THE CHANGING RETAIL PAYMENTS LANDSCAPE: WHAT ROLE FOR CENTRAL BANKS? An International Payments Policy Conference Sponsored by the Federal Reserve Bank of Kansas City Kansas City, Mo. November 9-10, 2009 Copyright © 2010 by the Federal Reserve Bank of Kansas City. ISBN # 978-0-9744809-3-0 Contents Foreword vii THOMAS M. HOENIG, President and Chief Executive Officer, Federal Reserve Bank of Kansas City Contributors ix Conference Summary xvii BRUCE J. SUMMERS, Former Director, Federal Reserve Information Technology KEYNOTE ADDRESS 1 DAN HESSE, Chief Executive Officer, Sprint Nextel Corporation General Discussion 7 THE CHANGING RETAIL PAYMENTS LANDSCAPE: 11 AN OVERVIEW HARRY LEINONEN, Advisor to the Board, Financial Markets and Statistics, Bank of Finland Commentary: TONY HAYES, Partner, 41 Oliver Wyman Financial Services iii iv Contents General Discussion 51 CONSUMER PAYMENT CHOICE: 61 MEASUREMENT TOPICS MARC RYSMAN, Associate Professor of Economics, Boston University Commentary: KYLIE SMITH, Manager, Payments 83 Policy Department, Reserve Bank of Australia General Discussion 93 EXTERNALITIES IN PAYMENT CARD NETWORKS: 99 THEORY AND EVIDENCE SUJIT CHAKRAVORTI, Senior Economist, Federal Reserve Bank of Chicago Commentary: DENNIS W. CARLTON, Professor, 125 University of Chicago General Discussion 135 IMPLICATIONS OF THE CHANGING PAYMENTS 143 LANDSCAPE FOR COMPETITION AND EFFICIENCY OF RETAIL PAYMENTS SYSTEMS Moderator: WIEBE RUTTENBERG, Head of Market Integration Division, DG Payments and Market Infrastructure, European Central Bank Panelists: MATTHEW BENNETT, Director of Economics, Office of Fair Trading GWENN BÉZARD, Co-Founder and Research Director, Aite Group DICKSON CHU, Vice President of Global Product and Experience, PayPal ADAM LEVITIN, Professor, Georgetown University Law Center Contents v General Discussion 161 IMPLICATIONS OF THE CHANGING PAYMENTS 167 LANDSCAPE FOR INTEGRITY OF RETAIL PAYMENTS SYSTEMS Moderator: MARK GREENE, Chief Executive Officer, FICO Panelists: CATHERINE A. ALLEN, Chairman and Chief Executive Officer, The Santa Fe Group JAMES VAN DYKE, President, Javelin Strategy and Research DANIEL ECKERT, Senior Vice President, HSBC Card and Retail Services PAOLA MASI, Head of Payments Division, Bank of Italy General Discussion 189 THE ROLE OF CENTRAL BANKS IN RETAIL 199 PAYMENTS: THE CENTRAL BANK AS OPERATOR RICHARD OLIVER, Executive Vice President and Retail Payments Product Manager, Federal Reserve Bank of Atlanta STUART E. WEINER, Vice President and Director of Payments System Research, Federal Reserve Bank of Kansas City Commentary: JOSHUA PEIREZ, Group Executive, 217 Innovative Platforms, Global Products and Solutions, MasterCard Worldwide General Discussion 225 vi Contents CENTRAL BANK OVERSIGHT AND 233 THE CHANGING RETAIL PAYMENTS LANDSCAPE RON J. BERNDSEN, Head of Oversight Department, De Nederlandsche Bank BOUKE H. J. BUITENKAMP, Overseer Retail Payments, Oversight Department, De Nederlandsche Bank Commentary: Jonathan Williams, Director of 249 Strategic Development, Experian Payments General Discussion 255 CONFERENCE WRAP-UP 259 BRUCE J. SUMMERS, Former Director, Federal Reserve Information Technology General Discussion 265 Conference Attendees 269 The papers in this publication can be obtained in electronic form from the Federal Reserve Bank of Kansas City’s website: http://www.KansasCityFed.org. Foreword Retail payment systems around the world have entered a period of dramatic change. The shift from paper to electronics, the emergence of new instruments and payments channels, the rise in nonbank participation, the change in risk profiles— all are elements of this new landscape. What role should central banks play in this new environment? The shift toward electronic payments has been striking. In the United States, for example, a recent Federal Reserve study indicates that electronic payments are now more than two-thirds of all noncash payments. Accompanying—and in large part driving—these developments have been dramatic technological advances in computing power and telecommunications that have created economies of scale. Technology has also led to a growing complexity and interrelatedness in technical and business relationships, increasing vulnerability to “single points of failure.” Risk profiles accordingly have shifted, with new sources of systemic risk, opera- tional risk, and fraud risk emerging. In addition, industry structures in retail pay- ments are also evolving. One example is the increased concentration of credit, debit, and ATM markets. Another is the increased prominence of nonbanks in the payments system. Central banks traditionally serve three roles in retail payment systems: opera- tor, facilitator, and overseer. The level and type of involvement in these three roles varies