Canadian Bankers Association

Canadian Bankers Association
Submission to the Task Force
for the Payments System
Review

September 15, 2010

EXPERTISE CANADA BANKS ON
LA RÉFÉRENCE BANCAIRE AU CANADA

Table of Contents

Table of Contents ............................................................................................................................ 1
Executive Summary......................................................................................................................... 2
Summary of Principles and Issues that the Task Force Should Consider ...................................... 4
Introduction ...................................................................................................................................... 6

Strong Financial Institutions in a Strong Payments System................................................6
The Critical Role of Payments .............................................................................................7
Competition in the Payments System ............................................................................................. 7
Large Value Systems ..........................................................................................................7
Small Value Systems...........................................................................................................8
What makes a market competitive? ....................................................................................9
Efficiency of the Canadian Payments System............................................................................... 12
Ubiquity – a Key Part of Payments Efficiency ...................................................................14
Cross-Border Payments – An International Challenge .....................................................15
Balancing Privacy with National Security ...................................................................................... 16
The Importance of Payments System Safety and Soundness...................................................... 16
Effective Disclosure ...........................................................................................................18
Fighting Financial Crime....................................................................................................19
Assessing Liability in a Many-Layered Payments Environment........................................20
Better Tools for Authentication ..........................................................................................21
Meeting the Needs of Consumers and Merchants ........................................................................ 22
Consumer Choice..............................................................................................................22
Payment Options for Merchants ........................................................................................23
Innovation – A Challenge and an Opportunity............................................................................... 24
The Role of Public Policy in Payments Innovation ............................................................25
Debit Card Market Evolution..............................................................................................26
Phasing Out Existing Payments Products.........................................................................26
Ensuring the Law Keeps up to the Technology.................................................................28
Developing a more Holistic Approach to Governance ......................................................28
Conclusion ..................................................................................................................................... 29

Submission to the Task Force for the Payments System Review – September 15, 2010

Executive Summary

Canada benefits from a strong and robust payments system. Built on the foundation of strong
financial institutions, Canadians value and trust the payments system to enable them to make the
transactions they need to carry out their daily life. Statistics bear this out – Canadians are one of
the most frequent users of their payments system in the G7 nations. And the Canadian payments
system is continuing to evolve, as new entrants enter the marketplace and new payments
technologies are presented to consumers.

While entry and innovation are clearly positive developments, they give rise to a number of issues
that need to be addressed in order to preserve the security, stability, and reliability of the
payments system and to maintain consumer confidence in it. The focus of the Task Force should
be to set the framework needed to ensure that it builds on the strengths of the Canadian
payments system.

From a banking industry perspective, public policy related to the payments system should be
grounded by four key principles:

 All payments system users, both individuals and businesses, are best served by a
competitive payments market where a number of participants compete for business on
a level playing field. The principles that govern efficient markets hold true in payments as
they do everywhere else – an efficient market is one with a number of firms competing for the
business of fully-informed customers on a level playing field.

 Canadians are confident in their payments system. Public policy should ensure that
innovation builds upon that rather than detracting from it. Canadians trust and rely upon
their payments services providers to meet the needs of consumers and business. They trust
that the payments system will be there when they need it. All payments services providers
should be able to meet that expectation, should be able to verify that they can meet that
expectation, and should be held to account if they cannot meet that expectation.

 Safety and soundness are paramount and must not be compromised. Innovation should
not mean excessive risk or an erosion of the current payments system. Entry and innovation
should be encouraged, but not at the expense of compromising the integrity and security of
the payments infrastructure. Excessive risk would erode consumer confidence resulting in a
decline in the economic efficiency of the payments system.

 Innovation should be enabled but not directed by the regulatory and legislative
environment. Best practices for government are to establish a solid framework within an
industry along with basic rules of entry and let the market forces determine the economically
optimal outcome. That principle holds true in the payments space.

Arising from these four key principles are a series of issues that the Task Force may wish to
address in order to ensure that the payments system reflects these principles, such as

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Submission to the Task Force for the Payments System Review – September 15, 2010
implications of having less regulated payments services providers, ensuring that consumers have
an acceptable level of security irrespective of their choice of service provider, ensuring that
consumers are informed about the consequences of their choices, determining liability when
consumers fall victim to financial crime, and assessing where the current regulatory environment
acts as a brake on innovation.
The banking industry welcomes this review as an opportunity to examine the payments system
against these principles.

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Submission to the Task Force for the Payments System Review – September 15, 2010

Summary of Principles and Issues that the Task Force
Should Consider

Principle: All payments system users, both individuals and businesses, are best served by
a competitive payments market where a number of participants compete for business on a
level playing field.

 The asymmetric regulatory burden between the payments services offered by regulated
financial institutions and other payments services providers is an issue that the Task Force
should address.

Principle: Canadians are confident in their payments system. Public policy should ensure
that innovation builds upon that rather than detracting from it.

 The Task Force should consider the value of ubiquity of the existing payments system as it
examines options for payments system evolution.

 The Task Force should review international standards and assess their implications on the
ability of Canadians to access payment systems.

Principle: Safety and soundness are paramount and must not be compromised.

 When considering the future of the payments system, the Task Force needs to consider if
measures need to be put in place to ensure that new technologies or new entrants do not
compromise the privacy, safety, soundness, and reliability of the system, or consumers’
confidence in it.

 The Task Force should consider what performance standards all payments services
providers should be held to, what disclosure standards should be required and whether
disclosures and other measures are needed to assist consumers in making informed choices
about their payment channel and service provider.

 The Task Force should consider the merits of functional equivalency between electronic and
paper channels for the provision of information or product changes as a component of
effective and efficient disclosure.

 The Task Force should examine the standards in fraud management that payments services
providers are required to meet in order to provide payments services and assess whether
there are minimum standards that all providers should be required to meet.

 The Task Force should consider whether additional steps should be taken to bring together
government, industry and law enforcement to combat e-crime.

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Submission to the Task Force for the Payments System Review – September 15, 2010

 The Task Force should consider how the government can take a leadership role in
strengthening international efforts to bring e-criminals to justice.

 The Task Force should consider the principles that should govern the apportionment of
liability in cases involving fraud given the ongoing changes in the payments system.

 The Task Force should review recent developments in on-line authentication and identity
management systems and assess whether additional measures are needed to improve
identity management in Canada.

Principle: Innovation should be enabled but not directed by the regulatory and legislative
environment.
 The Task Force should examine why some sectors are still largely dependent on paper

instruments as their primary payments technology.
 The Task Force should explore the trends in usage and acceptance of on-line debit payments

in Canada and the factors influencing its use, including whether Canada and Canadians face
any competitive issues or constraints.
 The Task Force should consider the competitive and public policy issues in the Canadian
debit card market, and their impact on innovation.
 The Task Force should review the usage of paper-based payments instruments such as
cheques in both a Canadian and international context and assess the options that have been
considered concerning the future of these instruments, including the viability of possible
electronic vehicles that could be considered as substitutes.
 The Task Force should consider whether processes need to be put in place to ensure that
the payments system legislative and regulatory environment is kept evergreen to meet the
needs of the evolving payments system.
 The Task Force should consider how the current governance structure of the payments
system can be improved to meet the needs of the evolving payments marketplace for all
participants.

