EFFECTIVE AND EFFICIENT PAYMENT SYSTEMS FOR FINANCIAL STABILITY

EFFECTIVE AND EFFICIENT PAYMENT SYSTEMS FOR FINANCIAL STABILITY AND TRANSFORMATIVE DEVELOPMENT IN AFRICA Presented to the: CAUCUS MEETING OF THE AFRICAN CENTRAL BANK GOVERNORS Abuja, Nigeria March 27 th, 2014

Presentation Overview Financial Landscape Overview ü Global and African Impact of Financial Inclusion Initiatives on Payment Systems Kenyan Payment and Settlement Systems Overview ü Structure, Initiatives and Outcomes Payment Systems and Financial Stability The Way Forward 2

Financial Landscape Overview About 1 billion people worldwide are poor and live in countries characterized by four traps; conflicts, civil wars, reliance on natural resources - that stifle other economic activities, and poor governance (Collier 2007). A large proportion of the poor are in Africa, in countries that have experienced at least one of the traps. In Sub-Saharan Africa alone, half of the population live below the poverty measure of less than USD 1. 25 per day. (Ravallion, 2010; 2008; World Bank, 2008). Majority of the poor are unbanked (about 3 billion people in developing countries have little or no access to formal financial services that can help them increase their incomes and improve their lives). In Kenya, about 46% of the population live on less than 1. 25 dollars a day (2006 Kenya Integrated Household and Budget Survey). The poor are mainly characterized by low levels of education, low levels of capital accumulation and poor access to markets – all mutually reinforcing. Strategies to enhance financial inclusion therefore are important for 3

Global Map of Financial Exclusion Percent of total adult population that does not use financial services 0 - 25 Middle East • 136 million adults • 12 -15 million MSMEs ▪ ▪ ▪ 51 - 75 Central Asia & E. Europe • 193 million adults • 5 -7 million MSMEs High-income OECD • 60 million adults • 10 -12 million MSMEs Latin America • 250 million adults • 11 -12 million MSMEs 26 - 50 Sub-Saharan Africa • 326 million adults • 26 -30 million MSMEs 75 - 100 East Asia • 876 million adults • 140 -170 million MSMEs South Asia • 612 million adults • 60 -70 million MSMEs Over half of the world’s population, 2. 5 billion adults, do not use financial services Over 80% in Sub-Saharan Africa are un-served (326 million) Over 90% are in developing economies, in Africa, Asia and Latin America 4 CGAP, 2011 4

Financial Inclusion Initiatives on Payment and Settlement Systems Central banks promote effective and efficient payments and settlement systems. Ø Financial inclusion is a public policy for reducing poverty sustainably. This is demonstrated through accumulation of capital. Ø The Central Bank of Kenya (CBK) plays a proactive role in financial sector development through promotion of innovative delivery channels (agency banking and Mobile-phone Financial Services) and provision of appropriate support infrastructure (real time payments and settlement systems and consumer protection). Ø Financial inclusion initiatives and the evolution of retail and e-mobile payment mechanisms have resulted in increase in the number of participants in the payment systems landscape. Ø § The dominance of banks as the only payment systems providers is being eroded by the provision of innovative payment systems by non-banks. 5

Kenya’s Payment System Overview Ø Section 4 A 1(d) of CBK Act - Promoting efficiency and competition in the payments system and the overall stability of the financial system. Ø Kenya payment system oversight encompasses Real Time Gross Settlement (RTGS) - Kenya Electronic Payments and Settlement System (KEPSS), the Automated Clearing House (ACH), the Payment Cards Industry and the Mobile-phone Financial Services (MFS) platforms. Ø The CBK has a formal regulatory role to ensure that the infrastructure supporting the clearing and settlement of transactions in financial markets is operated in a way that promotes financial stability. ◦ A payment systems modernization process was recently undertaken to enhance safety, efficiency and effectiveness of the payment system as well as promote access and inclusion 6

Kenya’s Payments System Structure LARGE PAYMENT SYSTEMS RETAIL PAYMENT SYSTEMS • Kenya Electronic Payment and Settlement System (KEPSS) • Automated Clearing House (ACH) • ATM Switches (Ken. Switch and Pesapoint) • Securities Payment and Settlement Systems e. g. CDS and CDSC for Government & NSE Securities, respectively • G-Pay: Government Payment System • Cross-border money transfers including EAPS, Western Union, Money. Gram & IRINET • Mobile Payments (Money Transfers, Mobile Banking, etc) • Internet Banking 7

Evolution of Kenya’s Payment System KENYA ELECTRONIC PAYMENTS AND SETTLEMENT SYSTEM (KEPSS) Only large value payment system classified as Systemically Important Payment System (SIPS) in Kenya. Ø An RTGS system that removes settlement lags and implicit overdrafts associated with net settlement systems: § From January to December 2013, KEPSS had an average system availability level of 98. 19 per cent. Ø AUTOMATED CLEARING HOUSE (ACH) The automation and modernization of the ACH has been in place and progressing since 1998. Some of the initiatives that have been undertaken include: § Value Capping on cheque payments. § Introduction of the Cheque Truncation System. Ø This has reduced the cheque clearing cycle from 20 days in 1998 to t+1 by 2013: Ø § During January to December 2013, the ACH system maintained an average availability level of 99. 97 per cent. 8

