VdN - 22/05/01

Euro-retail payments at crossroads?

Jozef Van den Nieuwenhof

Euro-retail payments at crossroads? .................................................................. 2

The payment industry is the most important industry in the world ................................ 2
Generic payment solutions: cash vs. electronic, domestic vs. euroland ....................... 3
Discerning technological tendencies can highlight payment solutions for the
future....................................................................................................................... 4
Enhancing present systems only is not the way ahead ....................................... 5
ICT: "You ain’t seen nothing yet!" ........................................................................ 6
Storage Capacity today ......................................................................................................................... 6
Telecommunications Speed today ........................................................................................................ 6
Number of IP Addresses in IP v.6 ......................................................................................................... 6
Theoretical Processing Power with existing technologies..................................................................... 6
When will we reach the "Point of Singularity"?...................................................................................... 7
Pervasive computing brings about disruptive changes ........................................ 7
Ubiquitous telecommunications .................................................................................... 7
XML............................................................................................................................... 8
Bluetooth ....................................................................................................................... 9
The networked business environment .............................................................. 10
The mathematics of networks ............................................................................ 10
Will customers become technophiles very soon? .............................................. 11
Payments are part of a value chain, not stand-alone operations ....................... 12
Private customers and the value chain ....................................................................... 13
Corporate customers and the value chain .................................................................. 14
Practical conclusions from these tendencies ..................................................... 16
Are banks on the right track?............................................................................. 16
"A Lombard banker of the 14th century would still recognise the system of
correspondent banking today" ........................................................................... 16
Is a P2P Payment Gateway the solution?.......................................................... 18
A Payment Gateway could cover most of the transaction scenarios .................................................. 18
A Payment Gateway could manage trust............................................................................................ 19
A Payment Gateway could prepare and initiate clearing and settlement............................................ 19
A Payment Gateway could prepare integrated transaction reporting ................................................. 19
"The network is the computer" ........................................................................... 19
The advantages of VIPs: Value-chain Integrated Payments.............................. 20
VIP Scenario 1: Remote real-time............................................................................... 21
VIP Scenario 2: Remote deferred ............................................................................... 23
VIP Scenario 3: Face-to-face / Person-to-person ....................................................... 23
Corporate governance of payment systems..................................................... 24
Who will manage the new payment infrastructure? ........................................... 24
Where value lives in a networked world............................................................. 26
Back to basics: Standards and Procedures ....................................................... 26
The need for a blueprint...................................................................................... 27
But beware of technicians.................................................................................. 27

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 VdN - 22/05/01

Euro-retail payments at crossroads?

The payment industry is the most important industry in the world

• The turnover of the payment industry is higher than the combined turnover of all other
economic sectors together. Indeed, for each commercial transaction there is a
corresponding payment.

• The payment industry is the most diverse industry in the world. For every transaction
scenario, remote, face-to-face, deferred or real-time, a corresponding payment
mechanism exists. Financial institutions do not invent payment systems for the sake of it.
They create payment systems based on the very diverse and complex requirements of
administration, commerce, trade and transport.

Moreover, in our economic system, the payment industry can be considered as a vital
infrastructure, such as railroads, motorways and telecommunications.
This means that "corporate governance" of this industry is a complex matter.

With the publication of "The Core Principles for Systemically Important Payment Systems",
the central banks1 clearly subscribed this complexity.

Today, the European payment industry is in turmoil. First of all because of the massive euro
conversion.
It is true that the cross-border payments volume remains quite marginal as compared to
domestic payments. But there will be a strong political and societal pressure, quite
understandably, to abandon the local domestic concept, to consider all euroland payments as
domestic. Why should non-cash payments be different from cash payments, in euro, in
euroland?

But also because of the ongoing ICT2 evolution. This leads to all kinds of new and fancy hi-
tech payment instruments, some of them even developed completely outside the financial
industry.
A vital national and European infrastructure cannot afford to be subject to the whimsical
development of new gadgets and new players. Trust is vital for payment systems.

There is a serious need for:

• Generic and uniform euroland non-cash payment solutions;

• built on solid future-oriented technological tendencies;

• and based on correct and generally accepted "corporate governance" principles.

1The Committee on Payment and Settlement Systems (CPSS) of the central banks of the
Group of Ten countries (G10) (Bank for International Settlements in Basle).

2 ICT: Information and Communication Technology

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 VdN - 22/05/01

Generic payment solutions: cash vs. electronic, domestic vs. euroland

There is no European payment industry yet. Official statistics clearly indicate that payment
habits are very diversified. So are corresponding infrastructures, standards, laws, regulations
and users’ habits. Unifying all these bottom-up, i.e. linking while maintaining existing
domestic instruments and systems, is a chimera.
Moreover, it would not be effective, because existing systems have only been adapted to new
ICT evolutions, but make no use of all of the possibilities. In short, they are barely adapted to
the e-i-m3 world.

3 D \ P H Q W+ D E LWV    

Country Transfers Cheques Direct Debit Cards

Belgium 54.00 7.00 9.30 29.70
Germany 50.50 4.80 39.50 5.20
France 18.30 45.30 14.80 21.60
Netherlands 45.00 1.90 28.50 24.50
UK 19.30 28.10 19.40 33.10
US 3.70 70.00 2.00 24.30
C o m m itte e o n P a ym e n t a n d S e ttle m e n t S y s te m s - F e b ru a ry 2 0 0 0 - S ta tis tic s o n P a y m e n t S y s te m s in th e G ro u p o f T e n C o u n trie s - fig u re s fo r
1998

3 D \ P H Q W+ D E LWV    

Country Transfers Cheques Direct Debit Cards

Belgium 51.90 5.80 10.20 28.90
Germany 50.60 4.00 40.20 5.20
France
Netherlands 41.60 1.00 28.90 28.60
UK 17.60 29.00 18.90 34.60
US 3.20 68.60 1.70 26.60
C o m m itte e o n P a y m e n t a n d S e ttle m e n t S y s te m s - M a rc h 2 0 0 1 - S ta tis tic s o n P a y m e n t S y s te m s in th e G ro u p o f T e n C o u n trie s - fig u re s fo r 1 9 9 9

Building a new infrastructure, top-down, might be more effective and more efficient. Most
building blocks exist.