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Submission to the Task Force for the Payments System Review – September 15, 2010

Introduction

Canadians largely take for granted the reliability of their payments system. They assume, with
good reason, that payments they initiate will be processed efficiently and accurately by the
payments system. That confidence is a key component to a healthy and efficient Canadian
economy. Without it, individuals and businesses would be reluctant to deal in anything other than
cash. By expanding the range of trusted payment options and offering more efficient forms of
reliable payments technologies, payments system participants have increased domestic
productivity and expanded the size of the Canadian economy. For the Canadian economy, a
study by Global Insight1 found that electronic payments have contributed $107 billion to the
Canadian economic growth in the last two decades. The same study also found that over the last
two decades, $60 billion of the increase in personal consumption expenditures was directly
attributable to electronic payments both from credit cards ($49.4 billion) and debit cards ($10.4
billion) because of the transactional efficiencies they create.

Strong Financial Institutions in a Strong Payments System

Much of the confidence in the payments system is derived from the strength of the financial
institutions that support it. Both Moody’s and the World Economic Forum have named Canada’s
banking system the strongest in the world. Canadians recognize this – a recent survey conducted
for the CBA found that 81 per cent of Canadians believe that Canada’s banks are more stable
and secure compared to other banks around the world.2 The strength of the Canadian payments
system is, in many respects, a reflection of the strength of the Canadian financial system:

 Reliable participants – at its core are a number of strong, stable participants, including both
financial institutions and system operators, that have earned the trust of Canadian consumers
and firms;

 Effective regulation – the central elements of the payments system and the central players
in the payments system are subject to an extensive regulatory environment that provides a
high level of user protection and a core set of standards that system operators must meet;

 Informed consumers – the foundation of any effective economic system is an informed
consumer. Canadian banks and Canadian regulators have made it a priority to ensure that
Canadians are informed of their rights and responsibilities, as well as their avenues for
recourse in the event of problems.

1 The Benefits of Electronic Payments in the Canadian Economy: A White Paper Prepared by: Global Insight Visa Canada
Association.
2 CBA Factsheet, What Canadians Think About Their Banking Industry.
(http://www.cba.ca/contents/files/backgrounders/bkg_annualpoll_en.pdf)

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Submission to the Task Force for the Payments System Review – September 15, 2010

The Critical Role of Payments

The payments system is part of the core economic infrastructure of the economy from both a
domestic and international perspective. While the payments sector is an industry, it is not just an
industry like any other; it is a core element upon which the Canadian economy depends. Key
elements of the payments system – LVTS, CLS Bank, CDSX and the settlement operations of the
Bank of Canada – are designated for direct oversight by the Bank of Canada because failure of
those mechanisms would create “systemic risk” across the financial system. These key elements
are considered to be components of Canada’s critical infrastructure. Public Safety Canada
defines critical infrastructure as follows:

Critical infrastructure refers to processes, systems, facilities, technologies,
networks, assets and services essential to the health, safety, security or
economic well-being of Canadians and the effective functioning of government.
Critical infrastructure can be stand-alone or interconnected and interdependent
within and across provinces, territories and national borders. Disruptions of
critical infrastructure could result in catastrophic loss of life, adverse economic
effects, and significant harm to public confidence.3

Therefore, while there is a temptation to view payments strictly through the lens of technological
efficiency and innovation, care must be taken to avoid compromising safety and security since the
economic costs of mistakes can be enormous.

Competition in the Payments System

To understand the competitive nature of the payments system, one must segment it between
large value and small value systems.

Large Value Systems

Large value systems form the backbone of developed economies. They are the foundation upon
which value is transferred between major economic agents both within nations and across
borders. They are the backbone of commercial business-to-business transactions. The dollar
value of transactions effected through large value systems dwarf those of small value systems
(Figure 1, below). Given their critical role in the economy, safety, soundness and reliability are the
paramount concerns in the operation of a large value payments system since the consequences
of failure would be large and widespread. As a result, internationally, large value systems are
typically regulated by public entities.

3 Public Safety Canada, National Strategy for Critical Infrastructure. 2009. P. 2.
(http://www.publicsafety.gc.ca/prg/em/ci/_fl/ntnl-eng.pdf)

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Submission to the Task Force for the Payments System Review – September 15, 2010

Figure 1

Payments by Value

Debit Cards Credit Cards
0.3% 0.7%

ABM (excl. on- Cheques Other
us) 2.4% Transactions
0.1%
Cleared
through
ACSS

8.4%

LVTS
89%
Source: Canadian Payments Association. Credit card data from the Canadian Bankers Association.

Small Value Systems

While the large-value payments system forms the economic backbone, it is the small value
payments systems that consumers and small businesses interact with on a daily basis. This
becomes clear when the payments system is examined on the basis of transaction volumes.
Figure 2, below, provides a picture of the payments system by transaction volume.

Even this view does not provide a complete picture of the diversity of channels used for small
value payments because it does not provide an entirely accurate picture of payment channels
from the perspective of the consumer. For example, if a consumer uses a payments services
provider such as PayPal, the transaction may be funded through one of these channels (e.g. by
instructing PayPal to charge his/her credit card account) but, from the consumer’s perspective,
he/she paid using PayPal as the payment mechanism. In addition, pre-paid cards may be loaded
by the holder using a debit card but, from the consumer’s perspective, all purchases are made via
the pre-paid card. In short, from a consumer’s perspective, there are far more payment channels
than this chart would suggest. However, it also points to another fact – alternative payment
systems often rely on the efficiency, effectiveness, and reliability of the core interbank small value
payments technologies to make their businesses work, so they benefit from the systems that
banks and other formal payments providers have built, and are continuing to build. This
represents an enormous investment of resources, time and expertise that alternative payments
providers have not had to make.

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Submission to the Task Force for the Payments System Review – September 15, 2010

Figure 2

Payments by Volume

Other LVTS ABM (excl. on-
Transactions 0% us)
3%
Cleared
through ACSS

19%

Debit Cards
37%

Cheques
11%

Credit Cards
30%

Source: Canadian Payments Association. Credit card data from the Canadian Bankers Association.

What makes a market competitive?

The Task Force has asked for views on whether the payments market in Canada is competitive.
The best way to approach that question is to go back to first principles and assess the payments
market against the characteristics of a competitive market. In general, competitive markets are
characterized by several competitors offering substitute products to an informed consumer base.
By this standard, the Canadian payments market is very competitive from a consumer and a
merchant perspective.

There are a large number of small value payments options in the Canadian market. Depending
on the circumstances, Canadians can transfer funds using a wide variety of techniques including
cash, cheque, credit cards, debit cards, pre-paid cards, payments services, email money transfer,
and wire payments. In the financial institutions space alone, consumers can choose from 44 debit
card issuers and 22 credit card issuers providing cards both to their own customers as well as
those of other financial institutions.

