Nonbanks and Risk in Retail Payments

Transcription

1 Nonnks n Risk in Retil Pyments By: Memers of Europen Centrl Bnk Oversight Division * Memers of Feerl Reserve Bnk of Knss City Pyments System Reserh Funtion Working Pper Pper for presenttion t the Joint ECB-Bnk of Engln Conferene on Pyment Systems n Finnil Stility Frnkfurt, Novemer 2007 Astrt This pper ouments the importne of nonnks in retil pyments in the Unite Sttes n in 15 Europen ountries n nlyses the implitions of the importne n multiple roles plye y nonnks on retil pyment risks. It shows tht nonnks ply multiple roles long the whole pyment proessing hin of five min pyment instruments (r pyments, eletroni heques, reit trnsfers, iret eits n e-money n other pre-fune/store vlue instruments). The importne of nonnks is ssesse s prominent in the Unite Sttes ross ll the onsiere pyment instruments, n high n growing in Europe where however ifferenes mong the vrious ountries n pyments lsses persist. In Europe the importne of nonnks is expete to grow in the future, riven y inustry n regultory evelopments. The pper rgues tht nonnks presene hs shifte the lous of risks in retil pyments towr higher relevne of opertionl risk in its vrious forms (mlfuntioning, t seurity, n t protetion), s well s higher relevne of fru risk n system-wie impt of isruptions t key proviers onentrting proessing for importnt pyment mrket segments. Bnks hve eome inresingly epenent on nonnk servie proviers, n the option of new tehnologies in pyments proessing, prtiulrly s regrs ommunition networks, while on the one hn supporting mitigtion of reit n liquiity risks onnete to pyments uthoristion, inreses the numer of possile points long the proessing hin tht my e vulnerle to fru n illiit use. The pper reviews the min regultory sfegurs in ple, n onlues tht there my e nee to reonsier some of them in view of the growing role of nonnks n of the glol reh of risks in the eletroni er. * Simonett Rosti. The views expresse in this pper re those of the uthor n o not neessrily reflet the views of the ECB or the Eurosystem. Terri Brfor, Fumiko Hyshi, Christin Hung, Rihr J. Sullivn, Zhu Wng, n Sturt E. Weiner. The views expresse in this pper re those of the uthors n o not neessrily reflet the views of the Feerl Reserve Bnk of Knss City or the Feerl Reserve System. Pge 1

2 Tle of Contents 1. Introution Nonnks in retil pyment systems Methoology Definitions Pyment types n pyment tivities Nonnk prevlene Overview EU nonnk prevlene U.S. nonnk prevlene Risks in retil pyments proessing Risks in retil pyments Risks long the proessing hin Impt of nonnks on risk Risks n nonnk presene in the EU Risks tht n e generte t vrious points long the whole proessing hin Risks relte to settlement tivities Creit n liquiity risks outsie the settlement stge Risks relte to outsouring to thir prties Risks n nonnk presene in the U.S Comprison of nonnk prevlene to risk in pyment tivities Risk implitions Puli regultion n oversight of pyment risk mngement in the U.S Supervision n regultion Oversight of the U.S. pyment system Chnging risk profiles: implitions of rising nonnk presene for risk Conlusions n losing remrks...36 REFERENCES...39 Pge 2

3 1. Introution Retil pyment systems throughout the worl ontinue to evolve in mny wys. Chief mong them is the ontinue migrtion from pper-se to eletroni-se systems. Aompnying this eletronifition of pyments hs een n inrese in the prevlene of nonnks in the pyments system. In n erlier pper (ECB, FRBKC 2007), we took first step in oumenting n nlysing the role of nonnks in Europen n U.S. retil pyment systems. We foun tht nonnks re most prominent in the Unite Sttes ut re prominent n eoming ever more so in mny Europen ountries s well. We lso foun tht the regultory frmework surrouning nonnk pyments prtiipnts is uneven oth within n ross ountries. This seon fining is prtiulrly importnt for entrl nks euse entrl nks re lmost uniformly hrge with ensuring tht pyment systems re sfe s well s effiient. At the ore of sfety onsiertions, of ourse, is the presene n mitigtion of vrious types of risk. The erlier pper spent some time exploring risk issues, ut t firly generl level. The purpose of this pper is to elve more eeply into risk issues. Speifilly, this pper explores the vrious types of risk ssoite with the mny tivities long the pyments hin, n sks, to wht extent oes the presene of nonnks heighten or lessen these risks? As with the first pper, this pper rws on the results of joint stuy unertken y stff t the Europen Centrl Bnk (ECB) n the Feerl Reserve Bnk of Knss City. The fous is on eletroni (non-pper) retil pyment servies in the Europen Union (EU) n the Unite Sttes. The pper opts ommon set of efinitions n uniform nlytil frmework. The following questions re resse: 1. Wht pyments tivities n sutivities re performe long the pyments hin? 2. Wht types of risk re ssoite with these tivities n sutivities? 3. Do the risks ssoite with vrious pyments tivities n sutivities vry y type of pyments instrument? 4. Does the inrese presene of nonnks in vrious pyments tivities heighten or lessen the egree of risk? 5. Are equte sfegurs privte n/or puli in ple to ensure tht risk levels re mngele n eptle? The pper is orgnize s follows. The next setion ssesses the importne of nonnks in retil pyments. It first summrizes the methoology use in this n the previous pper: the efinition of nonnk, the ifferene etween front-en n ken pyment servies, n the vrious tegories of pyment types n pyment tivities. It then ouments the role plye y nonnks in the EU n the Unite Sttes. Pge 3

