Viewpoint: With Russian Payments Landscape in Disorder and Chaos, Is a National Payment Scheme the Logical Answer?

By Mark Beresford and Tim Grocott-Mason, Edgar, Dunn & Company

A fragmented and underdeveloped payment infrastructure has kept electronic payments in Russia at relatively low levels. Yet, with a population of 143.5 million, consumers with increasing discretionary incomes and re-emergence on the world stage through major athletic competitions, Russia is eyed as a tremendous emerging market for payments.

But Russian history has never moved in a straight line, and neither is its march to a modern electronic payments infrastructure. World events, prompting sanctions from Western countries and reactions from Moscow, have created tensions in the payments world and possibly a move toward a national payments scheme (similar to CUP in China and RuPay in India) that will look to domestic resources, instead of international ones, to foster growth. Yet, Russia faces challenges if it wishes to emulate China and India—not the least of which is whether there is a business case to do so and will the funding follow.

This article addresses the issues at work in Russia as it lurches toward an electronic payments infrastructure.

Slow Move to a Stable Electronic Payments Infrastructure

Cash remains the dominant form of payment in Russia, but recent years have seen a surge in payment cards, reaching 240 million^[1] in 2012, growing with a CAGR of 19 percent since 2008. That’s nearly 1.7 cards per Russian.

Government initiatives to reduce cash and change consumer attitudes in favor of electronic payments have helped fuel this growth. Vast investment was designated to upgrade the payments infrastructure in preparation for the Winter Olympic Games in Sochi in 2014, and the country will look to build on this for the 2018 FIFA World Cup in Samara.

Of those 240 million cards in the hands of Russians, debit cards dominate due to the widespread implementation of payroll programs, but the cards are used primarily for cash withdrawals at ATMs. Prepaid cards are growing rapidly, although from a small base, as fraud-wary consumers use the cards for spending online. Credit cards have a small market share, but as banks look to increase consumer lending programs we can expect significant growth. Payment cards are generally international card scheme-

branded (i.e., Visa, MasterCard), with Russian participants, such as Sberbank’s Universal Electronic Card (UEC). Visa and MasterCard dominate the payment processing market with more than 90 percent of all card transactions. The Internet is thriving in Russia, but e-commerce sales remain relatively small, as poor infrastructure and an expensive and unreliable postal service has led to low consumer confidence in e-commerce, hampering the success of major global retailers.   

Rocky Road to Regulation

Russia has been at the forefront of international controversy this year, culminating with a wave of sanctions from the U.S. in March and more recently European countries, in response to the annexation of Crimea from the Ukraine and the downing of Malaysia Airlines Flight 17. The sanctions target politicians and businessmen within Russian President Vladimir Putin’s “inner circle,” many of whom were key stakeholders in several Russian banks. As a result of these sanctions, Visa and MasterCard stopped processing card transactions for customers of four Russian banks for several days earlier in the year. 

President Putin responded aggressively, signing off on a series of new laws to create a National Payment Scheme (NPS), with the intention to protect Russia’s financial services industry from the future impact of foreign sanctions. The laws stipulate that any international payment system operating in Russia must place a security deposit with the Russian central bank equivalent to 25 percent of daily revenue. The payment system is liable to pay 10 percent of that deposit for every day that its services are unavailable. Further mandates declare that all payment transaction data must be kept within Russian borders, in response to data privacy concerns.

Visa and MasterCard processed $1.9 billion worth of transactions in 2013 and it is estimated the payments networks would be required to deposit a staggering $2.9 billion to comply with Russian law.  Visa called the obligations of the new law “unprecedented,” and MasterCard expected to experience difficulties—with rumors that the companies might leave the market altogether. Although Russia accounts for only a small percentage of Visa and MasterCard’s global revenues (2 percent for MasterCard; likely more, by our estimations, for Visa), the growing use of payment cards and a population of more than 140 million holds immense potential for future business. The Russian government then made a U-turn on its decision, stating that the international card schemes could avoid paying security deposits if a partnership with a Russian processor was established by Oct. 31, 2014.  This announcement was welcomed by both schemes and MasterCard was quick to announce it was working towards partnering with a Russian processor capable of delivering the required switching and processing. Visa continues to work closely with the Russian Central Bank and government to satisfy the necessary requirements.   

Disorder in the Russian Payments Landscape and the Case for a Russian NPS

The existing payment card infrastructure is chaotic, with more than 60 local and international payments systems.^[2] Since Visa and MasterCard entered Russia in the 1990s, they have provided consumers with a convenient, reliable and international solution. There have been several past attempts to introduce a Russian payment scheme, but lack of political motivation and conflicting interests between Russian banks have prevented the idea from ever materializing. This has left Visa and MasterCard with the bulk of the market share. The enormous number of domestic players is the antithesis of consolidation, which is needed for a real NPS. Moreover, the majority of credit institutions are active members of Visa and MasterCard, with over 100 million Visa-branded cards issued in Russia.

The primary aim of a Russian NPS would be to limit the Russian financial system to exposure from political risk, but it could present further strategic benefits. An NPS would enable the government to take control of the Russian payments agenda, helping drive growth of electronic payments with the added benefit of reducing the shadow economy. Although these benefits certainly seem attractive on paper, the state of the Russian market and the extensive developmental requirements to make the NPS a reality will not be an easy task.