Technology has also allowed several institutions to expand their product offerings in the
payments marketplace. Several financial institutions now also offer enhanced mobile banking
applications to allow users to carry out many payments-related functions through their smart
phones and personal digital assistants. New technologies have also created opportunities for new
entrants to compete in the payments market. Some names such as PayPal and Google Checkout
are well-known and others are entering the market every day, either catering to specific niches or
offering unique technologies. In addition, Canada’s major telecommunications companies have
recently entered the payments market with a new mobile-phone-based product called Zoompass.

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Submission to the Task Force for the Payments System Review – September 15, 2010

While there is no single metric that captures both dimensions of market growth (i.e. new payment
providers and new product offerings from existing providers), patent issuance provides an
interesting insight into the growth of the payments marketplace. Figure 3, below, documents the
growth of patents issued in Canada to new or existing firms where the term “payment” is included
by the firm in the description of innovation. The results are telling: since 1990, patents issued on
innovations related to “payment” in Canada have grown at more than twice the rate of total
patents issued.

Figure 3

Innovation in Payments
Patents Issued in Canada on Devices or Systems with "Payment" in their Description

Patents that were issued in that five-year period 180
160
140 1995-1999 2000-2004 2005-Present
120
100

80
60
40
20

0
1990-1994

Payment Growth Rate of All Patents Issued

Source: Compiled by CBA from data in the Canadian Intellectual Property Office Patent Database.

The Canadian Trade-Mark Database provides further details on the growth in competition in the
payments industry. Through examination of patents registered with the Database, the CBA has
been able to identify at least 26 non-bank payments services providers that have registered
trademarks in Canada on payments-related services since 2005. New firms are entering the
market constantly.

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Submission to the Task Force for the Payments System Review – September 15, 2010

In all parts of the economy, a competitive All payments system users, both
market is good for consumers. It provides individuals and businesses, are best
choice, reduces prices, improves quality, served by a competitive payments
and spurs innovation. Payments is no market where a number of participants
exception to this rule. This leads to the compete for business on a level
first principle upon which we believe the playing field.
Payments System Review Task Force
should base its work.

While there is ample choice in payments channels for consumers and businesses, and more
entering the market each day, the degree to which consumers are fully informed about the
features of these different payments channels, and their rights and responsibilities associated
with each, often depends on the type of payments services provider they are dealing with. In the
case of payments services provided by banks, consumers are fully informed about their rights
and responsibilities for two reasons:

 it is good business practice – financial institutions often have a multifaceted relationship with
their clients and therefore have a strong incentive to ensure that clients are placed with the
proper product and understand its features;

 it is the law – there is an extensive body of legislation and regulation that requires regulated
financial institutions to disclose information about product features, pricing, recourse, and
consumer rights and responsibilities. In the case of banks, compliance with this legislation
and regulation is overseen by the federal Financial Consumer Agency of Canada.

By contrast, the other payments services providers are subject to far less oversight and have a
much narrower relationship with their clients. This opens the possibility that clients may not fully
understand their rights, responsibilities and risks that are associated with using some of these
new payments services. The asymmetric regulatory burden between the payments services
offered by regulated financial institutions and other payments services providers is an
issue that the Task Force should address.

While there is substantial choice at the consumer-facing end of the payments system, it must also
be acknowledged that much of this relies upon a common core infrastructure of networks through
which most transactions are routed. With the exception of credit cards, in which there are three
competing networks, in other cases transactions are dependent upon a core set of networks
operated by the Canadian Payments Association and, in the case of debit cards, Interac. This
creates its own unique set of challenges with respect to competition and innovation that need to
be explored (see “Debit Card Market Evolution”, p. 26).

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Submission to the Task Force for the Payments System Review – September 15, 2010

Efficiency of the Canadian Payments System

The Task Force has expressed an interest in assessing the current state of efficiency of the
Canadian payments system. While that is a seemingly straightforward question, in reality it is
complex. Economic efficiency is not the same as technical efficiency. It is not simply a matter of
“faster = better = more efficient”. Rather, an efficient payments system is one that facilitates the
most transactions within required time parameters in the most cost-effective manner with an
acceptable level of security and with an acceptable level of risk while yielding system operators
and participants a sufficient rate of return to encourage them to maintain and upgrade the system.
This suggests that to have an efficient payments system, a country needs several different
payments channels available to users that vary in price, speed and security.

Perhaps the most telling measure of the efficiency of the payments system is the extent to which
people tend to make use of it as opposed to using cash. By this measure, the Canadian
payments system scores well relative to its international peers. Statistics compiled by the Bank
for International Settlements indicate that Canadians are among the most frequent users of non-
cash payments channels in the G7, surpassed only by the United States (see Figure 4, below).
Clearly, Canadians trust and value their payments system.

Figure 4
Average Number of Non-Cash Transactions per Inhabitant, G7, 2007

350
300 327

250 267
244 243

200

181
150

100

50 Canada United France Germany 64 64
Kingdom Japan Italy
0
United States

Source: Bank for International Settlements

Japan provides an interesting case study from among the G7 nations in the area of payments
because it demonstrates the need to consider use when evaluating efficiency. Non-cash
payments instruments in Japan are predominantly electronic and Japanese consumers make far

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Submission to the Task Force for the Payments System Review – September 15, 2010

more frequent use of e-money payment technologies than their peers in other G7 countries (see
Figure 5, below).

Figure 5

Breakdown of Non-Cash Payments by Number of Payments - G7, 2007

100% E-money payment
90% transactions
80% Card payments
70% (except e-money)
60% Cheques
50%
40% Direct debits
30%
20% Credit transfers
10%
0% Italy Japan United United
Canada France Germany Kingdom States

Source: Bank for International Settlements

However, notwithstanding this seemingly technologically-advanced payments infrastructure,
Japanese consumers make very few non-cash payments. Data on cash in circulation per person
(Figure 6) makes it clear that Japanese consumers are far heavier users of cash than their peers
in other countries. This suggests that the Japanese payments system may not be economically
efficient notwithstanding its technological advancement since consumers still find cash a
preferable means to exchange value.

Overall, the data indicates that the Canadian Canadians are confident in their
payments system is comparatively payments system. Public policy should
economically efficient. This leads to the ensure that innovation builds upon that
second core principle that must form the rather than detracting from it.
foundation of any recommendations or
reforms coming out of the Task Force.

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Submission to the Task Force for the Payments System Review – September 15, 2010

Figure 6

Banknotes and Coin in Circulation per Inhabitant, G7*, 2008

$8,000 $7,436 $3,324 $2,927
$7,000 Japan
$6,000 $1,444 $1,168
$5,000 Canada United Kingdom
$4,000
$3,000
$2,000
$1,000

$0

Euro area United States

Source: Bank for International Settlements.
Note: Euro area figure represents all Euro area countries.

In considering how to improve the efficiency of the Canadian payments system, the Task Force
should bear in mind that it is economic efficiency rather than technological efficiency that is of
paramount concern and that introducing substantial technological changes does not always lead
to greater economic efficiency.

