 R60,000

VISA once-off membership fees: VISA VISA VISA Principal: Principal: Principal: • Principal - US$ 60,000 R360,000 R360,000 R360,000 • Associate - US$ 35,000 Associate: Associate: Associate: • Acquirer- US$35,000. R210,000 R210,000 R210,000 Transaction MasterCard: A transaction fee per US$1000 – MasterCard MasterCard MasterCard fees on a sliding scale is applicable. A minimum of Minimum Minimum Minimum US$30,000 per quarter applicable. R720,000 R720,000 R720,000 per annum per annum per annum VISA in 2002 was US$4c for domestic transactions and US$33c for international Approx. VISA VISA transactions where monthly volumes were less 26c per R250,000 R5 million than 26,000 transactions. transaction to to R10 (2005) R450,000 million per per annum annum Technology MasterCard: Monthly and quarterly charges MC: MC: MC: costs (principal members only) R326,400 R326,400 R326,400 per annum per annum per annum VISA: US$ 100,000 once-off VISA: VISA: VISA: R600,000 R600,000 R600,000 once-off once-off once-off Other Switch costs Switching While precise details were not available the cost Range: 15c na na and network indicated for switching services provided by to 45c per costs other players (such as EasyPay) ranged from transaction 15c to 45c per transaction dependent on the payment instrument and services provided. Typically these would be over-and-above those of BANSERV.

ENTITY DESCRIPTION OF FEES AND THEIR COST COST (R) COST (R) DETERMINATION (e.g. (e.g. SMALL LARGE BANK) BANK)

SBV Costs Cash The cost indicated in respect of the handling of na 150 million handling fee cash ranged from 15c to 23c per R100. This represents the distribution of cash between branches and ATMs. TOTAL COSTS

Once-off cost R1,5 R2,6 million million Minimum Annual Costs (excluding cash and R2,5 R95 interchange) million million

Importantly the above cost estimates do not include interchange fees.

8.3.4 Cost overview

Table 20: NPS participation costs COMPONENT DESCRIPTION TYPICAL COST TYPICAL COST SMALL BANK LARGE BANK Rand Rand Regulatory 49 Annual costs: License renewal 3,000 150,000 Costs

Membership Once-off costs: PASA membership 28,000 60,000 Costs Annual costs: PCH membership, 352,000 3,400,000 PASA annual participation fee, SAMOS account management and transaction fees Switching, Once-off costs: Bankserv 1,500,000 2,600,000 clearing & membership, Card association settlement membership (two associations) costs Annual cost: Bankserv transaction 2,500,000 95,000,000 fees, Card association fees, Swift, Cash handling fees Total once-off costs 1,528,000 2,660,000 Total annual costs (excl. cash) 2,855,000 98,550,000 Total annual cash cost 2,000,000 140,000,000

49 These cash costs exclude the capital requirements of R250 million to do business as a bank other than a mutual bank.

The table above sets out a summary of key cost elements in respect of NPS participation. Indicated are indicative costs for a small bank (with reasonable volumes) and a typical large bank in South Africa.

It is important to note that these numbers do not include bank interchange fees between the banks. Taken as a closed system, the net revenue for interchange should be zero. However, this view masks the distributional impact of market share. For example in the case of cards (debit and credit) interchange is paid to the issuer of the cards, by the bank acquiring the transaction (i.e. the merchant’s banker). In the case of ATM transactions the issuer (of the ATM card) pays the acquirer (who has provided the ATM infrastructure). A big bank that issues debit and credit cards and which has an extensive ATM network is likely to be a net receiver of interchange, relative to a small bank that does not issue cards and has few (if any) ATMs.

8.4 Transaction costs & revenue

The cost and revenues from a typical debit card transaction are analysed below. The intention is to provide an illustration of the relationship between the cost of the transaction to the consumer and the cost of the key payment components to the bank participants. The revenues earned by the banking industry and other non-bank players are also discussed in the following section.

Illustrated in the example is what happens in respect of fees and cost for a typical debit card purchase transaction that involves a different issuing and acquiring bank (off-us transaction). An illustration of a typical “on them” or “off us” debit card transaction serves to show the exchange of fees between participating banks, merchant and customer. Here, the merchant A banks with bank A, while the customer B banks with bank B. Customer B makes a purchase from merchant A, which involves a customer fee, a merchant discount (fee), and interchange fee and a switch fee through Bankserv.

The amounts shown are illustrative values for a R100 debit card purchase. The figure shows the different cost components of the transaction, as well as the distribution of the revenue by various players. The example suggests that there is little apparent link between the switching cost and the fees customers pay. In this example, Bankserv earns only 2% of the revenue generated by the transaction, the rest is earned by the acquiring and issuing bank.

Figure 21: Debit card transaction cost & revenue

Bank A Bank B Interchange fee

Switching fee PIN fee or transaction Merchant BankServ charge fee

Merchant a Cardholder b

Value Cost From To (based on R100)

Customer or Pin fee / transaction Consumer Bank B R2.3350 charge

Interchange Bank A Bank B R0.55

Bankserv/Operator Bank B Bankserv R0.0951

Merchant Fee Merchant Bank A R2.50

Total R4.83

Amount earned Share of Institution from revenue transaction

Bank A (Acquirer) R1.95 40%

Bank B (Issuer) R2.79 58%

Bankserv/Operator R0.09 2%

Total R4.83 100%

Of the R 2.33 (comprising a fixed per transaction fee as well as a fee per R100)52 that a consumer would typically pay for a R100 debit card purchase to her issuing bank, about 9c for such a transaction would be paid to Bankserv for the switching costs.

50 Average charge by big banks for a typical “cheque” or “transaction” type account. 51 Excluding the portion of the annual fixed Bankserv fee allocated to debit card transactions. This will be higher for smaller banks, per transaction, as they have far fewer transactions. 52 This fee is a composite of an average equivalent fee, from a number of large retail banks. The pricing difference between the large banks for equivalent services and transactions is small.

The merchant would typically pay the acquiring bank a percentage of the value of the transactions. These rates are negotiated on a bilateral basis and are hence confidential and are likely to vary with the size of the retailer (currently the market reports rates from 1.5% to 5% of the value of a transaction). In turn the acquiring bank is required to pay the issuing bank an interchange fee which for an off-line debit card is currently set at 0.55% of the value of the transaction.

The net position in our example transaction is that the issuing bank receives the largest share of the fees (58%), while the acquiring bank receives (40%). The Bankserv switching cost is negligible.

It should be noted, however, that the above transaction has a set interchange rate53. In a number of other payment instruments such interchange rates are not set but are negotiated bi-laterally between two banks. Consequently these costs could be substantially higher.

Moreover the above example does not indicate all the other cost associated with a transaction or cost that need to be incurred to enable such a transaction. Notably these would include card association fees (to VISA or MasterCard), the cost of the electronic network (e.g. to Swift or others), cash handling fees as well as other telecoms, operating, staffing and compliance costs.

53 The current debit and credit card interchange fees are an outcome of a cost study conducted by Edgar Dunn, that computed an average interchange fee based on bank costs submitted by the industry.

In this case, the issuing bank (Bank B) pays the acquiring bank, Bank A that provides the ATM infrastructure. Once again there appears to be a 60/40 split of the revenue generated between the banks, with the bulk going to the issuing bank (where the customer banks) rather than the acquiring bank that provides the ATM infrastructure (and that carries the cost of ensuring there is cash in the machine). Bankserv earns around 1% of the revenue generated.

Table 21: Off-Us ATM Cash-withdrawal transaction Fee / Cost From To Value (based on R100)

Pin fee / transaction Charge Consumer Bank B R10.00

Interchange Bank B Bank A R3.90

Bankserv Bank B Bankserv R0.13

Total 10.00 ATM Charges: R3.25 + 65 c per R100

Amount Share of Institution earned from revenue transaction

Bank A (Acquirer) R3.90 39%

Bank B (Issuer) R5.97 60%

Bankserv R0.13 1%

Total R10.00 100%

Table 22: Typical Consumer Transaction Charges for the first R10054 Payments Cash withdrawals Cheque payments R5.81 Cash withdrawals / Counter R16.74 Debit order (external) R5.33 Cash withdrawals bank's ATM R3.89 Cash withdrawal “off-us” Stop order R5.97 R10.00 Cheque Saswitch ATM account Banks' ATM (external accounts) R4.03 Branch payment R5.81 Debit card Point-of-Sale R2.33 Bank's ATM R2.90 Cash withdrawals / Counter R16.74 Branch payment R13.03 Cash withdrawals bank's ATM R4.08 Savings Cash withdrawal “off-us” account Debit order (external) R5.85 R9.49 Saswitch ATM Stop order R4.23 Debit card Point-of-Sale R2.48 Source: Various bank web sites: Pay per transaction fees as at March 2006

It should be noted that the data in the table are simplified. In order to create such a table, we have had to make assumptions about equivalence of account types between banks and in some cases undertake fairly lengthy searches to find comparable data for transactions types. It is fair to say that while there is disclosure on these fees, it is fairly obscure for someone attempting to make interbank comparisons. Charges are typically bundled and dependent on a range of factors such as account type, minimum balance level etc., which affect various rebates and pricing options. It should be noted that the data in the table above and below clearly exclude all other service fees and charges which accrue to account holders – such as cheque book fees, monthly fees, internet banking fees, etc. It is possible that the banks could provide further insights into their pricing for these transactions that would put a different complexion on the data.

54 Note that credit card costs are excluded here as typically there is no transaction fee levied, instead an annual fee is charged.

Table 23: Transaction Charges based on Average Transaction Values

In the table above, the transaction fees customer fees for the average size of transaction are shown. Apart from the counter cash withdrawal, the fee that appears to stand out is the “off-us” SASWITCH55 ATM transaction, representing 4.5% of the value of the transaction. At the other extreme, the cost of cheque transactions appear to be low, and subsidised by other payment streams. This is particularly remarkable as interviewees have pointed to the high costs of cheque processing in the system.

8.5 Industry costs and revenue

The analysis attempts to provide and overview of the industry-wide costs and revenue associated with the payment system. The process may be more complicated than expected. One could liken the process to the derivation of the gross national product, which aims to avoid double-counting and to add only the value added in each part of the process. A number of components need to be considered:

1. The consumer price (or user fee) 2. Retailer or business fees 3. Bank (and non-bank) processing costs 4. Central bank settlement costs.

Double counting may create difficulties as the central bank costs, for example, will be part of bank expenses or costs.

Just like the derivation of the gross national product, there is more than one way to calculate the cost of the payment system. One can use the resource approach (which sums the costs involved) or the income approach (which sums the revenue per producer). The latter approach appears to be the simpler and more commonly used and one that has some precedent. For example, the Wallis report (1997), evaluated the cost of the Australian financial system to be some

55 This terminology is a little misleading – as one would expect SASWITCH fees to be the fees charged by Bankserv, since the SASWITCH infrastructure is part of Bankserv. In reality, all Bankserv does is ensure hat the agreed interchange fees are correctly assigned to the acquiring bank in this case.

(Aus)$40 billion, where the cost of the banking system was equivalent to the total net interest income plus total non-interest income. (It is from the latter that fee (and payments) income can be calculated.) In South Africa, the transaction based fee income (used as a proxy for payments income) makes up most of non-interest income of banks.

The use of the income approach entails looking the income arising from payments activity of the various payment participants. Banks’ income sheets are the major source of information here – but this is not always as revealing as one might like. Radecki (1999) for example points that banks’ payment income may be understated on banks’ income sheets, even though the bank holding companies in the US tend to report a lot more detail on non-interest income than do South African banks. Radecki’s analysis shows that while deposit account fees are included in payments income, payments services may be linked to a credit card or trust account, or may be for securities handling, for which banks do not separate out payment services income. He also maintains that an important part of net interest income is actually compensation for payment services, rather than intermediation services. These include foregone interest on accounts and annual fees – all of which in his opinion should be counted as payment services income.

His estimates for these missing figures, suggest that in the US, 36 – 42% of operating income is derived from payments services (Radecki, 1999), where 35 – 41% of total non-interest income and 37-42 % of net interest income come from payment services. This range is significant given that in aggregate terms, banks’ returns on business lines imply that they receive just 7 % of their net revenue from payment services.

Other estimates suggest that as much as 33% of bank revenues are generated from payment services (CapGemini, 2005).

The table on the following page sets out the annual bank income data from the Bank Supervision Department (BSD). Net interest income (interest earnings less interest expenses), non-interest income (of which transaction based fee income is a significant part) are shown from 1996. Transaction based fee income is seen as a proxy for payment system activity (although as Radecki warns us, this may understate the income from payment system activity).

In 1996, non-interest bank income amounted to just under 37% of total bank income, and interest income accounted for 62% of bank income. By 2004, non- interest income amounted to over 54% of total bank income, so non-interest income continues to grow in importance relative to interest income. By 2004, interest income represented 46% of bank income.

At first glance, a comparison with the transaction based fee income share in 1996 and 2004 suggest there has been little change over the period, with the

share growing only from 37% to 38%. However, there appears to be a structural break in the data reported in the DI returns.

From 1996 to 2000, the share of fee based income rose each year, so that in 2000, fee-based income accounted for just on 42% of total bank income, representing some 94% of non-interest income. However, in 2001, there appears to be a structural change in the proportion of transaction based fee income, which falls to 34% of total income and to 77% of non-interest income. The structural change has to do with a change in reporting, so that investment and trading income is added as a separate category of non-interest income. It could be that Radecki would argue that at least part of the new income category should be seen as payments activity as it includes transactions with securities. At this stage however, there is no way of knowing precisely how much should be re-categorised to a broad definition of payments services.

From the data provided by the banks through the DI returns, it appears that transaction based fee income accounts for 69% of non-interest income and 38% of total bank income. This is considerably higher than the level of 33% suggested by CapGemini (2005), but falls within the range suggested by Radecki for share of total income in the US (36-42%). At 69% the South African transaction based fee income exceeds considerably the range of 35-41% indicated by Radecki as the US share of non-interest income.

It could be that the DI returns understate the importance of payment system activities on the interest income (as per Radecki), but there is no data to indicate by how much. As it is, the banks provide little information on the breakdown of their non-interest income – even in their annual reports. Over the past three years, their data suggest that transaction based fee income accounts for between 62%-81% of non-interest income.

Table 24: Composition of bank income statements

R million 1996 1997 1998 1999 2000 2001 2002 2003 2004

Total bank income R 20,962,561 R 25,336,132 R 31,593,672 R 36,170,623 R 39,879,536 R 56,085,591 R 58,986,622 R 62,153,986 R 76,558,527

Net Interest R 13,004,604 R 15,179,969 R 17,744,865 R 20,475,617 R 22,105,186 R 30,750,915 R 30,376,116 R 32,645,911 R 34,887,148 income

Non interest R 7,957,957 R 10,156,163 R 13,848,807 R 15,695,006 R 17,774,350 R 25,334,676 R 28,610,506 R 29,508,075 R 41,671,379 income

Interest income as a share of total 62.04% 59.91% 56.17% 56.61% 55.43% 54.83% 51.50% 52.52% 45.57% income

Non-interest income as a share 37.96% 40.09% 43.83% 43.39% 44.57% 45.17% 48.50% 47.48% 54.43% of total income

Transaction based R 7,847,313 R 9,635,263 R 11,796,441 R 14,519,228 R 16,681,170 R 19,582,361 R 22,635,524 R 22,148,003 R 28,833,424 fee income

Transaction based fee income share 98.61% 94.87% 85.18% 92.51% 93.85% 77.29% 79.12% 75.06% 69.19% of non-interest income Transaction based fee income share 37.43% 38.03% 37.34% 40.14% 41.83% 34.92% 38.37% 35.63% 37.66% of total income

Source: BSD DI 200 returns.

Given their pervasive role, it is perhaps not surprising that by far the largest part of revenues earned from payment system activity accrue to the banks.

In the table below, the revenue from transaction based fees for the banking industry amounted to some R28.8 billion for the year ending 2004. This represents some 2.1% of the Gross National Product (of R1,394 trillion) in 2004 and 89% of the total “net” revenue56. The annual reports of the big four banks, (which are variable in terms of the level of breakdown they provide) suggest that they earn some 86% of this industry revenue (some R21 billion in 2004).

Our estimates suggest that non-banks that are participating in the payment system in some way, such the Postbank, EasyPay, Direct Transact, Net 1, Fundamo and the private bureaux and others, earn in the region of R2 billion per year from payment based activity. The card associations earn an estimated R300 million per year, and SWIFT and CLS between them around R38 million). The revenue earned by SAMOS and PASA is an insignificant part of the total. However, the cash distribution costs, earned by SBV, are not. SBV is not used in every case however, as banks may have in-house cash distributors, or employ Fidelity Guards or other similar cash transit company57. The number is likely to be somewhat understated for these reasons.

The share of revenue data in the table below shows the banks earning the lion’s share, around 94%. Cash distribution appears to account for more than the entire Bankserv switch – making up 1.7% and 0.6% of the revenue generated from payments respectively.

Table 25: Revenue generated by payments activity Payments system revenue R million % Year ending data 2004 Share of revenue Banking industry (less costs enumerated below) 28,833 93.5% Non-bank industry 2,000 6.5% of which: SBV 500 1.6% Card Associations 300 1.0% BankServ 166 0.5% SWIFT and CLS 38 0.1% SAMOS 19 0.1% PASA 1 0.0% Sources: Bank data: BSD 2004 Annual report; Card Assoc: Derived from Global earnings Non-banking: Estimates based on annual reports and other estimates Bankserv data - Submission for report; SAMOS data - NPSD Submission for report CLS and SWIFT - info from banks PASA data -derived from fee structure SBV- Cash distribution. Information in interview

56 The term net is used to indicate that double counting has been avoided, but the revenue calculations include only those entities engaged in facilitating payments stream activity directly. 57 Note that although STRATE and BESA represent a transaction costs to the banks, we have excluded this information as neither the cost nor revenue data are shown in the data above.

The banks also experience the greatest costs of participation in the payment system. An estimate of the banking industry costs is provided below. The bulk of the cost represents the operating costs of the industry. This is estimated to be the average cost-to-income ratio of the industry of 63.9% (BSD, 2004). More nuanced data do not exist although one industry player suggested that banks were far more efficient in card and ATM and EFT streams than in cheque processing streams. The operating costs reflects the staff and other resource costs such as, the infrastructure, the IT equipment and software.

