ABSA Annex 3 Background Info on NPS

7/31/2019 ABSA Annex 3 Background Info on NPS

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ANNEX 3 : BACKGROUND

INFORMATION ON THE NATIONAL

PAYMENT SYSTEM


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1. Introduction

1.1 The National Payment System refers to the behind-the-scenes

infrastructure that enables individuals and firms to transact with one

another by using various means of payment such as cheques, debit andcredit cards and electronic funds transfers. ATM withdrawals are also

part of the National Payment System. The FEASibility report and the

Technical Team of the Competition Commission Enquiry have raised

questions regarding access to the National Payment System and the

interchange fees that are paid from one bank to another in transactions

that involve more than one bank. These questions are explained and

addressed in this annex.

1.2 The annex is organised as follows:

1.2.1 Section 2 provides an overview of the National Payment System.

This section explains that the National Payment System is

essentially a network of competing and complementary services

that facilitates transactions involving various types of payment

streams. It provides information on the various different

participants in the payment system including the monitoring role of

the South African Reserve Bank. It also highlights the various

innovations that have underpinned the payment system and that

have contributed to greater interoperability and inter-bank

competition.

1.2.2 Section 3explains that access to all levels of the payment system

is determined on the basis of open and transparent criteria and that

the current structure and rules of the payments system do not act

as a barrier to entry that limits new competition in the South African

banking industry. One of the characteristics of the South African

payment system is that banks have invested in a central switch to

help facilitate more effective switching. It will be demonstrated that

there are many advantages of a central switching network,

including lower barriers to entry for new players as these new

participants only need a single link to a single system for full access

to a variety of payment systems.


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1.2.3 We also explain that proposed changes to the regulatory landscape

in the form of the Co-operative Banks Bill and the Dedicated Banks

Bill and initiatives in the industry to incorporate non-banks will

remove some of the remaining impediments to access. This annex

shows that indirect access to the National Payment System by way

of sponsorship or agency arrangements is a valuable substitute for

direct or full access. Absa, in particular, has been involved in a

number of major sponsorship arrangements which has facilitated

access to the payment system and through agency arrangements

Absa has assisted smaller banks to compete in its market by

assisting them to receive deposits.

1.2.4 Section 4 describes and explains the economic function of

interchange fees. We review how interchange fees have been

determined in South Africa and in other countries and discuss the

advantages from an economic perspective of multilateral

determination of interchange fees.


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2. Overview of the Payments System

This section provides an overview of the South African National Payment

System, examining the importance of a well functioning system with

interoperability between different participants. The section also gives a brief

description of the key participants in the system.

2.1 Importance and role of the National Payment System

2.1.1 Broadly speaking, payment systems allow for the transfer of funds

from one person to another. The Bank for International

Settlements (BIS) defines a payment system as follows,

A payment system consists of a set of instruments, banking

procedures and, typically, interbank funds transfer systems that

ensure the circulation of money.1

2.1.2 Payment systems therefore lie at the heart of banking systems and

play an important role in the smooth functioning of an economy by

facilitating the flow of payments and value. By protecting the

exchange of payments, such systems reduce the risk of an

uncompleted payment which in turn reduces the potential loss to

the economy.

2.1.3 In South Africa, the National Payment System enables financial

institutions to interact with one another and the interoperability

created within the National Payment System allows end customers

to do the same. Given the important function of the National

Payment System, it is therefore vital that all participants in the

National Payment System ensure that appropriate safety and

security measures are built into the National Payment System

value chain.

2.1.4 Co-operation and commitment from participants is essential and

has resulted in the establishment and maintenance of a world class

system of the highest standard in terms of security, risk

containment and service levels. South Africa has an internationally

acclaimed, recognised and sound National Payment System, which

1BIS (March 2003) "A glossary of terms used in payments and settlement systems, Committeeon Payment & Settlement Systems, Revised Edition, Basel, Switzerland


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accords with and in some instances, sets the trend for, international

best practices. The interoperability of the systems within the

National Payment System is also used by international institutions

when rating South Africa on a global scale and, as such, if the

National Payment System infrastructure is not managed in a sound

and efficient manner, the knock-on effect to the South African

economy would be significant.

2.1.5 Furthermore, the National Payment System is subject to concerns

about systemic risks whereby incorrect payment transactions by

one party or insufficient money being available to fund such

transactions can be detrimental to all parties involved in the

National Payment System. In the year ending August 2006,

transactions worth some R47.87 trillion were facilitated through the

National Payment System. This is thirty-seven times the value of

the Gross Domestic Product of the country (R1.3 trillion) in 2004

and the value of banking assets in the country (R1.4 trillion in

2004). With such large values of transactions at stake it is vital that

the National Payment System is well regulated and well-functioning

at all times.2

2.1.6 The National Payment System is therefore regulated in order to

ensure adherence to standards that enable level playing fields,efficiency, effectiveness, soundness and stability of the payments

domain. The regulatory framework for the National Payment

System is based on the BIS's "Core Principles for Systemically

Important Payments Systems" banking framework. It is essential to

have a proper legal structure that underpins the functioning of the

National Payment System. This legal foundation seeks to provide:

2.1.6.1 efficiency, effectiveness, reliability, security, risk management

and adherence to all standards

2.1.6.2 legal certainty with regard to the rights and obligations of the

respective participants;

2Based on data from the FEASibility Report as well as updated Reserve Bank/NationalPayment System data.


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2.1.6.3 a sound and enforceable basis for resolving conflicts between

transacting parties, intermediaries and regulators;

2.1.6.4 a legal foundation for clearing, netting and settlement

arrangements between participants in each particular payment

stream;

2.1.6.5 an environment in which specific criminal activities are to be

reported;

2.1.6.6 legal clarity in bank curatorship and liquidation situations; and

2.1.6.7 support for the removal or reduction of risk in the National

Payment System.

2.2 Key participants in the National Payment System

There are a number of different elements to the National Payment

System. In this section we provide high level information on the main

participants within the regulated part of the payment system.

2.2.1 The Reserve Bank

2.2.1.1 The South African Reserve Bank has overall responsibility for

overseeing the payment systems for the purpose of promoting

the maintenance of a sound and efficient financial system. In

this regard the Reserve Bank is tasked with monitoring the

interactions of participants together and with implementing

risk-reduction measures in the payment system to reduce

systemic risk. The Reserve Bank looks to the BIS for best

practice, guidance and standards for payments regulation. The

Reserve Bank also supports a sound legal basis for payments

clearing and exchange.

2.2.1.2 Within the context of sound governance, the role of the

Reserve Bank, as payment system overseer, is particularly

relevant to ensure safe and efficient payments and securities

settlement systems through reliable and efficient infrastructure.

The direct involvement of the central bank in managing

clearing and settlement systems is an important element in


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governing the overall structure and operation of payment

systems in all major countries. The Reserve Banks

involvement helps to ensure that the desire to limit systemic

risk, especially in the area of large value payment systems, is

adequately taken into account.

2.2.1.3 Within the Reserve Bank there is a financial stability committee

keeping a close view on the payment flows and other actions

of all banks such that any possible liquidity problem of a bank

will be noticed and managed long before it becomes a real

commercial issue.

2.2.1.4 The Reserve Bank is also responsible for the designation of

payment systems as well as the recognition of PASA as the

payment system management body. Within the Reserve

Bank, the National Payment System Department oversees the

functioning of the National Payment System. The National

Payment System Department is a (non-voting) member of

PASA Council and, as such, is in a position to ensure that the

duties delegated by it to PASA are carried out in the correct

manner with the correct governance. The National Payment

System Department also ensures that proper governance is

being applied to all PASA members.

