ABSA Annex 3 Background Info On NPS

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ANNEX 3 : BACKGROUND INFORMATION ON THE NATIONAL PAYMENT SYSTEM
1. 1.1
Introduction The National Payment System refers to the behind-the-scenes infrastructure that enables individuals and firms to transact with one another by using various means of payment such as cheques, debit and credit cards and electronic funds transfers. ATM withdrawals are also part of the National Payment System. The FEASibility report and the Technical Team of the Competition Commission Enquiry have raised questions regarding access to the National Payment System and the interchange fees that are paid from one bank to another in transactions that involve more than one bank. These questions are explained and addressed in this annex.
1.2 1.2.1
The annex is organised as follows: Section 2 provides an overview of the National Payment System. This section explains that the National Payment System is essentially a network of competing and complementary services that facilitates transactions involving various types of payment streams. It provides information on the various different It also highlights the various and inter-bank participants in the payment system including the monitoring role of the South African Reserve Bank. have contributed to greater innovations that have underpinned the payment system and that interoperability competition.
1.2.2
Section 3 explains that access to all levels of the payment system is determined on the basis of open and transparent criteria and that the current structure and rules of the payments system do not act as a barrier to entry that limits new competition in the South African banking industry. One of the characteristics of the South African payment system is that banks have invested in a central switch to help facilitate more effective switching. It will be demonstrated that there are many advantages of a central switching network, including lower barriers to entry for new players as these new participants only need a single link to a single system for full access to a variety of payment systems.
1.2.3
We also explain that proposed changes to the regulatory landscape in the form of the Co-operative Banks Bill and the Dedicated Banks Bill and initiatives in the industry to incorporate non-banks will remove some of the remaining impediments to access. This annex shows that indirect access to the National Payment System by way of sponsorship or agency arrangements is a valuable substitute for direct or full access. Absa, in particular, has been involved in a number of major sponsorship arrangements which has facilitated access to the payment system and through agency arrangements Absa has assisted smaller banks to compete in its market by assisting them to receive deposits.
1.2.4
Section 4 describes and explains the economic function of interchange fees. advantages from We review how interchange fees have been an economic perspective of multilateral determined in South Africa and in other countries and discuss the determination of interchange fees.
2.
Overview of the Payments System This section provides an overview of the South African National Payment System, examining the importance of a well functioning system with interoperability between different participants. The section also gives a brief description of the key participants in the system.
2.1 2.1.1
Importance and role of the National Payment System Broadly speaking, payment systems allow for the transfer of funds from one person to another. The Bank for International Settlements (BIS) defines a payment system as follows, A payment system consists of a set of instruments, banking
procedures and, typically, interbank funds transfer systems that ensure the circulation of money. 1
2.1.2 Payment systems therefore lie at the heart of banking systems and play an important role in the smooth functioning of an economy by facilitating the flow of payments and value. By protecting the exchange of payments, such systems reduce the risk of an uncompleted payment which in turn reduces the potential loss to the economy. 2.1.3 In South Africa, the National Payment System enables financial institutions to interact with one another and the interoperability created within the National Payment System allows end customers to do the same. Given the important function of the National Payment System, it is therefore vital that all participants in the National Payment System ensure that appropriate safety and security measures are built into the National Payment System value chain. 2.1.4 Co-operation and commitment from participants is essential and has resulted in the establishment and maintenance of a world class system of the highest standard in terms of security, risk containment and service levels. South Africa has an internationally acclaimed, recognised and sound National Payment System, which
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BIS (March 2003) "A glossary of terms used in payments and settlement systems, Committee on Payment & Settlement Systems, Revised Edition, Basel, Switzerland
accords with and in some instances, sets the trend for, international best practices. The interoperability of the systems within the National Payment System is also used by international institutions when rating South Africa on a global scale and, as such, if the National Payment System infrastructure is not managed in a sound and efficient manner, the knock-on effect to the South African economy would be significant. 2.1.5 Furthermore, the National Payment System is subject to concerns about systemic risks whereby incorrect payment transactions by one party or insufficient money being available to fund such transactions can be detrimental to all parties involved in the National Payment System. In the year ending August 2006, transactions worth some R47.87 trillion were facilitated through the National Payment System. This is thirty-seven times the value of the Gross Domestic Product of the country (R1.3 trillion) in 2004 and the value of banking assets in the country (R1.4 trillion in 2004). With such large values of transactions at stake it is vital that the National Payment System is well regulated and well-functioning at all times.2 2.1.6 The National Payment System is therefore regulated in order to ensure adherence to standards that enable level playing fields, efficiency, effectiveness, soundness and stability of the payments domain. The regulatory framework for the National Payment System is based on the BIS's "Core Principles for Systemically
Important Payments Systems" banking framework. It is essential to

