Bank of England Payment Systems Oversight Report 2011.

The Bank of England has published the 2011 Payment Systems Oversight Report (see link below).  The Oversight Report is an important element of the Bank’s oversight work.  It offers public accountability for this statutory function of the Bank, as well as increasing transparency about the performance of the overseen payment systems and acting as a tool to encourage further risk reduction by the owners and operators of these systems.

The Oversight Report sets out how the Bank the Bank has exercised its responsibilities under Part 5 of the Banking Act 2009 (Box 1) since the previous Oversight Report in March 2011.

The main UK payment systems have continued to demonstrate high levels of operational availability. Since March 2011, systems have delivered reductions in risk. Further work remains necessary in some areas.   These include reducing tiering in the wholesale payment systems, mitigating credit and liquidity risks in central counterparties’ payment arrangements, improving default arrangements, strengthening governance, and improving contingency arrangements.

Notes

The Bank uses the Oversight Report as a means of explaining how it is discharging its public policy responsibilities for oversight.  These responsibilities were placed onto a statutory footing under Part 5 of the Banking Act 2009, as part of the Bank’s broader mandate for financial stability.  (The Banking Act 2009 is available at: http://www.opsi.gov.uk/acts/acts2009/pdf/ukpga_20090001_en.pdf ).

The Bank oversees interbank payment systems that are ‘recognised’ by order by HM Treasury.  HM Treasury has issued recognition orders for Bacs, CHAPS, CLS, Faster Payments Service, the embedded payment arrangements within CREST, and the embedded payment arrangements within the CCPs operated by ICE Clear Europe Ltd and LCH.Clearnet Ltd.

A summary of the Bank’s statutory framework for oversight was published in September 2009, and can be found at

http://www.bankofengland.co.uk/publications/other/financialstability/oips/oips090928.pdf

Download the BoE Payment Systems Oversight Report 2011.

Source: Bank of England

Remarks by Malcolm Edey, Assistant Governor (Financial System), Reserve Bank of Australia.

Panel session on Public Policy and Innovation at the Federal Reserve Bank of Kansas City Payments Conference, Kansas City , March 2012.

The question I have been asked to address is whether inertia (or coordination failure) is an obstacle to payments system innovation. And if so, what do we do about it?

To begin with, it helps to distinguish between two types of innovation: proprietary and systemic.

An example of the first type might be a new piece of card technology, or a new customer platform for an individual bank. An example of the second might be the adoption of a new interbank messaging standard or a system-wide shift to faster payment times. The difference lies in whether the benefit can in some sense be captured by the innovator, or whether the benefits are more dispersed and dependent on coordinated action.

Payments service providers are good at proprietary innovation, as you would expect – they have an incentive to be good at it. It’s in the second area that problems of inertia and coordination failure can come into play.

I can think of two general reasons why this is the case.

The first is the problem of capturing benefits so as to give a return to the innovator. To give a concrete historical example, think of the question of faster cheque clearing. For a given cost, faster clearing is obviously an improvement, but it can only be achieved collectively. Yet doing so confers no competitive advantage to any individual participant in the cheque-clearing system, so there is little incentive to agree on costly action to make it happen.

To make the example more up-to-date, the same problem exists with incentives to deliver faster (or real-time) electronic transfers at the retail level. Faster payments can only happen if the system as a whole is set up for it, and then only if a critical mass of the individual participants are set up to provide timely access. But putting this in place will obviously involve some cost, with little or no proprietary benefit to the investor, particularly where it may cannibalise other potentially profitable product lines. This problem would exist even if all the payments industry participants faced identical incentives. Without an effective coordinating mechanism, industry will tend to under-invest in this kind of innovation.

The second reason is that the costs and benefits of participating in coordinated actions of this kind are not in fact evenly distributed across participants. Some participants will benefit more than others from a given innovation, or may find it more costly than others, for reasons to do with their size or their business model. Another factor is the timing of investment cycles: collective action has to be collective, but the timing of any given investment in payments technology will always be more advantageous to some than to others. A bank that is just about to undertake a regular technology upgrade may be quite receptive to aligning that with a general change in standards; whereas a bank that has just completed a major round of investment may not be.

These things can make it very hard for industry participants to agree on the timing of a systemic innovation, or on the pricing arrangements that will underpin it. The end result can be a degree of inertia, or a slower pace of innovation than would be socially efficient.

I think this problem is inherent in any network that doesn’t operate as a kind of proprietary unit in the way that, for example, a credit card network does (competing of course with other networks).

For the payments system as a whole, then, this points to the need for coordination mechanisms. What sorts of mechanisms might we be talking about?

For a lot of issues, the appropriate coordination mechanism could be an industry body – especially where the issue is mainly technical in nature and where there are no strong proprietary interests at stake. An example would be routine updating of technical standards.

But where there are significantly conflicting incentives that make coordinated decision-making more difficult, it may need a regulator to take a leadership role.

In Australia the payments system regulator is the central bank, and regulatory decisions are made by the Reserve Bank Payments System Board. We have a mandate to promote stability and efficiency, which I think we can view as including the efficient resolution of the coordination problems that I’ve just described. And we have significant powers that can be directed to that end.

For these reasons, the RBA has been increasing its focus on these coordination issues in recent times.

As you may be aware, we announced a Strategic Review of Innovation in the Payments System in July 2010, and we are now in the finishing stages of that review. In the course of the review, we held two rounds of extensive consultation with service providers as well as with end-users of the payments system.

Broadly speaking, the Review focused on three questions, which I could sum up as Gaps, Governance and Hubs.

On Gaps, the question is, are there potential innovations that would be in the public interest that are not happening because of coordination failures?

Responses to the consultation suggested that there might be. The main points highlighted as possible areas for improvement were:

• Faster or real-time payments at the retail level
• Greater availability of payments systems outside normal banking hours
• Improved capacity to send information with payments
• And, greater ease of addressing payments

The last one of these can be illustrated by analogy with the cheque. A cheque payment can be addressed very easily when all you know is the name of the recipient. But we don’t yet have a comparably easy mechanism for addressing electronic payments.Obviously it is not costless to deliver these things, and so a coordinated decision process would need to have some way of taking into account both the costs and benefits, including benefits to end-users, in order to determine whether an investment is worth making.That raises the further question of who should provide that leadership and under what arrangements – the general question of Governance.To make it more concrete, we can pose the following questions. In the Australian case, should the Payments System Board take a more prescriptive approach to setting objectives for payments system innovation? Could it, for example, set an objective of real-time consumer payments, or the adoption of new messaging standards, by a specified target date? Could it then perhaps delegate the implementation of those targets to an industry body with the necessary technical expertise?