Other cost items for the banks include the fees to SAMOS, PASA, Bankserv, SWIFT and CLS, VISA and MasterCard. The data look familiar – essentially the revenue data of these entities represent the costs to the banks.

Table 26: Annual costs of banks’ participation

Estimated costs to banks (2004) R'000 Operating costs of banking industry58 17,400,458 SAMOS59 19,200 PASA 1,300 Bankserv 165,600 SWIFT 32,000 Visa and Mastercard 300,000 CLS 6,000 SBV 500,000 Total identifiable costs 18,424,558

Given that banks earn R28,8 billion through their transaction fees, the data suggest that the banks find their payment activities profitable, although no banks publish profitability ratios for payment system activity.

8.6 Banks and the payment system

It has been suggested that the systems (which include information systems and skills) required to evaluate credit, monitor and enforce loan agreements and extend credit - which Goodfriend (1999) calls information-intensive lending - are also the same systems required to provide payment services efficiently. Losses from payment systems can arise from fraud, operational glitches, systemic breakdowns and failures of counterparties to fulfil obligations due to bankruptcy. There is much overlap between managing these risks in payments and in lending (Radecki, 1999).

This suggests that the banks are natural producers of payment system services, as much as they are natural producers of credit. Banks seldom advertise this range of services as a key service – particularly when compared to deposit taking and granting credit, however. This is in spite of the fact that the provision

58 Estimated on the basis of existing cost-to-income ratio (as in BSD annual report, 2004). 59 Excluding capex costs of SAMOS, which is essentially sponsored by SARB.

of payment services is a significant, and some times dominant, revenue earner for the banks. This suggests that a re-education process may be necessary – for both bankers and customers alike – particularly if a more accurate and fairer pricing of payments services is to be achievable.

While the skills learnt in granting credit may predispose banks to naturally succeed at payment services, these skills are not necessarily exclusive to banks. As has been seen in the credit environment, these skills can be learnt by non- bank firms and indeed, it is these firms that may prove to be the innovators in providing services. The South African micro-lending environment is a case in point, where entities that do not take deposits (and hence are by definition not banks) have proven to be successful grantors of credit particularly to consumers who are not traditional bank clients. In some cases, banks have expanded their operations in this arena by acquisition of such non-bank micro-lenders.

However, there are those who regard innovation into electronic payments, for example, as unavoidable, and suggest that banks will have to become involved, or they will simply lose market share – being left with a legacy payment infrastructure (and therefore responsible for its costs and social liabilities) while losing the customer relationships (Leitaer, 2002).

That technology has provided the means for non-bank payment providers to gain market share in the payments arena is beyond dispute. In the US, for example, non-bank owned networks now process around one-third of ATM transactions, whereas ten years ago, their control was minimal (Sullivan, 2005). At the same time, they have brought innovations into the payments arena, as evidenced by development in electronic bill presentment and payment, retailer issued debit cards and online payments.

Developments in technology have undermined the privileged position of banks in the payments arena. The general sense in the literature is that a strategy of keeping non-banks out is bound to be unsuccessful. It has been argued that a pro-active approach by banks in addressing widespread consumer concern, and in enhancing access to reasonable payment services, rather than risking a struggle with the government and regulators and customers alike, would do much to protect the image of banks and strengthen their customer base (Lietaer, 2002).

8.7 Conclusion

The payment system of a country provides a network for exchange of financial obligations. Traditionally the preserve of banks, payment system activity appears to require similar skills as successful credit granting. While this may provide banks with an advantage in payment system activity, technology is increasingly creating opportunities for non-banks to offer payment services (at least in part).

The banks make no bones about the fact that they price commercially for payment services. Given that cost data are clearly not readily available, it is uncertain how profitable their payments activity is, however, the data shown here suggest that both from an individual payments stream perspective and from an industry perspective, there is little apparent relation between the costs associated with switching and membership based fees and what the customer pays for the transaction. This may be partly because the interchange fee does not, the banks maintain, cover their full cost for each transaction. Hence they seek to recoup the costs from the consumer.

In an environment where only four entities make up the bulk of the payments activity and through their vertical holdings command much of the revenue generated by such activity, the current consumer pressure and disquiet regarding banks fees may be justified. This is further discussed in the following section.

9 Competition and the NPS

9.1 Introduction to the key concerns

Broadly speaking, the NPS network affects the lives of consumers and firms throughout the economy. Quite frankly, we cannot do without it. We may only dimly become aware of the importance of the NPS when a transaction is denied because of a time-out of the system, for example, but it plays an essential role in the smooth functioning of the economy.

The NPS is a national network that embraces the Reserve Bank’s SAMOS system and NPSD department, PASA, the industry body with its payment clearing houses, operators like Bankserv, MasterCard, VISA and STRATE, the registered banks, the Post Office and a number of payment providers and networks of other institutions.

The national network requires co-operation amongst players, which has lead to some parts of the network being classified as ‘co-operative’, while other areas are seen as ‘competitive’. These labels are not as helpful as they could be however, as there is some dispute about what they mean and how they are applied.

Clearly this is a profitable network. As far as is possible to tell, each participant in the network generates profit from his or her payment activities (the exception being the Reserve Bank’s SAMOS system, which aims only at cost recovery). What is of potential concern to the Competition Commission is the extent to which control over parts of this network may undermine competition and produce an outcome that is to the detriment of consumers, be they individuals or firms.

This section highlights possible concerns for the Competition Commission. Not all of these fall under the remit of the Commission, but they generate uneven playing fields that undermine competition.

The key concerns that emerge as a consequence of the analysis and consultation with interviewees include:

• The institutional legacy of the system • Participation of non-banks • Access to an essential infrastructure • Governance and ownership of key infrastructure • Bilateral interchange negotiations and their impact on the system • Innovation and efficiency trade-offs • Penalty fees • Interoperability and Access.

9.2 The institutional legacy of the system

The provision of payment services has traditionally been seen as the domain of banks - together with deposit-taking. Knowledge of payment systems, institutional memory, payment stream innovation and economic interest in payment systems vests in the banks.

South Africa’s big four banks contribute not only the vast majority of transactions to the NPS, but also derive the lion’s share of the revenues. In addition the key payment personnel of the big four sit on all representative and regulatory structures including PASA, the PCHs, SANPAY, PayStrat, ABCI, and Bankserv. They are the members and board members of PASA and the PCHs. They are the shareholders and board members of BankServ and STRATE.

It is not only the case that these banks are represented throughout all the structures. In most instances the same individuals are present on the different structures. While this undoubtedly raises serious questions about conflict of interest and the ultimate rationale being adopted to regulate and manage the NPS, it also raises questions as to what the impact of such concentration has on levels of innovation and willingness to accept outsiders. During the course of the research it was noted by the large banks that such concentration reflects a severe lack of payment system skills in the country – if this is so the regulator should be tasked with addressing this, together with the industry, in the medium to long term.

The consequence of this legacy means that much of the influence and authority over the payment system is vested in the banks. There is no forum, for example, that captures the views of consumers. While SANPAY exists to capture the voice of industry associations, such as retailers or micro-lenders for example, participants express concern that this is little more than a talk-shop60. There is no non-bank equivalent of PASA, nor is it evident that there is any entity that takes a view of the payment system as a whole – i.e. in terms of the strategic perspective that the network plays in the national interest.

9.3 Participation of non-banks

Non-banks play in an undefined and uncertain environment in the payment system. While the link between offering payment services and taking deposits is traditional, it is not inviolate. Even the 1995 Blue book allowed for non-banks to participate as Customer Payment Service Providers (CPSPs). While the rules for participation of CPSPs were never set out, it is clear that such providers do and will provide value-added payment services for customers and firms. The Blue book made it clear that clearing and settlement activities should be left in the

60 This has lead to certain players lobbying the NPSD outside SANPAY meetings.

hands of the banks, but that others could participate in offering payment services.

CPSPs appear to be operating in the absence of rules and in the absence of an effective forum through which to voice frustrations or devise systems for the national good. Their offerings are varied: There are players who effectively offer an entire outsourced banking IT system, those that switch and reconcile payment instructions from retailers to the banks, those that gather instructions and channel them direct to Bankserv and so on. They represent an anomalous situation in that they clearly offer services which are desired by firms and banks alike, but should they fail to deliver as a consequence of operational failure or fraud, they will bring reputational risk on the regulated and unregulated portions of the network alike. For this reason, they operate in an uncertain environment, and it must be said, bring an element of uncertainty to the environment.

Private bureaux, that have in the past channelled EFTs direct to Bankserv (the EFTs represent payment claims from large insurance companies, as well as micro-lenders), face the prospect that such instructions will be channelled only via the banks in future. The motivation for the change in rules is not entirely clear and this has formed the subject of a complaint to the Commission.

A PASA representative has confirmed that the phasing out of the outdated mag- tape technology, through which private bureaux instructions were previously delivered to Bankserv is long overdue and that new technology will be put in its place before the deadline of June 2006. This suggests the change is technological in nature. However, one of the major banks has suggested that there may be other motivations too, indicating that the regulatory motive for excluding the private bureaux is that some bureaux have passed on disputed payment instructions and created problems for the banks who are seen to bear ultimate responsibility by the customer. The bureaux perceive this move as an orchestrated one by the big banks to eliminate them and grow their own bureaux business. Whatever the final outcome, there is a sense that clearer regulatory guidelines regarding non-bank participation could have avoided what is seen by the bureaux as an undermining of their economic existence.

Another instance where there is an allegation of anticompetitive practice towards non-banks is that of multiple acquiring or sorting-at-source. An example may illustrate the principle: A large retailer processes hundreds of thousands of credit card transactions a month. It is currently restricted to using a single acquiring bank to process these transactions. The acquiring bank identifies those transactions that are from its customers and processes them directly. These are “on us” transactions which do not get processed via a switch and do not attract interchange fees. All the other “on them” transactions are directed via Bankserv61, to the appropriate bank and attract both a switch fee and

61 It is possible that MasterCard or Visa could be used for processing instead but Bankserv is the dominant service provider.

interchange fees. The retailer argues that it has access to the appropriate technology to effectively do what the switch (Bankserv) does, hence converting all transactions to “on us” at a lower charge to the merchant (if not the consumer). The IT service provider that can act as a switch argues that it can process these transactions as effectively as Bankserv or the card associations.

A letter from the NPSD, dated the 1 December 2004, indicates that new multiple acquiring or sorting-at-source arrangements should be placed under a moratorium until a position paper is finalised in this regard. The reasons given in the letter relate to the soundness of the payment system:

The main aim of the moratorium on sort-at-source and our support for the implementation of single acquiring in the EFT and card environments is to halt the practice where payments are off-sorted to many banks from a point, thereby eliminating any interbank clearing.

Should interbank obligations not arise from these payments, no central bank settlement can be effected via the established clearing and settlement process, nor are exposures from these payments visible to the Reserve bank. This in itself impacts negatively on the soundness of the payment system. NPSD, 2004

The providers that can act as a switch argue that it can provide such information as is required by the Reserve Bank and that if sort-at source is a concern to the authorities, the moratorium should apply to both new and existing multiple acquiring arrangements62.

The participation of non-banks creates problems for regulators, given the uneven legacy of participation. However, it would add greatly to the transparency of the system if such rules were regularised and made explicit. It could also go a long way to addressing the perceptions of the arbitrariness and anti-competitive nature of regulatory decisions made by the self-regulatory body, PASA.

9.4 Access to an essential infrastructure

Without exception, the interviewees argued that the NPS network is an essential infrastructure. However, it was also apparent that what is seen as essential varies between stakeholders groups. For example, the NPSD views the payment system from the perspective of the real-time high-value SAMOS system, non- bank service providers frequently hone in on Bankserv as the key element and PASA sees the payment system predominantly as the infrastructure which the banks provide. Others see the benefit of the NPS in its network of providers, both bank and non-bank, that allow inter-household and inter-firm payments.

62 The NPSD have indicated that the moratorium on the sorting at source issue has subsequently (as of January 2006) been lifted. The retailers have understood this to mean that sorting at source is now permissible and are currently engaging all of the major banks on the issue. The reasoning for the “about turn” is not transparent and the impact on the consumer (in terms of possible lower debit card transaction fees, for example) unknown.

Each of these perspectives provides a different point of departure in terms of what access to the payment system means. From the perspective of banks, access implies non-banks wanting access to “their” bank accounts. The regulator stresses that access to SAMOS is not a problem, one simply has to be a registered bank and obtain a settlement account with the Reserve Bank. Retailers who are frustrated by single acquiring63 want direct access to a switch – possibly their own.

The network effect can be described as that characteristic of a payment system that generates trust or confidence in the system. For example, payment systems and the streams that make them up allow money to be transferred between parties who do not know each other and have no reason to trust each other (OFT, 2005). Hence the payments activity is about providing a service to customers throughout the economy and the question raised - when a customer’s bank account is accessed in order to receive payment - is who is getting the service and is it appropriate for the bank to be the gatekeeper of the client’s account? The economics of networks suggest that the value of the system increases for the users as the number of participants grows, but this may not accord with how the banks see it.

The lack of a holistic view of the payment system suggests that some activity going on in the payments arena is unregulated - albeit functional from the perspective of the users. Such activity has the potential to generate failure which would undermine confidence and trust in the system and hence the network benefits of the system. The role of non-banks in the payment system and the appropriate supervision of such players appear to becoming more widely considered in other countries (see Sullivan, 2005 and Kemppainen, 2003). It is likely that this will remain a concern in South Africa until adequately addressed.

While it may be that there are no simple solutions to access, what is clearly required is a forum with membership of all payment participants, banks and non- bank alike, with authority to engage and consult NPSD and PASA in order to address decisions regarding the future of the NPS in the national interest, with a view to presenting and enhancing the network effects.

9.5 Governance and ownership of key infrastructure

Banks in relatively concentrated environments tend to develop an automated clearing house (ACH) or payments switch that is owned by the participating banks. Indeed some have argued that it is only in a concentrated environment that the economic incentives to achieve the high levels of interoperability associated with such a switch exist (Humphrey et al, 2002).

63 Single acquiring refers to the restriction that transactions of a particular type may only be transacted through a single bank (rather than routing the transaction to the bank involved and hence avoiding interchange fees).

The high levels of interoperability associated with jointly owned and governed switches can in some ways be seen as a trade-off against more competitive, but frequently less efficient systems. Hence it seems that the industry structure determines, at least in part, the structure of payment system and the nature of the network, as well as some competitive trade-offs. For example, the banks own the ACHs in Sweden and the UK where relatively few clearing banks exist.

Stakeholders such as PASA, the banks and the NPSD have argued that there is much to lose should the co-operative nature of their Bankserv arrangement come under the scrutiny and action of the Commission. They point to the speed and efficiency of the system - in the ability to achieve same day and next day settlement of payments instructions and the minimisation of float for most payment streams64.

In countries where there are many clearing banks, the ACHs may be owned by the central bank, or through some joint form of ownership. In a country like Germany, where there are 2075 direct clearing institutions, the central bank owns the ACH (ECB Blue book, 2005). There is mixed ownership between the central bank, the banks and payment associations of the ACHs in France and Greece. In these cases, the central bank can be seen as a moderator of the monopoly position implicit in providing the essential infrastructure associated with ACHs.

Where the ACHs are privately owned by the banks alone, there are potentially concerns with the mutual governance model. The UK has begun to deal with the mutual governance concerns raised in the Cruickshank report and subsequent investigations by the Office of Fair Trade and HM Treasury. As an initial process, the BACS ACH was split into two companies, BACS Payments Schemes Limited (BPSL) and Voca Ltd. The former is a non-profit membership based industry body whose role is to develop, promote and enhance the use and integrity of automated payments. Voca is a profit-making company with a contract to run the electronic banking infrastructure on behalf of BPSL. BPSL in our terminology is the PCH, setting the rules for access and usage, while Voca provides the service. Although Voca is the only domestic ACH for retail electronic payments, it faces potential competition from its near rivals in continental Europe and there is scope for BSPL to contract another ACH after the current contract expires in 2007.

The governance and ownership problem is not entirely out of the way yet, however, as BSPL is still mutually governed by twelve banks and building societies. While the payment system Task Force of the Office of Fair Trade indicated it would have an initial report for commentary on possible innovations to access and governance arrangements by mid-2005, the report has yet to be released. The Task Force has said they are exploring ways for the domestic payment system to have a more strategic focus, be able to consider the costs

64 Cheques and international payments are the exceptions.

and benefits of any innovation on UK users and mechanisms for independent oversight and stakeholder involvement where decisions are made in a transparent way (Mullen, in interview, 2005).

In South Africa, there is some concern regarding the implications of the big banks’ domination of both the shareholding and governance of Bankserv. While there is an acknowledgement that wresting ownership of Bankserv away from the big banks may undermine the incentive to invest in the interoperability of the system, there are those who call for big bank domination of ownership to be diluted. Suggestions elicited in the interview process include limiting the ownership of any one entity to 15% of the shares and extending membership to non-bank participants.

The banks argue that while they could clear directly between themselves, they believe it is in the national interest to retain the central processing mechanism of Bankserv. They maintain that unless a significant shareholding of Bankserv is retained by the banks, they will not have the economic incentive to maintain the infrastructure and invest in new development.

One of the solutions to the conundrum is to set up an independent board for the retail payment system which would formalise interaction between the strategic payments forum and the relevant PCH bodies. In terms of the former, the board structuring of STRATE, the securities settlement system, is instructive. The STRATE board comprises 13 members, and was initially dominated by its shareholders - the banks and the JSE - with an independent chairman. However, in spite of the independence of the chair, and the relative balance of power between the main shareholder interests, the board had a number of teething problems and impasses. Very recently, the board has been restructured to allow for more independent members, and while it is still early days, the general impression is that this may be a more workable outcome. In the words of one industry commentator, the governance structure of STRATE is “clean”.

