ATPC ATPC. No. 11. African Trade Policy Centre. Briefing. 1. Introduction. Payments System and Intra-African Trade 1.

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1 September 2010 ATPC ATPC Briefing No. 11 African Trade Policy Centre Payments System and Intra-African Trade 1 Economic Commission for Africa 1. Introduction In spite of more than two decades of financial reforms, African payment systems to transact trade and business have remained very cumbersome, underdeveloped, fragmented, costly and inefficient. That has remained a key impediment to intra-africa trade and an obstacle in way of the completion of single market in the continent in its quest to achieve a common market. While, for instance, it takes just a few minutes to wire money from one corner of world to another, to transact business payment across borders in Africa may take days, weeks or even months. Indeed, a lack of cost-effective payment systems in the region has proved very costly both in terms of resources and time to most business men and women in the region. Consequently, since independence, this has remained a key challenge to intra- African trade. A number of factors are at play as to why Regional Payment Systems have remained dismal and underdeveloped for the past 50 years. Large parts of Africa are geographically disadvantageous, with forty percent comprising of islands or landlocked economies. Most African economies are cash based involving a lot of paperwork to effect payments and transact business across borders, rendering the payment system very costly and inefficient. As a result, finality of payment is not always guaranteed due to potential counterfeits and the lack of financial discipline. In addition, most payments system in Africa are very small, fragmented and lack competition resulting in low inefficiencies, high payments costs and exorbitant bank charges. Notwithstanding Africa s sluggish, underdeveloped and inefficient payment system that has hindered intra-african trade, which by extension, limit economic growth and development; well-developed and cost-effective payment systems in general have many good attributes and benefits to the economy as whole. As elsewhere, development of payment systems is closely associated with the movement of goods, services, capital and people; reduces costs and delays of effecting transactions as well as minimizing the risks of holding cash such as theft, 1 For further insights into this policy brief, done by Vincent Leyaro and Mkhululi N Ncube, refer to Chapter 8 of ECA/AUC/AfDB joint publication entitled Assessing Regional Integration in Africa (ARIA IV): Enhancing Intra-Regional Trade publiched in May 2010.

2 currency counterfeit and losing of interest and exchange rate value. Moreover, there more benefits accrue to well developed and efficient payment system both directly and indirectly at national, regional and global level. Directly, it helps to promote cross-border trade, intra regional-trade and regional integration. This is so, as it directly affects the efficiency of circulation of goods and services and the pace of economic expansion due to enhanced competition, improved efficiency and productivity, and increased effectiveness and efficiency in the flow of goods and services in the regional groupings. Subsequently, this too has two way causal directions effects of further improving efficiency, increasing competition and diversification as well as reducing the costs of payment services. Indirectly, there are other benefits of strengthening payment systems that can help to promote intra-regional trade in addition to the direct effects. These include: facilitating sound monetary policy and liquidity management; enhancing monetary and financial sector integration; expediting customs processing and government transactions and supporting foreign exchange trading. It is against this backdrop that the fourth edition of Assessing Regional Integration in Africa Report on the theme: Enhancing Intra-African Trade ARIA IV, has paid special attention to the issues, challenges and difficulties facing the Systems in Africa in effecting regional payments and transactions. The focus being on: what is the status of Payment Systems in Africa; it s potential to promote cross-border and intra regional trade in Africa; the performance to date and offer some recommendations and policy implications that would improve efficiency and functioning. 2. Status of Payment Systems in Africa Given their important role in trade and resource flows and in financial sector management, central banks in Africa have since the 1960s, paid close attention to their efficient functioning. Even though, most payment systems in the continent have remained very cumbersome, underdeveloped, fragmented, costly and inefficient. As a result, there was an urgent need to restructure the moribund payment systems in Africa and tackle their inefficiencies. Consequently, by the early 1990s most African countries 2 had begun implementing broad reforms to upgrade their payment systems. The most important of these reforms involve automation which comprises several modules, including: i) Real-time gross settlement (RTGS) or wholesale payments systems, which are the main arteries and usually dedicated to large value, systemically important and urgent payments. ii) The clearing systems for retail payments, characterized by a large volume of low-value transactions that need not be settled individually but rather on a net basis between participants. iii) The card switch, which handles card payment operations, emanating from automated teller machines (ATMs) and points of sale (POSs) to a cardholder s banks information system and processes the transactions once they are authorized and executed and iv) The delivery-versus-payment (DvP), which is designed for government and stock-market securities transactions. One thing to note in addition to these is that a good payment system includes not just the automated system, but also soft infrastructure such as the payment instruments used to effect the transactions; the financial institutions that provide payment accounts, instruments and services to consumers; the market arrangements for producing, pricing, delivering and acquiring the various payment instruments and services; to mention some. At national level, reforms to upgrade the payments systems were done both at supply and demand sides. At the supply side the reforms aimed at: reducing settlement risk; enhancing public confidence in the national payments systems; promoting economic efficiency; and enabling the introduction of new payment instruments. At the demand or users side, the reforms have been popular because they could enhance access to cost-effective instruments and minimize risks associated with counterfeiting and fraud. The payments systems reform projects have included, among others: reforms of the legal framework for payments and securities settlements; ensuring that the systemically important payments systems comply with international principles by launching modern RTGS systems; coordinating the integration of sound and efficient securities settlement systems, the Central Securities Depository, with the new RTGS systems operated by the African national central banks; introducing the automated retail payments clearing system for retail payments, the exchange media, which has

3 the most visible bearing on average size trade and everyday transactions and establishing effective payments system oversight functions. 3. Payments System and Regional Economic Communities in Africa Given the instrumental role it plays as a stepping stone into Africa s integration with the global economy, most focus of reforms to upgrade Payment Systems in Africa has been towards improving and easing of Regional Economic Communities (RECs) cross-country exchange. Rapid integration has linked RECs and put increasing demand on their Member States national payments systems to extend services across borders and facilitate regional trade. Pressure also comes from technological innovations, especially mass use of broadband internet and mobile technology which has given some RECs the chance to provide retail payments services across borders. Consequently, a number of RECs and their institutions, including AMU, SADC, COMESA, WAEMU, CEMAC and WAMZ have implemented or planned to establish regional payments system arrangements on the backbone of these technological advancements. This can be done, either by linking various national payments systems in a network or by setting up specific clearing and settlement systems dedicated to cross-border transactions as a separate process from domestic transactions. Few RECs have taken huge strides, with the likes of the West African Economic and Monetary Union (WAEMU) and the Communauté Économique et Monétaire de l Afrique Centrale (CEMAC Economic and Monetary Community of Central Africa) being in economic and monetary unions with a single currency, and having adopted an integrated regional system using the same structure for national and cross-country payments. The others are free-trade or common market areas without a uniform currency, oriented towards establishing links and mutual accounts among their RTGS systems. We briefly look the status of each so far. WAEMU: Payments systems reform in WAEMU, initiated by the Central Bank of West African States (BCEAO), rests on three pillars, namely, (i)the establishment of an RTGS for systemically important payments, known as (STAR- UEMOA); (ii) the operationalization of an automated multilateral clearing system known as (SICA-UEMOA); and; (iii) the development of a regional inter-bank card based payments system known as (CTMI-UEMOA). A Payment Incidents Centre was established as a tool to ensure payment system safety and is undergoing modernization. The WAEMU regional payments project has achieved its primary objective: STAR, SICA and CTMI are operational as designed - resulting in increased speed of cross-border transactions, transaction fees paid by end-users for low-value transactions having declined by 25 percent and the number of available ATMs POS outlets as well as the number of card transactions now also expected to increase. CEMAC: The CEMAC Member States use the same currency and are fully integrated in terms of monetary policy, laws and trade rules. This is laudable considering that none of them had an automated payment system when BEAC, the Regional Central Bank, determined the strategy of the regional payments system. In 2003, the BEAC launched a reform project for the payments and settlement system in CEMAC countries. The reform renders the regional and national payments systems more effective and secure through usage of modern payment instruments. Its objective is to increase the average bank use rate to 10 percent by The reform project focuses on harmonization of payment and settlement instruments and the standardization of formats for information and data exchange amongst various participants. The new payment system is not yet fully introduced throughout the region. A plan is scheduled to improve the performance of the system by improving the performance of the payments infrastructure and the performance of the platforms, as well as increasing the level of competence of the payments system users within the CEMAC banking community. COMESA: COMESA adopted a phased monetary harmonization programme towards establishing a monetary union and in 1999 became the first REC to implement a separate payment system dedicated to cross-country transactions. The initiative was intended to increase speed, lower transaction costs and reduce risks associated with currency convertibility in an effort to promote intra-regional trade. Systematically, it was designed to enable the participation of other African banks as well as European and Asian banks in countries that have commercial exchanges with COMESA Member States. As

