An interview with State Bank’s Director Payment Systems:

Syed Sohail Javaad is currently serving as the Director, Payment Systems at the State Bank of Pakistan (SBP). He is a career central banker with more than 15 years of experience of working with the SBP. His experience varies broadly, with emphasis in areas of IT systems’ implementation, treasury operations and payment systems, Payment Systems Operators and Service Providers (PSOs/PSPs), and SBP’s Real Time Gross Settlement System (RTGS) of the country. In this interview with BR Research, Sohail talks about the regulatory environment for electronic payments, specifically relating to Electronic Money Institutions and the digital on-boarding of retail merchants. Edited excerpts are produced below:

BR Research: Could you give us a background to the recently-introduced Electronic Money Institutions (EMI) regulations and explain how they are different from the already-existing rules for Payment Systems Operators/Payment Service Providers (PSO/PSP)?

Syed Sohail Javaad: We had issued Rules for PSOs/PSPs in October 2014 to develop an environment for efficient, convenient and secure processing of payment transactions in the country. Those rules had spelled out the entry criteria for prospective PSOs/PSPs, but we adopted a more flexible approach and played an enabling regulatory role to classify the business models of PSOs/PSPs because of the realization that this was an ever-emerging field.

PSOs/PSPs were prohibited to hold the customer funds under the rules, therefore the SBP decided to develop a separate regulatory framework for e-money institutions. With the issuance of Regulations for E-Money Institutions, the non-bank market players in the private sector would be able to attract and hold customer funds and channelize payment transactions through digital means.

In the case of fintechs especially, we noticed young energetic entrepreneurs and start-ups go out in the market, talk to merchants and industries and come up with solutions. But when they go to the banks, the banks aren’t always receptive; therefore their ideas can not materialize. The EMI Regulations aim to fill that gap, and to authorize e-money institutions that, unlike PSO/PSPs, can actually take money from people and then issue payment instruments against those funds.

BRR: What kind of business areas EMIs could compete in?

SSJ: The field is quite open at the moment. They could get into a variety of business areas; the biggest business appears to be the aggregation of merchants, whether it is online merchants or brick and mortar. They can also do bill aggregations. But the possibility is limitless; for instance, the SME sector does not have an invoice-processing capability, or they ask schools to issue ‘chalaans’ and collect money from parents against a collection fee. The growth trajectory could be such that newspaper delivery boys and milk sellers can collect their bills via digital methods.

BRR: Who will bear the cost of payment? Will it be free of cost as it is in many other parts of the world?

SSJ:  The most expensive cost of payment is cash; in my personal opinion, it’s about 3 percent of the transaction cost. The only difference is that the cost of cash is being absorbed either by the SBP or by the banks, in terms of printing, storage, transportation, distribution. The bank consumer, receiver or payer, does not face the burden of that cost.

This changes when it comes to digital payments, where there are elements like merchant discount rate, interchange, payment scheme fee etc. In this case, the cost could range from 1.5 percent to 2.5 percent, under a mechanism which is fairly complex.

But to answer your question of whether a free payment can take place, it absolutely can. For instance, if an EMI offers a cash management solution to a merchant or corporate, then it can also earn float income through those cash flows and thereby allow itself the room to provide free-of-cost payment solution.

Value-added service concept is also important. In the case of mobile wallet, for instance, the wallet itself may not be the core proposition. The core proposition could be a value-added product or service like network of taxis, bike riders or food stores that could create a wallet for receiving payments against their service.

BRR: Some stakeholders contend that the Rs200 million capital requirement screens out the start-ups because they are small and cannot bring so much money to the table? How would you respond to those concerns?

SSJ: The Rs200 million capital requirements is set for financially sound and serious entities because this critical business entails money handling and payment processing along with information security and technology. That amount of regulatory capital ensures that robust systems are being used to process huge volume of payment transactions and also ensures security of the system. Besides, no one expects the start-ups to come up with Rs200 million, which is why there are venture capitalists in this world.

BRR: Do the rules allow cross-border payments as well?

SSJ: We have not allowed cross-border payments as yet. But with e-money, if somebody has a good business proposal and wants to carry out cross-border payments or bring in remittances, then it could be considered by the State Bank of Pakistan.

BRR: Are there any companies that are already looking to launch EMIs?

SSJ: Right now, there are about five potential companies that are ready to offer their services under the EMI regulations, but it is premature to name any.

BRR: Could you share the kind of value-added businesses or business propositions they involve?

SSJ: They are primarily providers of e-money payment instruments like digital wallets and prepaid cards. Apart from these, there could be network owners who already run merchant networks.

BRR: Under the EMI rules, the EMIs cannot issue e-payment instruments at a discount i.e. issue e-payment instrument that has a monetary value greater than the funds received by customers. Why is that so?

SSJ: The reason is that we do not want the EMIs to involve in money creation, which is why no interest or discounting shall be allowed to be paid to customers. The EMIs’ objective is payments alone; they cannot do any other banking function.

BRR: Can EMIs collaborate with a bank?

SSJ: They definitely can. For instance, if an EMI wants to give a cash-out option to its customer, then it could collaborate with a bank for the same. Or, for example, in the case of biometrics, if EMIs don’t wish to keep biometric devices themselves, then they can enter into agreements with other players in the eco-system.

We are open for facilitation and collaboration of entities, especially for payment purposes and other value-added services. The whole idea behind EMIs is that there was a need for separate entities that could compete or collaborate with banks for payment services.

