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PETER MAIR: _SUBMISSION TO RBA ON PAYMENTS SYSTEM INNOVATION
INNOVATION OR PROCRASTION
The draft of Newton’s first law of motion went along the lines:
.....nothing happens next unless someone does something first
.........and his longer story embraced setting sensible objectives along with making plans for
doing things likely to achieve them. Newton’s draft did not anticipate a corollary attributed to
Dickens, that nothing will come of doing nothing, hoping that something will turn up.
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nothing doing
In context, nothing will happen to reform the retail payments system unless someone gets
about it with a sense of purpose and direction – and that prospect includes players that could,
taking over from incumbent players that won’t, as well as placing bets on ideas likely to be
winners in a supporting regulatory framework. The mantras about being ‘unable to regulate
innovation’ and eschewing the prospect of ‘backing a winner’ have the hallmarks of both
excuses for doing nothing and not understanding the critical elements of what has to be done
and can be done.
The nonsense of wasting time, but doing nothing, is becoming evident enough along with the
commonsense of intruding a public utility body into the payments infrastructure to ensure
reforms are made in steady successful steps toward known objectives. It is certainly clear that
policy initiatives could do much to make the retail payments environment more conducive to
innovation – and that is the focus of this submission.
It would be helpful, and probably essential, to promoting innovative reforms if the RBA were
to first set down, in plain English, for the wider community – and political government – just
how the retail payment system is presently operating inappropriately and disadvantaging the
community. If the RBA cannot muster the humility to now do that, the job will eventually be
given to an agency that can and will.
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no we won’t
The complement to ‘nothing doing’ on the regulatory front, is the sensibly predictable ‘no we
won’t’ attitude to innovation of the dominant banking players and their affiliated card-scheme
promoters.
As things stand, the incentives in the market for retail payment services encourage banks to
defend present arrangements unchanged, except as they may be allowed to exploit additional
regulatory concessions. Put more sharply the major banks would hardly volunteer to make
changes that would compromise the excessive profitability of current arrangements operating
with characteristics of exploitative cartels. This exploitation has the tacit support of the
regulators and government ministers that the community believes are otherwise responsible to
prevent.
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A sadly cautionary note
(i) still broken, not fixed
While ever the RBA purports to believe that it has been making a useful contribution to
payments system policy it is difficult for others to put a contrary point of view expecting it
will be respected. The following self-assessment extracted from the Bank’s ‘cheques’
submission to APCA is, to my mind, a gross exaggeration:
The Payments Systems Board’s work has in the past focused on: establishing clear price
signals; removing restrictions on merchants that limit their choices in accepting payment
instruments; improving access to payment systems; and increasing transparency in the
payments system.
To my eyes, this is just not so: there are no proper cost-related price signals faced by bank
customers initiating payments; the general run of competitive retailers are beholden to the
banks and their customers in terms of the cost and selection of payment instruments and the
dominance of the major banks in this market means that there has not been, and cannot
presently be, any substantial new player providing retail payments facilities. More generally,
the mysteries of the apparently ‘free banking’ model so beloved of banks, bank customers and
politicians (and regulators?) are simply not being explained frankly, as they should be, to
anyone -- the Bank as a self-proclaimed ‘independent’ regulator comes across as anything but
in this payments-policy role.
It would be difficult to overstate the damage being done by the prevailing ‘free banking’
mindset and the official policy (mis)settings still underwriting it.
(ii) cooperative v. uncooperative
The sense of despair deepens when one reads, in the next paragraph, that
The purpose ...of undertaking a strategic review of innovation... is to identify areas in which
innovation in the Australian payments system may be improved through more effective cooperation among stakeholders.
If the main stakeholders are identified as banks and retailers and the customers of both, then it
is probably fanciful to be building utopian expectations of useful outcomes originating in
voluntary cooperation when the three groups are sensibly each for one and none for all. What
we need, on the contrary, is a firm regulatory hand underwriting a policy framework ensuring
that customer and participant choices, however self-centred, are much more consistent with
efficiency, innovation and fair-dealing than are present arrangements.
In its published policy commentaries on retail payments it is not at all clear that the RBA is
willing to acknowledge the way its present policy settings suit the banks better than the
community. There is no reason to expect the banks to cooperate with innovative reforms that
might prejudice the profitability of their present practices allowing the tax-free barter of ‘free
services’ for ‘interest-free deposits’ and the raft of ‘joint venture’ screens hiding the excessive
and uniform pricing of services associated, for example, with credit-cards and BPay.
