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«July 2012 THE WORLD BANK Acknowledgements The preparation of this paper was led by the Financial Inclusion Practice of the World Bank. Lead author is ...»

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Lack of efficient payment services impacts the ability of the financial institutions to provide these services in a cost-effective manner, often resulting in non-provision of these services. Also, the increased use of payment services by traditionally unbanked and under-banked individuals also may provide banks and other service providers an insight on the financial condition of these persons, potentially making them eligible for further financial services such as credit, investment, or insurance services, among others.48 The estimates for world-wide levels of financial inclusion vary. The World Bank and CGAP estimate that there are around 2.7 billion working age adults who do not have access to savings, transactions or credit accounts.49 While the levels of financial inclusion are certainly lower in developing and low-income countries, there are significant extents of population financially excluded even in high-income countries. For As an example, Annex 3 describes financial inclusion initiatives undertaken by the Reserve Bank of India.

CGAP and World Bank 2010.

example, in the United States it is estimated that 10 percent of households are unbanked.50 In the European Union, there are indications that about seven percent of consumers 18 years old and above do not have a bank account.51 Regional estimates for the penetration of basic banking services and infrastructure are shown in Table 2. As this data shows, the differences in banking service coverage and traditional banking infrastructure between developing countries and developed countries are still very significant. These gaps have a significant bearing on the low number of percapita electronic transactions in developing countries as shown earlier in Figure 1.

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Apart from limited financial inclusion, those individuals and organizations that do have access to traditional payment services may keep on using cash and other paper-based instruments on a large scale, thereby further undermining the demand for electronic payment instruments. This could be explained by a variety of factors, going from the lack of convenient and/or cost-effective alternatives to them, to regulatory environments and working habits that favor paper-based instruments and records, among others elements.

Table 3 shows data on the main payment instruments used for government payments and government receipts or collections, as depicted in the Global Payment Systems Survey 2010.

§ Table 3: Payment Instruments used for Government Payments FDIC 2009.

European Commission, Commission Staff Working Paper 2011.

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The typical usage patterns of the financially excluded, which are often erratic and/or small-value, when coupled with limited ability of these groups to comply with product requirements like maintaining minimum balances and having the ability to bear the standard transaction fees, make it financially unviable for financial institutions to service these segments using their traditional payment products. Seen another way, traditional payment products might not be affordable for the financially excluded. It needs to be noted that the costs associated with a payment instrument includes not just explicit costs like account opening fees and transaction fees, but also indirect costs like time to travel to access a transaction channel. In many cases, indirect costs may be more relevant to the explanation of financial exclusion than direct costs.

III.3 Availability of an Efficient Infrastructure to Process Payment Instruments and Support Retail Customers The supply or provision of electronic payment instruments and services is largely dependent on the availability of certain common infrastructure like payment networks, clearinghouses and ACHs, as well as on certain institution-level infrastructures such as a centralized account management system.

In many low-income and middle-income countries, commercial banks and other payment service providers typically face an unviable business case to expand the traditional payment and banking infrastructure beyond major urban areas. In recent years, there have been many promising innovations that could assist in addressing the infrastructure

gap. These developments mainly include:

 Using mobile phones on which payment instructions can be initiated and/or received; and,  Using business correspondents equipped with mobile phones and/or custom-built POS terminals to provide banking services, reducing the need to rely solely on traditional banking infrastructure for provision of payment services.

It should be noted, however, that these developments will not reach their full potential without availability of appropriate payment infrastructures for clearing and settlement.

The supply can also be constrained by limited automation of financial intermediaries and other payment service providers. Only with some basic automation of their retail and corporate customer account-management systems will electronic payment instruments be able to reach their full potential (e.g. to allow rapid authorization of transactions with cards, quick processing of payment instructions, or quick posting of incoming payments to clients‘ deposit accounts).

The market structure of the financial services industry can also play a substantial role in slowing down the growth of electronic retail payments. For example, the market may be characterized by barriers to entry, to innovation and to effective competition in the provision of retail payment services. Such barriers might have been created by market participants themselves or in some cases by regulation. Under these circumstances, the market arrangements can limit the incentives of existing retail payment service providers to expand their service base for retail payments and, as a result, to invest in the development of new electronic payment instrument and service infrastructure, which can require significant volumes to be cost-efficient.

III.4 Availability of a Socially Optimal mix of Payment Instruments There is a wide range of payment instruments in use today. However, the proportion of relative usage varies significantly from country to country due to a variety of reasons, including those of a socio-cultural nature. Usage of payment instruments also entails costs, with some payment instruments being better suited for certain payment needs than others. For example, for payments of a somewhat larger value, a credit transfer might be a better option than a payment card—transactions costs are lower for the receiver, and possibly for the sender as well, and the funds can usually be made available to the receiver immediately or within a day.

However, for an individual who does not have sufficient funds in his current account, a credit card payment linked to an available line of credit can finance immediate transactions. Also, some incidental costs such as account maintenance fees might cause traditional credit transfers and debit transfers to be unaffordable for certain types of payment needs (e.g. disbursement of some government social benefit transfers to unbanked recipients), whereas a prepaid payment cards might be more cost-effective for this purpose.

