Strategic Review of Innovation in the Payments System: Issues for Consultation – June 2011 6. Innovation Gaps in the Australian Payments System

The Board's expectation is that putting in place the right environment for innovation will be helpful, but not always be sufficient, to address potential gaps in the payments system. There may still be a need to determine an agenda for industry and set priorities. To that end, there are some specific areas that are currently worthy of additional consideration.

This section examines a number of specific areas that have been raised during the Bank's consultations with stakeholders. In some cases these are areas where there is specific functionality that some stakeholders consider to be important but which is currently unavailable. Others are areas where technological change is generating rapid change in payments and there is a case for considering whether the landscape is evolving in a desirable way or whether there is a need for greater co-ordination.

6.1 The Transmission of Data with Payments

An important theme that has come out of the Bank's initial consultations is the difficulty in transmitting additional data with payments in Australia. This links closely with the objective of integrating payment systems with other processes, noted in Section 2. Businesses, in particular, find that the absence of an electronic means to carry additional data with payments results in them either having to resort to using cheques or to separate data and payment information and reconcile them at a later stage. Inevitably, this means more cumbersome and often manual processes. To a lesser degree, this can also be an issue for individuals, who might wish to provide information with a payment made through internet banking, for example.

This issue is also related to electronic bill presentment and payment, otherwise referred to as e-invoicing. Such systems allow a bill to be sent electronically to a customer, who can then view and pay the bill through the same system, with notification returned to the biller. Such a service is available through the BPAY system.

The issue is principally focused on the Direct Entry (DE) system, through which a large share of business and internet banking payments are made. An example of the types of difficulties that currently arise is where an employer is making payments to a superannuation fund on behalf of multiple employees. While it would be convenient to make these payments via the DE system, the superannuation fund also needs a range of information in relation to the payments, which might include items such as the employer's Australian Business Number (ABN), contact details of the employer and employee, a contribution reference, tax file number, the employee's personal details and the type of payment. However, the DE system can only carry 18 characters of free-form information. In many cases, employers are forced to pay by cheque with physical documentation attached.

Several solutions are possible.

First, the DE system could be re-engineered to allow each payment to be accompanied by a much richer set of information. International messaging standards are moving in this direction. This might also require significant re-engineering of both bank and end-user systems.

A somewhat less disruptive solution would be for the existing 18 characters in DE messages to be used to carry referencing information that could direct the recipient to more detailed data. A proprietary system is already using this approach to direct payment recipients to a web address containing the information required for superannuation payments. Such a system could be applied more generally for the DE system. Those that support this approach suggest that the new standards could be voluntary to allow adoption ahead of the pace of slower movers.

A third suggested solution assumes that changes to the DE system are likely to be difficult to co-ordinate and expensive to implement. It suggests that a completely separate system be used where there is a need to carry additional data, perhaps using the ISO 20022 standard, which allows both structured and unstructured remittance information to be sent with the payment. The BPAY MAMBO system, which is currently under development, has been suggested as one system that might be able to provide this.

6.2 The Timeliness of Payments

The timeliness of payments has been identified as an important attribute of payment systems and is attracting an increasing focus around the world. As suggested in Section 2, there are at least two elements of timeliness. First, those receiving payments may wish to access funds as quickly as possible after the payment has been made. Second, for a retail transaction, merchants may wish to have real-time confirmation of the payment so that goods and services can be exchanged, even if funds cannot be accessed until a later time. These are dealt with separately below.

Timing of availability of funds

As discussed, Australia's main retail payment systems operate on a deferred settlement basis. Payments information is batched into files, which are exchanged between banks during the day and processed through their systems overnight.^[15] Settlement between banks occurs the next day at 9am. While, for direct participants, customer accounts are treated as having been debited and credited on the day of the file exchange, funds are only required to be made available to the recipient at 9am on the day after the payment has been made. For other participants, funds may be available later than this.^[16] Accordingly, this system is not well suited to making funds accessible quickly, especially across all financial institutions. Where weekends or public holidays are involved, the delay will potentially be even longer.

For many payments, delayed availability is not a great concern. For instance, salaries or other predictable payments can be timed so that funds are available when required. However, emergency government or personal payments are more problematic and failure for them to be received in time could result in considerable hardship for the recipient. In recent times, many Commonwealth emergency payments have been made through the high-value real-time gross settlement system because there has been no viable alternative. In other cases, for instance during the recent floods in Victoria, payments have been made with prepaid cards.