Ubiquity – a Key Part of Payments Efficiency

A key component in building a payments system that is widely-used and widely trusted is
ubiquity. The payments system is a network (or series of networks) and its use and value is
governed by network economics. Put simply, the more broadly a payments network is available,
the more people will be interested in using it and therefore the more efficient the payments
system as a whole becomes. A network that is fractured may be more likely to offer novel
technological solutions to gain acceptance, but the system as a whole is less economically
efficient because users may only be able to use it within a limited region. As a result, they are
more likely to revert to cash as the key form of payment outside their own region because their
preferred form of payment may not be accepted. In a 2008 speech on the benefits of the Single
European Payments Area, a European Central Bank Board member highlighted the benefits of
ubiquity:

The benefits of a harmonized and integrated cards market are way too obvious to
oversee: standardisation, integration instead of current fragmentation and more
competition, means more choice for consumers (which schemes to use), more
choice for banks (which schemes to issue and to acquire and which processors
to use as well as access to cheaper technical infrastructure due to

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Submission to the Task Force for the Payments System Review – September 15, 2010

standardisation), more choice for retailers (which schemes to accept) and more
choice for infrastructures (which schemes to process).4

While she was speaking of the payment cards market, the point can be generalized over all forms
of payments – everyone benefits from ubiquity. That is one of the key strengths of the Canadian
payment system – every consumer knows that he/she can use virtually any of the principal forms
of payment from coast-to-coast and every merchant knows that it can reach virtually the entire
population of Canada by making available a few key payment channels. While some targeted and
niche payments solutions will always be a feature of the payments marketplace, in the absence of
a critical level of ubiquity, people will resort back to the one payment form that is universally
accepted – cash. This is a step backwards on the road to building a more efficient payments
system. The Task Force should consider the value of ubiquity of the existing payments
system as it examines options for payments system evolution.

Cross-Border Payments – An International Challenge

While Canada’s domestic payments system is relatively efficient, as are those of many other
countries, unfortunately for smaller-value payments that efficiency level diminishes if a client tries
to make a payment that crosses an international border. National payments systems are typically
domestic. They are designed primarily to transfer funds between individuals and institutions within
the same country. However, commerce is increasingly international and people are now more
mobile than ever. As a consequence, this limitation is an increasingly binding constraint. At
present, international transfers (excluding card purchases) are done largely through private
money transmission services (if they have a presence in both the sending and receiving country),
through wire transfers (which make use of the large value payments infrastructure) or by paper
instruments (mailing a cheque or money order). All of these present issues: private money
transmission services can be expensive and may have limited coverage, wire transfers are more
expensive than conventional smaller-value payments vehicles, and international cheques are
slow and present risks for both the payor and payee.

In the case of large-value payments, mechanisms have been developed to facilitate cross-border
transfers. Most notably, Society for Worldwide Interbank Financial Telecommunication (SWIFT)
provides a uniform international format and platform for large-value payments messaging. This
ensures that payment instructions can be seamlessly transmitted across national borders and can
be integrated into national payments systems that conform to SWIFT messaging standards.
While there are several entities that are presently trying to develop a similar standard for smaller-
value transfers (SWIFT, NACHA, etc.), a uniform standard has yet to emerge. For small, trading
nations such as Canada, it is advantageous to ensure that domestic standards are properly
aligned with international standards. The Task Force should review international standards
and assess their implications on the ability of Canadians to access payment systems.

4 “SEPA for cards”, Speech by Gertrude Tumpel-Gugerell, Member of the Executive Board of the ECB, EFMA Conference
on Cards and Payments, Paris, 9 September 2008. (http://www.ecb.de/press/key/date/2008/html/sp080909.en.html)

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Submission to the Task Force for the Payments System Review – September 15, 2010

Balancing Privacy with National Security

Trying to balance the sometimes conflicting objectives of maintaining privacy rights with tracking
the movement of money to guard against its use for criminal purposes is a challenge that policy
makers face constantly.

All payments services in Canada must comply with a highly-developed regulatory structure that is
designed to thwart attempts by criminal elements to transfer funds in order to finance their
criminal activities. In considering the present and future role of new payments services providers,
the Task Force should be cognizant of the importance of ensuring that new entrants be subject to
similar levels of scrutiny as existing players. A recent report by the international Financial Action
Task Force concluded the following:

Criminals have shown adaptability and opportunism in finding new channels to
launder the proceeds of their illegal activities and to finance terrorism. As the
Internet becomes more and more a worldwide phenomenon, commercial
websites and Internet payment systems appear to be subject to a wide range of
risks and vulnerabilities that can be exploited by criminal organizations and
terrorist groups.5

Criminal elements are drawn to these types of systems precisely because they believe they can
utilize them to move funds without attracting the attention of authorities. The report goes on to
conclude that in order to ensure that internet-based payment systems do not pose a higher risk of
use for illicit purposes, both the sector and its regulators must “understand the potential
vulnerabilities associated with commercial websites and Internet payment systems” and ensure
“appropriate risk-based measures with regard to customer identification, record keeping and
transaction reporting are taken.”6 As the Task Force considers the role of alternative payments
services providers in Canada’s payments system, it may wish to consider how to ensure that the
robust regulatory environment that has developed to monitor transactions is not compromised.

The Importance of Payments System Safety and
Soundness

The modern economy is built around the concept of efficient, uninterrupted access to funds held
in accounts. An efficient, reliable payments system rests at the core of Canada’s economy. As
noted earlier, it forms the foundation of the critical infrastructure that the financial sector
represents. Key elements of the payments system – LVTS, CLS Bank, CDSX and the settlement
operations of the Bank of Canada – are designated for direct oversight by the Bank of Canada

5 Financial Action Task Force, Money Laundering and Terrorist Financing Vulnerabilities of Commercial Websites and
Internet Payments Systems. June 18, 2008. P. 36.
6 Money Laundering and Terrorist Financing Vulnerabilities of Commercial Websites and Internet Payments Systems. P.
37

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Submission to the Task Force for the Payments System Review – September 15, 2010

because failure of those mechanisms would create “systemic risk” across the financial system.
Robust systems and procedures have been created so that parties can be certain of the reliability
of their counterparties and the certainty that initiated transactions will be settled. Procedures
ensure that even the failure of a participant in the system will not jeopardize settlement of
transactions currently in process. The Bank for International Settlements’ Core Principles for
Systemically Important Payments Systems articulates clearly the relationship between payments
system reliability and systemic stability.

