1. Global Reform of payment infrastructure instruments, systems and retail banking Finance Forum 2002 - World Bank June 20 Cgarrigues@worldbank.org

2. Washington DC, June 20, 2002 World Bank / FSD / C G 2 Agenda Introduction (definition) Strategic issues (objectives, stakeholder, scope) Reform Approach (principles, phases, I, II, III) Results ( decisions and project implementation) Conclusions

3. Washington DC, June 20, 2002 World Bank / FSD / C G 3 Introduction World Bank experience World Bank’s experience in many countries in transition or development (more than 50 countries) Lessons learned –To clearly identify objectives, constraints, opportunities –Stakeholders should be involved early in the process –Cooperation and Competition are not antagonistic –Reform should be “business driven” –Technology is only a powerful mean and an enabler to implement feasible and reliable solutions

4. Washington DC, June 20, 2002 World Bank / FSD / C G 4 Introduction Payment infrastructure objectives Payment infrastructure final target: to transfer value from one participant’s account to another one (bank’s or customer’s account) It is composed of several main components –International standards/rules –Legal rules ( laws, regulations, contract) –Instruments (credit/ debit orders ; paper/electronic) –Participants (clients, banks, Central Bank, operators) –IT Infrastructure ( accounting, clearing, settlement, risk management, liquidity management, transfers )

5. Washington DC, June 20, 2002 World Bank / FSD / C G 5 Introduction Payment Infrastructure Quality Quality of payment infrastructure covers: –Fast settlement (end to end): instant, end of day –Security (fraud, operational risk) –Finality (value available-in a predictable time) –Cost (acceptable for all participants) –Transparency (clear information is provided to all participants regarding payment process status, results, potential risks)

6. Washington DC, June 20, 2002 World Bank / FSD / C G 6 INTERBANK SYSTEMS Transportation/Exchanges CLEARING Payment System Architecture is composed of three main layers Client AClient A1Client A2 Branch A1 Branch A2 Head Office BANK A Client BClient B1Client B2 Branch B1 Branch B2 Head Office BANK B VALUE transferred from Bank to Bank in Central Bank’s Books SETTLEMENT between Branches and Customer’s Accounts CENTRAL BANK FINAL SETTLEMENT 1 2 3 3 3 2 2 Risk/Credit Management BANKS Securities Financial markets

7. Washington DC, June 20, 2002 World Bank / FSD / C G 7 Functional Architecture covers many functions/systems Real Time Gross Settlement Large Value, Liquidity NET Clearing LOW VALUE SECURITIES ATM, POS, PHONE, INTERNET, E-COMMERCE RISK / CREDIT MANAGEMENT Bank branch Commercial Banks’ Head Offices Bank branch Clients CARDS INTER-BANK layer INTRA-BANK layer CENTRAL BANK layer Delivery channels

8. Washington DC, June 20, 2002 World Bank / FSD / C G 8 Complex migration process paper -> electronic, local -> national Local offices Regional offices Exchange interface Queuing mechanism Settlement accounts Net systems interfaces CB Interfaces Liquidity General ledger Monitoring Real Time Commercial ‘Banks Interface Real Time Gross Settlement System RTGS Central Bank Local clearing Regional clearing National Clearing Centres End of day Net balances Low value payments HQ commercial banks Large value payments Commercial banks paper Balances Electronic transactions Securities Cards Electronic paper

9. Washington DC, June 20, 2002 World Bank / FSD / C G 9 Large value system=> Low volumes Low value systems => Large volumes FRANCE: year 1999 –Population: 60 million –Customers accounts: Banks: 45 million, Post Office: 10 million –Branches Banks: 25 000, Post Office: 17 000 –Low value net clearing system : value: 4,300 billion Euros (5%) Checks: 3.4, others: 6 billion (including card transactions) –Large value systems : 6.6 millions, value: 75,000 billion Euros –Cards: (year 2000) dramatic increase after 1985 from 5 to 20% /y 40 million ; 3.3 b payment, 1 billion cash withdrawal ATM: 35 000; POS: 740 000; telephone booth: 210 000; Minitel: 600 000; TV decoder: 1 700 000; mobile phone: 200 000.