The business case for such a new, top-down, euroland payment system is overwhelming:

• The European Parliament and the European Commission urge, rightly so, for affordable
European instead of domestic payment systems;

• The existing domestic payment systems are very often cross-subsidised by banks, and
are not self-supporting;

3 Electronic - interactive - mobile.

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 VdN - 22/05/01

• The charges for existing payment systems are not equally distributed between all parties
concerned;

• The use of cash should be seriously restricted, because its societal financial cost is not
justified anymore.

Studies indicated that the cost of cash takes away a significant part of GDP. With electronic
alternatives available, society cannot afford to use cash anymore. The State of Singapore
already decided to make electronic payments legal tender in 2008. This is a praiseworthy
initiative.

Even central banks agree, albeit at a cost.

"Yet we must also recognise that a diversion of seigniorage4 may be an inevitable by-product
of creating a more efficient retail payment system in the long run".5

But: “Alas! How deeply painful is all payment!”6

Designing and operating payment systems is not a popular task. Nobody likes to pay, so
nobody likes payment systems. To ease this pain for customers, payment systems need to
be cheap, agreeable and user friendly.

Discerning technological tendencies can highlight payment

solutions for the future

There are two ways to think about the future. One way is to describe all kinds of science-
fiction scenarios. Let us avoid this, and try to follow a more academic or at least a more
systematic way for discerning future tendencies.

Indeed, over a 10-year time span, 4 out of 5 new technological concepts or brands disappear,
or go bankrupt. Discerning the lasting and generic ones is of vital importance.

One of the most famous bankers in the world, Mr. Alan Greenspan, states that:
« The newest innovations, which we label information technologies, have begun to alter the
manner in which we do business and create value, often in ways not readily foreseeable even
five years ago. »7

As the reason appears to be ICT, we have a clue as for where to start the analysis.
Therefore, the suggestion is to look first at technological change. Will technology bring about
sustaining change, or disruptive change?

We will try to prove that pervasive computing is here to stay and to develop, and that
networks are the key. Critical mass is less of a problem.

4"Seigniorage can be estimated by multiplying notes and coins outstanding (non-interest-

bearing central bank liabilities) by the long-term rate of interest on government securities (a
proxy for the return on central bank assets)." (Bank for International Settlements)
For Belgium the annual seigniorage cost can be estimated at EUR 13,000,000,000 * 5%,
equals EUR 700,000,000.

5 Alan Greenspan - U.S. Treasury Conference, Washington D.C., September 1996.

6 Don Juan - Lord Byron.

7 Alan Greenspan, Chairman, Federal Reserve Board, May 6, 1999.

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 VdN - 22/05/01

We will try to prove that bank customers will become technophiles.

Most of all, we will try to prove that we need a system view on the whole value chain, instead
of concentrating only on payments. We will have to introduce JIT8, meaning zero latency and
STP9, in the whole value chain in order to obtain maximum synergy.

Are banks ready to achieve this? Are payment system developments on the right track?

Enhancing present systems only is not the way ahead

Technological innovations are not predictable.

« When we discovered petroleum, we did not know that, one day, we were going to make
Tupperware boxes out of it »10

We can make guesses about the speed of change. It is however more difficult to make a
guess about the direction of change. Unforeseen results are possible. Serendipity might
change courses mid-way.

The most important question is: “Will technological change be sustaining or disruptive?”
It appears that:
“One of the deadliest of corporate shortcomings is incrementalism - the pervasive sentiment
in big, bureaucratic companies that this year's goal is to continue to do what we've done
before, only "do it better".
Successful companies today realise that change is the new order and innovation is the
primary driver.”11

8 Just In Time.

9 Straight Through Processing.

10 Unknown businessman when asked about the impact of e-commerce on his business.

11Harvard Business Review - May-June 1992 - Corporate Redemption and the Seven Deadly
Sins - Andrall E. Pearson.

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 VdN - 22/05/01

ICT: "You ain’t seen nothing yet!"

Let us look at some realistic technological tendencies. Forecasts tell us that we «ain’t seen
nothing yet». On all domains, storage capacity, telecommunications speed, addressing
technology as well as processing power, we are only at the beginning.

Storage Capacity today

• 80 Gbyte/sq.inch = 80,000,000,000 bytes/inch

• Which means 80,000 pocketbooks of 300 pages (40 lines of 80

char.) on 1 square inch

Telecommunications Speed today

• Optical cables: 5.2 terabits/sec

• Which means 600,000,000,000 bytes/sec

• And 600,000 pocketbooks of 300 pages in 1 second

• Wireless UMTS: 2,048,000 bits/sec

• Which means 0.25 pocketbooks of 300 pages in 1 second

Number of IP Addresses in IP v.612

• 340,282,366,920,938,463,463,374,607,431,768,211,456

• which is 2128 , or a third of a duodecillion

• Which means that every grain of sand on the surface of the Earth
can be addressed several times, or

• About 4 billion addresses for each of 4 billion people on each of 4

billion planets in each of 4 billion galaxies13

Theoretical Processing Power with existing technologies

• 3/2 .1012 MHz

• Which means 1,000,000,000 times the power of today top PC (1,500

MHz)

The possibilities of technology will expand exponentially, and there is no end in sight. On the
contrary, progress seems to speed up, rather than slow down.

