Risk Management Standards for Retail Payment Systems
Heller, H. Robert, American Banker
This article is adapted from an address at the recent Payments '96 Conference in San Francisco.
Central banks are increasingly concerned about payments system risk and have actively encouraged private-sector operators to reduce their exposures. A key question is whether the risk management standards that have been promulgated for large-value networks should also be applied to retail oriented systems, such as credit cards.
The central banks of the most important countries in the financial world, the Group of 10, mutually agreed upon minimum standards in the 1990 "Lamfalussy Report." In 1994, the Federal Reserve Board issued a policy statement adopting these standards and instituted a further set of risk management principles that are applicable to large-value payments systems like Fed Wire and Chips.
The Fed defines a "large-value" system as one that routinely settles more than $500 million a day. This is regularly exceeded by the large card based retail payments systems. Furthermore, the Federal Reserve made clear that the established standards should apply to all networks, though batch type systems like the cards and automated clearing house were exempted for the time being.
The central question is whether the differences between large-value and small-value systems are so significant that they constitute a difference in kind rather than in degree, therefore exempting retail systems from the strict Lamfalussy standards.
There tends to be an inverse relationship between the number of transactions in a payments system and their total value. Visa and MasterCard executed about 15 billion transactions in 1994, while Chips and Fed Wire exceeded 100 million.
The total value moved over Chips and Fed Wire exceeded $500 trillion in 1994, compared with Visa's and MasterCard's half a trillion dollars. The large- value payments systems move more funds in a day than the retail systems do in a year.
These disparities are also reflected in the average transaction size: about $6 million in Chips, $3 million on Fed Wire, but only $70 in the bank card systems. Would one follow the same safety rules on a conquest of Mount Everest as on a molehill? Hardly.
To make the same point in still a different way: In no country for which the Bank for International Settlements reports the relevant data do card payments constitute more than one-third of 1% of the total value of cashless payments.
It can therefore hardly be argued that retail payments systems present the same kinds of systemic problems as the large-value systems. Nevertheless, retail systems may represent some moderate risks that should be monitored and contained.
Can the retail systems meet the Lamfalussy standards? If yes, this would certainly be beneficial; if no, we must ask ourselves what, if anything, should be done about it.
One of the standards retail payments systems can meet, Lamfalussy IV, calls for objective and publicly disclosed criteria for membership and fair and open access to the system. The bylaws of the various retail payments organizations spell out these conditions in detail and most should be in compliance with this standard.
Another standard, Lamfalussy VI, calls for the operational reliability of technical systems and availability of backup facilities.
Many retail systems have set and met standards of 99.99% operational reliability and should have no difficulty in meeting the Lamfalussy criterion. But 0.01% downtime amounts to 52 minutes during the year. If that occurs during the peak Christmas season, consumers might be very unhappy. However, this is not a regulatory issue but a service quality issue that can be left to the free market.
Lamfalussy II calls for participants in a netting system to fully understand the various risks to which they might be exposed. This is certainly a reasonable requirement that any financial institution can and should meet. The various retail payments systems have done much to educate their members through seminars and the publication of appropriate manuals. …