9.6 Bilateral interchange negotiations and their impact

Strictly speaking interchange negotiations refer to the fees exchanged between acquiring and issuing banks. In the interviews, however, it appeared that the views on bilateral interchange negotiations appear to be polarised. It is the understanding in the industry that the Competitions Act (s4(1)) precludes multilateral negotiations (the banks have not sought an exemption).

Those who are for the continuation of the multilateral negotiations (dealt with at the PCH level), point out that this is the most practical option to implement. The multilateral solution is that all banks would pay the same fee for certain transactions, irrespective of investment in legacy infrastructure or volume or value of transactions, such as currently occurs in the case of debit and credit card transactions.

Bilateral negotiations would allow for the agreement of interbank pricing principles, cost components and fees on a bilateral basis, between issuers and acquirers. Those who argue against this approach point out that it is not practical to implement as too many negotiations will be required65. In particular, this is likely to discriminate smaller players – both banks and non-bank - as they will have to devote resources to the many negotiations required which would take –up the time of key resources. The burden would fall disproportionately on smaller players as they typically have one payment system official, not a fully- staffed department. Another key consideration is that small players lack negotiating power. This potentially disadvantages them in two ways – they are likely to pay higher rates where larger players have achieved price concessions and they are likely to be pushed to the back of the queue in the negotiating process because they are simply less interesting to the big banks with whom they wish to negotiate.

In general, smaller players indicated support for the multilateral approach, especially if it could be based on some fair evaluation of costs. The big banks also favoured this approach for practical reasons. The large non-bank players called for bilateral negotiations however, keen to flex their respective muscle.

9.7 Innovation and efficiency trade-offs

Many of the concerns raised with regard to access relate to new innovations. A useful point of departure for this appears to be the economic effects of networks (such as the payment system). A network effect is that the value of the service made available through some form of access increases for its users when a new client is incorporated into the network (FSA, 2004). The network effect impacts on the technology employed by participants – technology used tends to depend on the technology chosen by other participants. This may lead to inertia in innovation in networks.

Farrel and Saloner (1986) argue that inertia in payment networks occurs because of the cost of change – where existing participants are reluctant to upgrade or adopt new technology. This is because they will have to bear the cost of transition and future users may be able to take greatest advantage of the benefits of new systems. Historical legacy also plays a key role in inhibiting change in payment systems as the interoperability standards may have taken years to develop.

The existence of this inertia appears to be confirmed by South African interviewees, who spoke of the pace of change in existing PCHs adapting to the slowest mover. For this reason, establishing new PCHs may be an easier route. There are currently a number of new PCHs in the pipeline to accommodate new

65 One bank official estimated that some 8000 negotiations would be required - on an annual basis- within the industry

payment innovations, including the AEDOS/NAEDOS PCH for non-preferential debits on customer accounts; the Mzansi transfer PCH which allows for remittances even where one party does not have a bank account; the money market PCH and a “cash” PCH.

9.8 Penalty fees

Penalty fees on bank accounts tend to be expensive, the world over, as they are designed to change customer behaviour through penalisation. Dishonoured cheques or overdrawn overdrafts are costly to banks as they require personnel to deal with these exceptions. Hence while they are expensive, it is difficult to say a priori whether they are expensive relative to costs.

The discussion of penalty fees does take on a new dimension in South Africa, as some of the transaction accounts have facilities usually associated with current accounts, even although no overdraft is permitted. For instance transmission accounts accessible to low to middle income consumers carry a high penalty for dishonoured payments that are rejected due to insufficient funds. While it might be argued that banks incur costs when dealing with overdrawn accounts, in basic bank accounts, there is no overdraft facility and so a debit order typically associated with an instalment payment or repayment of a micro-loan is rejected electronically, without human interface. Currently creditors can recoup their instalment on three successive attempts. If the debit order instruction is rejected three times, then the client will pay the penalty three times. Currently, the fee for such a dishonoured payment ranges from around R64-R99. One interviewee stated that this had been a lucrative source of income for the banks and/but it has been viewed as gouging by customers and the press alike.

Sometimes customers also feel penalised even if they have not incurred penalties. This may have to do with the low levels of financial literacy in South Africa. Examples are frequently raised of instances where consumers are perplexed about their balance and proceed to make further balance enquiries or obtain a statement. In general, all of theses queries incur charges, which erode the consumer’s balance. A couple of interviewees referred to this in the interview as an example of inadequate education and disclosure on the part of banks, and of market power.

9.9 Interoperability and Access

The term interoperability may be narrow or broad, with the narrow definition referring to the agreement of common technical and business standards and the broad term embracing the narrow definition and reciprocity (Kemppainen, 2003). An example of reciprocity is when banks agree reciprocal access to each other’s bank accounts.

In general, the technical and business standards ought to be relatively easy to resolve as these refer to the legal agreements regarding the procedures and technical standards for interbank transaction, clearing and settlement processes. What is frequently more contentious is the agreement to allow reciprocity, particularly when market players do not have equivalent sizes of market share. Networks by their nature are associated with access and exclusion considerations.

The anticompetitive effects of network exclusivity have been identified by Balto (1999) as: 1. Foreclosure of new entrants 2. Enhancement of the ability to exercise market power 3. Enhancement of the opportunity for cartel activity 4. Deterrence of innovation. By comparison, the pro-competitive effects of network exclusivity are: 1. Promoting network competition 2. Encouraging promotional services by preventing free-riding 3. Reducing supply and demand activity 4. Recovering network investments.

In the interview process, it became clear that for the banks and PASA, interoperability includes reciprocity. New entrants seeking interoperability were in reality seeking access to clients’ bank accounts. New entrants appeared to be frustrated as while they could meet the technical standards associated with interoperability, they were still excluded from reciprocity agreements, or found these to be an unacceptable hurdle.

More specifically incumbents raised the prospect that any removal of standards and criteria or their relation in respect of NPS access would jeopardise the overall interoperability of the system. In addition however the concern was voiced that those who wish to gain access want to do so “for free”. The undercurrent of much of this discussion concerned the mechanism and willingness of incumbents to allow potential new participants access to their accounts.

The challenge overall is to balance interoperability (which is critical to ensure an effective payment system with ubiquitous points of access) against risk and commercial issues.

Overall it would appear that the matter of interoperability is primarily a technical one that can be dealt with through appropriate risk management and technology guidelines and procedures. If anything the addition of new participants should enhance the overall interoperability and network effect of the entire NPS as increased points of presence are introduced.

However the issues of account access remains more vexed. While the incumbent view is understandable in that these banks currently service and maintain customer accounts, the key point is that without access to such accounts (for instance the ability to effect an EFT) any new entrants will be unable to offer a viable payment solution (to some extent their interoperability will have been curtailed). Again incumbents make much of the risk associated with this as well as their carrying cost. The risks should be adequately managed through proper procedures and standards as noted above, while the cost issue should be the subject of reasonable commercial negotiation.

Clear guidelines in respect of standards for access to ensure interoperability as well as integrity of the system are required. However access needs to be allowed to all accounts in a PCH for any new participant that meets these standards. Obviously such access should not be “free” but should be subject to some appropriate commercial arrangement.

9.10 Conclusion

The interview process clearly raised a number of debates. Perhaps this stresses the need for appropriate fora where such views can be voiced and addressed.

While the debates are wide ranging, in general, the range of opinions could be divided into two camps, with the incumbents and the would-be entrants standing in opposing corners. This complicates the process as views are seldom objective and do not always provide clarity as to the critical issues.

The opposing views of the insiders and the outsiders point to the structure of the industry as an underlying concern. It could well be that if there was membership (albeit second-class) for non-banks, the debates would be less intense. In the same way, if there were more points of entry into the system in terms of offering core banking services, again some of the intensity of the debate would be eliminated.

As it stands, there are already options for those who would enter –including collection facilitators such as Easypay, paying facilitators such as salary payment institutions and card issuers such as buy aid societies. However, most of the would-be payment system entrants are not willing to pursue the existing options because it means entering an environment that lacks clear parameters in terms of their participation. Entrance into this environment also does not allow them to provide the sought after core banking service of deposit taking – for this they need to become a commercial bank which is clearly not their aim.

10 The way forward

The report has proposed a number of concerns and has put forward a number of recommendations. However, it has also raised some further questions. These are set out below.

A stakeholder workshop which involved regulators from the BSD, NPSD, the Department of Trade and Industry and representatives from the National Treasury, as well as senior representatives of the Competition Commission, held on 20th February 2006, brought into relief additional questions raised by the research. These are also summarised below.

10.1 Questions raised by the research

The National payment system (NPS) network affects the lives of consumers and firms throughout the economy. The South African NPS is a highly developed network with high levels of interoperability and ubiquity. In many ways it is more developed than similar networks in more economically developed countries. The findings and concerns below need to be viewed with this perspective in mind.

However, an efficient system may not be fair to consumers or other service providers. The questions raised below have more to do with fairness than efficiency.

1. The report highlights the absence of market conduct regulation throughout the industry and in the NPS in particular. The Bank Supervision Department, NPSD and PASA regulate prudential and technical aspects.

Market conduct is not within the remit of the BSD or the NPSD and as regards PASA, market conduct issues are seen to fall into the “commercial” rather than “co-operative” space.

While draconian measures such as price control may be inappropriate, public concern relating to bank charges, the domination of the system by the big banks through their provision of the vast majority of accounts in the system and their ability to utilize the NPS to further related market activity, suggest that market conduct regulation needs to be addressed in the interest of fairness. How should this be handled?

2. The national importance of NPS has been emphasized throughout the report; however, it appears that there is no statutory authority over the entire system - beyond SAMOS and the banks. Is it necessary to create such an authority that would view the NPS network from the perspective of the national interest and chart its strategic direction?

3. PASA is a self-regulatory body for banks in the settlement and clearing space. Payment Clearing Houses or PCHs comprise the banks active in the particular payments stream. This invariably involves the big banks plus some small banks. While each member has a vote of similar status, the application of PCH rules has drawn criticism by those who feel disadvantaged by the system. Who should be making the rules in the PCHs and how should they be monitored, if at all?

4. Currently there are a limited number of PCH system operators in the system (including Bankserv and STRATE). While the operator cost to the system in the case of Bankserv, appears to be relatively small, the question has been raised as to whether more such operators would lead to the undercutting of costs without undermining interoperability. However, the possibility of new operators raises the question as to the ownership of operators and how it ought to be structured.

10.2 Questions raised by stakeholders

1. Does the distribution of the cost of the NPS (estimated to be some 2% of GDP) fall disproportionately on low income consumers?

2. Do the conduct concerns suggest that the governance of PASA needs to be changed?

3. Should the overseer (NPSD) play a more prominent role in defining the rules of the game for PASA participants?

4. Should the entry of a new bank into the system – such as a Dedicated bank – or a new operator of a switch - be subject to a regulatory evaluation of its commercial viability?

5. What is the best way for interchange between banks to be set?

6. The banks have used their position in the NPS to create a preferential situation to their own advantage in related markets such as micro lending and bureaux, which are dependent on the terms and conditions of access to the NPS network. Should the setting of these terms and conditions remain the exclusive domain of the banks?

7. What proportion of the fees charged to consumers represents a mark-up for the banks?

10.3 The way forward

The nature of the questions indicates the complexity in separating out competition (or fairness) concerns and general regulatory concerns.

Clearly some of these questions, particularly the market conduct questions impact directly on fairness. Others, relating to the strategic authority, impact on the system as a whole but cannot be said to be primarily about competition. The Competition Commission has authority over those aspects which fall within the ambit of competition, other questions will have to be dealt with by other authorities.

The Competition Commission has decided to publish this report as a mechanism to stimulate debate around these and other questions, and welcomes public submissions on the NPS in this regard.

11 Interviewees

Organisation First Name Surname Position Contact Number Email General Manager ABSA Walter Volker ABSA Group (011) 350-5291 [email protected] payment systems Bob Tucker CEO (011) 370-3553 [email protected]

Banking Cas Coovadia Managing Director (011) 370-3555 [email protected] Association SA Stuart Grobler General Manager (011) 645-6714 [email protected]

Nicky Lala Mohan General Manager (011) 370-3504 [email protected] Bankserv [email protected] Pieter Cilliers CEO (011) 497-4008 [email protected] Capitec Bank Dirk Ehlers Head: Interbank (011) 809-5960 [email protected] Limited Consultant to Johnny Pienaar Consultant (012) 313-3234 [email protected] PASA

Anthony De Gray Birch Executive Director (012) 421-5544 [email protected] Direct Transact Hennie Dreyer CEO (012) 421-5544

Head, Central (011) 529-2870 Discovery Mark Kitching [email protected] Finance Operations 082 606 2870 (021) 680-0184 EasyPay Mike Smith CEO [email protected] 083 677 1866 CEO-InterBank, Peter Scaife (011) 352-9121 [email protected] Risk & Compliance First National Chief Financial Bank Jason Taylor Officer – InterBank, (011) 352-3697 [email protected] Risk & Compliance Fundamo Hannes Van Rensburg CEO (021) 943-2200 [email protected]

Professor GIBS Gill Marcus (011) 771-4000 [email protected] Extraordinary Head: Banking and +44 (020) 7270 James.parket@hm- James Parker payment systems 5937 treasury.x.gsi.gov.uk HM Treasury, Financial Systems UK +44 (020) 7270 Eve.atkins@hm- Eve Atkins and International 5937 treasury.x.gsi.gov.uk Standards Independent Tom Lawless - (011) 888-3568 [email protected] Consultant Independent Keith Smith 082 416 4926 [email protected] Consultant National Raadhika Sookoo Director: (012) 315-5671 Raadhika.Sookoo@treasury. Treasury Economic Policy gov.za Head: Wholesale [email protected] Martin Pienaar Product (011) 294-1068 [email protected] Management Nedbank Senior Manager Carmen Whateley Global Trade & (011) 295-5548 [email protected] Interbank Economist, Office of Fair +44 (020) 7211 Philip O’Donnell Payment Systems [email protected] Trading, London 8000 / 8793 Team

Organisation First Name Surname Position Contact Number Email Head, Payment +44 (020) 7211 Hugh Mullen [email protected] Systems Team 8000 Chief Operating Hendrik Pelser (011) 645-6761 [email protected] Officer PASA Peter Rawlings Director: Risk (011) 645-6764 [email protected]

Pick ‘n Pay Ronnie Herzfeld Director (021) 658-1601 [email protected] General Manager: (012) 401-7637 Marietjie.lancaster@postoffice Post Office Marietjie Lancaster Transformation & 082 828 9977 .co.za Innovation Engelbrecht Protea FSG Natie MD (021) 481-2700 [email protected] (Advocate) (043) 702-4614 Real People Johan Van Rooyen Managing Director [email protected] 082 825 5734 SA Payments Brad Gillis CEO (011) 645-6789 [email protected] Strategy Senior Project Liesl Henn (011) 645-6783 [email protected] Association Manager Shoprite Ed Nilson Director (021) 980-4379 [email protected] Checkers

Monica Singer CEO (011) 759-5300 [email protected]

Chief Operation (011) 759-5312 STRATE Limited Erna Solomon [email protected] Officer 083 601 1285 Head of Internal (011) 759-5322 Dale Connock [email protected] Audit 083 655 7062

Gerrit Groot Director (021) 949-2445 [email protected] Smart ATM Wollie Wolmarans Director (021) 949-2445 [email protected]

General Manager: Dave Mitchell (012) 313-4743 [email protected] South African NPSD Reserve Bank Bank Supervision [email protected]. Carel Oosthuizen (012) 313-3911 Department za Director Group IT & [email protected]. Alewyn Burger Business (011) 636-8764 za Operations Brian Le Sar Director: Group (011) 631-3814 [email protected] Payments o.za Standard Bank Strategy & Interbank Ian Sinton Head of Legal (011) 636-4772 [email protected] Risk, Executive .za Committee Member

Xpertek Group Ray Leonard Chairman (011) 519-3141 [email protected]

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South African Reserve Bank. www.reservebank.co.za

13 Glossary

Term Definition

access the right of or opportunity for an institution to use the services of a particular payment system to settle payments on its own account or for customers. automated clearing house an electronic clearing system in which payment orders are exchanged (ACH) among financial institutions, primarily via magnetic media or telecommunications networks, and handled by a data processing centre. See also clearing / clearance. automated teller machine an electromechanical device that permits authorised users, typically (ATM) using machine-readable plastic cards, to withdraw cash from their accounts and/or access other services, such as balance enquiries, transfer of funds or acceptance of deposits. ATMs may be operated either online with real-time access to an authorisation database or offline. Batch the transmission or processing of a group of payment orders and/or securities transfer instructions as a set at discrete intervals of time. central counterparty (CCP) an entity that is the buyer to every seller and seller to every buyer of a specified set of contracts, e.g. those executed on a particular exchange or exchanges. clearing the process of transmitting, reconciling and, in some cases, confirming payment orders or security transfer instructions prior to settlement, possibly including the netting of instructions and the establishment of final positions for settlement. Sometimes the term is used (imprecisely) to include settlement. confirmation a process whereby a market participant notifies its counterparties or customers of the details of a trade and, typically, allows them time to affirm or to question the trade. counterparty the opposite party to a financial transaction such as a securities trade or swap agreement. credit risk the risk that a counterparty will not settle an obligation for full value, either when due or at any time thereafter. In exchange-for-value systems, the risk is generally defined to include replacement cost risk and principal risk. delivery versus payment a link between a securities transfer system and a funds transfer system that ensures that delivery occurs if, and only if, payment occurs. finality irrevocable and unconditional. interbank funds transfer a funds transfer system in which most (or all) direct participants are system financial institutions, particularly banks and other credit institutions. interoperability a situation in which payment instruments belonging to a given scheme may be used in systems installed by other schemes. Interoperability requires technical compatibility between systems, but can take effect only where commercial agreements have been concluded between the schemes concerned. large-value payment payment, generally involving a very large amount, which is mainly exchanged between banks or between participants in the financial markets and usually requires urgent and timely settlement. large-value payment a system through which large-value and high-priority funds transfers system are made between participants in the system for their own account or on behalf of their customers. Although, as a rule, no minimum value is set for the payments they carry, the average size of payments passed through such systems is usually relatively large. Large-value funds transfer systems are sometimes known as wholesale funds transfer systems. liquidity risk the risk that a counterparty (or participant in a settlement system) will not settle an obligation for full value when due. Liquidity risk does not imply that a counterparty or participant is insolvent since it may be