have a proper legal structure that underpins the functioning of the National Payment System. This legal foundation seeks to provide: 2.1.6.1 efficiency, effectiveness, reliability, security, risk management and adherence to all standards 2.1.6.2 legal certainty with regard to the rights and obligations of the respective participants;
Based on data from the FEASibility Report as well as updated Reserve Bank /National Payment System data.
2.1.6.3
a sound and enforceable basis for resolving conflicts between transacting parties, intermediaries and regulators;
2.1.6.4
a legal foundation for clearing, netting and settlement arrangements between participants in each particular payment stream;
2.1.6.5
an environment in which specific criminal activities are to be reported;
2.1.6.6 2.1.6.7
legal clarity in bank curatorship and liquidation situations; and support for the removal or reduction of risk in the National Payment System.
2.2
Key participants in the National Payment System There are a number of different elements to the National Payment System. In this section we provide high level information on the main participants within the regulated part of the payment system.
2.2.1 2.2.1.1
The Reserve Bank The South African Reserve Bank has overall responsibility for overseeing the payment systems for the purpose of promoting the maintenance of a sound and efficient financial system. In this regard the Reserve Bank is tasked with monitoring the interactions of participants together and with implementing risk-reduction measures in the payment system to reduce systemic risk. The Reserve Bank looks to the BIS for best practice, guidance and standards for payments regulation. The Reserve Bank also supports a sound legal basis for payments clearing and exchange.
2.2.1.2
Within the context of sound governance, the role of the Reserve Bank, as payment system overseer, is particularly relevant to ensure safe and efficient payments and securities settlement systems through reliable and efficient infrastructure. The direct involvement of the central bank in managing clearing and settlement systems is an important element in
governing the overall structure and operation of payment systems in all major countries. The Reserve Banks involvement helps to ensure that the desire to limit systemic risk, especially in the area of large value payment systems, is adequately taken into account. 2.2.1.3 Within the Reserve Bank there is a financial stability committee keeping a close view on the payment flows and other actions of all banks such that any possible liquidity problem of a bank will be noticed and managed long before it becomes a real commercial issue. 2.2.1.4 The Reserve Bank is also responsible for the designation of payment systems as well as the recognition of PASA as the payment system management body. Within the Reserve Bank, the National Payment System Department oversees the functioning of the National Payment System. The National Payment System Department is a (non-voting) member of PASA Council and, as such, is in a position to ensure that the duties delegated by it to PASA are carried out in the correct manner with the correct governance. The National Payment System Department also ensures that proper governance is being applied to all PASA members. 2.2.1.5 The Reserve Bank recently published its Vision 2010 which sets out a framework for how the National Payment System should be structured and operate in the future (more details are provided on this in section 3.11.) 2.2.2 2.2.2.1 PASA As noted above, Reserve Bank has recognised the Payments Association of South Africa (PASA) as the payment system management body, authorised by the National Payment System Act to manage risk in the National Payment System through co-regulation of its member banks. Hence PASA has management oversight of the National Payment System through authority delegated by the Reserve Bank. The
National Payment System Act provides for the Reserve Bank to withdraw the recognition of a management body, nominate more than one management body or to retain this management within the Reserve Bank should it so desire. 2.2.2.2 PASA, under the supervision of the Reserve Bank, is responsible for facilitating the introduction of PCH agreements and has introduced agreements pertaining to settlement, clearing and netting. PASA must allow all persons who meet PASAs access criteria to participate in the National Payment System. The criteria set must be fair, transparent and equitable. 2.2.2.3 PASA Council is responsible for the strategic direction and governance of the Association. Not only does the Council represent the interests of the members but it also bears the responsibility of ensuring an efficient, reliable and stable payments environment to serve the economy and people of the country. 2.2.2.4 The PASA Council is constituted of the chairperson as well as representatives of: 2.2.2.4.1 the five Association members (banks) with the highest throughput, as a product of value and volume cleared through the inter-bank systems during the previous year; 2.2.2.4.2 two Association members elected by the rest of the members (commonly referred to as the Smaller Banks); and 2.2.2.4.3 2.2.2.5 the Reserve Bank (non-voting). The PASA Executive Office (PASA Exco) manages the day to day risk management / administration functions and ensures the effective management of the payment clearing operations between banks and the operators so as to minimise the systemic risk impact of the National Payment System as a whole.
2.2.3 2.2.3.1
PCHs Payment Clearing Houses (PCHs) are arrangements
governing the clearing of payment instructions between parties for a particular payment stream (e.g. cheques, credit cards etc). PCHs are all founded on a principle of centralised operators providing connectivity and switching of transactions between all banks participating in a particular payment stream. (Using a centralised approach brings considerable benefits including access to new entrants and this issue is discussed further in section 3.9.8). 2.2.3.2 2.2.3.2.1 The PCHs undertake a number of roles as they: manage clearing practices of banks through PCH agreements and clearing rules; 2.2.3.2.2 2.2.3.2.3 2.2.3.2.4 set standards; monitor and manage risks; and monitor the performance of operators to ensure efficient and secure payments exchanges. 2.2.3.3 The PCH Agreement is supported on a more detailed level by PCH Clearing Rules that establishes the operational rules regulating participation. This is in keeping with key principles supporting sound governance which requires that participants have access to relevant information concerning the risks to which they are exposed and are able to take actions to manage those risks. 2.2.3.4 A PCH and its operations are managed by a committee of representatives of the participating banks as a PCH Participant Group (PCH PG). Participation and decision-making takes place on an equal basis with every member having one vote. Decision-making is therefore not linked to the volumes of any particular member within the PCH. The PCH PG bears responsibility for the effective functioning and risk management of the payment streams that falls under its
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responsibility. In some instances more than one PCH, such as Electronic Funds Transfers (Debit and Credit), is managed by a single PCH PG. 2.2.3.5 Any two or more PASA member banks may elect to create a new payment clearing house with the approval of PASA Council. The PASA Council will consider whether or not such new payment streams could be accommodated in an existing PCH (since this could be more efficient). Any PASA member can join any PCH at any time access is in no way limited to the founding members of a PCH (see section 3.9.8 below). 2.2.4 2.2.4.1 PCH System Operators The rules of PASA allow for Payment Clearing House System Operators (PCH System Operators) to perform the role of switching payment transactions i.e. they are responsible for clearing and calculation of payment obligations on behalf of banks. In doing this the PCH System Operators must adhere to standards set by Reserve Bank, PASA and PCHs including ensuring business continuity in interfacing with operators and the Reserve Bank. The Reserve Bank, in conjunction with PASA, approves the PCH System Operators. The ownership, control and governance of PCH System Operators differs according to each entity. 2.2.4.2 There are a number of different PCH System Operators that are active in different PCHs including: Bankserv; Visa; MasterCard and STRATE. Since the FEASibility report Detailed expressed most interest in Bankserv, the role of Bankserv is considered in more detail in section 3.9.8. information on other PCH System Operators is not provided in this annex (since many of them do not appear to be relevant to the current Enquiry) although information can be provided if required. 2.2.4.3 In addition to these operators is the South African Multiple Options Settlement System (SAMOS), which is owned by the
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SAR Reserve Bank B and operated by the National Payment System Department. Final and irrevocable interbank settlements for all domestic transactions are facilitated via SAMOS, as well as all forex transactions via continuous linked settlement (CLS). In addition, all customer transactions that are above the PCH limits, or else customer transactions designated as such, are processed (cleared and settled immediately) via SAMOS. 2.2.4.4 The Reserve Bank, in conjunction with PASA and the PCH System Operators, conducts an annual review of the National Payment System to ensure the systems used continue to deliver the highest levels of safety and efficiency. 2.2.5 Providers of payment services and system operators The final set of participants in the National Payment System are those firms that use the National Payment System functionality in order to offer payment services to end customers. These providers will then compete with each other in order to offer services for end customers or merchants. As in other markets, such competition might be expected to lead to cost efficiencies and innovation over time. Some of these providers are banks although other firms can also gain access to the National Payment System as explained in section 3. 2.3 2.3.1 Different payment instruments As highlighted above there are different PCHs according to different payment streams or instruments. In the retail environment, these instruments are what most consumers or merchants would consider using or accepting when paying for goods or services. These include all instruments used to effect payment between two transacting parties, including legal tender in the form of notes and coins. time. The benefits of these different payment instruments differ and the use of them has changed over
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2.3.2
Electronic Funds Transfers (EFTs) and ATM transactions are now the most common payment instruments. Currently, the share of the volume of all non-SAMOS transactions through Bankserv is approximately as follows:3
2.3.2.1 2.3.2.2 2.3.2.3 2.3.2.4 2.3.2.5 2.3.2.6
EFT over 53%; ATM transactions 17%; Cheques 10%; Credit Cards 11%; Debit Cards 9%; and ZAPS and other smaller PCH's represent less than 0.1% of transactions.
2.3.3
The large share of EFT transactions is even more pronounced in terms of the value of transactions. The share of EFTs has grown each year, so that EFTs now account for approximately 63% of the value of the non-SAMOS transactions with cheques making up 35% of the value of transactions and the value of Credit Cards and ATM transactions, making up around 1% each.
2.3.4
These proportions are by no means stable with cheques in particular declining over time while EFT transactions have increased. The use of credit cards and debit cards has also increased in recent years, although from low levels. For example, in 2002, only 2.2 million debit card transactions were processed through Bankserv whereas by the year ending June 2005, this had increased to 50.3 million.
2.3.5
Payment instruments offer different functionality or associated services, although they are substitutes to some degree because of
These figures are based on information from Bankserv and as such represent only the proportions based on the transactions that they switch. This is likely to underestimate the volume of transactions in both credit cards and debit cards for these payment types. (For example, FNB uses Visa to switch its debit card transactions and Investec uses Visa to switch its credit card transactions.) Data is taken from the Bankserv MPR report for June 2006, which details all transactions for the 12 months ending June 2006. Figures have been rounded to the nearest percentage point.
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the fundamental nature of the instruments to transfer money between parties in the retail area this would typically be from a consumer to a merchant. 2.3.6 From a merchants perspective, they can choose to accept or reject all non-cash payment instruments. From a consumers perspective, they can choose to take out the option to use particular payment instruments e.g. by having a cheque book or by having a debit card. Then on an individual transaction basis, depending on the merchants acceptance of these different payment instruments, the consumer can choose which payment instrument to use on any particular occasion. 2.3.7 Trade-offs between the different instruments arise and from the merchants perspective: 2.3.7.1 Credit cards provide a guarantee of payment and offer value on the same day. The transaction is secure, convenient and efficient, and, because the customer is given credit to purchase the goods and services, may lead to additional purchases being made; 2.3.7.2 Debit cards provide a guarantee of payment and offer value on the same day. efficient; 2.3.7.3 Cheques typically do not provide a guarantee of payment and also have a long clearing cycle.4 In the light of the availability of electronic payment methods, merchants are increasingly rejecting cheques as a form of payment. 2.3.7.4 Cash involves a direct payment and removes any need for guarantees or transfer of value by the issuing bank. However, cash handling involves indirect costs such as the cost of The transaction is secure, convenient and
Bankserv does offer a Cheque Verification Service which would provide a potential lowering of risk, but not a payment guarantee. However, this service is not particularly popular and the volumes are declining. In addition, some customers might have a form of cheque guarantee up to a prescribed limit (such as R2,000 or R3,000 or R5,000) involving details of their credit card number being written on the back of the cheque as well as using the credit card for signature verification.
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counting/recounting, loss from stealing and human error, transportation, storage, and security costs. 2.3.8 The overall value of these different options to the merchant will also be determined by the price paid for these services where credit card transactions will typically be more expensive than debit cards although the former do offer additional services in comparison to the latter. 2.3.9 Trade-offs between the different instruments also arise from the consumers perspective: 2.3.9.1 Credit cards are a convenient form of purchase as there is no need to carry cash, or cheques. It is widely accepted, secure and has a status association (i.e. MasterCard or Visa) which can also be used abroad. It also provides a customer with a ready source of pre-approved credit. 2.3.9.2 Debit cards are a convenient form of purchase as there is no need to carry cash, or cheques. It is widely accepted, secure and typically has a status association (i.e. MasterCard or Visa) which can also be used abroad. Due to its on-line real-time nature more effective financial management is enabled. 2.3.9.3 Cheques are more convenient and less risky to carry around than cash although they would be more risky than payment cards. 2.3.9.4 Cash is free at the point of sale (although costs may be incurred in accessing the cash) and is useful for low value payments. However, time costs are incurred because of the need to withdraw cash at a branch or ATM and it is not considered safe to carry in large amounts. 2.3.10 The overall value of these different options to the consumer will also be determined by the price paid for these services. For example, credit card transactions will typically incur an annual fee for the card but no transaction charges, whereas debit cards would not have an annual fee, but may incur a transaction fee depending
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on wider pricing issues since debit cards would typically be linked to current accounts. 2.4 2.4.1 Unregulated payments Thus far, consideration has only been given to aspects of the regulated National Payment System. There are however, a number of players that participate in the National Payment System and that do not fall within the ambit of any regulation at present. In essence these are payment systems that operate and exist completely outside the National Payment System. The part of the payment system that is not regulated include the closed payment systems (e.g. store cards), substitute payment products (e.g. cellphone airtime) and a variety of system operators that provide third party payments (e.g. EasyPay). (These issues are considered further within section 3.12 and section 3.13.) The National Payment System Act has been amended to regulate some of these players, but the Reserve Bank needs to finalise Directives that will provide for the detailed regulations. 2.4.2 These forms of payment services compete with payment services which are part of the regulated payment system. In so far as they do not have to comply with regulatory requirements, they have an unfair advantage over those within the regulated system. 2.5 2.5.1 Innovation in the National Payment System Innovation and the ability to find new ways of improving products and processes are often the hallmark of a dynamic and competitive system. This is because competition is an important driver of increased performance and innovation. Competition encourages the adoption of innovation as participants in the market evolve and seek new products and processes in order to flourish. This is indeed the way in which many developments and innovations related to the payment system have contributed to further competition within the payment system. 2.5.2 The tables below provide lists of successful innovations related to the payment system. The tables differentiate between those
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innovations that have been developed on an industry wide basis and those that have been developed by Absa or by Absa in partnership with other providers as opposed to across the whole industry. It is also clear from these tables that Absa has played an important role and has been at the forefront of many innovative developments relating to the National Payment System.
CONFIDENTIAL Table 1 CONFIDENTIAL Table 2 2.5.3 As innovation is a dynamic process, sometimes characterised by failure, information has also been provided regarding innovations that failed as well as those that have been found to be successful. These initiatives are just as much part of the competitive process as successful ones. This also helps to identify the fact that the payments system should not be seen as a static environment or one in which profitability or market share gain is guaranteed. Again the tables differentiate between those innovations that have been developed on an industry wide basis and those that have been developed by Absa or by Absa in partnership with other providers. CONFIDENTIAL Table 3 CONFIDENTIAL Table 4 2.5.4 The beneficiaries of these payment system innovations are two fold: 2.5.4.1 First, competing service providers and participants in the payment system benefit as they have improved ways in which transactions maybe facilitated. Some innovations have also facilitated access by non-bank participants to the payment systems (for example, the service providers for the AEDO and NAEDO initiatives discussed below). 2.5.4.2 Second, consumers and merchants benefit as they have access to a wider choice of payment instruments and hence more and efficient ways in which they may make and receive payment. For example, Absa, Capitec and FNB are the first
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banks to offer cross-bank real time clearing for either person to person payments or business to business payments. 2.5.5 2.5.5.1 (N)AEDO The most recent example of a successful innovation that relates to the payment system is the development of an authenticated early debit orders (AEDO) PCH and a non authenticated early debit orders (NAEDO) PCH. The development of these PCHs arose from the concerns of microlenders regarding the priority of transactions in debit orders and the requirements in the National Payment System Act. 2.5.5.2 In particular, there was concern that when debit orders were processed, those that are processed first on a particular day (when salaries were paid in) would get paid from a client's account, but those that were processed later on that day would not get paid (because the money would already have been paid out or withdrawn at an ATM) as all the funds in the client's account would have been depleted. In these circumstances, those who are due to receive the payments would clearly prefer to be the first set of transactions that are processed. 2.5.5.3 Concern arose because some firms were able to receive priority in the ordering of transactions being processed. Partly in response to this, the AEDO and NAEDO systems were developed which allow beneficiaries equal opportunity in the collection of payments i.e. they effectively introduce randomisation into the system in order to ensure that no institution has priority over others.5 2.5.5.4 AEDO works as follows: When a customer decides to enter into a credit agreement (for example, with a furniture retailer, micro financier or insurer) the contractual obligations placed on the customer, specifically in terms of the minimum repayments
In terms of section 6A of the National Payment System Act, as of 1 July 2006, a person may not change, manipulate, maintain or apply a payment system in any manner that provides preferential treatment to a payment instruction over any other payment instruction in that system, unless such preferential treatment is prescribed by law.