2.2.1.5 The Reserve Bank recently published its Vision 2010 which

sets out a framework for how the National Payment System

should be structured and operate in the future (more details

are provided on this in section 3.11.)

2.2.2 PASA

2.2.2.1 As noted above, Reserve Bank has recognised the Payments

Association of South Africa (PASA) as the payment system

management body, authorised by the National Payment

System Act to manage risk in the National Payment System

through co-regulation of its member banks. Hence PASA has

management oversight of the National Payment System

through authority delegated by the Reserve Bank. The


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National Payment System Act provides for the Reserve Bank

to withdraw the recognition of a management body, nominate

more than one management body or to retain this

management within the Reserve Bank should it so desire.

2.2.2.2 PASA, under the supervision of the Reserve Bank, is

responsible for facilitating the introduction of PCH agreements

and has introduced agreements pertaining to settlement,

clearing and netting. PASA must allow all persons who meet

PASAs access criteria to participate in the National Payment

System. The criteria set must be fair, transparent and

equitable.

2.2.2.3 PASA Council is responsible for the strategic direction and

governance of the Association. Not only does the Council

represent the interests of the members but it also bears the

responsibility of ensuring an efficient, reliable and stable

payments environment to serve the economy and people of

the country.

2.2.2.4 The PASA Council is constituted of the chairperson as well as

representatives of:

2.2.2.4.1 the five Association members (banks) with the highest

throughput, as a product of value and volume cleared

through the inter-bank systems during the previous year;

2.2.2.4.2 two Association members elected by the rest of the

members (commonly referred to as the Smaller Banks);

and

2.2.2.4.3 the Reserve Bank (non-voting).

2.2.2.5 The PASA Executive Office (PASA Exco) manages the day to

day risk management / administration functions and ensures

the effective management of the payment clearing operations

between banks and the operators so as to minimise the

systemic risk impact of the National Payment System as a

whole.


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2.2.3 PCHs

2.2.3.1 Payment Clearing Houses (PCHs) are arrangements

governing the clearing of payment instructions between parties

for a particular payment stream (e.g. cheques, credit cards

etc). PCHs are all founded on a principle of centralised

operators providing connectivity and switching of transactions

between all banks participating in a particular payment stream.

(Using a centralised approach brings considerable benefits

including access to new entrants and this issue is discussed

further in section 3.9.8).

2.2.3.2 The PCHs undertake a number of roles as they:

2.2.3.2.1 manage clearing practices of banks through PCH

agreements and clearing rules;

2.2.3.2.2 set standards;

2.2.3.2.3 monitor and manage risks; and

2.2.3.2.4 monitor the performance of operators to ensure efficient

and secure payments exchanges.

2.2.3.3 The PCH Agreement is supported on a more detailed level byPCH Clearing Rules that establishes the operational rules

regulating participation. This is in keeping with key principles

supporting sound governance which requires that participants

have access to relevant information concerning the risks to

which they are exposed and are able to take actions to

manage those risks.

2.2.3.4 A PCH and its operations are managed by a committee of

representatives of the participating banks as a PCH Participant

Group (PCH PG). Participation and decision-making takes

place on an equal basis with every member having one vote.

Decision-making is therefore not linked to the volumes of any

particular member within the PCH. The PCH PG bears

responsibility for the effective functioning and risk

management of the payment streams that falls under its


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responsibility. In some instances more than one PCH, such as

Electronic Funds Transfers (Debit and Credit), is managed by

a single PCH PG.

2.2.3.5 Any two or more PASA member banks may elect to create a

new payment clearing house with the approval of PASA

Council. The PASA Council will consider whether or not such

new payment streams could be accommodated in an existing

PCH (since this could be more efficient). Any PASA member

can join any PCH at any time access is in no way limited to

the founding members of a PCH (see section 3.9.8 below).

2.2.4 PCH System Operators

2.2.4.1 The rules of PASA allow for Payment Clearing House System

Operators (PCH System Operators) to perform the role of

switching payment transactions i.e. they are responsible for

clearing and calculation of payment obligations on behalf of

banks. In doing this the PCH System Operators must adhere

to standards set by Reserve Bank, PASA and PCHs including

ensuring business continuity in interfacing with operators and

the Reserve Bank. The Reserve Bank, in conjunction with

PASA, approves the PCH System Operators. The ownership,

control and governance of PCH System Operators differs

according to each entity.

2.2.4.2 There are a number of different PCH System Operators that

are active in different PCHs including: Bankserv; Visa;

MasterCard and STRATE. Since the FEASibility report

expressed most interest in Bankserv, the role of Bankserv is

considered in more detail in section 3.9.8. Detailed

information on other PCH System Operators is not provided in

this annex (since many of them do not appear to be relevant to

the current Enquiry) although information can be provided if

required.

2.2.4.3 In addition to these operators is the South African Multiple

Options Settlement System (SAMOS), which is owned by the


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SAR Reserve Bank B and operated by the National Payment

System Department. Final and irrevocable interbank

settlements for all domestic transactions are facilitated via

SAMOS, as well as all forex transactions via continuous linked

settlement (CLS). In addition, all customer transactions that

are above the PCH limits, or else customer transactions

designated as such, are processed (cleared and settled

immediately) via SAMOS.

2.2.4.4 The Reserve Bank, in conjunction with PASA and the PCH

System Operators, conducts an annual review of the National

Payment System to ensure the systems used continue to

deliver the highest levels of safety and efficiency.

2.2.5 Providers of payment services and system operators

The final set of participants in the National Payment System are

those firms that use the National Payment System functionality in

order to offer payment services to end customers. These providers

will then compete with each other in order to offer services for end

customers or merchants. As in other markets, such competition

might be expected to lead to cost efficiencies and innovation over

time. Some of these providers are banks although other firms can

also gain access to the National Payment System as explained in

section 3.

2.3 Different payment instruments

2.3.1 As highlighted above there are different PCHs according to

different payment streams or instruments. In the retail

environment, these instruments are what most consumers or

merchants would consider using or accepting when paying for

goods or services. These include all instruments used to effect

payment between two transacting parties, including legal tender in

the form of notes and coins. The benefits of these different

payment instruments differ and the use of them has changed over

time.


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2.3.2 Electronic Funds Transfers (EFTs) and ATM transactions are now

the most common payment instruments. Currently, the share of the

volume of all non-SAMOS transactions through Bankserv is

approximately as follows:3

2.3.2.1 EFT over 53%;

2.3.2.2 ATM transactions 17%;

2.3.2.3 Cheques 10%;

2.3.2.4 Credit Cards 11%;

2.3.2.5 Debit Cards 9%; and

2.3.2.6 ZAPS and other smaller PCH's represent less than 0.1% oftransactions.

2.3.3 The large share of EFT transactions is even more pronounced in

terms of the value of transactions. The share of EFTs has grown

each year, so that EFTs now account for approximately 63% of the

value of the non-SAMOS transactions with cheques making up

35% of the value of transactions and the value of Credit Cards and

ATM transactions, making up around 1% each.

2.3.4 These proportions are by no means stable with cheques in

particular declining over time while EFT transactions have

increased. The use of credit cards and debit cards has also

increased in recent years, although from low levels. For example,

in 2002, only 2.2 million debit card transactions were processed

through Bankserv whereas by the year ending June 2005, this had

increased to 50.3 million.

2.3.5 Payment instruments offer different functionality or associated

services, although they are substitutes to some degree because of

3These figures are based on information from Bankserv and as such represent only theproportions based on the transactions that they switch. This is likely to underestimate thevolume of transactions in both credit cards and debit cards for these payment types. (Forexample, FNB uses Visa to switch its debit card transactions and Investec uses Visa to switchits credit card transactions.) Data is taken from the Bankserv MPR report for June 2006,which details all transactions for the 12 months ending June 2006. Figures have beenrounded to the nearest percentage point.


