In search of speed and efficiency
By Michael Moon, Head of Payments, Asia Pacific, SWIFT
[Adapted from the Japanese version, first published in Kinzai in July 2015]
The Zengin System is in need of an overhaul. For decades, it has provided a reliable system for payments in Japan and has met customer needs well. But both consumers and businesses are demanding faster and more efficient payment systems, seven days a week. This has prompted the Japan Bankers Association to begin a review and consider a system that will allow financial institutions to compete effectively and meet evolving customer requirements. Japan may want to take a leaf out of the book of Australia's New Payments Platform (NPP), an innovative infrastructure developed specifically for low-value payments.
An increasing demand
A key reason behind the demand for faster payments is that companies and consumers access real-time services in everything from retail purchases and media to instant messages and alerts, so they expect their payments too to be completed real-time 24/7. Frustrated when payments are limited to weekdays or take days rather than seconds to arrive, customers have started to look at new market entrants or other organisations for alternatives that allow them to send and receive funds faster.
For corporates, faster payments translate into a better cash and working capital management. Regulators consider faster payments from the angle of risk mitigation, operational efficiencies and customer satisfaction.
Globally, the trend is towards real-time payments. Nearly 20 countries currently operate domestic real-time payments systems, including Singapore and the UK, and many more, including the entire Eurozone, are either considering or developing new systems.
Apart from speed, businesses and consumers expect more information about their payments. Consumers want to see full payment details, and businesses need additional data as well as tools for easier reconciliation. A new financial messaging standard, known as ISO 20022, is designed to simplify financial communications and carry additional remittance information with the payment. The extended message format of ISO 20022 enables longer messages which can increase efficiency for companies reconciling payments to back-end accounting systems. Using ISO 20022 standards enables banks to complete payments faster, reduce risk and increase efficiency because they have a common financial language for communications.
A number of central banks, banks and corporates in the Asia Pacific region have already implemented or are getting ready to implement the ISO 20022 standard to enable them to provide more information. The service is not available in Japan, though.
As the financial institutions that will process real-time payments go about developing the technology that enables these benefits, they are seeking solutions that will make their work more efficient. Multinational banks such as HSBC and Citi, as well as Japanese financial institutions expanding overseas, need to connect to different systems in multiple countries. Rather than incurring the costs of developing customised solutions in each country, banks want technology that connects to the domestic system to connect between markets as well.
In addition to meeting customer demand, financial institutions are considering the business case to justify their move towards 24/7 real-time payments. While banks have found it difficult to develop a meaningful business case for the retail banking market (because it is hard to charge consumers), they have discovered that they are able to charge businesses for real-time payments if extra services such as reconciliation are added or if help is provided to reduce the businesses' costs by eliminating inefficient practices.
Bank cooperation in the clearing system
One example of the shift toward real-time payments is Australia's NPP, which the financial services industry has committed to implementing by 2017. The NPP is expected to provide faster payments and more information-rich transactions beyond the 18-character limitation of Australia’s current Bulk Electronic Clearing System (BECS). A major piece of work for NPP is establishing standard market practices for ISO 20022 messages, and banks have set up an industry-wide working group focused on ISO 20022.
One key difference between Australia and other countries that results in Australia being such a good example internationally is the cooperation between financial institutions in building a common payments infrastructure.
This has enabled a less expensive and more efficient solution. Specifically, the Australian financial services industry is developing an architecture that maintains a basic payments infrastructure for bank-to-bank payments, while allowing commercial overlays for services related to the underlying payments.
For example, additional messaging information can be arranged as an overlay service, corresponding to the type of payment (such as mobile payment).
Different models for Real-Time Payments
Despite strong areas of commonality across the real-time retail payments systems (RT-RPS), the systems differ from one another in their approach to clearing (i.e. the validation of all the payment instruction details between payer’s and payee’s banks), the approach to posting (i.e. the debiting and crediting of payer’s and payee’s accounts) and the approach to settlement (i.e. the irrevocable debit and crediting of funds between bank accounts).
Three approaches prevail, each with their own characteristics: hub, Real Time Gross Settlement (RTGS)-based and distributed-clearing.