10. Washington DC, June 20, 2002 World Bank / FSD / C G 10 PORTUGAL: year 1999 –Population: 10 million –Customers accounts: Banks: 20.5 million, Post Office: (negligible) –Branches Banks: 5,000; Post Office: 1 000 –Low value net clearing systems : Checks: 870, others: 250 million (excluding card transactions) –Cards: 12.9 million ; 510 payment, 290 million cash withdrawal ATM: 8 850; POS: 81 000; E-money cards: 3.4 million ; transactions 4.9 million Large value system=> Low volumes Low value systems => Large volumes

11. Washington DC, June 20, 2002 World Bank / FSD / C G 11 Payment Reform Objectives Economy –Facilitate Industry and economic development –Increase efficiency of Government's tax collection and expenses payments Population –To offer better banking services to all potential customers (range of payment instruments/ credits) –To prepare easy insertion of e-payment, e-banking and e-commerce environment –To facilitate access to basic needs like water/electricity by pre-paid cards payment

12. Washington DC, June 20, 2002 World Bank / FSD / C G 12 Financial sector objectives –To develop business –To increase depth and resistance to shocks –To complying with international standards (BIS CPSS « Core Principles) attached to clearing and settlement systems : Clear and fair legal framework, Credit and liquidity risk, Efficiency, Transparency

13. Washington DC, June 20, 2002 World Bank / FSD / C G 13 Stakeholders consensus is a prerequisite to success CENTRAL BANK GOVERNMENT COMMERCIAL BANKS INDUSTRIES MERCHANTS SME’S INDIVIDUALS ADVISORY COUNCIL ON PAYMENT REFORM

14. Washington DC, June 20, 2002 World Bank / FSD / C G 14 Reform Approach MAIN PHASES –Candid diagnostic (SWOT, BIS/CPSS principles, FSAP) –Strategy and long term vision (business, legal, technology) –Systems' Architecture design (shared / non shared) –Financing and Prioritization (budgeting and planning) –Implementation of systems architecture (project management) –Evaluation (performance indicators) –Evolution and adaptation (quality, costs recovery) Key issues –Legal framework, standardization, cooperation/competition –Project management/organization

15. Washington DC, June 20, 2002 World Bank / FSD / C G 15 List of frequently observed deficiencies –Cash and paper based instruments are dominant, –Transaction processing is unreliable (lengthy delays in clearing and settlement process, uncertainty in finality) –High rate of rejection or return, fraud, –Central bank and commercial banks’ information systems are non compatible ( no straight through processing) –Telecommunication services are underdeveloped –Population access to services is low (10%) –Retail banking and financial services are poor –Lack of transparency in process status

16. Washington DC, June 20, 2002 World Bank / FSD / C G 16 How to move Success conditions –Strong commitment of the Central Bank and Government authorities in Reform process –Long term approach supported by a long term business vision shared by major stakeholders –Development of standards, norms, legal framework –Realistic implementation schedule of components supported by a large cooperation to accelerate and optimize investments in technology, human resources, marketing, culture changes,

17. Washington DC, June 20, 2002 World Bank / FSD / C G 17 Participatory reform approach principles 3 to 4 Workshops (4 to 5 full days each) to cover –Analysis and diagnostic –Strategy and business vision, –Global architecture design, –User’s requirements per components –Prioritization, budgeting and planning –Implementation Plan –Evaluation methodology Duration of the study phase 9 to 12 months.

18. Washington DC, June 20, 2002 World Bank / FSD / C G 18 Participatory reform approach principles Workshops/ Seminar organization –Day 1: Plenary session: Experts conferences, example of Reforms, organization of groups and work, –Day 2 to 3: three to five working groups in parallel; themes: business strategy, legal framework, large value transactions, low value transactions, cards, technology –Day 4: Plenary session: Reports of Working groups and discussions –Day 5: General report, working plan, conclusion

19. Washington DC, June 20, 2002 World Bank / FSD / C G 19 Workshop’s Participants ( 80 to 100 /workshop) –Central bank ( national and regional levels) –Commercial banks ( experts and managing directors) –Governments ( Ministry of finance, …) –Consultants ( Legal, Large value, Low value, Cards,Technology) –Central Bank experts ( Tunisia, Swizerland, France) –International institutions ( WB, IMF, BIS) one major condition of success : to maintain continuous work between workshops seminars Participatory reform approach principles