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the fundamental nature of the instruments to transfer money

between parties in the retail area this would typically be from a

consumer to a merchant.

2.3.6 From a merchants perspective, they can choose to accept or reject

all non-cash payment instruments. From a consumers

perspective, they can choose to take out the option to use

particular payment instruments e.g. by having a cheque book or by

having a debit card. Then on an individual transaction basis,

depending on the merchants acceptance of these different

payment instruments, the consumer can choose which payment

instrument to use on any particular occasion.

2.3.7 Trade-offs between the different instruments arise and from the

merchants perspective:

2.3.7.1 Credit cards provide a guarantee of payment and offer value

on the same day. The transaction is secure, convenient and

efficient, and, because the customer is given credit to

purchase the goods and services, may lead to additional

purchases being made;

2.3.7.2 Debit cards provide a guarantee of payment and offer value on

the same day. The transaction is secure, convenient and

efficient;

2.3.7.3 Cheques typically do not provide a guarantee of payment and

also have a long clearing cycle.4 In the light of the availability

of electronic payment methods, merchants are increasingly

rejecting cheques as a form of payment.

2.3.7.4 Cash involves a direct payment and removes any need for

guarantees or transfer of value by the issuing bank. However,cash handling involves indirect costs such as the cost of

4Bankserv does offer a Cheque Verification Service which would provide a potential lowering ofrisk, but not a payment guarantee. However, this service is not particularly popular and thevolumes are declining. In addition, some customers might have a form of cheque guaranteeup to a prescribed limit (such as R2,000 or R3,000 or R5,000) involving details of their creditcard number being written on the back of the cheque as well as using the credit card forsignature verification.


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counting/recounting, loss from stealing and human error,

transportation, storage, and security costs.

2.3.8 The overall value of these different options to the merchant will also

be determined by the price paid for these services where credit

card transactions will typically be more expensive than debit cards

although the former do offer additional services in comparison to

the latter.

2.3.9 Trade-offs between the different instruments also arise from the

consumers perspective:

2.3.9.1 Credit cards are a convenient form of purchase as there is no

need to carry cash, or cheques. It is widely accepted, secure

and has a status association (i.e. MasterCard or Visa) which

can also be used abroad. It also provides a customer with a

ready source of pre-approved credit.

2.3.9.2 Debit cards are a convenient form of purchase as there is no

need to carry cash, or cheques. It is widely accepted, secure

and typically has a status association (i.e. MasterCard or Visa)

which can also be used abroad. Due to its on-line real-time

nature more effective financial management is enabled.

2.3.9.3 Cheques are more convenient and less risky to carry around

than cash although they would be more risky than payment

cards.

2.3.9.4 Cash is free at the point of sale (although costs may be

incurred in accessing the cash) and is useful for low value

payments. However, time costs are incurred because of the

need to withdraw cash at a branch or ATM and it is not

considered safe to carry in large amounts.

2.3.10 The overall value of these different options to the consumer will

also be determined by the price paid for these services. For

example, credit card transactions will typically incur an annual fee

for the card but no transaction charges, whereas debit cards would

not have an annual fee, but may incur a transaction fee depending


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on wider pricing issues since debit cards would typically be linked

to current accounts.

2.4 Unregulated payments

2.4.1 Thus far, consideration has only been given to aspects of theregulated National Payment System. There are however, a

number of players that participate in the National Payment System

and that do not fall within the ambit of any regulation at present. In

essence these are payment systems that operate and exist

completely outside the National Payment System. The part of the

payment system that is not regulated include the closed payment

systems (e.g. store cards), substitute payment products (e.g.

cellphone airtime) and a variety of system operators that provide

third party payments (e.g. EasyPay). (These issues are considered

further within section 3.12 and section 3.13.) The National

Payment System Act has been amended to regulate some of these

players, but the Reserve Bank needs to finalise Directives that will

provide for the detailed regulations.

2.4.2 These forms of payment services compete with payment services

which are part of the regulated payment system. In so far as they

do not have to comply with regulatory requirements, they have an

unfair advantage over those within the regulated system.

2.5 Innovation in the National Payment System

2.5.1 Innovation and the ability to find new ways of improving products

and processes are often the hallmark of a dynamic and competitive

system. This is because competition is an important driver of

increased performance and innovation. Competition encourages

the adoption of innovation as participants in the market evolve and

seek new products and processes in order to flourish. This is

indeed the way in which many developments and innovations

related to the payment system have contributed to further

competition within the payment system.

2.5.2 The tables below provide lists of successful innovations related to

the payment system. The tables differentiate between those


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innovations that have been developed on an industry wide basis

and those that have been developed by Absa or by Absa in

partnership with other providers as opposed to across the whole

industry. It is also clear from these tables that Absa has played an

important role and has been at the forefront of many innovative

developments relating to the National Payment System.

CONFIDENTIAL Table 1


2.5.3 As innovation is a dynamic process, sometimes characterised by

failure, information has also been provided regarding innovations

that failed as well as those that have been found to be successful.

These initiatives are just as much part of the competitive process

as successful ones. This also helps to identify the fact that the

payments system should not be seen as a static environment or

one in which profitability or market share gain is guaranteed. Again

the tables differentiate between those innovations that have been

developed on an industry wide basis and those that have been

developed by Absa or by Absa in partnership with other providers.



2.5.4 The beneficiaries of these payment system innovations are two

fold:

2.5.4.1 First, competing service providers and participants in the

payment system benefit as they have improved ways in which

transactions maybe facilitated. Some innovations have also

facilitated access by non-bank participants to the payment

systems (for example, the service providers for the AEDO and

NAEDO initiatives discussed below).

2.5.4.2 Second, consumers and merchants benefit as they have

access to a wider choice of payment instruments and hence

more and efficient ways in which they may make and receive

payment. For example, Absa, Capitec and FNB are the first


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banks to offer cross-bank real time clearing for either person to

person payments or business to business payments.

2.5.5 (N)AEDO

2.5.5.1 The most recent example of a successful innovation thatrelates to the payment system is the development of an

authenticated early debit orders (AEDO) PCH and a non

authenticated early debit orders (NAEDO) PCH. The

development of these PCHs arose from the concerns of micro-

lenders regarding the priority of transactions in debit orders

and the requirements in the National Payment System Act.

2.5.5.2 In particular, there was concern that when debit orders were

processed, those that are processed first on a particular day

(when salaries were paid in) would get paid from a client's

account, but those that were processed later on that day would

not get paid (because the money would already have been

paid out or withdrawn at an ATM) as all the funds in the client's

account would have been depleted. In these circumstances,

those who are due to receive the payments would clearly

prefer to be the first set of transactions that are processed.

2.5.5.3 Concern arose because some firms were able to receive

priority in the ordering of transactions being processed. Partly

in response to this, the AEDO and NAEDO systems were

developed which allow beneficiaries equal opportunity in the

collection of payments i.e. they effectively introduce

randomisation into the system in order to ensure that no

institution has priority over others.5

2.5.5.4 AEDO works as follows: When a customer decides to enter

into a credit agreement (for example, with a furniture retailer,

micro financier or insurer) the contractual obligations placed on

the customer, specifically in terms of the minimum repayments

5In terms of section 6A of the National Payment System Act, as of 1 July 2006, a person maynot change, manipulate, maintain or apply a payment system in any manner that providespreferential treatment to a payment instruction over any other payment instruction in thatsystem, unless such preferential treatment is prescribed by law.


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and payback period, are captured electronically and authorised

by the customer, after checking the captured information for

correctness by swiping his or her ATM or debit card through

the AEDO terminals adjoining keypad.