Term Definition able to settle the required debit obligations at some unspecified time thereafter. national payment system the entire matrix of institutional and infrastructure arrangements and processes in a country for initiating and transferring monetary claims in the form of commercial bank and central bank liabilities. netting an agreed offsetting of positions or obligations by trading partners or participants. The netting reduces a large number of individual positions or obligations to a smaller number of obligations or positions. operational risk the risk that deficiencies in information systems or internal controls could result in unexpected losses. oversight central bank oversight of payment and settlement systems is a function whereby the objectives of safety and efficiency are promoted by monitoring existing and planned systems, assessing them against these objectives and, where necessary, inducing change. payment the payer’s transfer of a monetary claim on a party acceptable to the payee. Typically, monetary claims take the form of banknotes or deposit balances held at a financial institution or at a central bank. payment infrastructure arrangements involving network facilities, technologies and arrangements procedures for accessing and transacting instruments and for processing, clearing and settling related payments. payment order an order or message requesting the transfer of funds (in the form of a (instruction) monetary claim on a party) to the order of the payee. The order may relate either to a credit transfer or to a debit transfer. Also called payment instruction. principal risk the risk that the seller of a security delivers a security but does not receive payment or that the buyer of a security makes payment but does not receive delivery. In this event, the full principal value of the securities or funds transferred is at risk. retail payment system mainly a consumer payment of relatively low value and urgency. settlement refers to the final and irrevocable discharge of an obligation of one bank in favor of another bank, in central bank money. settlement risk general term used to designate the risk that settlement in a transfer system will not take place as expected. This risk may comprise both credit risk and liquidity risk. settlement system the entire matrix of institutional and infrastructure arrangements and processes for issuing and administering securities liabilities, administering and safekeeping holdings of securities issues, and for initiating, confirming, matching, transferring and settling securities transactions. stakeholder in a payment system, stakeholders are those parties whose interests are affected by the operation of the system. system participant participant in an infrastructure arrangement that acquires infrastructure services in order to provide other related services to end users. systemic risk the risk that the failure of one participant in a transfer system, or in financial markets generally, to meet its required obligations will cause other participants or financial institutions to be unable to meet their obligations (including settlement obligations in a transfer system) when due. Such a failure may cause significant liquidity or credit problems and, as a result, might threaten the stability of financial markets. systemically important a payment system is systemically important where, if the system were payment system insufficiently protected against risk, disruption within it could trigger or transmit further disruptions amongst participants or systemic disruptions in the financial area more widely. transfer operationally, the sending (or movement) of funds or securities or of a right relating to funds or securities from one party to another party

Term Definition by: (i) conveyance of physical instruments/money; (ii) accounting entries on the books of a financial intermediary; or (iii) accounting entries processed through a funds and/or securities transfer system. The act of transfer affects the legal rights of the transferor, transferee and possibly third parties in relation to the money balance, security or other financial instrument being transferred. user payment system users are entities, comprised of both participants in infrastructure networks (user participants) and their customers in end user markets (end users), that acquire and use various payment services.

14 Research annex: international comparison by Prof Akinboade

14.1 Indicators of payments system development

This chapter makes an international comparison of various aspects of national payments systems. It covers payments system’s penetration, use of payments instruments, payments clearing and settlement, ownership of payments infrastructure, and the effects of ownership patterns of participation in the payments system. Later, the study makes a cross country comparison of payments systems costs and fees. In the last section, the role of regulators in payments system development is briefly discussed.

14.1.1 Commercial bank branch and ATM outreach

The following table presents selected cross country comparison of payments systems development using simple indicators of Commercial banks’ branch as well as ATM penetration. These indicators measure the outreach of the financial sector in terms of access to banks’ physical outlets. Higher geographic penetration would thus indicate smaller distance and thus easier geographic access. Per capita measures of branches and ATMs are used to capture the demographic penetration of the banking sector. They proxy for the average number of people served by each physical bank outlet. Higher demographic penetration would indicate fewer potential clients per branch or ATM and thus easier access.

Per capita measures of branches and ATMs are used to capture the demographic penetration of the banking sector. They proxy for the average number of people served by each physical bank outlet. Higher demographic penetration would indicate fewer potential clients per branch or ATM and thus easier access.

The number of branches per area varies from less than 0.18 branches per 1,000 square kilometers (the lowest 5th percentile of the distribution) for countries such as Bolivia, Botswana, Guyana, Kazakhstan and Namibia to more than 119.65 branches per 1,000 square kilometers (the top 5th percentile of the distribution) for countries like Bahrain, Belgium, Malta, Netherlands, and Singapore. The median number of branches per 1,000 square kilometers is 4.80, which is representative of the statistics for Estonia and Sweden.

Ethiopia, Honduras, Madagascar, Tanzania, and Uganda have less than 1.24 branches per 100,000 people (bottom 5th percentile), while Austria, Belgium, Portugal, Italy, and Spain are at the top 5th percentile of the distribution with more than 49.74 branches per 100,000 people. The median figure for the number of branches per 100,000 people is 8.42. Indonesia, Turkey, Iran,

Colombia, Kuwait and Poland have indicators close to this value. There is a pattern of increasing branch penetration in more developed countries. The total global estate of ATMs reached 1.3m by the end of 2003 and is projected to reach a global total of 1.54m by end 2007. Of these, 394,000 were located in the USA, a number that exceeded the machine populations of every other region. For example, outside Japan, the Asia-Pacific region still had fewer than 200,000 machines in operation in 2001. Members of the major payment systems organisations, MasterCard and Visa, have access to around 800,000 ATMs globally (Retail Banking Research, MasterCard and Visa).

The pattern of distribution of ATM terminals in different parts of a country and within specific regions of the same country varies and is related to the convenience of the institution that is maintaining the network.

In terms of number of ATMs per area, Botswana, Ghana, Kenya, Namibia, Nigeria, Russia, Tanzania, Zambia, Nepal, Madagascar and Guyana are at the bottom of the distribution with less than 0.7 ATMs per 1,000 square kilometers, while the countries at the top 5th percentile of the distribution include Korea, Malta, Bahrain, Japan and Singapore with more than 253.12 ATMs per 1,000 square kilometers. The median for the number of ATMs per 1,000 square kilometers is 10.07. The ATM per area indicators for Sri Lanka and Costa Rica are close to this figure.

The number of ATMs per 100,000 people is lowest for countries such as Bangladesh, Nepal, Madagascar, Pakistan, Tanzania, and Uganda with less than 0.7 ATMs per 100,000. On the other hand, countries such as Canada, Japan, Portugal, Spain and the United States are at the other end of the distribution with more than 101.46 ATMs per 100,000 people. The median value for this indicator is 16.63. Countries such as Mexico, Malaysia, Lebanon, Thailand and Venezuela have ATM per capita indicators close to this value. Figures 3 and 4 show that both geographic and demographic ATM penetration increases with the level of economic development.

South Africa’s is the most advanced country in Africa in terms of ATM establishment. Its ATM base compares with those of Australia, India, Mexico, Portugal, and Russia and is better than what obtains in comparable Latin American countries such as Chile and Argentina which have 3435 and some 7,250 ATMs respectively. There are about 4,812 ATMs in the Philippines, 1700 in Hong Kong etc.

South Africa’s ATM networks serve a much higher number of inhabitants per 100,000 people when compared with other developing countries. This ratio of 17.71 compares favourably with estimates for Argentina, Brazil, Mexico, Malaysia, Thailand, Trinidad and Tobago, Venezuela, Saudi Arabia, and Poland.

Table 27: Geographic and demographic bank branch and ATM outreach Country GDP per Geographic Demographic Number Geographic Demographic ATM Transa- Interchange & capita branch Branch of ATMs ATM ATM outreach ction Volume Remarks ($) outreach outreach outreach and Value Branch per Branch per ATM per 1000 ATM per 100,000 1000 sq. km 100,000 people sq. km people Albania 1,922 2.45 2.11 108 2.74 2.37 6 of 16 banks (2005) provide ATM services Argentina 3,381 1.40 10.01 7,250 2.09 14.91 22.6 million 2 networks, (2002) transactions per Banelco and month Red Link Australia 26,062 0.77 29.86 20,899 1.66 64.18 About $10 billion Six networks; (2004) is withdrawn Interchange every month. agreements on networks Austria 31,202 52.47 53.87 7,499 84.95 87.21 194.7 million (2003) transactions worth US$30.04 billion in 2003 Bahrain 10,791 135.21 13.48 2,048 269.01 26.83 Propriety bank (2000) ATMS; BENEFIT network connects all ATMs Belarus 1,770 2.28 4.79 900 2.41 5.06 (2005) Belgium 29,205 181.65 53.15 7,067 229.28 67.09 263.8 million 13 ATM networks; (2003) transactions 84% restricted worthUS$33.7 access billion in 2003 Belize 3,583 1.67 14.67 17 -- -- 4 banks; (2005) 3 ATM networks; Belize Bank 8 ATMs Scortia Bank 6 ATMs; Barclays 3 ATMs; Atlantic Bank none. Botswana 4,290 0.11 3.77 84 0.27 9.00 No interchange; (2003) owned by 4 banks Brazil 2,788 3.05 14.59 137,400 3.72 17.82 5,672 million 29 networks; (2003) transactions or Banco24Horas $231 billion connects 15 value in 2003 financial institutions & Rede Verde- Amarela connects 11 state and regional banks Bulgaria 2,538 9.81 13.87 1,222 21.09 29.79 38.8 million 34 banks (2005) transactions in BORICA operates 2003 worth main network US$1.96 billion Post bank operates another. 100% open access; Canada 26,380 1.56 45.60 46,178 4.64 135.32 One network; 35% (2004) of ATMs (ABMs) are owned by banks; 65% by independent cash dispensers Chile 4,591 1.98 9.39 3,435 5.06 24.03 US$143 million 2 networks; (2002) in 2003 Globalnet owned by 10 banks and dominated by Bancoestado & Redbanc which is owned 33.4% by Santander Central Hispano & 25.4% by Banco de Chile respectively. China 1,094 1.83 1.33 38,000 5.25 3.80 Moneylink owned (2000) by 80 banks and financial institutions Costa Rica 4,365 7.52 5.59 984 10.07 12.83 (2001) Croatia 6,356 18.62 23.36 1,787 31.96 40.10 Group I banks own (2004) 1450 ATMs, Group II (267); Group III (64); Group IV (6 ATMs). Ecuador 2,066 4.38 9.30 714 2.97 6.32 (2001) Egypt 1,220 2.45 3.62 949-1500 1.21 1.78 3.5 million (2002) transactions worth $437 million in 2004 El 2,204 14.58 4.62 816 34.89 11.07 4 shared ATM Salvador (2001) networks; 2 largest banks operate own networks; one network for a consortium of

Country GDP per Geographic Demographic Number Geographic Demographic ATM Transa- Interchange & capita branch Branch of ATMs ATM ATM outreach ction Volume Remarks ($) outreach outreach outreach and Value smaller banks and one network owned by a credit card company. 16 banks in all France 29,269 46.94 43.23 41,988 76.33 70.30 1.2 billion (2003) transactions worth US$96.7 billion in 2003 Ghana 375 1.43 1.60 91 -- -- 84 ATMs of five (2003) banks linked by Visa Inter-national; Two banks run MONDEX network Greece 16,203 25.53 30.81 5,465 39.39 47.55 163.5 million 18 networks; (2003) transactions 100% open access worth US$42.9 billion in 2003 India 563 22.57 6.30 16,000 -- -- (2005) Indonesia 971 10.0 8.44 6, 848 5.73 4.84 138 commercial (2003) banks in 2003; 5 local inter-bank ATM networks, 88.4 % Owned by 10 banks and 2 international ATM networks Ireland 37,637 13.41 23.41 1,914 27.78 48.49 172 million 1 network transactions 100% open access worth US$26.3 billion in 2003 Israel 16,686 47.82 14.74 1,322 61.01 18.81 1 network; Owned (2003) by 5 major banks Italy 25,429 102.05 52.07 31,720 131.71 67.20 1,002 operations 90% of banks are (2000) per terminal per connected to year Bancomat Network Kenya 434 0.77 1.38 242 0.56 0.99 5 ATM networks; 3 (2005) owned by major banks; 1 by Kenswitch and 1 by Paynet. 14 Kenswitch ATM locations in 2002; Owned by a consortium of 18 SMME banks. Kuwait 14,488 11.05 8.27 270 26.32 19.69 7 commercial (2002) banks; ATM network is shared via K-Net Latvia 5,460 791 Six Networks are Four banks manage (2004) compatible. their own ATM networks BankServiss individually. supports 155 ATMs Two ATM networks While the central are managed jointly bank supports by BankServiss and 356 ATMs. the Central Bank

Lebanon 4,224 79.18 18.01 571 73.90 16.81 $737 million in (2001) 2001 Lithuania 5,273 1.81 3.39 15.34 28.78 Madagas- 4,164 0.19 0.66 0. 0.07 0.22 car Malawi 32 8 banks surveyed Malaysia 9,699 7.39 9.80 12.40 16.44 Mauritius 4,265 71.92 11.92 261 133.0 22.04 2.5 million 9 banks surveyed; (2003) transactions in 3 networks; December 2002 Mauritius commercial bank 128 ATMs; State Bank 87 ATMs; HSBC 12 ATMs Mexico 6,121 4.09 7.63 21,000 8.91 16.63 1.1 billion 3 inter-connected (2005) transactions ATM Networks equivalent to 1. Banamex- US$78 billion in Citibank, 2. BBVA 2001 Bancomer and 3. RED which connects all other banks Mozambi- 4 (1996) 48,096 transa- 1 network; que ctions per year 5 banks (1996) Namibia 2,312 0.11 4.47 235 0.30 12.11 4 networks; (2003) Standard Bank 87 ATMs; FNB 81 ATMs Commercial Bank 11 ATMs; Bank

Country GDP per Geographic Demographic Number Geographic Demographic ATM Transa- Interchange & capita branch Branch of ATMs ATM ATM outreach ction Volume Remarks ($) outreach outreach outreach and Value Windhoek 56 ATMs Nether- 31,548 163.81 34.23 7,142 223.02 46.60 500 million lands (2001) transactions worth US$4311 billion in 2001 Nigeria 370 2.41 1.62 >352 -- -- 931,991 Individual banks; ATMs in transactions in Afribank (7); First June 2005 2005 valued at bank (100); Union US$38.5 million (106); Diamond (21); Chartered 28 banks use (7); Guarantee 250 ATM Trust(3); Oceanic Interswitch. (2); Platinum (2); Some are inter- Prudent (4); operable with standard Trust (9); other cards such United Bank (76); as ValuCard, Universal Trust (1); Master Card and Wema (6); Zenith Visa Card. (16); ATM consortium of Businesses (60) 0thers (>10); Norway 48,592 3.41 22.92 >2000 .. .. 270 million cash (2003) withdrawals in 2003 Peru 617 0.89 4.17 1.24 5.85 UNIBANCA Owned by 14 Small banks;

No inter-perability across networks; Large banks own their individual ATM networks Philippines 2,247 21.4 7.83 4,812 14.52 5.31 3 ATM Networks

Bancnet, Megalink, and Expressent; Owned by 45 participating banks Poland 5,487 10.25 8.17 21.72 17.31 Portugal 14,665 57.45 51.58 11,985 121.5 109.9 371 million 79% open access (2003) transaction worth US$ 25.7 billion in 2003 Romania 2,719 13.26 13.76 1,283 12.02 12.47 Via 3 card (2003) processing companies, an ATM network operated by BORICA interconnects individual bank ATMs. Russia 3,022 0.19 2.24 10,000 0.53 6.28 (2004) Saudi 8,366 0.56 5.36 3,400 1.54 14.70 219 million 100% open access Arabia (2004) transactions worth US$36.5 billion in 2001 Sierra- 200 5 Leone (2003) Singapore 21,492 636.07 9.13 1,609 2,642 37.93 US$4.97 billion NETS manages ATM (2004) in 2004 networks Slovakia 5,922 11.33 10.28 32.21 29.21 South 3,630 2.22 5.99 14,024 6.49 17.50 Inter-operable Big Five in ATM Africa (2004) (2005) networks deployment: First National Bank, Standard Bank, ABSA Bank and Nedcor and independent deployer ATM Solutions. South 12,634 65.02 13.40 60,000 436.88 90.03 Korea (2004) Spain 20,343 78.9 95.87 51,978 104.18 126.60 894 million 3 networks (2003) transactions worth US$104.2 billion in 2003 Sri Lanka 965 20.41 6.87 721 10.91 3.67 34 million (2003) transactions worth US$ 1.17 billion in 2003 Tanzania 275 0.23 0.57 67 0.07 0.17 210,717 26 commercial (2005) transactions banks; 9 operate 29 Absa worth US$8.6 own ATM networks; ATMs million in 2002 Not inter-operable Thailand 2,309 8.71 7.18 5,865 20.69 17.05 1.5 million (2000) transactions

Country GDP per Geographic Demographic Number Geographic Demographic ATM Transa- Interchange & capita branch Branch of ATMs ATM ATM outreach ction Volume Remarks ($) outreach outreach outreach and Value worth US$131million (jan-june 2000). Trinidad 7,769 23.59 9.22 254 52.44 20.49 9.3 million 1 Network and (2000) transactions in Tobago 2000 Tunisia 2,630 5.32 8.77 615 3.77 6.15 17 banks (2004) (2004) Turkey 3,365 7.81 8.50 16.54 18.0 Uganda 245 0.67 0.53 >150 0.90 0.70 Stanbic bank National inter-bank (2005) network 66 switch launched in ATMs, Bankom june 2005; network 60 ATMs; others are Baroda and Barclays networks. Ukraine 1,024 .. .. 450 0.76 0.93 195 commercial (2001) banks United 30,278 45.16 18.35 54,000 104.46 42.45 An average of LINK ATM network Kingdom (2004) 6,126,030 system. daily transactions 100% open access worth $366 million in 2004 USA 37,388 9.81 30.86 394,500 38.43 120.94 93 million 25 regional (2005) transactions networks in 2005; worth $3.3 top 5 networks billion in January handle 78% of 2004; switched 40 billion transaction volume. transactions per year Venezuela 3,319 1.28 4.41 4,242 4.81 16.60 (2001)

Zimbabwe 634 1.11 3.27 288 1.15 3.38 9 networks; (2003) inter-operable

Sources: Thorsten Beck et al (2005); KPMG (2005); BIS Country Reports; European Central Bank (2004); Bank of England (2004); Central Bank Reports of Several Countries; Tremont Capital Group (2005)

14.1.2 Feasibility of ATM deployment

For a bank, the feasibility of deploying an ATM to any location is measured by the profitability of the location in terms of inter-bank fees charged whenever a customer of another bank carries out an operation on its ATM terminal. For example, if an ATM is installed by a bank in a specific public space such as shopping Mall, hospital compound, University Campus etc, and the interbank fee received does not produce earnings that are at least sufficient to cover costs, such machines will be shifted to a different more suitable location (Central Bank of Brazil, 2004). With an interchange fee averaging around $1 per cash withdrawal in Australia in 2005, any locations where the cost of operating the ATM would be higher than $1 per transaction is unlikely to be supplied with an ATM. This means that remote locations with high costs and a low number of withdrawals have no ATMs but cities have an abundance of them (Reserve Bank of Australia, 2005).

