Cooperation versus Competition: Real or Mythical Trade-off in Payments Systems? Presented at the World Bank Conference Exploring Frontiers in Payments System Development May 29, 2007 by Sean O’Connor Bank of Canada The views expressed in this presentation are those of the presenter and do not necessarily represent those of the Bank of Canada

Trade-Offs and Corollary for a Payments System Two related trade-off propositions : –Behaviours: cooperation versus competition –Outcomes: systemic safety versus efficiency Behavioural Corollary: –Cooperation in payment infrastructures -- competition in payment service

Trade-Off Propositions: Myth or Reality Depends on specific issue and the context For specific service production processes: –Efficiency-safety trade-off some reality –Cooperation-competition trade-off less applicable For developing micro-structure of payments system –Efficiency-safety trade-off less applicable –Cooperation-competition trade-off more mythical than real

Key Points of Presentation Why ‘trade-off’ doesn’t apply to cooperation- competition, nor systemic risk and efficiency, in context of payments system market micro-structure Why differing cooperation-competition balances for different core payment service markets not trade-off ‘point equilibrium’ but balanced ‘equilibrium path’ How competition-cooperation and systemic efficiency-stability co-relate in effective market micro-structure for a payments system

Definition: Payments System Context => developing supply-side micro-structure Payments system: organizations and mechanisms providing services to efficiently, securely and reliably transfer money –Banking system plus payments infrastructures – transaction, clearing and settlement network arrangements Infrastructure roles: integrated production and delivery of various payment services in decentralized service markets

Behavioural Definitions Cooperation and competition => interaction behaviours Cooperation => multilateral activity by a coalition of parties to achieve a common purpose or outcome Competition => rivalry among individual players or groups to singularly achieve an individual, although possibly commonly-held, purpose or outcome

Concept of a Trade-Off Trade-off => constructed relationship among substitute choices at pre-specified outcome level Applicability to market micro-structure context –Do the working definitions imply that cooperation and competition are necessarily substitutes in a payments system overall, or in any specific network or service market arrangement? –Can cooperation and competition co-exist as optimally balanced behaviours in a payment service market? Responses for micro-structure context: –‘No’ to the first and ‘yes’ to the second!

Trade-off: Myth versus Reality? Proposition: trade-off is universal concept in payments system even for behaviours –A myth in payments service market micro-structure at least for cooperation-competition behaviours –Cooperation and competition are not mutually exclusive behaviours in practical market arrangements Realities: –Trade-off concept not applicable to behaviours in context of payments system micro-structure –Payments system development requires a balance of cooperation and competition among service providers and users –Cooperation and competition are complements for developing the micro-structure of payments service markets

Competition-Cooperation Corollary Proposition: cooperation in infrastructures, competition in services Competition in markets is generally derived from some degree of cooperation in infrastructures –Network infrastructures compete on provision of similar service and cooperate on interoperation of different services –Network service providers and users cooperate on institutional arrangements for service markets and compete on terms and conditions for bilateral service contracts –Network participants compete on user-demand for network services and on provision of related payment services

Balance or Trade-off in Behaviours? Implications of corollary => balance not trade-off –Cooperation in organization and set-up of payment service infrastructure and competition in service provision and use => complementary behaviours ‘Good’ cooperation-competition balance in payments system –One that yields ‘good’ balance between systemic risk and systemic efficiency –‘Good’ balance varies with type of payment service and its market structure and with innovation over time

Systemic Risk and Efficiency: Trade-Off? Systemic risk and systemic efficiency: definitions in a micro-structure context –Systemic risk: adverse shocks to one system or market spills over to others to severely disrupt financial system –Systemic efficiency: allocation of benefits, costs and risks in a system or market welfare optimal due to new or existing allocations in related systems or markets. Trade-off between systemic efficiency and safety more myth than reality in context of market micro-structure –Systemic safety and systemic efficiency complements not substitutes in sound market micro-structure –Need a balance of both in every payment service market for systemically efficient and safe payments system

Relating Behaviours to Outcomes Co-relation of behaviours and outcomes –Cooperation in set-up and interoperation of networks and markets => stability in supply of payment services –Competition in provision of similar services and in user- demand for the service => efficiency in market allocation Two ‘rules of thumb’ for ‘good’ behavioural balance: –More (less) competition than cooperation in decentralized (centralized) payment service markets –More competition than cooperation toward end-user service markets and less toward settlement service markets

Relating Behaviours to Outcomes Market structure and behaviour-outcome relation –Decentralization of service providers => diffuses systemic risk to service supply and promotes competition of service providers –Centralization of service providers => limits competition, concentrates supply risk, supports incentives to cooperate Good balance in behaviours for well-balanced outcomes in specific infrastructure service markets –Centralized settlement infrastructures => cooperation in user- demand and interoperability of complementary service networks –Decentralized transaction infrastructures => competition between rival service networks for user demand but cooperation with complementary service networks

Policy Preference Trade-off: Good versus Bad Behaviours Trade-off: good versus bad behavioural balance –A reality, not myth, for policy design and implementation ‘Bad’ cooperation-competition balance => bad balance in systemic efficiency-safety –Competition in demand for network services among users => incentives to unduly restrict network access to a ‘cooperative’ subset of participants –Cooperation in provision of complementary services => limits producer-user competitive contracting Policy objective => get behavioural balances right for systemically efficient and safe payments system