The New Payment Platform (NPP) in Australia : Explained

The Australian banking industry has been busy over the last couple of years building a New Payment Platform (NPP). Set to go live towards the end of next year many are still unaware of what is it, how it works and how will it impact Australia?

Hype surrounding the NPP is all focused around the ability to make payments 24x7 from a mobile phone to an email address, a phone number or a business number. This is the capability it will provide but is actually not what the NPP is.

The NPP is exactly what the name implies, it is a new platform to process payments. The NPP is not another layer on top of the existing ACH or RTGS payment channels to try to make the old steam engine look better and run faster, it is a new set of rails for the Australian economy. It will provide the underlying payment infrastructure to enable banks and other commercial organisations to build “Overlay Services” which will provide the enriched functionality such as phone number to email address payments and link business transactions to payments, but more on that later...

The Technical Bits

1.      New standards:

Key to the NPP is ISO 20022, which is the International Standards Organisation (ISO) standard for electronic data interchange between financial institutions. This is a relatively new standard using XML which has much greater flexibility in the way it can convey data than other financial message standards. Most formats used for in-country settlement systems (ACH and RTGS) have fixed fields and character lengths limiting data such as the Transaction Reference Number (TRN) to 16 characters with only one TRN per transactions, which is usually assigned by the processing bank, leaving organisations to reconcile from a customer input transaction description field that customers often get wrong and cause a reconciliation headache.   

In todays’ digital world where data is king, 16 characters are not adequate, businesses need more information about the transaction the payment relates to and not just the payment. Business has the need for rich data to be transmitted with the payment instruction, this is the capability ISO 20022 provides.

2.      New Network:

Australia’s existing RTGS settlement system has been running on the SWIFT network since 1998, the existing RTGS uses ISO 15022 (an older type of flat file based standard) and only operates during banking hours.

The SWIFT network is capable of carrying an ISO 20022 payload and will be used as the backbone of the NPP with a few enhancements. A new Domestic Messaging Channel (DMC) and three new Backbone Access Points (BAPs) are deployed in Australia with a distributed server architecture of Payment Gateways (PAGs) connecting into the network to provide a high-throughput, low-latency network needed for such a system.

3.      New Settlement Accounts

The Australian banking system has been electronic for a very long time, core to this is what are called Exchange Settlement Accounts (ESA) held at the Reserve Bank Australia (RBA). Due to the requirements of the NPP, the RBA has built a Fast Settlement Service (FSS) set of accounts that will enable the processing of NPP payments, the FSS accounts will be linked to ESA accounts via a sweep to pegged balance positions outside of normal banking hours.

4.      Addressing Service

In any routing delivery system you need a method to identify where data is being sent, a new addressing service has been built which will use the most common form of personal identifiers used in Australia being mobile phone number, email address and business number. The addressing service will link these identifiers to bank accounts the user will register.

How it works:

So basically we have a new set of standards, a new network, a new set of RBA settlement accounts and a new addressing service. Linking these new and shiny widgets together is a distributed switching system of SWIFT Payment Gateways (PAGs). Each PAG is hosted by one of the ‘connected participants’, which can function under both direct (mainly use by Banks for their own customers) and indirect (mainly used by Credit Union agencies) connectivity models.  

The PAGs do the switching, they have a set of rules built into them dictating how to process and route transactions between settlement parties and the RBA, along with a huge amount of error handling, retries, SLA and so on (…they get fairly complicated). The end result for a typical NPP transaction look something like this:

?1 - An end user initiates an NPP transaction, this could be a Credit Union customer through an Indirect connection. New ordering channels need to be built to facilitate NPP transactions

?2 - Basic transaction resolution and core banking validations (eg. Does the destination customer exists? Does the sending party have funds?)