14.1.3 Patterns of ATM deployment

Many countries around the world follow a relatively similar deployment pattern concerning ATMs: Banks start deploying and usage of ATM’s in the branch first, then start accessing locations outside the branch (so called off-branch deployment) and at that point we also see independent operators or ATM deployers starting to deploy their own ATM network, usually at merchant locations.

Off-premise or off-branch deployment is a trend in Europe, with variations per country related to interchange fee conditions. Banks locate ATMs where they believe the machines will be convenient for their customers. In many off- premises locations, such as gas stations and convenience stores, banks must pay the owner of the location a fee to place a machine on the property. Current trends in Canada and in Europe include a strong growth of independent networks in countries where the interchange fee is high, such as UK, Germany and Netherlands, and in these countries third party deployers like MoneyBox, Pharro, BBG have won a strong market share. A similar trend is observed in Nigeria and Kenya. Pesa Point, an independent network of 30 automated teller machines (ATM’s) was officially launch on Friday October 21st, 2005 in Kenya. Banks compete with independent cash dispenser operators for these locations and over time this competition has resulted in increased costs for off-premises machines.

Table 28: ATM deployment by banks and independent cash dispensers in Canada 1994 1999 2000 2001 2002 2003 2004

Bank-owned ATMS2 12,660 16,626 17,174 16,806 16,546 16,624 16,160

Total ATMs3 16,703 26,727 31,922 35,632 39,996 42,773 46,178*

Bank-owned ATMs as a % of the total 76% 62% 54% 47% 41% 39% 35% Source: Canadian Bankers Association (2005)

Similarly, off-branch deployment was developed in Slovenia and Greece, while it has yet begun in some countries like Slovakia and Croatia. Most of the existing third party operators in this region usually own and operate a network of ATMs on behalf of a bank. Besides the traditional ATM, there are kiosk based self service channels like statement printers, financial kiosks, bill payment etc, that are very fast growing channels (Ralasic, 2005) .

ATM, debit and credit card networks

The number of ATM/Debit Card networks varies depending on the degree of sophistication of each country payments system. In some countries, individual banks operate own ATM networks which are not inter-operable with others. In other countries, there are opportunities for network inter-operability. As highlighted in table 1, some countries operate several ATM networks.

The sharing of ATM, debit and credit card terminal networks and network interoperability

In several countries, ATM terminal networks are shared, though there are different sharing structures. The single network and the shared network models are the most common. In the single network model, financial institutions have a high level of standardization and interoperability (Central Bank of Brazil, 2004). In these cases, machines are standardised and access to basic operations such as withdrawals, consultations and payments is open to all users independently of the bank. Operations of the networks, maintenance of the machines and the development of new platforms and products are carried out by a company that belongs to the banks, thus generating gains in scale and significant reduction unit cost per transaction (Central Bank of Brazil, 2004). Generally, in this model, the machines belong to the banks and the banks receive inter-bank fees as a result of interoperability.

Some countries such as Ireland, Portugal, Switzerland, Belgium, UK, Finland and France adopt a single network model for ATM terminals. In the UK, Sweden and Finland, the single ATM network first appeared as a consequence of mergers among two or more previously existent ATM networks and resulted in complete inter-operability among bank terminals. In the case of Portugal, banking system automation, from the very start was based on the adoption of a single shared infrastructure for receiving and processing transactions in ATM and EFTPOS terminals.

The model of sharing with more than one network is found in Australia, Belgium, Greece, Spain, Italy, United States and Germany. In the United States there are 25 different networks (Rosenberg, 2005). In this case, basic operations are shared, despite the existence of differentiated financial products which can be exclusively offered by each individual networks.

In these countries, inter-operability of the ATM networks made it possible to cut installation and maintenance costs, generating increasing utilization of the distribution channel. Furthermore, the number of transactions per inhabitant and the number of terminals increased sharply.

One factor that can influence the utilization of interoperable ATM networks is the question of whether or not to charge user fees for the utilization of the shared machines. In general, in those countries where there are no direct fees charged to users, such as Portugal, Sweden and UK, utilization has grown more rapidly than in countries where the direct charging system exists such as Italy, Finland, Germany, USA and Belgium (Central Bank of Brazil, 2004).

Whether interoperability exists or not, self-service terminals are classified as open access or restricted access. Open access networks provide access to customers or clients of more than one financial institution. In 2002, 38 percent of ATM terminals in Brazil were open access networks. When access is restricted,

the network is used only by customers of the proprietor financial institution. This means that access is restricted to cards that have been issued by the network owner. Access restriction may be connected with the high-level of asymmetry among ATM terminal networks, a situation that often results in propriety networks varying in size and technological levels. Access restriction could also be due to 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. Access restriction could also be related to a lack of coordination among financial institutions in defining the level of inter-bank fees that are compatible with the need for financial equilibrium and the feasibility of investment in infrastructure, systems and connectivity of the propriety network in a shared structure (Central Bank of Brazil, 2004).

Where the level of infrastructure sharing of ATM terminals is low, the result is that: (1) the level of utilization of ATM terminals capacity becomes low (2) there is an overlapping of terminal location (3) there is a high cost of logistics, development and maintenance of networks and terminals (4) there is a low standard of communication protocols, environment, methods and processes.

14.2 Cross country differences in use of payments instruments

In all countries, payments can be effected in that country’s banknotes and coins. Usage of payment instruments however varies significantly from country to country. It is normally easy to buy or exchange cash in banks, ATMs or bureaux de change all over the world. Even though international payment cards can be used in many countries, cards are not necessarily accepted everywhere. Payments are big business. In Europe, approximately 52 billion non-cash payments are processed every year. (CapGemini, ABN AMRO, 2005).

14.2.1 Retail payments instruments

Western Europeans hold 721 million payment cards

According to ATM Market Place (2005) research, there are 721 million payment cards in issue in western Europe used in retail payments. Six countries account for almost 80% of cards in the region: the UK remains the largest market with 166 million cards and Germany second with 123 million. These two countries are followed, some way behind, by France, Spain, Turkey and Italy. At the other end of the scale, Norway, Austria, Finland, Denmark and Ireland are all home to fewer than 10 million cards.

Table 29: Western Europe’s largest card markets, 2004 Country Cards (millions) Share of market (%) UK 166.1 23.0 Germany 123.2 17.1 France 86.1 11.9 Spain 79.8 11.1 Turkey 66.8 9.3 Italy 57.4 8.0 Others 141.7 19.7 Total 721.1 100 Source: ATM Market Place (2005)

Seventy nine percent of payment cards in Europe carry international branding

568 million (79%) of the 721 million payment cards in western Europe now carry international card scheme branding. Of these, 98% carry one of the MasterCard or Visa brands. The Visa Electron and Maestro debit marques represent over half the market. Overall, the MasterCard and Maestro brands have a higher share of the cards in issue than Visa flag and Visa Electron, although in the charge and credit card segment, Visa is the larger player. American Express and Diners Club account for less than 2% of the region’s international cards; this rises to 5% if debit cards are excluded. JCB has a negligible share with just a few thousand cards in circulation in the region.

Table 30: International card schemes in Western Europe (2004) Type of Card Share of market by number of cards Maestro 39.9% Visa 28.6% Mastercard 17.3 American Express 1.5 Dinner Club 0.4 JCB Negligible Visa Electron 12.2 Source: ATM Market Place (2005)

Four out of five cards are issued by banks Financial institutions are by far the most important issuers of payment cards and account for 81% of cards in circulation. Cards issued by private label organisations (such as retailers and credit specialists) form the second largest category, and represent more than one sixth of the total. In recent years, issuers in a number of countries have been converting their private label cards to Visa or MasterCard products, in an attempt to increase usage levels. The Travel & Entertainment (T&E) companies American Express and Diners Club represent less than 2% of the total.

Table 31: Payment card issuers in western Europe (2004) Card Issuer Market Share (%) by number of cards Financial Institutions 81.3 Private Label 17.1 T&E Organizations 1.6 Source: ATM Market Place (2005)

As at December 2003, 416,891 valucards (e-purse) and 12,000 ATM cards were in use in Nigeria (Nigeria Bankers’ Committee, 2004). In Kenya, the number of Visa cards in circulation has risen by 34%, from 620 087 in June 2004 to 828 937 in June 2005 (Reynolds, 2005). Total expenditure on Visa cards in Kenya has reached US$560 million per annum and represents about 6% of total consumer expenditure (or Private Consumption Expenditure). In comparison, At end August 1996, there were approximately 14.4 million debit cards in circulation in Thailand (Bank of Thailand, 2000) and there were 9.4 million credit cards and 33 million debit cards in circulation in Mexico in 2003.

Cross country differences in use of cash for payment

Although attitudes towards cash vary widely from country to country, many Europeans are still distrustful of cards. Approximately 60% of European payments are made in cash (CapGemini, ABN AMRO, 2005). For example, Germans are steadfast cash carriers; Similarly, Austrians, like their German neighbours, also prefer cash, settling 93% of their bills with notes and coins (The Taipei Times, 2004). In 2003, 92% of personal consumption expenditure in China was in cash. 77% of urban Brazilians continue to use cash for all payments, even utility bills. Only 12% of purchases in Mexico are made with credit cards (Rosenberg, 2005) In Bulgaria, retail transactions are made in cash owing to tradition and the limited number of point of sales terminals. For these reasons, debit cards are mainly used to withdraw cash at ATM terminals rather than to make payments (Bulgarian National Bank, 2004). The UK’s ATM placements rose by 8,000 to 54,000 during 2004, and cash is still the payment of choice for the Greeks.

Outside Europe, cash plays an even more prominent role in consumer spending habits. For example, a report published by Electronic Payments International claims an estimated 90% of personal consumption expenditure in India is still made with cash (Electronic Payments International, 2005).

And, reports from the 2005 Retail Bankers International conference say cash remains by far the most widely used means of payment across Africa. Nigeria is essentially a cash-based economy. Even where credit cards and cheques are accepted, which is in a limited number of places (for example, major hotels), fear of financial fraud means that many customers often still pay in cash.by June 2003 only 17,326 automated teller machine cards had been issued in Nigeria (EIU, 2004).This is also the case in South Africa, which already has a well- developed electronic payments infrastructure and unquestionably the most advanced retail banking market on the continent.

The use of non-cash payments instruments

Table 32: Volume of non-cash payments in Europe, 2002 (millions) Non-cash Country payments Austria 1013 Belgium 1708 Denmark 921 Finland 1073 France 13368 Germany 12043 Greece 87 Ireland 285 Italy 3138 Luxemburg 50 Netherlands 3423 Portugal 1074 Spain 2783 Sweden 1143 United Kingdom 11371

Non-cash payments volumes are highest in the France, Germany and United Kingdom, where the volume of this payment instrument has been accelerating in recent years.

Table 33: Number of non-cash payments per inhabitant per instrument in Europe (2003) Direct Country Credit transfers Debits Cheques Credit Cards Debit Cards France 42 38 64 71 Germany 68 64 2 7 20 Italy 17 12 9 6 11 Netherlands 77 61 3 71 Spain 11 32 4 12 18

Table 34: Share of payment instruments in total non-cash payments in Euroland (2002) e- Country Credit transfers Direct Debits Cards Cheques money Austria 47 34 18 1 Belgium 47 10 35 2 6 Finland 49 5 46 France 19 16 31 34 Germany 45 37 17 1 Greece 10 13 54 19 4 Ireland 13 13 48 26 Italy 32 22 29 17 Luxemburg 26 8 25 1 Netherlands 37 27 33 3 Portugal 6 11 59 24 Spain 15 43 36 6

Credit transfers and direct debits account for more than half on non-cash payments in Austria, Belgium, Finland, Germany, Italy, Netherlands and Spain. The use of credit cards is also quite important in Belgium, Finland, Greece, Ireland, Portugal and Spain.

The importance of payment cards when payments system is under- developed

Many banks in Africa have been installing ATMs over the past few years. Since there has been no coordination, they have been developing proprietary networks and processes to operate their ATMs. As a result, users of ATM services are generally restricted to the bank where they maintain an account. However, the foreign banks allow their customers in one country to have access to the bank’s ATMs in another country where they are located and also throughout the world. The indigenous banks have limited inter-operability among the ATMs of the different banks, though this is being developed in countries such as Nigeria. More recently, this interoperability arrangement is being boosted through the use of internationally branded (e.g., Visa, MasterCard, etc.) debit cards to acquire cash from ATMs or pay for goods using EFTPOS terminals. However, the costs are unduly high because of the settlement fees.

The trend is toward debit cards to facilitate the reduction of banking floor traffic for the withdrawal of funds through ATMs rather than using cheques. Some companies that have moved forward with direct deposit of payroll funds encourage their employees to obtain a debit card for withdrawals of cash to reduce the time away from work. However, some customers are restricted to the services of one bank unless they have a card that allows for inter-operability.

The use of direct credit/debits when payments system is under- developed

In many countries, interbank arrangement for the direct deposit of payrolls is still being developed. Some companies require their employees to maintain accounts at the banks where the company does business. Some banks will provide other banks with a listing of payroll credits and a cheque to facilitate the process for interbank direct deposit of payroll, but often this takes an extra day for the customer to receive the payroll funds. Some banks refuse to accept the payroll entries for other banks and then the company must create a payroll cheque for those employees who maintain accounts at banks other than where the company maintains an account. There are certain employees that banks do not wish to accommodate because there is little profitability in maintaining these types of accounts.

There is no electronic interbank direct debit capability. The ATM debit and POS debit transactions go to the bank where both the customer and merchant have an account. Utilities are beginning to accept debit cards as payment for services.

This approach requires the utility to maintain an account with each bank in the country where they provide service to obtain timely credit. They would welcome the opportunity to have an interbank direct debit authorization service or to make a monthly charge to a customer’s account without having to maintain an account with each bank or process and deposit paper cheques. Use of an electronic direct debit approach would require bilateral agreements between the user, banks and the utility.

The use of cheques as payment instrument

Compared with credit transfers, cheques, as a payment instrument, are not popular in Switzerland, Sweden, Germany, Belgium, Austria, Finland and the Netherlands. France, U.K., Portugal, Ireland, Italy show a more significant reliance on cheques as a non-cash payment method. A CapGemini, ABN AMRO (2005) survey found a wide frequency-of-use range in cheques, from 70 cheques per year per US individual to less than 0.4 per year in the Netherlands, Belgium, Sweden, Norway and the less mature markets that were studied. The main users of cheques were customers in the US, Canada, Australia, the UK, France and Portugal.

Table 35: Cheques as a proportion of total non-cash payment transactions in Europe (1998-2002) Country 1998 1999 2000 2001 2002 Austria 2.8 2.1 1.3 1 0.7 Belgium 7 5.7 5 3.8 1.7 Denmark 9.6 7.8 6.7 5.5 4.5 Finland 0.3 0.1 0.1 0.1 0.1 France 44.1 40.1 37.9 35.4 34.2 Germany 4.2 3.8 3.3 2.6 1.2 Greece 21.5 22.8 20.2 Ireland 56.6 49.2 41.3 30.1 26.3 Italy 28.3 25.2 21.7 19.3 17.2 Luxemburg 2.8 2.2 1.7 1.1 0.7 Netherlands 1.9 1 0.5 0.2 0 Portugal 39.8 34.1 29 27.1 24.1 Spain 12.9 10.7 8.9 7.3 6 Sweden 0.4 0.3 0.2 0.2 0.1 United Kingdom 31.7 28.8 26.1 23.5 21 Source: Xavier Tamayo, Luis Jimenez and Shawn P. Flynn (Pitney Bowes) (2005)

The use of cheques when payments system is under-developed

In general, the payments base is narrow in many African countries. As such, the cheque is probably the most commonly used non-cash payment instrument especially under conditions in which credit instruments are minimally used and direct debits are in many cases non-existent. Cheques hence dominate non-cash payments in many African countries because until recently, they were the only known and available non-cash instrument that was being cleared in the local clearing houses. A few cheques for inter-country payments cleared may take

more than four weeks to assure availability of funds. Cheques are mainly used by governments while the commercial sector prefers bank drafts and cash.

14.3 Clearing and settlement

14.3.1 Clearing arrangements

In countries where payments systems are well developed, payment instruments and information are increasingly exchanged among financial institutions through automated procedures. Such a tendency depends, partly, on the increasing use of automated payment instruments (such as debit cards and direct debits), and partly on the automation of clearing procedures for paper-based instruments such as cheques.

In some countries, settlement for inter bank transactions via the ATM, Debit and Credit Card networks is made by each bank calculating a bilateral net position against each other bank. The bilateral net positions are settled by cheque in some countries. Separate settlements are done for credit cards and ATM/Debit card transactions.