Systemically important payment systems are an essential mechanism supporting
the effectiveness of financial markets. They can also transmit financial shocks.
Poorly designed systems can contribute to systemic crises if risks are not
adequately contained, with the result that financial shocks are passed from one
participant to another. The effects of such disruption could extend beyond the
system and its participants, threatening the stability of money markets and of
other domestic and international financial markets. Systemically important
payment systems are therefore crucial for the economy, and their safety and
efficiency should be objectives of public policy.7

While the importance of reliability of large-value payments systems is recognized and well-

understood, it is also the case that reliability and robustness of small-value payments systems is

a crucial ingredient in a well-functioning economy. Canadians have come to expect that they can

access funds either in the form of cash from an ABM or in electronic form through point-of-sale

transactions when they want, where they want, and in the amount they want. The average

Canadian bank customer now makes approximately three ABM or Interac Direct Payment
transactions per week8, or roughly one every two days. Businesses too have become

accustomed to accepting electronic payments, to the point where many retailers will no longer

accept payment by cheque. Any prolonged disruption of service in lower-value electronic

payments could cause an economic disruption. Liquidity issues in certain payment providers

could cause a cascading effect. People would not get paid. Purchases could not be made. Bills

would not be paid. And people will not have sufficient cash on hand to sustain themselves for any

length of time – the median Canadian resident now holds approximately $30 in bank notes on

hand at any given time, and 25% of Canadians have no cash on Safety and soundness
hand.9 This simply will not carry people over given that the are paramount and
must not be
average Canadian household now spends $164 per week on compromised.

the basic short-term necessities of life – groceries, medicine,
and gasoline for their car.10 This points to the third core principle

that the Task Force should use in guiding its review.

7 Bank for International Settlements, Core Principles for Systemically Important Payments Systems. January 2001. p. 4.
8 CBA estimate. Figure represents total annual ABM and debit card transactions by bank customers expressed on a per-
week basis divided by the population of Canada over age 15 adjusted multipled by the percentage of the Canadian
population with a bank account and by the banking industry share of total deposits.
9 Varna Taylor, “Trends in Retail Payments and Insights from Public Survey Results”, Bank of Canada Review. Spring
2006. p. 28.
10 Source: Calculated by CBA based on statistics from Statistics Canada Survey of Household Spending 2008. Figure
represents the median household spending for “Food Purchased from Stores”, “Gasoline and Other Fuels” for owned and
leased vehicles, and “Medicinal and Pharmaceutical Products” presented on a weekly basis.

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Submission to the Task Force for the Payments System Review – September 15, 2010

Banks recognize their central role in the economy and have robust business continuity plans in
place to ensure that they can continue to provide core services to their customers. Banks’
operational risk management, security, contingency planning, and outsourcing arrangements are
all subject to oversight by the Office of the Superintendent of Financial Institutions. Non-financial
institution payment service providers typically face no similar oversight so their reliability and
robustness is often unknown, either to regulators or to the users of these services. If unregulated
providers underinvest in security and fail to build a resilient payments service, consumers and
businesses begin to lose confidence in the payments system in general and begin to migrate
back to paper instruments. This would have broad negative economic consequences. Recall that
Global Insight11 found that electronic payments have contributed $107 billion to the Canadian
economic growth in the last two decades. Presumably the reverse is also true – a migration away
from electronic payments would shrink the economy by a similar amount. Clearly, compromising
safety and soundness would have a significant, negative ripple effect through the entire economy.

In a recent paper co-authored by the European Central Bank and the Federal Reserve Bank of
Kansas City, the authors highlighted the importance of ensuring that consumers understand the
risks associated with alternative payments systems, stating that “From the perspectives of
consumer protection, and of safeguarding public trust in payments instruments, it is important that
all parties involved have a clear understanding of the risks involved in the various solutions, so
that they can choose the service most suitable to their individual risk preferences.”12

One of the key strengths of the Canadian payments system is safety, soundness, and reliability.
The success of any national payments network is grounded on these three characteristics. When
considering the future of the payments system, the Task Force needs to consider if
measures need to be put in place to ensure that new technologies or new entrants do not
compromise the safety, soundness, and reliability of the system, or consumers’
confidence in it. In addition, the Task Force should consider what performance standards
all payments services providers should be held to, what disclosure standards should be
required and whether disclosures and other measures are needed to assist consumers in
making informed choices about their payment channel and service provider.

Effective Disclosure

In addition to the volume of disclosure, the channel through which disclosure is provided also
forms part of an effective disclosure regime. In Canada, consumers and merchants receive
comprehensive and detailed disclosure of terms and information from regulated payment system
participants, particularly card issuers. While there is no shortage in the volume of disclosure
made available to consumers, there are issues related to the amount of disclosure and how that
disclosure is required to be made that the Task Force could examine. The Task Force should

11 The Benefits of Electronic Payments in the Canadian Economy: A White Paper Prepared by: Global Insight Visa
Canada Association.
12 European Central Bank Oversight Division and Federal Reserve Bank of Kansas City Payments System Research
Function, Nonbanks in the Payments System: European and U.S. Perspectives. FRB Kansas City Working Paper 07-01,
May 2007. p. 43.

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Submission to the Task Force for the Payments System Review – September 15, 2010

consider the merits of functional equivalency between electronic and paper channels for
the provision of information or product changes as a component of effective and efficient
disclosure. The recently published Electronic Documents (Banks) Regulations under the Bank
Act are a good start toward meeting the preferences of consumers who favour electronic
channels. We encourage the recognition of electronic delivery of communications as equal to
more traditional, physical options.

Fighting Financial Crime

It is an unfortunate truth that every new payments innovation is typically followed shortly by a new
variant of financial fraud designed to try to steal money from its users. An entirely new lexicon has
arisen in the last decade to describe the sorts of activities that criminals have devised to make
people unwitting victims of financial fraud – skimming, phishing, spoofing, trojans, bot-nets, man-
in-the-browser, and the list goes on. While financial institutions have put in place robust security
measures, unfortunately there are always victims who fall prey to the perpetrators of such
attacks. In 2009, fraud losses to financial institutions from credit and debit cards alone totalled
over $500 million.13 Added to this are losses through other channels such as cheques and on-line
banking. Provided that the customer has not contributed to the fraud, the customer bears no
liability for the loss so this is a cost borne by the financial institutions.

Losses, however, only convey one small dimension of the cost of fraud to financial institutions. A
much larger component is fraud prevention, including staff and technology designed to reduce the
likelihood of a successful fraud being perpetrated and education efforts to help payments system
users protect themselves from becoming victims of fraudsters. In addition, since fraud represents
a risk element, banks hold capital against it as a financial risk management tool. Taken together,
the total cost of fraud management at Canada’s banks is approximately $900 million annually.
Clearly, fraud management is an issue that the banking industry takes very seriously. To be in the
payments business in this day and age, a firm must be willing to make the investments necessary
to manage fraud and to compensate clients who become the unwitting victims of fraud. Statistics
show that Canadians recognize the security of the payments system in Canada and have
confidence in it. A recent survey conducted by the CBA found that more than eight in ten
Canadian believe that all four major small value payments channels – cash, cheques, credit cards
and debit cards – are secure.14 Moreover, when asked about how they choose to send money to
friends or relatives, the number one factor influencing that choice among all those who use
something other than cash was security.15 If consumers are not confident that they have recourse
in the instance that they fall victim to financial fraud, they will not use electronic payments
technologies which has strong, negative consequences for the economy. The Task Force
should examine the standards in fraud management that payments services providers are

13 Sources: CBA (credit cards) and Interac (debit cards).
14 Source: CBA Survey August 2010. Figures by channel – cash: 89%, cheques: 85%, credit cards: 82%, debit cards:
80%.
15 Source: CBA Survey August 2010. Figures by channel – cash: 20%, cheque or money order: 35%, electronic payment:
30%, other channel: 38%

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Submission to the Task Force for the Payments System Review – September 15, 2010

required to meet in order to provide payments services and assess whether there are
minimum standards that all providers should be required to meet.