?3 - Sending participant creates a Clearing Request (pacs.008), the PAG routes message to receiving participant

?4 - Receiving participant validates accounts exist for acceptance of funds and creates a Clearing Notification (pacs002), the PAG routes message back to sending participant

?5 - Sending participants PAG creates a Settlement Request (pacs009) and routes to the Reserve Bank which initiates a transfer of funds between the Sending participants FSS account and Receiving participants FSS account

?6 & 7 -? On settlement of funds at the RBA a Settlement Notification (pacs.002) is sent back to both Sending and Receiving participants

?8 & 9 -? Sending and Receiving participant need to finalise posting of settled funds to destination account held in their core banking systems

?10 - New system and delivery channels need to be built to interface NPP transactions back to end users and other internal systems as needed

And all this happens within 15 seconds. But that is not the end of it, more message types from the ISO 20022 set are used to enable functionality around payment returns, exceptions and investigations and then a whole new set of ‘overlay services’ that will use combinations of these functions to deliver end to end business transactions, for example paying your yearly car registration could be a single linked transaction of inspections, insurances and registration payments in the one business service.

The Business Bits

The easiest thing to do is to put your head in the sand and pretend the world did not just leave you behind. The difference between the way business operates in Australia today and when the NPP comes into full effect will be like the difference between using a 56k dialup modem and an optical fibre broadband internet connection, the speed, timing and demands on business will increase.

From the UK’s Faster Payments and SG’s G3 we have a good understanding of what is likely to happen and can speculate on how Australian business will be impacted after the NPP goes live in Q4 2017.

Customer Experience and Expectations

If you pay for something immediately you expect your goods and services provided immediately. Banks operate within normal business hours and thus have largely been out of the ‘internet market’ where immediate transaction confirmation is necessary, this has become the domain of credit card and other 3rd party providers such as VISA, MasterCard, PayPal, etc..

As customers become aware that NPP provides bank-to-bank, 24x7, real-time settlements they will start to demand the same service levels around service delivery on payment. The expectations of customers will increase as these types of transaction become the norm and businesses (domestically) will need to provide NPP as a payment option on internet type of transactions.

Larger value transactions such as buying a car will change, usually you go looking for a car on the weekend, maybe exchange a deposit and then need to go to a bank to draw a bank cheque. These types of transaction will be able to be carried out on the spot for both dealers and private sellers, and then motor registries and insurance companies will need to catch up to provide full automated re-registration services as part of that transaction (a car buying overlay service perhaps???).

Displacing Existing Payment Methods

A new settlement clearing system will not generate more payments in the market, it will transfer existing payment flows to itself due to a more efficient means of settlement. This will depend on how NPP transactions are priced by the Banks, it is envisaged the cost will be comparable to the Australian ACH system (aka Direct Entry) with costs absorbed in account keeping fees for retail customers and business fees somewhere around 10c per transaction.

Cash and Cheques – if it is easier to transfer money from your mobile device rather than having to travel to an ATM to get cash out to pay, people will use it due to the convenience. It is more convenient to press a few buttons on a screen rather than make a special trip to an ATM or a bank, it also lowers risk as you are not carrying large sums of money with you. We should see a decline in the use of larger value cash and other paper transactions as a result.

ACH (Direct Entry) – The ACH system in Australia is the primary payment system, it operates a batch process with several settlement windows during the day with transactions settled intraday, however they regularly take overnight depending on how lucky your transaction is in falling within the settlement windows and internal bank system batch runs.

People in general prefer not to wait, we do not like waiting in a bank queue, or for our morning coffee. In the same way, when we do a transaction we want to see the money move instantly and not have to wait for a bank receipt confirmation. It is about moving on with life, having closure and completion of the payment event without having to worry about and double-check on a payment to make sure it actually went through hours or even days later.

Another reason for the shift comes in the form of control, this will drive the corporate business shift to NPP transactions, if an organisation has large payment obligations (say a payroll or a large bill) there can be consequences of not paying on time such as late fees or unhappy employees. Companies usually add a settlement buffer due to the possible lag in the ACH environment, given greater control over timing the NPP may be a more attractive alternative.

Cards, EFT/POS and Internet – All card ‘type’ transactions, be it on the Internet or over the counter buying your groceries, attract interchange and acquiring fees, these are charged to the merchant so retail customers generally do not see these. Merchants sometimes charge customers a surcharge on top of these transactions to cover these fees, which are on average 1.5% for Visa/MCard and around 2.5% for Amex/Diners/other. These fees are typically much higher than ACH-type transactions but they do give instant payment based on a promise to pay from a revolving line of credit to the card holder.

