Interoperability: How Should Interoperability be Achieved in a Payment System?
A great deal has been written about interoperability, particularly for mobile money schemes in the developing world. Everyone seems to agree, in theory, that interoperability is a good thing, and serves end-users (customers) in their need to exchange transactions with counterparties.
In most (if not all) countries, the major bank payments systems (check, ACH, debit card, RTGS) are fully interoperable. This interoperability (referred to here as “scheme interoperability”) simply means that any bank participant in the scheme can exchange payment transactions with any other participant in the scheme. Such interoperability is scheme-specific: a check transaction does not interoperate with an RTGS transaction, for example. Although it may seem obvious, scheme interoperability requires a “scheme manager” to write and administer the rules of the scheme.
An alternative mechanism for interoperability is a bilateral or network exchange. At its simplest level, bilateral interoperability means that the provider of one closed-loop scheme interconnects with the provider of another closed-loop scheme, and enables the customers of one provider to exchange transactions with the customers of another provider.
Note that interoperability is tightly related to, but not the same as, transaction switching. (See Issue: Switch.)
Option “A”: Scheme interoperability
Scheme interoperability is a well-established and understood practice in payments. It easily enables multiple participants to exchange transactions, thereby facilitating the entry of new providers into the market. It is technically efficient, allowing any given participant to connect only once (to the switch), rather than to multiple counter-parties.
On the negative side, getting started may require more investment than participants are comfortable with; participants may feel a loss of control, or that the scheme (and its rules) could dictate practices and investments that participants do not want.
Option “B”: Bilateral interoperability or network exchange
This can be a much faster and somewhat less expensive method of achieving interoperability between two (or a limited set) of established providers. As the terms of the exchange are normally privately negotiated, it can give the providers a greater sense of control over their services. This kind of arrangement avoids the risk of a hub becoming overly powerful.
Conversely, bilateral interoperability is much less efficient as a method of connecting a large number of participants; in particular it acts as an effective barrier to entry to new and small participants. Over time, innovation can be limited because of the cost of each participant having to change each of their direct connections. (See Issue: Switch). This arrangement makes shared services (such as shared merchant services) very difficult to support, and makes centralized fraud management (see Issue: Fraud Management) virtually impossible.
The Financial Inclusion Perspective: Option “A” is preferred
Scheme interoperability is the superior long term choice for financial inclusion: it enables multiple players to participate without requiring the capital expenditure and duplication of efforts to build their own end to end network, thereby supporting longer term low costs. It also creates the underlying “rails” which support ubiquity of end-customer reach, regardless of the number of participants acting as DFS Providers. This ubiquity is necessary to incentivize appropriate participants to create value-added products and services on top of these “rails”.