In some other countries, multilateral clearing arrangements play a prominent role in the processing of retail payments, though their role varies considerably across different countries and sometimes also within the same country. It is the most common for clearing houses to be responsible for both setting the rules governing the clearing processes and providing relevant operational functions. The level of operational involvement of clearing houses, however, may differ from country to country. In Belgium, France, Italy, Japan, the Netherlands, Sweden, Switzerland and the United States, clearing houses directly provide all the relevant functions of a particular clearing process (exchange and netting procedures and sometimes also the interbank communication network). In Australia and Canada, clearing arrangements are based on clearing associations that mainly establish rules while not being involved - or being involved only to a limited extent - in the provision of operational procedures. In these countries - where banking system concentration is relatively high - payment information and instruments are exchanged among financial institutions on a bilateral basis according to the rules of the clearing associations. In Germany and the United Kingdom all variants can be found.

The structure of domestic clearing systems for retail payments (other than payment cards) differs significantly with regard to the number of multilateral clearing arrangements and their specialisation. In some countries, one single clearing arrangement processes most paper-based and paperless payment instruments (Canada, the Netherlands, Sweden, and Switzerland). In other countries, there exist two main clearing arrangements specialised in processing paper-based and paperless instruments respectively (Australia, Belgium, France, the United Kingdom).

In countries such as Germany, Italy, Japan, the United States, where various clearing arrangements and organisations are in operation. This may reflect the coexistence of clearing arrangements provided by different categories of credit institutions or, also, the provision of a multiplicity of local clearing arrangements that mainly process paper-based instruments. In these countries, however, linkages among clearing arrangements frequently exist. In Germany, there are four clearing organisations for different categories of financial institutions (commercial banks, savings banks, cooperative banks, Postbank) which are interconnected either through informal exchange procedures using bilateral exchange of data carriers/telecommunications for clearing and the RTGS9 system for settlement or through the usage of the retail clearing and settlement system provided by the Bundesbank. In Italy, clearing services for paperless payments are managed by four providers that are subject to the same rules and are linked to each other as well as to the clearing house for cheques, so that the Italian retail clearing systems are highly integrated and determine one single multilateral balance per financial institution to be settled at the central bank. In the United States, where 150 local clearing arrangements for cheques coexist with national arrangements, cross-membership is used in at least one case to link a national clearing house for cheques to regional arrangements. In Japan, a nationwide electronic clearing system handling both paper-based and paperless transactions coexists with about 600 local clearing houses for bills and cheques.

Table 36: Clearing and settlement systems Country Name of Processing Settlement Clearing Clearing House Method Belgium Clearing House Real Time Multilateral Same Day Transmission Netting Belgium CEC Real Time Multilateral Same Day Transmission Netting Denmark Retail Clearing ACH Multilateral Next Day Netting Germany RPS ACH Gross Settlement 1 Day Greece DIAS ACH Multilateral Same Day Netting Greece ACB Manual Multilateral Same Day Netting Finland PMJ Batc Bilateral Netting Same Day France SIT Real Time Multilateral Same Day Transmission Netting France CREIC ACH Multilateral Next Day or Netting 1-2 Days Ireland Retail Clearing Real Time Gross Settlement 3 Days Transmission Italy Local Clearing Real Time Multilateral -- Transmission Netting Italy Retail Clearing ACH Multilateral -- Netting Luxemburg LIPS-Net ACH Multilateral Same Day – 5 Netting times at real time. Netherlands Interpay ACH Multilateral Same Day Netting (Morning) Next Day (Evening) Portugal SICOI Real Time Multilateral --- Transmission Netting Portugal SLOD Manual Gross Settlement --- Spain SNCE Real Time Bilateral Netting Same Day

Country Name of Processing Settlement Clearing Clearing House Method Transmission Sweden BankGirot ACH Multilateral --- Netting Sweden Data clearing ACH Multilateral --- Netting Sweden PostGirot ACH Gross Settlement --- UK BACS ACH Multilateral 3 Days Netting UK CCCL Manual Multilateral 3 Days Netting

Inter Bank cheque clearing and settlement In countries where payment systems are under-developed or where the size of the country is small, a relatively low volume of cheques and as such virtually all cheques can be cleared and settled in less than a week. In some countries such as El Salvador, cheque settlement takes place on a next day basis, whereas in many African countries, it could take between 3 to 7 days. Thus, cheques deposited by bank customers on day 1 are generally cleared, settled and charged to the cheques issuer on day 2-7. In countries such as Madagascar delays in interbank payments settlement could be as long as 45 days.

In countries where the retail banking payment activity is based mainly on cheques, the central bank is empowered by regulation in many countries, to operate the cheque clearinghouse or to designate the operator. The number of cheque clearing houses varies depending on the size of the country and complexity of the financial system. Large countries, such as Mexico, India and China establish regional clearing houses, though the main clearing house is located in the capital city. There are 234 clearing houses in Mexico. The Central Bank may provide for the clearing of intra-country and international cheques. The Central Bank provides settlement services: it manages banks’ current accounts through which inter-bank payments and clearinghouse “due-from” and “due-to” positions are settled.

The Zambian Inter-bank Payment Settlement System (ZIPSS) was introduced on 21 June, 2005 while the Kenya Electronic Payment and Settlement System was officially launched in September 2005. All commercial banks licensed in these countries are connected to the system, which enables customers to pay and receive large and time-critical payments on a real time basis.

14.4 Ownership of payments system infrastructure

14.4.1 Ownership of ATM payments infrastructure

Commonly retail payment systems are jointly owned by participating banks or they are in public ownership (central bank). The mutual ownership (e.g. in the form of joint ventures) reflects the cooperative nature of payment provision services.

Generally speaking, the payment clearing system infrastructure is usually owned by the participating financial institutions (or at least the larger participating institutions), who are members by virtue of the bilateral agreements which they have concluded with each other.

In Ireland, ATMs are owned and operated by five retail clearing credit institutions. In Ireland, there is no specific ATM scheme, rather a series of bilateral arrangements between the five credit institutions that own and operate their own ATM networks. Access by financial institutions to the Laser card scheme is by means of membership of Laser Card Services, Ltd. In order to access a credit card scheme, a financial institution agrees to offer its customers a particular credit card brand or brands, which obliges the institution in question to abide by the credit card company’s rules of operation. Also, access to paper and electronic fund transfer mechanisms is by way of membership of the clearing companies, which has been described earlier in this paper. In The Netherlands, Interpay has its own licence requirements, parts of which are regarded as being unfair by some (potential) new entrants.

In The Netherlands, Interpay is owned by 8 major general banks; In the United Kingdom, Link interchange Network Ltd is a private company limited by share and is wholly owned by 22 financial organisations. Link has two constituent parts: the card scheme, which determines the operating rules, and procedures which govern the LINK ATM Network; and the operating company which manages the card scheme and provides the technical, commercial and settlement services which make ATM sharing possible.

Whereas in Sweden, probably the cheapest way for smaller bank to offer cash withdrawals and card payments is to issue international cards, like Visa and MasterCard. Card holding customers automatically qualify to use existing ATMs, owned mostly by larger banks. A bank has to be a member in Visa Sweden Förening to issue and acquire

Gaining access to and regulating payments schemes and infrastructures

Evidence from the literature reviewed suggests that in many African countries, propriety ATMs are the norm and interchange facilities are new or being developed. In the developed world, while each country has procedures in place for admitting new members to payment schemes and infrastructures, there is little uniformity from country to country.

14.4.2 Ownership or providers of cheque clearing arrangements

Private sector providers are prominent in retail clearing arrangements. Belgium, France, Germany, Italy, the United States have both privately run and central bank clearing arrangements for retail payments. Australia, Canada, Japan,

Sweden, the Netherlands, Switzerland and the United Kingdom have clearing facilities that are operated entirely through private arrangements.

In countries where both private and central bank clearing facilities exist, the central bank typically specialises in the clearing of paper-based payments, sometimes managing clearing houses on behalf of banking associations. Such a role may be explained historically on the basis of the need to overcome the inefficiencies associated with bilateral exchanges through a chain of correspondent banks in countries where the banking system was not concentrated on a national scale. However, some central banks are also involved in the provision of automated clearing facilities for retail payments.

Private sector providers of clearing services for retail payments include in some countries banking associations that may entrust a participating institution, most often the central bank, with operating the system. In most cases, however, the private sector providers of clearing services are owned by banking associations or groups of financial institutions. Some of these are specialised in operating clearing systems and provide their services mainly to their shareholders, which are the participants in the clearing system. Some other providers are represented by private sector data processing and communications firms, often owned by financial institutions, which may have a wider scope of activity also including services such as authentication, authorisation and confirmation of payments.

Table 37: Automated clearing houses owned by commercial banks in Europe (2003) Country ACHs Cleared Cleared Owned By Total Number Volumes Values of members (millions (Euro transactions) billions) 1. France SIT 11,043 4,337 Direct Participants = 2. United BACS 6,105 3,828 177 Kingdom

3. Netherlands Interpay 2,811 --

4.Portugal SIBS 1,189 308 Commercial Banks Indirect 5. Denmark PBS 845 556 Participants = 2,054 6. Sweden BGC 563 635

7. Finland PMJ 169 168

8. Ireland IRECC 149 245

Total 22,874 10,077 Source: CapGemini, ABN AMRO (2005)

Table 38: Automated clearing houses owned by commercial banks in other countries (2005) Country Automated ACHs Cleared Owned By Total Clearing Operated by Volume and Number of House Value members (ACH) Types Argentina Private Interbanking Member 12 of 40 Large Value banks member Clearing banks own Houses Provincanje Interbanking; Provincial banks own provincanje Argentina Private ACH, S.A & 9.3 million Member 39 banks Small Value Compensadora transactions banks belong to Clearing Electronica S.A per month ACH,S.A; House 70 banks belong to COELSA 1. Australia 1. Paper 856 million Australian 619 members Clearing. transactions Payments (2001) 2. Bulk (2000) valued Clearing electronic. at US$6.92 Association 3. Consumer billion in 2001 electronic. 4. High value Bulgaria Retail ACH Bank service 29.7 million Banks 37 (BISERA) transactions participants worth US$36.4 billion in 2003 Brazil 6 private Redecard 13.2 million clearing Visa net transactions or houses Tecban, $13,333 billion Belong to in 2003 STR

CIP 11.3 million transactions or $265.7 billion COMPE in 2003

3,129 million transactions or $678billion in 2003 Chile ACH; Camara de Private compensacion Small Value automatica (CCA) Clearing House El Salvador Manual BCR 32,000 16 banks Clearing cheques daily House worth $84 (2001) million France French Systeme 11,043 millions Member 17 Automated Interbancaire de banks participants Clearing Telecompensation House (SIT) Israel 1.Banks Banks Clearing Owned by 47 Direct Clearing Centre Limited five major participants in banks in 2002 Automated Bank Israel. 2. Services Ltd Automated CH Jamaica Jamaica

Country Automated ACHs Cleared Owned By Total Clearing Operated by Volume and Number of House Value members (ACH) Types Clearing Bankers Association Kenya Clearing Kenya House Bankers Association Malaysia Malaysia 592,000 Commercial 14 domestic Electronic transactions banks banks and payment worth RM 4.73 financial system billion in 2003 institutions (MEPS) Malaysia ACH to SPICK 176.43 million Owned and 12 domestic expedite transactions operated by banks and clearing of worth US$290 Bank financial cheques. billion in 2002 Negara institutions 90% Malaysia and 14 locally cheques (BNM) incorporated cleared in foreign banks. the country Mexico ACH Centro de Commercial 41 banks Compensacion banks Bancaria (CECOBAN) Namibia Manual 5 participants clearing house Netherlands ACH InterPay 2,811 million Commercial 10 banks transactions banks

Nigeria Nigeria $475m All Nigerian 89 Automated Commercial participants in Clearing Banks 2004 System Singapore Electronic Singapore Clearing US$74.8 billion Members of 48 ordinary Cheque House Association in 2004 the members and Clearing association 87 associate System members in (ECS) 2002 Singapore Provincial US$ 4.72 Provinces cheque billion in 2003 and Districts clearing system Swaziland Automated Automated Banks Clearing Electronic CH System United Automated Bankers 455 million Banks 14 settlement Kingdom Clearing Automated payments in members System Clearing Service 2001

About one half of the selected countries (Belgium, France, Germany, Italy, and the United States) have both privately run and central bank clearing arrangements for retail payments.

Table 39: Automated clearing houses owned jointly by the central bank and commercial banks in Europe (2003) Country ACHs Cleared Cleared Owned By Total Number Volumes Values of members (millions (US$ transactions) billions) Spain SNCE 1,045 1,642 Direct Belgium CEC 987 635.7 Participants =

Greece DIAS 68 81.4 Commercial 109 Luxemburg LIPS-Net 14 57.5 and Central Banks Indirect Total 2,114 2,417 Participants = 261 Source: CapGemini, ABN AMRO (2005)

Table 40: Automated clearing houses owned jointly by the central bank and commercial banks in other countries (2005) Country Automated ACHs Cleared Owned By Total Clearing House Operated by volume/Value Number of (ACH) Types members China 3 inter-bank Central Bank Most are payment systems and members owned by comprising the central 2,334 local clearing bank; others houses, national by members. interbank system and electronic NIS is owned interbank system by Central Bank

EIS jointly owned by Central and commercial banks

Hong Kong Hong Kong Half a million Hong Kong 68 direct Interbank Clearing cheques Monetary participants Ltd cleared daily Authorities amounting to And 164 indirect US$2.58 billion Association participants of Banks India Electronic CH 15 ECH of Reserve Bank 36 million 35 banks of India transactions in 2005/06 25 of State Bank of India

2 of PNB

1 of Union Bank of India Indonesia 102 clearing 38 operated 57 million Zengin-Net 138 houses in the by Central transactions commercial country; Bank; cleared worth PT Artajasa banks in US$ 125 billion for 26 2003 in 2003 members Or 1890 Inter-bank Others (100) participants electronic payment operated by in terms of Zengin-Net commercial branches (February,2004) banks located next to clearing houses Sri Lanka Sri Lanka ACH LankaClear 36.5 million 20% by 23 cheques Central worth US$ 26.2 Bank, 28% billion by 2 state banks; 52% by local and foreign entities

Table 41: Automated clearing houses owned by the central banks in Europe (2003) Country ACHs Cleared Cleared Owned By Total Number Volumes Values of members (millions (US$ transactions) billions) Germany RPS 2,157 2,527 Direct Participants = Italy BI-COMP 1,160 2,100 Central Banks 2600

Total 3,317 4,628 Indirect Participants = 500 Source: CapGemini, ABN AMRO (2005)

Table 42: Automated clearing houses owned by the central banks in other countries (2005) Country Automated ACHs Cleared Owned Total Clearing Operated by volume/Value By Number of House (ACH) members Types

Lebanon BDL Clearing Bank of 2.4 million Bank of 52 banks Houses Lebanon transactions Lebanon (BDL) worth $189.6 billion in 2001 Mozambique Manual CH Interbank 951,321 Central 5 banks Settlement transactions Bank Service Philippines PhilPaSS Central Bank 455, 749 daily Central 42 with a value of Bank commercial US$1,206 banks; 39 millions daily savings and thrift banks; 8 non-banks with quasi- banking facilities Saudi Arabia National Central Bank Central 11 banks Electronic Bank Interbank Cheque Clearing System Tanzania Dar es Central Bank Saalam Electronic Clearing house

14.4.3 Effect of ownership structure on participation in payment systems

Participation in retail payments system

What becomes clear is that in those countries where the Central Bank owns the payments system infrastructure, the level of direct and indirect participation is higher when compared with those countries where the private sector participants are dominant in the provision of payments systems infrastructure.

Participation in large value payments systems

In Africa, participation in large value payments of the Central Banks is still dominated by the bigger banks. In Uganda, Eleven (11) out of eighteen (18) banks are members of SWIFT and some banks in Uganda use SWIFT for some of their domestic payments. In Tanzania, 12 out of twenty (20) banks are members of SWIFT and some banks in Tanzania use SWIFT for some of their domestic payments, and inter-bank and money market transactions. Small banks find the use of SWIFT expensive considering their business volumes. Small banks in Tanzania have been invited to a shared connectivity, which is cheaper.

Table 43: Number of participants in large value payments system Country System No. of Direct No. of financial Participants Institutions Belgium ELLIPS 16 562 Brazil STR 156 Bulgaria RINGS 40 Canada LVTS 14 49 France TBS 156 1,069 PNS 21 Germany RTGSplus 93 2,463 Italy BIREL 204 1,300 Japan BOJ-Net 371 2,560 Kenya SWIFT 34 43 Mexico Extended electronic 2 largest banks and payment system; RED group of banks 3.5 million transactions or 68,904 billion pesos in 2002 Netherlands TOP 106 464 Sri Lanka SWIFT 9 32 Sweden K-RIX 19 906 E-RIX 13 Switzerland SIC 307 375 United Kingdom CHAPS Sterling 13 386 CHAPS Euro 19 United States FedWire 7,736 8,131 Source Bank of England (2004)

14.5 Cross country comparison of payments system costs and fees

Pricing depends on comparability. For directly comparable products, such as debit or credit card charges, prices tend to be closer than for products that are difficult to compare, including those that are less advertised and for which consumers are not aware of the actual price they pay. The obvious reason is that customers can readily make price comparisons, so banks tend to react strongly to competitive pricing moves by other banks (The Banker, 2005).

What does it Cost to make a payment? Fees and charges imposed on consumers for payment services are one of the most prolific sources of consumer complaints in many developed and developing countries. In 2004, foreign banks were under attack in Mexico for charging high fees. The National Commission for the Protection and Defence of Financial

Services Users in Mexico wrapped up a study of the local banking system in 2004. Although the report includes a broad view of the sector, it takes shots at Banamex, owned by US-based Citigroup, and Bancomer, the Mexican unit of Spain’s Banco Bilbao Vizcaya Argentaria (BBVA), Mexico’s two largest banks. The study maintained that Banamex and Bancomer charged the highest fees of any Mexican bank for services such as credit cards, checking accounts and withdrawals from third-party cash machines. A 15-month study published by CONDUSEF in September 2004 said fees for checking accounts and credit and debit withdrawals are "significantly higher" in Mexico than in other countries. "The leading banks are fixing the level of fees".