4 The thir setion of the pper tkes up risk in retil pyments. It first esries the vrious types of risk tht my e present in pyments environment, for exmple, settlement risk, opertionl risk, reputtionl risk, n so forth. It then exmines whih types of risk re most likely to e ssoite with whih types of tivities long the pyments proessing hin. The fourth setion of the pper superimposes this risk nlysis on the prior setion s oumenttion of nonnk presene y tivity, permitting one to evlute t reltively etile level nonnks potentil impt on pyments risk. Finlly, the pper loses with summry n suggestions for future reserh. 2. Nonnks in retil pyment systems 2.1 Methoology Nonnks n perform funtions t ll stges of the pyments proess. For ll forms of pyment (reit rs, eit rs, eletroni-heques, reit n eit trnsfers, e- money 1, n store-vlue trnstions) n for ll points on the pyments hin (hrwre n softwre provision, onsumer n merhnt intertion, kroom proessing, lering n settlement, n post-trnstion ounting) nonnks n ply mjor role. This susetion provies frmework for oumenting n nlyzing these roles Definitions A nonnk pyment servie provier is efine in this stuy s ny enterprise tht is not nk n whih provies, primrily y wy of eletroni mens, pyment servies to its ustomers. In the Europen ontext, nonnks inlue ll entities tht re not uthorize s reit institution; hene, eletroni money institutions (ELMIs) re onsiere to e nonnks. In the U.S. ontext, nonnks inlue ll entities tht o not ept emn eposits. A nonnk pyment servie provier my e either nkontrolle or nonnk-ontrolle. 2 A nonnk pyment system provier s ustomers my e either: (i) en-users of retil pyment servies, in whih se the nonnk is proviing front-en servies; (ii) nks or 1 In Europe, e-money is efine s monetry vlue s represente y lim on the issuer whih is: (i) store on n eletroni evie, suh s hip r or omputer memory; (ii) issue on reeipt of funs of n mount not less in vlue thn the monetry vlue issue; (iii) epte s mens of pyment y unertkings other thn the issuer (Diretive 2000/46/EC). Thus, stritly speking e-money is not pyment instrument ut mens of pyment, tht is, sustitute for sh n eposits. E-money issune is usully ompnie y the servie or evie neee to trnsfer it, n for simpliity in this survey with the term e-money we refer to the pyment evise or instrument use to trnsfer e-money. E-money n e issue only y nks n y e-money liense institutions (ELMIs), entities sujet to simplifie pruentil regime whih is however moelle on tht of nks, n re sujet to ertin limittions (for instne in terms of tivities they n rry out, n investment of the funs). 2 Exmples of nk-ontrolle nonnk pyment servie proviers inlue susiiries of nks, for exmple, TSYS, lrge U.S. proessor owne y Synovus Bnk (lthough out to e spun off), n nk ssoitions, for exmple, Vis Europe, the lrge Europen reit n eit r network. Nonnkontrolle servie proviers re firms without governing nk ffilition, for exmple, First Dt Corportion, PyPl, Hyperom, Vofone, et. Pge 4

5 other nonnk pyment servie proviers, in whih se the nonnk is proviing ken servies; or (iii) oth types of ustomers. Exmples of front-en servies inlue money-trnsfer servies provie to househols n quiring servies provie to merhnts. Exmples of k-en servies inlue k-offie t proessing, uthentition n uthoriztion, n hosting of pyments-enle we sites. An exmple of firm with oth types of ustomers is ompny tht is lesing point-of-sle (POS) evies to merhnts n t the sme time performing proessing n routing servies on the t pture on those evies for the nks issuing the ssoite pyment rs. Suh firm woul e onsiere to e proviing front-en servies to the merhnts n k-en servies to the issuing nks Pyment types n pyment tivities There re two wys to think out the pyments proess. One is to think out pyment types the mens n instruments through whih trnstion is unertken. Exmples re reit r trnstions, eit r trnstions, reit n eit trnsfers, n person-to-person Internet pyments. The seon wy is to think out pyment tivities the vrious steps n servies tht re provie s given trnstion tkes ple. These two onepts pyment types n pyment tivities re lerly very losely relte. Tle 1 (p. 41) shows the ro pyment types tht re use in this pper. Ctegories inlue eletroni heques; reit trnsfers; iret eits; pyment (reit n eit) rs; n e-money n other prefune or store-vlue instruments, inluing Internet person-to-person (P2P) pyments. 3 The first tegory, eletroni-heques, re those pyment types tht egin with pper heque, or informtion from pper heque, ut re onverte to n eletroni pyment t some point in the proess; en-to-en, tritionl pper heques re exlue. The seon n thir tegories, reit trnsfers n iret eits, utilize greements tht reit or, with preuthoriztion, eit ounts. The fourth tegory, pyment (reit/eit) rs, relies on networks to ess either line of reit or emn eposit ount to enle pyment. The fifth tegory, e- money n other pre-fune/store-vlue instruments, uses n eletroni store of monetry vlue, whih my not neessrily involve nk ount, to mke pyment. A seon wy of thinking out the pyments proess is to exmine pyment tivities, tht is, the vrious steps n servies tht re unertken s trnstion moves from eginning to en. The pyments proess n e thought of s hin of events in whih four prinipl tegories of servies re performe: pre-trnstion tivities enompssing ustomer quisition n the provision of front-en infrstruture; uring-trnstion Stge 1 tivities enompssing onnetion, ommunition, uthoriztion, n fru etetion tivities; 3 ECB, FRBKC (2007) inlues two itionl instrument tegories: money remittne n trnsfer trnstions; n other pyment instruments. They re not onsiere in this pper euse of insuffiient t in some of the surveye ountries. Pge 5

6 uring-trnstion Stge 2 tivities enompssing lering n settlement tivities; n post-trnstion tivities enompssing sttement provision n reonilition tivities. All in ll, one n ientify twenty-three primry pyment tivities tht unerlie, to vrying egrees, ll pyment trnstions. Within these twenty-three primry tivities, there re, in turn, host of sutivities, numering over fifty. The full list of primry tivities n sutivities is shown in Tle 2 (p. 42). 2.2 Nonnk prevlene Overview A pyment trnstion n e initite in severl wys, n the relte pyment informtion n instrutions n e pture n trnsmitte using severl methos. Nonnks n e involve t mny points long the proessing hin, s well s in the iret provision of pyment servies to en ustomers. Nonnks hve long h presene in ore pyments proessing, s nks n other finnil institutions hve sought to outsoure suh tivities s t proessing, file trnsmission, n relte tsks. Other uring-trnstion tivities in whih nonnks hve een hevily involve inlue network servies, suh s gtewy provision n swithing servies, uthoriztion servies, n fru n risk mngement servies. All of these tivities re importnt elements of the retil pyments proess n re of key importne in mintining puli onfiene in the sfety of pyment instruments. Aitionlly, nonnks hve een tive in the rnge of tivities tht tke ple efore n fter the exeution of given pyment trnstion. Exmples of suh pretrnstion tivities inlue the evelopment n provision of hrwre for eletroni pyments (for exmple, r proution n POS evies) n the estlishment of ontrtul reltions with rholers n merhnts. In the se of emerging pyments, in mny ses these pre-trnstion servies involve new wys of proviing ess to tritionl pyment types, for exmple, reit trnsfers initite vi the Internet or vi moile phones, or we portls tht onsolite illing n filitte pyment initition. Moreover, nonnks hve lso een importnt in mny post-trnstion servies, inluing sttement provision, reonilition, n retrievl. This susetion ouments in systemti wy the role plye y nonnks in the EU n U.S. retil pyment systems. The nlysis is onute through the use of tles showing, for eh of the vrious pyment tivities n eh of the vrious pyment types, the importne of nonnks reltive to nks. In the se of Europe, five tles re presente, one for eh of the mjor pyment instruments, Pyment Crs, Creit Trnsfers, Diret Deits, e-cheques, n e-money. Within eh of these tles, for eh pyment tivity, the egree of nonnk prevlene is shown, moving, left to right, from surveye ountries ounting for the lrgest shre of EU27 pyments of tht type to ountries ounting for the smllest shre of EU27 Pge 6