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Put differently, the banks run, with official compliance, payments system rackets which they
will defend to the hilt but will not compromise with cooperation in the public interest.
The sense of continuing with an agenda relying on voluntary cooperation flies in the face of
the experience of more than fifteen years. Practically it is to be expected that the major banks
will protect their private interests, both by sensibly following mutually compatible strategies
and, equally sensibly, procrastinating with conditionally promised commitments to deliver on
regulatory wish-lists before deciding that they won’t. One illustration of this is the major
banks’ repeated failure to adapt the very-cost effective direct entry system to handle modern
message formats – instead the banks established lucratively more costly BPay arrangements
in 1997 and more recently envisaged a similarly more profitably costly (mambo) adaptation,
apparently now abandoned.
A similar game seems to be developing around official hopes for EPAL as an independently
competitive local debit-card scheme: so far card-issuers participating in EPAL have newly
been given the scope to take (rather than pay) interchange fees, as do the international scheme
debit cards, but no one has explained why the Australian banks would be making a major
investment to add a third debit-card network, which is hardly necessary, and having done so
would price its services any differently to the two scheme-debit cards they already operate.
One cannot resist the inference that the banks will only ‘cooperate’ if they get another
protected and excessively profitable joint-venture scheme to exploit – at some point
‘cooperation’ only on those terms is tantamount to blackmail, of the regulators and a
community being held to ransom.
One small saving grace, one glimmer of hope in the RBA submission to APCA is the
belatedly acknowledged importance of having prices charged for using cheques reflecting the
substantial and growing average total cost of processing cheque payments -- but it begs the
question of how the Bank could earlier allude to “establishing clear price signals”.
At the risk of being considered rude, a properly informed community would have no reason
to be pleased with the Bank’s present regulation of the retail payments system and – see
above -- no reason to confidently expect better in the foreseeable future. The community
deserves a proper explanation of the deceptive ‘free banking’ arrangements they have been
wrongly encouraged, including by the Bank, to think are in their best interests. The
community deserves a proper explanation of why very mature joint-ventures are still
permitted to set uniform process well in excess of costs: this ‘legal concession’ being quite
contrary to the findings of the Dawson Review of the trade practices legislation a decade ago.
There is simply no evidence that the RBA – as the payments system regulator – has pursued
the coordinated regulatory framework needed to do its job properly: where is the record of the
RBA asking the Treasurer to make sure the ACCC and Australian Tax Office, for example,
are aware of the RBA’s overlapping concerns and the importance of facilitating a coordinated
regulatory response to address them?
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A SENSE OF PURPOSE AND DIRECTION
The RBA’s consultation paper -- at Section 6 --seems to have reasonable handle on the gaps
in the system that need filling, especially ensuring electronic payment and transfer systems
are compliant with international message standards and usually capable of delivering same
day value for payments to retailers and person-to-person transfers.
In circumstances where the RBA is ultimately likely to underwrite the settlement of interbank
obligations, any posturing about the practicality of allowing immediate settlement of
legitimate payment instructions surely becomes a moot point – save perhaps for some
provision for real-time monitoring of accumulating net settlement positions of banks
individually.
Accordingly my response takes its lead from the issue nominated for discussion:
Are there any significant changes in the payments landscape in prospect that have not been
considered by this paper, for instance in terms of architecture or significantly different
payment products? What will be the implications of these changes? Are there actions that
should be taken now to take full advantage of these changes?
Whatever the problems with picking winners for payments system innovations, it is easy to
nominate cash and cheques and credit cards as ‘losers’ and the regulatory sense of
encouraging their demise.
In context, there are actions that can and should be taken now, in respect of cash and cheques
and credit cards, to ensure the system is conducive to prospective innovations and
developments that can be confidently expected to emerge and unfold.
It has been clear for some decades now that the future of retail payments lies more
exclusively in electronic instruments -- implicitly, tangible instruments, cash and cheques,
will be displaced. Practically, surveys of payments behaviour confirm this shift globally
although the pace of change has been patchy – a lingering attachment to cash and cheques has
unfortunately been fostered by a weakness of the regulatory will to ensure appropriate market
incentives – also known as explicit, user-pays prices -- are in place to encourage sensible
change.
The indictment of credit-cards is more about their enduring existence being contrived to
protect the excessive profitability of the mirror-image international credit card schemes. For
most cardholders, one card embraces both ‘credit’ and ‘debit’ card functions and a few
moments reflection will reveal credit-card schemes as redundant – sustained only by
discretionary monopolistic restrictions imposed on the functionality of the debit card option:
there is no reason why eligible customers with debit cards could not have both a linked line of
credit and the facility for debit cards to be used for on-line and other card-not-present
transactions.