widely across central banks, reflecting different histories, institutional struc- tures, and legislative authorities. Almost all central banks play at least a minimal operational role by providing settlement services, and a majority also act in some capacity as facilitator or catalyst. A number of central banks also have explicit oversight responsibilities. Recognizing the significant changes under way in the payments industry, central banks around the world have been reevaluating their roles in their respective payment systems, and many have recently adopted or are considering new policies. vii viii Foreword To explore the changing retail payments landscape and to assess implications for central bank payments policies, the Federal Reserve Bank of Kansas City spon- sored an international payments conference titled, “The Changing Retail Payments Landscape: What Role for Central Banks?” on November 9 and 10, 2009. The conference brought together a distinguished group of industry executives, central bankers, and academics for an exchange of views and ideas. The first day of the conference presented an overview of the evolving retail payments landscape and examined the underlying economic forces driving change. How are various coun- tries’ payments systems evolving over time? In what ways do consumer preferences affect industry outcomes? How do payments markets differ from other markets? The second day of the conference explored policy implications, with a focus on ef- ficiency, integrity, and the role of central banks. Are payments markets sufficiently competitive and safe? If not, what private and public policies would be beneficial? What role should central banks play in the retail payments system of the future? Though questions remain, we believe the conference contributed significantly to our understanding of retail payments developments and implications. This vol- ume includes all of the presentations and papers from the conference as well as all commentary and general discussion. The exceptional knowledge and insight of participants are evident throughout the volume. We at the Federal Reserve Bank of Kansas City sincerely thank them all for their contributions to this very important topic. Thomas M. Hoenig President and Chief Executive Officer Federal Reserve Bank of Kansas City Contributors Catherine A. Allen, Chairman and Chief Executive Officer, The Santa Fe Group Ms. Allen serves as chairman, chief executive officer and founder of The Santa Fe Group, a strategic consulting company serving financial institutions and other crit- ical infrastructure companies focused on risk management, payments evolution, innovation and public policy. She also serves on a number of public and private boards, including the boards of Stewart Title Guaranty Company; Singlepoint, LLC; and Hudson Partners, LLP, and she serves as chair of the Advisory Council for the National Foundation for Credit Counseling. She is the recipient of U.S. Banker magazine’s Marion O. Sandler Lifetime Achievement Award. Matthew Bennett, Director of Economics, Office of Fair Trading Mr. Bennett is director of economics in the Office of Fair Trading (OFT). He is responsible for economic analysis of OFT cases and developing OFT economic policy. He joined the OFT in 2008 from LECG, where he was a principal directing competition cases. Some of the larger cases he worked on during this time include the Aer Lingus/Ryan Air merger and the recent European Union Bananas Informa- tion Exchange case. Prior to that, he worked within the Chief Economists team at the UK communications regulator, Office of Communications. Ron J. Berndsen, Head of Oversight Department, De Nederlandsche Bank Mr. Berndsen is head of the Oversight Department of De Nederlandsche Bank. He is a member of the cooperative oversight committees for Continuous Linked Settlement, Euroclear SA, LCH.Clearnet SA, LCH.Clearnet Group Ltd. and So- ciety for Worldwide Interbank Financial Telecommunication. He is a member of the Eurosystem’s Payment and Settlement Systems Committee and vice chairman of the Dutch Escalation Committee on Payments and Securities. He joined the central bank in 1992 and has held several management positions on the monetary and economic policy side of the Bank. ix x Contributors Gwenn Bézard, Co-Founder and Research Director, Aite Group Mr. Bézard is a co-founder and research director at Aite Group, LLC, managing the firm’s banking and payments practice. His recent coverage has focused on the transformation of the payment industry, emerging products such as prepaid and decoupled debit cards, competition among card networks, the evolution of loyalty marketing, and the optimization of the online banking channel. He has more than a decade of experience in assisting financial