7 pyments of tht type. Thus, eh tle is mtrix, in whih the rows re pyment tivities, the olumns re ountries, n the entry in n iniviul ell is the uthors ssessment of whether nonnk presene is prevlent (lue), high (green), meium (yellow), low (ornge), or nonexistent (pink) for tht prtiulr pyment tivity-pyment type-ountry omintion. In the se of the Unite Sttes, single tle is presente. Rows re gin pyment tivities. Columns re now pyment types, moving, left to right, from those pyment types ounting for the lrgest shre of nonsh pyments to those ounting for the smllest shre of nonsh pyments. Thus, the tle is gin mtrix, in whih the entry in n iniviul ell is the uthors ssessment of whether nonnk presene is prevlent (lue), high (green), meium (yellow), low (ornge), or nonexistent (pink) for tht prtiulr pyment tivity-pyment type omintion. For oth the Unite Sttes n Europe, ells in grey re not pplile, while ells in white inite insuffiient informtion to juge. The ssessments re se on survey results, inustry t, n other soures. Also inite in eh ell is n ssessment of the qulity of the t (high, meium, or low) on whih the prevlene ssessment is se EU nonnk prevlene The role of nonnks in pyments in Europe ws nlyze y rrying out survey mong Pyment Experts of the Ntionl Centrl Bnks (NCBs). The survey ws voluntry, n not ll the ESCB Ntionl Centrl Bnks prtiipte. The results presente inlue 15 ountries, 10 from the euro re (Austri, Belgium, 4 Germny, Finln, Frne, Greee, Itly, the Netherlns, Portugl n Sloveni) n five from EU Memer Sttes tht hve not yet opte the euro (Bulgri, Cyprus, Czeh Repuli, Ltvi n Lithuni). These ountries together proess out 67 perent of the numer of pyment trnstions in the Europen Union. However, s the NCBs of the lrgest non-euro re Memer Sttes i not prtiipte in the survey (in prtiulr the U. K., whih lone ounts for more thn 20 perent of the numer of pyments proesse in the EU), the fous of the nlysis is minly on the euro re: the ove mentione 10 euro re ountries in the survey together proess out 92 perent of the totl numer of euro re pyment trnstions, n 66 perent of the totl EU pyment trnstions. 5 All in ll, these ten ountries represent 65 perent of the EU GDP (88 perent of the euro re), n 54 perent of the EU popultion (86 perent of the euro re popultion). The survey ws rrie out using ommon methoology. Some responents stresse tht they fe t limittions tht i not llow onsiering the results s omprehensive n exhustive esription of the role of nonnks in their respetive ountries. Thus, the survey oes not imply tht these re the only tivities tht nonnks perform in pyment proessing or tht ll pyment solutions offere to ustomers in the surveye ountries re overe. Moreover, the level of etil n the qulity of the t 4 For Belgium n ssessment of nonnks importne ws ville only for rs n e-money pyments. 5 The perentges provie re se on 2003 t n inlue the ountries tht joine the EU in 2004 (i.e., exluing Bulgri n Romni who joine in 2007). Pge 7

8 vries from ountry to ountry, s responents relie on ifferent t soures n reserh methoologies, rnging from pulily ville informtion to interviews with mjor nks n nonnks. For some ountries, the survey s finings provie more of n overview thn fully representtive piture. These ifferenes in omprehensiveness n qulity of t gthere in the vrious ountries mke it iffiult to rry out rossountry omprisons, n require re in onsiering the results. Nevertheless, in the sene of more preise or homogeneous t, we ept these t limittions n elieve tht the survey provies useful overview of the role of nonnks in pyments, sheing some light on n spet of the Europen pyment inustry tht ws not thoroughly investigte previously. The results re reporte, for eh pyment instrument (eletronilly proesse heques, reit trnsfers, iret eits, pyment rs, e-money n other pyment instruments), in Tles 3-7 (pp ). The results re presente following the orer of importne of the vrious shless pyment instruments in terms of numer of trnstions proesse in Europe: in 2003 (the most reent yer for whih ross-ountry omprle t re ville) rs represente 31 perent of Europen pyment trnstions, followe y reit trnsfers (30 perent), iret eits (24 perent), heques (13 perent 6 ), n e-money (1 perent). It shoul e note tht omprehensive sttistis re not ville for money trnsfers or for other, innovtive pyment instruments inlue in the survey sent to responents. Furthermore, the t ollete through the survey on nonnks for these two instruments were extremely limite n o not llow mking ny ut preliminry ssessment of the role of nonnks. Before moving into eh tle, it is importnt to unerline three preliminry oservtions: First, informtion on the role of nonnks is not eqully ville ross ountries n ross pyment instruments, s shown y the lrge white res in mny of the ountries. Informtion on entities involve in retil pyments proessing my e more esily ville for those pyment instruments tht re more populr in the ountry: ntionl preferenes in the use of pyment instruments re very mrke in Europe, refleting ulturl preferenes, 7 tritions, historil evelopment of the inustry, or ifferent stges of mturity in the pyment servies inustry. For instne, heques re not use in the Netherlns (where their use eline lrey in the 90s, n the Duth 6 Sttistis on heques in the Europen Union inlue ll heques sumitte for lering. The figures inlue vrious types of trnstions (e.g. trveller s heques, petrol heques, nkers rfts n promissory notes), s there re no seprte sttistis for e-heques. However, most heques re trunte in Europe, n pper en-to-en proessing n e onsiere s n exeption tking ple only in few ountries. (For instne, in the Unite Kingom hnge in the lw in 1996 remove the requirement for heques to e presente physilly t the rnh on whih they were rwn. Most nks now follow prtilly trunte proess wherey heques re retine t entrl point n). In Frne ll heques re trunte n emterilise sine 2002; in Itly 80 perent of heques re trunte; in Portugl, 98 perent of heques were trunte in In some ountries (e.g. the Netherlns) heques hve een ompletely ismisse s pyment instrument n o exist either in pper or in eletroni form. See ECB (2006) n ECB (2007) for further etils. 7 The impt of preferenes in terms of ulturl similrities, geogrphil proximities, n lnguge ws shown y Rosti n Seol (2006) for lrge-vlue ross-orer pyments in euro. It is likely tht in the retil mrkets ulturl preferenes my lso ply role. Pge 8