In the United States, the federal government has taken a lead role in bringing industry and law
enforcement together to take a coordinated approach to finding and bringing to justice
perpetrators of e-crime. Organizations such as the U.S. National Cyber-Forensics Training
Alliance (NCFTA) have been established that bring financial institutions, IT security researchers,
and law enforcement all under one roof to provide an integrated approach to thwarting e-crime.
While an attempt is being made to replicate this model in Canada, the synergy that exists
between industry, government, and law enforcement needed to make it work has yet to form. The
Task Force should consider whether additional steps should be taken to bring together
government, industry and law enforcement to combat e-crime.

One area of vulnerability where more work can and should be done is in fighting international e-
crime. While the Canadian government is taking laudable steps in this direction by enacting
legislation to make identity theft and malicious spam crimes, the challenge of bringing
perpetrators to justice remains. E-crime perpetrated across borders is a particular challenge
because the criminals may reside on the other side of the world but the victims are here in
Canada. In order to address these challenges, governments and law enforcement must develop a
mutual understanding of the importance of pursuing the perpetrators of electronic financial fraud
even if the victims are outside their borders. The Task Force should consider how the
government can take a leadership role in strengthening international efforts to bring e-
criminals to justice.

Assessing Liability in a Many-Layered Payments Environment

In the instance that a successful fraud is perpetrated on a payments system user, the growing
complexity of the payments system can make it difficult to assess who is liable for compensating
the client for their loss. Consider the following situation:

A consumer arranges to transfer funds from their credit card to a third party
payments services provider which, in turn, moves money to the account of the
final recipient. Somewhere along the way, the consumer’s financial information is
compromised and money is stolen from the client’s account.

In this transaction there a number of different service providers, any one of which may be fully or
partially liable for the loss: the consumer, his/her bank, the credit card network, the third party
payment services provider, and the recipient’s bank. Moreover, these service providers often
have no relationship with each other and may not even be aware that they are part of the chain of
players involved in making this transaction happen. In an instance such as this, it is likely that the
consumer is the only player with complete knowledge of the chain. If one assumes that the
consumer does not knowingly contribute to the fraud and should be compensated, the question
then becomes “By whom?”. At present, there is no system-wide mechanism (other than the
courts) to assess and apportion liability and to ensure that those deemed to be liable make the

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Submission to the Task Force for the Payments System Review – September 15, 2010

consumer whole. While there are individual arrangements and mechanisms between the
customer and many of the system participants, there is no system-wide forum for making a
single, overall decision on liability. As a consequence, the burden of compensation falls
disproportionately on the financial institution since it has the account-level relationship with the
client notwithstanding the fact that it typically is the most secure element in the payment chain
and the one subject to the most oversight. As new players continue to enter the payments
services business, and add additional layers of intermediation, this problem is going to become
more acute. The Task Force should consider the principles that should govern the
apportionment of liability in cases involving fraud given the ongoing changes in the
payments system.

Better Tools for Authentication

One of the challenges banks face in providing safe on-line banking and payments functionality to
clients is authentication. On-line banking is conducted remotely from the bank, so the bank must
rely on authentication technologies to verify that the person logging in as the client is indeed who
they say they are. Banks have developed a variety of authentication tools beyond the PIN and
password to help reduce fraud losses such as challenge questions and other similar verification
techniques. In addition, some banks made available to clients specialized software to reduce their
vulnerability to malware and other devices that could compromise their account access
credentials.

While the measures that banks have taken have been effective, the challenge of authentication
will only grow as the point of service increasingly moves away from environments controlled by
institutions (branches, ABMs) and towards environments controlled by the customers themselves
(PCs, mobile phones, PDAs, etc.). This points towards the importance of authentication across
the system. The United States government has realized the importance of authentication and, in
June 2010, developed a draft National Strategy for Trusted Identities in Cyberspace16. The
National Strategy highlights secure and robust methods for widely-accepted client identification
and authentication mechanisms as a key component in creating an on-line environment that is
conducive to innovation. While this could include the creation of new forms of identification, the
National Strategy makes it clear that that is not a requirement. Rather, the strategy focuses on
making better use of existing forms of identification, broadening interoperability of acceptable
forms of identification, and providing customers with an easy way to be informed that the entity to
which they are providing their information is taking sufficient steps to protect it. The Task Force
should review recent developments in on-line authentication and identity management
systems and assess whether additional measures are needed to improve identity
management in Canada.

16 Available on-line at http://www.dhs.gov/xlibrary/assets/ns_tic.pdf

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Submission to the Task Force for the Payments System Review – September 15, 2010

Meeting the Needs of Consumers and Merchants

Millions of times each day, Canadians send and receive electronic debits (e.g. electronic bill
payments) and credits (e.g. direct deposits), use credit cards, debit cards, cheques, pre-
authorized payment agreements, and make other payments. The payments system ultimately
exists to serve the needs of Canadians and businesses. There are a wide variety of payment
options available which gives users great accessibility and flexibility. Consumers and merchants
have continual access to one of the most affordable, easily available and reliable payments
systems in the world as witnessed by the extensive use it enjoys (see “Efficiency of the Canadian
Payments System”, p. 12).

Consumer Choice

Competition and consumer choice are the hallmarks of Canada’s payments system operated by
the financial services industry. Market penetration rates for payments services in Canada are
substantial.

 96% of Canadians aged 18 and over have a savings, chequing or other account with a
financial institution that they can use to write cheques, pay bills, or transfer money without
having to handle cash.17

 94% of Canadians have a debit card to use at point-of-sale or at ABMs to make
transactions.18

 82% of Canadian households have at least one major credit card.19
 45% of Canadians use on-line bill payment as their primary tool for paying bills.20

Moreover, market penetration by new entrants is growing substantially. On-line payment provider
PayPal indicates that it now has more than four million users in Canada.21 Clearly, Canadians
have options and are making use of those options. And Canadians realize that they have choice.
The CBA recently conducted a survey to assess Canadians’ usage of, and attitudes towards, the
payments system. The results were telling. The overwhelming majority of Canadians (91%)
believe that they have a sufficient amount of choice when it comes to making payments, and
slightly over half (53%) believe there is a good deal or great deal of choice. Interestingly, this
proportion increased as the age of the respondent decreased. This finding is consistent with the
evolution the payments system – new payments technologies are emerging to serve the internet
economy, and the principal participants in that economy – the young – are the earliest adopters.

17 Financial Consumer Agency of Canada, General Survey on Consumers' Financial Awareness, Attitudes and Behaviour
2006. (http://www.fcac-acfc.gc.ca/eng/publications/surveystudy/attbehav2006/AttBehav2006_toc-eng.asp)
18 General Survey on Consumers' Financial Awareness, Attitudes and Behaviour 2006
19 Statistics Canada Survey of Financial Security 2005.
20 Canadian Bankers Association, “Record number of Ontarians banking online”, July 28, 2010.
(http://www.cba.ca/en/media-room/65-news-releases/524-record-number-of-ontarians-banking-online)
21 “More than one-third of Canadians using cash, cheques less frequently”. PayPal Canada news release, June 22, 2010.

