Rethinking payments system

The Financial Action Task Force (FATF) has recently decided to keep Pakistan on the grey list till it's next plenary scheduled for February 2020. According to the data contained in the Pakistan-Mutual Evaluation Report (October 2019-Technical Compliance Index), out of 40 FATF recommendations, Pakistan completely complied with only one. The country has been labeled as “largely compliant” for nine recommendations and “partially compliant” for 26 recommendations. However, Pakistan was placed under the “non-compliant” category in four areas. This scenario suggests rethinking our payments system and focusing on devising a robust strategy capable of meeting international standards of monetary transactions. It is because the FATF’s 40 recommendations are linked, directly or indirectly, with our payments system at the micro and small retailers’ level. The World Bank’s Ease of Doing Business parameters are also directly related to modish payments systems such as the Real-Time Retail Payments System (RRPS), allowing millions of payments to settle in a single system in real-time.

The evolution of a modern payment system in developed countries has not been an overnight phenomenon. The transformation of economies from cash and cheques based discordant transactions to modern electronic transfers is more a matter of adaptability than technological advancement. The gradual transformation of the payments system in the United States could be treated as a case study in this regard. John James and David Weiman, associated with the University of Virginia and Columbia University respectively, juxtapose the evolution of centralised payments institutions in the United States. Similar to Pakistan, the use of cheques has been quite prevalent in the United States until the early 1990s. However, since the mid-1990s, the monolithic domination of cheques in the country’s economy is in the decline. Despite the efficiencies of correspondent banks, the panoply of concerned institutions in the United States could not quickly adopt nascent electronic technologies. It was, perhaps, due to the presence of risky externalities in the smooth flow of public coffers through cheques. A similar maelstrom of resistance also exists in Pakistan to readily adopt newer electronic payment technologies both at macro and micro levels.

The gossamer of Pakistan’s financial digital ecosystem faces several challenges on the acceptance and issuance sides. According to the February 2019 Summary of Pakistan National Payments System Strategy (PNPSS), cash transactions still dominate the country’s overall economy. The use of electronic payments, particularly by micro and small retailer neophytes, remains significantly small irrespective of the quantum and value of a transaction. Cash payments are still considered safe by the vast majority of suppliers and retailers. Paper cheques are, however, widely used for making commercial payments and government transactions. The PNPSS also notes that Pakistan has proactively been transforming its payments system by such interventions as branchless banking cobbled with the endeavours to formulate a new National Payments System Strategy (NPSS). Despite such positive changes in the payments system, the overall transformation process is sluggish and slow. Apart from technicalities involved in the development of a new payment system, there are few rudimentary areas where Pakistan needs to be circumspect: adaptability to new technologies, clarity of the concept of e-money, and a robust regulatory framework for oversight. Any future NPSS may initially focus on the transformation of cash and cheques transactions.

As far as cash transactions are concerned, a vast majority of retailers use cash as a reliable way to carry out businesses. The inherent psychology is to largely rely on cash rather than e-payments. The adaptability of the small and medium businessmen to newer technologies depends on their own ease of doing business at the local level. It is not difficult to understand that the World Bank’s ease of doing business parameters are way different from the business parameters of retailers at the local level. It is actually the ease of making instant payments at the micro-level that matters to small and medium businessmen. A fundamental step is to encourage electronic payments, instead of demurring cash, through modes such as interbank funds transfers or credit transfers. Such facilities are available all over Pakistan and can be operated through ATMs, bank branches, mobile banking and internet banking. A vast majority of businessmen, at the micro and retailers level, have social media accounts that significantly add to their adaptability to electronic modes of payments. However, the real issue is that Pakistan’s National Payment System is very fragmented requiring well-coalesced e-interventions in framing its future architecture of payments.

In addition to cash, the second major barrier is the frequent use of cheques for the payments of repetitive transactions such as payments of utility bills, salaries, and government transactions. On the cheques usage front, Pakistan today faces similar challenges as the United States did back in the early 1990s. At that time, according to John and David, the frequency and usage of cheques in the United States were as high as 45% and 59% respectively. Despite being the most inefficient payment instrument, cheques are widely issued and accepted in Pakistan. They are collected from myriad bank branches from all over the country and then transferred to the National Institutional Facilitation Technologies for further manual processing involving significant time and human costs. This suggests that modernising the cheques clearing system through electronic means must stand at the core of priority areas.

Formation of clearinghouses, as recommended by Stephen Colwell in his 1860 book The Ways and Means of Payments, may still be theoretically manipulated in designing future payments infrastructure in Pakistan. The elementary ingredients of such infrastructure, as per the PNPSS, include a paragon of automated clearinghouse (ACE) meant for interbank payments transfer system for retailers, a real-time gross settlement system (RTGS) cobbled with an efficient communications system. Pakistan has a functioning RTGS but no ACE. Focusing on the functionalities of RRPS and ACE can help Pakistan come out of the ongoing FATF crisis. Once it is done, it will set the scene for further rethinking and refinement of the payments system in line with the requirements of Pakistan’s micro and retail level businesses.

Published in The Express Tribune, October 23^rd, 2019.

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