Mexican banks obtain about 31% of their income from fees, compared with 36% for counterparts in Brazil under dispute. It is estimated that South African banking fees are the highest in the world, with approximately two percent of an individual’s income going into paying bank charges (Deloitte 2004). If South Africa’s Standard Bank had been included on Fortune’s global list of banks in 2005, it would have the second-highest after-tax profits as a percentage of revenues. It would also be the second-most profitable of any company on the Global 500. Standard Bank’s taxed profits-to-revenue ratio of 28,8% dwarfs that of Fortune’s median of 10.5% for the 56 banks included in the list. Another bank in the country, ABSA derives 67% of non-interest income from transaction costs. Banks in Angola collect most of their profits from service fees, largely from foreign exchange transactions (US Treasury, 2005).

The results of any international comparisons study should be interpreted with care. The price of any particular good or service is determined by a multitude of factors, which include not only the intensity of competition in the market in question but also many other features of the economic and regulatory environment. This is especially true of the banking sector. Market structure, pricing and profitability in a country’s banking markets are all dependent on factors such as the regulatory framework in force, the degree of Government support for small businesses, tax regimes, insolvency laws and attitudes to risk. Thus, a ‘good’ performance in an international comparison does not by itself show that a particular market is competitive. Low observed prices may be a consequence of non-competition factors, such as tax breaks. Moreover, even where price differentials can be traced back to differences in competition, this does not necessarily mean that the market with the lowest prices is perfectly competitive. It may simply be less inefficient than its peers. Similarly, prices may appear comparatively expensive due to lower distortionary subsidies relative to other countries.

The cost of making a payment will vary across different payment instruments due to differences in their production functions, most notably their scale economies and the technology used as well as their scale of operation. Payments services typically account for at least 33% of banking revenues today (CapGemini, ABN AMRO, 2005)

14.5.1 Fees/costs per payments system instruments

The World Retail Banking Report is an annual global pricing benchmark conducted jointly by CapGemini, the European Financial Management & Marketing Association (EFMA) and the ING Group, provides retail data on 19 countries, 15 European states (eight from the eurozone), the US, Canada, China and Australia. The 2005 Report, which covered 130 banks in these countries, concluded that the annual average price of basic banking services was $98, with prices between countries ranging from $31 in the Netherlands, the cheapest, to $172 in Switzerland, the most expensive. This broad 1-5.5 range represents a local pricing model that estimates the average price local customers pay, reflecting their frequencies of use of particular products and services in their particular countries. Specifically, in Europe indirect pricing of payment services through cross-subsidisation is common payment services are offered free or under-priced but, at the same time, they are implicitly charged through low interest on transaction account balances.

The annual average price in Germany and the US was above average at $123 and $117 respectively, while the UK and Belgium were below average at $81.7 and $71.6 respectively.

The CapGemini, ABN AMRO (2005)’s World Retail Banking Report 2005, among others, examined local banking prices in relation to GDP per capita. The report notes that usage and customs vary substantially from one country to another. In mature economies the cost was always below 0.6% of GDP per capita with an average of 0.4%. However, the cost was significantly higher in less developed countries, with China at 3%, Poland at 2% and the Czech Republic and Slovakia at 1%. In those countries banking is still a high-premium service.

The study suggests that there is a clear link between a country’s level of development and the price of day-to-day banking services. These services apparently follow the standard industrial development pattern in which relative prices decline with maturity.

Table 44: Average cost of banking services among 135 retail banks in selected countries Country Banks Surveyed Local Market Average Bank Share Charges ($) (€= $1.256) Australia •CBA, •WBC, •NAB, •St 86% Credit 101.8 George, •ANZ 90% Deposit Austria •BA-CA, •WBC, •Bawag, 74% Credit 123.1 •Sparkassen sector, 66% Deposit •Raiffeisen sector, •Volksbaken sector Belgium •Dexia, •Fortis Bank, 67% Credit 79.2 •ING Bank, •KBC 66% Deposit Canada •BMO, •CIBC, 94% Credit 116.8 •Desjardins, •RBC, 94% Deposit •Scotia, •TD China •ABC, •CMB, •BC, 75% Credit 67.8 •Minisheg, •BOC, • Pudong, 89% Deposit

Country Banks Surveyed Local Market Average Bank Share Charges ($) (€= $1.256) •CCB, •Shenzen, •ICB Czech Republic •Csob, •CS, •KB 73% Credit 104.3 57% Deposit France •Banque Populaires, •BNP 91% Credit 124.4 Paribas, •Bred, •Caisses 69% Deposit d’Epargne, •CCF HSBC, •CIC, •Credit Agricole, •Credit Lyonnais, •Credit Mutuel, •Societe Generale, •La Poste Germany •Deutsche Bank, •Commerz 89% Credit 280.1 Bank, •HVB, •Postbank, 89% Deposit •Dresdner Bank, •Savings Bank Sector, •Mutual Bank, Sector Ireland •Bank of Ireland, •AIB Bank, 86% Credit 74.1 •Permanent Tsb, •Ulster Bank, NA% Deposit •National Irish Bank Italy •Unicredit, •Banca Intensa, 66% Credit 316.6 •San Paolo IMI, •MPS, 51% Deposit •BNL, •Banca di Roma Netherlands •ABN AMRO, •ING bank, 85% Credit 42.7 •Post bank, •Ratbobank, NA% Deposit •SNS Bank, •Fortis Bank Norway •DnB NOR, •Nordea, 69% Credit 164.6 •Sparbank 1 Alliansen, 63% Deposit •Fokus Poland •PKO BP, •Kredyt, 96% Credit 126.9 •PEKAO Bank, 89% Deposit •BPH, •BZ WBK, •Citi Bank, •BGZ, •BRE, • Millenium, •ING, •Reiffeisen Portugal •CGD, •BCP, •BES, 70% Credit 124.4 •Totta, •BPI 71% Deposit Slovakia •HVB Bank Slovakia, 83% Credit 131.9 •Slovenska, Sporitel’na, 79% Deposit •Tatra Banka, •Unibanka, •Vseobecna Uverova banka, •Ceskoslovenska Obchedna Banka Spain •BBVA, •IberCaja, 54% Credit 135.7 •SCH, •Unicaja, 54% Deposit •La Caixa, •Cajamadrid, •Banesto, •Banco Popu, •Caixa Catalo, •Bsanco Saba, •Bancaja, •CAM, •Bankinter Sweden •Svenska Handelsbanken, 89% Credit 100.5 •Swedbank, •Nordea, •SEB, 90% Deposit •Danske Bank, •Skandiabanken Switzerland •UBS, •CS, •Raiffeisen, 100% Credit 199.8 •Postfinance, 100% Deposit •Kantonalbanken sector •Regionalbanken sector UK •HSBC, •RBOS, •Barclays, 87% Credit 80.4 •HBOS, •Lloyds, TSB 87% Deposit USA •ABN AMRO, •Bank of 51% Credit 158.3 America, •FleetBoston, NA% Deposit •Bank One, •Citi Group, •HSBC, •JP Morgan Chase, •Sun Trust, •US Bancorp, •Wachovia, •Wells Fargo, •Washington Mutual Global Average = $135.7 Source: CapGemini, 2005

In Canada and the US, banks charged for more products and services in 2005, even though their average price went down by 1% and 6% respectively. In both countries, a few banks started charging for debit cards. Some US banks eliminated account management fees and online banking charges and some began charging for standing orders and cash deposits at the teller’s window.

Banks in El Salvador are reluctant to levy explicit charges for customers for transaction services. Rather, the banks rely on spreads on balances to generate the bulk of their income. Banking charges in Nigeria are relatively low. At the extreme end, banking charges in Kenya are exceptionally high, that few Kenyans have bank accounts and those that do use them less. Monthly charges for bank account holders are estimated to be around 32% of the monthly salary of the average blue collar worker. A stop-order service or monthly direct debit from one account to another to pay regular bills - is so expensive in Kenya (about $30 a transaction) that it is hardly ever used (French, 2005). World Retail Banking Report 2005 finds that banks in some less developed countries were leap-frogging more developed countries that have large branch networks. The research found that retail banking services in China were low-profit activities, and banks there were trying to convince their clients to use self- service channels from the start.

14.5.2 Retail payments instruments

The cost of ATM machines

Table 45: The cost of ATMs Key Small-Footprint Multifunction Cash Full-Featured ATMs Characteristics Cash Dispensing Dispensing ATMs Appliances

Price Range $3000 to $15 000 $12 to $20 000 $20000 to more than $40 000 General Description Kiosk-like PC-like PC-like Cash Dispensing Yes Yes Yes Capability Check Deposit No No Yes Capability Enterprise Integration No Yes Yes Capability Expansion No Limited Yes Typical Hardware x86 or non-x86 chipset; x86 Chipset; minimum x86 chipset; Specifications and less than 233 MHz 233 MHz processor, minimum 233 MHz Operating System processor, minimum 64 MB to 128 processor, minimum Requirements less than 64 MB of RAM MB of RAM 128 MB of RAM Windows OS CE.NET, XP Embedded, or XP Embedded or XP XP Embedded or XP (Recommended) XP Professional Professional Professional

Sources: Microsoft white paper (2003, a, b)

Automated teller machine charges and fees Banks have regarded ATMs as a way to lower their costs, as customers substitute ATM transactions for costly live teller use. To induce customers to use

ATMs instead of live tellers, some financial institutions impose fees for teller use or reduce monthly charges to depositors who use only ATMs. It costs between $15,000 and up $50,000 to deploy a single machine. As such, ATMs generate huge costs, so banks in many countries are unwilling to provide free ATM services to non-customers. To pay for ATM service, some banks in some countries typically charge a fee to help defray the cost of belonging to the network. ATM fees are prices charged for a service—typically a cash withdrawal. The more machines a bank has, the more convenient it is for cardholders to withdraw cash.

However, the cost of operating ATMs has turned out to be higher than had been originally anticipated. It costs between $12,000 and $15,000 per year to maintain and operate a single ATM machine. Humphrey (1994) found that substituting ATMs for traditional bank branches actually raises a bank’s average cost. Although he also found that ATM use marginally raises banks’ profits, the net benefits appear to be very small.

Prior to the 1990s owners of ATMs in the USA typically did not charge other banks' customers for the use of ATMs; indeed, such surcharges were expressly forbidden by most networks. But, in the early 1990s, local banks and other ATM owners, who could not cover the cost of maintaining ATMs that face a high demand for cash withdrawals from non-local banks, pushed for lifting the voluntary ban on surcharges. As a result, legislatures in 23 states passed laws that allowed individual members of ATM networks to impose surcharges. ATM networks have allowed banks to charge non-customers for withdrawing money from their ATMs since 1996.

There are in general no customer charges in the European Union for making cash withdrawals at ATMs, provided a debit card is used for the transaction and the ATM belongs to the cardholder’s bank (“on-us” transactions). Italian banks do not charge their customers to withdraw cash from their own ATMs (or from those belonging to institutions of the same banking group). The practice of not charging fees for payment services and transactions related to customers’ own accounts has been quite widespread in most industrialized countries (Tarkka 1995, chapter 1, Humphrey et al 1996a and 1996b), although there is evidence that in some countries direct pricing of payment services has become more important of late, especially in the Nordic countries (Humphrey et al 1998).

According to European Central Bank (1999), the practice of direct pricing of payment and other associated account services was still not very common in the other EU countries in the late 1990s. The kr. 0.50 fee (US$0.08) charged to Dankot consumers in Denmark was abolished on 1 March 2005.

In six out of the 12 eurozone countries, “not-on-us” fees levied on customers when using another bank’s or network’s ATMs have either been introduced for the first time or increased since 2001. This is the case in Belgium, Finland, France, Italy, Luxembourg and Spain.

Nearly 22,000 of the UK's 54,000 ATMs levy a cash withdrawal fee and increasing numbers are being put in newsagents and convenience stores. In 2004 the private companies who install and operate these charging ATMs made $244 million (£140m) in withdrawal fees. The spread of fee-charging ATMs has been rapid. Last year alone the number of machines rose 16%. At the same time, the number of free-to-use ATMs has remained static. This is partly due to some banks selling off their non-branch-based ATM sites to fee-charging providers (BBC, 205).

Since 2003, the Irish Government has applied an annual $12 (€10) stamp duty on each single-function debit card or ATM card, a duty of $24 (€20) on a dual- function ATM and debit card (where both applications are used) and a duty of $48 (€40) on a credit or charge card. In Italy, customers are charged a fee ranging from $2.1 (€1.75) to $2.63 (€2.20) per “not-on-us” cash withdrawals transaction, with an average of just under $2.4 (€2.0).

There are charges for ATM cash withdrawals at Irish ATMs. Regardless of where the transaction takes place, only the cardholder’s bank applies charges. Under certain conditions, ATM transactions are free, such as keeping more than $599 (€500) in the account, or if drawn on special accounts which have their own charges. Cash withdrawals (cash advances) at ATMs using credit cards currently incur a fee of 1.5% of the amount withdrawn, with a minimum of between $2.3 (€1.90) and $3 (€2.54).

Table 46: ATM charges and fees (2005) Country Application Annual Utility Bill Own ATM Other ATM Comments fee Fees Payment Transaction Transaction Fixed via ATM Costs Costs

Australia US$1.18 US$0.44 US$1.08 Account servicing US$43.7 per annum Austria US$0-48 0 0 0 Bahrain Maximum of US$2.7 per transaction Belgium US$7.2- US$0.0-012 74.2 Brazil $1 for ATM Float income withdrawal was 40% of (2005) banks revenue (4% of GDP) during 1990- 93. It is now eliminated Bulgaria US$0.15 US$0.23 Canada US$0- US$0-1.3 Network access Interact single 30.5 per Or fee = US$0-1.3 network month US$0.4-0.5 system; In average 2001 non- interest Convenience income, fee = at $31.4 billion, US$0.9-2.6 accounted for over 50% of

Country Application Annual Utility Bill Own ATM Other ATM Comments fee Fees Payment Transaction Transaction Fixed via ATM Costs Costs gross Banks’ revenue Denmark US$0- Dankort is a 155.6 non-profit system El Salvador 7.5 colones Rarely passed ($0.8) per to customers interchange Finland US$0- US$0.0 US$0.0 80.2 France US$38.3- US$0-1.2 153.2 Germany US$0-36 US$0-5.1 Greece US$0- US$0-2.98 39.5 India Insurance US$1.13 US$0 (at US$0.23-1.13 US$2.15 for charge is UTI Bank UTI) to card US$2.2 US$0.45- replacement 0.57 Indonesia US$0.32- 0.54 Ireland US$12- US$0.18- 70.7 0.48 Italy US$0- US$0.0-26 37.1 Mexico ATM interchange ($0.70) in 2005 Namibia Free -0.92% US$1-2 Float income of also generated transaction value Netherlands Card issuing bank pays interchange fee New US$0- US$2.55 US$0-0.34 US$0.34 Zealand 10.2 Norway US$0.58 US$0.7 during Float income office hours; not allowed by US$0.81 outside law office hours in 2003 Portugal US$3.74- US$0.0 90 South Flat fee of Flat fee of $0.95 Balance Africa US$0.3 (Capitec) or enquiry $0 (Capitec) or $0.48+interbank (FNB)-$0.27; US$0.33- fee of $0.94- Card 0.48 For $1.1 for first replacement first $16.4 + $16.4 + fee is $4.9; $0.15/$16.4 $0.15/$16.4 ATM cash thereafter thereafter deposit fee $0.66-1.76 Spain US$12.2- 0 - 3.45% 25.6 Sri Lanka Charge is Minimum $0.98 balance is US$24.5; Sweden $1.4 $19.4- 0 0 (2005) 25.2 Thailand $1.3-25.4 $2.54- $0.5-0.8 From 5th (2005) 30.5 per transaction, transaction $0.08 per transaction United Standard 0 0 $3.1 Standing order Kingdom $52.3 float income is Gold US$35-43.6

Country Application Annual Utility Bill Own ATM Other ATM Comments fee Fees Payment Transaction Transaction Fixed via ATM Costs Costs $165.7 million a year USA 0 $0.75 $5 for card replacement; Fees/Float =$59 billion in 2002

The practice of charging for payment and account transaction services by means of interest forgone by depositors who receive lower-than-market interest rates implies cross-subsidization between deposit and payment services (Vesala, 2000). That is, in this context cross-subsidization refers to one type of banking service subsidizing the production of another type. Banks typically face strong customer resistance toward any direct service charges, which thwarts banks from imposing them unilaterally. There are, however, economic reasons why this form of cross-subsidization could remain as a long-run industry-wide phenomenon, even in liberalised banking markets.

The observed persistence of cross-subsidization was not expected by the early analysts, but later on two lines of explanation have emerged. Firstly, in many fiscal systems, deposit interest income is taxable while the benefit of free or under-priced services is not taxed, and direct service charges are not deductible in taxation. If this is the case, banks have incentive to compete via tax free ‘implicit interest’ in the form of free or under-priced payment services instead of taxable explicit interest accompanied by direct service charges (Walsh 1983 and Tarkka 1995, sec. 5.2). Second, an optimal ‘two-part tariff’ pricing strategy in imperfectly competitive banking markets with lump-sum fees and zero per transaction costs, where the tariff is used as a device for price discrimination, entails cross-subsidization (Mitchell 1988, Tarkka 1995, sec. 5.3). Hence, to the extent that cross-subsidization is a symptom of imperfect competition and imperfect substitutability of banks’ services, intensifying price competition and emerging ‘outside’ competition have the effect of reducing the scope for cross- subsidization. For example, banks started to implement some service charges in Finland in 1988 when effective competition in certain deposit rates was anticipated.