All of that would amount to a governance model where the regulator makes high-level decisions as to the public interest, while industry participants determine the most efficient means of implementing them. I won’t foreshadow what we might conclude on these things, but these are the sorts of questions the Payments System Board is now considering.

The Board is also considering a third area, namely Hubs, or specifically the question of whether there needs to be greater use of centralised architecture for clearing and settlement of retail payments. This is a particular issue in Australia, because many of our payments systems are built on bilateral links between institutions. Arguments can be made in favour of hubs on the basis that they may be more efficient than bilateral networks and more conducive to both competition and innovation. But these considerations need to be balanced against the costs of the investment. Again, this is a key question of system design for which there needs to be a coordinated answer, whether the eventual decision is for or against.

To sum up:

• Coordination failures can be an obstacle to innovation.
• That problem is inherent in the nature of payment networks.
• It’s very hard to design governance structures that make appropriate provision for coordination while still allowing for normal competition to occur.
• That suggests a role for leadership by payments regulators or central banks
• In some ways, central banks have a natural leadership role because they act as a hub already in many payment systems. In Australia’s case, the central bank is also the regulator for payments-system efficiency and stability.
• Finally, in carrying out any leadership role in this area, it’s very important to consult. The advantage we have (as regulators or as central banks) is that we can take a public-interest perspective. But we also need to make use of the expertise of payments industry participants in determining what is feasible and what is the most efficient means of delivery.

Source: Reserve Bank of Australia

Shred all documents that have any bank, Social Security, credit card or insurance identification numbers

Preventing Identity Theft Without Paying Monthly Fees.

By Alina Tugend

My first Shortcuts column, almost seven years ago, was on identity theft. At that point, in 2005, it seemed to be a scary and ever-growing trend, with tales everywhere of stolen credit cards and Social Security numbers leading to bad credit ratings that could haunt you for years, potentially costing you car loans, mortgages and even jobs.

Spurred by a Consumers Union report this month that argues that identity theft is being hyped by marketers to scare consumers into buying costly and unnecessary services, I decided I wanted to revisit the issue.

Is identity theft going up or down? What can we do to protect ourselves? And is it worth it to buy protection?

First of all, the numbers. According to Justice Department figures released last November, in about 8.6 million households at least one person 12 or older experienced some kind of identity theft in 2010. That’s up from 6.4 million households in 2005, when I first wrote about it.

So it’s still a problem, and an expensive one. The Justice Department wrote that identity theft cost households a total of $13.3 billion in 2010 in direct financial losses.

That sounds pretty serious. So why is Consumers Union telling people not to worry?

“We tell people they should take the problem seriously, but don’t panic,” said Jeff Blyskal, senior editor at Consumer Reports, who has been investigating issues surrounding identity theft for years and wrote the recent article.

If you look more closely at the figures, the Justice Department states that the unauthorized use of existing credit cards “accounted for much of the increase in household identity theft from 2005-2010.”

And the percentage of households experiencing “the misuse of personal information to open a new account or commit another crime” declined to 14 percent from 23 percent in the period.

Over all, 24 percent of households that experienced identity theft suffered no direct financial loss in 2010, compared with 19 percent in 2005.

So we’re doing well, right?

Well, not so fast.

It’s true that the most common type of credit card fraud is pretty easy to deal with. Most people are liable for up to a maximum of $50 if someone fraudulently charges items using their number. This recently happened to us. We were notified of suspicious activity on the card, confirmed we hadn’t recently charged anything in Nordstrom’s in New Jersey (somewhat classy criminals) and were sent a new card fairly quickly. It was painless.

A word of warning, though. A stolen debit card number is much less simple. If you don’t notify the bank right away, “you’re liable to be responsible for a lot more than $50,” said Phil Blank, managing director of security, risk and fraud at Javelin Strategy and Research.

And there are other kinds of identity theft that can create many more problems than the credit card type. Although less prevalent, these include criminal identity theft, where someone who is arrested for a crime uses your information, and suddenly you have a warrant out for your arrest; medical identity theft, where someone accesses your medical insurance and misuses it; tax identity theft, where your tax records, and refund, are misappropriated; and child identity theft, in which someone uses a child’s Social Security number to commit fraud.

In cases like these, if the bad information gets on a credit report or impinges on another part of your life, it can take many hours — and sometimes a fair amount of money — to clean up.

“It’s not just the numbers taken out of your account,” Mr. Blank said.

So what’s a consumer to do? Sign up for one of the myriad companies that promise to protect and defend you, often for around $10 a month and up?

Let’s consider that for a moment.

First, there are plenty of free services that will help protect you, or at least sound an alert, if something’s going wrong with your accounts.

When I last wrote about this in 2005, only five states allowed consumers to freeze their credit reports. If you do that and someone tries to open a credit card in your name or take out a car loan, the credit will be denied because the vendor can’t access your credit report. Now, almost every state allows you to freeze (and unfreeze) your credit report, some free and some for a minimal fee.

Banks are also offering far more services that alert you to potentially criminal activity. For example, Mr. Blank said his bank alerted him every time a “card not present” purchase was made — that is when his card number was used to buy something online or over the phone.

“Most people don’t know what alerts are,” he said. “All sorts of alerts can empower the consumer.”

Here are some of the situations that some banks and credit card companies offer to alert to you, by e-mail or text message, usually without charge:

¶ When there is a withdrawal of cash from an A.T.M.

¶ When a charge is entered for more than an amount that you stipulate, like $100.

¶ When there is a change in the phone number or other information on your account.

Currently, though, most alerts let you know after the fraud has occurred.

“The new technology that we’re seeing coming out will alert you when someone is trying to charge $1,000 on that credit card,” Mr. Blank said. “You can say right away, yes or no, if you approve.”

Here are other things you can do to protect yourself: Check your credit reports free once a year. If you stagger it, you can receive a free report once every four months from one of the three major credit reporting companies — TransUnion, Equifax and Experian.

For medical fraud, check in with your medical insurer to see if there are any claims you don’t recognize. LexisNexis Full File Disclosure (Go to personalreports.lexisnexis.com and click on “access your personal information”) offers, among other things, a public records search, reports on claims for auto and homeowners’ insurance and pre-employment background checks.

And, still true after all these years: shred all documents that have any bank, Social Security, credit card or insurance identification numbers.

But what if you want more? Surely there’s no problem paying for some added protection?

That’s where opinions divide.

For Mr. Blyskal of Consumers Union, it’s better to be an informed and active consumer than to buy these services. It’s necessary to really dig into the fine print to see what protection is truly being offered, he said. Over all, identity theft protection companies “can give you a false sense of security,” he said.