9 nks stoppe issuing heques in July 2001), they re rrely use in Austri n Finln, n their use is very limite, ompre to other pyment solutions, in Germny, while they re still ommon in Frne (where more thn 55 perent of ll EU heques trnstions tke ple), Itly, Cyprus, n Portugl (lthough their use is, in generl, elining) 8. Itly, Belgium, n Finln n e onsiere reit trnsfers ountries (n in Bulgri out 90 perent of pyments re reit trnsfers) while iret eits hve een introue reltively reently in severl ountries n re eoming inresingly populr (in 2003 iret eits were out 24 perent of pyments in EU, ut in Austri, Germny, n Spin they represente out 40 perent of the ntionl volumes). In ontrst, r pyments re ommon n populr in most ountries. Thus, responents were le to ssess the importne of nonnks for lmost ll the relevnt pyment tivities with reltively high onfiene for pyment rs. Seon, nonnk presene vries signifintly y ountry. In generl, when onsiering nonnks importne ross ll pyment instruments for eh ountry, ountries n e ivie in three groups (ECB, FRBKC 2007). In first group, inluing Austri, Germny, the Netherlns n Itly, nonnks ply lrger role ompre to other ountries in the tivities of most pyment types. Finln, Frne, Ltvi n Sloveni re in the seon group, where nonnks seem to ply more limite role. The lst group inlues the remining ountries: Bulgri, Cyprus, Czeh Repuli, Greee, Lithuni n Portugl. Nonnk presene in these ountries n e onsiere somewhere in etween. Thir, in the mjority of the 15 ountries, the role of nonnks for pyment rs is high or prevlent in mny of the tivities onsiere. This is proly ue to the high utomtion of the pre-trnstion n uring-trnstion Stge 1 tivities (e.g., swith routing, uthentition, n rel-time uthoriztion of the trnstion) n, lso, to the interntionl imension of rs-proessing stnrs. It shoul e note tht in Europe there re numer of ntionl r shemes tht re usully o-rne with the interntionl shemes like Vis n MsterCr to llow ustomers to use the r ro. In ition to o-rning, in Europe there lso re few exmples of (ilterl) interoperility greements etween ntionl (minly eit rs) shemes, prtiulrly to llow use in the EU ross-orer ontext. As result, rs proessing is lrgely orgnize roun ommon moel, exept for the settlement phse, whih my e rrie out ifferently in the vrious ountries. (In some ountries, ntionl r trnstions re settle in the ACH or other ntionl retil pyment system. In others, they my e settle y nks ilterlly. Furthermore, s it reltes to interntionl rs trnstions, the orresponent nking hnnel normlly is use for settling internk positions). The tles show tht the role of nonnks is high in most surveye ountries for rs, with the exeption of Frne (where there is trition of reserving the pyments usiness to nks) n the Czeh Repuli, where it ws ssesse s meium for ll 8 This explins why Frne is the ountry where heques proessing is highly utomte lso in the initil stges of the proessing hin (pre-trnstion n uring-trnstion Stge 1, e.g. provision of heques reers/pos, provision of heques verifition softwre n of heques verifition servies) n more informtion is ville on nonnks roles in heques proessing, while in other ountries the heques olumn ontins goo el of white n grey ells. Pge 9

10 pyment instruments. However, in Frne, nonnks still ply n importnt role in the pre-trnstion stge. For the other pyment instruments, s mentione erlier, responents to the survey were le to provie reltively less t, s shown y the high numer of grey n white ells. Where more informtion ws ville (s for reit trnsfers n iret eits) nonnks seem to ply reltively more importnt role in those ountries tht represent higher shre of the EU trffi in tht instrument n the pyment instrument onerne represents high shre of the ntionl pyments (for exmple, for reit trnsfers: Germny, Austri, Itly, the Netherlns), gin, with the exeption of Frne. Finlly, irrespetive of the role plye in pre-trnstion n other uring-trnstion tivities, the settlement phse remins prerogtive of the nking setor in Europe, n this is true for ll pyment instruments, not only for rs. In the se of tritionl pyment instruments, this my e expline y the ft tht nks re normlly those entities tht hve ess to the retil pyment systems (n, in mny ses, ntionl nking ssoitions tully hve set up or own the ntionl lering n settlement ompnies) or those to whom the legisltion in ple reserves settlement ounts provision n mngement. In very few ountries (the Netherlns n Bulgri), however, nonnks my ply role in the settlement stge. However, loser look t the entities involve shows tht they re jointly owne y the nking setor, n thus n e onsiere in the nking omin (e.g. the ompnies Equens in the Netherlns, Bori (Bnk Orgnistion for Pyments Initite y Crs) n Bnkservise in Bulgri). A notle exeption is Belgium, where nonnks importne in settlement tivities 18 n 18 from Tle 2 (posting reit n eit t eh finnil institution s entrl nk n ommeril nk ount) is ssesse s prevlent. This is relte to the role plye y the rs ntionl proessor, the previously nk-owne Bnksys. The ompny is now integrte into Atos Origin ( Frne-se multintionl IT servies group proviing en-to-en tehnologil pyment servies). Thus, this is n exmple of shift from the nking setor to nonnk (n nonnk-owne ompny) of tivities t the hert of the settlement yle. For e-money n other innovtive pyment solutions, settlement lso remins lrgely ominte y nks, whih is onsistent with two oservtions on the evelopment of new pyment methos in Europe. First, tht innovtion seems to hve fouse on mens (using moile, Internet tehnology) to ess tritionl nking funs trnsfers servies (i.e. the so-lle ess prouts ), rther thn pyment instruments lterntive to those offere y nks. 9 Seon, e-money s n lterntive to instruments trnsferring nk eposits hs remine somewht unerevelope ompre to initil expettions n most e-money shemes in Europe re tully nk ventures with some notle exeptions (e.g., PyPl, whih until reently, when it requeste nking liense in 9 See ECB (2005), where reporting the results of survey on pyment innovtion (with sope wier thn e-money prouts only), it is onlue tht two-thirs of the (surveye) ompnies re relte to the nking setor, either y liense or y ownership n, s onsequene, most of the e-prouts inlue link to settlement. This is lso onsistent with wht ws reporte y Msi (2004), who notes tht the gretest prt of the new pyment inititives oes not moify the lering n settlement phses of the pyment yle whih re mnge n regulte y nks. Pge 10

