Regulating and overseeing nonbank payment service providers Seminar

Regulating and overseeing non-bank payment service providers Seminar on Payment Schemes and Payment Institutions, Brasilia, Brazil, September 9, 2014 Massimo Cirasino Head, Payment Systems Develoment Group The World Bank

Content of the presentation § Public policy objectives in retail payments, remittances, and financial access § Role of non-banks in the provision of payment services § Towards common principles for the regulatory and market approach § Empowering the payment system overseer 2

Considerations around public policy objectives in retail payments / remittances • 1) Affordability and Ease of Access to Payment Services • The “demand” for electronic payments is often restricted by limited inclusion of the country’s population • The typical usage patterns of the financially excluded – erratic, small-value – coupled with limited ability to comply with product requirements (ID, minimum balance, fees) and indirect costs (e. g. , time / distance travelled) may make it financially unviable for banking institutions to service these segments using traditional payment product • 2) Availability of an efficient infrastructure to support development of payment products • Supply / provision of electronic payments is dependent on availability of certain common infrastructure (payment networks, ACHs, etc. ) • Where commercial banks could not make a viable business case to expand the traditional payment infrastructure beyond major urban areas, there have been promising innovations, e. g. mobile phones to initiate / receive payments and non-bank agents • These developments cannot reach their full potential without an appropriate payment infrastructure • 3) Socially Optimal Usage of Payment Instruments • Usage of payment instruments also entails costs, with some payment instruments being better suited for certain payment needs than others • While at a conceptual level the overall public policy objective could be to promote and encourage usage of electronic payment instruments, associated costs and other factors must be taken into consideration 3

The 5 x 5 objective: reducing the average cost of sending remittances globally by 5 percentage points over 5 years - If the cost of sending remittances could be reduced by 5 percentage points relative to the value sent, remittance recipients in developing countries would receive over $16 billion dollars more each year - Adopted by the G 8 at the 2009 L’Aquila meeting and in by the G 20 in 2010 - Global efforts led by the World Bank matched with interventions at the country level are bringing down the cost of remittance services: estimated US$ 42. 48 billion saved - Over ¾ of the 226 corridors evaluated (77%) are below 10%, and almost ¼ of the corridors evaluated (24%) are already below the 5% target - 118 corridors, or 52%, have average total costs that are between 5% and 10% Source: Remittance Prices Worldwide data 4

Transaction Accounts for All – TALL the new objective • Source: IFC-The World Bank Press Release, 11 October 2013 World Bank Group President Jim Yong Kim • “Universal access to financial services is within reach – thanks to new technologies, transformative business models and ambitious reforms” • “As early as 2020, such instruments as e-money accounts, along with debit cards and low-cost regular bank accounts, can significantly increase financial access for those who are now excluded” 5

Classification of non-banks* • Front-End Service Provider • Provides services to Payers or Payees in association with / On Behalf of Payment Service Provider (PSP) • Examples: Agents, Payment Gateways • Back-End Service Provider • Provides services to the PSP • Examples: Operation of IT infrastructure, Customer service Center • Payment and Settlement System Operator • Operates a payment system for participating payment service provider • Examples: Operator of Card Switch, ACH, CSD/SSS, CCP • Independent provision of payment Service • Offers services to payers and payees independently • Examples: Mobile Money, Remittance Service Provider * Not the only way of classifying non-banks. Similar entities could organize themselves differently in different situations. There could be overlaps 6

Role of non-banks in the provision of innovative payment services (2009) ØRole of banks still dominant - but in (contractual) collaboration with other entities: 73% Banks are involved in the operation of the innovative product in terms of being responsible for signing up new customers, setting up account and managing customer service, BUT in only 33% banks are solely responsible 43% of the products surveyed use agents, with highest usage of agents found in low-income countries (75%), EAP (100%) and SSA (71%), and large countries >30 million inhabitants (49%) • Banks and their branches • Non-bank financial institutions (NBFIs) • Retailers (e. g. grocery stores) 9% schemes are operated by explicit joint venture between banks and non-banking entities • Other • 0% • 50% • 100% 7