BRR: Could the payments data maintained by EMIs be used in credit scores of businesses, merchants and individuals under the latest CIB regulations? Especially in the case of businesses because payments could be a proxy for revenue-book in the absence of properly-maintained books of accounts.

SSJ: In my personal view, the way we are used to thinking about credit bureaus will change very drastically for us very soon, because now this concept of data repositories is coming about. Now we can bring about all sorts of data under the radar.

There is something called key digital enablers. The first step towards that is having a digital identity. The second step is the EDIs: electronic data interchanges. How we use that digital ID to collate various datasets existing out there to get a picture of your customer and then accordingly offer him or her services. For example, there are concepts like nano lending, micro lending, quick lending, where a financial service provider may want the payment data of bills because the lending amount is so small that it would just want to know an individual’s spending pattern to assess whether or not a customer is living a regular life. Right now, this isn’t prevalent, but going forward it will be.

So what you are saying is very likely and I think we should be ready for that as well. Basically, every transaction including buying, selling of commodities and rental payments will be attached to your user ID and then we can see it from various dimensions.

BRR: What are other digital enablers?

SSJ: There is something called customer consent architecture, which is needed if the digital enablers are to work. For example, if I am using an app and if I am standing at some point, I should immediately be able to give you as a loan provider my consent to pull out certain data from those datasets and use that data to determine and establish my credibility and then give me money. It’s a bit too early for Pakistan, but we should be prepared for it.

BRR: What else is the SBP working on insofar as digital payments is concerned?

SSJ: We are working on two things in addition to EMI regulations. First, we are targeting merchants where we are simplifying merchant on-boarding process. Currently if a merchant goes to a bank or financial institution and wants to be digitally enabled, it has to follow the lots of procedures to become a merchant regardless of the size of business and volume that the merchant is generating. But now we are working on simplifying the process for merchants through creation of different tiers or categories of the merchants.

One way towards that is a model where merchants will be able to download a mobile app and open a basic account. This is for smaller merchants who have been given a small limit, say for example Rs15,000. At least, they will get into the habit to use e-payments at a micro level. Consequently, if a merchant grows and needs to expand the limit then he could go to a location and get their biometric done to identify them and enhance the limit of their account. And if after that a merchant wants to further increase his limit, then he can go to the bank and fulfill the whole set of requirements to become a full-fledged merchant.

BRR: Why do merchants still charge 1 to 2 percent on credit card transactions? It is a major deterrent toward cash-less economy.

SSJ: Let me explain how the system works. When a merchant gets a machine, he pays a fee to his bank that has given him the credit card machine. The merchant’s bank has a payment scheme that facilitates this payment mechanism.

The merchant’s bank — let’s call it acquirer bank – charges, say 2 percent, from the merchant. Of that 2 percent, about 0.2 to 0.3 percent goes to the payment scheme. A bigger chunk, about 1.3 percent, goes to the customers’ bank – the bank that issued the card to the customer - in the shape of interchange fee.

The interchange on classic card used to be 1 to 1.3 percent. But as the bank gives you a better card with more points and discounts, the interchange increases to 2 percent, which that acquirer bank has to pay to the issuer bank. Our market is an issuer market because of this interchange. Over 20 million debit cards exist. Every time your card is swiped, whether debit or credit, this scheme comes into play.

For big merchants who give big business to their banks, the acquirer banks do not charge that 2 percent. They only charge it from smaller merchants, many of whom don’t have enough margins, which is why they try to charge 1-2 percent fees from the customer swiping the card.

BRR: Shouldn’t there be a solution to it considering that most shops in Pakistan are micro, small, and medium enterprises?

SSJ: The solution is there: QR code. And we are working on it. Instead of the machine, you put a printed QR code and customer take a picture of it from the app and the customer’s bank account is debited and the merchant gets the money immediately. The cost of its interchange is expected to be 0.5 percent which is negligible and can be borne by the merchant. Mastercard and Visa have already launched this platform.

So that’s the third thing that we are going to do with e-money and merchants is that we will be standardizing financial QR codes for customers. Right now, we are working on the standardized coding which will be issued by the SBP, using EMVCo QR code, which is a global standard system of QR code, to ensure interoperability of QR payments and promote merchant payments. Once it is rolled out, any customer can transact with any QR at any location regardless of it being of any bank or any payment scheme and his or her transaction will be processed.

BRR: What are your targeted timelines for these plans?

SSJ:  By end of December 2018, these three things will be issued; namely EMI, standard QR code and merchant on-boarding.

BRR: Does the central bank also have targets for these; such as XYZ numbers of merchants are targeted to be on-boarded by such and such time? Can you please share those targets?

SSJ: We have some internal targets which we can’t share. But on the whole, it is difficult to set such targets mainly because while we want to digitize payment in the economy, we recognize that every payment is actually backed by economic transactions, and majority of our transactions are cash based. Even recording of those transactions are not digital; for instance, the retailer’s cash-till is not digital.

BRR: How can that be fixed?

SSJ: It is beyond SBP’s mandate. This is much bigger task which involves a number of stakeholders from the government and private sector. In Russia, for example, they passed a law that merchants whose business is above a certain threshold must have digital tills. Soon after, the payments of all these merchants became digital. Similarly, school fees and hospital/clinic bills could be made digital. And this is where EMIs could prove to be very useful.