As Central 1 continues to make good progress on our Payments Modernization strategy, we spoke to Deputy Governor Bank of Canada, Timothy Lane, about what’s expected from financial institutions as Canada moves towards a more competitive payments system and as the financial world adjusts to the realization that the COVID-19 pandemic could bring lasting changes in payments behaviour.
In the following Q&A, Deputy Lane discusses managing risk among new non-bank payment service providers participating on the Real-Time Rail and warns financial institutions to continually “up their game” on cybersecurity as payments are modernized.
C1: How does the Bank of Canada view the payments landscape and what challenges and opportunities does it see on the horizon for smaller financial institutions?
TL: The payments landscape is changing quickly, and both the private and public sectors must adapt to meet the challenge of accelerated change. Payments Modernization aims to support open, risk-based access to Canada’s payment infrastructure. This includes designing payment systems to have more flexibility – where types of access can be aligned to the needs of participants (e.g. exchange versus settlement). The intent is to create a more level playing field, so that smaller financial institutions can compete and offer levels of service comparable to large financial institutions. For example, customers should be able to transfer funds in a way that makes them available quickly to the recipient. Broader access should also facilitate increased competition from new non-bank payment service providers. Established financial institutions, both large and small, need to be ready to respond to increased competition from technology driven challengers.
C1: the Bank of Canada commits to “help ensure Canadians can use their preferred methods of payment with confidence”, what action is required by participants in Canada’s payments eco-system in order to plug existing gaps and bolster safety and soundness?
TL: Giving Canadians greater choice among different methods of payment- with confidence in their safety- is a core objective of the ongoing Payments Modernization initiative. Payments Canada is driving this agenda, which also relies on important investments by the industry. We at the Bank of Canada are actively involved.
This initiative will introduce a new generation of safe and resilient systems. In particular, the Real-Time Rail will enable payments that are real-time, final and irrevocable so that funds are available immediately to the end–recipient. This will create opportunities for service providers to build additional functionality upon it, so it should foster the emergence of many new customer-facing payment services.
As the Real-Time Rail supports innovation in payments services, our regulatory framework needs to keep up with the new reality- where payment services are increasingly being provided by companies that are not traditional deposit-taking institutions. The Government of Canada announced in the 2019 budget that it intends to establish a Retail Payments Oversight Framework, with the Bank of Canada being given the main responsibility. That will build on our existing role in overseeing payments systems that could pose systemic risk or payments system risk.
I should also mention another kind of safety that is becoming increasingly important as Canadians increasingly move towards more digital payment methods and banking: cybersecurity. Maintaining strong cybersecurity throughout the financial system is essential. As cyber threats become increasingly sophisticated, system operators and financial institutions also need to keep upping their game.
C1: Please tell us more about Bank of Canada’s involvement in the new Real-Time Rail and the Retail Payments Oversight Framework which will allow non-bank payment service providers (PSPs) to participate. How can credit unions be confident that this won’t cause undue risk?
The Bank of Canada is involved in Payments Modernization in its capacity of overseer and settlement agent, and we work with Payments Canada and the Department of Finance to ensure the new systems satisfy public policy objectives. The Real-Time Rail will be a new, ‘always on’ (i.e. 24/7/365) system that facilitates the real-time delivery of low-value payments with immediate funds availability for the recipient. Real-Time Rail will be a platform for competition and innovation which will benefit from having a broad set of institutions, including regulated non-bank PSPs, able to participate.
As plans for the Real-Time Rail move forward, we are focusing on how to ensure the risks are well-managed. First, only regulated entities will be able to participate. Non-bank PSPs will be subject to the Retail Payments Oversight Framework which the Government of Canada intends to establish as announced in its 2019 Budget. Second, all entities will have to fully pre-fund their payments. This eliminates credit risk in the system. Third, all entities will need to meet risk management standards required by Payments Canada for membership.
C1: Central 1 processes more than 300 million payments annually on behalf of more than 300 Canadian credit unions and financial institutions and we are one of the holders of a Bank of Canada Lynx settlement account. What expectations does the Bank of Canada have of direct clearing and settlement participants such as us as Canada modernizes its payments infrastructure?
TL: The Bank of Canada recently set out an explicit set of eligibility requirements and standards for institutions holding a Lynx settlement account. This is the first time we have made our expectations so explicit. Direct settlement participants are expected to be subject to appropriate regulation or supervision, to have a payments-based business model, and to meet stringent operational, financial, regulatory and legal standards. As you say, Central 1 meets these requirements.
C1: How are Canadians’ preferred methods of payment changing as a result of COVID-19 and how is that being factored into the Bank of Canada’s priorities for payments?
TL: COVID-19 has sped up the ongoing decline in the use of cash for payments (although cash still plays an essential role, especially for small-value transactions and P2P transactions). Online shopping had a major boost during the lockdown. Also, fear that banknotes could carry the virus has driven some Canadians to use contactless payments and some merchants are refusing to accept cash. (We have been urging merchants not to refuse cash as that would exclude some people, particularly the poor and isolated, who may not have access to other methods of payment.) Surprisingly, though, the value of cash in circulation grew sharply in March and April 2020: apparently many people were withdrawing cash as a precaution, but not spending it. We’ll be watching to what extent these trends persist beyond the pandemic.
To get a clearer picture of how the pandemic is affecting methods of payment, we conducted a survey in April 2020, the height of the lockdown in most of Canada. Respondents said they still had good access to cash and were able to pay in cash at most but not all merchants. More than a third had used cash for payments during this period, compared with more than half who had paid with debit or credit cards and over a third who had used Interac e-Transfer. But about three-quarters said they had no intention of going cashless from now on.
Of course, only time will tell whether these trends will persist beyond the pandemic, and it will be important to monitor them. We have further surveys planned for later in 2020 and in the first part of 2021, for example to see what is happening to the use of cash payments at the point of sale.
C1: How will digital disruption, blockchain and digital currencies like Libra impact payments in the future and what contingency planning is the Bank of Canada doing to prepare?
TL: There has been remarkably rapid innovation in payments over that last couple of decades and there’s every indication that this pace will continue for some time yet. The Bank of Canada is constantly monitoring these developments to determine their potential impact on the efficiency and stability of the Canadian payment ecosystem and the financial system more generally.
In responding to these developments, our goal is to promote competition and innovation while safeguarding the resilience and stability of the system. Here, I would like to highlight a couple of aspects.
First, the Bank of Canada is partnering with other regulators in Canada and internationally to establish an appropriate regulatory structure for innovative products. In particular, with regard to Libra and other stablecoins, we are participating in international work under the auspices of the FSB to clarify the regulatory issues. The Bank is part of the international regulatory college for Libra itself.
Second, we have been exploring the potential implications and features of a Central Bank Digital Currency (CBDC) – a cash-like liability of the Bank of Canada in a digital form. We have not made any decision to launch such a digital currency. But we are exploring it as contingency planning in the event of a further decline in acceptance of cash and/or a situation where one or more private digital currencies makes serious inroads as means of payment in Canada. We are continuing our policy research into the potential benefits and risks; technical research on how a CBDC could be designed; and engagement with stakeholders and the broader Canadian public. This topic is becoming all the more pressing, given the possibility that the COVID-19 pandemic could bring lasting changes in payments behaviour.
Reach out to Central 1
If you would like to speak with Central 1’s payments experts about any aspect of Payments Modernization planning and implementation, don’t hesitate to reach out today.