2.5.5.5 The customers card details, PIN and contractual payment

information are then forwarded in a secure format to the

customers bank, which verifies the authenticity of the

transaction from the card and PIN data received. Authentic

transactions are registered on AEDO for future payment.

Transactions which are rejected are relayed back to the

payment collector.

2.5.5.6 On the applicable dates, AEDO presents the previously

authorised payment instructions for processing, directly after

the transmission of bulk salaries. Confirmation of the payments

success, or otherwise, is distributed to the relevant payment

collectors soon thereafter. In the event of non-payment of any

one of the payments on the pre-designated date, a message is

relayed to the payment collector, who is then able to follow-up

with the customer directly.

2.5.5.7 NAEDO uses a very similar process although it does not

require authentication before submission for clearing.

2.5.5.8 Despite the fact that the early debit order transactions

constitute only 0.069% of total transactions through the

payment system, these switches were developed in order to

assist with the randomisation of debit orders. The benefits to

the institutions using these switches include improved daily

cash flow and ease of operations. AEDO and NAEDO are

clear examples of how non-bank institutions such as the

service providers offering terminal and transaction processing

services to micro-lenders have been able to gain access in a

National Payment System accepted manner to the payment

system through this innovation and the micro-lenders receive

an improved service from banks that suits their needs.


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3. Access to the National Payment System

3.1 Access to payment services is an important issue in the provision of

banking services. It has been raised within the Terms of Reference to

the Enquiry and was highlighted as of particular interest by the

Technical Task Team of the Competition Commission during a meeting

with Absa. This section therefore seeks to provide information on the

different parts of the payment system, the varying requirements

regarding access and the developments that are underway to widen

access in different areas.

3.2 As a precursor to assessing the issues underpinning access to the

National Payment System, it is important to understand what is meant

by access. In this section access to the payment system refers to

access for participants (bank and non-bank) who provide payment

services. Consumers and merchants benefit from access to approved

payment system services through the use of various payment

instruments (for example debit cards and cheques). As is explained

below it is clear that participation in the payments system as a whole is

primarily driven by normal business related considerations, rather than

as a result of any unreasonable or unnecessary barriers caused by

industry activities or structures.

3.3 In respect of the Payment Clearing Houses we note that these are

centralised systems governing the clearing of payments instructions

between parties. As centralised systems, these allow for easy access

for new entrants since access is to a single centralised switch avoiding

the need to make arrangements with all other banks in the system.

Furthermore, prices offered by PCH System Operators are generally

cost based and in some cases there is additional competition through

having a choice of operator in a particular PCH.

3.4 In an international context it is important to note that access to the

South African National Payment System is believed to be considerably

easier than access to payment systems in other countries. Indeed,

before Barclays purchased its controlling stake in Absa it had obtained

access to the National Payment System. It was Barclay's experience

that the process of obtaining access to the South African National


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Payment System was straightforward in comparison to that in other

countries. Barclays has obviously had considerable experience in this

regard, given its global presence.

3.5 In addition, while there are many firms participating in the payments

system through direct access, participation also arises on an indirect

basis through sponsorship and agency arrangements. These

arrangements provide a low cost method of participating in the National

Payment System without the need to incur the full costs associated with

direct membership. When considering access to payment systems, it is

important to understand the various different levels of the payment

system since the requirements differ at the various stages.

3.6 In all areas of access to the National Payment System, the Reserve

Bank has stated its intention to ensure that access is fair and

transparent with the criteria for access aligned with international best

practice.6 In part this will include enabling wider access for participants

by providing for different categories of participation, publishing

information for new participants in the payment system and disclosing

entry criteria and other regulatory requirements for participants.7

3.7 Developing a National Payment System which enables access to its

infrastructure on a fair, equitable and transparent basis is an ongoing

and dynamic process. In particular, technological developments and

innovation in different payment instruments will inevitably mean that

access is a dynamic issue. Recent regulatory changes in the form of the

Dedicated Banks Bill and the Co-operative Banks Bill are expected to

have a significant improvement on access to the system going forward.

3.8 Furthermore, as payment systems develop into the future, the

interoperability of payment systems across countries is likely to become

of greater importance. Thus it is important not to take action in this area

in a way that would jeopardise future developments and the potential for

additional competition to arise either from greater integration across the

Southern African Development Community or elsewhere.

6This is also explained in the National Payment System Act.

7The National Payment System Framework and Strategy, Vision 2010, South African ReserveBank, 2006, p10


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3.9 Direct access to the National Payment System

3.9.1 The diagram below provides a graphical representation of the

entire payment system.

Figure 1: Overview of the Payment system

Settlement

Source: Absa

3.9.2 The centre comprises the activities of Settlement and Clearing, with

the next area being the core payment services (i.e. open payment

systems such as EFT and cards). According to the National

Payment System Act, these three components are the functions of

registered banks as payment facilitators. There are no restrictions

on providers outside these areas and broadly speaking, services

can be offered by any firm at present and do not need to conform to

any particular regulations.8

3.9.3 It is a principle followed by most countries in the world that clearing

and settlement should be undertaken only by institutions that are

registered banks. This is because of systemic risk issues that arise

and therefore the need to ensure that these functions are subject to

8At present services outside the central three rings can be offered by any firm without meetingregulatory restrictions. However, the National Payment System Act provides for the ReserveBank to issue Directives governing these areas at which point the payment services wouldneed to meet any requirements specified. Criteria for the authorisation of system operatorsare in draft form at present, as they have not yet been authorised by the Reserve Bank.


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very stringent regulatory requirements. In addition the functions

towards the outside could be seen as being dependent on functions

closer to the centre. Hence it is appropriate that regulatory

requirements are greater for those functions closer to the centre.

3.9.4 The centre is closely regulated by the Reserve Bank National

Payment System Department, through PASA. The outer two circles

represent the areas where providers of value-added services

compete and where the markets served by the providers and the

banks themselves are located. Examples include bureaux, retailers

offering banking services, bill payments or other value-added

banking services, such as cashback at point of sale, store cards,

gift vouchers etc.9

3.9.5 Access criteria vary depending on the portion of the diagram that is

under consideration with regulatory requirements broadly

increasing towards the centre of the diagram and reducing towards

the outside. As discussed above, this is appropriate due to the

increased systemic risk from the activities closer to the centre. The

diagram also highlights the fact that access to the payment system

is possible at various levels. In practical terms many players are

able to gain access to, and hence participate in, the payment

system at outer levels which enables the provision of a great dealof functionality of payment services without necessarily fulfilling the

criteria necessary to gain access to the central domain.

3.9.6 Access to clearing and settlement

3.9.6.1 In terms of access to the central component namely clearing

and settlement, there are a number of conditions that must be

fulfilled including:

3.9.6.1.1 A participant must be a registered bank. The National

Payment System Act provides that clearing and

settlement is the domain of registered banks. The

requirement in terms of the National Payment System Act

is in accordance with international best practice and is

9Bureau services refer to the collection, processing and batching of EFT Debit Orders.


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fundamental for a sound national payment system, as it

enables counterparty risk to be contained to acceptable

levels.10 The requirement to be a registered bank is not

considered to be either unreasonable or to reduce the

number of potential participants unduly. There are large

numbers of registered banks in South Africa and it is also

easy for foreign banks to gain entry as Barclays found in

the past. At present there are 21 different banks that are

members of PASA .11

3.9.6.1.2 The participant must have a settlement account at the

Reserve Bank (namely a SAMOS account). Since the

Reserve Bank is the banker to the banks and is

responsible for the settlement of all cleared transactions,all banks who wish to clear and settle in their own name in

the National Payment System are required to have a

settlement account at the Reserve Bank. This is

necessary in order to facilitate the actual settlement of

positions between the banks in a manner that will always

be acceptable to all banks. This requirement does not

impose additional constraints over and above the

requirement to be a bank. All SAMOS costs are fully

recovered from the participating banks (although the

SAMOS system is run and managed by the Reserve

Bank). Only banks, a designated settlement system

operator (in this case the CLS System) and the Reserve

Bank itself may participate in SAMOS.