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Some suggestions following will appear a bit brutally forceful but, to the wider community,
the sense of quickening the pace of change would be made more clearly understandable by
the RBA delivering the asked-for frank exposition of the problems with cash and cheques and
credit cards which, being the ways of the past, are no longer essential options – and the
benefits of switching to cheaper and more efficient alternative payments technologies that are
the way of the future.
(i) Taking out cash
The first brutal suggestion is that the community be given five-years notice that currency
notes in denominations greater than $20 will be withdrawn from circulation and that, after
another 12 months, redemptions of larger denomination notes at bank branches will be at a
discount from the face value. New bank notes would be clearly marked with a use-by year,
after which they would be redeemable only at a discount.
The corollary is that the continued availability of conventional cash in low denominations –
coins and $5, $10 and $20 notes – would meet all reasonable needs for both a circulating
medium of exchange and reasonable precautionary cash holdings, pending the ubiquity of
contactless point-of-sale technology and electronic payment alternatives. There is a sound
case also for imposing a modest fee or tax on the issue of currency both to cover costs of
production and encourage the switch to e-money alternatives.
The rationale for this bold step in Australia partly relies on the commonsense observation that
the RBA, being of sound mind, cannot continue to run an on-demand note issue function
when the high-denomination notes issued have little prospect of remaining in circulation for
day-to-day purchases -- because they are not necessary for day-to-day purchases. As is, high
denomination notes – zero coupon bearer bonds -- are mainly hoarded as a tactic for avoiding
means-tested limits on entitlements to age pensions or more generally for underwriting the
cash-economy with attendant income-tax evasion.
The unfair and unnecessary cost to the public purse of the RBAs current conduct of the note
issue function demands a strong public policy response to put a stop to it. The policy response
should immediately include relocating the responsibility for the currency note issue in
Treasury or a separate currency board.
At a more constructive level, the business case for developing and providing e-money
alternatives to cash would be stronger if cash were less conveniently available for making
payments for values larger than say a hundred dollars or two. Provided the international card
payment networks and participating local banks can be contracted to provide transaction
facilities domestically on fair and reasonable terms, the way would be open for the RBA to
develop a regulatory framework conducive to both PIN-secured and contactless debit-card
transactions substituting effectively for conventional currency.
[Incidentally, an appropriate concept of ‘fair and reasonable’ would be accompanied by both
a regulatory prohibition on the charging of ad valorem interchange fees for credit card
transactions and securing related undertakings both to ensure that appropriate functionalities
attach to debit cards (including a line-of-credit option) and precluding ad valorem levies on
retailers accepting card-scheme payments.]
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(ii) Taking out cheques
Much the same sense of an appropriately brutal determination applies to the objective of
taking cheques out of the retail payments system -- because there is no longer any reasonable
need for them to be used. Again it is a step to be carefully explained to the wider community
and only finalized after due notice. Concurrently the RBA would be negotiating with banks
and others to put in place appropriate electronic alternatives to cheques.
In terms of the mechanics for driving this change, one sensible first step would be ensuring
that customers drawing cheques pay an explicit fee reasonably reflecting the high and rising
average total cost of banks processing cheque payments – and it would be equally appropriate
for businesses accepting cheque payments to surcharge cheque payments to cover costly inhouse paper processing. Already, and apart from the culturally addicted aged, the
discretionary use of cheques is largely confined to small businesses and foolishly
accommodated by banks cross subsidizing their high costs from the soft revenues flowing
from holding interest-free deposits.
Banks’ inclination to provide underpriced payments facilities would be considerably less if
the regulatory framework provided for income tax to be paid by bank customers on the
income fairly deemed to accrue if transaction account deposit balances attracted interest at a
market rate.
Already banks have facilities in place for making person to person transfers electronically at
branches or over the internet and it is a short practical step to contract with agents – like
Australia Post – to offer those facilities to customers not otherwise able to use internet
facilities or visit branches or, presumably, use telephone payment options. There is nothing in
this approach to preclude the provision of basic banking and payment facilities to the needy
free of charge – such costs to be met from the budget as payments to contractors tendering to
provide the services.
While it is essential that the community be given appropriate notice and education on
alternatives, before cheques are fairly priced out of the market, it is disturbing to read of
knee-jerk political interference in the UK to protect the continued availability of cheque
facilities. Among other things such opportunistic reactionary nonsense begs the question of
central banks and payments regulators exercising their nominal independence to put their foot
down and stop the rot.