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and payback period, are captured electronically and authorised by the customer, after checking the captured information for correctness by swiping his or her ATM or debit card through the AEDO terminals adjoining keypad. 2.5.5.5 The customers card details, PIN and contractual payment information are then forwarded in a secure format to the customers bank, which verifies the authenticity of the transaction from the card and PIN data received. Authentic transactions are registered on AEDO for future payment. Transactions which are rejected are relayed back to the payment collector. 2.5.5.6 On the applicable dates, AEDO presents the previously authorised payment instructions for processing, directly after the transmission of bulk salaries. Confirmation of the payments success, or otherwise, is distributed to the relevant payment collectors soon thereafter. In the event of non-payment of any one of the payments on the pre-designated date, a message is relayed to the payment collector, who is then able to follow-up with the customer directly. 2.5.5.7 NAEDO uses a very similar process although it does not require authentication before submission for clearing. 2.5.5.8 Despite the fact that the early debit order transactions constitute only 0.069% of total transactions through the payment system, these switches were developed in order to assist with the randomisation of debit orders. The benefits to the institutions using these switches include improved daily cash flow and ease of operations. AEDO and NAEDO are clear examples of how non-bank institutions such as the service providers offering terminal and transaction processing services to micro-lenders have been able to gain access in a National Payment System accepted manner to the payment system through this innovation and the micro-lenders receive an improved service from banks that suits their needs.
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3. 3.1
Access to the National Payment System Access to payment services is an important issue in the provision of banking services. It has been raised within the Terms of Reference to the Enquiry and was highlighted as of particular interest by the Technical Task Team of the Competition Commission during a meeting with Absa. This section therefore seeks to provide information on the different parts of the payment system, the varying requirements regarding access and the developments that are underway to widen access in different areas.
3.2
As a precursor to assessing the issues underpinning access to the National Payment System, it is important to understand what is meant by access. In this section access to the payment system refers to access for participants (bank and non-bank) who provide payment services. Consumers and merchants benefit from access to approved payment system services through the use of various payment instruments (for example debit cards and cheques). As is explained below it is clear that participation in the payments system as a whole is primarily driven by normal business related considerations, rather than as a result of any unreasonable or unnecessary barriers caused by industry activities or structures.
3.3
In respect of the Payment Clearing Houses we note that these are centralised systems governing the clearing of payments instructions between parties. As centralised systems, these allow for easy access for new entrants since access is to a single centralised switch avoiding the need to make arrangements with all other banks in the system. Furthermore, prices offered by PCH System Operators are generally cost based and in some cases there is additional competition through having a choice of operator in a particular PCH.
3.4
In an international context it is important to note that access to the South African National Payment System is believed to be considerably easier than access to payment systems in other countries. Indeed, before Barclays purchased its controlling stake in Absa it had obtained access to the National Payment System. It was Barclay's experience that the process of obtaining access to the South African National
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Payment System was straightforward in comparison to that in other countries. Barclays has obviously had considerable experience in this regard, given its global presence. 3.5 In addition, while there are many firms participating in the payments system through direct access, participation also arises on an indirect basis through sponsorship and agency arrangements. These arrangements provide a low cost method of participating in the National Payment System without the need to incur the full costs associated with direct membership. When considering access to payment systems, it is important to understand the various different levels of the payment system since the requirements differ at the various stages. 3.6 In all areas of access to the National Payment System, the Reserve Bank has stated its intention to ensure that access is fair and transparent with the criteria for access aligned with international best practice.6 In part this will include enabling wider access for participants by providing for different categories of participation, publishing information for new participants in the payment system and disclosing entry criteria and other regulatory requirements for participants.7 3.7 Developing a National Payment System which enables access to its infrastructure on a fair, equitable and transparent basis is an ongoing and dynamic process. In particular, technological developments and innovation in different payment instruments will inevitably mean that access is a dynamic issue. Recent regulatory changes in the form of the Dedicated Banks Bill and the Co-operative Banks Bill are expected to have a significant improvement on access to the system going forward. 3.8 Furthermore, as payment systems develop into the future, the interoperability of payment systems across countries is likely to become of greater importance. Thus it is important not to take action in this area in a way that would jeopardise future developments and the potential for additional competition to arise either from greater integration across the Southern African Development Community or elsewhere.
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This is also explained in the National Payment System Act. The National Payment System Framework and Strategy, Vision 2010, South African Reserve Bank, 2006, p10
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3.9 3.9.1
Direct access to the National Payment System The diagram below provides a graphical representation of the entire payment system.
Figure 1: Overview of the Payment system
Settlement
Source: Absa 3.9.2 The centre comprises the activities of Settlement and Clearing, with the next area being the core payment services (i.e. open payment systems such as EFT and cards). According to the National Payment System Act, these three components are the functions of registered banks as payment facilitators. There are no restrictions on providers outside these areas and broadly speaking, services can be offered by any firm at present and do not need to conform to any particular regulations.8 3.9.3 It is a principle followed by most countries in the world that clearing and settlement should be undertaken only by institutions that are registered banks. This is because of systemic risk issues that arise and therefore the need to ensure that these functions are subject to
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At present services outside the central three rings can be offered by any firm without meeting regulatory restrictions. However, the National Payment System Act provides for the Reserve Bank to issue Directives governing these areas at which point the payment services would need to meet any requirements specified. Criteria for the authorisation of system operators are in draft form at present, as they have not yet been authorised by the Reserve Bank.
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very stringent regulatory requirements. In addition the functions towards the outside could be seen as being dependent on functions closer to the centre. Hence it is appropriate that regulatory requirements are greater for those functions closer to the centre. 3.9.4 The centre is closely regulated by the Reserve Bank National Payment System Department, through PASA. The outer two circles represent the areas where providers of value-added services compete and where the markets served by the providers and the banks themselves are located. Examples include bureaux, retailers offering banking services, bill payments or other value-added banking services, such as cashback at point of sale, store cards, gift vouchers etc.9 3.9.5 Access criteria vary depending on the portion of the diagram that is under consideration with regulatory requirements broadly increasing towards the centre of the diagram and reducing towards the outside. As discussed above, this is appropriate due to the increased systemic risk from the activities closer to the centre. The diagram also highlights the fact that access to the payment system is possible at various levels. In practical terms many players are able to gain access to, and hence participate in, the payment system at outer levels which enables the provision of a great deal of functionality of payment services without necessarily fulfilling the criteria necessary to gain access to the central domain. 3.9.6 3.9.6.1 Access to clearing and settlement In terms of access to the central component namely clearing and settlement, there are a number of conditions that must be fulfilled including: 3.9.6.1.1 A participant must be a registered bank. The National Payment System Act provides that clearing and settlement is the domain of registered banks. The requirement in terms of the National Payment System Act is in accordance with international best practice and is
9
Bureau services refer to the collection, processing and batching of EFT Debit Orders.
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fundamental for a sound national payment system, as it enables counterparty risk to be contained to acceptable levels.10 The requirement to be a registered bank is not considered to be either unreasonable or to reduce the number of potential participants unduly. There are large numbers of registered banks in South Africa and it is also easy for foreign banks to gain entry as Barclays found in the past. At present there are 21 different banks that are members of PASA .11 3.9.6.1.2 The participant must have a settlement account at the Reserve Bank (namely a SAMOS account). Since the Reserve Bank is the banker to the banks and is responsible for the settlement of all cleared transactions, all banks who wish to clear and settle in their own name in the National Payment System are required to have a settlement account at the Reserve Bank. This is necessary in order to facilitate the actual settlement of positions between the banks in a manner that will always be acceptable to all banks. This requirement does not impose additional constraints over and above the requirement to be a bank. All SAMOS costs are fully recovered from the participating banks (although the SAMOS system is run and managed by the Reserve Bank). Only banks, a designated settlement system operator (in this case the CLS System) and the Reserve Bank itself may participate in SAMOS. 3.9.6.1.3 The participant must have specialised skills and processing capabilities. The payments clearing and settlement environment is a specialised environment and given the important nature of central functions it is
10
11
The requirement to be a bank brings with it various restrictions set out in the Banks Act (Act 94 of 1990) regarding entry costs and requirements with which any institution must comply with before it may carry on the business of a bank. It is therefore important to note that changing some of the access requirements within the National Payment System does not fall within the ambit of the payments environment alone, but is regulated by the Banks Act. Note that this excludes Albaraka Bank which currently has provisional membership of PASA while it awaits supervisory approval by the Reserve Bank.
24
essential that only those institutions that have the requisite skills gain access to ensure that the necessary standards are fulfilled. If a new participant does not possess the necessary skills, existing members are available to mentor new entrants into the National Payment System. More details are provided on this in section 3.10.5. 3.9.6.1.4 The participant must make the necessary investment in technology. The investment in technology, and specifically the technology that supports payment clearing and settlement operations, is an essential part of providing payments services. Interoperability is key, and stringent and prescribed standards across the industry are necessary. This eliminates costly processing within each bank, in payment system operators and across the industry as a whole, resulting in efficiencies and cost reduction to the benefit of all participants. Outsourcing of clearing has become more popular over time (see below). 3.9.6.1.5 Operator certification and interbank testing. All
systems must be certified with an PCH System Operator (for example, Bankserv). This is vital as any operational risk that may be introduced into the system will originate at this point. Processes are in place for testing with the operator and the other banks. month period required for This includes a three live data testing and
modifications to existing systems to accept transactions from new participants). These processes are essential to ensure the continued, reliable operation of the National Payment System and the reduction of systemic and operational risks within the National Payment System. 3.9.6.1.6 Risk, operational must and meet liquidity risk and management interoperability
structures must be in place. infrastructure
The participants
standards and proper Disaster Recovery and Business
25
Continuity plans, systems and procedures must be in place. 3.9.6.1.7 Financial and capital costs must be sufficient to ensure the safe, efficient and ongoing participation of banks in each of the payment streams and initiatives within the industry. In respect of the capital costs these are the same as those set out in the Banks Act and therefore do not impose any additional constraints. 3.9.6.2 The criteria set out above apply only to clearing and settlement and not to access to the whole of the payment system. As explained below, there are many entities actively participating in the payments system that do not fulfil the above criteria. Whilst this means that they cannot participate in clearing and settlement, they are able to participate in the wider payments system and thus avoid the costs associated with this level of participation. 3.9.6.3 3.9.6.3.1 Outsourcing of clearing arrangements As noted above, the outsourcing of clearing arrangements has become more popular over time and is now commonplace. This involves using a service provider This specialising in interfacing with clearing operators rather than banks having to do this themselves. outsourcing is properly understood as technical At no
outsourcing for IT and transactional purposes and is focused on the ability to process transactions. stage does a financial transaction go to, or through, the outsourcing company. Furthermore, the bank retains the responsibility for the transaction in the payment system.12
12
The service provider acts as a system operator as defined in the National Payment System Act. A system operator is a person, other than a designated settlement system operator, authorised in terms of section 4(2)(c) to provide services to any two or more persons in respect of payment instructions. Section 4(2)(c) empowers PASA to authorise a person to act as an system operator in accordance with criteria approved by Reserve Bank. PASA has developed such entry criteria, which include financial, operational, technical, legal and contractual, risk and reporting requirements. The services provided by a system operator to
26
3.9.6.3.2
The ability to outsource assists new entrants in regard to standards and interoperability since they do not need to make the capital investment required to ensure that these standards are maintained. For example, Direct Transact supports a number of banks such as Ithala, African Bank, Theba, Standard Chartered, Rennies, First National Bank and Absa. In the case of Absa, Direct Transact is only used for the gift cards. It is also understood that only a portion of FNBs services are outsourced to Direct Transact. In the case of Ithala, Direct Transact processes all transactions for clearing.
3.9.6.3.3
The ability to outsource these arrangements further increases the competitive nature of the National Payment System. This arises partly because new entrants can more easily participate without needing to invest in infrastructure (this was believed to be the case for Ithala). It also ensures that incumbent providers have to keep reducing costs in this part of the process in order to remain competitive with the outsourcing providers. Indeed, the potential for incumbents to outsource if this becomes cheaper also ensures a low cost functioning of the payment system.
3.9.7 3.9.7.1
Access to PASA Part of gaining access to clearing and settlement involves obtaining access to PASA. Membership of PASA is open to entities such as banks, mutual banks or branches of foreign banks.
3.9.7.2
The Reserve Bank has recognised the Payments Association of South Africa (PASA) as the payment system management body, authorised by the National Payment System Act to manage risk in the National Payment System through self regulation of its member banks. Hence PASA has
any two or more persons in respect of payment instructions, include the delivery to, and/or receipt of, payment instructions from a bank and/or a PCH System Operator.
27
management oversight of the National Payment System through authority delegated by the Reserve Bank. The National Payment System Act provides for the Reserve Bank to nominate more than one management body or to retain this management within the Reserve Bank should it so desire. 3.9.7.3 Access to PASA is inextricably linked to access to clearing and settlement as well as access to PCHs (discussed below). That is, it is not possible to have access to clearing and settlement, or to a PCH, without also having access to PASA. three elements always go together. 3.9.7.4 As part of the access requirements for PASA, additional conditions need to be fulfilled including: 3.9.7.4.1 Payment of membership fees to participate in various industry structures. All banks who participate in the National Payment System pay membership fees to PASA according the volume and value of their transactions. These fees are to pay for central overheads and to ensure that the industry has the correct infrastructure, staff and systems to keep systemic and other risks within the National Payment System to a minimum. The PASA Executive Office is a self regulatory association funded entirely by its members. To ensure that all costs are covered, members are required to pay for all costs associated with their connectivity to the PCH system operators (such as testing and processing costs for each stream). 3.9.7.4.2 Membership of at least one Payment Clearing House (PCH). Banks are not allowed to be a member of PASA unless they are also a member of at least one PCH, and banks can not be a member of a PCH without being a member of PASA. All PASA members are members of the Immediate Settlement Payment Service which is operated by SAMOS. These
28
3.9.7.5
As with access to clearing and settlement, membership of PASA is limited to banks and to those who have the right to clear and settle within SAMOS. As explained above this is because of the systemic risks associated with the payment system.
3.9.8 3.9.8.1
Access to Payment Clearing Houses Access to a Payment Clearing House (PCH) is conditional on the applicant being a member of PASA and having a clearing agreement with all banks that are members of the PCH. As such all of the requirements listed above regarding access to clearing and settlement arrangements also apply here. fulfilled including: In addition to that there are a number of criteria that need to be
3.9.8.1.1
Approval by existing members. In order to ensure payment to the ultimate customer can always be made, each participant in a payment clearing house (PCH) is exposed to every other participant in respect of settlement failure in each PCH. Therefore each applicant is required to get a letter (willingness to trade and accept the additional risk into the existing PCH) from each existing participant. In turn, all banks are required to get credit approval for the additional risk exposure. This is because the PCHs are set up on a survivor pays model, so as to ensure that settlement takes place. On a practical level, approval by members has proven to be a mere formality. Once an entity has qualified through the Reserve Bank for a banking licence and has fulfilled the requirements in terms of the Banks Act, this effectively eliminates any possible concerns in respect of National Payment System entry. No new entrant has ever been refused access by an existing participant on this basis. equitable. In any event the rules for the PCH require admission to be fair and
29
3.9.8.1.2
Payment of membership fees. There are a number of fees that are due including: An application fee of R6,000 excluding VAT is payable on application to a PCH to cover the costs associated with the administration and staff time to assist new entrants in completing the relevant applications for membership to one or more PCH; and An exit fee of R6,000 excluding VAT is payable on termination of a banks PCH membership; Ongoing (annually payable) fees apply for each PCH of which the bank is a member.
3.9.8.1.3
Any two or more PASA member banks may elect to create a new payment clearing house with the approval of PASA Council. PASA Council will consider whether or not such new payment streams could be accommodated in an existing PCH (since this could be more efficient). Any PASA member can join any PCH at any time access is in no way limited to the founding members of a PCH.
3.9.8.1.4
Different PCHs exist for different payment types and individual banks do not need to join all of the PCHs. (If they do not join any of the PCHs they would not be able to be a member of PASA.) Figure 2 below provides a table of the PCH System Operators together with the participating, or member banks.
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30
Figure 2: PCH membership