On the other hand, Matthew Davis, a victim adviser at the nonprofit Identity Theft Resource Center, said that “you have to be a proactive consumer, but I would disagree that no products are helpful.”

Mr. Davis wouldn’t recommend any particular companies, but said word of any poor service would trickle out quickly on the Internet through customer reviews.

Just as important as fraud alerts, Mr. Blank said, is that the companies “have people extremely experienced who handle this information.” That, he said, “allows consumers to reduce the time around the fraud once it occurs.”

Mr. Blank’s company offers some tips if you decide to hire someone: know what protection is actually provided and what is hype. And use paid services in addition to the free security options your bank already has in place, not instead of them.

The bad news is that even if we want to pay someone to defend us against identity theft, we still need to do most of the work ourselves. The good news is that seven years after I first wrote about this topic, there are a lot more free and easy ways to protect ourselves.

Source: New York Times

Speech by Chris Salmon, Executive Director, Bank of England

In a speech delivered at the BAFT-IFSA Global Annual Meeting on 24 January 2012, Chris Salmon, Executive Director for Banking Services and Chief Cashier, describes how the financial crisis has influenced the perspective of financial stability policymakers towards payment operations. He argues that this will impact upon banks in two main ways: first, authorities are likely to place more attention on the overall network of payment operations within a financial system; and second, in the context of resolution plans, authorities are likely to ask more questions about the internal organisation of firms’ operations. Chris Salmon concludes by encouraging those in the transactions banking world to consider the attitudes of financial stability authorities and the broader regulatory back-drop when developing their medium-term planning.

In terms of the overall network, Chris Salmon focuses on the pattern of direct and indirect participation in payment systems and highlights some of the risks of systems which have a disproportionately high level of indirect participation.

Following comments from a speech in July, Chris Salmon reiterates the Bank’s view that an increase in direct participation in CHAPS would be good for UK financial stability. He provides an update on the Bank’s work to achieve this including the fact that one large indirect participant has formally committed to join and a second is moving towards a similar formal decision. “If all the banks we have talked to in this round of discussions were to join CHAPS…payment flows made by indirect participants would account for less than 40% of the total, making substantial inroads into our tiering problem.” Chris Salmon also outlines a number of other ways in which the overall payment systems network could be made more robust.

Chris Salmon goes on to consider the impact of the work of the Financial Stability Board (FSB) on the orderly resolution of financial institutions on the payments world. Salmon believes it is unlikely that the internal organisation of payments will be unaffected as and when large firms address the organisational issues which the FSB has identified. Resolution authorities will also want to understand how customers will be able to continue making and receiving payments following a resolution.

Notes

1. The payments map comprises a central hub, the system and its direct members, with many spokes reflecting agency relationships between the direct and indirect participants. The relative importance of the ‘hub’ and the ‘spokes’ for a payments network is typically summarised through a ‘tiering’ statistic: the ratio of direct participants to all banks that make payments via the system. In highly tiered systems the ‘spokes’ are relatively important (and the statistic low in value), with the opposite true when most participants are direct members of the core scheme. (Taken from page 4 of the speech.)

2. CHAPS is a high value payment systems. The CHAPS payment system is designed for making instant, high-value sterling transfers. Typically, members of the public will initiate payment using CHAPS only rarely, for example when buying a house. Financial institutions will make many large CHAPS transactions daily, regularly settling inter-bank loans worth hundreds of millions of pounds.

Download the Full Speech, 24 January 2012.

Source: Bank of England

Executive summary

Retail payment markets have been developing rapidly throughout the last decade. In Europe a number of legal and regulatory measures have been adopted with the aim of achieving an integrated single market for payments. In other regions (e.g. Australia, Canada and the United States) retail payments have recently also been subject to regulatory and legal interventions. The market-initiated Single Euro Payments Area (SEPA) project has accelerated the development of the European retail payments market into one that is based on increasingly integrated and more competitive market structures. Technological innovations have facilitated these fundamental changes. Other regions have had similar experiences or even more significant changes in the field of payment innovations and developments. Although there is a widespread belief that developing and increasing the integration of the retail payments market is likely to generate macroeconomic benefits, it may also involve challenges regarding risks and security threats. Against this background, it is important to understand the economic factors driving future developments and to take a forward-looking perspective that anticipates the factors likely to influence developments in the retail payments market.

In this context the ECB organised the second biannual retail payments conference, this time in cooperation with the Oesterreichische Nationalbank. The conference took place in Vienna on 12-13 May 2011. Its objectives were twofold: first, to improve the general understanding of payment economics (and related disciplines) in the field of retail payments and, more specifically, to help identify possible developments and dynamics that will shape the future payment landscape; and second, to provide a forum for debate and interaction among market participants, policy-makers and researchers.

The two-day event was centred on four main themes:

• the transformation of the banking business and its impact on retail payments;
• payments behaviour and usage of payment instruments; • the creation of a competitive retail payments market;
• future challenges and opportunities in retail banking and payments.

The following paragraphs highlight a number of key messages and conclusions that emerged from the debate on these themes.

It was widely acknowledged that retail payments are a cornerstone of retail banking and consequently banks’ business case. As the financial crisis has shown, Europe has benefited substantially from the level of integration and innovation achieved so far in the field of retail payments and banking. However, more work needs to be done to achieve a fully integrated and innovative European retail payments market. It further emerged from the discussions that retail payment integration should be understood not as harmonising payments behaviour but as harmonising instruments, standards, rules and systems.

For Europe, it was recognised that the SEPA project is on the right track and that a lot has been achieved over recent years. However, more work needs to be done, in particular in the area of the standardisation of card payments and the migration towards the SEPA payment instruments. In this respect the Eurosystem welcomes the European Commission’s proposal for a regulation setting an end date for migration. Moreover, it is important to involve users and to ensure the acceptance of the SEPA instruments

In this respect, a few speakers mentioned network effects as an obstacle to integration and innovation and argued in favour of intervention by public authorities to address the coordination failure in payment innovations and in the standardisation of the security of retail payments. Other speakers said that the policy strategy should be clear and the regulatory environment stable and consistent in order to win support from banks for change.

Research work in this field has concluded that payments behaviour differs considerably across cultures and countries. In fact, a marked persistence of traditional payment habits can be observed across European countries. Despite the relatively high cost of cash when it comes to payments above a certain threshold, cash continues to be used extensively for day-today payments at the physical point-of-sale. One reason why the use of cash is high in some countries is the budget monitoring and memory feature of cash. Further country evidence shows that other factors also play an important role in consumers’ payment decisions, i.e. speed, merchant acceptance and low transaction specific fees. Empirical evidence shows that debit and credit cards are used for higher-value transactions because of perceived safety, record keeping, rewards and the possibility of delaying the settlement of the payment.