Trends based on the Global Payment Systems Survey 2012*: Non-banks issuing non-cash payment instruments • In over 1/3 of the countries surveyed, non-banks issue non-cash payment instruments. ** At the global level, the postal network and mobile operators are equally active as NBFIs • Mobile operators are mostly active in low income and lower-middle income countries, typically of large population, located mainly in SSA, and EAP • The postal network has a stronger role in European countries and higher income levels • Credit cooperatives offer non-cash payments in slightly less than 30% of the countries surveyed, followed by MFIs. The first appear to have a stronger role in upper-middle income countries, while the latter have a bigger presence in low-income countries. These are mostly supervised – nevertheless exceptions exist and are more frequent for MFIs • The overall picture is not yet clear: unspecified “other” non-bank financial institutions were found to be equally relevant • Where applicable, unsupervised NBFIs and non-financial institutions rely almost exclusively on a customer relationship with a direct account holder to access RTGS services. Although indirect access is more common, it emerges that supervision often translates in NBFIs being granted direct access (either with or without access to credit) • Direct access of ACH infrastructure is mainly the prerogative of banks*** *Based on preliminary results **Ongoing analysis will establish the extent to which this figure may be underestimated – due to lack of oversight /regulation powers (? ) ***Bank ownership and specific risk control requirements are being considered as the main factors behind this result 8

However, the incumbent continues to hold strong lead… 2) Electronic payment transactions by type of instruments in select CPMI countries, 2012 (millions, total for the year)** 1) Use of payment instruments by non-banks: relative importance of payment instruments, in number of transactions in CPMI countries* (2012) • 25, 000 • 20, 000 • Credit transfers • 17. 4 • Direct debits • 33. 2 • 13. 9 • 15, 000 • E-money transactio ns • 10, 000 • Direct debits • Cheques • E-money payment • 9. 7 • Card payments transactions • Credit card payments • 24. 4 • 5, 000 • Credit transfers • 1. 4 *% of total number of transactions, based on available data. Please note, e-money transactions nav for 7 CPMI countries. Source: CPMI, 2013 • 0 • Brazil • China • India • 3) Global trends for innovative retail payment products (GPSS, 2012)*** • 80% • 62% • 22% • Are growing • Russia • South Africa **Source: CPMI, 2013. Please note, direct debits nav for China. E-money nap for China and South Africa • 39% • 16% • Account for more than • Are growing at a faster • Are being used for • For the majority of 5% of traditional rate than traditional payments - not just for users, the innovative electronic instruments safekeeping of money product is the only electronic instrument they have access to *** Based on 150 countries covered in the GPSS. Preliminary findings 9

Banks vs. non-banks according to RPW (Q 2 2014 trends) MTOs and Post Offices remain well below the Global Average, at 6. 65% and 4. 66%, respectively The current costs of sending remittances through MTO are the lowest since before 2008 (6. 56 percent on average in Q 2 2014, remaining below 7% for two consecutive quarters) At the beginning of 2014, the yearly variation in the cost of sending remittances through Banks showed a considerable decrease of 1. 01 pp. A further decrease of 0. 50 pp was registered in Q 2 2014 10

Remittance transfers by remittance products: mobile still limited, online gaining ground (Q 2 2014 trends) • Cash-to-Cash services continue to be the most popular remittance transfer method, but Account -to-Account services are gaining ground • The average total cost of Cash-to-Cash services is 6. 60% (0. 55 pp decline in the last year) versus 12. 93% for Account-to-Account (1. 96 pp decline in the same period) • Remittance costs for Mobile Services declined to 6. 39% (0. 93 pp decline), however they only represent 1% of remittances services • Online Services are gaining ground (16% of services in the sample compared to 13% in the last iteration) and now cost at 6. 13% on average • Cash to account services are the cheapest product type and are becoming more widely available (9% of the sample) 11

Impact of mobile financial services on financial inclusion in Tanzania (2009 -2013) Case in Point: Tanzania Source: Fin. Scope Tanzania 2013 12

Entry of non-banks: some regulatory considerations • Safety of customer funds – operational reliability issues and bankruptcy of issuer. Even where a bank is the issuer, existing treatment of deposit accounts might not be legally applicable to prepaid account. Measures like trust funds, segregation of funds, requiring basic operational reliability measures etc. can be used to mitigate risk • (Perceived? ) heightened AML/CFT risks. This is addressed effectively through simple measures, e. g. limit transaction size and frequency • Security issues. Weaker authentication could lead to higher fraud risks • Consumer protection. The profile of customers targeted could be first-time users of payment products. Need to ensure they understand the terms and conditions. Ownership and use of customer data may pose privacy concerns • Competitive market conditions. Restrictive, non risk-based access conditions to clearing and settlement infrastructure may result in impeding non-banks’ ability to effectively compete with banks. On the other hand, in the absence of a functional approach to regulation, banks may be constrained with banking regulations while the new set of players have relaxed or no regulatory requirements thus affecting costs and competition • System-wide risk. While systemic risk may not be relevant, major disruptions / operational issues incurred by non-banks can impact the overall retail payments system and affect customers’ trust in electronic payments. Source of reputational risk for central banks and regulators 13