(iii) Taking out credit-cards
I have long laboured elsewhere the case against the payments regulators continuing to
accommodate the affront to the community embodied in the conventional credit-card product
– they are a redundant contrivance against the public interest and have no place in a modern
electronic payments system.
I won’t labour the point for long again here, except to say that I could make only perverse
sense of the – roundly rejected -- PSB proposal to cap retailer surcharges on credit card
payments. To my eyes this proposal, to cap surcharges, instead made the contrary case to
proscribe the imposition of ad valorem interchange fees on credit card transactions – as once
promised by the RBA. There should be no ad valorem transaction fees to be surcharged or not
– customers should pay directly for the services they use, including credit needed.
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It remains to say as well that the payments regulators should head off at the pass any
suggestion that the promoters of the established international card schemes might retaliate (as
they are in the US) with the imposition on retailers of an alternative ‘scheme network
participation fee’ to make up the revenue lost as a regulated reduction in interchange fees.
In a related context, much of the debate contrived around the regulation of interchange fees
on credit card purchases has been fuelled by the role played by travel and entertainment cards
charging high commissions to fund high rewards to card users. For the most part these card
schemes are also a similarly contrived affront to the community in that they are mainly a
vehicle for unfairly converting a tax-deductible business expense – high commissions
deducted from sales proceeds -- into the tax-free personal income in kind embodied in the
generous rewards paid to individuals using corporate cards. It adds insult to this injury when
other credit-card schemes leverage this malpractice to justify competitively similar, but
equally objectionable, ‘premium card’ schemes funding high rewards funded from differential
interchange fees on different cards subject to an overall average ‘cap’.
The time is nigh when the taking of interchange fees for credit card (and BPay) transactions
needs to be reviewed with a view to proscribing any ad valorem fees -- and, with the
cooperation of the ATO, the scope to convert business expenses to untaxed personal income
should also be proscribed.
In the wider context, to protect the incentives for innovation and product development,
interchange fees payable to ‘issuers’ would sensibly be limited to those applying to debit card
payments: as is ad valorem fees are an inexcusable barrier to innovation.
INITIATIVES TO FACILITATE INNOVATION
The ‘innovation’ consultation paper explored the role which established players and industry
bodies might have in reformed governance arrangements coordinating reform initiatives.
Among other things, possible reforms would allow a central payments hub to clear payments
between participating institutions, probably exclusively but possibly in conjunction with
continuing bilateral clearing arrangements. There is some undertone of Australia needing to
replace existing bilateral payments clearing arrangements with a centralized hub-based
system able to process payments in message formats complying with established international
standards. This undertone is pleasing.
In the somewhat convoluted words of the consultation paper:
.............. a key priority is ensuring that the governance structure for the industry is one that
supports innovation. An important consideration is the role the Reserve Bank and the
Payments System Board should play in these arrangements. The Board is seeking views on
the capacity of industry-driven governance to produce the level of innovation that is in the
public interest. If this capacity is currently deficient, it is interested in whether broader
representation in governance arrangements could overcome these constraints, and how, and
through what body, this representation could occur. The Board also sees some justification
for considering the current structure of rules for clearing and settlement given the evolving
landscape for retail payments.
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By way of summary response, one might observe both that the present governance structure
protects the status quo, and inhibits innovation, and that market failure invites the RBA/PSB
to play a forceful role in correcting it – at some point the RBA should assume responsibility
for the establishment of a central payments hub to which all licensed participants would be
connected, irrespective of some continuing to swap payments bilaterally.
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the case for forceful leadership
Presumably the emerging debate on governance will polarize, reflecting factional interests.
So far – and we are talking decades – the institutional arrangements in place for deciding
innovations and reforms have seen the private commercial interests of the major banks take
precedence over any concept of the broader public interest, which is poorly served as a
consequence.
The illustrative litany of the regulators blandly accommodating the self-serving demands of
the dominant commercial banking interests is becoming legendary. The more crass
illustrations include the barriers placed in the way of non-bank deposit takers issuing cheques
and then paying the major banks participation fees to use the clearing house; the uniquely
Australian approach to eftpos which first saw interchange fees paid to acquiring banks rather
than card issuing banks but more recently has seen this regime overturned, after major
retailers became acquirers, and the substitution of interchange fees payable to card issuers;
the exclusion of the major international card schemes from supervision by the industry
payments body, APCA; the subordination of the reform of the direct entry clearing stream to
allow a more profitable arrangement administered by BPay, complete with ad valorem
interchange fees – and the apparent intention of the major commercial banks to further adapt
the BPay system to newly accommodate person-to-person payments on more profitable terms
than now applying with the use of BSB and account number protocols. Along the way the
major banks have valued the reluctance of the RBA to deal appropriately with the interchange
fee arrangements underpinning the ongoing excessive profitability of credit-card issuers and
credit-card scheme operators.