12 Internet Protocol version 6.

13 Upgrading the Internet - The Economist Technology Quarterly - March 24th 2001.

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 VdN - 22/05/01

When will we reach the "Point of Singularity"?

5 H D F K LQ J WK H S R LQ WR I©¬V LQ J X OD ULW\ ¬ª"

N u m be r
of n ew
in ven tion s

F u tu re

Historians tell us, based on statistical and empirical experience, that the speed of innovation
increases. We will reach one day soon the "point of singularity", when we will invent in one
short time span (a day, a week, a month?) as much as in the entire history.
This will make it very hard to amortise investments. It will make it very hard to make any
choices at all.

Pervasive computing brings about disruptive changes

One conclusion is certain. Computing power will be available everywhere, built-in in all
objects, tools and apparatuses. This phenomenon is called “pervasive computing".

The toolkit for this pervasive computing is already available today, off the shelf:

• ubiquitous telecommunications,

• a universal data-exchange language, a kind of Esperanto,

• and an easy means of connecting devices,

Let us look at the three building blocks.

Ubiquitous telecommunications

A first building block for pervasive computing is ubiquitous telecommunications.

“Analysts estimate that at the end of 2000, at least 60 percent of people in Western Europe
had a mobile phone”14

With the introduction, very soon, of GSM 2.5 or 3rd generation, circuit switching15 will be
replaced by packet switching16 techniques. This will have two major consequences:

14 International Herald Tribune - Friday January 5, 2001 - p.15.

15POT (Plain Old Telephone) system where for each call a circuit is dedicated (switched),
making very inefficient use of the infrastructure. Tariffs are based on switched-on time period.

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 VdN - 22/05/01

• All these devices will be "always-on", i.e. always connected and locatable;

• Communications costs will not be per connection time, but per data packet transmitted,
i.e. extremely cheap for small messages (e.g. payment messages).

: LUH OH V V WUD Q V P LV V LR Q V S H H G

Bits/se c Se co nd s to tra ns mit Se co nd s to tr a nsmit

Bo o k Picture
300 pa ge s
Bits Bits
1 0 ,0 0 0 ,0 0 0 2 ,4 0 0 ,0 0 0

GSM 9,6 00 1 ,04 1.6 7 25 0.0 0

G PRS 1 1 5 ,0 0 0 8 6 .9 6 2 0 .8 7
EDG E 3 8 4 ,2 0 0 2 6 .0 3 6 .2 5
Blue to o th 7 2 1 ,0 0 0 1 3 .8 7 3 .3 3
UMTS 2 ,04 8,0 00 4.8 8 1 .1 7
Hip e rla n/2 5 4 ,0 0 0 ,0 0 0 0 .1 9 0 .0 4

Telecommunications speed for those wireless devices is exploding. We can already transmit
data with mobile handset today, GSM. But with tomorrow’s UMTS infrastructure this speed
will be multiplied by 20.

Let us show this with an example. What can we transmit during only one second, with the
various techniques?

' X ULQ J V H F R Q G Z LUH OH V V WUD Q V P LV V LR Q «

G SM GPR S E DG E B luetooth UMT S

XML

A second building block is a universal and easy data-exchange language to have all
pervasive computing devices talking to each other. As such a language for inter-application
communications, XML looks very promising. It does not happen every day that an
international newspaper mentions this as a leader on its first page.

16Terminals are always connected, but only packets of digitalised information (voice and
data) are sent through, which makes a much more efficient use of the infrastructure. Tariffs
are based on number of packets transmitted.

8
 VdN - 22/05/01

;0 /

Even Microsoft states: « The introduction of XML is in many ways like the creation of writing in
the evolution of language » 17

XML is a meta-language, which allows data to be described and transmitted in such a way
that simple browsers can receive, verify, understand, and process it. It means for data: "Write
Once, Understand Everywhere". One might call it the "Esperanto" of ICT devices.

Bluetooth

A third building block is an easy and unobtrusive way of connecting these pervasive
computing devices.
In Business Week we read that: «Just as the Internet has lassoed together the world’s
computers, Bluetooth promises to extend that network, by means of a 10-meter radio signal,
to nearly every machine on earth.»

Bluetooth is a cheap wireless means of communications. It is based on a worldwide

standard, and allows for two-way communications based on radio signals. Within the 10 to
100 meter distances, pointing is not necessary, unlike infrared devices such as remote TV
controls.
Because of this worldwide standard, the receiver-transmitter and corresponding chip will be
very cheaply available in all devices.

Without cabling and connectors, the Bluetooth wireless technology will be capable of hooking
all apparatuses to each other and to the Internet. Interconnecting
340,282,366,920,938,463,463,374,607,431,768,211,456 appliances can be done without
hassle.

17 David Turner - Microsoft.

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 VdN - 22/05/01

The networked business environment

The mathematics of networks

All this means that there is no technological reason whatsoever to avoid or retard pervasive
computing. These techniques will be available cheap and in a very user-friendly way.

Pervasive computing leads us to networks.

We cannot avoid some mathematical logic to prove the beneficial effects of networking.

• For each connected appliance separately:

a+b(ne)

A network device has its own added value, a. But its added value increases with b, as
more and more similar devices are connected and the network effects become
e
exponential (n ).
So overall customer value increases when more members adhere to the network18.