Relevant findings on regulation of payment service providers from the Global Payment Systems Survey 2012* • Regulation and supervision of non-bank payment service providers is the main responsibility of central banks, followed by, or in cooperation with, the banking supervision authorities. An exception is mobile operators whose regulation and supervision involves telecom authorities more heavily – although still second to central banks • Role of anti-trust authorities is relatively stronger in other developed countries (ODC), euro area, and ECA • MTOs and exchange bureaus are subject to AML/CFT regulations in the great majority of the countries (91% and 87% respectively). This figure is slightly lower for other NBFIs (credit unions and microfinance institutions) and for non-financial institutions (postal network and mobile operators) • MTOs must be licensed and/or registered in 2/3 of the countries. The legal and regulatory framework of most countries (68%) requires that supervised NBFIs be subject to specific licensing and/or registration regimes – although if NBFIs are not supervised these regimes do not apply for the most part. In less than half of the jurisdictions mobile operators are required to be licensed and/or registered *Based on preliminary results 14

A holist approach to retail payment development • Retail payment systems need a holistic reform approach – synthetized in the WB “retail package”: Ø Developing a comprehensive national retail payments strategy Ø A practical guide to retail payments stocktaking Ø From remittances to m-payments: understanding ‘alternative’ means of payment within the common framework of retail payments system regulation Ø World Bank Survey on Innovative Payment Products • • Cost does matter. Knowledge of cost structure can result in offering appropriate incentives to pave the way for epayments Ø World Bank is developing a methodological framework to measure and compare costs of retail payments and quantify benefits deriving from migration to electronic payments Ø Main features are: ü Comprehensiveness (all retail payment instruments, cost elements) ü Comparability across countries and over time ü Standardization of terms ü Broad applicability (developed and developing economies) In May 2012, the CPMI published a report on Innovations in Retail Payments. An analytical study on the involvement of non-banks in retail payment systems – including implications for central banks – has been conducted by the Working Group on Non-Banks in Retail Payments and will be published shortly 15

CPSS-WB General Principles for International Remittances Services • GP 1: The market for remittances should be transparent and have adequate consumer protection • GP 2: Improvements to payment system infrastructure that have the potential to increase the efficiency of remittance services should be encouraged • GP 3: Remittance services should be supported by a sound, predictable, nondiscriminatory and proportionate legal and regulatory framework • GP 4: Competitive market conditions, including appropriate access to domestic payments infrastructures, should be fostered in the remittance service industry • GP 5: Remittance services should be supported by appropriate governance and risk management practices Remittance Service Providers Public Authorities Should participate actively in the application of the general principles Should evaluate what action to take to achieve the public policy objectives through implementation of the general principles 16

Payment Aspects of Financial Inclusion (PAFI) Task Force • CPMI and WB established in Nov. 2013 the PAFI Task Force. Members are CPMI central banks, non. CPMI central banks active in the area of financial inclusion, the IMF, and international development banks • PAFI’s work will be comprehensive addressing the user and the supplier perspective, legal and regulatory aspects and the payment infrastructure element of FI • PAFI will support the “Financial Inclusion Action Plan” approved by the G 20 at the Seoul Summit (Nov. 2010) • Building on the work already carried out by CPMI / WB, PAFI is expected to fill the gap in international FI guidance and recommendations by analyzing: ü ü ü • the role of PS as a gateway to more comprehensive FI and how to realize that role advances in FI to enhance PS efficiency, flexibility, competitiveness, and integrity requirements for effective, broader, reliable and cost-efficient access to PS for adult individuals (i. e. 15 years or older) and micro and small enterprises (MSEs) PAFI aims to publish a report in the second half 2015 • PAFI Focus Areas • Regulatory Frameworks • Basic Bank Accounts • Government Payments • Payment System Infrastructure Interoperability, Standardization • Competition, Level Playing Field • Risk Management and Security • Consumer Protection and Transparency • Payment Products 17

