1 THE WORLD BANK AND THE BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM TRAINING COURSE REFORMING PAYMENT AND SECURITIES SETTLEMENT SYSTEMS Washington, D.C., November 3-7, 2003 POLITICAL AND INSTITUTIONAL ENVIRONMENT Mario Guadamillas, World Bank

2 Content A.What is the political and institutional environment? B.What are the main issues from the political and institutional environment affecting a National Payments System (NPS) reform? C.Conclusion

3 A.POLITICAL AND INSTITUTIONAL ENVIRONMENT  Country demographics and physical infrastructure  Size, population, GDP per capita, urban vs. rural population, literacy rates, access to internet, etc.  Transport system, mail system, electricity supply, telecommunications network, degree of automation, etc.  Involvement in international trade and financial transactions  Macroeconomic framework  High-middle-low income country  Macroeconomic indicators (GDP growth, inflation, unemployment, public sector deficit)  Monetary, exchange rate and fiscal policies

4 A.POLITICAL AND INSTITUTIONAL ENVIRONMENT  Financial sector  Level of development of financial sector  Stock Exchange vs. OTC markets  Level of development of the interbank money market  Legal and Regulatory framework  Laws and regulations  Contracts  Judicial systems  Oversight/supervision  Enforcement

5 A.POLITICAL AND INSTITUTIONAL ENVIRONMENT  Stakeholders  Government (central bank, supervisory agencies, Treasury, etc.)  Banking industry  Stock Exchange  Other players (securities dealers and brokers, etc.)  Business perspective  Payment instruments  Payment practices  Processing systems and procedures

6 B. COUNTRY DEMOGRAPHICS AND PHYSICAL INFRASTRUCTURE  Payments systems have been normally created on ad hoc basis in response to specific requirements, thus, adding institutional and functional complexity (lack of a driven strategic approach)  Continuous decline in the cost of information technology and telecommunication services  Increasing access to internet is introducing changes in the business landscape resulting from the development of business to business (B2B), consumer-to-consumer (C2C), consumer to small business payments, among others

7 B. COUNTRY DEMOGRAPHICS AND PHYSICAL INFRASTRUCTURE  Rapid development of communication networks accelerates the trend toward the creation of new payment and settlement systems  Automation is widespread but not uniform, particularly, at the retail level, reflecting continuing customer preference for paper-based instruments  The internet model dissociates the network from the physical infrastructure. Its development is no longer controlled by a single entity or even a group of entities, and thus allows interconnection between heterogeneous networks. Security remains the paramount issue (financial, technological, operational and legal risks)

8 B. INTERNATIONAL TRADE AND FINANCIAL TRANSACTIONS  Deregulation and globalization have led to a spectacular growth in the value of non-trade related financial transactions, settled through electronic large value payment systems  The increasing emphasis on non-trade-related settlement has created an agenda of concerns which are increasingly divorced from the issues faced by businesses and individuals seeking to make low-value transfers  Different acces to payments between large multi- national corporations (trade within their own network of subsidiary companies) and SMEs  Changes induced by the implementation of several global initiatives to increase efficiency and reduce risks (e.g., CLS Bank)

9 B. MACROECONOMIC FRAMEWORK  Unstable macroeconomic conditions (e.g., hyperinflation) have incentivated ad hoc improvements on payment systems but made difficult a strategic approach  Recent developments on payment systems made them resilient to financial crises, thus, financial sector crises have been reflected on them but they have not been the cause and/or exacerbated the crisis  Economic policy mix important to design the payments system, that should be neutral in this regard  E-money: A further evolutionary state from fiat money, a monetary system in which convertibility into legal tender ceases to be a condition for electronic money

10 B. FINANCIAL SECTOR  Changes in the industrial organization of the sector, banks look for economies of scale via consolidation and economies of scope deepening the universal banking model  Stock exchanges and pension funds are also consolidating, following the liberalization of access and deregulation of brokerage commissions  Changes in the output-mix with development of new banking products and decline of others (e.g., checks)  Rapid process of globalization of financial institutions through cross-border investments  Increasing cost pressures on payment system providers because of a much lower interest rates environment

11 B. LEGAL AND REGULATORY FRAMEWORK  Legal certainty, clear property rigths and enforceability of contracts are preconditions for well functioning payment systems  Important implication of electronic trading for the contract law, which attaches great importance to the existence of an offer and acceptance, as evidence that the parties to an asserted contract have in fact agreed  Trading takes place global while underlying legal systems continue to be domestic  Absence of a unique framework  Problems with legal certainty in collateralized transactions  Uneven application of national conflict of law rules

12 B. STAKEHOLDERS  Provision of payment services is not the exclusive domain of banks  Differences among countries in organization of payment systems and level of interbak cooperation, reflecting the underlying structure of the banking industry  Delicate balance between cooperation and competition. Importance of interinstitutional arrangements (e.g., securities depository)  Central bank oversight role focused on large value payment systems (financial stability) less on retail systems  Restricted access and cooperative governance by financial institutions are being challenged, large users, industrial corporations or big retailers want direct access and a say in governance

13 B. BUSINESS PERSPECTIVE  Proprietary closed networks have been developed by financial institutions to handle large and increasingly internationally based payment systems. Underlying technology is often mainframe-based with communications restricted to leased circuits  Paper-based non-automated payment systems remain an established part of accepted business practice for varying institutional reasons, thereby remaining ingrained in the economic system  Internet has become an important delivery channel well suited for the provision of standardized and commoditized financial products and services

14 C. CONCLUSION The environmental aspects are changing continuously and quickly, thus, the payments system reform should be considered as an on-going process to adapt the systems, their regulation and their oversight to the new emerging needs of users