3.9.6.1.3 The participant must have specialised skills and

processing capabilities. The payments clearing and

settlement environment is a specialised environment and

given the important nature of central functions it is

10The requirement to be a bank brings with it various restrictions set out in the Banks Act (Act 94of 1990) regarding entry costs and requirements with which any institution must comply withbefore it may carry on the business of a bank. It is therefore important to note that changingsome of the access requirements within the National Payment System does not fall within theambit of the payments environment alone, but is regulated by the Banks Act.

11Note that this excludes Albaraka Bank which currently has provisional membership of PASAwhile it awaits supervisory approval by the Reserve Bank.


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essential that only those institutions that have the

requisite skills gain access to ensure that the necessary

standards are fulfilled. If a new participant does not

possess the necessary skills, existing members are

available to mentor new entrants into the National

Payment System. More details are provided on this in

section 3.10.5.

3.9.6.1.4 The participant must make the necessary investment

in technology. The investment in technology, and

specifically the technology that supports payment clearing

and settlement operations, is an essential part of

providing payments services. Interoperability is key, and

stringent and prescribed standards across the industry are

necessary. This eliminates costly processing within each

bank, in payment system operators and across the

industry as a whole, resulting in efficiencies and cost

reduction to the benefit of all participants. Outsourcing of

clearing has become more popular over time (see below).

3.9.6.1.5 Operator certification and interbank testing. All

systems must be certified with an PCH System Operator

(for example, Bankserv). This is vital as any operationalrisk that may be introduced into the system will originate

at this point. Processes are in place for testing with the

operator and the other banks. This includes a three

month period required for live data testing and

modifications to existing systems to accept transactions

from new participants). These processes are essential to

ensure the continued, reliable operation of the National

Payment System and the reduction of systemic and

operational risks within the National Payment System.

3.9.6.1.6 Risk, operational and liquidity management

structures must be in place. The participants

infrastructure must meet risk and interoperability

standards and proper Disaster Recovery and Business


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Continuity plans, systems and procedures must be in

place.

3.9.6.1.7 Financial and capital costs must be sufficient to

ensure the safe, efficient and ongoing participation of

banks in each of the payment streams and initiatives

within the industry. In respect of the capital costs these

are the same as those set out in the Banks Act and

therefore do not impose any additional constraints.

3.9.6.2 The criteria set out above apply only to clearing and settlement

and not to access to the whole of the payment system. As

explained below, there are many entities actively participating

in the payments system that do not fulfil the above criteria.

Whilst this means that they cannot participate in clearing and

settlement, they are able to participate in the wider payments

system and thus avoid the costs associated with this level of

participation.

3.9.6.3 Outsourcing of clearing arrangements

3.9.6.3.1 As noted above, the outsourcing of clearing arrangements

has become more popular over time and is now

commonplace. This involves using a service provider

specialising in interfacing with clearing operators rather

than banks having to do this themselves. This

outsourcing is properly understood as technical

outsourcing for IT and transactional purposes and is

focused on the ability to process transactions. At no

stage does a financial transaction go to, or through, the

outsourcing company. Furthermore, the bank retains the

responsibility for the transaction in the payment system.12

12The service provider acts as a system operator as defined in the National Payment SystemAct. A system operator is a person, other than a designated settlement system operator,authorised in terms of section 4(2)(c) to provide services to any two or more persons inrespect of payment instructions. Section 4(2)(c) empowers PASA to authorise a person to actas an system operator in accordance with criteria approved by Reserve Bank. PASA hasdeveloped such entry criteria, which include financial, operational, technical, legal andcontractual, risk and reporting requirements. The services provided by a system operator to


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3.9.6.3.2 The ability to outsource assists new entrants in regard to

standards and interoperability since they do not need to

make the capital investment required to ensure that these

standards are maintained. For example, Direct Transact

supports a number of banks such as Ithala, African Bank,

Theba, Standard Chartered, Rennies, First National Bank

and Absa. In the case of Absa, Direct Transact is only

used for the gift cards. It is also understood that only a

portion of FNBs services are outsourced to Direct

Transact. In the case of Ithala, Direct Transact processes

all transactions for clearing.

3.9.6.3.3 The ability to outsource these arrangements further

increases the competitive nature of the National Payment

System. This arises partly because new entrants can

more easily participate without needing to invest in

infrastructure (this was believed to be the case for Ithala).

It also ensures that incumbent providers have to keep

reducing costs in this part of the process in order to

remain competitive with the outsourcing providers.

Indeed, the potential for incumbents to outsource if this

becomes cheaper also ensures a low cost functioning of

the payment system.

3.9.7 Access to PASA

3.9.7.1 Part of gaining access to clearing and settlement involves

obtaining access to PASA. Membership of PASA is open to

entities such as banks, mutual banks or branches of foreign

banks.

3.9.7.2 The Reserve Bank has recognised the Payments Association

of South Africa (PASA) as the payment system management

body, authorised by the National Payment System Act to

manage risk in the National Payment System through self

regulation of its member banks. Hence PASA has

any two or more persons in respect of payment instructions, include the delivery to, and/orreceipt of, payment instructions from a bank and/or a PCH System Operator.


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3.9.7.5 As with access to clearing and settlement, membership of

PASA is limited to banks and to those who have the right to

clear and settle within SAMOS. As explained above this is

because of the systemic risks associated with the payment

system.

3.9.8 Access to Payment Clearing Houses

3.9.8.1 Access to a Payment Clearing House (PCH) is conditional on

the applicant being a member of PASA and having a clearing

agreement with all banks that are members of the PCH. As

such all of the requirements listed above regarding access to

clearing and settlement arrangements also apply here. In

addition to that there are a number of criteria that need to be

fulfilled including:

3.9.8.1.1 Approval by existing members. In order to ensure

payment to the ultimate customer can always be made,

each participant in a payment clearing house (PCH) is

exposed to every other participant in respect of settlement

failure in each PCH. Therefore each applicant is required

to get a letter (willingness to trade and accept the

additional risk into the existing PCH) from each existing

participant. In turn, all banks are required to get credit

approval for the additional risk exposure. This is because

the PCHs are set up on a survivor pays model, so as to

ensure that settlement takes place. On a practical level,

approval by members has proven to be a mere formality.

Once an entity has qualified through the Reserve Bank for

a banking licence and has fulfilled the requirements in

terms of the Banks Act, this effectively eliminates any

possible concerns in respect of National Payment Systementry. No new entrant has ever been refused access by

an existing participant on this basis. In any event the

rules for the PCH require admission to be fair and

equitable.


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3.9.8.1.2 Payment of membership fees. There are a number of

fees that are due including:

An application fee of R6,000 excluding VAT is

payable on application to a PCH to cover the costs

associated with the administration and staff time to

assist new entrants in completing the relevant

applications for membership to one or more PCH;

and

An exit fee of R6,000 excluding VAT is payable on

termination of a banks PCH membership;

Ongoing (annually payable) fees apply for each PCH

of which the bank is a member.

3.9.8.1.3 Any two or more PASA member banks may elect to

create a new payment clearing house with the approval of

PASA Council. PASA Council will consider whether or not

such new payment streams could be accommodated in an

existing PCH (since this could be more efficient). Any

PASA member can join any PCH at any time access is

in no way limited to the founding members of a PCH.