20. Washington DC, June 20, 2002 World Bank / FSD / C G 20 Participatory reform approach implementation study : phase I First workshop/seminar objectives to educate and create motivation and consensus to define (first draft) –A long term and agreed business vision to identify –Global functional architecture and major components –Legal issues to be addressed –Technology issues to be addressed

21. Washington DC, June 20, 2002 World Bank / FSD / C G 21 Business Strategy should combine 3 dimensions ( at least) Delivery Channels Branches ATM POS Home banking Mobile phone Internet Telecommunication network Phase I: Business strategy 10* thousandmillion access pointsthousand Banking products Customer’s segments Individuals Merchants SME’s Industry Government

22. Washington DC, June 20, 2002 World Bank / FSD / C G 22 Phase I: Payment Instruments strategy : Paper => Electronic => Virtual High value ValueNumbers CashCardsChecks Electronic Debit/Credit orders Electronic purse some (or more) paper transactions billionthousand millionthousand

23. Washington DC, June 20, 2002 World Bank / FSD / C G 23 Phase I : Payment instruments Checks: an obsolete product ? slow or rapid decline ( % of non cash transactions in nb)

24. Washington DC, June 20, 2002 World Bank / FSD / C G 24 Phase I: Payment instruments Direct debit Direct debit: a random evolution ( % of non cash transactions in nb)

25. Washington DC, June 20, 2002 World Bank / FSD / C G 25 Phase I: Payment instruments Debit card Debit card: a sharp development ( % of non cash transactions in nb)

26. Washington DC, June 20, 2002 World Bank / FSD / C G 26 Phase I : Payment instruments a whole range is available to serve the population Cash Checks Direct debit Cards ( prepaid, debit, charge card, credit) Credit orders, Tele-banking ( phone, e-banking, e-payment) Electronic money/ purse / wallet Letter of Exchange

27. Washington DC, June 20, 2002 World Bank / FSD / C G 27 Phase I: Payment instruments conclusion Strategy: to develop a whole range of PAYMENT INSTRUMENTS Each payment instrument corresponds to a specific requirements depending on the culture and financial education of the customer Payment infrastructure should be fully adaptable to changes

28. Washington DC, June 20, 2002 World Bank / FSD / C G 28 Phase I :Functional Architecture users and business requirements Real Time Gross Settlement Large Value, Liquidity NET Clearing LOW VALUE SECURITIES ATM, POS, PHONE, INTERNET, E-COMMERCE RISK / CREDIT MANAGEMENT Bank branch Commercial Banks’ Head Offices Bank branch Clients CARDS INTER-BANK layer INTRA-BANK layer CENTRAL BANK layer Delivery channels

29. Washington DC, June 20, 2002 World Bank / FSD / C G 29 Phase I :Functional Architecture some findings One centralized single settlement account per financial institution to reduce liquidity and credit risk Each function may be processed in one or several systems, shared among banks or not, however one major objective is to avoid duplication and centralize data and processes to reduce costs and enable an efficient risk management mechanism, ( trade off between cooperation versus competition, cost /benefit analysis) Electronic clearing system should process all payment instruments Risk/Credit management system should cover all instruments Anti Fraud fight requires specialists in close relation with police and justice (speedy reaction and decision are key factors of success) End to end processing and efficient connection between inter-bank and intra bank systems and networks are key factors to be considered in the architecture design, security features, standards,

30. Washington DC, June 20, 2002 World Bank / FSD / C G 30 Participatory reform approach implementation study : phase II Second workshop/seminar: in depth work –to confirm and validate the business vision –to define users’ specifications and functions of the infrastructure components to be implemented –to progress on standardization, legal reform and regulations –to identify technical investments to be installed in Central Bank, at inter-bank level and inside each individual bank

31. Washington DC, June 20, 2002 World Bank / FSD / C G 31 Phase II Large value system (RTGS) Commercial Bank HO A Commercial Bank HO B Network Central Bank General Ledger Participant Interface Settlement Account Management ( debit A and credit B) Real Time Transactions Interface RTGS Central Bank