Another important topic addressed during the conference and closely linked to perceived safety related to fraud in retail payments. Even if financial stability is not directly affected by the overall level of fraud losses, fraud incidents can have downward effects on card usage. On the basis of evidence from the analysis of debit card payments and media coverage of security incidents, however, it can be concluded that the effects seem to be economically relatively small compared with other influencing factors. This suggests that consumer confidence in the debit card is relatively high and robust.

Efficient and secure payment systems are a key concern for central banks worldwide, for which reason central banks are interested in the field of retail payments. While the role of central banks in offering large-value payment systems is generally accepted, the future of retail payment processing in an integrated market and the operational involvement of central banks is still subject to intensive discussions.

A large part of the conference was dedicated to the discussion of issues related to card payments. Country-level evidence demonstrates that merchants’ perception of the cost of different payment instruments affects acceptance as well as surcharging decisions. Merchants who find payment cards expensive are less likely to accept them and more likely to surcharge their customers for card payments. Merchants facing competition accept debit card payments relatively more often and are less likely to surcharge their customers for debit card use than merchants with monopoly power.

The discussion on the possible and/or allowed level of multilateral interchange fees in the field of cards and the methodology to be used for calculation has not been conclusive so far. Therefore, increased clarity on the business model for cards seems to be needed to increase planning security for issuers and acquirers.

The provision of consumer credit in payment networks plays an important role in efficient pricing and competition between debit card and credit card networks. Moreover, academic research has shown that merchant fees and reward programmes generate an implicit monetary transfer to credit card users from non-credit card (debit card, cheque or cash) payers because merchants generally do not set differentiated prices per payment instrument to recoup the costs of fees and rewards. Since credit card users are on average wealthier than persons without a credit card, this monetary transfer also benefits higher-income families to the disadvantage of lower-income families. Accordingly, reducing merchant fees and card rewards would likely increase consumer welfare.

It was generally accepted that innovations in retail payments will make everyday life more convenient by offering easier access to payment instruments. In addition, innovation may also be a chance to decrease the number of unbanked and underbanked people, i.e. it could be a powerful tool for financial inclusion. Several speakers pointed out that innovations in retail payments are taking place more rapidly than ever and that banks and regulators should adapt quickly to their changing business and technological environment.

The remainder of these conference proceedings is structured as follows. Section 2 contains the opening and welcome remarks by Wolfgang Duchatczek (Oesterreichische Nationalbank). Section 3 presents a summary of the first panel session, chaired by Gertrude Tumpel- Gugerell (European Central Bank), including her opening remarks. Section 4 highlights the discussions on payments behaviour and the usage of payment instruments. Sections 5 and 7 deal with issues relating to the creation of an efficient and competitive retail payments market. Sections 6 and 8 give keynote speeches on opening financial services markets by Cecilio Madero Villarejo (European Commission) and on innovation in retail payments by David S. Evans (Market Platform Dynamics). Section 9 highlights the key messages from the panel session on innovations, security and financial inclusion.

Download the papers, The future of retail payments: opportunities and challenges.

Pay with cash, credit cards or mobile phones to dodge banks’ new charges

So, your bank has started charging a fee for using your debit card to make purchases. You don’t have to take it. Money experts and consumer advocates say there are alternatives every cardholder should consider before paying the new fee.

“You can shop for a better deal at another bank,” says Pam Banks, senior counsel with Consumers Union, the nonprofit owners of Consumer Reports magazine. “Small community banks and credit unions have a reputation of being consumer friendly. Do your homework and shop around.”

Another option: Negotiate with your bank, says Gail Cunningham, a spokeswoman for the National Foundation for Credit Counseling.

“If a person has multiple accounts with the bank, I would ask to have the fee waived,” Cunningham says.

Bank of America, which announced that starting in early 2012, it will begin charging certain customers $5 a month if they use their debit cards to make purchases, is already giving some customers a pass on paying debit fees. So-called “premium” customers with high average daily balances are exempt.

“If you’re a valuable enough customer, they might say, ‘Yes.’ It’s worth a try,” says Cunningham.

Customers aren’t charged a fee in months they don’t make debit card purchases. On an annual basis, the new fees would be as much as $60 (under BofA’s $5 a month fee schedule). Depending on your family budget, that might not seem like a lot of money. If you’re trying to cut costs, however, or you’re irked by the general increase in bank and checking fees, that $60 could be the thing that sends you searching for alternatives.

Here are some suggestions on how to avoid paying debit card usage fees:

• Cash always works. OK. Many of us have grown accustomed to paying with plastic and avoid carrying cash, which is untraceable when stolen and the least secure payment method. Paying with cash means going to a bank or ATM to actually get the cash.
• Withdraw cash from a bank ATM. The banks currently aren’t planning to charge customers who use their debit cards to withdraw cash. However, use the bank’s ATM to avoid third-party ATM charges. This requires some pre-planning to make sure you have enough cash on hand to cover your purchases.
• Upgrade accounts. The debit card use fees are waived for so-called “premium” accounts. Bank of America is exempting high-dollar account holders, who will still be able to get free debit card use. Chase’s pilot program in Wisconsin, for example, also waives its $3 debit card fee for accounts with average daily balances of at least $1,500. If you have enough money to meet the minimum balance requirements on these premium accounts, consider upgrading your account.
• Switch banks. Banks with more than $10 billion in assets are impacted most by the interchange caps that took effect Oct. 1, 2011. They are most likely to charge debit use fees. Consumer advocates urge debit cardholders to do their homework and find lenders that don’t charge fees. That is most likely going to be a local credit union or small community bank.
• Use a credit card. Credit cards have gotten a bad reputation in recent years because of high interest rates and “gotcha” fine print and many credit counselors urge people who are overloaded with debt to stop charging their purchases. However, credit cards are a good payment option if you pay the entire balance off each month, so that you avoid interest charges. A September 2011 study from the Boston Federal Reserve Bank found that consumers turned off by debit card fees would most likely switch to credit cards as an alternative. Warns Cunningham: “Even though being charged a fee to use our own money feels like an assault on our intelligence, the fee is likely far less than the interest that would be assessed if the [credit card] account balance could not be paid in full each month.”
• Pay with a check. Although not all merchants accept personal checks as payment anymore, many large retailers still will take your check. Be prepared. The folks in line behind you may give you the evil eye because checks take longer to process at the cash register. That’s one of the reasons many people switched to paying with plastic in the first place. Many banks are eliminating “free checking” and charging higher monthly checking account fees to certain customers. Why not pay with checks to get your money’s worth out of the deal?
• Switch to mobile payments. Smartphone technology allows you to use your . If your merchant is equipped to process payments in this manner, consider paying by phone. The technology is still evolving and there are concerns about privacy and security of mobile payment transactions. Consumer watchdogs warn that mobile payments should be linked to credit cards — rather than billed to the cell phone carrier — to get the maximum consumer protections for resolving disputes with merchants.
• Use electronic checking. Paying your bills with a debit card using the bank’s online bill payment service does not incur any additional charge.
• P2P transfers. New and emerging money transfer options offered by companies such as Pay Pal, foursquare and others, allow person-to-person (P2) payments via a mobile phone and e-mail accounts. Money can be transferred from the payer’s checking account, credit card or prepaid card to the recipient’s bank or deposit account. “Given that this is such a highly competitive marketplace, you’re going to see a lot of new kinds of products emerge — mobile payments, virtual payments — different ways to pay than what this is might emerge,” says Trish Wexler, spokeswoman for the Electronic Payments Coalition trade association.