Electronic Credit Payment ZAPS 1 1 1 1 (1) (1) Cancelled 1 Cancelled 1 1 1 1 1 1 Cancelled 1 1 1 1 1 Cancelled 1 Cancelled Cancelled 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 (1) 1 1 (1) 1 1 (1) 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 Cancelled 1 Cancelled 1 1 1 1 1 1 1 1 Cancelled 1 Cancelled 1 1 1 1 1 1 (1) 1 1 1 1 1 Cancelled 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 (1) (1) 1 1 PIN Validated Electronic Debit (ATM) CLC Debit (New) Cash Settlement
Member Banks ABN Amro NV Johannesburg Branch ABSA Bank Limited African Bank Limited Albaraka Bank Limited Barclays Bank PLC South Africa Branch Calyon Corporate and Investment Bank South Africa Branch Capitec Bank Limited Citibank NA South Africa FirstRand Bank Limited Habib Overseas Bank Limited HBZ Bank Limited Investec Bank Limited Mercantile Bank Limited Nedbank Limited Peoples Bank Limited Rennies Bank Limited Saambou Bank Limited (terminated 1/4/04) Societe Generale Johannesburg Branch South African Reserve Bank Standard Chartered Bank Jhb Banch State Bank of India South Africa Branch Teba Bank Limited The South African Bank of Athens Limited The Standard Bank of South Africa Limited
No of PCHs 4 17 10 (3) Cancelled 1 9 7 16 5 5 6 13 16 Cancelled 5 Cancelled 2 5 5 2 8 12 16
Immediate Settlement 1 1 1 (1) (1) 1 1 1 1 1 1 1 1 1 Cancelled 1 Cancelled 1 1 1 1 1 1 1
Paper Credit
EFT Debit 1 1 1
EFT Credit STRATE 1 1 1 1
BESA
Debit Card Credit Card
NuPay
RTC
AEDO
NAEDO
MMT
1 1 (1)
1 1
1 1
1 (1)
1 (1)
1 1
Sponsorships Ithala Postbank 1 1 1 1 1 1
31 3.9.8.2 It is clear from this table that banks choose the particular PCH in which they wish to participate and that certain banks have chosen to belong to different PCHs illustrating that banks are able to successfully conduct their business by choosing to participate in only certain PCHs. In part this reflects the different business models adopted by the various banks regarding offering retail banking services and thus not all banks would wish to enter the PCHs for retail payment instruments. 3.9.8.3 However, to the extent that different retail payment instruments compete with each other, it would not be necessary to participate in all PCHs related to retail payment instruments. Indeed, it is worth noting that the larger banks are not all members of all of the same PCHs. For example, First National Bank and Nedbank are not members of Nupay and Standard Bank is not a member of RTC. 3.9.8.4 3.9.8.4.1 Centralised switch PCHs represent a centralised system enabling the clearing and settlement of payments across different providers. In the past, banks in South Africa decided to invest in a central switch to facilitate more effective and efficient switching so that economies of scale in this function could be maximised. In other countries, banks might link directly to each other in a direct access network model (which is the situation in Australia). 3.9.8.4.2 It is clear, however, that the larger the number of participants in the payment system, the more complex, inefficient and uncontrollable the direct access model becomes. Hence the direct access model is typically only feasible where there are only a very small number of banks. 3.9.8.4.3 A centralised approach therefore has very strong advantages. Indeed in payment systems globally, a
32 centralised system has generally been preferred by competition authorities (for example the Irish Competition Authority expressed concerns about the use of direct bilateral arrangements for clearing in Ireland and the European Commission has also expressed concern about bilateral arrangements in those countries where these are used). 3.9.8.4.4 In particular, a model which has a central switch makes it easier for new entrants to access a particular payment stream since access only needs to be obtained to the central switch rather than to each and every individual bank. Access to this one central switch then enables firms to offer transaction services to customers. In the case of South Africa, the relevant PCH Operator also assists them in the technical process of linking up, as well as sharing the rules and certifying them. 3.9.8.4.5 In addition, operating via a central switch offers several other advantages including: 3.9.8.4.5.1 Gains from economies of scale as fixed costs are shared across more transactions and more efficient technology can be used; 3.9.8.4.5.2 Ensuring the best possible security standards including Disaster Recovery and Business Continuity Plans, thereby assuring stability and reliability; and 3.9.8.4.5.3 Enabling the easier adoption of new innovation, sharing of costs and adoption of new standards as well as ensuring interoperability between all providers. 3.9.8.4.6 Furthermore, the use of centralised PCHs with
interoperability is likely to lead to wider acceptance and usage of a particular payment instrument.
33 3.9.8.5 Sorting-at-source Sorting-at-source has gained new focus as an issue in recent years. Sorting-at-source appears to be unique to South Africa and is the process whereby institutions sort or regroup payment instructions with the purpose of submitting the payment instructions directly to the banks holding the respective accounts of the payers. As such, it is the equivalent of clearing by a non-bank (if the BIS glossary definition is used), while it has the effect of bypassing the regulated interbank clearing process (including the PCH and the designated PCH Systems Operators). For a number of years now, the Reserve Bank has consistently indicated that it was opposed to the concept of sorting-at-source and consequently imposed a moratorium on the practice in December 2003. Although the Reserve Bank appears to have rescinded the moratorium placed on new sorting at source, the legal position remains unclear. However, Absa's understanding is that the Reserve Bank still remains averse to arrangements that allow for the by-passing of the clearing system. 3.9.8.6 3.9.8.6.1 PCH System Operators Payment Clearing House System Operators perform the role of switching payment transactions i.e. they are responsible for clearing and calculation of payment obligations between different providers of payment services. In doing this the PCH System Operators must adhere to standards set by the Reserve Bank, PASA and PCHs including ensuring business continuity in interfacing with operators and the Reserve Bank. 3.9.8.6.2 There are a number of entry requirements that are in place in order to act as a PCH System Operator including those related to financial, pricing, service, managerial, operational, legal, and risk elements. These requirements are set by PASA and the PASA members and are approved by the Reserve Bank. Since the focus of the
34 current Enquiry is on retail banking, we do not examine in any further detail the access conditions for the PCH System Operators themselves. 3.9.8.6.3 Within the payment system there are a number of different PCHs each of which have operators which are able to undertake the switching services. The following PCH System Operators have been licensed by PASA: SBV cash; Bankserv EFT, CLC, Credit Cards, Debit Cards, ATM transaction switching, AEDO/NAEDO, NuPay, Mzansi Money Transfer; VisaNet Credit cards, Debit Cards, Pre-Paid Cards, Visa Travel Money (Visa is also able to switch EFT transactions although at present the necessary testing has not occurred since Visa does not appear to have any customers for EFT services); MasterCard Network Credit Cards, Debit Cards, Pre-Paid Cards; 3.9.8.6.4 STRATE Bond Exchange, Equities Exchange;
In addition to these is the South African Multiple Options Settlement System (SAMOS), which is owned by the Reserve Bank and operated by the National Payment System Department. Final and irrevocable interbank settlements for all domestic transactions are facilitated via SAMOS, as well as all forex transactions via CLS.
3.9.8.6.5
The FEASibility report highlighted the role of Bankserv in respect of retail payments and hence we focus on Bankserv in the considerations below regarding pricing arrangements and competition between PCH System Operators.
35 3.9.8.7 3.9.8.7.1 Pricing arrangements by PCH System Operators In connection with pricing, the domestic PCH System Operators ensure that their pricing is fair and transparent and PASA does not encourage any undisclosed crosssubsidisation.13 In addition it must ensure that clearing services are available to all member banks on identical price structures. 3.9.8.7.2 For example, in the case of Bankserv, prices are cost based allowing for a small profit margin. These profits are typically reinvested in Bankserv in order to continually improve the services offered. While the prices to individual firms will differ according to the volume of their transactions, the main aims when setting prices are to: reduce extreme year-on-year price fluctuations; allow for funding of new projects or upgrade of systems without needing to resort to borrowing from shareholders which may cause delays in innovation; ensure that fees remain competitive with alternatives such as Visa, MasterCard, SWIFT or switching directly; and ensure that all customers are charged on a similar basis. 3.9.8.7.3 This last point is important to note. There are
considerable economies of scale in the processing of transactions and hence those banks that have large volumes of transactions would receive lower prices than banks that have small volumes of transactions. However, the cost curve that is used is the same for all banks. In particular, there is no differentiation in prices charged to
13
Although PCH System Operators are required to limit cross-subsidies, as global operators, Visa and Mastercard can not be policed. The South African transactions would be a small proportion of transactions that they switch. In addition, when new PCHs are in start-up phase there may be some cross-subsidy in their favour before they become established.
36 the main shareholders compared to other providers other than because of the volume of transactions. 3.9.8.7.4 In addition, dividends are only paid to shareholders on an irregular basis depending on the investment plans and any surplus money that is not required for investment. However, since such dividends would be taxable and given that the major shareholders are also the major customers, these dividends are typically minimised in favour of lower prices being achieved for services. 3.9.8.7.5 Furthermore, although considerable attention seems to have been placed on the pricing arrangements of PCH System Operators, it is important to note that the prices of switching services represent only a very small cost of offering payment services. services was very small indeed, Private ownership of the switch does not appear to Indeed the report by FEASibility correctly identified that the cost of Bankserv
be the primary cause of high bank fees the switch fees appear in most cases to be insignificant cost items relative to bank revenue. In the long term, disruption of this essential infrastructure through ownership directives may dissipate that which contributes to SWAP and efficiency in the system, even though it may provide some short term consumer satisfaction. The proliferation of a number of proprietary systems as an alternative to Bankserv would not necessarily lead to lower prices if it had a negative impact on efficiency.14
3.9.8.7.6 The cost-based pricing approach that is used by Bankserv, alongside the benefits of having a centralised switch in order to facilitate access to the PCH by new entrants provide strong support for the continuation of the existing approach. Furthermore, given the very small cost represented by Bankserv, any changes to this part of the National Payment System would be expected to have an
14
The National Payment System and Competition in the Banking Sector, FEASibility, March 2006, p31.
37 insignificant effect on the prices charged to end consumers. 3.9.8.7.7 In addition to the transaction fees, Bankserv also applies a fixed fee to banks. In the past the Reserve Bank expressed concern about these fixed fees regarding the impact on new entrants and smaller banks. In response to this Bankserv implemented a tiered structure such that smaller banks pay only 25% of the fixed fee that is paid by the larger banks, with this proportion increasing as their transactions increase. Hence the Reserve Bank is understood to keep a careful watch on the prices charged by Bankserv which has also taken steps to prevent small banks from being discouraged from entry. 3.9.8.8 3.9.8.8.1 Competition between PCH System Operators In some PCHs (although not all of them) individual banks have a choice of PCH System Operator and hence additional competition arises through the choice of PCH System Operator for a particular service. In these cases, should any of the PCH System Operators prove to be cost inefficient, alternatives therefore exist to which banks can direct their routing instead. 3.9.8.8.2 This is illustrated in the case of debit and credit cards where the issuing bank has the choice of switch for the processing of transactions between acquiring and issuing banks. More specifically, banks have the option of using Bankserv, Mastercard or Visa. There are no differences between the three PCH System Operators as to the guarantees to customers. 3.9.8.8.3 For cards issued under MasterCard or Visa, the default option is that switching would take place through their switch. However, it is common to preload a Bank Identification Number (BIN) on Point of Sale terminals to allow these transactions to be switched through a different
38 operator depending on the preferences of the issuing bank. The majority of South African banks, including Absa, use Bankserv to switch these transactions rather than using MasterCard or Visa. This is because Bankserv represents a less costly option for the reasons explained below: In contrast to VisaNet and Mastercard, which have dollar-denominated transaction charges, Bankserv charges are Rand-denominated and hence banks do not take on any currency risk regarding having costs set in dollars and prices set in Rand; and Bankserv is able to pass on an economies of scale and scope benefit to banks because its transaction charges are based on all transactions switched, not just credit or debit card transactions. Thus using Bankserv for these transactions means that prices for other transactions are also cheaper.15 3.9.8.8.4 In addition, while Bankserv currently processes in excess of 1 billion transactions per annum, it is expected that in the future, Bankserv will compete with some of the larger European and other global Automated Clearing Houses. This will give further opportunity to increase volume and drive economies of scale. 3.9.8.8.5 In the case of other PCHs that have only one operator, this is because no other operators have been forthcoming as yet. In principle there would be nothing to prevent As has operators from entering these other PCHs.
already been noted, however, economies of scale are substantial in this area and hence would play a role in determining the business viability of offering such
15
Note that there is a base cost that applies to each payment stream, thus the overall pricing does not involve any cross-subsidisation between payment streams. While the software used differs between the different PCHs, hardware, Disaster Recovery and Business Continuity Plans, management and operational oversight all occurs across the different PCHs for which Bankserv is an operator and hence economies of scope arise as well as economies of scale.
39 services. Apart from this, any two banks have the option of making direct clearing arrangements between each other should they so wish. 3.9.9 3.9.9.1 Summary on direct access In terms of gaining direct access to the payment system, it is seen from the various requirements that, under the National Payment System Act, this is currently limited to banks. This is because membership of Payment Clearing Houses involves systemic risk issues. PCHs are set up using a survivor pays model so as to ensure that settlement will always take place. As such it is vital that members of PCHs meet rigorous requirements to ensure that they do not bring unnecessary risk into the payment system. minimised. 3.9.9.2 Within the PCHs, the PCH System Operators, such as Bankserv, offer switching services to the different member banks. These services are priced in a cost-based manner with prices across the PCHs primarily determined by the volume and value of transactions undertaken. In addition, some PCHs have multiple operators ensuring that prices are kept to a minimum. Furthermore, the overall costs imposed by the PCH System Operators represent only an extremely small part of the end price to consumers for making payments. Thus it appears to be the case that the current functioning of PCHs and the PCH System Operators are in no way either limiting competition between banks to offer payment services for end customers or leading to increased prices for these services. 3.10 3.10.1 Indirect access to the National Payment System The National Payment System Act prohibits anyone, as a regular feature of its business, from accepting money or payment instructions from any other person for purposes of making a payment on behalf of that other person to a third person unless that The regulatory oversight of the Reserve Bank and PASA ensure that systemic risks are
40 person is the Reserve Bank, a bank, a designated settlement system operator, the Postbank or the money is accepted or payment made in accordance with directives issued by the Reserve Bank (no such directives having been issued as yet). 3.10.2 However, while these restrictions are in place, and prevent direct access to the National Payment System, various alternatives are in place to allow for indirect access to the National Payment System. It is important to note that in these circumstances, it is not, in fact, necessary to gain full access to clearing and settlement arrangements in order to participate in payments or to offer payment services to customers. Instead, this can be done through indirect access i.e. through making arrangements with those banks that do have full access. 3.10.3 It is well recognised that access to payment systems on an indirect basis represents a good substitute for direct access since this allows firms to offer payment services to end users. It is therefore important to note that sponsorship arrangements are already possible within the National Payment System and as noted in section 3.11 below, plans are already in place to extend the use of this to other providers through the Dedicated Banks Bill and the Cooperative Banks Bill. Therefore although direct access to the National Payment System is limited to banks, indirect access is already available and hence, it is not clear where access is being unduly restricted, or where a lack of access is preventing other firms from offering payment services to end customers. 3.10.4 3.10.4.1 Sponsorship Sponsorship is a means by which new entrants may gain access to the payment system without having to fulfil the aforementioned entry criteria or incurring the same levels of participant costs. Sponsorship comprises the processing of At present only banks, and the transactions in the name of the sponsoring bank on behalf of the sponsored participant. sponsored access. exempted non-banks, Postbank and Ithala, can obtain