Credit Cards and other internet payment schemes are 3rd party provided with final settlement still being done through normal bank accounts, this creates an extra reconciliation layer in comparison to a normal account to account transaction adding an extra layer of complexity to the merchant.

Value is not exchanged immediately, it is a promise to pay with settlement occurring when the banks are open through the normal bank settlement channels. This means that value and interest on that value is withheld until settlement. When you take into account the turnover a large retail outfit would have during weekends and public holidays that they do not get value on until the banks open on Monday morning, even in our current low interest rate environment it adds up to a significant number.

The comparatively higher cost of card schemes and loss of interest due to delayed settlement will likely drive domestic retailers preferring for their customers to use NPP transactions rather than credit cards.

Real Time Gross Settlements (RTGS) – (aka Priority Payments) provides real time, line by line settlement at the RBA with a daily settlement session of 9:15am to 4:30pm Monday to Friday. RTGS is expensive with bank fees ranging from $30 to $50 per transaction, RTGS was built as a high value clearing system not intended for high volume, low value retail business.

International TTs pose a bigger problem, they generally come into Australian banks through the use of SWIFT (ISO15022) MT103/202 messages. The ACH system does not have the necessary data fields to capture information held in an International TT message, Australian regulation states that all information on an international TT must be passed on to the recipient. This means that international TTs that come through correspondent banks (which tend to be the majority) are forwarded to the destination banks through the RTGS system which adds additional domestic fees to most international TTs. The NPP will have data fields capable of capturing all the information, making it ideal to take on the international TT correspondent banking transaction flows at a much lower cost.

As the NPP theoretically does not have an upper transaction limit, and a much lower transaction cost, we should see most RTGS flows migrate to NPP flows with a natural technology extinction of the RTGS environment occurring through being replaced with a better, faster, cheaper and more advanced NPP environment.

The Cash Economy

Cash works well for certain types of transactions, cash exchanges value immediately without any trust or promise to pay agreement. These are particularly handy for payment ‘once-off’ payment for goods and services even up to a few thousand dollars, and these transactions cannot be tracked.

The ‘Cash Economy’ is where people in business deliberately use cash transactions to hide income and evade tax, this is alive and well mostly in small service businesses (plumbers, electricians, cleaners, etc.) but also for larger transactions such as scrap metal merchants and flipping cars. In Australia this cash economy is estimated at somewhere around $5 billion.

The NPP will make it more convenient to pay for services in real time from a home computer or mobile device then it will be to go down the street to withdraw physical cash from an ATM. Payment for services becomes tracked electronically in bank accounts of these service businesses and because a record exists these transaction must be reported for income tax. This will not eradicate the cash economy, but when your tradiee insists on cash in hand instead of an NPP payment, the only excuse left is tax evasion, and that is when to ask for a bigger discount.

Across the board these smaller types of cash transactions will start to become tracked, as a result we should see the income of small service business increase, resulting in more tax being paid along with a shrinking cash economy.  

Interest and Liquidity

The NPP introduces a few additional consideration outside of normal bank operating hours. For banks funds will be swept from ESA to FSS accounts, the banks will need to manage liquidity and funding levels in FSS accounts outside of normal business hours. The same will hold true for corporate organisations as funds can flow freely 24 hour per day 7 days per week.

Value on funds will be given in near real time, this introduces an interesting question around how interest will be calculated. Will the banks still apply a daily interest calculation? If so then what would the bank cut-off time be? Or will that interest calculation need to be calculated down to the second the funds hit the account?

The overall effect should be positive on organisations, especially those that trade over weekends and public holidays such as retailers who have to wait for Monday morning settlement runs. This will potentially have a negative impact on banks as they would have to pay out more interest reducing banks net interest income, but don’t worry, the banks will probably reduce deposit rates to compensate for the losses so the net impact should be negligible.

Time to embrace the change

The NPP brings with it a significant change that will affect our daily lives and what is possible within the financial markets. There will be some adjustment required by most, at the very least awareness of what the NPP is, what it means to you, your business and your industry.

At Praxsys we are working with organisations to help prepare for the change that the NPP will bring, we see the NPP as an opportunity that will help benefit the Australian economy and one that all individuals and businesses should embrace.