Bank of America is the largest bank to roll out debit card fees. Other large banks, such as Wells Fargo and JP Morgan Chase are testing $3 a month debit card fees. More banks are expected to follow suit.

Large banks are trying to find new ways to bolster revenues lost from federal limits on debit card swipe fees. This is the money (called interchange fees) banks collect from merchants every time customers use their cards to make in-store or online purchases. The Federal Reserve Board set the cap at 21 cents plus a few pennies extra to cover fraud and other costs.

Cunningham, from the credit counseling foundation, says debit fees may be unavoidable, adding, “Such fees may be the new reality, but consumers don’t have to take them lying down.”

Debit cards are a great tool to help control spending, adds Cunningham. “When the money’s gone, the spending has to stop.”

For some consumers, however, “Debit card use has increased due to a diminished access to credit. Their accounts have either been closed, or the credit line lowered. Therefore, many people, either by choice or by necessity, have switched to using their debit card.”

Says Banks from Consumers Union: “Consumers need to be vigilant. If there’s something that they don’t like about their credit card company or bank, they have the option of walking with their feet.”

Source: CreditCards.com

Speech by Jeffrey M. Lacker, President, Federal Reserve Bank of Richmond

I am honored to be asked to speak at this conference. I have had a longstanding interest in payment economics, particularly the economics of payments systems innovations. From that perspective, the topic of this conference — immediate funds transfer — is intriguing because what it represents — low-cost, real-time funds transfer for all — sounds like payments system nirvana.

I would like to use my remarks today to review some of the thinking that I and others — mostly others — have devoted over the years to the role of the central bank in the payments system, particularly in regard to payments innovations. I also would like to emphasize that these remarks are my own and the views expressed are not necessarily shared by my colleagues in the Federal Reserve System.^[1} Central banks have a natural interest in the development and evolution of payments systems. In fact, one could legitimately say that payments systems are central to central banking. The processes by which payments get made, cleared and settled represent the mechanics of monetary exchange, and the characteristics of these systems can affect the transmission of monetary policy to economic activity and inflation.^[2] Related, most payment arrangements achieve finality through the transfer of central bank liabilities, whether in the payment of cash at the point of sale or in the transfer of reserve balances between the banks of the payer and payee. Indeed, the historic origin of central banks is as public sector intermediaries for the clearing and settling of payments, such as bills of exchange — central banks are essentially nationalized clearinghouses.^[3]

The Federal Reserve’s interest in the payments system has long been organized around its three-fold goal of efficiency, integrity and accessibility. To an economist’s ear, the first two of these sound more like a single goal of economic efficiency more broadly defined. Integrity is an attribute of a payment instrument or process, and the public policy objective, in this regard, should be that payments embody a socially efficient degree of integrity — that is, the degree of integrity that maximizes the social benefit net of social costs.^[4] In the central bank lexicon, the term “efficiency” is often construed more narrowly as the minimization of resource costs. The goal of accessibility, in turn, suggests a public policy concern for the distribution of costs and benefits among payments system participants and intermediaries. In the history of the Fed’s involvement in payments, this has taken the form of shielding small depository institutions from too large a share of the common costs associated with clearing and settlement systems. (Common costs are those that are not attributable to particular users or sets of users.) This aligns with the Fed’s founding purpose of realigning, in favor of “country” banks, the governance of how financial crises are resolved.

The importance of common costs and the distributional questions they raise are the result of the technological nature of payments systems. At their most basic, these are systems that communicate and process information — instructions regarding the transfer of bank balances, to be precise. The dramatic innovations in information processing and communication technology that we have seen in recent decades have made payments practices feasible that not too long ago were utopian. People can now carry around with them their own personal connections to universal communications networks, creating the possibility of retail payments initiation using mobile devices. Computational advances have allowed settlement systems — for instance in the CHIPS or CLS services — that economize on both central bank balances and counterparty credit in making “wholesale” payments. The immediate funds transfer services that are the topic of this conference take advantage of newer technologies to create a payment service that blurs the traditional distinctions between “wholesale” and “retail” payments.

Immediate payments also can be thought of as an attempt to move payments further away from their batch processing history. Gathering many payment instructions into a single file for communication and processing made sense in a world where there were economies of scale in batch size. But the evolution of technology has reduced the fixed cost associated with individual communication packets, which makes batch processing less compelling as a means of economizing on the resource costs of payment clearing and settlement. For example, I am told that a majority of the ACH files presented to the Federal Reserve contain just a single item.

When technological progress makes possible new ways of initiating, clearing or settling payments, delay in the realization of the anticipated improvements is sometimes taken as evidence of market failure and as a motivation for the involvement of the central bank. Indeed, it is common to hear payments systems referred to as “public goods.” Clearly they are not. Public goods have the technological characteristic that they are provided jointly to many users and, crucially, are not excludable, meaning that one cannot easily prevent enjoyment of the benefits (or costs) of provision. Payments systems are provided jointly to many users, but a user’s participation can easily be prevented, so they are club goods, not public goods. The efficiency case for government intervention in markets for club goods is much harder to make, and intervention tends to be motivated by considerations related to the allocation of joint or common costs.