41 3.10.4.2 Sponsorship, therefore, allows banks not wanting to clear and settle in their own name to participate in the National Payment System by entering into a sponsorship arrangement with a direct clearing and settlement member. If the sponsored institution does not think it is receiving a service of high enough value for money, they can always seek sponsorship arrangements with a different institution. of the clearing and settlement system. 3.10.4.3 Sponsorship enables low cost access to clearing and settlement and reduces the time necessary for participation in this part of the payments system since it is quicker to develop a sponsorship arrangement than to invest in the necessary infrastructure to have direct access. In this way new entrants or small banks can gain quick and cheap access to payments. 3.10.4.4 At present there are only 3 sponsorship arrangements in place: 3.10.4.4.1 3.10.4.4.2 3.10.4.4.3 3.10.4.5 MEEG Bank which is sponsored by Absa; Ithala which is sponsored by Absa; and Postbank which is sponsored by Standard Bank. It should be clear that Absa fully supports the use of sponsoring arrangements. Indeed, Absa has never declined a request to act as a sponsor.16 The small numbers of sponsored arrangements partly indicate a lack of demand for this service (as well as the requirement to be a bank) rather than a lack of willingness to offer it. 3.10.4.6 A brief overview of Absa's sponsorship arrangement with the respective institutions that it sponsors is set out below. In addition, the sponsored banks have the option to become direct members
16
Section 6A of the National Payment System Act stipulates that a person providing access to a payment system may not deny a person which meets its criteria (which must be fair equitable and transparent) access to the payment system. This was inserted in the National Payment System Act of 2005.
42 3.10.4.7 3.10.4.7.1 MEEG Bank Limited Absa has a 49.8% equity stake in MEEG. The processing of MEEG's payments is embedded in the Absa systems. This means that Absa performs all the transaction processing, inter-bank as well as to the customer accounts on behalf of MEEG using Absa's infrastructure and systems. This is a unique situation from a South African perspective in that Absa sponsors MEEG's clearing (operational) as well as settlements (financial) in the clearing houses.17 3.10.4.8 3.10.4.8.1 Ithala Limited Ithala does not have a banking licence but has been exempted from the Banks Act in order to allow it to offer deposit taking services. Absa sponsors Ithala for its daily inter-bank settlements (financial sponsorship) as well as its clearing participation by virtue of the fact that it does not have PASA membership. Ithala also issues a Debit Card through a Batch Identification Number (BIN) in Absa's name.18 In addition, Absa provides an informal advisory service for Ithala 3.10.4.8.2 Ithala plays an important role in terms of providing banking services to the rural communities in KwazuluNatal and is currently in the process of obtaining its own banking license but it is anticipated that this process may take some time to complete. In both of these cases, therefore, Absa is offering upstream payments services to institutions that are downstream competitors.
17
18
The Reserve Bank has ruled that MEEG needs to separate its clearing from Absa and this process is underway although it may take several years to complete. This is because in the SAMOS system the Reserve Bank would like to have a view of what the exposures of the various banks are in the National Payment System and settlement system. A dispensation has been created through an amendment to the National Payment System Act whereby institutions which are exempted and excluded via the Bank's Act may become limited members of PASA. However, the criteria and rules for such members have not yet been finalised.
43 3.10.5 3.10.5.1 Mentorship PASA regulations require that a new participant in a Payment Clearing House (PCH) must serve a period of three years under the mentorship of a larger player in that PCH before becoming a full participant. During this time there are no restrictions or limitations on the actions of the new participant as compared to full participants who have been in the PCH for longer. Mentorship comprises the provision of advice, rather than hands-on assistance although it could involve assisting with day to day processing operations and staff training. 3.10.5.2 From the Mentors perspective, this is purely an advisory and support service and it does not bring with it risk or obligations for the Mentor which always remain with the new participant. Absa has been a popular choice as a Mentor and has provided mentorship services to Capitec and Bank of Athens in respect of various PCHs. 3.10.6 3.10.6.1 Agency arrangements Similar to sponsorship arrangements with respect to access to the National Payment System, agency arrangements allow customers of other banks to use the Absa branch network for depositing cash and cheques. 3.10.6.2 Agency arrangements represent another low cost means by which access to the payment system may be facilitated and Absa has agency arrangements with many smaller banks in South Africa. This allows smaller banks (with limited branch networks) and their customers to make deposits at all the Absa branches throughout the country. In turn this allows them to compete more effectively in the market for customers and assists them in receiving deposits that are important for their liquidity. Again it is clear that offering such agency involves providing upstream services to arrangements
downstream competitors.
44 3.10.6.3 Absa has agency arrangements with clearing participants such as Citibank, HBZ Bank, Habib Overseas Bank, Investec Bank, Bank of Athens, Mercantile Bank, Capitec Bank, State Bank of India, Standard Charter, Rennies Bank, Saambou (under receivership) and to some extent the other major South African retail banks. Absa also collects cheques included in these deposits and processes these through the clearing systems on behalf of these banks.19 3.10.7 3.10.7.1 Joint ventures, alliances and outsourcing Joint ventures allow for access to payment infrastructure to be gained through commercial arrangements between existing members of the payment system and other providers who wish to offer payment services to the end customer. In this regard, joint ventures often assist in facilitating a wider choice, acceptance and accessibility to the payment services for customers. Many such joint ventures exist between corporates and banks for payment service provision. 3.10.7.2 This includes the joint ventures between MTN Banking and Standard Bank, Discovery and FNB, Go Banking (Pick n Pay) and Nedbank as well as Virgin Money and Absa. It should be noted that these joint ventures can only be conducted through the creation of a separate division within a bank or under the banking licence of the particular bank. 3.10.7.3 Other alliances also include co-branding and affinity programs for both Debit & Credit Cards and are additional examples of competition such as Woolworths (Mercantile), Clicks (FNB) SAA (Nedbank), Kulula.com (FNB). In addition, the Shoprite Checkers Money transfer product with Capitec is a further example of competition. 3.10.7.4 Outsourcing of clearing services has already been identified, and described, in section 3.9.6.
19
Absa also has Corporate Accounts for the Central Banks of Swaziland and Lesotho, allowing them to trade easily within South Africa.
45 3.10.7.5 All of these options mean that in South Africa many banks along with exempted non-bank participants are able to access the payments system on a competitive basis in order to provide merchants and customers with an array of payment alternatives and on this basis are able to effectively compete in providing payment services to customers. Thus competition in these upstream services encourages and allows competition in the downstream services. Furthermore, with the anticipated changes regarding expanding participant access, the use of sponsorship, mentorship, and agency arrangements would be expected to increase with the introduction of Dedicated Banks and Co-operative Banks. 3.10.8 3.10.8.1 Summary on indirect access Overall, therefore, it is clear that the opportunity already exists for firms to gain indirect access to the National Payment System such that payment services can be offered to end customers. The opportunity for firms to be sponsored by a direct member of the National Payment System means that they can gain the benefits of access to services without incurring all of the costs of investing in the infrastructure that is necessary for direct members in order to maintain a robust payment system. 3.10.8.2 We note that at present there are very few examples of providers being sponsored in the National Payment System but the fact that Absa sponsors both Ithala and MEEG, and that Standard Bank sponsors Postbank indicates a willingness of direct members to offer such services. Indeed Absa is willing to offer sponsorship of payment services despite the fact that the sponsored firms represent competitors with respect to offering payment services to the end consumers. This is because the sponsoring market, despite its small size, is competitive. Furthermore, the fact that the sponsoring market is currently small is taken as evidence that there may be relatively limited demand for other banks to offer payment services as a standalone offering.
46 3.10.8.3 Indeed, Absa is not aware of any entities that want access to the National Payment System and cannot obtain access to it in at least an indirect manner. Considerable effort has already been expended to ensure that reasonable access is available for participants. In addition, as noted below further widening of access is currently underway in order to further encourage the participation of system operators and payment facilitators on behalf of third parties. 3.11 3.11.1 Widening access to the regulated payment system There is considerable effort already being used to widen the current levels of access to the payment system. Encouraging wider access to the payments system helps to ensure technological developments, competition and to maintain an efficient system. Indeed there is much support for efforts directed towards achieving this as evidenced by banks and industry participants assisting in the opening up of the payments system. 3.11.2 The Dedicated Banks Bill and the Co-operative Banks Bill are also expected to lead to increased participation in the payments system as the requirements for registering as a bank would reduce significantly. 3.11.3 In addition widening access was also a focus of the Reserve Banks Vision 2010 document as the market requirements and technological developments that have arisen over the last few years make this increasingly possible. 3.11.4 3.11.4.1 Dedicated Banks Bill and Co-operative Banks Bill The legislature has taken certain steps in order to achieve the objective of widening participation in the payments system. In particular, new statutes including the Dedicated Banks Bill and the Cooperative Banks Bill have been designed. The broad aim of both of these Bills is to reduce the regulatory requirements necessary to become a bank. As this arises and the number of firms that are designated as banks increases, this will have a direct effect on the National Payment System
47 by increasing the number of banks that gain access to the National Payment System. Dedicated Banks and Co-operative Banks will be able to enter the core components of the National Payment System without changes to the regulation in the payment industry. 3.11.4.2 At present the minimum capital requirements to become a bank are set at R250 million. However, the intention of the Dedicated Banks Bill and the Co-operative Banks Bill is to reduce this capital requirement considerably. So-called Tier
2 banks which offer both savings and loans will have a capital
requirement of R50 million and Tier 3 banks that only offer savings will have a capital requirement of only R10 million.20 Both types of banks will be able to offer transactional services. 3.11.4.3 It is very clear that these reductions in capital requirements dramatically reduce the entry barriers for new providers of banking services. As this arises access to the National Payment System is also widened to include these new banks. It is also important to note that even if these banks do not wish to incur the infrastructure costs to gain direct access to the National Payment System, the option of sponsorship will be available to these banks and hence additional indirect access to the National Payment System would be expected. In addition to this the options of forming joint ventures will also remain available to these new banks (as well as to non-banks as is currently the case). 3.11.5 3.11.5.1 Vision 2010 Earlier in 2006, the Reserve Bank published its Vision 2010 document which provides high level strategic guidance for the development of the South African payment system leading up to 2010. Vision 2010 addresses a number of different issues including access to the national payment system.
20
The key
Due to the lower capital requirements these new banks will face restrictions regarding their banking activities such as not being able to offer venture capital, highly leveraged transactions or loans to developing countries.
48 issues underpinning access are - enabling wider access to the payment system for different participants, providing for different categories of participation and allowing different participants to expand within the payment system to gradually increase the extent of their participation in that system. Indeed, the Reserve Bank states that one the challenges up to 2010 is,
to increase the accessibility of the payment system by, inter alia, providing for new types of participants, but at the same time maintaining the safety and efficiency of the payment system by adhering to sound internationally accepted payment system risk principles. It is critical to the safety and efficiency of the payment system to identify and address potential payment system risks (settlement risk, liquidity risk, operational risk, legal risk, credit risk and reputational risk) on a pro-active basis. Increased accessibility by new participants will also facilitate wider usage of the payment system by the public. One of the objectives would be to address further the payment needs of the unbanked community21
3.11.5.2 Therefore, while increased accessibility is a primary goal, it is also necessary to ensure that the safety and efficiency of the payment system is not compromised. 3.11.5.3 Part of the Vision 2010 document includes the aim to include different tiers of banks (including dedicated and co-operative banks) within the functioning of the payment system and these banks would be included in the banks that are able to clear and settle in their own name. As such it is clear that the proposed legislative changes regarding dedicated banks and co-operative banks will give full access to the payment system and these banks will be able to issue payment instruments which access bank accounts.22
21
22
See the Executive Summary of The National Payment System Framework and Strategy, Vision 2010, South African Reserve Bank, 2006. See paragraph 2.4.2.4 of Vision 2010.
49 3.11.5.4 Vision 2010 also makes reference to the availability for banks to use sponsoring arrangements through other banks for clearing and settlement purposes.23 3.11.5.5 Thus, it is clear that the issue of widening access to the payment system is already high on the agenda of the Reserve Bank and that steps are already being taken to facilitate this through the publication of Vision 2010 and the associated implementation. 3.11.6 3.11.6.1 Summary on widening access It is clear that there is already much that is being done to encourage wider access to the National Payment System so that South Africa maintains its position of a world class payments environment. However, when increasing the access to the National Payment System, the systemic risks cannot be ignored. Indeed, this is recognised by FEASibility which states that,
The increasing involvement [of] non-banks may potentially increase risks which could undermine confidence in the system.24
3.11.6.2 Therefore when widening access it is important to ensure equitable access so that all parties are evenly regulated. 3.11.6.3 Clearly the issues of widening access to the payment system and greater transparency within the system are high on the agenda of the Reserve Bank, which has ultimate responsibility for management and oversight of the payment system. Striking a delicate balance between ensuring the safety and efficiency of the system, and broadening access to the system, will no doubt require time and careful management to achieve. 3.11.6.4 It is notable that the Reserve Bank and other members of the National Payment System have already put in place a number
23 24
See paragraph 2.4.2.5 of Vision 2010. The National Payment System and Competition in the Banking Sector, FEASibility, March 2006, p5.
50 of steps including Vision 2010 which are aimed at widening participation in the National Payment System. The Dedicated Banks Bill and the Co-operative Banks Bill are already aimed reducing the requirements to become a bank and would directly enable these additional banks to gain access to the National Payment System. Thus it seems clear that the desire to widen participation in the National Payment System is already in progress. 3.12 Increasing the scope of the regulated segment of the payment system 3.12.1 Until very recently, there was for all practical purposes, no regulation governing non-core payment services. Any organisation, bank or non-bank was therefore free to offer non-core payment services to the public. One of the concerns about this approach is that it leaves a large portion of the National Payment System unregulated. 3.12.2 The Reserve Bank National Payment System Department has recognised that it has an increasing responsibility to ensure greater oversight in this outer shell of the National Payment System. As a result, a number of directives are under discussion to start ensuring greater levels of systems reliability, security and integrity. 3.12.3 Furthermore, widening access to the National Payment System through increasing the scope of the regulated environment has already been recognised in legislation as it was anticipated in the 2004 amendments to the National Payment System Act. In this regard, section 7 provides for payments to third persons and section 12 provided for the Reserve Bank to issue Directives that will make it easier to issue regulations for such players. At present directives have not yet been issued and therefore payments to third parties are currently outside of the regulated payment system. Once such directives are issued these payment types would then be brought within the regulated system.