• For the network as a whole:

“ The sum of a network increases as the square of the number of members.” 19
This formula is also the Second Law in the new Network Economy, “The Law of
Plentitude - More gives More”.

Therefore, critical mass is essential in networks, and the multiplication effects are huge.

New networks have the potential to generate a lot of groups, and they all gather critical mass
quite easily.

7 K H F ULWLF D OP D V VJ

V J H Q H UD WH G E \Q H Z Q H WZ R UN V

N= 5 10 100
Number of possible groups
Law of Sarnoff TV 1 1 1 1
Law of Metcalfe Telephone (N^2)-N 20 90 9900
Law of Reed Internet (2^N)-N-1 26 1013 1E+30
T h e L aw of th e Pac k - H B R - F ebru ary 2 0 0 1

1 E +3 0 = 1 ,0 0 0 ,0 0 0 ,0 0 0 ,0 0 0 ,0 0 0 ,0 0 0 ,0 0 0 ,0 0 0 ,0 0 0 ,0 0 0

• The Law of Sarnoff states that a television broadcast creates only one network, with 1
broadcaster and n spectators.

• The Law of Metcalfe states that the telephone system allows calling everybody, except
2
oneself. So it creates (n -n) groups of two people calling.

18 Dr. Leo Van Hove - VUB - Zijn betaalmiddelen publieke goederen?

19 The Network Economy - Kevin Kelly - Wired Magazine Group Inc.

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 VdN - 22/05/01

• The Law of Reed states that the network potential of the Internet is tremendous. Groups
of 2 or more can be created. In fact, (2n-n-1) groups. With 100 members, this means
about 1,000,000,000,000,000,000,000,000,000,000 possible groups.

We have proven that technology will lead to on-line pervasive computing, and that critical
mass can be obtained. Users can easily connect to a lot of groups.

Will customers become technophiles very soon?

But how about bank customers?

Are they fast enough to adopt all these innovations? Will they participate in the network?

Mr. Braudel hesitates. He states that “Development is driven by changes in the limits of the
possible in the structures of everyday life”20.

Some historical facts support his thesis. 15 years ago we had a choice between fax and EDI
(Electronic Document Interchange). EDI of course was (and still is) much more efficient.
But it appeared to be one bridge too far, at that moment. There were no supporting
communications standards, no user-friendly Internet facilities, no client/server workstations on
everybody’s desktop. Therefore, EDI never took off.
Fax, on the contrary, did not require other supporting technologies. It behaved as a fast
letter. It could be integrated in all existing procedures and paper-based workflows. So it was
accepted quite easily, and benefited maximally from the network effects.

Is Mr. Braudel still right today? The adoption rates of new technologies seem to increase
faster. It took 74 years for the television to reach 50,000,000 spectators. More recently, it
only took 4 years for the Internet to reach 50,000,000 surfers.

< H D UV LWWR R N WR UH D F K   P LOOLR Q X V H UV

,Q WH UQ D WLR Q D O+ H UD OG 7ULE X Q H 

WWW
Television
1 PC
Radio
Telephone

0 20 40 60 80

Adoption rates will increase faster still in the future:

« By 2003, 99.9% of Internet-enabled devices will be « technologically invisible » to the user,

producing greatly increased adoption rates. »
« By the end of 2005, the majority of Internet-enabled devices will require no sign-on, physical
connection or software integration. »21

20 Capitalism and Civilization - Fernand Braudel.

21 Gartner Group 2000 - Financial Services 2005 - Frank W. Schlier.

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 VdN - 22/05/01

This creates very demanding customer expectations. They ask banks some very pertinent
questions:

• « If my e-mail can go from Brussels to Brisbane in a couple of seconds, why not my

payment? »

• « If I can sell my stocks on NASDAQ via Internet in a couple of seconds, why do I have to
wait five days to have the proceeds on my account? »

In experiencing the speed of the networks, customers see no reasons for bank back-offices to
add those delays. Are they wrong? From their point of view, certainly not. Back offices are
the bankers’ problem, not theirs.

Payments are part of a value chain, not stand-alone operations

We do not pay for the pleasure of paying.

Indeed, « Who wakes up in the morning and thinks, ‘Gosh, I want to buy a payment
today’?»22.

A payment is an unavoidable second leg in a commercial transaction. It is unrealistic to

analyse the future of payments without analysing the future of commerce and trade
administration.

And here two characteristics emerge:

• Electronic information exchange allows for complete deployment of JIT23 techniques.

With direct communications silo effects, i.e. delays, accumulations and resulting
amplification effects disappear. This is called the “zero-latency" economy.

• This also needs Straight Through Processing, where data are input and validated only
once, and then seamlessly and automatically transmitted and processed through all
subsequent stages of the value chain, without unforeseen delays, without human
intervention and without error creation.

Zero-latency and STP are about the processes in the whole value chain.

22 Eric Sepkes - Citibank - SIBOS 2000 - San Francisco.

23 Just in Time.

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 VdN - 22/05/01

Private customers and the value chain

Of course, for private customers JIT, STP and Zero Latency have a simpler meaning. It has
no direct and measurable impact on their "Profit and Loss account".
Nevertheless, also private retail customers purchases are subject to "experience cycles",
influencing their behaviour24.