11 Luxemourg, h operte s n ELMI). 10 In summry, se on the limite t ville, it n e onlue tht nonnks ply n importnt role in severl Europen ountries, n we expet their role to grow further, prtiulrly t the k-en, in those ountries where their role is still somewht more limite. Drivers will e: first, the growth of shless pyments; seon, SEPA, n the resulting restruturing n onsolition ongoing within the pyments proessing outsouring inustry; thir, the mturing of pyments mrkets segments n sustitution mong pyment lsses fvouring instruments whose growth is lrgely supporte y nonnks (rs n iret eits); n fourth, t the front-en, following the regultory opening up of the mrket to new tegory of nonnk pyment servies proviers, the pyment institutions. From k-en perspetive, it shoul e note tht the growth of the use of rs n the evelopment of ntionl r shemes hs gone hn-in-hn with the growth of the mrket for r trnstion proessing, whih ws often hrterize y ntionl hmpions onentrting most of the trnstions n llowing the exploittion of sle eonomies t the iniviul ountry level. 11 This mrket now seems to e unergoing very ynmi phse in Europe, riven y the reent evelopment of SEPA, the projet to rete single Europen pyment re y removing ll legl, tehnil n ommeril rriers within the Europen inustry n mking shless pyments in euro s esy, effiient n sfe s it is toy within one ountry. 12 Mzzi (2007) reports tht oring to figures n estimtes ville for the mrket shre of thir-prty proessors in the rs issuing mrket (EU 15 ountries), for instne, in the four-yer-perio etween 2002 n 2006, the numer of eit rs inrese from 293 million to 342 million, n reit rs inrese from 278 million to 362 million. In-house issuer proessing y nks erese from 42 perent to 33 perent for eit rs, n from 60 perent to 51 perent for reit rs while the mrket shre of thir-prty proessors inrese from 3 perent to 7 perent for eit rs, n from 21 to 28 perent for reit rs (the rest ws proesse through shre nk-owne utilities). Furthermore, onsolition proess hs strte with the ojetive to hieve suffiient sle to llow repositioning of ntionl plyers s Europen plyers serving the ommon euro pyment re. The proess hs reently elerte n hs tken vrious forms, through wve of llines n joint ventures, ut lso mergers n quisitions, involving ompnies tive t the sme stge of the proessing hin (horizontl 10 In 2003, e-money ounte for only 0.5 perent of pyment trnstions in Europe. EC (2006) reports eviene tht the e-money mrket hs evelope more slowly thn expete, n is fr from rehing its full potentil, n tht s of lte 2005 there were only four ELMIs, lthough the numer ws expete to inrese s t lest five-to-eight pplitions were either in proess or expete shortly (however, out 72 ompnies were operting t ntionl level in seven Memer Sttes uner wiver) noting lso tht, two-thirs of the e-money in irultion ws issue y nks, n only one-thir y ELMIs (p.6). 11 For exmple, SBB in Itly or Bnksys n BCC in Belgium (the Belgin ompnies, previously owne y onsortium of Belgin nks, re now owne y Atos Origin, n interntionl IT group.) 12 SEPA is n inustry-le projet supporte y the Europen Commission n y the ECB. Detile informtion n e foun on the wesites of the ECB ( n of the Europen Pyment Counil ( the eision-mking n oorintion oy of the Europen nking inustry in reltion to pyments). Pge 11

12 integrtion) n t ifferent stges of the hin (vertil integrtion). 13 For instne, in Septemer 2006 the Duth ACH Interpy n the Germn pyments proessors Trnsktioninstitut gree to merge to form Equens, ompny iming t serving the Europen mrket. Similrly, the interntionl rs pyments proessor SiNSYS ws rete y three ntionl proessors (from Itly, the Netherlns, n Belgium), n is now owne y SIA-SSB (n Itlin firm proviing tehnology for rs pyments, finnil mrkets, pyment systems n networks) n Atos Origin. At the eginning of 2007, Atos Origin quire the Belgin ompny Bnksys (whih offere hrge uthoriztion, seurity n gurntee of eletroni pyments in the ountry) n BCC (whih ffilites merhnts n mnges the pyment systems linke to Vis n MsterCr on ehlf of nerly forty Belgin nks). The geogrphil sope of the SEPA projet is wier thn the euro-re ountries n lso inlues ll other Memer Sttes of the Europen Union, together with Ieln, Liehtenstein, Norwy n Switzerln (the ltter four sujet to their option of onsistent legl frmework). It is no surprise, therefore, tht the onsolition evelopments mentione ove lso hve strte to involve these ountries: for instne, in Mrh 2007, the Dnish rs proessor PBS n the Norwegin nking servie provier BBS gree to merge their r trnstion proessing tivities into the new ompny Northern Europen Trnstion Servies (NETS), with the im to servie Nori n Europen nks. An exmple of glol firm expning in Europe y mens of quisitions is First Dt. 14 The group, whih hs opertions in 38 ountries worlwie inluing 13 Europen ountries, hs quire severl ntionl plyers in vrious Europen ountries, e.g. in Poln (POLCARD, leing inepenent merhnt quirer n r proessor), in Germny (Gesellshft für Zhlungssysteme mh, leing proessor of shless, r-se pyment trnstions, n Telesh, the ountry s premier network servies provier), in Austri (Austrin Pyment Systems Servies, the ntionl proessor), n in Greee (Delt Singulr Outsouring Servies, leing pyments proessor). The ompny hs lso quire leing r proessor in Centrl n Estern Europe (EuroProessing Interntionl), n the r proessing unit of n Itlin nk. Inustry onsolition in Europe hs tken ple t the ross-orer level oth horizontlly (involving ompnies operting t the sme stge in the proessing hin) n vertilly (involving ompnies operting t ifferent stges, e.g. ACH n rs proessor). An interesting tren oserve in this inustry trnsformtion proess is tht in vrious ses leing ompnies tht were nk-owne n sometimes proesse lrge shre of their ntionl trnstions hve move outsie the nking omin from governne point of view, n now elong to speilise IT interntionl or multintionl firms. The proess of onsolition in the pyments outsouring usiness is not 13 Corone (2004) n Moeller (2006) provie ifferent exmples of suh oopertive ventures. See lso Mzzi (2007) for generl piture out the sttus of the inustry onsolition. 14 First Dt ws puli ompny until Septemer 2007, when its gree quisition y n ffilite of the privte equity firm Kohlerg Krvis Roerts & Co. (KKR) ws omplete. Pge 12

13 omplete n is expete to elerte further. 15 At the front-en, the role of nonnks is lso expete to grow in the future, s one of the min innovtions introue y the reently opte Pyment Servies Diretive 16 is the opening up of the mrket y llowing tors other thn nks n e-money institutions to provie pyment servies, the pyment institutions, whih re entitle to provie the pyment servies liste in nnex to the Diretive. There re five tegories of servies whih enle the trnsfer of funs hnle y the users: sh withrwls n eposit trnstions, trnstions from n ount or line of reit inluing r pyments, reit trnsfers n iret eits, interntionl money remittnes, trnstions using moile phones or the Internet, n issune of pyment instruments n quisition of t relte to the susequent trnstions (Mrgerit, 2007). Contrry to e-money liense institutions, the pyment institutions will e llowe to rry out other usiness tivities (for instne, they oul e merhnts or telephone ompnies), ut uthorities my require them to estlish seprte entity for the pyments servies. The Diretive speifies tht they my not onut the usiness tivity of tking eposits within the mening of nking legisltion, ut they my provie reit if ertin requirements re met (e.g. reit n e grnte exlusively in onnetion with the exeution of trnstion, short term, it nnot e grnte from the funs reeive or hel for pyment trnstions, n sujet to the pyment institution hving n pproprite level of its own funs). One importnt innovtion is tht pyment institutions will e llowe to set up pyment ounts in the nme of users, ut the Diretive introues ertin requirements ime t sfeguring the funs reeive from users (the sfeguring mesures introue re esrie in more etil in setion 4.1) U.S. nonnk prevlene To ssess the role of nonnks in pyments in the Unite Sttes, stff t the Feerl Reserve Bnk of Knss City omplete the sme survey s tht istriute to EU survey responents. Informtion utilize inlue inustry iretories n news rtiles, interviews with nonnks n inustry oservers, n other soures more neotl in nture. Tle 8 (p. 48) presents the results for the Unite Sttes. Rows re the vrious pyments tivities n sutivities previously expline. Columns re the prinipl pyment types foun in the Unite Sttes. Pyment types re liste in esening orer, 15 See for instne the Atos Origin Hlf Yer Report 2007 (p.12 the pyment servies usiness proess outsouring (BPO) mrket is extremely iverse, ontining omintion of suppliers with kgroun in vrious inustry-speifi proesses, s well tehnology speilists n IT servies proviers. The mrket is strting to mture n we expet onsolition mongst servie proviers to ontinue. Growth is eing riven y regultory hnges (suh s the Single Europen Pyments Are), prolifertion of pyment styles (suh s moile pyments), n seurity (suh s hip n PIN in the Unite Kingom, n the use of hologrms) ). 16 Diretive 2007/64/EC of the Europen Prliment n of the Counil of 13 Novemer 2007 on pyment servies in the internl mrket mening Diretives 97/7/EC, 2002/65/EC, 2005/60/EC n 2006/48/EC n repeling Diretive 97/5/EC (hereinfter, the Pyment Servies Diretive) (Offiil Journl No. L319, of 5th Deemer Aoring to Artile 94(1) of the Pyment Servies Diretive, Memer Sttes will hve to ring into fore the neessry legisltion to omply with its provisions efore 1st Novemer Pge 13

