Saturday, 12 October 2013

Why the new Payments Systems Regulator needs to avoid rushing in change


The UK government has announced that the bank dominated Payments Council is to be replaced by a competition-focused utility style regulator for payment systems, under the Financial Conduct Authority (FCA), part of the Bank of England. This new body will assume its powers in late 2014 and will be fully operational by Spring 2015. The focus will be on providing competition, innovation and responsiveness to consumer demands in the payments system. It is hoped by the government that the Payments Council will in turn reform itself into a more traditional trade body.

Talk of reforming the payments system has been going on for a very long time with the Cruikshank Report into competition in banking  back in 2000 recommending the setting up a full blown payments regulator, the so-called ‘Payco’. That recommendation was never acted upon, not only because of the active lobbying by the banking industry but also because of the size of the investment required to set up the regulator and the fear of disruption to the payments system in the process. Little progress has been made since 2000 except the slow introduction of Faster Payments and the reluctant abandoning of end of cheques, which had been due in 2018.

The new Payments Systems Regulator may want to show that whilst the creation of the body has taken a long time that it is a body with a mission and at pace. However whoever heads this body should be wary of rushing in change too quickly.

The UK has one of the best set of payments systems in the world – in many ways the envy of the rest of the world. After 9/11 it wasn’t the fact that the Twin Towers had come down or that the US had been attacked on its own soil and that hundreds had died that nearly brought down the US economy, but rather the grounding of all the airlines. In the US at that time (and even today)  because the economy was highly reliant upon cheques (or checks if you are outside the UK) the fact that the planes could not fly the cheques raised on one bank to deliver them back to their originating bank for clearing meant that the US economy almost ground to a halt.  The flow of money was stopped. Given similar circumstances in the UK the impact on the UK economy would have been far less. The UK has a highly resilient, highly reliable payments infrastructure. Britain should be proud of the long history of a payments infrastructure that is only invisible to most because it works and customers take it for granted that when they make a payment it will arrive where it is meant to in the time that it is meant to. This is despite the fact that the systems have, primarily, been built by those 'empires of evil', as portrayed by the politicians, the big four banks (Barclays, Royal Bank of Scotland, Lloyds Banking Group and HSBC).

However the UK payments infrastructure has been slow to change, has failed to grasp innovation and has had to be dragged and screaming towards the twenty first century. The Payments Council dominated by the Big Four banks has had the unenviable task of leading by consensus and with each of the Big Four being competitors has rarely got to consensus and where it has it has been through a suboptimal compromise.

The new regulator has the challenge of addressing the level of competition in the industry, increasing the innovation and making sure that the consumer’s voice is heard.
Despite all the reviews and all the parliamentary committees which have reviewed and reviled the banking industry, a forensic analysis of the payments industry has not really been carried out. Whilst the small banks and building societies who process low volumes of transactions and the new challenger banks may complain they are unfairly charged for access to the payments system the arguments seem to be based on little data and a lot of emotion.
One of the first tasks that the new regulator should commission is an independent, forensic analysis of the costs to both build and operate the existing infrastructure. The natural instinct will be to use one of the Big 4 accountancy firms to do this, however they are so dependent upon fees from the big banks that it is questionable whether they will be seen to be independent. The purpose of this analysis of the costs will be to determine what a fair cost to use the infrastructure should be (allowing for investment to build the next generation infrastructure) and compare that against what is being charge today.
The new regulator has an unenviable task because there is a clear conflict between significantly reducing the cost of using the infrastructure and encouraging investment and innovation into that infrastructure. It is analogous to Ed Miliband, the UK leader of the Labour opposition, saying that he will freeze the cost of utility bills whilst still expecting those utilities companies to invest in green technologies and maintaining and upgrading the creaking infrastructure.
This brings into question whether there can be real and speedy investment and innovation into the payments infrastructure while the big four banks still collectively own it. Over the last forty or so years they have demonstrated that getting to consensus has inhibited progress and has compromised innovation. There has also been a chronic lack of investment in building the next generation infrastructure. Is there any reason to believe that this will change?
The new regulator needs to decide whether the three objectives assigned to the regulator of creating competition, encouraging innovation and responding to consumer demand can be met while the ownership of the payments infrastructure remains with the big four banks.  A solution could be that the big four banks are forced to dispose of the payments infrastructure to an independent business to which they will become customers just like the smaller banks, building societies and challenger organisations. The acquiring organisation will need to demonstrate not only that they have the experience to run the infrastructure the resilience and reliability of which  is of national importance but also have a realistic strategy for the payments industry going forward and how they will fund both innovation and maintenance of that infrastructure whilst actively engaging with consumers. This is not a task for those who are looking for a quick in and out with a healthy profit. Only an organisation that is prepared to run the infrastructure independently of the banking sector for the long term will make any sense.
Without taking a measured, fact driven and courageous approach to changing the payments industry with cross-party support (given the length of time any programme will take to enact) this regulator will be no better than the Payments Council it is replacing.