Therefore, while at a conceptual level the overall public policy objective could be to promote and encourage usage of electronic payment instruments, the associated costs and other factors such as suitability of specific instruments for a specific type of transaction must be taken into account.

In summary, from a public policy perspective, the national payment system should support a range of electronic payment instruments that provide users with choice based on cost, convenience, speed of processing, and safety.

IV. Guidelines for Developing a Comprehensive Strategy for Reforming Retail Payments The overall trends in retail payment systems and services and the public policy goals identified in the previous chapters confirm the need for adopting a comprehensive, strategic approach when undertaking a reform of the national retail payments system;

even more so, considering the many choices that are available and the many business and technical decisions that need to be made.

In this chapter, a set of ―Guidelines‖ or ―Guiding Principles‖ are discussed, with an eye to providing a strategic framework for reformers and other stakeholders for the modernization of a national retail payments system.

IV.1 General Framework Underlying the Guidelines In revisiting the numerous studies that have been undertaken by the World Bank‘s PSDG, the CPSS and other international and domestic organizations it is clear that, in general, those studies‘ key findings and especially their public policy implications can be mapped around the CPSS-World Bank General Principles for International Remittance Services (hereinafter the ―GPs‖). At present, the GPs, shown in Box 5, are the prevailing international standards for a special type of retail payment—cross-border retail payments.

Box 6: The General Principles for International Remittance Services and Related Roles The General Principles are aimed at the public policy objectives of achieving safe and efficient international remittance services. To this end, the markets for the services should be contestable, transparent, accessible, and sound.

Transparency and consumer protection General Principle 1. The market for remittance services should be transparent and have adequate consumer protection.

Payment system infrastructure General Principle 2. Improvements to payment system infrastructure that have the potential to increase the efficiency of remittance services should be encouraged.

Legal and regulatory environment General Principle 3. Remittance services should be supported by a sound, predictable, nondiscriminatory, and proportionate legal and regulatory framework in relevant jurisdictions.

Market structure and competition General Principle 4. Competitive market conditions, including appropriate access to domestic payment infrastructures, should be fostered in the remittance industry.

Governance and risk management General Principle 5. Remittance services should be supported by appropriate governance and risk management practices.

Roles of remittance service providers and public authorities A. Role of remittance service providers. Remittance service providers should participate actively in the implementation of the General Principles.

B. Role of public authorities. Public authorities should evaluate what action to take to achieve the public policy objectives through implementation of the General Principles.

While there are some differences between an international remittance transaction and an ordinary retail payment transaction, these differences do not have much of a bearing on the applicability of the GPs to both. In fact, a remittance can be treated as two sets of retail payment transactions—one between the sender and the remittance service provider (RSP), and another between RSP and recipient. Moreover, some of the traditional particularities of remittances vis-à-vis ordinary retail payments have been disappearing overtime. For example, RSPs are increasingly establishing account-type relationships with remittance senders and recipients. Or, a growing share of remittances is now using one or more elements of the retail payments value chain.

On the other hand, the proposed expansion of policy objectives for retail payments beyond safety and efficiency as discussed in Chapter 3 requires a certain reformulation of the five GPs, and adding one more. Also, unlike in the GPs, separate roles for public authorities and private sector players have not been elaborated.

Guideline I: The market for retail payments should be transparent, have adequate protection of payers and payees’ interests, and be cost-effective.

Description Transparency From an efficiency perspective, adequate transparency promotes a greater usage of the most cost-effective payment instrument(s). From the perspective of consumers, improving transparency about the various cost elements and service conditions of payment instruments helps promote consumer confidence and trust in those instruments.

Often, however, consumers of retail payment instruments and services are not entirely certain about the real cost of using a particular payment instrument. Moreover, when they wrongly or rightly attribute a higher cost to the usage of a payment instrument, the usage of that payment instrument gets restricted.

This situation is due in part to the complexity of retail payment instrument pricing. Retail payments rarely involve usage of a stand-alone payment instrument, but rather involve using a broader financial product (e.g. a current account), one of the underlying functions of which is its usage as a payment instrument. The financial product would have various levels and types of fees.

Electronic payment instruments used for retail payments often involve an element of ―subscription,‖ that is, subscribing to a service which enables a person to use a particular payment instrument. For example, to pay using a credit transfer, a payer would need to sign-up for a banking account, or to make payments using a credit card, a customer would need to have signed-up for a credit card.

In many cases, the use of the underlying financial product also entails a monthly fee or some other type of ―maintenance‖ fee. Moreover, as part of using the product‘s payment functionality, consumers might incur additional costs (for example, per transaction fees).52 In addition, a major difficulty for achieving proper levels of transparency is that financial institutions and other service providers usually create a variety of ancillary services around the financial product, some of them not directly related to the payment function, for example accident insurance coverage. In other cases, the consumer is actually rewarded for using the financial product and/or associated payment instruments. These additional services and benefits by themselves could involve a specific price, though in most cases a bundled price structure is created. The variety of services bundled into the The discussion on pricing is further elaborated under Guideline IV.

total price makes it very difficult for consumers to determine the unitary price they are paying to their financial institution or service provider for their payment transactions.

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