14 from those ounting for the highest shre of nonsh trnstions in the Unite Sttes (in terms of numer of trnstions) to those ounting for the lowest shre of nonsh trnstions. Shres re se on 2004 t. In 2004, pyment rs ounte for 45.9 perent of nonsh trnstions; iret eits ounte for 6.9 perent; reit trnsfers ounte for 6.0 perent, e-heques 17 ounte for 4.4 perent, n the e-money shre ws nerly negligile. Within some of these roer tegories, in turn, re shown more speifi pyments instruments: three types of pyment r trnstions (four-prty reit n signture eit (e.g., MsterCr n Vis), PIN-eit, n three-prty reit (e.g., Amerin Express, Disover, n privte-lel); three types of iret eits (utomti, one-time, n those omplete uner, for exmple, the Tempo n PyByTouh shemes); n four types of e-money n other pre-fune or store-vlue instruments (open-loop prepi r, lose-loop prepi r, PyCsh, n PyPl trnstions). The most striking generl oservtion out Tle 8 is the high egree of lue n low egree of ornge n pink in the tle, initing tht where nonnks n ply role in the pyments proess, tht role is lmost lwys n integrl one. Looking ross the pyment type olumns, lmost ll pyment types show signifint nonnk presene in lmost ll fets of the pyments proess, with two exeptions. The first re those tivities, shown in grey, tht re not pplile, either euse (i) they re inherently nk funtions involving emn eposits, for exmple, some pre-trnstion tivities for reit trnsfers n utomti n one-time iret eits, or (ii) they re tivities tht re not pplile to tht pyment type, e it nk or nonnk, for exmple, trnstion uthoriztion tivities for utomti eit trnstions. The seon exeption to signifint nonnk presene is settlement tivities tht involve posting reits n eits to finnil institutions ommeril n entrl nk ounts here nks ominte. 18 Virtully everywhere else, nonnk presene reltive to nks is high, n, inee, prevlent. A more speifi oservtion is tht four-prty pyment rs n open-loop prepi rs hve the lrgest numer of lue n green ells. This is euse these pyment types require more uring-trnstion Stge 1 tivities nmely network swithing n trnstion routing through r-issuer proessors thn other pyment types. A omplementry oservtion is tht reit trnsfers hve the smllest numer of lue n green ells. This oes not imply nonnks importne in the reit trnsfer pyment tivities is reltively low; rther it implies this type of pyment oes not require s mny tivities s the other types of pyment o. The messge from Tle 8 is ler nonnks re fore in the U.S. retil pyments system, ominting lrge numer of pyments tivities for lrge numer of pyment types. 17 A physilly written heque is either trunte n eomes n ACH pyment t some point of heque proessing (ARC, BOC, n RCK) or is use s evie to pture informtion to rete n ACH pyment t the point of trnstion (POP, TEL, n WEB). 18 This lso is prinipl fining of Brfor, Dvies, n Weiner (2003). Pge 14

15 3. Risks in retil pyments proessing 3.1 Risks in retil pyments During the pyments proess vrious types of risks my rise, ffeting ifferent prties t ifferent stges, n to vrying egrees. This susetion provies rief review of vrious risk tegories relevnt to proessing retil pyments n to lering n settlement proeures 19. Liquiity n Creit Risks The risk tht ounterprty will not settle n oligtion for full vlue, either when ue (liquiity risk) or t ny time therefter (reit risk). Opertionl Risk Opertionl risk is efine s the risk tht efiienies in informtion systems, internl ontrols, humn errors, or mngement filures will result in unexpete losses (internl n externl events). Thus, one importnt omponent of opertionl risk is relte to mlfuntioning, whih my e the result of unintentionl irumstnes or events (e.g. omputer rekown or proessing slowown, or orgnistionl efiienies) or intentionl irumstnes or events (e.g., ttk or misuse of informtion or proeures). Reent hnges in the retil pyments system hve inrese wreness of the following types of risk, whih re often thought of s sutegories of opertionl risk. Dt Seurity Risk: form of opertionl risk involving unuthorize moifition, estrution, or islosure of t use in trnstions or use to support trnstions. Fru Risk: risk of finnil loss for one of the prties involve in pyment trnstion rising from wrongful or riminl eeption. The risk tht trnstion nnot e properly omplete euse either the ientity of the pyer nnot e esily sertine or the pyee oes not hve legitimte lim on the pyer. Counterfeit: the legl offene of mking flse instrument in orer tht it my e epte s genuine, therey using hrm to others (forgery). Opertionl risk is, in generl, relevnt long the entire proessing hin in the form of mlfuntions. Other types of opertionl risk my e speifi to ertin tivity or ertin pyment instrument. For exmple, fru risk is most relevnt for those steps of the proessing hin involving uthentition or ientifition with the relte t eing trnsmitte over teleommunition networks. For pyment instruments tht involve the 19 The efinitions use in this setion erive from vrious soures: for efinitions of risks in the ontext of pyments lering n settlement (reit risk, liquiity risk, opertionl risk, settlement risk, n systemi risk) see BIS (2003) n the glossry nnexe to ECB (2007(). On vrious spets of settlement risk, see lso Bsel Committee on Bnking Supervision (2000). On risks onerning, more speifilly, retil pyments (e.g. fru risk, risk of system-wie impt n reputtionl risk) see ECB (2007) n CCBS (Hnook No.8). Pge 15