In a recent Harvard Business Review article the authors demonstrate that a complete buyer
experience cycle consists of six subsequent stages:

7 K H % X \ H U([ S H ULH Q F H & \ F OH

Pu rc h ase U se M ain te n an c e
D e live ry S u pple m e n ts D isposal

K n owin g a W in n in g B u sin e ss Idea W h e n Y ou S e e On e - W . C h an Kim an d R e n é e M au borg n e

H B R S e p-Oc t 2 0 0 0

• Purchase, e.g.
How long does it take to find the product you need?
Is the place of purchase attractive and accessible?
How secure is the transaction environment?
• Delivery;
• Use;
• Supplements;
• Maintenance;
• Disposal
And for each of these phases, there are six utility levers:
• Customer Productivity;
• Simplicity;
• Convenience;
• Risk;
• Fun and Image;
• Environmental friendliness.
Without much imagination it is very clear that for all of these stages and levers, pervasive
computing devices with the smooth incorporation of value-added payment services are of
great help.

24Harvard Business Review Sep-Oct 2000 - Knowing a Winning Business Idea When You
See One - W. Chan Kim and Renée Mauborgne.

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 VdN - 22/05/01

Corporate customers and the value chain

For corporate customers, the value-chain effects are more directly measurable.

The value chain starts with the supply chain, incorporating multiple interlocking transactions.
Each transaction contains a payment, and each payment in itself is also composed of
interlocked processes.

Pervasive computing and network effects tend to re-enforce value-chain integration, via zero-
latency and STP.

We will have to consider STP not only in the payments process, but more and more over the
whole transaction value chain. We will have to create real synergies, and not only in payment
processes, but also in customer procurement and selling processes.
Complete "Accounts Receivable" and "Accounts Payable" integration is a minimum.

3 D \ P H Q W7 UD Q V D F WLR Q 6 X S S O\ F K D LQ

Paym e n t

C aptu re
Orig in ate V alidate C aptu re
c u stom e r T ran sm it Proc ess S e ttle
paym en t paym en t paym e n t
in fo

T ran sac tion

R ec e ive
L e arn S e le ct Orde r
Pay R e c on c ile

R aw
S u pply
M an u factu rer M ate rial
C on su m e r R etaile r W h ole sale r
S u pplie r S u pplie r

T o d a y ’s P a ram ete rs: P a y m en ts

in th e V alu e C h ain
(B o s to n C o n s u lt in g G ro u p )

The estimated savings by these synergies are huge, as calculated by Goldman Sachs. This
means in fact that STP and zero-latency create wealth. As such, they become a societal duty
for corporate managers.

(VWLPDWHGVDYLQJVIURP%%H&RPPHUFH
E s tim a t e d s a v i n g s
fr o m b u s i n e s s - to -
In d u s t r y b u s i n e s s E -C o m m e r c e *

A E R O S P A C E M A C H IN I N G 1 1 %
C H E M IC A L S 1 0 %
C O A L 2 %
C O M M U N IC A T I0 N S 5 -1 5 %
C O M P U T I N G 1 1 -2 0 %
E L E C T R O N IC C O M P O N E N T S 2 9 -3 9 %
F O O D IN G R E D IE N T S 3 -5 %
F O R E S T P R O D U C T S 1 5 -2 5 %
F R E IG H T T R A N S P O R T 1 5 -2 0 %
H E A L T H C A R E 5 %
L I F E S C I E N C E S 1 2 -1 9 %
M A C H I N IN G ( M E T A L S ) 2 2 %
M E D IA & A D V E R T I S IN G 1 0 -1 5 %
M R O * * 1 0 %
O I L & G A S 5 -1 5 %
P A P E R 1 0 %
S T E E L 1 1 %

*A n a ly s i s c o m p a r e d B 2 B t e c h n i q u e s w it h
t r a d i t i o n a l b u s i n e s s m e t h o d s , s u c h a s p a p e r ,
t e le p h o n e , f a x o r v a lu e - a d d e d n e t w o r k s .

** M a i n t e n a n c e , r e p a i r a n d o p e r a t i n g s u p p li e s
D A T A G O L D M A N S A C H S

14
 VdN - 22/05/01

The reasons for these huge zero-latency economies are easy to explain. Let us show this
with an example25.

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XWWL
LRRQ
Q V
V\\V
VWWH
HPP

A classic retailer-wholesaler-factory value chain reacts very late and chaotically to changes in
underlying parameters, e.g. to a change in demand.
Indeed, the old economy has built-in data and product silos, accumulations, delays and
subsequent amplification effects.

Suppose a regular fluctuation of 10% in sales at the retailer’s outlet.

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Via these delays and amplification effects, the results on inventories, order backlogs and
production capacity variation are tremendous.

E.g. factory output (red) varies between +72% and -61%, distributors’ inventories (green)
between +32% and -33%, and unfilled factory orders (blue) between +113% and -54%.

This is not very efficient, as it carries a huge cost, which can be reduced via zero-latency.

25Jay W. Forrester - Industrial Dynamics - John Wiley and Sons Inc., New York - London,
1961.

15
 VdN - 22/05/01

Practical conclusions from these tendencies

What does all this mean?

• All human beings, and all objects, can be addressed and reached on-line and wirelessly;

• New techniques can build critical mass quite easily;

• Value-chain and workflow integration generates added value and prosperity.

These conclusions mean that technology is ready to bring disruption, and that customers,
retail and corporate alike, will not be averse to it. On the contrary, customers expect banks to
lead the way, to support their network systems.

But are banks on the right track with their present systems?

Are banks on the right track?

"A Lombard banker of the 14th century would still recognise the
system of correspondent banking today"26

It appears that the classical architectures for administering euroland retail payments, cross
border and domestic, do not completely match the technological tendencies. They still treat
payments as a separate and uncoupled transaction, and as such, they do not create value-
chain synergy.