3.9.8.1.4 Different PCHs exist for different payment types and

individual banks do not need to join all of the PCHs. (If

they do not join any of the PCHs they would not be able to

be a member of PASA.) Figure 2 below provides a table

of the PCH System Operators together with the

participating, or member banks.


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12/2006 30

Figure 2: PCH membership

Member Banks No of PCHs

Immediate

Settlement

Electronic

Credit

Payment

ZAPS

PIN Validated

Electronic

Debit (ATM) CLC Debit

Paper

Credit EFT Debit EFT Credit STRATE BESA Debit Card Credit Card

ABN Amro NV Johannesburg Branch 4 1 1 1 1

ABSA Bank Limited 17 1 1 1 1 1 1 1 1 1 1 1

African Bank Limited 10 1 1 1 1 1 1

Albaraka Bank Limited (3) (1) (1) (1)

Barclays Bank PLC South Africa Branch Cancelled (1) (1) (1) (1)

Calyon Corporate and Investment Bank South Africa

Branch 1 1 Cancelled

Capitec Bank Limited 9 1 1 1 1 1 1

Citibank NA South Africa 7 1 Cancelled 1 1 1 1

FirstRand Bank Limited 16 1 1 1 1 1 1 1 1 1 1 1

Habib Overseas Bank Limited 5 1 1 1 1 1

HBZ Bank Limited 5 1 1 1 1 1

Investec Bank Limited 6 1 Cancelled 1 1 1 (1) 1

Mercantile Bank Limited 13 1 1 1 1 1 1 1 1 1

Nedbank Limited 16 1 1 1 1 1 1 1 1 1 1 1

Peoples Bank Limited Cancelled Cancelled Cancelled Cancelled Cancelled Cancelled

Rennies Bank Limited 5 1 1 1 1 1

Saambou Bank Limited (terminated 1/4/04) Cancelled Cancelled Cancelled Cancelled Cancelled

Societe Generale Johannesburg Branch 2 1 Cancelled 1

South African Reserve Bank 5 1 1 1 1 1

Standard Chartered Bank Jhb Banch 5 1 1 1 1 1

State Bank of India South Africa Branch 2 1 1

Teba Bank Limited 8 1 1 1 1 1

The South African Bank of Athens Limited 12 1 1 1 1 1 1 1 1 1

The Standard Bank of South Africa Limited 16 1 1 1 1 1 1 1 1 1 1 1

Sponsorships

Ithala 1 1 1

Postbank 1 1 1


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08/12/2006 31

3.9.8.2 It is clear from this table that banks choose the particular PCH

in which they wish to participate and that certain banks have

chosen to belong to different PCHs illustrating that banks are

able to successfully conduct their business by choosing to

participate in only certain PCHs. In part this reflects the

different business models adopted by the various banks

regarding offering retail banking services and thus not all

banks would wish to enter the PCHs for retail payment

instruments.

3.9.8.3 However, to the extent that different retail payment instruments

compete with each other, it would not be necessary to

participate in all PCHs related to retail payment instruments.

Indeed, it is worth noting that the larger banks are not all

members of all of the same PCHs. For example, First National

Bank and Nedbank are not members of Nupay and Standard

Bank is not a member of RTC.

3.9.8.4 Centralised switch

3.9.8.4.1 PCHs represent a centralised system enabling the

clearing and settlement of payments across different

providers. In the past, banks in South Africa decided to

invest in a central switch to facilitate more effective and

efficient switching so that economies of scale in this

function could be maximised. In other countries, banks

might link directly to each other in a direct access network

model (which is the situation in Australia).

3.9.8.4.2 It is clear, however, that the larger the number of

participants in the payment system, the more complex,

inefficient and uncontrollable the direct access model

becomes. Hence the direct access model is typically only

feasible where there are only a very small number of

banks.

3.9.8.4.3 A centralised approach therefore has very strong

advantages. Indeed in payment systems globally, a


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centralised system has generally been preferred by

competition authorities (for example the Irish Competition

Authority expressed concerns about the use of direct

bilateral arrangements for clearing in Ireland and the

European Commission has also expressed concern about

bilateral arrangements in those countries where these are

used).

3.9.8.4.4 In particular, a model which has a central switch makes it

easier for new entrants to access a particular payment

stream since access only needs to be obtained to the

central switch rather than to each and every individual

bank. Access to this one central switch then enables

firms to offer transaction services to customers. In the

case of South Africa, the relevant PCH Operator also

assists them in the technical process of linking up, as well

as sharing the rules and certifying them.

3.9.8.4.5 In addition, operating via a central switch offers several

other advantages including:

3.9.8.4.5.1 Gains from economies of scale as fixed costs are

shared across more transactions and more efficient

technology can be used;

3.9.8.4.5.2 Ensuring the best possible security standards

including Disaster Recovery and Business Continuity

Plans, thereby assuring stability and reliability; and

3.9.8.4.5.3 Enabling the easier adoption of new innovation,

sharing of costs and adoption of new standards as

well as ensuring interoperability between all

providers.

3.9.8.4.6 Furthermore, the use of centralised PCHs with

interoperability is likely to lead to wider acceptance and

usage of a particular payment instrument.


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3.9.8.5 Sorting-at-source

Sorting-at-source has gained new focus as an issue in recent

years. Sorting-at-source appears to be unique to South Africa

and is the process whereby institutions sort or regroup

payment instructions with the purpose of submitting the

payment instructions directly to the banks holding the

respective accounts of the payers. As such, it is the equivalent

of clearing by a non-bank (if the BIS glossary definition is

used), while it has the effect of bypassing the regulated inter-

bank clearing process (including the PCH and the designated

PCH Systems Operators). For a number of years now, the

Reserve Bank has consistently indicated that it was opposed

to the concept of sorting-at-source and consequently imposed

a moratorium on the practice in December 2003. Although the

Reserve Bank appears to have rescinded the moratorium

placed on new sorting at source, the legal position remains

unclear. However, Absa's understanding is that the Reserve

Bank still remains averse to arrangements that allow for the

by-passing of the clearing system.

3.9.8.6 PCH System Operators

3.9.8.6.1 Payment Clearing House System Operators perform the

role of switching payment transactions i.e. they are

responsible for clearing and calculation of payment

obligations between different providers of payment

services. In doing this the PCH System Operators must

adhere to standards set by the Reserve Bank, PASA and

PCHs including ensuring business continuity in interfacing

with operators and the Reserve Bank.

3.9.8.6.2 There are a number of entry requirements that are in

place in order to act as a PCH System Operator including

those related to financial, pricing, service, managerial,

operational, legal, and risk elements. These requirements

are set by PASA and the PASA members and are

approved by the Reserve Bank. Since the focus of the


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current Enquiry is on retail banking, we do not examine in

any further detail the access conditions for the PCH

System Operators themselves.

3.9.8.6.3 Within the payment system there are a number of different

PCHs each of which have operators which are able to

undertake the switching services. The following PCH

System Operators have been licensed by PASA:

SBV cash;

Bankserv EFT, CLC, Credit Cards, Debit Cards,

ATM transaction switching, AEDO/NAEDO, NuPay,

Mzansi Money Transfer;

VisaNet Credit cards, Debit Cards, Pre-Paid Cards,

Visa Travel Money (Visa is also able to switch EFT

transactions although at present the necessary

testing has not occurred since Visa does not appear

to have any customers for EFT services);

MasterCard Network Credit Cards, Debit Cards,

Pre-Paid Cards;

STRATE Bond Exchange, Equities Exchange;

3.9.8.6.4 In addition to these is the South African Multiple Options

Settlement System (SAMOS), which is owned by the

Reserve Bank and operated by the National Payment

System Department. Final and irrevocable interbank

settlements for all domestic transactions are facilitated via

SAMOS, as well as all forex transactions via CLS.