This litany, this history, is a sad one from a public interest perspective – and the sense of a
public interest sadly perverted is only reinforced by even casual reflection on the
consequences of allowing banks the benefit of a major rort of the public interest. The major
banks, primarily, effectively draw a substantial subsidy underwriting their dominance of retail
banking by bartering underpriced payments services, untaxed income in kind, in exchange for
very substantial deposits in transaction accounts in which no material interest is paid. This
arrangement, coupled with credit card interchange fees, has been destructive of the public
interest in the proper operation of the retail banking and payments system.
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a more positive agenda
My response has a more positive tone when recast in the terms of the RBA’s still tentative
commitment to making the shift in regulatory attitudes needed to reorient the retail payments
market so it is more compatible with efficiency and innovation.
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first things first
An essential prelude surely is a frank exposition, to the community and the parliament, of the
down and dirty operational economics of the present retail payments system -- and the related
need to substitute properly explicit user-pays arrangements for the regulatory corruption
inherent in the dominant ‘free banking’ model. Little useful can be done until the community
and the parliament are persuaded to accept a system which will be more equitable, more
efficient and more innovative.
Proposing precipitate action on payments policy without having the community on board
would be socially and politically disruptive – but it should not be hard to make the persuasive
case for change.
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next decisive steps
What would emerge from this full and frank exchange is the concept of a retail payments
system fairly exclusively reliant on electronic payments for both point-of-sale payments,
including e-money cash, and remote transfers between third-party accounts: ideally the emoney ‘cash’ payment facility would be compatible with micro-payments funding dot.com
internet sales.
The sense of commercial and community commitment to this general concept would be
encouraged if, concurrently, decisive action were taken concurrently to limit the use of
conventional cash, and cheques and credit cards. However superficially brutal this decisive
action may appear at first blush, there is a strong case for Australia to withdraw highdenomination bank notes; to put strong incentives in place to discourage the use of cheques
and, on the card front, to proscribe ad valorem interchange fees perversely underwriting credit
card schemes especially but also BPay. Conventional credit card functions will be better
provided by debit cards with enhanced functionalities and the new infrastructure for payments
and funds transfers generally made remotely could displace BPay.
Obviously the discouragement of large cash payments and cheque payments will need to be
linked to the more ready availability of suitable substitutes but here is less need to be gentle
about proscribing ad valorem interchange fees.
Beyond that,as with credit cards issued by the international card schemes, it is imperative that
Australia adapt its other retail payments systems to be seamlessly compatible internationally,
including compliant message formats. Similarly it should be possible to couple modern
communication technologies with deposit-guarantee arrangements to allow almost immediate
value to be given for cleared payments.
In terms of appropriate infrastructure, it is now clear that the present direct-entry clearing
system either can’t be or won’t be adapted to meet appropriately modern standards for
clearing and settlement arrangements for retail payments: the major banks have had their
chances to provide appropriate infrastructure but, after playing for time, have repeatedly
failed to do so. Only very slow learners would continue to play on the always losing side of
these games. In these circumstances, it is timely for the RBA to take the lead and commission
the development of the infrastructure needed to meet its objectives for efficiently facilitating
timely payments.
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It may be possible to adapt such new infrastructure to providing a network for debit card
payments but I am not convinced of the necessity for that unless it can be both linked
internationally and able to operate more efficiently that could the two existing networks
managed by the international card scheme promoters. Alternatively, contracts could
presumably be negotiated with these international network operators to provide debit-card
payment facilities – including for card-not-present transactions and contactless substitutes for
cash payments -- to Australia on demonstrably fair and reasonable terms.
Making a substantial commitment to those negotiations would stand the RBA in good stead
as a similar inclination emerges in other countries to rein back these monopolistically, mirrorimage card payment schemes: some international consensus is inevitable as the implications
of national currencies being displaced will need to be addressed lest the private card scheme
participants misappropriate related seigniorage revenue from the public purse.
End piece
As noted at the beginning, nothing will happen unless someone does something to set in train
a sequence of innovative reactions. The general idea of what needs to be done is clear
enough, even in the RBA/PSB discussion paper where it is, unfortunately, buried under a
layer of regulatory reluctance and political correctness.
Peter Mair
25 August 2011