In many countries it is usual to have a fixed price for account management, for example a fixed price per month combined with a number of free services. If direct prices and fixed charges do not cover costs, the remainder is covered by cross-subsidisation, either from float income, from banks’ interest rate margin or from other business areas in the bank. Float income is still usual in many countries, but provisions in Norwegian legislation have eliminated the possibility of such cross subsidization. Where low interest rates prevail, these also reduce banks’ possibilities for using the interest rate margin to finance the production of payment system services. Also where competition in the banking market is strong and banks’ interest rate margins may declined substantially, such that banks’ possibilities for covering costs in the payment system from other sources are may become limited. Over time, banks have managed to cover more of the

costs by increasing prices for payment services and subsidisation with income from other activities may reduce. Banks in Eastern Europe, those in Estonia, Hungary, Russia, seem to rely heavily on fee-based operations. This is also the case in some Latin American countries such as Argentina, Brazil, Columbia and Peru and in some African countries such as Nigeria and Zambia (Demirgüç-Kunt and Huizinga, 1999). The focus of banking income and activity in Europe and Canada is gradually moving away from interest income to other sources of revenue as banks seek to become providers of a wide range of financial services. The borders between banking, insurance, securities and other financial services are blurring and may soon disappear completely. The share of fees and commissions in total income is increasing, reflecting banks’ growing market share in the mutual fund and life insurance businesses and also the trend towards the fuller pricing of payment services, previously under priced or even provided free of charge for tax reasons (ILO, 2001; Canadian Bankers Association). However, there is still insufficient data on the proportion of fee income that is generated exclusively through payment service activity.

The cost of payment by cheque

The costs to banks in India for a cheque transaction is US$0.29-0.38, US$0.67- 1.13 for a physical (branch) transaction, and just US$0.04 – 0.11 for a debit transaction (Nelson, 2004).

Table 47: International comparison of personal cheque processing fees and charges Country Counter Chequebook Cheque Returned Cashier/ATM withdrawal fees transaction /dishonoured Cheque cost cheque fee

Australia US$1.9 US$1.00 US$7.4 US$29.7 (2003) A$ Or free special clearance Brazil Opening Average current account US$12.04, average Max US$92.6 US$6.5, maximum US$13.9 Canada US$0.65 China Manual 5% face value Automated ($0.07) or not less than ($0.14) $120.8) in 2000 El Salvador Penalty fee of 25 colones or $3 for insufficient funds Accounts closed for habitual offenders India Rs50 ($1.14) Indonesia US$0.22-0.43 Namibia 0.2-0.9% US$0.25- US$0 – 6.5 US$2.8-6.2 cheque value; 0.49 ; (Funds minimum value Maximum available); between US$3.27-7.9 Penalty fee US$0.82-2.1 US$18.8-37.6

Country Counter Chequebook Cheque Returned Cashier/ATM withdrawal fees transaction /dishonoured Cheque cost cheque fee for insufficient funds New US$0-0.27 US$20.5 US$3.4 Zealand South 10 free Special US$6.54-19.62 Africa transactions, clearance minimum $7.35-9.3 balance US$982; or $2.6-2.8 + $0.15 per $16.35 to a maximum of $8.17 Sri Lanka Sweden US$1.44 US$3.2 US$2.59 (2002) Thailand US$0.13 – Minimum of US$0.26-0.38 (2005) 0.15 US$5.1 or 0.3% per cheque cheque value USA $5 Varies by type $10 $1 $5 of book and number of pages

Cheque costs are mostly subsidised in developing African countries such as Tanzania. This makes cheques more popular to business enterprises - particularly paying companies (due to big floats) but not to payees (risk of bounced cheques).

Debit and credit card fees in Europe in February 2003

Table 48: Fees for debit and credit card operations (February 2003) Country Credit Card Fee Debit card fee Austria 2.5% 1% + 0.14 ct Denmark 0.75% 2.5 – 5.75% Finland 0.9 - 1.25% 0.05 ct France 0.55 - 2% 0.55 – 1% Germany 1.5 - 3.8% 0.1 – 1% Greece 2 - 7% 2 – 7% Ireland 2 – 7% 2 – 7% Netherlands 27 ct 2 – 5% Portugal 3 – 5% 3 – 5% Spain 0.52 – 5.77% 0.52 – 5.77% UK 1.2 – 2.5% 6 – 50 p * Debit card transactions are often split in a percentage + flat rates figure in eurocents

Large value payment system fees

Table 49: Fees for large value payments in selected countries Country 2003/4 Remarks Operation/adminis Remarks tration Albania Automated Bank of Albania Participants must keep Electronic enough funds to cover Clearing House transactions. Brazil 156 STR Brazil Central Bank US$0.29 for transfers sent

Country 2003/4 Remarks Operation/adminis Remarks tration participants and received; Early transfers (before 08:00) are charged at US$0.14 on either party; offline participants incur costly surcharge Italy BI-REL Bank of Italy Annual Fee of US$1,794 and per transaction fee of US$0.6 for domestic payments and US$14.4 for paper instructions in 2001; Late settlement fees US$598; Late settlement of multilateral balance in LDT procedure is < US$29,912 Kenya 48 banks 11 banks Central Bank 27 banks participate in participate via SWIFT Fin-x-Bureau, RSA, 32 Banks via Kenya Exchange Service Bureau Latvia 21 banks SWIFT Central Bank Intra-day credit is free of charge. Transaction fee of US$0.43 is levied. A higher fee of US$1.08 is levied for rejected cheques Lithuania 9 commercial LITAS Central Bank Ordinary Payment fee = banks; 2 US$0.1; Urgent payment branches of fee = US$1.1 in 2005 foreign banks; 10 other financial institutions Malaysia Real Time 52 participants Bank Negara Annual membership fee = Transfer of in 2002 Malaysia US$1,342; Per transaction Funds and fee = US$0.67 Securities (RENTAS) Peru Central bank Philippines Central Bank Transaction fee of US$1.94 Romania ReGIS Central Bank Membership fee from August 2005 = zero; US$5.06 per transaction Serbia Real Time RTGS Bank of Serbia Monthly subscription of Gross US$684; Fees per Settlement transaction are time dependent on NBS system; 8:00-14:00 =US$0.34; 14:00-16:30 = US$0.82; 16:30-17:30 = US$1.64 Serbia SWIFT Bank of Serbia Fees per transaction are time dependent on NBS system; 8:00-14:00 = US$0.48; 14:00-16:30 = US$0.96; 16:30-17:30 = US$1.8 Tanzania In 2002; Annual subscription fee 5 direct applicable; US$1.26-4.2 per participants; 5 processing; Rejected indirect settlement on RG line is participants US$84.3; Rejected queque transaction at EOD penalty fee of US$84.3; Batch Rejection fee to the participant is US$421.5 Turkey Owned and operated

Country 2003/4 Remarks Operation/adminis Remarks tration by the Central Bank Slovakia Slovak National Bank of One time fee and monthly Interbank Slovakia fee exit. In addition, per Payments input transaction fee of System (SIPS) US$0.01; standard and (2004) priority fees range from US$0.04 to US$0.2 South Africa 39 participants SAMOS is owned and One time fee of US$812; operated by the A higher fee of US$3,248 is Central Bank levied for batch failure Sri Lanka $570 million LankaSettle All inclusive flat fee of worth of US$2.49 per settlement transactions per day United States Fedwire Federal Reserve $0.10 per transaction in Banks 2003

14.5.3 Access pricing of retail payment system ATM clearing houses

Where payment system development is still at its infancy, the Central Bank may assume the cost of running the payment infrastructure. The Kenyan Central Bank assumes the cost of running the Nairobi Clearing House, though the cost of the acquisition of new technology and computers is shared equally among members of the Bankers Association, including the Central Bank.

The system in most countries determines its pricing policy according to the full cost recovery principle. Participation fees might be lower in some cases for banks, which are shareholders in the payment institution. For example in Bulgaria, participation fees for Bankservice shareholders are lower in comparison with fees paid by non-shareholders.

The entry fee is BGN 130 (US$73.5) for shareholders and for non-shareholders: BGN 202 (US$123.8) for every branch. There is also a minimum monthly fee of BGN 50 (US$30.6) for shareholders and BGN 74 (US$45.3) for non- shareholders, for every branch. For payments between customers of different banks the transfer fee is BGN 0.25 (US$ 0.15) for shareholders, and BGN 0.37 (US$0.23) for non-shareholders. For membership of Visa cards in Sweden, there is a one-off cost of 600,000 SEK (US$77,559) to join this association and variable costs are divided according to size. CEK AB is a Swedish firm clearing payment transactions on the market. New entrants pay a one-off connection fee of 50,000-100,000 SEK (US$6,463-US$12,926) and a volume based discount system is used for transaction fees. Larger banks have about 10% lower costs for each transaction than smaller banks.

In Denmark, annual subscription is payable by the retail enterprises for participation in the Dankort A/S system, and is determined on the basis of size. Small retailers with less than 5,000 transactions a year pay approximately US$80.2 (kr. 500) per year. Medium-sized retailers pay approximately US$433.1 (kr. 2,700) and large retailers with more than 20,000 annual transactions pay

approximately US$1,604 (kr. 10,000) a year. The final terms of the subscription had not yet been finalized as of mid-2005.

Table 50: ATM payment system participation fees Country ATM Operator Fees Bulgaria BankService Entry fee is US$79.6 for BankService shareholders or US$123.8 for non- shareholders; Minimum monthly fee of US$31.1 for shareholders and US$60.5 for non-shareholders

Denmark The Dankort system Banks pay a licence fee + variable transaction charges South Africa BankServ Entry fee R550,000 or US$90,164 Sweden Visa Card Entry fee of US$77,559 + variable transaction charges Sweden CEK AB Entry fee of US$6,463-12,926 + variable transaction charges UK BACS Charges imposed per transaction Trinidad and Tobago Infolink Services Ltd.

Table 51: Automated clearing house charges in selected countries Country Name ownership Operation/admini Expenses stration Israel Banks Clearing 5 major banks Banking Clearing House Centre Ltd Kenya Wholesale Kenya Bankers KBA Shared by KBA members Retail Association Latvia Bank of Latvia Bank of Latvia Malaysia SPICK Bank Negara Bank Negara 1. US$0.01 per cheque for Malaysia Malaysia inward clearing 2. US0.27 per unpaid cheque; 3. US$0.01 per cheque image on CD Netherlands Retail transfers Interpay Nigeria Nigeria Central Bank of Central Bank of Once off Entry Fee: Automated Nigeria Nigeria For Direct Participants Clearing House US$39,000 and purchase US$7.8 million CBN Treasury Bills clearing collateral; Indirect Participants (US$1.9m) and US$1.9m CBN Treasury Bills clearing collateral Peru Central Bank of Peru US$2,040 (in 1999) is charged per participant Philippines Central Bank Annual Lumpsum Payment of US$387.5 million (20b pesos) for intra-day liquidity facility; Serbia Small value Bank of Serbia Bank of Serbia Clearing payments are payments effected in the net clearance settlement process in three clearing cycles on each business day (at 11:00 a.m.(Fee US$0.04), 1:30 p.m (Fee US$0.05 Dinars). and 4:15 p.m (Fee US$0.06). Sri Lanka CBSL owns and Flat fee of $2.49 per manages Lanka settlement in 2003. No

Country Name ownership Operation/admini Expenses stration Settle charges for cancelled or rejected messages Sri Lanka Lanka Clear Lanka Clear Charges in 2003. manages ACH Item procesing ($0.02), Fine Sorting ($0.003), invalid items ($1), Present rejected item ($0.02), Drawn rejected item ($0.05), late submission($0.05), monthly diskette charges ($55.8), monthly inward data transfer ($39.2) etc. Switzerland Operated by Swiss Interbank Clearing Agency on behalf of National Bank Tanzania Manual Clearing Member Banks Fees negotiated between Houses direct and indirect participants; There are no entry fees or per transaction fees; All costs are subsidized by the Central Bank. United Kingdom BACS Banks A flat fee of US$87,100p.a. Automated + transaction fee; Ranges Clearing System from US$92,327 – US$876,233 in 2004; Max contribution by member is 22.5% of total; Souce: Thorsten Beck, Asli Demirguc-Kunt and Maria Soledad Martinez Peria (2005) NigeriaBusinessInfo.com (2002)

14.6 Lessons learned from international comparison of payments systems ownership and costs

• In Europe and Canada, and some parts of Africa, there is a trend towards private deployment of ATMs in convenient locations. ATM services are hence attracting charges in these countries • Evidence is mixed regarding ownership of clearing houses infrastructure • Where payments system infrastructure is owned by the government, the level of direct and indirect participation in the system is higher than when infrastructure is privately owned • Access fees for retail payments differ for direct and indirect participants. They tend to be higher for indirect participants • Payments system charges in South Africa are considerably higher than those imposed elsewhere for similar payments instruments.

14.7 Role of regulators/authorities in payments systems

In network industries, firms having economies of scale in production and facing consumption externalities can obtain substantial market power in the absence of regulation. In essence, the aim of regulation is to provide ‘a fair framework’ (‘or a level playing field’ as commonly used in the context of payment system

competition) under which both safety and efficiency are safeguarded, and innovation incentives to develop new products and services are not hindered.

• Ownership of payments systems infrastructure The ownership structure can play an important role in the access to the system especially if some sort of exclusivity rights are used. Therefore, the authorities have a role in carefully examining the ownership question in order to provide ‘a level playing field’ to all market players.

• Safety and efficient functioning of the payments system Authorities have a role in ensuring that the activities of direct and indirect participants do not endanger the smooth working of the payments system. Where a system of totally open access to a payment system is adopted, authorities need to ensure that all participants fulfil their obligations as required so as not to endanger the smooth working of the system. In fulfilling their statutory role in payment system oversight, central banks are obliged to take all the necessary actions to limit the contagion effects of systemic risk inherent in all payment systems, including retail payment systems.

• Promotion of direct (cost-based) pricing of retail payments in Norway In countries such as Norway, the authorities have assumed a more active oversight role of the payments system. For example in Norway, changes to traditional charging conventions in the pricing of retail payment services have been promoted by authorities. Instead of applying the principle of indirect pricing backed by cross-subsidies, direct (cost-based) pricing to guide customers towards using the most efficient payment methods has been strongly promoted.

• Regulation of payments system access charges In Ireland and Kenya, authorities control bank fees and charges under statute (Competition Authority of Ireland, 2004). The Kenyan Central Bank publishes bank charges and fees with a view to enhancing competition in the provision of products and services and to empowering bank customers to make informed choices (Mullei, 2005). In the United Kingdom, in order to ensure that banks provide standardized marketing information on Basic Bank Accounts, the Treasury was to introduce a Charges, Access and Terms (CAT) standard, which refers to the standard for fair Charges, easy Access and decent Terms, by the end of 2001. This standard may help consumers to choose products on an informed basis that best suit their needs and thereby improve access to banking services by all groups in the community.

Access pricing is commonly adopted to regulate bottleneck-type industries. Too low access prices combined with completely open access to a payment system may adversely affect the security and stability of the system if the participants cannot fulfil their obligations in a timely fashion. Depending on the system design, this could lead to the contagion of systemic risk jeopardising the functioning of the whole market.

Fair and open access to systems by other potential participants is a prerequisite for that EU regulatory tolerance of payments system cooperation among participants. The principal problem for the relevant authorities is related to the question of how to define ‘fair and open’ access. In this vein, the natural first step is to define carefully the relevant markets where contestability is to be ensured.

• Permission of network cooperation to facilitate investment in infrastructure One of the most important issues in the economics of regulation is how to encourage firms to innovate and invest in infrastructure. Mason and Valletti (2001), suggest that there is a trade-off between optimal access regulation in static and dynamic framework. If static regulation reduces the use of monopoly power over the infrastructure, then it also reduces profits that can be earned by the investor/owner of the facility. Accordingly, access regulation based on simple cost-recovery rules can discourage investments and even lead to underinvestment. In retail payment systems, a certain degree of cooperation among service providers needs to exist (and, in principle, needs to be tolerated by the regulatory authorities) in order to achieve viable and efficient payment systems. By network cooperation or cooperation among payment service providers, it is possible to avoid overlapping investments and unnecessary and inefficient duplication of networks, as well as extend services to a larger population.

The regulatory/competition authorities can foster the competitive environment and investment incentives in the field by tolerant regulatory measures (e.g. allow for competing ‘payment clubs’). Where innovation in payments system is market-driven, the regulators need to tolerate the formation of the joint ventures and shared networks, but, at the same time, they need to ensure by different antitrust measures (access to systems, pricing etc) that a level playing field prevails and markets remain contestable.

Vesala (2000) explains that the European competition law allows banks to engage in cooperation in payment networks provided that the cooperation has no adverse impact on price competition. He summarises the basic elements of the competition policy guidelines as follows. Firstly, a clear distinction between interbank and bank-client relations; cooperation in the former is tolerated provided there is no adverse impact on competition in bank-customer relations. Secondly, the Commission has clearly stated that attempts to block entry to shared payment systems, and hence protect participants from outside competition, would be regarded as violations of the antitrust rules of the EU. Finally, EU competition provisions would be breached if the system were open in principle but entry conditions were discriminatory, i.e. if the levied entry charge and unit compensation for the services provided by the ‘host network’ exceeded the true economic cost of operating the network (including interest on initial investment, depreciation and goodwill).

• Regulation when there is infrastructure competition Mason and Valletti (2001) discuss the regulator’s dilemma as follows: the regulator may want to promote particular entry modes, where the typical dilemma is between (1) facility-based and (2) service-based competition. Facility-based competition may involve unnecessary duplication of infrastructure.

• Authority-driven involvement in the payments system The authorities can also ‘act as a catalyst or facilitator’ for development (e.g. participation by authorities in developing and enforcing payment standards).

The Central Bank of China introduced the “Golden Cards Project,” in 1993 with a view preparing the country's infrastructure for a national electronic payments system that would move payments in China from cash to chip (“Smart”) cards. To build this infrastructure, they established a national switching system, with sixteen regional centres, to combine the several incompatible card payments systems already established by Chinese banks. Otherwise prior to establishment of the switching system, payment cards were difficult to use due to incompatibility among the systems used by Chinese banks (Rosenberg, 2005).

• Authorities can resort to specific regulations As a stronger measure, authorities can resort to a specific regulation (like the EU Regulation on the cross-border payments in euro that obliges the service providers to act in a certain way, or prohibition of the ‘float’ in payment transfers as in Norway).

• Authorities can become operationally active in the payments system Finally, as the ultimate measure, the authorities can also become ‘operationally active’ by establishing their own systems to provide payment services. This could happen when the authorities judge that reliable and efficient payment systems are not provided by the market players. In this context, the universal service obligation principle as well as public good character of payment services are used as supportive arguments for the operational involvement.

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