Peter Mair: Submission to Rba on Payments System Innovation

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PETER MAIR: _SUBMISSION TO RBA ON PAYMENTS SYSTEM INNOVATION

INNOVATION ORPROCRASTION

The draft of Newton’s first law of motion went along the lines:

.....nothing happensnext unless someone does something first

...... and hislonger storyembracedsetting sensible objectives along with making plans for doing things likely to achieve them.Newton’sdraft did not anticipateacorollaryattributed to Dickens, that nothing will come of doing nothing, hoping that something will turn up.

-nothing doing

In context, nothing will happen to reform the retail payments system unless someone gets about it with a sense of purpose and direction – and that prospect includes players that could, taking over from incumbent players that won’t, as well as placing bets on ideas likely to be winners in a supporting regulatory framework. The mantras about being ‘unable to regulate innovation’ and eschewing the prospect of ‘backing a winner’ have the hallmarks ofboth excuses for doing nothing and not understanding the critical elements of what has to be done and can be done.

The nonsense of wasting time, but doing nothing,is becoming evident enough along with the commonsense of intruding a public utility body into the payments infrastructure to ensure reforms are made in steady successful steps toward known objectives. It is certainly clear that policy initiatives could do much to make the retail payments environment more conducive to innovation – and that is the focus of this submission.

It would be helpful, and probably essential, to promoting innovative reformsif the RBAwere to first set down,in plain English, for the wider community – and political government –just how the retail payment system is presently operating inappropriately and disadvantaging the community. If the RBA cannot muster the humility to now do that, the job will eventually be given to an agency that can and will.

-no we won’t

The complement to ‘nothing doing’ on the regulatory front, is the sensibly predictable ‘no we won’t’ attitude to innovation of the dominant banking players and their affiliated card-scheme promoters.

As things stand, the incentives in the market for retail payment services encourage banks to defend present arrangements unchanged, except as they may be allowed to exploit additional regulatory concessions. Put more sharply the major banks would hardly volunteer to make changes that would compromise the excessive profitability of current arrangementsoperating withcharacteristics ofexploitative cartels. This exploitation hasthe tacit support of the regulators and government ministersthat the community believes are otherwise responsible to prevent.

A sadly cautionary note

(i)still broken, not fixed

While ever the RBA purports to believe that it has been making a useful contribution to payments system policy it is difficult for others to put a contrary point of view expecting it will be respected. The following self-assessment extracted from the Bank’s ‘cheques’ submission to APCA is, to my mind, a gross exaggeration:

The Payments Systems Board’s work has in the past focused on: establishing clear price signals; removing restrictions on merchants that limit their choices in accepting payment instruments; improving access to payment systems; and increasing transparency in the payments system.

To my eyes, this is just not so: there are no proper cost-related price signals faced by bank customers initiating payments; the general run of competitive retailers are beholden to the banks and their customers in terms of the cost and selection of payment instruments and the dominance of the major banks in this market means that there has not been, and cannot presently be, any substantial new player providing retail payments facilities.More generally, the mysteries of the apparently ‘free banking’ model so beloved of banks, bank customers and politicians (and regulators?) are simply not being explained frankly, as they should be, to anyone-- the Bank as a self-proclaimed ‘independent’ regulator comes across as anything but in this payments-policy role.

It would be difficult to overstate the damage being done by the prevailing ‘free banking’ mindset and the official policy (mis)settings still underwriting it.

(ii)cooperativev.uncooperative

The sense of despair deepens when one reads, in the next paragraph, that

The purpose ...of undertaking a strategic review of innovation... is to identify areas in which innovation in the Australian payments system may be improved through more effective co-operation among stakeholders.

If the main stakeholders are identified as banks and retailersand the customers of both, then it is probably fanciful to be building utopian expectations of useful outcomes originating in voluntary cooperation when the three groups are sensibly each for one and none for all. What we need, on the contrary, is afirmregulatory hand underwriting a policy frameworkensuring that customer and participant choices, howeverself-centred, are much more consistent with efficiency, innovation and fair-dealing than are present arrangements.

In its published policy commentaries on retail payments it is not at all clear that the RBA is willing to acknowledge the way its present policy settings suit the banks better than the community. There is no reason to expect the banks to cooperate with innovative reforms that might prejudice the profitability of their present practices allowing the tax-free barter of ‘free services’ for ‘interest-free deposits’ and the raft of ‘joint venture’ screens hiding the excessive and uniform pricing of services associated, for example, with credit-cards and BPay.