In the hub approach, a third-party organisation runs a central application as a hub to handle the clearing between the participants (i.e. the banks) and manages the downstream settlement with the central bank’s RTGS. In general, risk management is implemented through pre-funding (participants have to earmark sufficient central bank money) or through deferred net settlement (participants have to put up enough collateral in the hub to cover this risk).
In the RTGS-based approach, the RTGS – not using a hub – effectively both supports the clearing and undertakes the final settlement of the retail transaction.
In the distributed clearing approach the validation and confirmation of the payment instruction are undertaken on a peer-to-peer basis, between both banks, before initiating downstream settlement at the central bank. As settlement is in real time and in central bank money, there is no need for banks to put up collateral.
Built on experience
SWIFT has been in Australia for over 30 years, and provides the secure, reliable and trusted messaging platform for Australia’s critical payment system infrastructures including the high value payment system, low value bulk payment system, and now the New Payments Platform (NPP) from 2017.
There are three major components of the NPP. The first is a Domestic Messaging Channel (DMC) which uses local backbone access points between participating banks and the Reserve Bank of Australia, enabling high volumes of messages with low latency. Second, a Payment Gateway (PAG) orchestrates clearing and settlement flows, but it can also handle additional flows, such as payment initiations from directly connected overlay services. Finally, an Addressing Database links customer identifiers such as mobile phone numbers or email addresses to bank account details.
Limited to business hours
Changing customer demands are creating a challenge for the Zengin System, which is an important part of the electronic payments system in Japan. It is a reliable online network that links banks nationwide and processes an average of more than six million real-time transactions per day, according to Bank of Japan data. However, it is only available on weekdays during banks’ working hours.
Moreover, 77% of consumer payments are still made with cash, according to McKinsey’s Asia Pacific Payments Map, and credit card usage remains low, as
“Evidence suggests,” Nakaso said recently, “that payment instruments provided by non-banking institutions have far outpaced the Zengin System, both in terms of amount and volume.” Moreover, Nakaso noted, other countries have developed retail services that offer near real-time payment services 24 hours a day, seven days a week.
Another challenge for the Zengin System is the limited amount of data that can be transmitted with a payment. When the system moved to its 6th generation platform in 2011, there was a recognition of this emerging requirement for electronically exchanging payment information. One new feature has been the acceptance of the ISO 20022 standard as an option for messages. Because adoption of ISO 20022 is not required, however, banks and customers generally do not use the new format.
“In light of such progress in overseas economies,” Nakaso said, “it has become a must in Japan to elevate bank transfers to a comparable level of convenience and efficiency in terms of service availability.” Recognising the trends overseas as well as customer needs and competition domestically, the Japan Bankers Association has started to consider how to renovate the Zengin System.
Financial institutions and regulators in Japan need to ensure that the new system to speed up payments for customers provides a platform for innovation, deals with legacy infrastructure and has low entry barriers, while still managing costs effectively. Financial institutions and corporates can benefit from international best practices and the experience of international experts.
While SWIFT used to focus more on large-value payments, it has shifted to supporting market infrastructures for small-value payments as well, because the trend towards real-time payments is having a profound impact on the global payments ecosystem. The solution it is developing for Australia, for example, combines components that are installed and operated locally yet which build on more than four decades of experience globally in supporting payments security, availability and reliability.
SWIFT has already worked closely with JASDEC (the Japan Securities Depository Center) to internationalise messaging standards for securities transactions, providing them with a world-class financial messaging standard expertise to adopt ISO 20022. JASDEC has chosen SWIFT as one of the connectivity options for the participants in order to increase efficiency for the overseas financial institutions. SWIFT was also appointed as a consultant for the adoption of ISO 20022 messages to the 6th generation platform for Zengin, including providing advice on the ISO 20022 message specifications and recommending an implementation approach based on its experience in other markets.
Moving forward with the times
The growth in consumer demand for real-time payments as well as new non-bank competitors providing faster payments services means that banks need to act quickly to remain at the forefront of low-value payments in Japan. The review by the Japan Bankers Association to consider renovating and renewing the Zengin System is a timely next step.
As they move towards real-time payments, banks and associations in Japan can clearly benefit from global best practices and experience so that they can develop a leading-edge system that will meet customer requirements and manage costs effectively. Taking advantage of global trends and selecting the optimal partner will be essential in making sure that financial institutions in Japan remain at the forefront of payments in the country.