4 a step further, in 2009, the payment system was morphed to enable and allow direct linkages with Member States national payment systems. Minimal costs associated with the usage of the reformed system should attract a larger volume of smaller transactions (including cash-and-carry), while helping to level the playing field for smaller banks. Amongst challenges hindering the use and expansion of the system are observed insufficiencies in the conceptual model such as exchange-rate risks brought about by sequential settlement and clearing and high expenditure incurred due to implementing the telecommunications network. Variable readiness of Member States and low volumes of intra-regional trade also hinder cost-effectiveness. EAC: EAC plans to have a single currency by It has designed a regional payment system, EAPS, based on national payment systems links amongst the EAC Member States. The EAC s solution has the advantage of same day transaction settlements. EAC regional authorities face a significant obstacle in implementing EAPS because national payment systems of Member States are also of variable advancement in implementation. Even though EAC s solution is cheaper than building a dedicated system to regional transactions, the low level of regional trade may negatively impact on the costs related to unitary transactions. Moreover, the effort required by commercial banks to manage multiple settlement accounts brings challenges in effectively implementing the system. AMU: The idea of establishing a regional payments system within AMU s Member States was first considered in Albeit slow progress, ongoing efforts to upgrade national payments systems have provided an opportunity to push for harmonization in the region. Work is underway to simplify the system and encourage buy-in from Member States. As a result of efforts in payments system reform, Member States, to differing degrees, have improved their national payments systems to cater for harmonisation in the region. Payment systems in AMU are still predominantly cash-based, with manual procedures and paper-based cheques marring the systems in some instances. This contributes to the slowdown of financial flows and increases intermediation costs. Regionally, AMU is confronted by inadequate Member States support as well as an incomplete roadmap to implementing a regional payment system. Whilst the AMU regional payments system would require considerable resources to develop, it holds great potential for furthering financial integration in the region as well as regional trade, possibly to the same levels that Member States have with mainly Europe and Asia. SADC: The SADC payments system project was launched in The obstacle to implementing the plan is that of variable development in each of the national payment systems of SADC countries. At present, only two countries have implemented the SADC regional payments system. Currently, the project implementation is on developing a proposal for a cross-border payments settlement system based on a single currency. SADC is also promoting mobilepayment arrangements, allowing commercial banks to use mobile technology to access banking infrastructure within and ultimately across borders. Mobile banking is already underway within other RECs, though headway is yet to be made on mobile payments across borders. WAMZ: The West African Monetary Zone (WAMZ) was formally launched in December 2000, to establish a common central bank and introduce a single currency. The monetary union was to commence in January 2003 after a convergence process. However, the launch has suffered two postponements following the inadequate status of macroeconomic convergence. On December 1, 2009, the WAMZ authorities adopted an expanded work programme and action plan for its delivery in accordance with the Banjul Declaration of May A recent report by the West African Monetary Institute (WAMI) on the WAMZ regional payments system s progress indicates significant progress in developing a regional payments system. However, similarities with all other regional payment systems implementation lie in the differential levels of systems development amongst Member States. Uncertainty still remains as to specific dates on the launch of a monetary union. 4. Performance of Payment System in Africa Following the reforms to upgrade Payment Systems, most African countries have made progress both at national and regional levels. To list some: by January , 1,004

5 users in 52 African countries were connected to the Society for Worldwide Interbank Financial Telecommunication (SWIFT) and enjoying the benefits of instantaneous and secure global reach. The last few years thus have seen countries upgrading their connection to SWIFT by introducing RTGS systems on to SWIFT. More than two-thirds of African countries either have or are putting RTGS systems in place, making their payment systems safer, stronger, and more secure. Furthermore, the advent of automated clearinghouses technology has paved the way for direct deposits and payments, ushering in emergent products such as mobile banking and mobile money transfers in some countries. Despite these achievements, African payments systems often remain inefficient in terms of supervision, cost and time, compared with international practices. Despite the connection to SWIFT, wholesale systems are uncompetitive and therefore more costly and slower than in other