51 3.12.4 3.12.4.1 System operators and third party payment providers The concept of payments to third persons was introduced with the 2004 amendment to the National Payment System Act. The purpose is to have "enabling" regulation for access into the clearing and settlement layers of the National Payment System. There are two draft directives currently in progress to regulate this which are "Payments to Third Persons and the "Criteria for the Authorisation to Act as a System Operator". 3.12.4.2 Two types of payments facilitators are provided for namely, Beneficiary Service Providers (the "many to one" type e.g. a service provider collecting payments on behalf of a municipality) and Payer Service Providers ("one to many" e.g. a service provider distributing salaries on behalf of an employer). These directives, when finalised and published will ensure regulation for this specific "space" in the National Payment System. 3.12.4.3 However, at present these types of payment are not regulated thereby creating risk for the public. System operators and third party payment providers include: EasyPay which offers bill payment services or bill payment consolidation. For example, a consumer might pay for their groceries and at the same time pay a bill at a different company using the EasyPay services and EasyPay will then pay the money over to the beneficiary. Although the actual transactions (both from the consumer to EasyPay and from EasyPay to the beneficiary) would be performed through the regulated National Payment System, this approach nonetheless means that EasyPay would retain the money for a period of time before passing it on to the ultimate beneficiary. Bureau services this includes collection, processing and batching of EFT Debit Orders
52 Systems operators front-end switching, transaction concentration and routing, offering wage deduction services, micro-lending collection services 3.12.4.4 The concern with these services at present is that they involve processing payments between different parties and yet they currently remain outside the regulated sector. As is explained below, part of the intention of the Reserve Bank is to bring these activities within the regulated arena. 3.12.5 3.12.5.1 Vision 2010 Once again the Vision 2010 document is relevant to the issue of widening the regulated space. In particular, the document states that the vision is that,
Non-banks are allowed to issue payment instruments which are linked to a credit line whereby they provide credit to the public. Non-banks may also provide payment services to third persons. Criteria exist for third-person payment providers and agency agreements are in place between these providers and their principals.25
3.12.5.2 Again this supports the view that plans are already in place to ensure that additional firms can participate in the payment system. 3.12.5.3 The intention is that these firms will become part of the regulated payment area as indicated by a further quote from Vision 2010:
The oversight domain of the National Payment System entails the entire process of making payment. In other words, it entails the process (including but not limited to) that enables the payer to make a payment (that is issuance of payment instruments), the payer to issue a payment instruction via a payment instrument or other infrastructure, the institution to receive the payment instruction via clearing or otherwise, the process of clearing and settlement (where applicable), the
25
See paragraphs 2.4.3.1 and 2.4.3.2 of Vision 2010.
53
beneficiary to accept the payment instruction, the beneficiary to deliver the payment instruction to an institution for collection, the institution to receive and deliver the payment instruction for collection into clearing and settlement, and the beneficiary to receive the benefit of the payment. Within the described process, banks, thirdperson payment providers, system operators, PCH system operators and agents of payers and/or beneficiaries are included.26
3.12.5.4 Furthermore, the Reserve Bank notes that,
Development paths exist for non-banks to become clearing and settlement banks in the payment system, for example non-banks could become dedicated banks and could then be sponsored and/or mentored into the clearing and settlement system.
3.12.5.5 This quote serves to show that the level of accessibility of the National Payment System that is available to a particular firm should not be seen as a static position that is unchangeable. Instead the position of individual firms can change over time and indeed the quote from the Reserve Bank indicates that Vision 2010 already has these changes in mind to enable greater access to the National Payment System for firms over time. 3.12.6 Summary on widening the scope of the regulated environment Again it is clear from the information above that plans are already in place to increase the scope of regulated part of the National Payment System such that new entrants will be able to have access and so that third party providers and system operators can gain access to payments. That enabling legislation has already been provided in the amendments to the National Payment System Act and that these issues are covered in Vision 2010 provide evidence of the existing plans to ensure that this occurs. 3.13 3.13.1 Access to non-regulated payments In addition to the system operators and third party payment providers described above where the intention is that these
26
See paragraphs 3.4.1 of Vision 2010 (our emphasis).
54 arrangements should move within the regulated payment arena, there are a number of other payment arrangements that are outside the regulated system. 3.13.2 In some of these cases it is believed that the current payment arrangements may in fact be going beyond the non-regulated area and moving into the core payments area without the necessary regulatory oversight or standard being in place. It is therefore important that clear frameworks and boundaries are in place to ensure that payment arrangements that should be regulated are in fact regulated. 3.13.3 Notwithstanding this concern, this section examines the increase in non-bank participation in certain aspects of the payment system that has already been observed. Since these different payment instruments are unregulated, access is open to any firm to offer such instruments and there are no particular access criteria that are in place. 3.13.4 In each case, however, the payment instrument is to some degree being used instead of an alternative instrument within the regulated payment system. The sections below highlight the fact that there are many such instruments that are in common usage and therefore competing with instruments within the regulated system without incurring the cost of meeting regulatory requirements. 3.13.5 3.13.5.1 Closed payment systems A closed payment system, such as a store card, only involves transactions within the same legal entity and as such it does not interact with the rest of the National Payment System. This is in contrast to an open payment system in which the instrument which is issued to the payer is accepted at two or more locations which are not the same legal entity as that of the issuing organisation. 3.13.5.2 When transactions flow through the open system, obligations are created between the various participants in the system which need to be settled according to the pre-determined
55 criteria in order to protect the integrity and stability of the system as a whole. It is for this reason that the National Payment System, which consists of a number of different open payment systems, needs to be well regulated in terms of both the types of participants, as well as the rules of participation. 3.13.5.3 By contrast closed systems do not involve these risks, but nonetheless compete with open systems. Examples of these systems include: Store cards and private label cards which are very commonly available; Close-loop smart card systems such as those used to make social grant payments; Gift vouchers or gift cards; and Buy-aid cards e.g. Pretorium Trust, Koopkrag whereby the members of the buy-aid co-operative use their cards to obtain a discount at particular merchants. 3.13.6 3.13.6.1 Substitute payment products In addition to the closed payment systems described above, alternative methods of payment have also been developed. One particular product is that of using telephony airtime as a means of payment. There are a number of areas where this is becoming increasingly common. For example: Consumers buying downloads or pictures for their cellphone; 3.13.6.2 Competitions on the television; and Making a donation to charities.
In all of these cases, it is now becoming possible to make these payments through telephony airtime. This can arise either on a pre-pay basis (in which case this is substituting for
56 deposits) or when consumers have contracts (in which case this is similar to extending a line of credit). 3.13.6.3 The major concern regarding the above two payment systems (closed systems and substitute payment systems) is that they involve the transaction of payments between different legal entities even though they are arising outside of the regulated payments system. 3.13.7 3.13.7.1 Summary on access to non-regulated payments There are a number of different payment arrangements that currently exist that operate outside of the regulated payments arena. Since these payment arrangements are unregulated, access is open to any firm to offer such instruments. 3.13.7.2 In each case, however, the payment instrument is to some degree being used instead of an alternative instrument within the regulated payment system. Hence these alternative payment instruments are able compete without incurring the costs of meeting regulatory requirements while those from the regulated arena are disadvantaged by the additional costs that must be incurred.
57
4. 4.1
Interchange fees In the case of debit and credit card transactions an interchange fee is a fee paid by the acquiring bank to the issuing bank for services the issuer provides in connection with a payment transaction27.
4.2
To ensure the smooth working of the debit and credit card systems, default/fallback interchange fees are commonly established:
4.2.1
in the event two members cannot reach a bilateral agreement on an interchange fee between them, a mechanism must exist to allow the scheme to continue to function while the differences between the disputing members are reconciled; and
4.2.2
generally the card scheme establishes these fees, often with the assistance of an independent third party.
4.3
The flow of services and interchange fee paid in a typical credit or debit card transaction is set out below:
CARD ASSOCIATION
Merchant Acquirer
Payment Guarantee and Other Services
Interchange fees
Issuer
Cardholder
27
In ATM transactions, the interchange fee is paid by the issuing bank to acquiring bank (i.e. the ATM owner).
58 4.4 In some countries interchange fees relate only to debit and credit card transactions, while in other countries including South Africa, however, the concept of interchange is much broader and encompasses a wider range of transactions indicating credit and debit card transactions, as well as, electronic fund transfers, ATM transactions, Mzansi Money Transfers and Authenticated and Non-authenticated Early Debit Orders (AEDOs and NAEDOs). The direction and level of the interchange fees depend on the type of transaction. 4.5 Table 1 presents data on the interchange fees paid and received by Absa during the 12 months ended 31 December 2005. The interchange fees received by Absa in connection with credit card transactions were approximately equal to the interchange fees paid. EFTs. CONFIDENTIAL Table 1: Net interchange Absa was a net recipient of interchange fees on debit cards, ATM transactions and
4.6
We note in passing that the data in Table 1 call into question a suggestion in the FEASibility report that larger banks, because of their absolute size, are likely to be net receivers of interchange fees. The FEASibility report observed on page 3: A big bank that issues debit and credit cards and which has an
extensive ATM network is likely to be a net receiver of interchange fees, relative to a small bank that does not issue cards and has few (if any) ATMs.
4.7 Table 1 shows that, even though Absa is one of South Africas larger banks, it is a net payer of interchange fees on credit card transactions. It is obviously true that if a small bank does not issue cards and is only active on the acquiring side, then it will necessarily be a net payer of interchange fees on debit and credit card transactions. But if a small bank is engaged in both card issuing and card acquisition, it should be clear that there is no obvious relationship between bank size and whether it will be a net payer or receiver of interchange fees. 4.8 Whether a bank is a net payer or receiver of card interchange fees depends on the size of the banks card acquiring activities relative to its
59 card issuing activities. If the banks card issuing activities are large
relative to its card acquiring activities, it will tend to be a net receiver of interchange fees on cards, whether the bank is small or large in absolute size. 4.9 Similarly, with respect to ATMs' whether a bank is a net payer or receiver of interchange fees depends on the scale of its ATM network relative to the number of customers holding debit cards issued by the bank. If a bank's ATM network is large relative to the scale of its debit card issuing, then it will tend to be a net receiver of ATM interchange fees, whether the bank is small or large in absolute size. 4.9.1 Rationale for different interchange fees for debit and credit cards 4.9.1.1 This section seeks to summarise some of the principal reasons why credit card interchange should legitimately be set at a level higher than debit card interchange. 4.9.1.2 Credit card interchange methodologies in Visa and
MasterCard have developed independently of debit card interchange methodologies, as in many cases debit card schemes have been independent (whether within or outside of the global schemes). 4.9.1.3 In many economies, a driver behind debit card issuance and usage is the replacement of less efficient forms of payment such as cash and cheques. However, the lack of sufficient incentives to use debit cards, and lack of incentives to use less cash and/or cheques, have explained the continued significant use of paper-based payment instruments. 4.9.2 Credit Card Interchange The key reasons why credit card interchange is often set at a higher level than debit card interchange are that: 4.9.2.1 credit cards provide additional benefits to merchants and cardholders, in particular, the provision of credit, of an interest
60 free period and the guarantee against cardholder default28. These additional benefits lead to additional costs being incurred by the card issuer; 4.9.2.2 credit cards were developed as a replacement for the private label store card, as a pro-competitive way of allowing small merchants to sell to consumers who do not have available funds; 4.9.2.3 merchants value the additional benefits of credit cards (overand-above debit cards and other forms of payment such as cheques and cash). Surcharging does not currently occur in South Africa. use in this way. 4.9.3 Credit cards provide additional benefits to merchants and cardholders 4.9.3.1 Typically, multi-lateral interchange fees include the following sets of issuer costs, relating to the benefits received by merchants: 4.9.3.1.1 4.9.3.1.2 4.9.3.1.3 4.9.3.1.4 provision of credit; processing costs; payment guarantee in case of fraud costs; payment guarantee in case of cardholder default costs; and 4.9.3.1.5 4.9.3.2 interest-free funding period costs. Of these, it can be argued that only processing and fraud costs are costs incurred by the debit card issuer. But even when surcharging is permitted, in many cases merchants choose not to disincentivise credit card
28
On signature-approved, use of debit cards there is also an element of credit risk (which is borne by the issuing bank). This credit risk associated with the use of debit cards is one of the factors taken into account by the Edgar Dunn method used to calculate debit card interchange fees. Cardholder default, however, is clearly a more significant issue with respect to credit cards.
61 4.9.3.3 Fraud costs may be higher in the case of credit cards, as the available limit on a credit card may be higher than the available funds on a current account accessed by a debit card. 4.9.4 Inclusion of costs of the provision of credit, interest free period and payment guarantee in the interchange fee 4.9.4.1 Credit cards providing cardholders with more flexibility to structure their repayments because of the interest free period and thus enable them to make larger purchases from accepting merchants than would otherwise have been the case. 4.9.4.2 Merchants also gain substantial benefits from the payment guarantee in respect of cardholders who take advantage of extended credit. They can sell goods to consumers who may not have funds in their current accounts (hence would be unable to pay with their debit cards), but without taking on the risk that these consumers would be unable to pay. This risk is taken by the credit card issuing bank. Authorisation will be given by the credit card issuing bank to transactions up to a certain level (the credit limit). The current account provider will take on much less risk in terms of payment guarantee, by usually only authorising transactions of low value (ie under floor limit), or within the consumer's current account balance. 4.9.4.3 Merchants rank the payment guarantee as one of the most beneficial aspects of accepting credit cards. 4.9.4.4 International evidence suggests that credit cardholders have a low willingness to pay for payment services, meaning that these benefits would not accrue to merchants unless credit card interchange were set at a higher level than debit card interchange. If issuers were to impose fees on cardholders, usage levels would fall as consumers switch to debit cards and less efficient payment instruments such as cash and cheques. This would damage merchants' interests as overall retail volumes would fall.
62 4.9.4.5 In addition, society's interests would also be harmed as overall demand for transactions would be met by payment methods that are more costly (on average). 4.9.5 4.9.5.1 Merchants value the additional benefits of credit cards Merchants are able to incentivise the use of debit cards (or cash, cheques, store cards, or other forms of payment), in several ways. Surcharging for credit card transactions is one method, this does not currently occur in South Africa, but it does occur in some countries. In addition, merchants can simply ask consumers to use a different type of card. 4.9.5.2 However, international evidence shows that such incentives are unusual, practiced in only some sectors such as travel. 4.9.5.3 The benefits of credit cards are more marked in sectors where the transaction value is large (and where the consumer is more likely to require the financial flexibility offered by a credit card). 4.10 4.10.1 4.10.1.1 Determination of interchange fees in South Africa Debit and credit cards For both debit and credit cards, and for both MasterCard and Visa, the current interchange rates in South Africa have been set by a cost-based study conducted by Edgar Dunn & Company (EDC) in 2001-2002. including: 4.10.1.1.1 The South African Reserve Bank as the regulator of the National Payment System was provided with details of the methodology, approach, time frames and cost components to be used in the study and agreed with the approach being taken; 4.10.1.1.2 EDC, the company that performed the study, is an independent third-party consultancy with experience in There are a number of features of the Edgar Dunn study that are important to note
63 other countries in conducting cost studies for the purpose of calculating interchange fees; 4.10.1.2 The broad methodology of the study was to follow a cost of
service approach. Based on the different cost components

