“In today’s digital world, there are demands for money to be faster than it is. You would think that the banking community would already have figured out ways to make money as fast as possible, but the reality is somewhat different.” [Robert J. Kauffman]
Robert J. Kauffman, co-author of Near Real-Time Retail Payment and Settlement Systems Mechanism Design and Professor of IS and Associate Dean (Faculty) at Singapore Management University’s (SMU) School of Information Systems, has been giving the subject of Faster Payments much thought lately. The SWIFT Institute had the opportunity to interview both Kauffman and Chris Hamilton, CEO of the Australian Payments Clearing Association (APCA), to examine the factors involved in devising faster payments systems.
A hybrid approach
Financial institutions are looking to systems for faster payments as a cost-effective means to expedite clearing and settlement of low-value retail payments. There are risk and incentive issues involved with the deferred net settlement (DNS) and real-time gross settlement (RTGS) approaches currently in use. What Kauffman’s paper aims to do is work out the proper incentives via the design of a settlement system in order to make faster payments possible whilst balancing risk and benefits. Kauffman elaborated, “When it comes to RTGS and faster payments, the goal is to get everybody’s incentives in harmony with one another so that one party does not feel that there is too much risk, the consumer feels they are paying money when it is appropriate, and the retailer receives the funds in real time.”
Kauffman and his team at SMU, Zhiling Guo, Mei Lin and Dan Ma, looked at examples of faster payments systems from around the world and leveraged this information by proposing a hybrid faster payments settlement system that takes advantage of their best features. This hybrid system would enable banks to decide whether to prioritise a payment either to an RTGS queue or a slightly delayed DNS queue. Enabled by liquidity pooling involving financial institutions contributing to a central ‘pot’ of funds held by a digital settlement intermediary, this system would make payments more likely to go through the RTGS channel. This is because, for most of the time, there will be funds immediately available from the intermediary’s liquidity pool to handle any shortfalls when the demand for payments settlement is high.
Kauffman noted, “The essence of payments settlement involves a sharing approach, but one that is currently being performed according to a set of agreements that are not really a part of our digital age. On one level, slower payments can translate into disadvantageous conditions for innovation and economic growth. What we are starting to see now, however, is a digital movement towards faster payments and the future of money – a digital megatrend.”
Momentum ‘down under’
With its origins developed in a working paper published in 2008, Australia’s New Payments Platform (NPP) was created in order to provide a faster, more versatile infrastructure for low-value payments. In 2012, the Reserve Bank of Australia (RBA) published its Strategic Review of Innovation in the Payments System and gave the Australian financial industry six months to come up with a proposal for a real-time payments system. APCA immediately set to work on a proposal for real-time payments and the ideas behind the NPP were born. Hamilton elaborated, “We asked ourselves at the time what the next generation of payment systems would look like and how we should be moving ourselves towards that.” Whilst the APCA established committee took into consideration the examples set by UK’s Faster Payments and Singapore’s MEPS+ programmes, Australia concentrated on its own particular set drivers, particularly the need to ensure public policy goals were met at the same time as participants were offered sustainable, competitive opportunities to offer new value-added service to their customers.
We asked about the structure of the NPP and if it came close to Kauffman and his co-authors’ proposed hybrid system. Hamilton explained that Australia’s SWIFT-designed NPP system has a different philosophy, aligned more to a low-value, high-volume environment. Each participant would keep a pool of funds at the central bank segregated for the NPP. The liquidity inside each pool would be managed by a set of highly automated and effective tools that monitor the transactions of each participant in their respective pool and allow draw-down and top-up on parameters set by the participant. Each individual payment is settled through the pools in real time, creating an account-netting effect in each pool. The netting efficiency would essentially depend on the size of participants, relative to the nature of their transaction flows.
Central Banks
The role of central banks has been integral in the process of implementing processes in the UK, Singapore and Australia, and both Kauffman and Hamilton agreed upon the importance of the central bank’s role in setting up new faster payments platforms. Kauffman noted that if it were purely down to the larger banks to lead the charge, the process would take much longer because of the problem of incompatibilities with infrastructure and architecture. He added, however, that it was not necessarily the central banks that would provide the money to build a new system, elaborating, “If the central banks took the issue of building of a faster payments system and turned it into a public policy issue, banks should then be paying out in some way according to the benefits they would all eventually reap.” Hamilton, meanwhile, compared the Singaporean experience to that of Australia’s, explaining that whilst central banks do play a very important role as a catalyst for industry action, the RBA could not very well force the industry into building a new payments system by themselves as did the Monetary Authority of Singapore. “In the long run, there has to be a sustainable business proposition for participants,” he stated.
Fast forward to the future of payments and overlay services
Innovation in technology is of course the key driver in the ability to create faster payments systems. “The banks by nature only want to collaborate in a faster payments project when they can all individually get ROI above their investment,” asserted Kauffman. “Yet one thing we know for sure is that technology will get cheaper over time. I believe that setting up for capital investments and building a solid banking infrastructure will be beneficial in ways that would lead to future business opportunities. Though it is true that the banks would not see an immediate return, they are preparing the ground for future growth.”
Australia has taken the point about sustainability in a market economy very seriously and made sure that the NPP system was developed and built around this central principle. Whilst the present focus is getting the NPP infrastructure successfully up and running, the next stage will involve the market-driven development of overlay services onto the system. In other words, the system will provide the ability for participants and others to build new payment services on top of an existing framework. Hamilton related, “For me it was a very interesting example of how an alignment of interest and strategic needs could actually flow directly into a system design.“
When questioned as to whether new financial technology, such as the Blockchain, could possibly supersede the current developments of faster payment systems, Kauffman agreed that the development of new technology was moving very fast. He did not believe, however, that the mechanism design of the payment system would be replaced, but it would be more a matter of how the packaging of information could be analysed within the system. Hamilton took the concept a step further by saying that he believed that the story was not simply one about technology; it was rather about incorporating all of the complex business relationships and the willingness of the marketplace to invest across the board. Not an easy task.
What Hamilton did see as potential for the future was the incorporation of payment systems into business automation streams. As economic transactions in society become more and more automated (for example, buying a coffee or a second-hand car via a smartphone app), the payment process would then disappear into the underlying automated business activity. In other words, payments would be seamlessly integrated as a value-transfer piece within an end-to-end process of automating a complex data flow. “What we’re going to end up with is a whole lot of automated systems for economic activity that happen to include value transfers,” Hamilton explained. “It’s not too much of an overstatement to say, in the future it would not make a lot of sense to talk about the existence of a payments system because all payments would occur as part of automated business systems that do something else.”
Build it and they will come
One thing that inventions such as the Blockchain illustrate is the current frustrations with the ability of payment systems to keep up with developments in other parts of the economy. The industry needs to step up and respond to this. Stakeholders across the globe are asking themselves how to develop their payments systems so that they are ready to help the automated economy as it emerges.
Unfortunately, each of the real-time systems developed so far uses a different model, and the present expense for building new payments systems is quite high. The eventual proliferation of near real-time payments systems and even the potential integration of these systems on an international basis is only likely to come about if the cost of technology cheapens and standards and agreements become widespread. What is clear is that regardless of technology platform, it is really through collaboration of different stakeholders and systems that success will be achieved. In Australia’s case at least, there is a strategic commitment to delivering sustainable business outcomes from new infrastructure investment through the NPP. The development of overlay services within a payments system should serve as a shining example of the possibility of both realising public policy demands, and as the creation of revenue for the industry.