Worldwide Payments Systems - Magazine

Canada's Payments system: A case study of success

The Canadian Payments Association has had great success over the years in fulfilling its key mandates. The checks, wire transfers, direct deposits, pre-authorized debits and bill payments, that pass through the CPA's payments system are the lubricants of the Canadian economy. And we make sure that they all flow smoothly.
The CPA operates clearing, payment and settlement systems that are the envy of countries around the world. And the organization continues to take the lead in the development of new technologies and payment methods.
The result has been a long and distinguished history of consistent growth in the number of members, transactions processed and dollar volume.
Last year, 4.5 billion transactions worth close to $34 trillion, an average of $134 billion a day, were cleared and settled, more than double the total of ten years ago. And the number of members has increased from XXX to 116 during the last X years.

Particularly impressive has been the success of the Large Value Transfer System, which provides real-time, final payment and settlement, according to global standards.
Along with the Automated Clearing Settlement System (ACSS), which handles paper-based and smaller transactions, LVTS a key element of the country's payment system, in particular, because it eliminates risk and enhances the system's overall stability.
LVTS has been highly successful since its inception in 1999, and now comprises over 85% of the high dollar value of transactions exchanged within the Canadian Payment Settlement Systems.
As a result, the CPA is trying to make LVTS even better, and to find ways of moving more ACSS payments streams to settle over to the LVTS.
One important step was taken late last year, when LVTS operating hours were harmonized into the international Continued Linked Settlement (CLS) system.
The CLS is a global service that enables the simultaneous settlement of both legs of a foreign exchange transaction between member financial institutions. The service currently links seven of the world's central banks and many of its leading financial institutions, including eight CPA members.
The implementation of a $25 million ceiling on paper-based payments was another important move. This ceiling has the potential to migrate an additional $7 billion a day over to LVTS.
Another key initiative that is inching slowly ahead is the Truncation and Electronic Check Presentment (TECP) Project, which the Board has devoted increasing attention to in recent months.
Check truncation is the most strategic and far reaching initiative to transform the Canadian Payment System that has been undertaken in recent years.
The use of imaging and electronic presentment would make an enormous contribution toward reducing end-to-end check processing times by decreasing paper movement between financial institutions.
Currently, more than a million kilograms of checks and other paper-based items are shipped or flown across the country each year, to the branches they were drawn on.
But with cheaper and faster digital scanning, storing, archiving and retrieval systems, computerizing the entire process is becoming an increasingly attractive option.
Electronic check presentment would eliminate numerous labour intensive processes, reduce shipping and courier costs and substantially boost the system's overall efficiency.
Several European countries have already gone ahead with check truncation and electronic presentation projects of their own, and the U.S. banking system is cautiously moving forward too.
Last year the Board formally established the goal of moving toward electronic check presentment as one of its key priorities.
However the project would entail a substantial, industry wide investment, -- about $183 million. And to implement such a system the Bills of Exchange Act would have to be amended.
As a result, a thorough and detailed study of the project's feasibility is currently being undertaken, and a final decision is the subject will be either dealt with at the May 31th Board meeting or at a subsequent Board meeting schedule in mid-June.
The bottom line is that in terms of openness, reliability, speed and safety, Canada probably has the best payments system in the world.
But it is not enough to be the best. Canadian financial institutions need stay ahead of the curve. And I am convinced that the CPA is taking the right steps and leading the way.

Key challenges facing the Canadian payment system
Despite the organization's impressive success during the last two decades there remain some important challenges facing the Canadian Payments system, and today I want to address a few of them.
The first issue I want to talk about is the openness of the system. Then I will discuss the organization's role in spurring financial services innovation. I will conclude with some thoughts about where the CPA is headed in the future.
Access to Canada's Payments System
The question of the openness of Canada's payments system is a crucial one. Over the years, bold steps have been taken to give new players access, and the organization's membership has increased dramatically as a result.
The first step came in 1981, when foreign banks got access to the payment system through their newly established Canadian subsidiaries.
A second big push came in 1998 when foreign banks were given the opportunity to open Canadian branches using liquidity reserves from head offices in other countries.
Some of these foreign banks joined the CPA as users of the Large Value Payment System (LVTS,) notably Bank of America National Association & BNP Paribas (Canada).
One could say that the LVTS was the first step in opening up the payment system for wholesale payments.
Most recently, in 2001, a third initiative, the Canada Payments Act, part of a major financial services legislation overhaul gave new players such as securities dealers, mutual funds and life insurance companies the opportunity to become members of their category in the Canadian Payment Association thus getting access on their own to the payments system.
However despite the changes, and despite major efforts by the CPA, not one of the new players that the legislation was designed to encourage has since joined the CPA as a member.
Many in the association would have liked to have seen such innovations as a life insurance company designing an annuity that is accessible through Interac, or money market funds available through Internet. But for various reasons none of these initiatives were undertaken.