32. Washington DC, June 20, 2002 World Bank / FSD / C G 32 Phase II Large value system (RTGS) Commercial Bank HO A Commercial Bank HO B Network and Vor Y Copy Service CB General Ledger Participant Interface Settlement Account Management ( debit A and credit B) Queuing Optimization Real Time Transactions Interface CB Operations LVS/RTGS Net Systems Interface Central Bank Liquidity

33. Washington DC, June 20, 2002 World Bank / FSD / C G 33 Phase II Large value system (RTGS) some findings (1) To specify which transactions are processed : credit, debit, balances – money market, foreign - multi-currency, - minimum value- etc.) To define optimum level of liquidity required to avoid settlement delays and grid lock risks on one side and financial costs for commercial banks on the other side To define liquidity management mechanism ( REPO, Guaranty, intra-day credit,…) To define processing of foreign transactions and relations with international systems To define quality of service and acceptable processing costs

34. Washington DC, June 20, 2002 World Bank / FSD / C G 34 Phase II Large value system (RTGS) some findings (2) To select functions to be included in the system and their required sophistication To define queuing processing ( FIFO, cancellation, priorities, ) and optimization methods To define daily processing profile: opening hours, cut(s)-off), and volumes to be processed (how to smooth volumes all along the day) To define messages to be exchanged and information accessed (in real time, at opening and closure, to Central Bank departments, to sender and beneficiary commercial bank, to netting systems operators, etc.) To define level of network security for exchange of financial and information messages

35. Washington DC, June 20, 2002 World Bank / FSD / C G 35 return Electronic Clearing House National level Regional Clearing systems/houses National level Branch A1 Branch B1 Branch C1 Paper Transactions HO A1 HO B1 HO C1 RTGS System HO Central Bank balances OK presentation Information (debit) balances Commercial Banks Clearing houses balances Phase II Low value net clearing system (ECH) architecture Automation capture Electronic Transactions

36. Washington DC, June 20, 2002 World Bank / FSD / C G 36 Phase II Low value net clearing system (ECH) flow of data Payee or Presenting BANK A Central System Electronic Net Clearing system MULTILATERAL BALANCES information MICR Data and image (checks) and other electronic transactions information Settlement in RTGS Payor or Receiving BANK Payor or Receiving BANKS B,C,D, Continuous flow of files Once a day or more information

37. Washington DC, June 20, 2002 World Bank / FSD / C G 37 Phase II Low value net clearing system (ECH) findings Electronic transactions should be legally or industry wide accepted It is recommended to process all kind of transactions (credit or debit orders, check image, cards, etc.) in a single Electronic Clearing House System (ECH) for economic and risk management reason All electronic transactions are sent by commercial banks to the most convenient regional or national receiving point including “out of station” transactions Paper documents are processed and stored independently from the electronic data and sent to the issuer bank’s branch only for further control, claims or and if it is required, for legal “proof” Rejections cases have to be very carefully regulated (including delays) Protections rules against netting settlement failure and systemic risk have to be efficient, including all messages exchanged between ECH, Banks and RTGS

38. Washington DC, June 20, 2002 World Bank / FSD / C G 38 Phase II Check truncation process example Check A Clearing based on MICR data calculation --- many schemes for exchange of images exchange of paper Check A on request data and image MICR data Checks are stored in Bank B Depository/ certification Image access Bank A head office branches or Bank B branches head office Image access Image access Check A

39. Washington DC, June 20, 2002 World Bank / FSD / C G 39 Phase II Check truncation process findings MICR data and imaging are captured by payee bank B and sent to a national clearing house in a centralized process Checks are stored in Bank B (Payee Bank) Clearing process is based on data files that can be received and exchanged all day long (continuous day) More than one cut off time allows to settle balances many times a day Check images can be exchanged and/or stored in a Central Check Image “Depository” easily accessible on line Payer Bank controls most check based on data and/or their image (authentication, signature, funds available) and in case of doubt ask for physical paper for further acceptance or rejection

40. Washington DC, June 20, 2002 World Bank / FSD / C G 40 Phase II Card based inter-bank architecture BANK ABANK B National Switch POS ATM SI Card System SI Inter-bank NETWORK SI BANK C