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Submission to the Task Force for the Payments System Review – September 15, 2010

While Canadians are generally satisfied with the choice available to them in payments, the survey
also found that there are some areas where options are limited. Most notably, while a significant
proportion of Canadians report that they still use cheques (62%); when asked why, the most
common response by far (43%) was that they use them in instances where no other means of
payment is accepted. When asked whether they would prefer to use another payment technology
if it were available, nearly half (48%) said they would. This could suggest that, to the extent there
is a bottleneck in payments system choice, it is not a function of a lack of product innovation or a
lack of consumer demand but rather slow acceptance of new payments technologies among
those businesses that accept payments. The Task Force should examine why some sectors
are still largely dependent on paper instruments as their primary payments technology.

Payment Options for Merchants

For merchants, the range of payment options currently available including debit and credit cards
and other electronic payment tools have meant increased business. The more payment options
consumers have, the more likely they are to make purchases. As noted earlier, research
suggests that over the last two decades, $60 billion of the increase in personal consumption
expenditures was directly attributable to electronic payments both from credit cards ($49.4 billion)
and debit cards ($10.4 billion) because of the transactional efficiencies they create. There are
also security benefits for merchants when alternative payment options to cash are selected by
consumers as well as reduced costs for not handling cash (which is expensive). Accepting a
variety of electronic payment methods allows merchants to sell their products on-line and expand
their customer base across Canada or even worldwide. Electronic payment options are valuable
tools that make doing business easier for merchants and their customers.

Since merchants share in the benefits of an efficient payments system, they also share in the
costs. This is one of the features of the payments system – all parties that benefit from it pay a
fee for using it, with the competitive market being the ideal arbiter of what that fee should be.
Market forces set prices and directs investment to its best use. It is important to remember that
our payments market functions very well and there are always unintended consequences when
restrictions are imposed on highly competitive and well-functioning markets. The resulting
unintended consequences can have negative impacts on consumers and merchants, some of
which cannot be predicted in advance.

One segment where merchant and consumer adoption of new payments technologies in Canada
appears to be slow in coming is in the area of on-line payments. While acceptance of major credit
cards by on-line merchants is commonplace, acceptance of on-line debit payment products by
merchants is limited notwithstanding the widespread popularity of debit cards among Canadians
in the physical retailing space. A recent survey of Canadians by on-line payment services
provider PayPal suggests there is consumer demand for alternatives. The survey found that 40%
of Canadians who shop on-line have abandoned their shopping carts prior to completing their

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Submission to the Task Force for the Payments System Review – September 15, 2010

transaction because their preferred method of payment was not available.22 The comparable
figure for the United States was only 24%.23 A survey conducted by the CBA also points to the
desire of Canadians to have alternative on-line payment choices. When asked why consumers
who use on-line payments services providers opted to do so, the most common response (39%)
was that no other payment form was accepted.24 This may suggest that there is demand for
alternatives, and on-line debit would seem to be an obvious choice given Canadians’ affinity for
direct debit. The Task Force should explore the trends in usage and acceptance of on-line
debit payment in Canada and the factors influencing its use, including whether Canada
and Canadians face any competitive issues or constraints.

Innovation – A Challenge and an Opportunity

There is no question that the payments space is experiencing a surge of innovation
internationally. Whether it comes in the form of web-based payments technologies, near-field
communications applications, SMS-based technologies, or others, clearly consumer choice in
payment options is expanding. This presents both an opportunity and a challenge for payments
system operators and for policy makers.

New payments technologies have provided a new mechanism to improve the payments service
experience to clients who have used alternative methods and to extend payment services to
those who had previously been unserved. The M-PESA experience in Kenya is illustrative of the
benefits of innovation and the economics that drive it. M-PESA is a mobile phone-based person-
to-person and consumer-to-business payments system that has experienced rapid growth in
Africa. Having launched in 2007, by 2009 it had reached approximately 38% of Kenya’s adult
population. M-PESA allows clients to pre-fund M-PESA accounts through a network of over
12,000 agents across the country. To understand the success of M-PESA, one needs to
appreciate the environment in which it is operating.

 Kenya’s population is largely unbanked. In 2009, only 23% of Kenyan adults held a
conventional bank account. Therefore, there was a large segment of the Kenyan population
that was unserved or underserved by conventional payments services providers.

 The alternatives for transferring funds among the unbanked population are expensive. The
chart below outlines the cost of transferring funds using M-PESA compared with other
alternative services available to Kenyans. While transfers using M-PESA are not free, it is
competitively priced relative to the incumbent services (M-PESA uses a sliding scale tariff

22 “New PayPal Survey Reveals Why Canadians Abandon Purchases When Shopping”, PayPal Canada news release,
June 24, 2009.
23 “New PayPal Survey Reveals Why Online Shoppers Abandon Purchases”, PayPal news release. June 23, 2009.
24 CBA Survey August 2010.

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Submission to the Task Force for the Payments System Review – September 15, 2010

but, for illustration, the cost of transferring the equivalent of $100 between M-PESA
customers is approximately 1% or $1).

Source: William Jack and Tavneet Suri, Mobile Money: The Economics of M-PESA. October 2009.

M-PESA services a market segment that was previously underserved in a market that was
broadly underdeveloped in the area of payments and, as a consequence, is able to charge a fee
that is sufficiently high to allow it to gain an acceptable rate of return for doing so. This dynamic is
key for a new payments system such as M-PESA to develop. Payments is a two-sided market so
any payments product must be able to charge a price, either to consumers or merchants or both,
that attracts both consumers and merchants to participate while offering the network operator a
sufficient rate of return to justify the investment. Unless all of those conditions are in place, any
new payments network will falter.

The need to find a successful product and pricing strategy presents a particularly challenging
obstacle to new payments technologies in a country such as Canada because the existing
payment technologies are widely-used by Canadians and are competitively priced. The last
decade has seen innovative, high-profile payments services such as Mondex and Dexit fail to
catch hold because they could not convince sufficient numbers of consumers and/or merchants
that they offered an attractive value proposition in the face of the well-established and efficient
alternatives.

The Role of Public Policy in Payments Innovation

All of this begs the question of the role that public Innovation should be enabled
policy should play in payments system innovation. but not directed by the
This leads to the final key principle upon which the regulatory and legislative
Task Force should base its work. environment.

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Submission to the Task Force for the Payments System Review – September 15, 2010

Innovation is not an end product on its own but rather is a by-product of a competitive market.
Individuals and firms develop and market innovations in order to gain customers and make
money. In doing so, they also improve the customer experience, expand the market, and grow
the economy. Therefore, if the desired public policy outcome is to spur innovation in the
payments system while having continued regard for the safety and soundness of the system, the
public policy response should be to make policy choices that reinforce competitive pressures in
the payments system while ensuring broad adoption of standards for safety and soundness that
keep the system resilient.