Ps Jean-Paul Caron, nous avions ici une reference ou un point de jugement qui disait : some of the more cynical people would say that Insurance Companies did not truly want access to the payment system, but were demanding this in part to head off banks efforts to sell insurance products at the branch level' (I though that statement had a good puch to it ­ is it politically incorrect?)
This brings us to the first question that I want to address: With the major structural changes to the legislation, why has there been so little change in the composition of the CPA?
Is it because the system is inequitable for those who want access?
Let me give you my take. I believe that the system as structured is substantially equitable for all the key financial service players, and that the perception ­ held in some quarters -- of the Canadian Payments Association being a bank-controlled club is largely a myth.
All membersin the Association play a major role in the exchange of settlement items. Some of the members have also built profitable businesses by developing relationships with smaller members and arranging to process their clearings. Others have set up systems to offer paper sweep checking accounts arrangements through their own infrastructure so as to offer non-members the capability to issue checks payable to order to third parties.
But participating as a full member status implies adherence to operational efficiency and tight standards and rules. To play the game as a full participating member, new membersmust incur substantial expenditures, which many players are reluctant to undertake, especially in light of the fact that easy profits in the deposit and loan businesses are far from certain.
Canadians are a particularly demanding lot when it comes to financial services.
Whichever financial institution they deal with, they insist on a complete set of payment services, which can be accessed through a variety of channels.
Canadians want access not only to a national network of branches and ABMs, they also want to be able to bank online, 24 hours a day, seven days a week and the list goes on.
They also want those services at a very reasonable price. And they are getting what they are asking for.
According to a recent independent survey, Canadians pay less for their financial services networks than in most advanced countries in the world.
However, as many potential players are finding out, it costs a lot of money to launch an affordable range of financial products.
It costs even more to link these systems with the Canada's payment system. And generating a sufficient number of clients to get unit operating costs is not easy.
In a nutshell, to set up the necessary infrastructure would be prohibitive for a new entrant with relatively small customer base. To give you an idea, it cost several million dollars just to set up a few white label systems and Internet pages.
Fortunately, as CPA members know, you don't have to be a Direct Clearer to get access to the payments system.
All of the major securities companies, except one, get access to the payment system through their parent companies, which for the most part are large Canadian banks. The exception, Merryl Lynch, works closely with BMO.
Mutual fund and insurance companies have reasons of their own for not diving head first into the deposit business.
At National Bank we discuss, negotiate and implement partnerships with mutual fund and insurance companies on and ongoing basis.
From these and other contacts, I have come up with two primary reasons that these organizations are not rushing into the golden doors of the payments system.
The first is that although Canadians might like their insurance and mutual fund companies, they also realize that they are being well-served by their existing financial institutions.
Canadians will not settle for less. Insurance and mutual fund companies realize this, and they are being very careful about moving into business sectors that are outside of their core competencies.
A second reason that insurers and mutual funds don't want to step too far on other financial institutions' traditional turf is that their business models are quite different.
Insurers and mutual fund companies make their money based on the value of the assets they manage. Their primary incentive is making sure that money flows in, but never out.
Sure, many would like to provide their clients additional flexibility to withdraw cash. But if they make it too easy, it could become counter-productive.
To put it bluntly, insurance companies and mutual funds want as much control as possible of their clients' financial resources.
There is nothing wrong with that. But I don't think that insurance companies and mutual funds will try too hard to market retail products until there is a more persuasive business case to be made.
Another important consideration is the fact the CPA has evolved over the years to increasingly accommodate stakeholders who are not members. These continue to have a strong voice in the organization through the stakeholders' advisory council.
The council is a good example of the organization's flexibility and ability to innovate. It was instituted several years ago (1997), after considerable consultation, to give various users and providers of payment system services a say in the evolution of the CPA. Those consultations are ongoing, and they include substantial access to the organization's management.
In fact, there is no more glowing example of the council's success than the fact that its existence was enshrined in the recent legislation.
One could say that the establishment of the Stakeholder Advisroy Council was the second step in opening up the payment system.
The CPA's diverse board of directors, recently expanded to 16 members from 11, is another indication of the organization's ability to integrate a variety of views into its decision-making process.