41. Washington DC, June 20, 2002 World Bank / FSD / C G 41 Phase II Inter-bank card arrangement principles A whole range of products and services should be distributed to customers under free competition (no standard customer’s fees) A Core Inter-bank service for all customers(minimum customer’s rights) should be agreed among banks as well as inter-bank fees Cooperation and sharing of several functions and systems should be agreed among banks Fraud and Incidents support systems have to be shared for better efficiency Service quality common monitoring ( availability and efficiency) is a key success factor Several options are available for authorization’ systems

42. Washington DC, June 20, 2002 World Bank / FSD / C G 42 Phase II Card transactions: 4 levels of authorization Acquiring Issuing Authorization center ( limits and delegation) Acquiring of transactions Bank A Real time customer account position processing Authorization by issuing bank’s system (limits) Smart card’s function: to secure the card holder identification Authorization processing ATM network POS network 1 2 3 4 off line

43. Washington DC, June 20, 2002 World Bank / FSD / C G 43 Phase II Card transactions: batch processing settlement Acquiring BANK or service provider / Acquiring Back Office Sorting (on us transaction) Acquiring of transactions Preparation of Files for Electronic Clearing Credit and debit own customers account Telecollection process ATM network POS network Batch process

44. Washington DC, June 20, 2002 World Bank / FSD / C G 44 Phase II Card transactions: authorization and settlement Several schemes of authorization: trade off between costs and risks between off line or full on line processes Chip card or smart card can decrease dramatically the level of fraud and enable a secured off line process for payment (POS) Clear rules should be defined for transferring risk between card holder, merchant, merchant’s and card holder’s banks Off line transaction collection ( batch processing and reconciliation) may enable easier control of risk and fraud It is of major importance to differentiate Inter-bank’s fees (cooperation) from customers’ fees (competition)

45. Washington DC, June 20, 2002 World Bank / FSD / C G 45 Paiements de gros montant en temps réel Gestion des comptes de règlement ( débit A et crédit B) Siège banque A Files d’attente Siège banque B Réseau BA ou SWIFT (?) Optimisation Interface des échanges temps réel Opérations BA Système comptable BA RTGSSiège BA Op. compensation Interface participant

46. Washington DC, June 20, 2002 World Bank / FSD / C G 46 Phase II E-money /purse/wallet process (example) account Customers Merchant Accounts Banks A,B,C Bank’s B E-money company group of transactions e-money Loading E-purses POS 2 000 (credit) - 10,30,50, -10., 50 150 150 (debit) Loading the E-Purse Paying with the E-Purse + 500,200,200, 100, 1000, + 10,30,50, 10., 50 - 500,200,200, 100, 1000, 150 (credit) 2 000 (debit)

47. Washington DC, June 20, 2002 World Bank / FSD / C G 47 Phase II E-money /purse/wallet findings Several schemes of loading: ATM, POS, home PC readers, etc … and storing the “mirroring” of the e-money: banks, service provider, merchants Potential creation of money has to be carefully controlled Risk : security and safety of transfer of value from one chip card or to another chip card or PC or other memory and on counterfeit chips No matching between loading amount and merchant credit nor between the remaining fund on e-cards and the balance in the e-money company, E-company should guaranty a fully safe cash deposit and should be supervised as deposit taking institutions by the Central Bank E-card individual transactions should be archived somewhere for statistic and trace-ability, fully anonymous cards should be avoided…

48. Washington DC, June 20, 2002 World Bank / FSD / C G 48 Phase II Multi Channel, approach Bank's SERVICES Bank’s Information System Brick and Click TellerATM POS Phone PC Mobile

49. Washington DC, June 20, 2002 World Bank / FSD / C G 49 Phase II Internet, cross-channel approach Bank’s IS Anytime, Anywhere, Anyway Services Provider ISMerchant's IS

50. Washington DC, June 20, 2002 World Bank / FSD / C G 50 Phase II Electronic, Internet banking, main issues Three main models: –Pure, many failures: Security First Network Bank, Unofirst (BBVA) –Click and mortar, big success: Well Fargo, Nordea –Online extension…from brokers, ( E*Trade) Success factors: –No revolution=> gradual approach, –Large customer base => a key factor –Sound marketing and business strategy and customer’s needs focus Issues to address –Economics (costs – iceberg structure-, and revenue -advertisements risk- ) –Standardization (technology, procedures) –Rules and regulation ( privacy, risks, security)