In the past few years there has been considerable focus overseas on providing systems that allow electronic payments to be available shortly after initiation by the payer. One example is the Faster Payments Service in the United Kingdom, which allows customers to initiate payments via internet banking with funds available to the recipient in many cases within seconds. Payment messages can be sent in real-time, similar to the eftpos and ATM systems in Australia, or submitted in batches, and are made immediately available to the recipient by the receiving bank providing credit. Interbank credit is managed via the use of three same-day settlement batches and a net debit cap for each bank. The National Electronic Funds Transfer system in India takes a different approach, with hourly settlement sessions 5½ days a week, and funds typically available to recipients within two hours of settlement. Another approach again is the Telegiro New Style system in the Netherlands, which can route urgent credit transfers either through the TARGET2 RTGS system or the European Bankers Association's deferred settlement arrangements, with funds available to the payee no later than 1½ hours after the payment is initiated.

There are two obvious obstacles to faster funds availability in Australia. First, as mentioned, next-day settlement of retail payments is not conducive to faster funds availability. Second, the internal systems of some banks are geared to overnight processing and are not presently capable of crediting accounts in real-time or near real-time. This is an argument for these older elements of the Australian payments system to be updated.

A related issue is the availability of such payments over weekends. Currently, a retail payment made on a Friday night might not be available to the recipient until the following Tuesday, as payment files would not be processed until Monday night. The Faster Payments Service does not provide interbank settlement over the weekend, although settlement would still occur a day earlier than in Australia. Funds continue to be made available to recipients in a timely fashion by the extension of credit, within the established bank limits. A similar approach could be taken in Australia, depending on the values involved, but consideration could also be given to extending settlement to weekends.

An alternative model for providing faster customer access to funds without the need for credit provision by the receiving institution is to move, not just to same-day settlement, but to real-time or near real-time settlement of retail transactions. As RITS is geared to processing a relatively small number of high-value payments, this would require changes to the RITS infrastructure, to build a high-volume messaging system which would pass interbank settlement positions to RITS on a near real-time basis. This would still be reliant on financial institutions' systems being capable of making funds available to customers in a timely fashion. Bearing in mind the relatively low values (and therefore credit risk) generated by retail systems, the possible benefits would need to be weighed against the efforts to build such a system.

Real-time confirmation of payments

For many merchants it is not immediate access to funds that is important, but immediate confirmation that an irreversible instruction to pay the funds has been made and that the funds are indeed available in the payer's account. Card payments facilitate real-time confirmation of payment to merchants by checking funds/credit available to the customer and blocking that amount in the customer's account. This allows purchased goods and services to be released to the customer immediately. In some cases, most notably contactless cards, transactions are processed ‘off-line’ (without checking funds/credit availability) up to a relatively low limit.

Given the rapid take-up of online payments, the provision of similar functionality online is important. This functionality is available from the international card schemes, which dominate this space, as well as some specialist online payment providers. It can be argued therefore that there is no gap here, but the Board has been concerned that there is not greater competition in this area. Widely used systems such as BPAY and Direct Entry are not able to provide this functionality, while the eftpos system can do so only in a point-of-sale environment.

6.3 Ease of Addressing Payments

A key element of the ease of use of payment systems is the process of providing details of the accounts to be debited and credited when a payment is made. The more difficult this process, the greater the transaction cost and the higher the risk that a payment might be misdirected, requiring costly manual repair, or even worse, resulting in loss of the transacted funds.

As discussed in Section 2, cheques can be very simply addressed using only the name of the payee, but the cost of this is a largely manual process for the payee depositing the cheque. Card payments could be thought of as the most user-friendly systems in this regard because neither the customer's nor the merchant's account details need to be entered manually; the customer's details are of course recorded on the card itself.

However, directing payments to businesses or individuals in other contexts can be problematic because it requires the payer to know the payee's account details, for instance the BSB and account number, and to enter them correctly. These issues have been a particular problem for government payments. The agency making the payment must have the correct account information for the individual in order to make an electronic payment. For less time critical payments, cheques currently can sometimes be a more reliable solution, while in some circumstances prepaid cards have been used.

Issues with correctly addressing payments have been dealt with for bill payments through the BPAY system, where the customer needs only enter a biller code and reference number printed on the bill. The industry is in the process of developing a system that would operate in a similar way for individuals. Another alternative that has been considered by the industry in the past, commonly referred to as ‘credit eftpos’, would allow a consumer to provide their details for an incoming payment by presenting an ATM/eftpos-enabled card. As discussed below, some fledgling person-to-person systems use a telephone number or email address as a reference to address payments.

6.4 Person-to-person Payments

Related to the problems of addressing payments, efficient person-to-person payments have been slow to develop in Australia. To date, there have been few effective electronic alternatives to the paper-based products of cash and cheques. Direct entry payments initiated through internet banking have been a reasonably popular method in recent times, but these suffer from the problems discussed in the previous section and funds might not be available until the next day. These payments are also simpler for remote transfers, where the payer might have easier internet access, than for immediate face-to-face payments (e.g. splitting a restaurant bill). This is of course becoming less of a constraint with the introduction of mobile phones providing internet access.