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Paye r P aye e

B an k B an k
A C

AC H
X

B an k B an k
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AC H - A u tom ate d C le arin g H ou se

26 Dreams of a cashless society - The Economist - May 5th-11th 2001.

16
 VdN - 22/05/01

& UR V V % R UG H U3 D \ P H Q WV

C ou n try A C ou n try B C ou n try A C ou n try B C ou n try A C ou n try B

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B an k B an k
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B D B D

C orre spon de n t B an kin g R e m ote A c c e ss AC H -to-A C H

eCommerce is defined as: “The application of advanced ICT to increase the effectiveness of
the business relationship between trading partners.”

It is not clear whether the classical configurations are compatible with this definition.

Correspondent banking requires banks to have account relationships with banks abroad,
which are capable of including cross-border payments in the local clearinghouse, applying
local rules and converting to local standards.

Remote access allows banks to have direct access to clearing systems abroad. However,
this requires also adhering to the different rules and procedures, and converting to different
standards.

ACH to ACH linking means that domestic clearinghouses are interlinked and proceed
centrally to switch all rules, procedures and standards.

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Payer Payee

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Global Batch Clearing means trying to create a universal clearinghouse, built on worldwide
accepted standards, rules and procedures. It also has to span different time zones.

But in an integrated e-i-m-world value chain, payer and payee are connected on-line to each
other, peer-to-peer.

So why should a bank retrace this connection afterwards, as it does in the former
architectures, with a disconnected payment operation?

17
 VdN - 22/05/01

To exploit fully all advantages of zero-latency and STP, it appears that a secure payment
gateway structure offers most possibilities. This kind of infrastructure is more or less used by
card systems. The SET27 protocol is a very good example28.

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Those functionalities can easily be expanded to all other kinds of payments. They can easily
be integrated in the value chain. They can even help to orchestrate and secure the whole
value chain.

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Is a P2P Payment Gateway the solution?

Such a payment gateway could orchestrate or perform multiple functions. A meticulous

evaluation of the business case of various outsourcing or cosourcing scenarios is required.

A Payment Gateway could cover most of the transaction scenarios

27 Secure Electronic Transaction - protocol to transmit payments, secured via PKI (Public Key
Infrastructure), guaranteeing buyer anynomity and seller trustworthyness (via licences).

28 Courtesy The International Herald Tribune - IBM.

18
 VdN - 22/05/01

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A Payment Gateway could manage trust

• Public Key Infrastructure
• Beneficiary licencing
• Transaction Monitoring
• Payee and payer risk and position keeping
• Intervening banks risk and position keeping
A Payment Gateway could prepare and initiate clearing and settlement

In a P2P environment, clearing and settlement should tend towards an on-line, real-time
continuous secured system. There are various ways to realize this, with gross versus net
systems and with risk management techniques.
A most advanced scenario could even incorporate e-settlement, where Central Bank money
is securely transmitted to intervening banks in a real-time environment29.

A Payment Gateway could prepare integrated transaction reporting

• Workflow orchestration
• Transaction aggregation
• Charge back management
• Billing

"The network is the computer"30

In a networked environment, the location of the computer, and the residing application
programs, are irrelevant. Indeed, they are connected via broadband telecommunications.
In the era of pervasive computing, this axiom is still more true.

However, today’s existing payment infrastructure is a legacy from the past, where the network
was not yet the computer. A lot of functionalities are dispersed among different
infrastructures, i.e. automated clearing houses, networks, debit card operators, credit card
operators, banks and customers. These legacy systems are very often based on domestic
payment instruments, and domestic currencies. Some of them are real-time, some of them
batch-oriented.

29Re-engineering Payment Systems for the E-world - Bank of Finland Discussion Papers
17/2000 - Harry Leinonen.

30 SUN Microsystems.

19
 VdN - 22/05/01

A payment gateway can take over these functionalities, but in an "always-on and always-
connected" device environment.

The advantages of VIPs: Value-chain Integrated Payments

Let us try to match the most important ICT tendencies with the payment configuration models.

6 WUD WH J LF 3 D UD P H WH UV
Global
Corresp. Remote ACH- Batch Pmt.
banking access ACH Clearing gateway
Universal addressability K K J J J
Wireless connectivity L L L L J
Gigantic data storage possibilities K K K K J
Value-chain integration L L K K J
Trust services offerings K K K K J
Cost sharing formulas L L L K J
Technophile customers expectations K K K K J
Critical mass newnetworks K K K K J

• Universal addressability: does the system use the possibilities to address whichever
device wherever on earth (and even beyond)?

• Wireless connectivity: does the system use the GSM 2.5 and 3rd generation possibilities?

• Gigantic data storage possibilities: does the system make use of the possibilities to store
whichever information wherever?

• Value-chain integration: does the system integrate a maximum of functionalities in a

seamless way?

• Trust services offerings: does the system take account of the need for secure and trusted
networks and certified intervening partners?

• Cost sharing formulas: does the system allow for a correct cost sharing, related to the
added value for each intervening party?

• Technophile customers expectations: does the system anticipate customers becoming

netizens?

• Critical mass new networks: does the system allow for maximising networks’ critical
mass?

It clearly appears that a secure payment gateway, built on-line between buyer and seller,
offers most best matches.

The same conclusion is clear when matching the configurations with some of the new
extended functionalities required of today’s payment systems.

20
 VdN - 22/05/01

7 D F WLF D O3 D U D P H WH UUV

V

Corresp. Remote ACH- Global Batch Pmt.

banking access ACH Clearing gateway
Bill presentment extensions L L L K J
Mobile payment extensions L L L L J
Payee initiated L L K J J
Payer initiated K K K J J
E-commerce certification of parties L L L L J
Portal or financial hub compatibility L L L L J
Zero latency K K K K J
Added value offering K K L L J
Anonymous payments L L L L J
Standards L K K K J
Access criteria L L K K K

• Bill presentment extensions31: does the system allow to incorporate end-to-end EBPP
functionalities?