The central bank has designated a separate corporation, the National Payment Card System (NPCS), to create the NPS. Essentially, the two options available for developing the NPS are: create a system from scratch or build on an existing payment system. The latter was thought to be the preferred option with the two leading contenders Sberbank’s Pro100 and Golden Crown (Zolotaya Korona); however, the central bank announced on July 29 that the NPS would be developed from scratch and ready by 2015. The reasons for this choice are unclear but are likely due to problems concerning the legacy of the existing systems infrastructure, branding or disagreements over the ownership structure between the central bank and Pro100 or Golden Crown.

Challenges for the NPS

Creating an NPS from scratch is a vastly extensive and complex process, but it is technically feasible.

• A proprietary EMV chip is expected to be developed for the new scheme; a Russian company called Payment Technologies announced in June that a chip had been developed but will not be ready for mass production for at least 18 months.    
• POS terminal specifications must be developed, requiring upgrades of payment infrastructure throughout Russia. The POS infrastructure is poorly developed outside urban areas and will require the collective efforts of acquirers to help improve acceptance and increase exposure of the NPS.
• Rules and operating regulations must be established to govern the NPS, which must be consistent with other card schemes. Conditions for international acceptance (if any), such as co-badging and currency conversion of the falling Russian ruble, will need to be considered and subsequently arranged.

The most significant task, however, will be developing a domestic switch, which will entail high development costs and implementation risks. Ongoing maintenance costs will be high, including regular updates to prevent fraud and technical failures. Multiple back-up data centers will be needed, and these will have to undergo vigorous stress testing to ensure reliability and security of the system. The sheer scale of technical developments required and the inevitably of delays as a result of political or business consultations would make it surprising to see a fully operational NPS in 2015—despite predictions.

The main hurdle will be to secure the vast capital required to create and maintain the NPS. Funding of national schemes typically depends on the ownership structure; other national schemes have been set up in collaboration with domestic banks (e.g., Denmark’s Dankort). In these cases, banks generally look for an ROI and seek a positive business case before committing to the scheme. The Russian NPS looks set to be operated by the central bank, in which case funding will come from the government, which has a strong strategic rationale to create the NPS; thus, likely bypassing the need for a positive business case.

The Chinese and Indian Models

Putin stated that the China UnionPay model “works very well,” and posed the question: “Why should we not do it?” Although an internationally recognized Russian scheme is a long way down the road, it’s important to understand the origin of prominent domestic schemes and how the strong backing of a government can aid development.

CUP is now the world’s largest payment card brand with 3.53 billion cards in circulation,^[3] just a decade after it was founded in 2002. The staggering success of CUP is aided by the vast population of China and the virtual monopoly it has achieved in China. CUP was founded by 85 Chinese banks and led by the five biggest state-owned lenders and approved by the Chinese central bank. The Chinese government mandates that all payment transactions in China be routed through the CUP network, including Visa and MasterCard transactions. Although this requirement has been argued as uncompetitive by foreign schemes, it provides an example of the power the government has to drive an NPS.

Russia is a long way off having a secure and reliable enough alternative to the international schemes to mandate this, but this stance could be considered later down the line if an NPS were successful.

The NPS of India, RuPay, was created in 2012. Created to reduce fees lost to international processing, it now has around 15 million cards issued. The Reserve Bank of India (RBI) created the National Payments Corporation of India (NPCI) to develop a not-for-profit scheme. The key aim was to provide a low-cost electronic payment scheme and help reduce the dependence on cash for payment in India. According to RuPay, Indian banks saved 40 percent on fees compared to international card schemes fees, in part due to new domestic processing capabilities and saving on foreign exchange. The influence of the Indian government impacted the uptake of RuPay products, as the RBI strongly encouraged Indian banks to issue RuPay cards.

The initial success of a Russian NPS will depend on the unity of the Russian banks to commit to the new scheme. If saving on fees can be achieved, similar to RuPay, then this will certainly incentivize the banks. Some banks already might be sold on the idea, tempted by the promise of independence from the international schemes, which ultimately are profit-driven non-Russian companies that have the ability to control them. Even if the banks are unsure whether to commit to the new scheme or content with their service from the international schemes, it wouldn’t be surprising to see the Russian central bank go a step further than the RBI and mandate that Russian banks issue NPS products.

The Russian NPS draws parallels to the models of both RuPay and CUP, and both circumstances show the power of strong political motivation behind creation of an NPS. It’s an impossible dream for a Russian NPS to emulate the success of CUP, and it remains years away reaching the stage of RuPay, but the drive of the Russian government under Putin is certainly capable of getting the NPS on the world stage.

What Would a Russian NPS Mean for the Worldwide Payments Community?

The NPS will provide Russia with greater independence and control over its payments agenda. The NPS is unlikely to ever have a significant international impact due to the minority of Russians that travel abroad. Part of the reason CUP grew so rapidly internationally was to meet the huge acceptance demand of Chinese overseas travelers.

Although the NPS will ultimately become a competitor to the existing international schemes, it doesn’t portend the end of Visa and MasterCard in Russia, as tourists in Russia will continue to use their Visa and MasterCard products and Russians traveling abroad will continue to use their internationally branded products. Domestic consumers are the most likely to migrate to an NPS-branded product, but Visa and MasterCard will look to establish in-country processing with Russian partners and continue to offer banks with competitive products.

The Future for a Russian NPS

The road ahead for the NPS is a long and expensive one, but the goal is achievable and there are strategic benefits to the Russian government—albeit  maybe not financial ones. Vast investment will be required to consolidate the landscape and develop the necessary infrastructure, but the strong political motivation behind the project will reduce the importance of this issue. The standoff with the West has left Putin’s approval rates at home at an all-time high (spiking at over 80 percent), and now may be the right time to drive a national scheme and succeed where others have failed.