Electronic Payments
Financial Services Industry Becoming Inventive

Overview

The accelerating electronification of the payment system has become a pervasive influence on consumers’ finances, corporate strategies, government operations and national economies – in the United States and around the world.  Although the most dramatic and visible changes have occurred in the past decade, the evolution of electronic payments can perhaps be traced to the debut in 1960 of the automated teller machine.  Subsequent developments – most recently the enactment of the Check Clearing for the 21st Century Act (Check 21) – have accelerated the evolutionary process and created today’s dynamic electronic financial marketplace.

In December 2004, the Federal Reserve announced that for the first time, Americans’ use of credit and debit cards and other forms of electronic payment had eclipsed paper checks.

Three major trends serve to encompass and explain the state of the art in electronic payments in the United States today:

• Payment methods are converging, the distinction among them blurring as technology makes more and more things possible;
• Paper checks are increasingly being converted to electronic payments at various points in the transactional process; and
• Consumer convenience and the analogous benefit to retailers and financial institutions  - efficiency – are driving and shaping the electronic payments marketplace.

New Technology

Technology is making it possible to reconfigure these components and to recombine them in new ways that respond to the evolving needs of consumers and businesses.  One of the earliest examples of this is the transformation of ATM cards into ATM/debit cards, a process that started in the early 1970’s; although the cards were originally used only to deposit and withdraw account funds at ATM’s, retailers began accepting them alongside credit cards, with funds coming directly from the checking account rather than from credit lines.  In time, credit card issuers began providing cardholders paper checks with which to access their credit lines, and consumers are increasingly using checking account numbers to order products and services by phone and on the Internet, in much the same way they use credit card numbers.

The beginning of the move from paper to electronic checks started with direct payroll deposits through the national clearing house established for this purpose in the 1970’s.  More recently, these clearing houses have begun processing direct withdrawals for recurring payments such as utilities and health club dues.  In 2003, the automated clearing house (ACH) network processed some 4 billion direct deposit transactions and 2.8 billion direct payments.

Consumers’ desire for greater convenience and businesses’ need to increase efficiency are at the core of virtually all electronic payment innovations – the hundreds that already benefit consumers and businesses, and thousands more that will do so in the future.

Electronic Payment Growth  

In the U.S., growth in card payments added an additional $6.5 trillion to real consumer spending between 1980 and 2000. Without this growth in spending, the cumulative loss to GDP would have been almost $10 trillion – the equivalent of 1.3 million new jobs – and would have reduced GDP growth by 0.5 percent per year.

This simulative effect generally holds true across a wide variety of international economies. An analysis of 50 countries worldwide, ranging from Egypt to Canada, found that on average, an increase of just 10 percent in the existing share of card payments in a country would stimulate an increase of 0.5 percent in consumer spending.

Electronic payment networks, by increasing the efficiency and velocity of payments, have the potential to create cost savings of at least 1 percent of GDP annually over paper-based systems in any given economy.

Business to Business Electronic Billing and Payment

A recent study by the Federal Reserve found that 86 percent of the 3.9 billion business-to-business (B2B) payments generated each year are in the form of paper checks.  Moreover, B2B payment accounts for nearly a third of all paper checks.  Research done by Gartner Inc. in 2002 found that the average cost of implementing a web based electronic invoice presentment and payment (EIPP) system ranged from $130,000 to $400,000, depending on the organizations size and complexity. Estimated savings of $7.25 per invoice, Gartner predicted than an average organization could realize a return on its investment within the first year, if just 2.3 percent of its customers opted to view and pay invoices online.

Smart Cards

Smart cards, also called chip cards because they incorporate a microprocessor chip, today boast processing power similar to that of a 386-chip based personal computer, circa 1990.  Able to hold 32 kilobytes (kb) of data and execute simple application programs stored in 64 kb of flash memory, these chips give smart cards the power to run multiple applications on a single card and process security algorithms that encode and secure all the cards’ data. Depending on the chip, a smart card may serve as one of the following: a payment card – either credit, ATM/debit, or stored-value; an identification and authentication (I&A) token for gaining access to a building or website or enhancing the security of an Internet transaction or other communication; or a combination of the two.  In addition, chips are generally powerful enough to run multiple payment and security applications on a single card.

Stored Value Cards

In contrast to the long time horizon seen for smart cards, the industry is bullish on prepaid debit cards.  At present, the leading applications for stored-value cards are gift, payroll, benefit and teen cards, as well as cards used for cross-border payments.

Contractless Payments

Contractless payments today fall into one of two categories: proximity and mobile. Proximity payments are initiated using a radio transponder – which can be contained in a payment card, keyfob or other small device – that sends a signal to a receiver; the two must be in close proximity to each other.  In contrast, mobile payments are initiated using a cellular telephone or wireless personal digital assistant (PDA) and are as unlimited in range as a cell phone.

Internet Payments

In a little more than a decade, the Internet has evolved into one of the most vibrant avenues for e-payments, first for purchasing goods and services, then for receiving and paying bills, and, most recently, for transferring funds between accounts.

Summary And Outlook

Although early predictions of a “cashless paperless economy” have not come true – and are unlikely to in the foreseeable future – continued electronification of the financial marketplace is inevitable.  Fueled by consumers’ demands for speed and convenience, businesses’ drive to increase efficiency, and the quarter-century old federally mandated war on float, electronic commerce increasingly influences every aspect of personal, corporate and government finance.

Sources: Visa International and Global Insight White Paper (July 10, 2020) and STAR White Paper (January 2005)