Debit Card Market Evolution

While this principle sounds simple, in practice it can be challenging to implement because
competition brings about change, which, in turn, creates uncertainty. The debit card market in
Canada is in the midst of significant change. Visa and MasterCard are entering the debit card
marketplace in Canada with new product offerings built on their international platforms. In
response, Interac has received permission to transition from a not-for-profit association to a not-
for-profit corporation in order to allow it to better compete with its for-profit rivals (although it has
yet to do so).25 At some point, the Competition Bureau may remove its restrictions on Interac
engaging in for-profit activities provided that the Bureau is satisfied that doing so would not raise
any competition-related concerns, which is a necessary step for Interac to compete on a level
playing field with Visa and MasterCard. The changes that competition in the debit card market will
bring for consumers and merchants has been the subject of substantial debate in Canada and is
likely to continue to be for some time. The Task Force should consider the competitive and
public policy issues in the Canadian debit card market, and their impact on innovation.

Phasing Out Existing Payments Products

In the case of a product or service phase-out, the government may need to play a role with
industry to ensure that the phase-out is both permissible by law and fully understood by
consumers. Competitive and legal considerations can make it difficult for sector participants to
make a collective decision to withdraw a product or service from the marketplace, even if better
alternatives exist.

From a banking industry perspective, electronic payments technologies are almost always
preferable to paper-based payments technologies and banks frequently encourage customers to
use them. Electronic payments are faster and more secure. Notwithstanding the benefits of
electronic payments, paper instruments still represent approximately 16% of the total volume of
instruments flowing through the Canadian Payments Association’s Automated Clearing and
Settlement System.26 That is driven in part by familiarity but is also driven by economics. The

25 “Commissioner of Competition Announces Decision in Response to Interac's Request to Vary Consent Order”
Competiton Bureau press release, February 12, 2010. http://www.competitionbureau.gc.ca/eic/site/cb-
bc.nsf/eng/03198.html,. Note: CBA’s understanding is that substantial changes to Interac’s corporate structure requires
unanimous support of Axcsys shareholders.
26 Source: Calculated from statistics found on the CPA website.

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Submission to the Task Force for the Payments System Review – September 15, 2010

benefits of speed and security accrue to the payee, but from the payor’s perspective, cheques
and other paper instruments are still attractive payment tools because they can be less expensive
and easy to use.

Within Canada, the problems associated with certified cheques present an example of this
paradox. Certified cheques are a paper instrument and, like all paper instruments, are at risk of
being counterfeit. Notwithstanding that, they are still used commonly in many areas such as real
estate. While more secure products exist such as wire transfers and bank drafts, a combination of
familiarity and inertia continues to drive consumer demand for certified cheques. Institutions can
and do highlight the availability of alternative payments tools to clients who frequently write and
receive certified cheques; however, it is extremely difficult for any single institution to withdraw the
product because it risks losing the business of those clients. The Task Force should review the
usage of paper-based payments instruments such as cheques in both a Canadian and
international context and assess the options that have been considered concerning the
future of these instruments, including the viability of possible electronic vehicles that
could be considered as substitutes. As part of this analysis, the Task Force may also wish to
examine the impact that migration away from paper-based payments instruments would have on
segments of the economy that are heavy users of those instruments and what could be done to
address those impacts.

The contrasting experiences of the UK and Ireland with their initiatives to phase-out cheque
clearing presents a useful case study in how government involvement can help in instances
where it is determined that a product or service has outlived its usefulness and should be
withdrawn from the market.

 In late 2009, the UK Payments Council (an industry body) announced that a decision had
been reached to end interbank cheque clearing by 2018 and that a plan had been developed
to manage the migration away from cheques. That plan immediately attracted the attention of
both legislators, who held Parliamentary hearings on the issue, and the UK Office of Fair
Trading, which indicated that it may review the decision to assess whether the members of
the Payments Council violated UK competition law.27

 In 2008, the Irish Payments Services Organization (an industry body) and the Irish Ministry of
Finance jointly announced a decision to phase-out the use of cheques in Ireland by 2016.
The Irish government provided mechanisms to help expedite the transition by increasing its
“stamp duty” (i.e. flat-rate tax) on cheques and reducing an existing stamp duty on debit
transactions in order to expedite the transition away from cheques.

Clearly, from an industry point of view, the latter scenario is preferable to the former. It ensures
that public and private efforts complement each other.

27 “Cheques could yet be saved from extinction after watchdog sounds the alarm”, Daily Mail On-Line, January 10, 2010.

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Submission to the Task Force for the Payments System Review – September 15, 2010

Ensuring the Law Keeps up to the Technology

A hallmark of the federal legislative regulatory framework for financial services has been the
desire to ensure that it continues to be up-to-date, balanced and responsive to ongoing industry
developments. Historically, policymakers have been sensitive to the risk that overly rigid or
outdated regulation could have negative implications on competition and efficiency. The goal has
been to strike an appropriate balance between allowing market forces to provide the broadest
possible access and choice for consumers while at the same time ensuring that protections are in
place to guard against risks in the system.

To strike this balance, governments have periodically undertaken a systemic review of the
regulatory framework to ensure that it continues to be as efficient and effective as it can be. The
sunset provisions in federal financial institutions legislation reflect this ongoing approach.
However, the payments system has not been subject to a substantive review for many years and
some legislation has therefore fallen behind the times. For example, the Bills of Exchange Act,
which is probably the central piece of payments legislation in Canada, was enacted in 1890 and
is unchanged in many key areas. To put in context how much the payments system has grown
and evolved since that time, in 1892 the total value of interbank clearing in Canada for the entire
year was just over $1 billion ($1.05 billion).28 Clearly, the world has changed and the system has
evolved. As a consequence, the language in the Act is often unreflective of how a modern
payments system operates. This can create legal pitfalls and uncertainties for payments system
participants and for payments system users. For example, in 2008 it came to light that the Bills of
Exchange Act allows for cheque writers to “cross” a cheque (putting two diagonal lines through
the cheque) to make the instrument non-negotiable so that the only option for the payee is to
deposit the cheque at his/her branch. While common in some other countries, the practice is
virtually unknown now in Canada. As such, if cheque-crossing had suddenly come in vogue, it
would have created a number of technical challenges and would have required a massive
education effort on the part of institutions and the government to ensure that both cheque writers
and cheque recipients understood the ramifications of crossing a cheque (since there are
implications for both). The timing is appropriate for the Task Force to assess whether the
payments system would benefit from a review process similar to that which has historically been
used to review financial institutions legislation.

The Task Force should consider whether processes need to be put in place to ensure that
the payments system legislative and regulatory environment is kept evergreen to meet
needs of the evolving payments system.

Developing a more Holistic Approach to Governance

The discussion about the relationship between the current legislative and regulatory structure and
technology leads to a broader question about governance and oversight of the payments system.
The historical approach to governance in the payments system has been a combination of self-

28 Journal of the Canadian Bankers Association, Volume 1, September 1893. p. 224.

28