It’s also common to hear talk of “barriers” to adoption of payments improvements, a word choice that suggests forces inhibiting the market from moving in an obviously superior direction. The stubborn persistence of checks as a dominant means of payment in the U.S., even as electronic alternatives became increasingly available, was a widely-cited example for many years, as was the persistently slow adoption by the banking industry of electronic means for clearing and processing paper checks. The dramatic change we have seen on the processing side came about after changes not just in the costs of handling and storing check images, but also in the legal rights surrounding check presentment. This suggests that check collection may have been reasonably efficient, in the broader economic sense, given the legal regime in place prior to the Check 21 legislation. It also suggests that central banks should be on the lookout for opportunities to use their good offices to advocate for legislation that removes legal barriers to private sector efforts to improve the economic efficiency of the payments system.

In the history of efforts to speed up payments through electronification, much of the perceived benefit has stemmed from the reduction in float. But the value of float — the forgone interest, that is — represents a transfer from the payee to the payer, and without explaining what keeps trading parties from taking this into account when voluntarily agreeing on their payment arrangements, it’s hard to see float as a source of market failure.^[5] When payment instruments do not accrue interest while in the process of settlement, there is a socially wasteful incentive to attempt to speed up payments to minimize forgone interest. Perhaps in the past the cost of calculating and crediting interest on payments being cleared may have exceeded the social cost associated with inefficiently “chasing float.” One under-appreciated side benefit of the current exceptionally low level of interest rates is that it minimizes the inefficiency associated with chasing float.

I believe we should be cautious about assessments of the private adoption of innovations, both in the payments arena and elsewhere; they are much more complicated than is implied by the language of “public goods” or “barriers.” For example, the popular understanding of the Fed’s original entry into the business of clearing checks holds that the banking industry’s fragmentation was a barrier to the creation of an efficient, nationwide check clearing system. I believe the record shows, though, that the evidence for inefficiency of pre-Fed check clearing is weak, and that the Fed’s entry was motivated by the desire to reduce the burden of the higher reserve requirements associated with Fed membership. My sense is that the effects of our entry had more to do with re-allocating the common costs of clearing checks, especially checks drawn on small banks outside of major cities, than it did with payments system efficiency per se.^[6]

As I noted earlier, general-use immediate funds transfer seems to represent a natural evolutionary response to recent technological advances, and as such, would appear to offer an obvious improvement. From that perspective, non-adoption might be interpreted as a failure of the payments marketplace. But this is a tricky conclusion to draw. The private value of alternative payment methods and practices to end users (for instance, buyers and sellers in commercial transactions) is very hard to identify and measure. Even harder is identifying the reasons, and quantifying the extent to which, social costs and benefits deviate from private costs and benefits. The failure of many proposed payments innovations in the mid-1990s offers a valuable lesson in the risks of pre-judging the viability of an innovative payment arrangement.

What can the central bank do to further the goal of payments innovations that promote economic efficiency? Central bank obligations play a special role in the payments system because they are free of credit risk. Certainly, a central bank should ensure the integrity and cost efficiency of the core interbank settlement functions it performs. Settlement on the books of the central bank can be a key part of any new payment service or process, so effective provision of this service is vital. It’s also important that this core central bank service not create competitive inequities among competing private sector networks. That is, a central bank should strive to ensure that access to settlement promotes the contestability of markets. The Fed’s net settlement service for private clearing networks is a good model for such a universally accessible settlement process, which levels the playing field among potential competitors.

If a central bank plays an expanded operational role — clearing retail payments, for example — it should ensure that these activities also contribute to economic efficiency. Although such roles are distinct from the core central bank roles related to currency and reserve balances, they may be justified if there are complementarities that make it more efficient to bundle clearing and settlement with the maintenance of central bank account balances. But a question worth asking is whether technological advances that have clearly reduced the cost of communications between financial entities have reduced these complementarities and made it easier to separate the various functions that make up the payments system. And if so, does this create greater opportunities for more of those clearing functions to be handled outside the central bank?

A central bank should also take care that the processes by which its own clearing services access central bank settlement services are neither artificially advantageous nor disadvantageous relative to the settlement terms it provides to private clearing networks. For example, settlement of Federal Reserve check and ACH transactions bypasses the controls of the net settlement service through which private competitors are required to settle. Such disparities have the potential to affect the terms of competition among public and private networks.

Because the nature of payments is such that barriers to effective competition could arise among private participants, payment services markets are always likely to attract the attention of competition policy authorities. Even if it does not have primary responsibility for enforcing pro-competitive policy in payments markets, the central bank is likely to be an important public sector source of expertise in payments. Because the payments system represents the mechanics of monetary exchange, the central bank needs to be well informed about developments and practices among all payments system participants.

The same technological and network characteristics that create potential market power problems create challenges for payments systems operated by the central bank or other public sector entities. In much of its payment services activity, the Fed has relied on the cost recovery rules mandated by the Monetary Control Act as a tool to ensure that its provision of services is consistent with overall economic efficiency. While this has been a largely effective policy, a central bank’s role as a provider of services can create particular challenges for the promotion and adoption of payment innovations.^[7] A public sector provider of services needs to take care that the terms under which it serves customers, particularly in those market segments for which it may have a competitive advantage, do not distort the evaluation of the potential net benefits of new products or processes. Moreover, such a provider should scrupulously avoid using a competitive advantage in a legacy market to subsidize entry into an emerging market.

Finally, we shouldn’t forget that payments innovation incentives can depend critically on the central bank’s performance of its most central role — the maintenance of price stability. This is especially true of innovations intended to reduce the time between initiation and settlement of a payment. In an environment with high inflation and thus high nominal interest rates, the value of float can have a powerful effect on the payment choices of individuals and intermediaries. Speeding up payments may yield benefits associated with the reduction of risk, but speeding up payments simply to reduce the transfer associated with float represents socially wasteful investments in innovation — the modern counterpart of the classic textbook account of the “shoe leather” costs of inflation. So it seems appropriate — and certainly consistent with my personal views on monetary policy — to end on this note: Perhaps the most important thing a central bank can do to promote efficient payments innovation is to provide an environment of stable prices, so that the payments system decision makers — like other economic decision makers — can better judge the true costs and benefits of alternative choices.

^[1] I am grateful to John Weinberg for assistance in preparing this speech.

^[2]Jeffrey M. Lacker and John A. Weinberg, “Payment Economics: Studying the Mechanics of Exchange,” Journal of Monetary Economics, vol. 50, no. 2, pp. 381-387.

^[3] Charles Goodhart, “The Evolution of Central Banks” (Cambridge, MA: The MIT Press, 1988).

^[4] For a discussion of the economic notion of efficiency as applied to the Fed’s payment system goals, see Edward J. Green and Richard M. Todd, “Thoughts on the Fed’s Role in the Payments System,” Federal Reserve Bank of Minneapolis Quarterly Review, Winter 2001, vol. 25, no. 1, pp. 12-27.