3.9.8.6.5 The FEASibility report highlighted the role of Bankserv in

respect of retail payments and hence we focus on

Bankserv in the considerations below regarding pricing

arrangements and competition between PCH System

Operators.


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3.9.8.7 Pricing arrangements by PCH System Operators

3.9.8.7.1 In connection with pricing, the domestic PCH System

Operators ensure that their pricing is fair and transparent

and PASA does not encourage any undisclosed cross-

subsidisation.13 In addition it must ensure that clearing

services are available to all member banks on identical

price structures.

3.9.8.7.2 For example, in the case of Bankserv, prices are cost

based allowing for a small profit margin. These profits are

typically reinvested in Bankserv in order to continually

improve the services offered. While the prices to

individual firms will differ according to the volume of their

transactions, the main aims when setting prices are to:

reduce extreme year-on-year price fluctuations;

allow for funding of new projects or upgrade of

systems without needing to resort to borrowing from

shareholders which may cause delays in innovation;

ensure that fees remain competitive with alternatives

such as Visa, MasterCard, SWIFT or switchingdirectly; and

ensure that all customers are charged on a similar

basis.

3.9.8.7.3 This last point is important to note. There are

considerable economies of scale in the processing of

transactions and hence those banks that have large

volumes of transactions would receive lower prices than

banks that have small volumes of transactions. However,

the cost curve that is used is the same for all banks. In

particular, there is no differentiation in prices charged to

13Although PCH System Operators are required to limit cross-subsidies, as global operators,Visa and Mastercard can not be policed. The South African transactions would be a smallproportion of transactions that they switch. In addition, when new PCHs are in start-up phasethere may be some cross-subsidy in their favour before they become established.


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the main shareholders compared to other providers other

than because of the volume of transactions.

3.9.8.7.4 In addition, dividends are only paid to shareholders on an

irregular basis depending on the investment plans and

any surplus money that is not required for investment.

However, since such dividends would be taxable and

given that the major shareholders are also the major

customers, these dividends are typically minimised in

favour of lower prices being achieved for services.

3.9.8.7.5 Furthermore, although considerable attention seems to

have been placed on the pricing arrangements of PCH

System Operators, it is important to note that the prices of

switching services represent only a very small cost of

offering payment services. Indeed the report by

FEASibility correctly identified that the cost of Bankserv

services was very small indeed,

Private ownership of the switch does not appear to

be the primary cause of high bank fees the switch

fees appear in most cases to be insignificant cost

items relative to bank revenue. In the long term,

disruption of this essential infrastructure through

ownership directives may dissipate that whichcontributes to SWAP and efficiency in the system,

even though it may provide some short term consumer

satisfaction. The proliferation of a number of

proprietary systems as an alternative to Bankserv

would not necessarily lead to lower prices if it had a

negative impact on efficiency.14

3.9.8.7.6 The cost-based pricing approach that is used by

Bankserv, alongside the benefits of having a centralised

switch in order to facilitate access to the PCH by new

entrants provide strong support for the continuation of the

existing approach. Furthermore, given the very small cost

represented by Bankserv, any changes to this part of the

National Payment System would be expected to have an

14The National Payment System and Competition in the Banking Sector, FEASibility, March2006, p31.


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insignificant effect on the prices charged to end

consumers.

3.9.8.7.7 In addition to the transaction fees, Bankserv also applies

a fixed fee to banks. In the past the Reserve Bank

expressed concern about these fixed fees regarding the

impact on new entrants and smaller banks. In response

to this Bankserv implemented a tiered structure such that

smaller banks pay only 25% of the fixed fee that is paid by

the larger banks, with this proportion increasing as their

transactions increase. Hence the Reserve Bank is

understood to keep a careful watch on the prices charged

by Bankserv which has also taken steps to prevent small

banks from being discouraged from entry.

3.9.8.8 Competition between PCH System Operators

3.9.8.8.1 In some PCHs (although not all of them) individual banks

have a choice of PCH System Operator and hence

additional competition arises through the choice of PCH

System Operator for a particular service. In these cases,

should any of the PCH System Operators prove to be cost

inefficient, alternatives therefore exist to which banks can

direct their routing instead.

3.9.8.8.2 This is illustrated in the case of debit and credit cards

where the issuing bank has the choice of switch for the

processing of transactions between acquiring and issuing

banks. More specifically, banks have the option of using

Bankserv, Mastercard or Visa. There are no differences

between the three PCH System Operators as to the

guarantees to customers.

3.9.8.8.3 For cards issued under MasterCard or Visa, the default

option is that switching would take place through their

switch. However, it is common to preload a Bank

Identification Number (BIN) on Point of Sale terminals to

allow these transactions to be switched through a different


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operator depending on the preferences of the issuing

bank. The majority of South African banks, including

Absa, use Bankserv to switch these transactions rather

than using MasterCard or Visa. This is because Bankserv

represents a less costly option for the reasons explained

below:

In contrast to VisaNet and Mastercard, which have

dollar-denominated transaction charges, Bankserv

charges are Rand-denominated and hence banks do

not take on any currency risk regarding having costs

set in dollars and prices set in Rand; and

Bankserv is able to pass on an economies of scale

and scope benefit to banks because its transaction

charges are based on all transactions switched, not

just credit or debit card transactions. Thus using

Bankserv for these transactions means that prices for

other transactions are also cheaper.15

3.9.8.8.4 In addition, while Bankserv currently processes in excess

of 1 billion transactions per annum, it is expected that in

the future, Bankserv will compete with some of the larger

European and other global Automated Clearing Houses.

This will give further opportunity to increase volume and

drive economies of scale.

3.9.8.8.5 In the case of other PCHs that have only one operator,

this is because no other operators have been forthcoming

as yet. In principle there would be nothing to prevent

operators from entering these other PCHs. As has

already been noted, however, economies of scale are

substantial in this area and hence would play a role in

determining the business viability of offering such

15Note that there is a base cost that applies to each payment stream, thus the overall pricingdoes not involve any cross-subsidisation between payment streams. While the software useddiffers between the different PCHs, hardware, Disaster Recovery and Business ContinuityPlans, management and operational oversight all occurs across the different PCHs for whichBankserv is an operator and hence economies of scope arise as well as economies of scale.


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services. Apart from this, any two banks have the option

of making direct clearing arrangements between each

other should they so wish.

3.9.9 Summary on direct access

3.9.9.1 In terms of gaining direct access to the payment system, it is

seen from the various requirements that, under the National

Payment System Act, this is currently limited to banks. This is

because membership of Payment Clearing Houses involves

systemic risk issues. PCHs are set up using a survivor pays

model so as to ensure that settlement will always take place.

As such it is vital that members of PCHs meet rigorous

requirements to ensure that they do not bring unnecessary risk

into the payment system. The regulatory oversight of the

Reserve Bank and PASA ensure that systemic risks are

minimised.

3.9.9.2 Within the PCHs, the PCH System Operators, such as

Bankserv, offer switching services to the different member

banks. These services are priced in a cost-based manner with

prices across the PCHs primarily determined by the volume

and value of transactions undertaken. In addition, some PCHs

have multiple operators ensuring that prices are kept to a

minimum. Furthermore, the overall costs imposed by the PCH

System Operators represent only an extremely small part of

the end price to consumers for making payments. Thus it

appears to be the case that the current functioning of PCHs

and the PCH System Operators are in no way either limiting

competition between banks to offer payment services for end

customers or leading to increased prices for these services.