developing countries. This has been due to insufficient or weak technical infrastructure in most African national payments systems. Regarding region-centric payments systems, much remains to be done in Africa. While some RECs adopted this approach in the 1990s, implementation has been slow. In 2009, in many areas, regional payments systems were still at a rudimentary implementation stage. About a third of African countries had still not been connected to the RGTS payment system, which creates serious weak links in international payments processes, delaying payments by up to a month in some cases. For instance, on average, crossborder transfers cost several times higher in Africa than in Asia, the Middle East or Central Europe. In the 129 countries across Europe, Africa, Middle East, Asia and the Pacific region, about 2.4 billion payment related messages were sent and received via SWIFT in Africa share was only per cent of the region and 50 per cent lower than Italy s. Besides, 209 banks in 40 African countries are SWIFT members, but this is fewer than the number of banks in Italy and Russia. The small size, fragmentation and lack of competition in the African payments systems also result in inefficiencies, high costs and exorbitant bank charges, which hurt the competitiveness of African enterprises, especially the SMEs. As a matter of course, though regional integration has provided the impetus for payments system reforms, especially at the regional level, the results have not been evident. 5. Recommendations In spite of the reforms pursued so far, the status of Payment System in Africa, both at the national and regional level, is still poor, costly and inefficient. However, given its critical role in effecting payment and easing business transactions that are so needed to expand intra-african trade, enhance regional cooperation and promote growth, a number of actionable items to reverse the poor performance are worth considering here: 1. African countries should continue with the reforms to upgrade their Payment System, modernizing by taking advantage of technological advancement and other international development so as to be able to cope with increasing demands due to globalisation. 2. At the national level the Payment System reforms should continue to tackle the payments infrastructure as well as the matters of regulatory reforms and institutional capacity-building. This includes improving payments system infrastructure by encouraging standardization and automation for mass application, encouraging interoperability among payment network arrangements and promote competition. 3. At the regional level, through respective RECs, it is necessary to construct an integrated payment services market at continental level that is derived both by national authorities as well as by continental and regional authorities that give practical guidance and coordinate national initiatives and finance the missing pieces. Since the final goal is to establish an African Economic and Monetary Union, the vision for payments system integration in Africa should be that of an integrated, cost-effective, easily accessible and risk-free system. Thus RECs should implement appropriate programs to help achieve this vision such as implementing multi and common currency systems.

6 4. In order to reduce risks introduced by competition - governance, risk management, compliance and oversight of the financial infrastructure, should be strengthened at national and regional levels. Rigorous standards for financial reporting improve the selfdiscipline of payment-management institutions and instill confidence in adoption of national and regional payment systems. In addition to harmonizing accounting standards and introducing international auditing standards, a credit registration bureau can play an important role in enhancing transparency. 5. Regional payment systems development and payments services liberalization present opportunities and challenges. Owing to the relatively low level of knowledge on the relevant regional issues, RECs should implement programmes to sensitize the major stakeholders such as central banks and political authorities, to these issues 6. Long-term commitments and demands of developing and implementing effective regional payments systems require constant engagement with key stakeholders, including market regulators, service providers, and financial infrastructure organizations such as payment transaction, clearing and settlement network operators and securities exchanges amongst others. Such partnerships improve participation in the design and implementation of systems, including the setting of an acceptable balance between cooperation and competition. 7. To ensure sound payments systems development in Africa, RECs and their Member States should strengthen their related capacities. Capacity-building of skilled and knowledgeable human resources is as critical as the development of the physical infrastructure. Central banks need to lead this process, sharing their knowledge and expertise about the emerging trends and issues on national and regional payments systems development and on ensuring system efficiency and security. 8. The development and integration of African payments services should undoubtedly be driven by Africans as per the issue of resources is concerned. Overseas Development Assistance is very much welcome in addition to packaged institutional strengthening and capacity-building in the short term without any conditionalities. International aid should not substitute countries efforts to achieve internal development objectives. Member States need to pool their respective budgetary resources and governments must encourage participation of the private sector in financing modernization and integration.