^[5] Jeffrey M. Lacker, “The Check Float Puzzle,” Federal Reserve Bank of Richmond Economic Quarterly, Summer 1997, vol. 83, no. 3, pp.1-25.

^[6] Lacker, Walker, and Weinberg, “The Fed’s Entry into Check Clearing Reconsidered,” Federal Reserve Bank of Richmond Economic Quarterly, Spring1999, vol. 85, no. 2, pp. 1-31.

^[7] Lacker and Weinberg, “Can the Fed be a Payment System Innovator?” Federal Reserve Bank of Richmond Economic Quarterly, Spring 1998, vol. 84, no. 2, pp. 1-25.

Mobile Wallet Gaining Currency

Nowadays, when Edward McLaughlin is paying for aspirin at the Walgreens drug stores in New York, he just has to tap his Nexus S mobile phone on a terminal device. He not only avoids having to fumble through his wallet and hold up the line, but the tapping also automatically adds loyalty points to his Walgreens’ loyalty card, also stored in his phone, and can help him redeem any coupon he might have downloaded from the Internet.

Soon, he will be able to do the same for his favorite sandwich at Subway.

Mr. McLaughlin, chief emerging payments officer at Mastercard, has been one of the first to try out the Google Wallet mobile pay system introduced by the Internet giant in May in partnership with Citigroup and Mastercard Worldwide.

In fact, Mr. McLaughlin started tapping to pay for his coffee or his taxi ride back in 2005 with a Nokia phone, as part of a small group that was testing a new two-way wireless technology called Near Field Communication, or N.F.C., which allows data to be exchanged between two devices at a very short distance.

N.F.C. transforms smartphones into virtual payment cards; it has become fashionable among cellphone manufacturers, telecommunications operators and finance providers. The technology has already been successfully tested in several cities around the world, including Seoul, Nice, Oslo and Singapore. But the paucity of available N.F.C.-enabled smartphones has hampered any major rollout.

This is changing fast. Over the summer, LG Electronics and Research In Motion, the maker of the BlackBerry, announced the release of their first N.F.C.-enabled smartphones. That was followed by Google’s acquisition of Motorola Mobility for $12.5 billion in August, which could give Google Wallet a lift.

“Right now we’re hearing a lot of talk, mainly from Asian manufacturers, that they’re coming out with N.F.C.-enabled phones,” said Frederick Huet, managing director of Greenwich Consulting, an international consulting firm for telecommunications and media. “You also have Apple hinting it will come out with N.F.C.”

Ashwin Raj, Visa’s head of mobile products for Asia Pacific, Central Europe, the Middle East and Africa, agreed.

“We are at an inflection point,” he said. “The handset manufacturers have started the ball rolling. Already terminal manufacturers are announcing their new terminals will support N.F.C. technology. There is finally momentum for this to take off.”

Mr. Raj pointed to two other important developments — the rollout of Isis, a major U.S. test program for the technology, and the migration of NTT DoCoMo, the biggest mobile operator in Japan, to N.F.C. in the coming year.

Isis is a joint venture in the United States of AT&T, Verizon Wireless and T-Mobile USA, the top three telecommunications operators, and the credit card companies Visa, MasterCard, Discover and American Express. The companies will conduct a trial in Salt Lake City, Utah, and Austin, Texas, during the first half of 2012 that should make use of N.F.C.-enabled devices widely available in those areas.

NTT DoCoMo has been offering a Japanese “mobile phone wallet” since 2004 using the one-way contactless technology, FeliCa, developed by Sony. But it recently announced plans to make phones that support both the international standard N.F.C. and the domestic FeliCa technology.

“Is it going to replace cash? No,” Mr. Huet said, “but many consumers are now used to tapping a card to pay, and tapping a phone is not very different.”

Mr. McLaughlin said that it was no longer a question of whether the underlying technology was working and secure — N.F.C. is actually more secure than credit cards, he said.

“If you lose your mobile, we can pull all your credentials off the phone within seconds,” he said. “We can’t pull the data from your credit card. The data in your phone are stored in a special chip, and here it’s almost James Bond-like; if it’s ever tampered with, it self-destructs.”

To be activated before a transaction, Google Wallet requires a password to start the application, which adds another layer of security.

The real question now is how N.F.C. can be used to enrich the consumer experience, Mr. McLaughlin said.

“If it’s simply ‘I can tap my phone instead of using my card,’ it’s moderately more convenient,” he said. “But if we can take advantages of smartphones’ capabilities to change the information available to you, the feedback you get — that’s what’s going to be key.”

Mr. McLaughlin said the smartphone allows the finance companies to talk to cardholders in new ways, like offering access to promotions and offers or information on an account balance before a purchase — “something you could never do with a piece of plastic,” he said.

Yet, beyond the hype surrounding N.F.C., analysts are warning that the rate of adopting this technology could be slow.

The research firm Gartner recently estimated that about 141 million consumers will have made payments using smartphones by the end of this year, up 38 percent from last year, but that the majority of these transactions are money transfers.

Sandy Shen, research director at Gartner, warned that the mass market adoption of N.F.C. payments is “at least four years away.”

“The biggest hurdle is the need to change user behavior by convincing consumers to pay with mobile phones instead of cash and cards,” she wrote in a report.

A recently published report by Datamonitor, a research firm based in Britain, found that only 1.8 percent of consumers globally were likely to adopt N.F.C. payment systems immediately; 12.2 percent were described as having a medium likelihood of using the system, while 31.7 had a low likelihood. The remaining 54.3 percent were considered “unlikely” to adopt the technology.

“The key reason why most consumers will not bite immediately on N.F.C. is, it doesn’t actually solve any immediate need,” said Gilles Ubaghs, senior analyst for cards and payments at Datamonitor, “and in most instances is likely to involve more steps to do an act they can already do with relative ease.”

“With an N.F.C.-enabled phone you still need to open your phone, find the app, open the app, perhaps push a few buttons and then hold it to the reader,” he said.

And in some instances, like paying a bus or metro fare, N.F.C. is actually slower than technologies like Mifare, a contactless chip used in the London Oyster card, and the FeliCa chip, which is used in Asia, Mr. Ubaghs said.

In Japan, despite the push given by NTT DoCoMo, the use of mobile payments remains a niche market. But Mr. Ubaghs acknowledged that offering added benefits, beyond the technology, like focused discounts and offers, could be key to driving up adoption.

“Consumers tend to be quite conservative in most developed markets when it comes to payments,” he added. “It seems crazy now, but all of the banks actually struggled for years to convert its full range of consumers into using ATMs for cash withdrawals.”