agreed by the Reserve Bank, EDC calculated the weighted average cost of services provided by issuers to acquirers. These figures were then used to determine the interchange fees. The effect of the initial study completed in 2002 was to lower the interchange fee across all of the payment types examined. In particular interchange fees changed as follows: 4.10.1.2.1 Embossed Credit Cards fell from 1.99% of the transaction value to 1.71%; a decrease of 14.07%; 4.10.1.2.2 Embossed Debit Cards (Cheque Cards) fell from 1.99% to 1.09%, a decrease of 45.23%; 4.10.1.2.3 Unembossed / Electronic only Credit Cards fell from 1.99% to 1.09%, a decrease of 45.23%; and 4.10.1.2.4 Electronic only / unembossed PIN-based Debit Cards fell from 0.75% to 0.55% a decrease of 26.67%. 4.10.1.3 In the case of debit cards, as noted above, EDC estimated that the weighted average cost of services was equal to 0.71% of the transaction value. However, at the time of the study, these cards were in an early growth stage. Thus EDC were asked to forecast the likely debit card volume based on expected future growth and then to calculate the debit card interchange based on these higher volumes. This led to a cost of 0.55% being implemented and provided merchants with the benefits of a lower interchange fee compared to the cost of providing the services for them. 4.10.2 4.10.2.1 Multilateral versus bilateral determination of interchange fees Interchange fees for debit and credit cards in South Africa are determined through a multilateral process, as opposed to
64 bilateral negotiations. While interchange fees in South Africa for various other payment mechanisms are determined on a bilateral basis (e.g. ATMs, EFTs, AEDO/NAEDO, and Mzansi Money Transfers), from an economics perspective, there are definite advantages associated with a multilateral process. 4.10.2.2 One clear advantage is a reduction in transaction costs. Given that arrangements need to be in place between all acquirers and all issuers, as the number of issuers or acquirers increases, the number of arrangements that need to be agreed increases exponentially. As such this imposes considerable and onerous implications on costs and resource requirements with very substantial transactions costs having to be incurred. 4.10.2.3 The second reason relates to barriers to entry. Because of these transaction costs, a system of bilateral arrangements would be likely to be a barrier to entry to new small players. Indeed, the FEASibility report notes that the burden of such negotiations would be particularly great on small players as they typically only have one payment system official rather than a fully staffed department. transactions costs to be incurred. 4.10.2.4 The third reason is that setting interchange fees on a multilateral basis means that all players face the same conditions irrespective of their market strength or bargaining power. Setting interchange fees on the basis of bilateral agreements will inevitably mean that those firms that have bargaining power will negotiate better deals than firms that do not have bargaining power. 4.10.2.5 Linked to this is the fourth reason which is that where interchange fees are set on a bilateral basis and small firms do not have bargaining power, the negotiation process of agreeing the interchange fees may prevent new entry. This would not be a deliberate decision but an inevitable consequence of the time and resource constraints imposed by A multilaterally determined interchange fee removes the need for these additional
65 the need to make hundreds of bilateral agreements across all of the payment systems. 4.10.2.6 From Absas perspective it would be essential to make agreements with other large players since these have the most significant impact on Absas business. Hence it would be necessary to prioritise these negotiations and agreements ahead of those with other smaller firms that have less impact on Absas business. 4.10.2.7 All of these advantages seem very powerful and indeed it was noted by the FEASibility report on page 30 that, It is possible that the best outcome in terms of fairness for
both consumers and smaller participants (including banks and retailers) would be to allow multilateral price negotiations...
4.10.2.8 In addition to all of these reasons, the use of multilateral interchange fees is the most common approach to interchange fees globally. 4.10.3 Observations on countries that do not have interchange fees for debit and credit card transactions 4.10.3.1 The Technical Team has noted that there are a small number of countries (Finland, Denmark and Luxembourg) that do not have interchange fees for debit or credit card transactions. These countries were identified as having zero interchange fees in the European Commissions ongoing examination of payment cards.29 There is very limited information contained in this report providing explanation of these (unusual) arrangements. It is notable however that, in each country, there appears to be a single acquirer: 4.10.3.1.1 In Denmark there is a single acquirer for both the international and domestic debit card schemes;
29
Interim report I Payment cards, European Commission, 12 April 2006
th
66 4.10.3.1.2 In Finland there is a single acquirer for international credit card schemes; and 4.10.3.1.3 In Luxembourg there is a single acquirer of international debit cards. 4.10.3.2 Because we have not studied the situation in these other countries, we cannot opine on the reasons why there are no interchange fees on debit and credit card transactions in these countries. It should be noted, however, that the structure of the market in South Africa is quite different. In South Africa there are multiple acquirers competing to offer services to merchants. 4.10.4 ATM transactions The interchange fee on ATM transactions has not been changed since the end of 1999. 5. 5.1 Summary of conclusions The National Payment System in South Africa is a well functioning network of competing and complementary services that facilitates transactions involving various types of payment streams. The integrity and interoperability of the system is vital to the South African economy and regulatory oversight by the Reserve Bank continues to ensured that the National Payment System maintains a world-class payment system meeting domestic, regional and international requirements. 5.2 Access: It has been demonstrated that access to the payment system is determined on the basis of open and transparent criteria. The use of central switches in the National Payment System, such as Bankserv, enables firms to reap the benefits of economies of scale and also ensures that barriers to entry for new players are low. reinvested into ensuring improved services for customers. 5.3 Indirect access to the National Payment System, by way of sponsorship or agency arrangements, is also available and provides a low cost alternative to the investments necessary to obtain direct access. Absa In addition, pricing for these services is cost-based and profits are primarily
67 in particular has been involved in a number of sponsorship arrangements which has facilitated access to the payment system. In addition, through agency arrangement Absa has assisted smaller banks to compete in its market by assisting them to receive deposits. 5.4 Further widening of access is anticipated in the near future as the Cooperative Banks Bill and the Dedicated Banks Bill reduce the barriers to banking and thereby enable more firms to gain access to the National Payment System. The Reserve Bank 's Vision 2010 document also supports the view that plans are in place to ensure that additional firms can participate in the payment system. 5.5 The economic function of interchange fees has also been explained and the determination of interchange fees in South Africa and in other countries reviewed. Clear advantages of multilateral means to set interchange fees have been highlighted including a reduction in transaction costs and ease of new entry. Indeed such an approach has been accepted by competition authorities in a number of other countries.