• Mobile payment extensions: does the system allow for end-to-end payment via mobile
phones instead of, e.g., fixed POS terminals?

• Payee initiated: can the payee initiate his claim?

• Payer initiated: can the payer honour his commitment?

• E-commerce certification of parties: does the system allow for incorporating the
certification of all intervening parties?

• Portal or financial hub compatibility: can the system be integrated in the new Internet
functionalities?

• Zero latency: does the system annihilate delays and silo effects?

• Added value offering: does the system allow for smoothly and seamlessly incorporating
added value offerings from the different intervening parties?

• Anonymous payments: does the system allow for anonymous payments?

• Standards: is the system based on worldwide open and generic standards?

• Access criteria: can all intervening parties have easy access to the system, directly or
indirectly?

VIP Scenario 1: Remote real-time

Mobile payments apparently are a most adapted solution for this scenario. Mobile handsets
act as a personal POS terminal, and allow transferring a payment from the payer’s account to
the beneficiary’s account. The payment gateway can certify both parties on-line, and verify
their account details.

31 "EBPP integrates electronically the presentment and payment of bills. It allows the biller to
present its customer with a bill electronically rather than on paper. The payer can then use
the same platform to pay the bill electronically." - Committee on Payment and Settlement
Systems - Clearing and Settlement Arrangements for Retail Payments in Selected Countries -
BIS.

21
 VdN - 22/05/01

This scenario can be used for payments via internet as well as for payments on-site.

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ac c ou n t an d b u ye r
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On Site:

1. Together with the goods bought, the cashier reads the mobile number via bar code.

2. The cashier transmits mobile number, requested amount and transaction reference to the
payment gateway.

3. The payment gateway certifies the cashier, and verifies amount and mobile number.

4. The gateway sends a request to the mobile phone to accept the requested amount, via
PIN code entry.

5. The buyer, at the cashier’s teller, enters his PIN code on his mobile phone.

6. This PIN code is verified by the payment gateway.

7. The gateway sends an authorisation to the cashier, and the customer takes his goods.

The same kind of scenario can be used for payments on the Internet, at home, or at a public
kiosk or self-banking site.

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In ter n e t 7 . A u th orization

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8. M obile N o. to GSM
Pu rc h ase e -sh op via
C on firm ed In tern et N WK 5 . PIN E n try

22
 VdN - 22/05/01

VIP Scenario 2: Remote deferred

( OH F WUR Q LF % LOO3 UH V H Q WP H Q W6 \ V WH P V

2 . B e n e fic iar y se n ds
in voic e s to se r ve r

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ac c e pts paym e n ts ( with P I N )

EBPP systems look like the most adapted for this scenario. Beneficiaries can dump their
claims in a database, after certification by the payment gateway. Payers can look into this
database via their PC, their mobile phones, voice-mail classical phones, or self-bank kiosks.
They can prioritise and accept the payments to be paid from their account, based on
urgencies or on immediate-payment rebates.

This scenario applies both for recurring direct debits and for one-time payments. Eventually
also standing orders could fit in such a scheme, via payee’s input.

VIP Scenario 3: Face-to-face / Person-to-person

As mobile handsets seem to become, amongst other things, the mobile payment terminal of
the near future, there are no technical problems in using them as P2P (peer-to-peer, or
person-to-person) terminals.

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7 . A u th orization
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be n e fic iary
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N WK

Certainly not when Bluetooth allows for those two terminals to establish a standardised,
reliable and user-friendly dialog.

A SET-like protocol will treat those P2P payments much like on-line bank account transfers,
with immediate certification, execution and acknowledgement.

23
 VdN - 22/05/01

Corporate governance of payment systems

Who will manage the new payment infrastructure?

How to build and manage a future euro and euroland payment infrastructure?

Only a few years ago, a concept of a new macro-economic information infrastructure32 was
proposed, looking quite gloomy for the banking sector.

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L ibrarie s S ou n d
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In form ation S u pe rh ig h way
C om pu tin g /In form ation T e lec om E qu ipm e n t
T e c h n olog y M an u factu rin g

This concept was supported by the increase in importance of telecom operators, merging with
value-added networks and Internet Service Providers. Alliances were made with content
providers, and interactivity services were added.

All other applications were considered as mere users of this backbone configuration. Banks
were considered to be amongst them.

Recent tendencies have changed this concept. In extended e-, m- and i-services, the
importance of trust and value-chain orchestration (or workflow management) becomes of the
utmost importance.

And are banks not the preferred providers of these vital services?

32Telecom Reform - Principles, Policies and Regulatory Practices - Edited by William H.

Melody - Technical University of Denmark.

24
 VdN - 22/05/01

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F in an c e H e alth / R e g ion al D isaste r

B an kin g M e dic al D e ve lopm e n t M an ag e m e n t
E du c ation &
T r ain in g
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C ON T E N T T r u st V alu e C h ain INT E RAC T IV IT Y

B r oadc ast M gt I n stan t & D e laye d
M e dia
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F ilm E L E C T R ON I C S E R V I C E S D ata
P ayT V , V A S , I n te r n e t,
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S oftwar e M u ltim e dia e tc . G r aph ic s
E tc . P u b lic -U se r G r ou p-P r ivate V ide o

T e le c om F ac ilitie s N e twor k
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C om pu tin g /I n f or m ation T e le c om E q u ipm e n t
T e c h n olog y M an u f ac tu r in g

So we can draw a design of another, enhanced macro-economic information infrastructure,

adding trust services and value-chain integration.