51. Washington DC, June 20, 2002 World Bank / FSD / C G 51 Phase II Global architecture complexity Cards ATM Check Debit / Credit orders E-card Receiving Bank Branch Paper to Electronic Data capture POS Receiving Bank Head office RTGS Card processing Center(s) National Electronic Clearing House Beneficiary Bank Head Office General Ledger CB Check image storage MICR data and Two sides checks scans ? SWIFT ? E-money Company CB Access Point Payment incidents Fraud, Abuse, … Data base CB Access Point

52. Washington DC, June 20, 2002 World Bank / FSD / C G 52 Participatory reform approach phase III Reform design validation and Implementation Plan Business vision and strategy Legal framework reform plan Architecture design and components to be installed Users requirements and technical specifications of each component ( RTGS, Low value, Truncation, Cards, Risks) Technology framework and normalization Investments sharing among participants and external financing Implementation plan priorities, schedule Project management/organization Reform Strategy and Implementation Document

53. Washington DC, June 20, 2002 World Bank / FSD / C G 53 Participatory reform approach Results achieved Motivation, information and consensus more than 500 persons involved in the process –Central bank ( national and regional levels) –Commercial banks ( experts and managing directors) –Governments ( Ministry of finance, …) –Consultants ( RTGS, Electronic Clearing, Cards,Technology. Legal) –Central Bank experts ( Tunisia, Swizerland, France) –International institutions ( WB, IMF, BIS)

54. Washington DC, June 20, 2002 World Bank / FSD / C G 54 Participatory reform approach Results achieved Strategy –Promotion of new electronic instruments and low cost decentralized check truncation mechanisms –Development of retail banking (customers’ accounts, basic banking services) –Inter-bank initiatives (cards, standardization, legal) –Clearing and Settlement architecture scheme –Shared telecommunication network –Legal framework supporting Reform

55. Washington DC, June 20, 2002 World Bank / FSD / C G 55 Participatory reform approach Results achieved Design, user requirements specifications –Large value transactions: RTGS, –Electronic clearing house ( all instruments) –Checks truncation –Inter-bank card association and center(s) –Telecommunication network upgrade –Legal framework supporting Reform

56. Washington DC, June 20, 2002 World Bank / FSD / C G 56 Participatory reform approach Results achieved Implementation –Priorities, –Project organization (CB, Financial Institutions) –Legal reform action plan –Creation of an Institution in charge of Norms and Standards –Budget and finance (cost around $US 20 million) –Schedule ( 4 to 5 years)

57. Washington DC, June 20, 2002 World Bank / FSD / C G 57 Participatory reform approach Project organization and costs Steering Committee Global Project Team Director, Sub-project leaders Legal, Finance and Budget Technology Training 34.5 Sub projects teams RTGS ACH/ Net Systems Card systems Telecommunication Risk Mg. Training 4.520.5 Commercial Bank’s projects teams Advisory Council TOTAL : US$ 20 million 1.5 4

58. Washington DC, June 20, 2002 World Bank / FSD / C G 58 Participatory reform approach Main difficulties Project organization / management Identification of (good) consultants / experts Level of knowledge of participants (heterogeneous) Real work between workshops/seminars Choice between urgent and non urgent requirements Tight time schedule and limited human resources Cooperation versus competition / Consensus

59. Washington DC, June 20, 2002 World Bank / FSD / C G 59 Participatory reform approach Conclusion Candid and clear assessment ( Strength, Weaknesses, Opportunities, Risks,) To agree on a long term shared business vision (trade off between ambition and feasibility) Strong cooperation among all stakeholders Clear Agreement on technical design and standards Professionalism in project management, budgeting, scheduling and implementation

60. Washington DC, June 20, 2002 World Bank / FSD / C G 60 Participatory reform approach Some thoughts Payment activity and systems constitute a key infrastructure of the financial sector in a country It is a field in which several stakeholders, even with conflicting interests, should share a common and realistic long term business vision and technology infrastructures It is a field in which technology play a key role but should not lead the process The process should be business and social driven Participatory approach methodology: key success factor to ensure consensus, cooperation, motivation, transparency

61. Washington DC, June 20, 2002 World Bank / FSD / C G 61 Payment Reform Success