What will catalyse the next wave of payments system innovation?
Say “electronic payment” to most Australians and they will probably think of logging into their web banking service. This might involve using the “bill payment” screens to pay a bill, or directing a payment to someone else’s account using the “pay anyone” screens. But these are relatively recent evolutions. Of much longer standing are the arrangements that cause a salary to appear automatically in the account every fortnight, as well as the “set and forget” authority with a regular provider (energy company, local council or insurer) to draw funds out for regular bills.

The Direct Entry (DE) system: electronic payment highways
Few of us give much thought to the underlying network that ensures these instructions are reliably and cheaply carried out. But all these examples, and many others, use the direct entry (“DE”) system that connects banks, building societies and credit unions and provides the means for more than 5 million direct credits and direct debits to flow between accounts every day. APCA supports the system by providing the rules, procedures and standards that these parties must adhere to if the system is to work efficiently. This is the Bulk Electronic Clearing System.

DE is to commerce what highways are to communities: basic linking infrastructure used and re-used for diverse purposes. Financial institutions use DE to provide a wide range of different payment and related services to consumers, government and every size and shape of corporate customer. Customers will, in many cases, have no awareness of (and possibly not much interest in) the underlying network, but network configuration, capability and capacity directly affect the convenience and efficiency of the services they ultimately enjoy.

Australia’s DE system has proved a robust and adaptable piece of infrastructure. The system dates its evolution back to the early 90's (APCA’s BECS system was formed from the merging of the bank, building society and credit unions direct entry systems in 1992). In those days, computers were mostly large, data-crunching mainframes, and the internet barely existed.

Despite this, the DE system has risen to the challenge of the internet age through front-end innovation by financial institutions – web-based business banking packages and “pay anyone” web banking for consumers. The number of registered users (that is, organisations able to inject credits or debits into the system through their financial institution) has ballooned to nearly 240,000. Perhaps most importantly, today’s system handles volumes and values well beyond anything envisaged by its original designers, and the system continues to enjoy double-digit growth.

The virtuous cycle of innovation
What we can see here is a virtuous cycle of innovation of the kind which must occur in any network industry if it is to develop successfully over the long term. The cycle, in broad terms, goes like this:

• Industry participants develop attractive new services for their customers that require some “networking” – ie, some interaction amongst the participants. Initially, this interaction may be ad hoc, and bilateral;
• As these services grow in popularity, the underlying network infrastructure needs to expand to service demand;
• In this way, a platform develops on which more new products and services can be offered by participants to their customers; and
• This leads to more customer demand for an expanded or improved network platform.

Perhaps it is easier to see the cycle in payment cards. ATMs developed in the 80’s as separate bank services, with each bank issuing cards useable only in that bank’s ATMs. Gradually, institutions gave reciprocal access to their systems (and smaller institutions joined larger networks) so that each cardholder had a wider range of ATMs to choose from. At the same time, growth in popularity of card payments in stores meant that EFTPOS devices were introduced and could support both credit card authorisations and EFTPOS transactions.

By 1990, there were two integrated ATM networks and a web of EFTPOS linkages. In this way, a virtuous cycle of development provided the basic infrastructure for an explosion in mag-stripe card services and products over a 15 year period.

Product innovation versus network innovation
One of the important things to observe about this cycle is that although both product innovation and network innovation are needed, these two types of innovation require quite different behaviour from industry participants. Product innovation is a function of competitive advantage: striving to get the jump on your competitors to have better, cheaper and/or more convenient services. Network innovation is a function of collaboration: industry players work together to define and build the basic infrastructure they all need in order to serve their customers better. Not too many organisations are good at competing aggressively in the product market while simultaneously collaborating with their rivals. Sometimes, competition laws make collaborative business case development very difficult.

For this reason, industries tend to cycle between bursts of collaborative infrastructure development and longer periods of competitive product development.

In electronic payments - and for that matter in payment cards - it can be argued that we are coming to the end of a long cycle of product innovation relying on stable, mature infrastructure. DE has been in place in more or less its current form since the early 90’s - with basic standards like message formats even older than that. Customers probably haven’t noticed, because in that time they have seen plenty of product enhancements. Consumers enjoy extensive phone and internet banking services with integrated “pay anyone” functionality; and businesses have access to web-based banking packages that integrate with their accounting systems, schedule bulk payments, handle authorisations and so on. This has occurred through product innovation, without fundamental network innovation.

Emerging issues
If the cycle holds true, ever-changing customer demand will ultimately require fundamental platform work. APCA sees some emerging issues for DE. In the early 90’s, DE’s delivery of value within 24-hours looked good against a 5 day cheque clearance cycle, and for that matter 3 to 5 day cycles for automated payments in other countries. In 2008, the world has moved on, and real-time value is often expected. Today’s large values and volumes are necessarily accompanied by increased settlement risk: not directly a concern for customers so much as participants, but the problem arises from the sheer popularity and growth of DE payments.

There are even larger, more complex questions. Will the existing infrastructure be able to meet the unknowable new demands of the next decade or two, as it has done in the past? In particular, how is the basic payment to be integrated or seamlessly reconciled with each underlying transaction, no matter how complicated or diverse? And perhaps the ultimate challenge: how do we ensure that Australian payments integrate on a global basis as geographic barriers disappear in the world economy?

These considerations led APCA to undertake extensive analysis and consultation into low value payments in 2008. APCA’s approach has been to focus on developing a “roadmap”. In effect this is an industry strategy document; it does not mandate any course of action, but seeks to develop broad industry consensus around directions for the future. In some areas, a strong strategic consensus can become a self-fulfilling prophesy: for example, if we can achieve consensus on the likely message standards we will all need to use in the electronic payments infrastructure of the future, then participants make their own future technology choices with this in mind, and begin to identify product opportunities to take advantage of this envisioned future.

Another complex issue is the future for paper payment instruments, particularly cheques. Australia has already done much to optimise clearing procedures through electronic exchange of value on cheques and a 3 day clearing cycle. However cheque volumes are in steady decline and the dilemma we face, in common with many cheque friendly jurisdictions, is whether to invest in further (and increasingly costly) optimisation for fewer and fewer cheques.

In other areas, the roadmap will point to new and challenging industry collaboration that must be separately scoped, costed and agreed. For example, it seems clear that the long-standing x.25 communications protocol used extensively across the payments system is approaching its end of life, so that payments industry participants must invest in replacing legacy systems and links with Internet protocol alternatives. This can be done by one-for-one replacement; but it also creates an opportunity for strategic network enhancement through reconfiguration.  APCA expects to sponsor an industry debate to explore alternatives and recommend opportunities in the coming months.

This work has identified the challenge: industry responses seem to agree that some network collaboration will be needed if we are to see the next cycle of product innovation kick-started successfully. Now the question is, how do we organise fierce competitors, each rightly focused on their own bottom lines, to engage in collaborative effort on the network for the benefit of the entire economy?

APCA’s conviction is that the Australian industry has done so with outstanding success in the past, and we will do so again.