ABSA Annex 3 Background Info On NPS

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ABSA Annex 3 Background Info On NPS

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ANNEX 3 : BACKGROUND INFORMATION ON THE NATIONAL PAYMENT SYSTEM

Important Payments Systems" banking framework. It is essential to

an environment in which specific criminal activities are to be reported;

PCHs Payment Clearing Houses (PCHs) are arrangements

2.3.2.1 2.3.2.2 2.3.2.3 2.3.2.4 2.3.2.5 2.3.2.6

Figure 1: Overview of the Payment system

structures must be in place. infrastructure

standards and proper Disaster Recovery and Business

Figure 2: PCH membership

No of PCHs 4 17 10 (3) Cancelled 1 9 7 16 5 5 6 13 16 Cancelled 5 Cancelled 2 5 5 2 8 12 16

Immediate Settlement 1 1 1 (1) (1) 1 1 1 1 1 1 1 1 1 Cancelled 1 Cancelled 1 1 1 1 1 1 1

EFT Credit STRATE 1 1 1 1

Debit Card Credit Card

Sponsorships Ithala Postbank 1 1 1 1 1 1

See paragraphs 2.4.3.1 and 2.4.3.2 of Vision 2010.

See paragraphs 3.4.1 of Vision 2010 (our emphasis).

Payment Guarantee and Other Services

service approach. Based on the different cost components

Interim report I Payment cards, European Commission, 12 April 2006

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