16 use of speifi hrwre (e.g. r reers), fru risk is relevnt if the hrwre n e ompromise or ltere for illiit purposes (e.g. skimming or loning of rs). Dt seurity risk is relevnt for ll tivities involving the storge n trnsit of pyment sensitive t (t tht my e use for ientity theft or for illiit uthentition or uthoristion of pyment trnstions). Dt seurity risk my result in fru risk if expose reors re then use for illiit purposes. Tritionlly, ounterfeit risk pplies to urreny tht is reproue without uthoriztion. Due to reent tehnologil evelopments, some pyment rs n tokens my store monetry vlue (e-money store on r/e-wllet). E-money tht is reproue or ltere without uthoriztion hs hrteristis tht re omprle to ounterfeit pper money. The term ounterfeit is now lso ommonly pplie to unuthorize mnufture of heques, r pyment instruments or other physil tokens use in monetry trnstions. 20 Settlement Risk The risk tht settlement in trnsfer system oes not tke ple s expete, usully ue to prty efulting on one or more settlement oligtions. It omprises reit risks, n liquiity risks when they emerge in lering n settlement systems. It lso inlues speifi form of reit risk, the risk of filure of the settlement gent, tht is, the entity whose ssets re use to settle the pyment oligtions (settlement gent reit risk). Settlement risk my lso result from rystllistion of opertionl risk, s inequte opertionl reliility, seurity n usiness ontinuity my ffet the integrity of the t exhnge within the lering n settlement proess, n my result in finnil losses for the involve or lile prties. Legl Risk The risk of loss euse of the unexpete pplition of lw or regultion or euse ontrt nnot e enfore. For instne, pplition of lw or enforement of legl rights my e omplex or hllenging in se of pyment instruments use interntionlly or in se of innovtive prouts whose nture is not initilly lerly efine, s n hppen when new pyment solution presents elements of ifferent pyment instruments. In generl, legl risk in lering n settlement rrngements my e soure of settlement risk if the unexpete pplition of lw ffets the positions of prtiipnts in the lering n settlement proess (e.g. unwining, or insolveny of the ounterprty resulting in freezing of ssets or revotion of trnsfers y the liquitor). Reputtionl Risk The risk tht the mteriliztion of nother risk tegory mges the onfiene in pyment servie provier. For exmple, it my result from the mterilistion of 20 A heque tht ers flse signture or hs een ltere is properly lle forgery. For our purposes, we inlue forgery with ounterfeit risk. Pge 16

17 opertionl or legl risk involving en-users n mging the pyment servie provier rn or the pyment instrument more generlly in the se of generlise isruption. The loss of reputtion in pyment servie provier my further inrese tul prolems of tht servie provier (e.g. ess to liquiity) n my even finlly result in the loss of puli onfiene in the pyment instrument. Compline Risk The risk of loss ssoite with non-ompline with lws, rules, regultions, presrie prties, or ethil stnrs. The risk is orne y the issuing, the istriuting, n the trnstion rhiving institutions n in generl y the institutions sujet to ompline uty. The tivities where this risk is most relevnt re those relte to seurity-relte tehnology where mrket stnrs re in ple (suh s the Pyment Cr Inustry (PCI) t seurity stnr), n those where puli regultions n lws ime t omting the riminl use of the pyment system (suh s ex-nte nti-money lunering n terrorist finning ontrols n ex-post t rhiving n reporting to uthorities for the purpose of k-feeing to ex-nte tses n efining suspet opertions profiles). At times these stnrs my ffet pyment prtiipnt iniretly, suh s when nk pyment quirers re iretly responsile for PCI stnrs ut they hol firms to whih they outsoure pyment proessing responsile for the stnrs. 21 To the extent tht pyment shemes re sujet to oversight y the entrl nks (s is the se in severl Europen ountries), ompline risk my rise if the rules n mngement of the pyment sheme o not omply with the regultory stnrs. Systemi risk The risk tht the filure of one prtiipnt in trnsfer system, or in finnil mrkets generlly, to meet its require oligtions will use other prtiipnts or finnil institutions to e unle to meet their oligtions (inluing settlement oligtions in trnsfer system) when ue. Suh filure my use signifint liquiity or reit prolems n, s result, might threten the stility of finnil mrkets. As fr s retil pyment systems re onerne, systemi risk oes not usully represent thret ue to the limite vlue of pyments settle. However, there re ses where some retil pyment systems re onsiere to e systemilly importnt s their mlfuntioning my threten the finnil mrket (in the Euro re, when ssessing the systemi importne of retil pyment system, the ECB n the NCBs tke ount of the mrket penetrtion within the respetive retil pyments mrket, the finnil risks pertinent to the system, n the risk of omino effets). System-wie Risk From the perspetive of speifi pyment instruments, it is unlikely tht the isruption of the funtioning of single pyment sheme or the impossiility to settle speifi pyment instrument my result in systemi risk. However, system-wie impt 21 Similrly, mnufturers of point-of-sle pyment terminls n ATM mnufturers re not iretly oligte y ontrtul reltionships with pyment networks, ut must omply with network seurity stnrs if they hope to suessfully mrket their prouts. Pge 17

18 is possile, tht is, the filure to settle n entire lss of trnstions oul uner ertin onitions isrupt, t lest temporrily, the funtioning of the rel eonomy y severely ltering the pity of eonomi gents to ishrge their oligtions on ount of the unvilility of n/or lk of onfiene in the pyment instrument onerne (n sustitutle pyment instruments). Of ourse, the severity of the impt will in prtie e epenent on the mrket struture for pyment servies n, in prtiulr, on the importne of the speifi pyment instrument n its sustitutes (see for exmple ECB (2007) for the se of rs shemes). 3.2 Risks long the proessing hin As riefly esrie in the previous susetion, vrious types of risks my rise uring the pyment proess, n prties involve my e expose to some of them t ifferent stges, n to ifferent egrees. Opertionl risk is present when pyment orers re trnsmitte over ommunition networks. Prties tht exhnge ssets to extinguish pyment oligtions my e expose to finnil risks (for exmple, liquiity n reit risk). All prties entering into ontrtul reltions in the ontext of pyments proessing my e expose to legl risk. Finnil institutions tht prtiipte in lering n settlement systems re vulnerle to opertionl, liquiity, n reit risk. These risks sometimes ompoun one nother: if opertionl risk results in omputer outge, one pyment prtiipnt my not reeive funs from other prtiipnts, n it my nee to refinne t higher pries, or suffer liquiity risk if it is unle to fulfil susequent pyment oligtions, or inur legl risk if it is hel lile to other prties. In se of outsouring of tivities to thir prties, they my eome sujet to legl risks (if the responsiilities of the prties re not suffiiently ler or leglly soun), n opertionl risk (if the outsouring prty eomes epenent on n improperly mnge thir prty). In the se of outsouring to thir prty tht onentrtes the tivities for whole pyment mrket segment, system-wie risk my rise if the thir prty eomes suenly impire or unle to operte. For pyment servie proviers whose outsouring tivities re sujet to regultion (s in the se of nks), ompline risk my rise. These risks n their relevne for the sfe n smooth funtioning of the pyment system, finnil mrkets, n the eonomy hve een nlyze t length, prtiulrly y entrl nks, n pproprite priniples for their mngement n mitigtion hve een set t n interntionl level. Although in generl retil pyments o not rry systemi risk, there re ses where retil pyment systems hve een onsiere systemilly importnt. In this setion we look t the vulnerility of ertin pyment tivities to speifi tegories of risk y using mtrix representtion (see Tle 9, pp ). Our im is to ientify the types of risk to whih speifi pyment tivities re expose, ut we o not ttempt to inite the mgnitue of the risk exposure. In lter setions we will isuss ontrols tht re in ple to mitigte these risks. Before entering into etile nlysis of the risks long the proessing hin, we nee to unerline tht ertin risk tegories y nture hve generl relevne n re Pge 18