3.10 Indirect access to the National Payment System

3.10.1 The National Payment System Act prohibits anyone, as a regular

feature of its business, from accepting money or payment

instructions from any other person for purposes of making a

payment on behalf of that other person to a third person unless that


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person is the Reserve Bank, a bank, a designated settlement

system operator, the Postbank or the money is accepted or

payment made in accordance with directives issued by the Reserve

Bank (no such directives having been issued as yet).

3.10.2 However, while these restrictions are in place, and prevent direct

access to the National Payment System, various alternatives are in

place to allow for indirect access to the National Payment System.

It is important to note that in these circumstances, it is not, in fact,

necessary to gain full access to clearing and settlement

arrangements in order to participate in payments or to offer

payment services to customers. Instead, this can be done through

indirect access i.e. through making arrangements with those banks

that do have full access.

3.10.3 It is well recognised that access to payment systems on an indirect

basis represents a good substitute for direct access since this

allows firms to offer payment services to end users. It is therefore

important to note that sponsorship arrangements are already

possible within the National Payment System and as noted in

section 3.11 below, plans are already in place to extend the use of

this to other providers through the Dedicated Banks Bill and the Co-

operative Banks Bill. Therefore although direct access to theNational Payment System is limited to banks, indirect access is

already available and hence, it is not clear where access is being

unduly restricted, or where a lack of access is preventing other

firms from offering payment services to end customers.

3.10.4 Sponsorship

3.10.4.1 Sponsorship is a means by which new entrants may gain

access to the payment system without having to fulfil the

aforementioned entry criteria or incurring the same levels of

participant costs. Sponsorship comprises the processing of

transactions in the name of the sponsoring bank on behalf of

the sponsored participant. At present only banks, and the

exempted non-banks, Postbank and Ithala, can obtain

sponsored access.


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3.10.4.2 Sponsorship, therefore, allows banks not wanting to clear and

settle in their own name to participate in the National Payment

System by entering into a sponsorship arrangement with a

direct clearing and settlement member. If the sponsored

institution does not think it is receiving a service of high

enough value for money, they can always seek sponsorship

arrangements with a different institution. In addition, the

sponsored banks have the option to become direct members

of the clearing and settlement system.

3.10.4.3 Sponsorship enables low cost access to clearing and

settlement and reduces the time necessary for participation in

this part of the payments system since it is quicker to develop

a sponsorship arrangement than to invest in the necessary

infrastructure to have direct access. In this way new entrants

or small banks can gain quick and cheap access to payments.

3.10.4.4 At present there are only 3 sponsorship arrangements in

place:

3.10.4.4.1 MEEG Bank which is sponsored by Absa;

3.10.4.4.2 Ithala which is sponsored by Absa; and

3.10.4.4.3 Postbank which is sponsored by Standard Bank.

3.10.4.5 It should be clear that Absa fully supports the use of

sponsoring arrangements. Indeed, Absa has never declined a

request to act as a sponsor.16 The small numbers of

sponsored arrangements partly indicate a lack of demand for

this service (as well as the requirement to be a bank) rather

than a lack of willingness to offer it.

3.10.4.6 A brief overview of Absa's sponsorship arrangement with the

respective institutions that it sponsors is set out below.

16Section 6A of the National Payment System Act stipulates that a person providing access to apayment system may not deny a person which meets its criteria (which must be fair equitableand transparent) access to the payment system. This was inserted in the National PaymentSystem Act of 2005.


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3.10.4.7 MEEG Bank Limited

3.10.4.7.1 Absa has a 49.8% equity stake in MEEG. The processing

of MEEG's payments is embedded in the Absa systems.

This means that Absa performs all the transaction

processing, inter-bank as well as to the customer

accounts on behalf of MEEG using Absa's infrastructure

and systems. This is a unique situation from a South

African perspective in that Absa sponsors MEEG's

clearing (operational) as well as settlements (financial) in

the clearing houses.17

3.10.4.8 Ithala Limited

3.10.4.8.1 Ithala does not have a banking licence but has been

exempted from the Banks Act in order to allow it to offer

deposit taking services. Absa sponsors Ithala for its daily

inter-bank settlements (financial sponsorship) as well as

its clearing participation by virtue of the fact that it does

not have PASA membership. Ithala also issues a Debit

Card through a Batch Identification Number (BIN) in

Absa's name.18 In addition, Absa provides an informal

advisory service for Ithala

3.10.4.8.2 Ithala plays an important role in terms of providing

banking services to the rural communities in Kwazulu-

Natal and is currently in the process of obtaining its own

banking license but it is anticipated that this process may

take some time to complete.

In both of these cases, therefore, Absa is offering upstream

payments services to institutions that are downstream

competitors.

17The Reserve Bank has ruled that MEEG needs to separate its clearing from Absa and thisprocess is underway although it may take several years to complete. This is because in theSAMOS system the Reserve Bank would like to have a view of what the exposures of thevarious banks are in the National Payment System and settlement system.

18A dispensation has been created through an amendment to the National Payment System Actwhereby institutions which are exempted and excluded via the Bank's Act may becomelimited members of PASA. However, the criteria and rules for such members have not yetbeen finalised.


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3.10.5 Mentorship

3.10.5.1 PASA regulations require that a new participant in a Payment

Clearing House (PCH) must serve a period of three years

under the mentorship of a larger player in that PCH before

becoming a full participant. During this time there are no

restrictions or limitations on the actions of the new participant

as compared to full participants who have been in the PCH for

longer. Mentorship comprises the provision of advice, rather

than hands-on assistance although it could involve assisting

with day to day processing operations and staff training.

3.10.5.2 From the Mentors perspective, this is purely an advisory and

support service and it does not bring with it risk or obligations

for the Mentor which always remain with the new participant.

Absa has been a popular choice as a Mentor and has provided

mentorship services to Capitec and Bank of Athens in respect

of various PCHs.

3.10.6 Agency arrangements

3.10.6.1 Similar to sponsorship arrangements with respect to access to

the National Payment System, agency arrangements allow

customers of other banks to use the Absa branch network for

depositing cash and cheques.

3.10.6.2 Agency arrangements represent another low cost means by

which access to the payment system may be facilitated and

Absa has agency arrangements with many smaller banks in

South Africa. This allows smaller banks (with limited branch

networks) and their customers to make deposits at all the Absa

branches throughout the country. In turn this allows them to

compete more effectively in the market for customers and

assists them in receiving deposits that are important for their

liquidity. Again it is clear that offering such agency

arrangements involves providing upstream services to

downstream competitors.


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3.10.6.3 Absa has agency arrangements with clearing participants such

as Citibank, HBZ Bank, Habib Overseas Bank, Investec Bank,

Bank of Athens, Mercantile Bank, Capitec Bank, State Bank of

India, Standard Charter, Rennies Bank, Saambou (under

receivership) and to some extent the other major South African

retail banks. Absa also collects cheques included in these

deposits and processes these through the clearing systems on

behalf of these banks.19

3.10.7 Joint ventures, alliances and outsourcing

3.10.7.1 Joint ventures allow for access to payment infrastructure to be

gained through commercial arrangements between existing

members of the payment system and other providers who wish

to offer payment services to the end customer. In this regard,

joint ventures often assist in facilitating a wider choice,

acceptance and accessibility to the payment services for

customers. Many such joint ventures exist between corporates

and banks for payment service provision.

3.10.7.2 This includes the joint ventures between MTN Banking and

Standard Bank, Discovery and FNB, Go Banking (Pick n Pay)

and Nedbank as well as Virgin Money and Absa. It should be

noted that these joint ventures can only be conducted through

the creation of a separate division within a bank or under the

banking

ABSA Annex 3 Background Info on NPS

Documents

Transcript of ABSA Annex 3 Background Info on NPS