Here banks play a double role:

• They have a vital part in the backbone service infrastructure;

• And they are an application provider, amongst other things.

Banks are maybe best placed for these additional backbone functions, because they already
have vital building blocks:
• Network;
• Information infrastructure;
• Corporate connections and confidence;
• Customer connections and confidence;
• Debit and credit card infrastructure;
• Chip card infrastructure;
• PKI infrastructure.
But building co-operative infrastructures is much more difficult today than in the past.

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◗ B road u tilitie s with larg e ◗ S m alle r, m ore foc u se d u tilitie s with fe w ke y

n u m be r of own e rs own e rs

◗ L arg e ran g e of fu n c tion s ◗ U tility pe rform s n arrow ran g e of fu n c tion s, th e

pe rform e d by u tility re st le ft to fre e m arke t or se g m e n t-foc u se d
u tilitie s
◗ On e size fits all ◗ F e e for se rvic e , opt-in /opt-ou t
◗ Proprie tary n e tworks, ◗ M ore ope n n e tworks, h e lpin g m ax im ize
ban ks c on trol ac c e ss c on n e c tivity in an in c re asin g ly on -lin e world

◗ C oope rative g ove rn an c e ◗ M ore pu blic stru c tu re s to bu ild in m arke t

m ode ls disc iplin e
◗ B an k-on ly m e m be rsh ip ◗ Partic ipation ope n to n on -ban ks

In the new era of networking, nobody can play it alone anymore. Virtual and flexible
partnerships are necessary, combining essential core competencies.

Let us draw some conclusions from all these facts and tendencies.

25
 VdN - 22/05/01

Where value lives in a networked world33

Value Trends in the Networked Age

• Value at the ends

• Value in common infrastructure

• Value in modularity

• Value in orchestration

In a recent article in the Harvard Business Review, the authors indicated the value trends in
the networked world. These match the payment gateway configuration.

• Value is created at the ends, with value-chain added value to payer and payee.

• The payment gateway offers a common infrastructure for all the underlying bread-and-
butter jobs.

• All building blocks can be connected in a modular way to deliver these services, as “the
network is the computer”. Banks, system operators and telco's manage many of these
modules.

• But the last trend may be the most important one. Who will orchestrate? Banks are
ideally equipped to do that. Customers expect it from them.

But to orchestrate, we need the score, the musical composition.

Back to basics: Standards and Procedures

Writing and implementing standards from scratch is easy. We did so for Belgian payment
systems 30 years ago, and we are not too unhappy with the results today. But SWIFT also
did so, and Microsoft became a standard leader already during the early development stages
of the PC industry.

Changing standards with existing systems in place is less easy. Look at the excellent
ECBS34 standards.
Here it appears that in the complex world of today, with a lot of systems in place and thus with
a lot of investments to amortise, imposing new standards needs a lot of conviction. Very
often, some serious arm-twisting is necessary to enhance standard implementation.

Experience shows that ICT standards such as COBOL or TCP/IP got critical mass because
there was some serious conviction power by the U.S. government.

In euroland we need a new grand design of on-line payments, built on today’s technologies of
pervasive computing. A lot of people already have quite excellent ideas for this new grand
design. But they need the backing of a real European authority.

33Where value lives in a networked world - Harvard Business Review January 2001 -
Mohanbir Sawhney and Deval Parikh.

34 European Committee for Banking Standards (www.ecbs.org).

26
 VdN - 22/05/01

Once the grand design has been outlined, banks have all the building blocks and instruments
ready to start the orchestration, together with telcos and outsourced systems operators.

The need for a blueprint

Maybe today the moment is most appropriate for writing a blueprint of such a grand design.

•
rd
We are on the verge of disruptive ICT change, with the wide-spreading use of 3
generation always-on, always-connected mobile pervasive computing devices;

• The euro creates a new payment landscape;

• The political determination from European Commission, European Parliament and

European Central Bank for the emergence of cheap and efficient euroland non-cash
payment systems;

• Customer expectations are increasing, in the new e-, i- and m-environment;

• All building blocks are readily available with different providers;

• To manage the ICT explosion, banks, telcos and customers urgently need to rationalise
and focalise investments, sometimes via outsourced systems;

• Some European banks already consider basic payment services as a universal service.

Extensive and detailed studies already exist, from various sources, describing almost all
facets of value-added payments.

But beware of technicians

A final message to conclude this rather technologically inspired discussion.

Remember Mr. Greenspan’s quotation, which we cited at the beginning.

« The newest innovations, which we label information technologies, have begun to alter the
manner in which we do business and create value, often in ways not readily foreseeable even
five years ago. »

But speaking about technology, our favourite warning is the one from Georges Pompidou:

"There are three roads to ruin; women, gambling and technicians. The most pleasant is with
women, the quickest is with gambling, but the surest is with technicians."35

As war is too important to leave it to generals, so are payment systems too important to leave
them to technicians.

35 Georges Pompidou (1911–74) - Sunday Telegraph - London, 26 May 1968.

27
 VdN - 22/05/01

Corporate guidance applied to payment systems requires:

• Oversight and co-ordination from the ECB;

• Acceptance and support from the European political authorities;

• Business case logic, marketing and servicing from banks, operators and telcos, each in
their specified role;

• Added value to the customers.

Jozef Van den Nieuwenhof

Directeur van het Departement Bancaire Informatica en Organisatie
Belgische Vereniging van Banken
Ravensteinstraat 36 - B-1000 Brussel
Tel.: +32 (0)2 507 69 52 Fax : +32 (0)2 507 69 59
Email : vj@abb-bvb.be - Website BVB : www.abb-bvb.be

28