Board members include Investors Group, and Trimark, which are represented through their Trust subsidiaries, as is Manulife through a banking subsidiary.
So if mutual fund and insurance companies are reluctant to take the tough steps necessary to become members of their own category, does that mean they are not interested in banking-type of products?
Of course they are interested. Mutual fund and insurance companies would love to be able to market investment loans to use as a leverage tool to help sell their investment products.
But most are not equipped, or not willing, to deal with the substantial challenges involved in evaluating and providing for credit risk.
Mutual fund and insurance companies would also like to offer high yield ING type of accounts, in which their clients could park their liquidity, before moving it into more permanent investments.
But these kinds of accounts require a costly interface with the payment system.
Mutual fund and insurance companies want to give to their clients the image of a full service financial institution, with the service structure they are used to.
At National Bank we have developed a model that enables mutual funds and insurance companies to offer all of these services, -- including investment loans and high yield accounts, --without the headache and expense of setting up the necessary infrastructure. We call it the white-label partnership offering.
We have set up numerous partnerships with insurance companies such as Promutuel and Great-West Life and mutual funds dealers such as Investors Group. These deals enable both partners to focus on their core competencies.
Our partners get substantial benefits from these deals:
- They preserve and broaden their existing clientele by providing broader and more attractive service offering.
- They get a cut on the sale of these additional services, whether they be deposits or loans, without incurring the infrastructure and regulatory costs required to provide these services internally
- They have limited set-up costs and are able to hit the ground running.
In short these partnership arrangements are win-win propositions for both parties.
To conclude, I believe that on balance Canada's financial institutions; including securities dealers, mutual funds and insurance companies, are well served by the existing system, which is designed to accommodate a wide variety of stakeholders and players.
Innovation in Canada's Payments System
But if newly eligible players are choosing not to become members, does that mean financial services industry innovation is dead?
I don't think so. I believe that it would be a mistake to link financial services innovation solely with access to the payments system.
In fact the evidence is overwhelming that financial institutions continue to innovate, and that the Canadian Payments Association is more than keeping up.
For example:
30% of Canadian adults now do some form of online banking and many take advantage of the many new functionalities like bill presentment services and person to person payment offered by many Financial InstitutionsCredit card use is increasing, as are EDI electronic payments, B2B payments, direct deposits, pre-authorized debits and shared ABM cash. At the same time the paper check usage is decreasing
Canada leads the industrialized world in per capita debit card usage. We are far ahead of our Southern neighbors in that respect.
Outsourcing is on the upswing. For example National Bank has major services contracts with IBM, Bell & CGI. At the same time, we are seeing Increased back-office efficiency as evidenced by the success of organizations such as INTRIA and SYMCOR
And there are many initiatives in the early stage of development such as Public-Key Infrastructure and one-time payments, which will enable Financial Institutions to take advantage of a projected multi-trillion dollar E-commerce market. In short, innovation is alive and well in Canada's financial services industry.
So where do we go from here?
I believe that the CPA should continue to focus on its key objectives and priority initiatives as outlined by the Board last year.
The CPA must continue to manage the efficiency, safety and soundness of the payments system.
In practice that means:
Continuing to move forward with the industry wide Truncation and Electronic Check Presentment initiative.
Investigating potential enhancements to the LVTS, such as introducing new services and promoting straight-through processing.
Evaluating a new framework that would facilitate "credit-push" payment applications.
Cooperating with other organizations to develop an industry-wide business continuity plan for the system as a whole.
The CPA must also continue to enhance relationships with key stakeholders, regulatory groups and related payment systems, as well as managing their diverse needs.
And finally, the CPA must continue to optimize organizational processes as well as its committee and rule structures.
In conclusion, I believe that the CPA's contribution and performance during the past year continues to be highly positive and that Canadians are well served by the existing systems.
However it's also clear that the Association has moved a long way from its roots as Canadian big bank-controlled oligopoly, and has clearly opened up to accommodate a range of new players.
In fact the final chapter in this saga has yet to be written. I am confident that with the new payments regulations we will eventually see new members seeking membership to the Canadian Payment Association.
In the meantime CPA membership continues to include foreign banks, mutual funds and insurance companies, which have a direct input into the decision making process through the stakeholders advisory council or through a Trust or Bank subsidiary.
In fact, with its new legislative mandate, its new president, its active board and its numerous initiatives, I am confident that the CPA is well-positioned to handle the challenges of the coming years.

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