N.F.C. will face a similar situation, “particularly if its consumer proposition remains muddled at best,” Mr. Ubaghs said.

Source: New York Times

Discussion Paper No 16/2011: Substitution between net and gross settlement systems – A concern for financial stability?

Non technical summary.

The design of large value payments systems is of high relevance for financial stability. Payments resulting from interbank transactions are predominantly settled in those payment systems. Broadly speaking one can classify large value payment systems in gross and net settlement systems.

In net settlement systems payments are accumulated over a certain period, for instance a day. At the end of the period offsetting bilateral and multilateral payments are netted and only the resulting balances are settled in central bank money. Since incoming payments are not finalized during the day, those payments imply an intraday credit of the receiver to the sender of the payment. Therefore, if at the end of the day the sender of a payment has too little liquidity to settle all balances with his counterparties the bilateral and multilateral netting of his payments has to be unwound and the receiver of the payment will not dispose of the expected liquidity. If he, as a result, disposes of too little liquidity also his payments need to be unwound which might again affect the liquidity position of the receivers of his payments. In this way the liquidity shortage of one bank can generate domino effects leading to defaults on payments between large parts of the banking sector.

In gross settlement systems, in contrast, each payment is settled in central bank money one after the other. Consequently, the receiver of the payment has the liquidity immediately and with certainty at his disposal. The domino effect that can occur in net settlement systems cannot emerge in gross settlement systems. However, in order to settle each payment individually banks have to withhold sufficiently liquidity. Thus compared to net settlement systems gross settlement systems impose higher costs on banks because of the higher liquidity buffers that those systems require.

In most developed economies gross and net payment systems coexist for large value payments. In this paper we study whether this coexistence and the potential substitution effects between the payment flow in the two types of systems affect financial stability. One could presume, for instance, that tensions in interbank markets that lead to higher costs of liquidity induce banks to send more payments through net settlement system in order to save on liquidity. However, in times of tighter money market the probability of a liquidity shortage of an individual banks seems more likely. This would mean that precisely when the probability of an unwinding in net settlement systems is large the transaction volume in those systems is also elevated.

However, in our econometric analysis of the large value payment systems in the euro area for the period from January 2000 to September 2007 we do not find evidence for such a destabilizing substitution effect. But we also do not find evidence that banks send more payments through gross settlement systems in response to an elevated credit risk in the banking sector. Our results rather suggest the opposite causal relation: In times of a high transaction volume in gross settlement systems the demand for liquidity seems to increase which leads to an rise in money market rates. An increased volume settled in net systems, in contrast, seems to bring about a higher credit risk premia in the interbank market.

In sum, during the relatively tranquil period prior to the current financial crisis it were not financial market prices that drove the choice of the payment systems. It is rather the transaction volume in the different payment systems that influences market rates. Thus, generally, the identified mechanisms rather contribute to a more efficient allocation of liquidity and risk and thereby foster the resilience of the financial system. In extreme cases, however, the increase in the transaction volume in net payment systems and the resulting increase in systemic risk might induce a hike in the credit risk spread in the interbank market that leads to a rationing of particularly risky banks in the money market which might make in turn a liquidity crisis and an unwinding more likely. Moreover, during the crises periods as the most recent one the severe spikes in money market rates and the substantial increase in counterparty risk and systemic risk might have very well affected the banks’ choice of payment systems.

[Summary also in German]

Full Discussion Paper

by Katrin Forster, Melina Vasardani and Michele Ca’ Zorzi.

Non-technical summary.

The global financial crisis that started in 2007 and intensified after the collapse of Lehman Brothers in September 2008 abruptly interrupted the more than two-decade-long process of increasing world financial integration. With the complex web of global interlinkages contributing to the spreading of the turmoil from the United States to the rest of the world, the crisis led to unprecedented declines, or even reversals, in global cross-border capital flows. Although financial markets have bounced back from their lows, cross-border capital flows have generally remained well below their pre-crisis levels.

The advanced economies, which have traditionally dominated global capital flows and were considered immune from sudden capital withdrawals, were particularly affected. Prior to the crisis, the euro area current account was close to balance, with cross-border financial flows mostly cancelling out when all components are summed. In net terms this indicated that the euro area was neither receiving nor exporting large capital flows, although significant developments were occurring in gross terms. The financial crisis, however, affected not only those countries with large current account deficits but all countries with open capital accounts.

The aim of this paper is to highlight the unprecedented adjustments triggered by the financial crisis in euro area cross-border financial flows. We find that during the turmoil there was a very sizeable scaling-down of gross external asset holdings across all types of investors and the whole range of instruments, amid soaring risk aversion, high liquidity needs, and balance sheet restructuring. Flows reversed and their volatility markedly increased, with potentially adverse effects for the real economy and financial stability. The strong increase in home bias and flight-to-safety behaviour was also manifested in shifts in the composition of cross-border financial flows, from equity to debt instruments, from long-term to short-term debt instruments and from private sector to public sector debt. At the same time, deleveraging activity in relation to cross-border loans and deposits reached high levels. The financial crisis also changed the sectoral breakdown of the euro area’s net external borrowing, with the government sector becoming the main, and for most of 2010 the only, net borrower from abroad. This was in line with the rise in government borrowing worldwide (and especially in the advanced economies), which was partly driven by higher financing needs on the part of governments in response to the crisis, but also by heightened global risk aversion on the part of investors.

As the global economy started to show signs of stabilisation in 2009 some of the trends in gross cross-border financial flows observed during the crisis abated or even reversed, towards the end of the year, particularly in the case of portfolio and direct investment. As regards other investment, deleveraging in relation to cross-border loans and deposits continued apace in 2009, with some signs of a normalisation, both on the asset and on the liability sides, only emerging in the first half of 2010.

Looking ahead, it is still uncertain which trends will prevail in the near future. Investors appear to have become more selective in qualitative terms, for example by increasingly differentiating across countries in relation to government debt securities. While the global economic outlook and fiscal developments are expected to play a key role, overall international financial flows could still be affected by the balance sheet restructuring of financial and non-financial corporations in advanced economies, including the euro area. Following the surge in international financial activity prior to the crisis, the recovery may not be synchronised across different world regions, as shown by the stronger rebound of cross-border flows to emerging markets.¹

¹ Rottier and Veron (2010, p.3) illustrate how the share of emerging markets in the 100 largest banks has been steadily increasing and has overtaken that of Europe. These banks have engaged in a limited degree of cross-border activity, but this could change. According to these authors, one can expect that “the combination of deleveraging in the West and continued financial development in the emerging economies will certainly reinforce the trend toward multipolarity”.

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