Ongoing Payment System Initiatives Ø Rolling out and operationalization of the NPS Regulations to implement the NPS Act to provide for: § Delivery of retail transfers and the provision of electronic payment services without compromising the safety and efficiency of the national payment system; and § Minimum standards for consumer protection and risk management to be adhered to by all providers of retail transfers. Ø Continuous revision of system's Business Continuity Plan (BCP) – the CBK’s oversight role requires monitoring, detecting and intervening to ensure solvency of all participants. Ø Implementation of the Money Remittance Regulations, 2013 to facilitate international (Diaspora) money remittances. 9

Ongoing Payment System Initiatives Ø The Bank together with other partner states within the EAC and the COMESA region are in the process of implementing the East African Payments System (EAPS) and the Regional Payments & Settlement System (REPSS). Ø Both systems are aimed at integrating payment systems among regional member states with a view of promoting trade within member countries. § Similar to the European Economic and Monetary Union (EMU) largevalue payment system – TARGET. § The Af. DB has provided a grant to lift other EAC countries to effectively participate in EAPS. ü This grant will be used to purchase the payments infrastructure for countries deficient and bring them at par with the others. 10

Outcomes: 1. Relative Importance of Kenya’s Payment Systems 11

2. Rapid Growth and Development of the Financial System provides Payments and Settlement Touch Points No. of bank branches increased to 1, 313 in September 2013 from 534 in 2005. Gross Deposits increased to Ksh. 1. 98 trillion (USD 23. 07 billion) in December 2013 from Ksh. 498 billion (USD 5. 8 billion) in 2005. • Gross Loans increased to Ksh. . 61 trillion (USD 18. 76 billion) in December 2013 from Ksh. 399 billion (USD 4. 65 billion) in 2005. • • 12

3. Expanding Financial Access Touch Points Source: Country Geospatial Surveys, 2013 1 3 13

4. Increasing Financial Depth. . . 44. 0 Financial Depth in Kenya (%) 43. 0 42. 0 41. 0 M 2/GDP (Percent) 40. 0 39. 0 38. 0 37. 0 36. 0 35. 0 34. 0 33. 0 32. 0 30. 0 q Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 31. 0 Financial depth (proxy: M 2/GDP) has generally been increasing in the region, but remains much higher in Kenya. 14

Payment Systems for Financial Stability Ø Payments and settlement systems play a critical role in financial development. § Efficient processing of monetary policy signals - especially through the influencing of short-term interest rates. Ø As payment systems evolve, we gain a deeper understanding of the system characteristics and the risk they pose to the financial system. § Payments and settlement systems are characterized by high fixed costs and low marginal costs as the number of transactions processed increase. This creates oligopolistic markets with payment systems concentrated amongst a few large-scale providers. Ø A case in point is e-mobile innovations; mobile-phone related innovations have proven to be dynamic and thus have a high potential for growth; but the risks also increase with: § Increasing the value of transfers cleared and settled. § Increasing the complexity of the technological innovations. § The use of third-party payment systems providers. 15

Emerging Risks The main emerging risks in payment and settlement systems are credit risk, liquidity risk, operational risk and systemic risk. Ø Systemic risks are mainly attributed to (Rochet and Tirole, 1996): Ø § Widespread liquidity problems arising from unwinding in a net system or gross system gridlock. § Propagation of failures through interbank lending. § Effect of macroeconomic events having an effect on several banks – e. g. economic recessions, stock market crashes. § Bank runs in relation to negative information emanating from the participants in the payment system. Ø The growing concern for financial regulators on the link between payment systems and financial stability mainly emanate from: § The high volumes being transferred on a daily basis and their tractability. § The large size of the individual payments. § Increased cross-border transactions as a result of financial integration – raises fears that crises in different parts of the region or globally can affect financial stability. 16

Payment Systems and Financial Stability Ø In principle, to effectively facilitate the smooth functioning of payment systems, Central Banks should establish appropriate oversight, as well as appropriate arrangements for liquidity provision – either through intraday and/or overnight facilities: § Due to the inter-linkages of participants, failure by a payment system (especially large-value systems) can have broad financial and economic repercussions and therefore Central Banks have the mandate to supply emergency liquidity when need be. § Operating systems must be reliable even when the markets around them are in turmoil. Ø Policymakers mandate in ensuring financial stability should be commensurate to the critical role a given payment and settlement system plays in the financial system. 17

The Way Forward In ensuring payment systems inclusiveness for stability and transformative development, our mandate as policymakers should entail: - § Ensuring stability while promoting access and inclusion to financial services. § Provide regulations and policies in relation to access and standards to be complied with by participants in payment systems to guarantee the safety, efficiency and effectiveness of the payments system. § Initiating collaborative initiatives to effectively and efficiently monitor and oversee payment systems by carrying out frequent inspections and commissioning independent reports. § To ensure adequate funds management by participants and to provide liquidity when required either through intra-day or overnight facilities. § Cooperation with other regional central banks and working closely with other industry regulators and the respective stakeholders of the payment systems. § Adoption of global oversight and cooperation standards such as the Committee on Payment and Settlement Systems (CPSS)18