Put differently, the banks run, with official compliance, payments system racketswhich they will defend to the hilt but will not compromise with cooperation in the public interest.

The sense of continuing with an agenda relying on voluntary cooperation flies in the face of the experience of more than fifteen years. Practically it is to be expected that the major banks will protect their private interests, both by sensibly following mutually compatible strategies and, equally sensibly, procrastinating with conditionally promised commitments to deliver on regulatory wish-lists before deciding that they won’t. One illustration of this is the major banks’ repeated failure to adapt the very-cost effective direct entry system to handle modern message formats– instead the banks established lucratively more costly BPay arrangements in 1997 and more recently envisaged a similarly more profitably costly (mambo) adaptation, apparently now abandoned.

A similar game seems to be developing around official hopes for EPAL as an independently competitive local debit-card scheme: so far card-issuers participating in EPAL havenewly been given the scope to take (rather than pay) interchange fees,as do the international scheme debit cards, but no one has explained why the Australian banks would be making a major investment to add a third debit-card network, which is hardly necessary,and having done so would price its services any differently to the two scheme-debit cards they already operate.

One cannot resist the inference that the banks will only ‘cooperate’ if they get another protected and excessively profitable joint-venture scheme to exploit –at some point ‘cooperation’ only on those terms is tantamount to blackmail,of the regulators and a community being held to ransom.

One small saving grace, one glimmer of hope in the RBA submission to APCA is the belatedly acknowledged importance of having prices charged for using cheques reflecting the substantial and growing average total cost of processing cheque payments -- but it begs the question of how the Bank could earlier allude to “establishing clear price signals”.

At the risk of being considered rude, a properly informed community would have no reason to be pleased with the Bank’s present regulation of the retail payments system and – see above -- no reason to confidently expect better in the foreseeable future.The community deserves a proper explanation of the deceptive ‘free banking’ arrangements they have been wrongly encouraged, including by the Bank, to think are in their best interests. The community deserves a proper explanation of why very mature joint-ventures are still permitted to set uniform process well in excess of costs: this ‘legal concession’ being quite contrary to the findings of the Dawson Review of the trade practices legislation a decade ago.

There is simply no evidence that the RBA – as the payments system regulator – has pursued the coordinated regulatory framework needed to do its job properly: where is the record of the RBA asking the Treasurer to make sure the ACCC and Australian Tax Office, for example, areaware of the RBA’s overlapping concerns and the importance of facilitating a coordinated regulatory response to address them?

A SENSE OF PURPOSE AND DIRECTION

The RBA’s consultation paper --at Section 6 --seems to have reasonable handle on the gaps in the system that need filling, especially ensuringelectronic payment and transfer systems are compliant with international message standards and usually capable of delivering same day value for payments to retailers and person-to-person transfers.

In circumstances where the RBA is ultimately likely to underwrite the settlement of interbank obligations, any posturing about the practicality of allowing immediate settlement of legitimate payment instructions surely becomes a moot point – save perhaps for some provision for real-time monitoring of accumulating net settlement positions of banks individually.

Accordingly my response takes its lead from the issue nominated for discussion:

Are there any significant changes in the payments landscape in prospect that have not been considered by this paper, for instance in terms of architecture or significantly different payment products? What will be the implications of these changes? Are there actions that should be taken now to take full advantage of thesechanges?

Whatever the problems with picking winnersfor payments system innovations, it is easy to nominate cash and cheques and credit cards as ‘losers’ and the regulatory sense of encouraging their demise.

In context, there are actions that can and should be taken now, in respect of cash and cheques and credit cards, to ensure the system is conducive toprospective innovations and developments that can be confidently expected to emerge and unfold.

It has been clear for some decades now that the future of retail payments lies more exclusively in electronic instruments -- implicitly, tangible instruments, cash and cheques, will be displaced. Practically, surveys of payments behaviour confirm this shift globally although the pace of change has been patchy – a lingering attachment to cash and cheques has unfortunately been fostered by a weakness of the regulatory will to ensure appropriate market incentives – also known as explicit, user-pays prices -- are in place to encourage sensible change.

The indictment of credit-cards is more about their enduring existence being contrived to protect the excessive profitability of the mirror-image international credit card schemes. For most cardholders, one card embraces both ‘credit’ and ‘debit’ card functions and a few moments reflection will reveal credit-card schemes as redundant – sustainedonly by discretionary monopolistic restrictions imposed on the functionality of the debit card option: there is no reason why eligible customers with debit cards could not have both a linked line of creditand the facility for debit cards to be used for on-line and other card-not-present transactions.

