Introduction

Payment and settlement systems make up the backbone of the financial system in any country. An efficient payment and settlement system ensures that payment obligations are processed and settled in a timely manner and with certainty, and that potential systemic instability from failed settlements is minimised. An efficient system will also be flexible and facilitate innovative development while managing risk, and also support the integration of national economies into regional and international payments systems.

A payment and settlement system comprises three important components:

o Infrastructure (hardware, software, communications etc.)
o The legal and regulatory structure
o Institutions and markets

All three components must evolve, both as a result of economic, financial and technical developments, but also to support those developments.
Within Africa most countries have undertaken payment system development programmes, under which their payment and settlement systems have been modernised. The core components of such a “modern” system comprises:

1. Trading and dealing systems: initiation of payment instructions, whether from ATMs, POS devices, mobile devices, foreign exchange systems, commodity or securities trading systems (exchanges) etc., and associated acquiring and switching systems. There may be many market-specific systems, developed by market participants themselves.
2. Payment processing systems: acceptance of payment instructions into the banking system and route appropriately (on-us/off-us) and submission to bulk clearing (low value) or single payment clearing (high value) streams;
3. Clearing and settlement: clearing of payment instructions and issuance of associated settlement instructions, whether on a deferred net or real time gross basis; settling transactions and issuing settlement/payment notifications.

Individual payment and clearing systems will handle one or more components of this process, e.g. automated cheque processing, truncation and clearing systems, electronic funds transfer (EFT) systems and associated automated clearing house (ACH) will clear low value payments and transmit settlement instructions on a deferred net (batch) basis.

A real time gross settlement (RTGS) system will accept high value payment instructions, including the net settlement instructions from low value systems, and undertake settlement irrevocably in central bank money. Whereas the various trading and dealing systems under (1) are operated privately, the payment processing , clearing and settlement systems in (2) and (3) are typically operated within the banking system and include both commercial banks and the central bank.

Emerging Issues

Most countries in the East African Community (EAC) and indeed throughout Africa have the above elements in place . In addition, there are a number of ongoing initiatives in the EAC region towards payments system integration, notably the East African Payment System (EAPS), which will link all national RTGS systems, connectivity of the existing payment switches and integration of financial and capital markets.

The proposed East African Monetary Union (EAMU) raises many issues relating to the integration of payments and settlement systems. The eventual objective of a single currency will require the implementation of monetary policy on a regional basis, which in turn has implications for the organisation of wholesale money markets and high value payment systems on a regional basis. In addition, the logical consequence of a single currency is the creation of a common integrated retail payments market.

A number of issues related to payments systems development and integration in East Africa are emerging. These reflect the fast-changing nature of payments and associated technology, as well as broader economic developments and the pursuit of regional integration. The key issues can be broadly divided into infrastructure issues and regulatory issues.

Infrastructure Issues

Regional Economic and Monetary Integration: the EAC has an ambitious agenda for regional economic integration and eventual monetary union. The latter will involve a single currency, single central bank and single payments area. The run-up to monetary union raises many payments system issues:

1. Regional RTGS: integrating high value systems to provide a single RTGS system, providing final settlement in central bank money, which will be necessary for the implementation of monetary policy by the regional central bank.

2. Linking national payment, clearing and settlement systems. This covers the linkages of private systems and switches, and banking systems (e.g. cheque clearing and automated clearing houses), to build a common integrated retail payments market.

3. Integration of capital market systems. This covers securities and commodities markets and exchanges (e.g. stock and bond exchanges), as well as related depositories, which will have to be integrated if the benefits of a regional capital market are to be realised.

Regulatory Issues

Building a single regional payment and settlement system from various national payments systems requires extensive regulatory reform and harmonisation. There are also various areas where market innovation and development is taking place at a rapid pace, and regulatory developments are lagging.

A harmonised response to these developments will help establish a modernised regulatory structure and support market integration.

1. Harmonisation of national payments system regulations. At present, there are different regulatory approaches taken across countries. The modernisation of payment, clearing and settlement regulations and legislation should endeavour to harmonise across the EAC, to provide the basis for a single regulatory area.