19 thus not represente s olumns in the mtrix. For instne, legl risk pplies to pyment trnstions n to the pyment proess s whole, n thus nnot e restrite to speifi tivities. Similrly, systemi risk my ffet the funs trnsfer systems (where lso retil pyments my e settle) ut it woul e inpproprite to tth it to speifi tivity in the proess hin of n iniviul retil pyment trnstion. The likelihoo n the severity of system-wie impt woul epen on the hrteristis of the pyment inustry s whole. Finlly, reputtionl risk is generl tegory risk tht pplies to ll tivities s eh of them, if unuly performe, hs the potentil to mge the reputtion of the pyment servie provier or ffet puli onfiene in the sfety or effiieny of the involve pyment instrument. In the mtrix we show liquiity risk, reit risk, n settlement gent reit risk. The mtrix highlights with yellow kgroun where these risks mterilize in the settlement proess (settlement risk). Outsie of the settlement proess, reit n liquiity risk is orne y vrious prties involve in pyment sheme epening on the timing of the proess, wht prty hs ustoy of funs, n on the esign of (n legl n ontrtul provisions governing) the speifi pyment instrument involve. For instne, typilly merhnt epting pyment instrument in exhnge for goos or servies is expose to reit risk unless the pyment is settle with suess in rel time or t the sme time of the elivery of the goos or servies, or unless the pyment instrument ontrtul frmework provies for its mitigtion or trnsfer to nother prty (for exmple, pyments y rs my e ssiste y gurntee provie y the r issuer or y the r sheme). In r shemes, the r issuer is typilly expose to reit risk vis-à-vis rholers of its rs. When r trnstion is properly uthorise n epte for exeution y/within r sheme, the r issuer tkes the reit risk y gurnteeing pyment to the merhnt. In the se where retil pyment is exeute using eit trnsfer orer (for exmple, iret eit) the pyee s ount my e reite in some ses efore the tul eiting of the pyer s ount in the ooks of its nk. When this is the se, n if the pyee s nk hs vne the funs to its ustomer efore the suessful finl eiting of the pyer s ount, it my e expose to liquiity risk or reit risk if the ltter (pyee) hs lrey withrwn the reite funs. In generl, prepi pyment instruments entil reit risk for the holer of the instrument vis-à-vis the issuer (suh s in se of prepi rs or e-wllets), while in se of post-pi pyment instruments it is the pyment servie provier of the pyee or the pyee itself tht is expose to reit or liquiity risk. For exmple, this hppens with post-illing pyment servies provie y ertin moile n teleommunition ompnies. This my lso hppen when pyment servie is provie in rel time to oth pyer n pyee, ut the top-up overing the speifi pyment is settle t lter stge (for exmple, PyPl pyment toppe-up y iret eit on the pyer s nk ount). As fr s opertionl risk is onerne, we represent in Tle 9 its generl spet (suh s mlfuntioning or humn error) whih is pplile to ll tivities, n opertionl risk in onnetion with t seurity n ounterfeiting. Dt seurity hs reently ttrte ttention euse numerous t rehes hve llowe unuthorize ess to sensitive t. Beuse the primry onern of t seurity is the potentil for pyments fru s well s violtion of responsiility to protet privy of ustomers, the Pge 19

20 olumn notes these onsequenes in its lel. Counterfeiting oes not generlly get the ttention of t seurity, ut sttistis for the Unite Sttes suggest tht in terms of its ost, fru through ounterfeiting is fr more ostly thn tht from t rehes. Cheque fru, for exmple, is estimte to ost 10 to 20 illion ollrs per yer in the Unite Sttes, sum tht is lrger thn estimtes of fru in ll other forms of retil pyments. In r shemes, the prty suffering the loss eriving from mterilistion of fru risk is etermine y the sheme s rules, n epens on numer of ftors, inluing the physil environment in whih the trnstion ws exeute (POS or r-notpresent), the time of the trnstion in se the rholer h informe the issuer tht the r h een stolen or lost, n the seurity n risk mitigtion tehniques employe y the merhnt n quirer; s rule, the loss is suffere y r holers only up to ertin mount (ut they my lso e exempte) provie they hve omplie with notifition requirements, y the r issuers if the trnstion h een uthorise n epte, y the merhnt if it h not omplie with the seurity stnrs for POS trnstions, n y the quirer in the se of r-not-present fru. Although opertionl risk is relevnt to the settlement proess, it hs prtiulr prominene for retil pyments, n we fin it useful to highlight those tivities where the pyments proess my e prtiulrly vulnerle to it. The next-to-lst olumn of Tle 9 shows ompline risk. Pyment prtiipnts n e require to omply with speifi lws, regultions, n ontrtul rrngements. In the Unite Sttes, pyments re sujet to legl requirements uner the uniform ommeril oe n regultions suh s the Feerl Reserve s Regultion E. Memers of pyment networks (ATM, ACH, online eit, offline eit, n reit r) re ontrtully oun to omply with operting n seurity stnrs set y the network. One of the most signifint reent efforts to improve t seurity in r pyments is the pyment r inustry t seurity stnr (PCI stnr). 22 The stnr ws revise in Jnury 2005 n the pyments inustry is in trnsition phse to the new stnr. Bnks tht re in the prtiipting r network re responsile for omplying with the stnr s well s ensuring tht its outsouring prtners n pyment lients omply with the stnr. Pyment prtiipnts sujet to ompline risk n fe signifint penlties if it is foun tht they o not properly follow guielines set forth for t seurity n other opertionl requirements. The lst olumn of Tle 9 is for risk ssoite with illiit use of pyments. One of the tritionl fouses of lw enforement efforts to ur illiit use of pyments is money lunering. Pyment prtiipnts, suh s nk, re sometimes require to monitor use of nk ounts n to report suspiious tivities. More reently, poliymkers hve een onerne with the use of the pyments system to fun terrorist tivities, whih is nother form of illiit use of the pyments system. A tool use to omt illiit use of the pyments system is to refully ientify n sreen new ustomers efore grnting ess to the pyments system. In the Unite Sttes, nks re now require to use more relile forms of ientifying onsumers when they open nk ounts. Bnks re lso oligte 22 The stnrs were evelope s ollortion etween Amerin Express, Disover Finnil Servies, JCB, MsterCr Worlwie, n Vis Interntionl. Pge 20