Some suggestions following will appear a bit brutally forceful but, to the wider community, the sense of quickening the pace of change would be made more clearly understandable by the RBA deliveringthe asked-for frank exposition of the problems with cash and cheques and credit cards which, being the ways of the past, are no longer essential options – and the benefits of switching to cheaper and more efficient alternative payments technologies that are the way of the future.

(i)Taking out cash

The first brutal suggestion is that the community be givenfive-years notice that currency notes in denominations greater than $20 will be withdrawn from circulation and that, after another 12 months, redemptions of larger denomination notes at bank branches will be at a discount from the face value. New bank notes would be clearly marked with a use-by year, after which they would be redeemableonly at a discount.

The corollary is that the continued availability of conventional cash in low denominations – coins and $5, $10 and $20 notes– would meet all reasonable needs for both a circulating medium of exchange and reasonable precautionary cash holdings, pending the ubiquity ofcontactless point-of-sale technology and electronic payment alternatives. There is a sound case also for imposing a modest fee or tax on the issue of currency both to cover costs of production and encourage the switch to e-money alternatives.

The rationale for this bold step in Australiapartly relies on the commonsense observation that the RBA, being of sound mind, cannot continue to run an on-demand note issue function when the high-denomination notes issued have little prospect of remaining in circulation for day-to-day purchases-- because they are not necessary for day-to-day purchases.As is, high denomination notes– zero coupon bearer bonds -- are mainly hoarded as a tactic for avoiding means-tested limits on entitlements to age pensions or more generallyfor underwriting the cash-economy with attendant income-tax evasion.

The unfair and unnecessary cost to the public purse of the RBAs current conduct of the note issue function demands a strong public policy response to put a stop to it. The policy response should immediately include relocating the responsibility for the currency note issue in Treasury or a separate currency board.

At a more constructive level, the business case for developing and providing e-money alternatives to cash would be stronger if cash were less conveniently available for making payments for values larger than say a hundred dollars or two. Provided the international card payment networks and participating local banks can be contracted to provide transaction facilities domestically on fair and reasonable terms, the way would be open for the RBA to develop a regulatory framework conducive to both PIN-secured and contactless debit-card transactionssubstituting effectively for conventional currency.

[Incidentally, an appropriate concept of ‘fair and reasonable’ would be accompanied by both a regulatory prohibition on the charging of ad valorem interchange fees for credit card transactions and securing related undertakings both to ensure that appropriate functionalities attach to debit cards (including a line-of-credit option) and precluding ad valorem levies on retailers accepting card-scheme payments.]

(ii)Taking out cheques

Much the same sense of an appropriately brutal determination applies to the objective of taking cheques out of the retail payments system -- because there is no longer any reasonable need for them to be used.Again it is a step to be carefully explained to the wider community and only finalized after due notice.Concurrently the RBA would be negotiating with banks and others to put in place appropriate electronic alternatives to cheques.

In terms of the mechanics for driving this change, one sensible first step would be ensuring that customers drawing cheques pay an explicit fee reasonably reflecting the high and rising average total cost of banks processing cheque payments – and it would be equally appropriate for businesses accepting cheque payments to surcharge cheque payments to cover costly in-house paper processing. Already, and apart from the culturally addicted aged, the discretionary use of cheques is largely confined to small businesses and foolishly accommodated by banks cross subsidizing their high costs from the soft revenues flowing from holding interest-free deposits.

Banks’ inclination to provide underpriced payments facilities would be considerably less if the regulatory framework provided for income tax to be paid by bank customers on the income fairly deemed to accrue if transaction account deposit balances attracted interest at a market rate.

Already banks have facilities in place for making person to person transfers electronically at branches or over the internet and it is a short practical step to contract with agents – like Australia Post – to offer those facilities to customers not otherwise able to use internet facilities or visit branches or, presumably, use telephone payment options. There is nothing in this approach to preclude the provision of basic banking and payment facilities to the needy free of charge – such costs to be met from the budget as payments to contractors tendering to provide the services.

While it is essential that the community be given appropriate notice and education on alternatives, before cheques are fairly priced out of the market, it is disturbing to read of knee-jerk political interference in the UK to protect the continued availability of cheque facilities. Among other things such opportunistic reactionary nonsense begs the question of central banks and payments regulators exercising their nominal independence to put their foot down and stop the rot.