2. Modernisation and Harmonisation of Regulations for Innovative Payment Instruments. Rapid innovation is taking place in mobile payment instruments and technologies. The most notable of these is the emergence of mobile money transfer (MMT) schemes, which make use of mobile phone based systems for person-to-person (P2P) remittances or for person-to-business (P2B) payments for goods and services.

Examples in the EAC include Safaricom’s M-Pesa scheme in Kenya and MTN Mobile Money in Rwanda and Uganda. Consumer uptake of some of these systems has been dramatic, suggesting that they have addressed unmet needs, especially for the unbanked. There is also evidence that the potential efficiency and productivity benefits are significant.

Mobile Banking: MMT schemes are not banking as conventionally defined (deposit-taking activity). However, other technological and product developments are moving closer to banking activity, whereby value (e-money) is stored on a smartcard, including both mobile phone and POS-based systems. These may involve the crediting of wages, welfare payments, prepaid value or savings to a card. Such technology-based systems, with their different cost structures, have the potential to significantly extend the reach of banking and other financial services to the unbanked.

Regulatory challenges: while the proliferation of MMT systems has been rapid, regulatory systems have generally lagged and there has been an inconsistent response from regulators. Some have imposed banking regulations on MMT schemes, even though the main regulatory challenges are related to consumer protection rather than the conventional deposit protection or systemic stability challenges that banking regulations conventionally address.

Other regulators have focused on the payments element, but lack appropriate regulations for payments (as opposed to clearing and settlement) activity. More generally, there are generally no dedicated regulations governing low value e-money deposits. With rapid technological and market change taking place, regulators need to find an appropriate balance between the appropriate management of risk and encouraging innovation.

3. E-commerce (internet-based commerce) is taking off rapidly but typically lacks a regulatory framework. This needs to be developed and should be consistent with the EAC framework for cyber law.

4. Cross-border remittances: while the new MMT systems have revolutionised the domestic remittance landscape, challenges remain for cross-border remittances. There are large cross-border flows both within East Africa and into the region, mainly from developed countries.

While the technological challenges can be easily resolved, there are additional regulatory challenges, especially relating to exchange controls and anti-money laundering. For the prospective efficiency gains to be realised, regulatory issues need to be addressed by inter-country or intra-regional negotiations.

Proposed Conference

One of the key lessons learned from the recent global financial crisis is the need for policy makers to share experiences, find creative solutions, and take collaborative actions. In this regard, the African Development Bank in collaboration with USAID and other Development Partners, under the auspices of Making Finance Work for Africa Partnership, are intending to organize a conference on the Development and Integration of Payment and Settlement Systems in the East Africa Community.

The focus of the conference will be the actions that can be taken by Governments, Central Banks and Regulators to support innovation, development and integration of the payment and settlement system in the EAC. It will draw upon the experience of other regional integration initiatives and how they have dealt with these challenges.

It will also consider the role that the private sector can play, whether entities such as mobile network operators (MNOs), independent technology companies, private switches, or other independent service providers.

The conference will be structured around the key infrastructure development and regulatory issues outlined above. Attendees will be drawn from the full range of stakeholders in payment and settlement system development and integration in the EAC. The objectives will be to:

o Sensitise and mobilise stakeholders around the key themes in regional payment systems
o Determine the steps required to address the five issues outlined above, and to ascertain responsibilities
o Assist AfDB/MFW4A to draw up an action plan for follow-up work

Potential presenters at the conference include the following:
o African Development Bank/MFW4A
o Representative(s) of EAC Central Banks
o Capital Market Representatives
o BCEAO: development of integrated payment system in the WAEMU (CFA) single currency area
o WAMI: development of payment system in the WAMZ
o IFC: experience with payments system development in other regions
o IMF: experience on financial system stability issues emerging from its Financial Sector Assessment Program (FSAP) in EAC countries
o BIS-Committee on Payment and Settlement Systems (CPSS): core repository of development and regulatory expertise on payment and settlement system development
o FATF representative on AML/CFT issues
o European Union: experience of (i) integration of single payments area (TARGET) and (ii) regulation of e-money
o Banks
o Mobile Network Operators
o Private sector service providers (e.g. VISA, SWIFT)