There are some fledgling person-to-person systems now available in Australia. For instance, PayPal offers this functionality, though, as a closed system, it relies on payments between PayPal accounts held by members. At least one bank also provides a system that allows payments to be made to other customers of the same bank using only a phone number and password. Payments to customers of other banks can also be made using this system, but the payee must log on to a website to provide account details before the payment can be processed through the Direct Entry system.

These examples highlight the absence of a user friendly, universal person-to-person electronic payment system in Australia. This absence is made starker by the existence of some mobile-based systems in developing countries, although these may reflect a greater willingness of consumers in these countries to trust relatively large telecommunications companies with what are effectively banking relationships. These systems also tend to be less user friendly when used across carriers.

6.5 Mobile Payments

One of the most active areas of innovation in payments globally is mobile payments. Mobile devices have appeal as payment devices because they are ubiquitous and are almost always in close proximity to the user.

The term ‘mobile payments’ is in fact used to encompass several different types of payments that can be made with a mobile device. These can differ with respect to the payment interface and the source of funding. The payment interface generally takes one of three forms:

1. Short Message Service (SMS) initiated payments, where an SMS is sent by the user to trigger a payment, for example for premium mobile or other services or from a stored-value system. Such models have been slow to take off in Australia and many other developed countries, presumably because alternative payment options, with financial institutions at the centre, are available;
2. mobile internet payments, where the phone provides a means of accessing the internet, with payments made in a similar way to transactions using a personal computer. Services are often tailored to make them more suitable for a mobile environment, for instance with tailored applications. Examples are internet banking payments on a mobile device, mobile PayPal, or making mobile payments through any number of web-based services or specialised mobile phone applications; or
3. contactless transactions, where a mobile device is placed in proximity to a terminal and transmits payment information using radio frequencies. Communication between the two devices can be one-way (giving the same functionality as a contactless card), or two-way, allowing more sophisticated services to be offered. In its simplest form, the contactless chips and aerials contained in contactless payment cards can be attached to, or incorporated into, a mobile phone for making standard contactless credit or debit card payments.

Mobile payments can be funded from a range of traditional payment instruments. For example, mobile PayPal may be funded by a linked deposit account, credit card or pre-funded account, while a contactless payment can be linked to a specific credit or debit card. Under these models, authorised deposit-taking institutions retain an integral role in the payments process.

In addition to traditional payment sources, mobile payments raise the possibility of telecommunications companies expanding their role as holders of stored value or providers of credit. For instance, in some models, payments made on a mobile phone are charged directly to the user's mobile phone bill, drawing funds from stored value on a pre-paid phone account, or a line of credit on a post-paid account. In Australia, mobile premium services are the principal example of such a model, but this is currently limited to digital goods and services. This model is more prevalent overseas and has led to concern among regulators about banking-like functions being undertaken by telecommunications companies.

Point-of-sale transactions are one area where mobile payments have not yet made inroads, but have potential to affect payments relationships significantly. Mobile systems have the potential to provide a more complex interaction at the point of sale than is currently the case with card payments. For instance, a range of traditional card-based payment options may be available on a single phone, allowing the customer to select the method used. This might, for instance, provide the benefits of a multi-function card, while still allowing consumers to choose the payment method used for a contactless transaction. These more complex interactions may also provide greater integration of other services, such as loyalty programs. It is also possible that mobile phones may allow internet banking services to become better integrated into point-of-sale transaction processes over time, although the lack of real-time functionality may be a constraint.

To date the Board has taken the view that there are no particular impediments to the development of mobile payments in Australia. Nonetheless, the Board is interested to hear other views on this issue.

6.6 Electronic Purse Systems

A number of other countries have in place widely used ‘electronic purse’ systems. These are typically reloadable, contactless, pre-paid cards that process transactions off-line to aid transaction speed. Examples are the Octopus system in Hong Kong and Suica in Japan, both of which are transport ticketing systems that have broadened into general use payment systems. The transport ticketing base of these systems seems to have been critical to their development as broader payment mechanisms by ensuring a wide cardholder base, making acceptance more attractive to merchants. There appear to be relatively few cases where electronic purse solutions have successfully developed independently.

While over the years there have been some trials of electronic purse-type systems in Australia, none have progressed to widely commercially available systems. This may be a reflection of the relatively slow development of chip-based electronic ticketing systems in major cities, different approaches to ticketing from state to state, or a level of satisfaction with existing card payment systems.

6.7 Standards

The use of common standards has a number of benefits, including: lowering the barriers to entry for new firms; increasing the size of the market by enabling firms to compete across borders or for the business of multinational companies; providing greater certainty for users and producers of software and hardware and fostering innovation by reducing the risk of investing in a redundant standard. Of course, there are costs to implementing new standards, as they often require new software, new hardware, and retraining for staff. There are also potential difficulties in integrating new standards with other standards and systems used within an organisation.