• !!! For example, outsourcing / agency schemes may generate additional risks. Although the service provider is responsible for agents / operators, the regulator must be in a position to identify sources of risk and have the power to intervene directly in how arrangements should be shaped • Provision of payment services by non-banks should be considered under the same set of general parameters and evaluated for their inclusion into this business sector. This approach would inevitably lead to apply the same (riskbased) analysis also to “traditional” financial institutions / providers • WB-CPSS Principles for International Remittance Services represent a very relevant, flexible tool for all retail payment services / service providers • Empowering the overseer • Abandoning a pure institutional approach, regulation should be based on kinds of services provided and, most importantly, on the business scheme adopted • Common reference framework • Risk-based assumptions Towards common principles in retail payments • Adopting a “functional approach” requires a parallel empowerment of one or more financial authorities able to oversee a more complex / diverse market. Conversely, an institutional approach in financial regulation often leads to some services being left outside the realm of financial authorities • Lack of empowerment may result the adoption of a “conservative” approach and blocking / delaying market developments; in this sense, proper oversight serves as an enabler of innovation 18

Payment system oversight as the fundamental building block* • 139 countries indicate that their central banks have formal legal powers to perform the payment system oversight function, equivalent to 93%. Proportions are higher in the EU, ECA, and other developed countries • At a global level, about half of the countries indicate that oversight powers are explicitly stated in the law (similar to 2010). (Possible underestimation? given the recent surge in payment systems laws – cited as the second most important source of oversight powers – one would expect increasingly explicit empowerment…) • In 83% of the countries the payment system oversight function was formally established and operating on a continuous basis. In 70%, oversight is independent of payment system operations • Responsibility ranges from wholesale (80%) through retail (70%) to international (30%) aspects of payments • Oversight is limited to central bank-owned systems in only 19% of the cases • At 1/3 of central banks, responsibility extends beyond financial stability to encompass financial inclusion, the promotion of competition and consumer protection *Based on GPSS preliminary results 19

Challenges faced by the overseer (I) • A number of challenges may be identified which are not of exclusively related to non-banks, rather apply to a more differentiated / sophisticated retail payments landscape also as a result of new entrants / products • Risk controls Ø Generations of technology bring in new threats whose implications require time and effort to be fully appreciated, and demand more forward-looking monitoring tools and sufficient technical expertise Ø Concentration can create the potential for a single point of failure with widespread consequences. Question whether overseer has the tools (legal and technical) to identify and possibly address concentration issues Ø Outsourcing to non-banks may generate uncertainties in the assignment of responsibilities, and scope of overseer’s direct intervention Ø Fraud and operational disruptions become major sources of risk in networks that are open to large numbers of participants and users, and integrate various technological components 20

Challenges faced by the overseer (II) • • Maintaining level-playing field Ø Competition can be intense among providers, all striving to achieve a critical mass. Incentives to unfair competition could be strong. Strategic choices that providers can use to win competition are exclusivity and non-interoperability – to be monitored Ø When, how, and to what extent to impose interoperability is a significant policy issue with relevant implications on schemes’ viability and ability to compete Ø Overseer to monitor access conditions to the clearing and settlement services / infrastructure as a possible factor to influence level-playing field and competition. (See also recent MTO accounts’ closure trends) Other relevant challenges include adequacy of oversight tools and cooperative arrangements Ø Central banks have traditionally preferred “soft” oversight instruments: monitoring, moral suasion, assessment against international standards / best practices Ø Although the World Bank found over 70% of central banks reporting a significant degree of cooperation with other regulators, this is more likely to be occurring between central banks, banking supervisors and securities regulators 21

Closing Remarks • Non-banks can play a key role in enhancing efficiency of and access to payment services • Non-banks could enhance certain types of risks due to their structure and operating model; however risks need to be also seen in context / functional approach • Non-banks are very varied and have different roles and inherent challenges; need for a robust regulatory and oversight framework to achieve proportionality • The World Bank – CPSS General Principles for International Remittances provide a framework for non-banks / innovative products as well • Payment system oversight to broaden scope and overcome challenges to cover the entire spectrum of payment services / providers. Information gathering and knowledge / expertise sharing are fundamental 22

PPP Goals Thank you Payment Systems Development Group The World Bank www. worldbank. org/paymentsystems 23