Section 5 outlined potential difficulties in establishing standards at the industry level. The academic literature, and a number of parties with which the Bank has consulted, indicate that there are circumstances where external intervention to either set a standard, or to force industry to set a standard, can be beneficial. The Board is open to the notion that innovation may be supported by it taking this role in some circumstances. While standards apply in a number of areas relevant to retail payments, the Board sees two immediate areas for consideration – messaging standards and security standards.

The Australian standard for card payment devices, security and messages, AS 2805, was pioneering, having been developed before many relevant international standards. In some cases AS 2805 influenced later international standards. However, international standards are now being recreated to take advantage of the advent of Internet Protocol networks and XML (eXtensible Mark-up Language). With the increased globalisation of finance and business, there is also a push for the standards to be used across business areas and used more consistently across jurisdictions. To that end, the International Standards Organisation (ISO), with SWIFT, has developed the ISO 20022 framework for payment messaging standards.

ISO 20022 is a methodology for constructing message standards that are interoperable across industries and jurisdictions. Messages are constructed using a set of internationally agreed data definitions, known as message elements (individual fields) and message components (groups of elements that perform a specific function). These message components and elements, their description, and information on how they should be used are stored in the ISO 20022 repository, maintained by ISO. This then provides a reference for constructing message standards. Any message constructed using the repository can be understood by all ISO 20022 users. ISO also publishes approved message standards in the repository. In addition to the construction of new standards, ISO 20022 can be used to translate between standards so as to enable interoperability between different payment systems.

ISO 20022 is emerging as international best practise for payments messaging. Examples of its adoption include:

• SWIFT helped to draft the original ISO 20022 standard and has used ISO 20022 to create new message formats;
• the European Payments Council chose ISO 20022 global message standards as the payment message standard for the SEPA Direct Credit (2008) and Direct Debit (2009) transfer systems. The Direct Credit and Direct Debit systems can be used for cross border and domestic payments;
• new remittance message standards that allow up to 9,000 characters to be sent along with payment will begin operation in CHIPS and Fedwire in the United States in November 2011. The new message standard includes an unstructured field that can carry the ISO 20022 format. The message has also been mapped to ISO 20022. The Federal Clearing House and CHIPS have also worked with SWIFT to map their bank and customer transfer messages to ISO 20022 data elements;
• ISO 20022 is being used as a bridging standard to enable non-urgent cross-border credit transfers between banks in different countries under the International Payments Framework (IPF). IPF began operation in 2010 for US-European transactions, including in pound sterling and Swiss francs. Work is underway to expand IPF to include South Africa, Brazil, Canada and Australia; and
• an international project is underway to develop a common global implementation standard for ISO 20022 messages for corporate-to-bank payments.

Undoubtedly adoption of the ISO 20022 framework would improve compatibility of Australian systems with overseas systems. It would also allow for greater transmission of data with payments and make it easier for foreign players to enter the Australian payments system. APCA is in the process of developing an ISO 20022 framework for Australia but is not requiring its adoption. The question, therefore, is whether a more aggressive strategy is required, either requiring an industry shift to international standards or ensuring that participants are at least able to accept payments compatible with international standards.

Another area for consideration is whether there is a case for greater co-ordination on security standards. For instance, card schemes generally set their own rules on fraud reduction innovations, such as mandated adoption of chip at point-of-sale terminals and in ATMs, mandated use of PIN for point-of-sale transactions and use of password-based verification systems for online transactions. Such decisions raise two issues. First, they impose obligations on third parties, who may have to bear a considerable cost in upgrading equipment, but have little say in the decision-making process. Second, to the extent that such changes place a burden on end-users, there may be an incentive for schemes to hold off in the expectation that another scheme may move first, producing a short-term competitive advantage, while also ‘breaking the ice’ to reduce resistance somewhat with users. Together these factors may result in security improvements not being implemented in an optimal way. There may be a case for a more co-ordinated standards-setting process for security measures to avoid these problems.

6.8 Future Trends

The discussions in this paper have focused on issues and trends that are evident or easily foreseeable at the time of writing, which may imply a medium-term rather than a long-term time horizon. The Board is also interested in possible developments further ahead, the implications for the payments system and possible opportunities that these might present. In particular, the Board is interested in whether there is potential for more fundamental changes in payments system architecture that might simplify entry, improve interoperability and increase both competition and innovation. Similarly, it is interested in whether new products that represent a fundamental break from current or prospective systems are likely to emerge. To the extent that it is possible to contemplate such changes, it may be appropriate for the industry to position itself now to take full advantage of them.

Footnotes

Payments information is generally exchanged in real time in card-based systems, but settlement still does not occur until the following day. [15]

For illustrative purposes, this would be likely to apply to fewer than 5 per cent of credits processed through the Direct Entry system, if received by institutions' cut-off times. [16]