Retail Circuits and Instruments: Main Trends Reforming Payment and Security Reforming Payment and Security Settlement Systems World Bank – Federal Reserve Board Washington, D.C. November 4, 2003 Stuart E. Weiner Federal Reserve Bank of Kansas City

Introduction Payments systems worldwide are experiencing rapid, unprecedented change Payments systems worldwide are experiencing rapid, unprecedented change Key driving forces are evolving end-user needs, technological advances, network integration, increased cross-border payments Key driving forces are evolving end-user needs, technological advances, network integration, increased cross-border payments As retail payments systems develop and evolve, how are the needs of end-users best met? As retail payments systems develop and evolve, how are the needs of end-users best met?

Terminology Retail versus wholesale Retail versus wholesale Consumer retail payments Consumer retail payments Merchants Merchants Billers Billers Business, government retail payments Business, government retail payments

Key Points To be successful, consumer retail payments instruments and systems must meet three criteria To be successful, consumer retail payments instruments and systems must meet three criteria Safety Safety Efficiency Efficiency Accessibility Accessibility Consumer/merchant/biller acceptance, in turn, will help payments instruments and systems achieve necessary critical mass Consumer/merchant/biller acceptance, in turn, will help payments instruments and systems achieve necessary critical mass

Presentation Structure Payments mix across countries Payments mix across countries Consumer/merchant/biller needs and preferences Consumer/merchant/biller needs and preferences Critical mass Critical mass Case studies Case studies Business needs Business needs Closing remarks Closing remarks

Source: BIS Payments: Cross-Country Snapshot 2001

Source: BIS Payments: Cross-Country Trends 1997, 2001

Source: Derived from NACHA - the Electronic Payments Association Payments: U.S. ACH Growth from New Sources 2002 – 2003

Consumer/Merchant/Biller Needs and Preferences Despite strikingly different retail payments mixes across countries, all successful instruments and systems meet three critical criteria: safety, efficiency, accessibility Despite strikingly different retail payments mixes across countries, all successful instruments and systems meet three critical criteria: safety, efficiency, accessibility There will often be tradeoffs among these three characteristics There will often be tradeoffs among these three characteristics Distinction between instruments and systems Distinction between instruments and systems

Safety Retail payments instruments must be perceived by consumers, merchants, and billers to be safe and reliable Retail payments instruments must be perceived by consumers, merchants, and billers to be safe and reliable Payments providers (banks, nonbanks, networks, processors) thus have a strong incentive to provide this safety Payments providers (banks, nonbanks, networks, processors) thus have a strong incentive to provide this safety Providers may not, however, have an equally strong incentive to provide this level of safety at the macro level Providers may not, however, have an equally strong incentive to provide this level of safety at the macro level Systemic and operational risk issues can arise Systemic and operational risk issues can arise

Efficiency Consumers, merchants, and billers want payments methods that are low-cost and convenient Consumers, merchants, and billers want payments methods that are low-cost and convenient Providers will consequently have an incentive to operate as efficiently as possible Providers will consequently have an incentive to operate as efficiently as possible Economies of scale and “network economies” (a payments mechanism takes on more value to existing users as more users elect to participate) may lead to consolidation and concentration among providers Economies of scale and “network economies” (a payments mechanism takes on more value to existing users as more users elect to participate) may lead to consolidation and concentration among providers

Source: Hayashi et al. Timeline of Regional ATM and Debit Card Networks

Accessibility Providers have an incentive to provide broad access Providers have an incentive to provide broad access But access need not be universal to be profitable for providers But access need not be universal to be profitable for providers Two levels of access Two levels of access Front-line access by consumers, merchants, billers Front-line access by consumers, merchants, billers Infrastructure access by providers, making the first level of access possible Infrastructure access by providers, making the first level of access possible

U.S. Consumer Payments Choices: Research Results Consumers are more likely to use electronic forms of payment Consumers are more likely to use electronic forms of payment the younger and more educated they are, and the greater income they have the younger and more educated they are, and the greater income they have the more they use new technologies or computers the more they use new technologies or computers Payment choice depends on characteristics of the transaction, including transaction value, physical characteristics of the point of sale, and a bill’s frequency and value variability Payment choice depends on characteristics of the transaction, including transaction value, physical characteristics of the point of sale, and a bill’s frequency and value variability

Critical Mass A successful payments instrument must reach a critical mass of users A successful payments instrument must reach a critical mass of users To reach critical mass, must have consumer, merchant, biller acceptance To reach critical mass, must have consumer, merchant, biller acceptance Also, providers must ultimately find it profitable to participate Also, providers must ultimately find it profitable to participate

Critical Mass (cont.) Reaching critical mass is important for two reasons Reaching critical mass is important for two reasons Allows merchants, billers, and providers to cover fixed costs Allows merchants, billers, and providers to cover fixed costs Allows network economies to be realized (overcoming the chicken versus egg problem) Allows network economies to be realized (overcoming the chicken versus egg problem) Private versus public provision Private versus public provision Competitive-network model versus regulated- monopoly model Competitive-network model versus regulated- monopoly model

U.S. Case Studies The three criteria (safety, efficiency, and accessibility) and critical mass The three criteria (safety, efficiency, and accessibility) and critical mass Have successfully been met by credit cards, debit cards, and ACH Have successfully been met by credit cards, debit cards, and ACH Have unsuccessfully been met by digital cash Have unsuccessfully been met by digital cash Have met resistance but are attempting to take hold in the P2P and EBPP markets Have met resistance but are attempting to take hold in the P2P and EBPP markets

Business Payments Needs Same three criteria: safety, efficiency, accessibility Same three criteria: safety, efficiency, accessibility Two key efficiency considerations: Two key efficiency considerations: Internal technology integration (compatibility with existing systems, i.e., straight-through processing) Internal technology integration (compatibility with existing systems, i.e., straight-through processing) Common standards, interoperability across firms Common standards, interoperability across firms Same need for critical mass Same need for critical mass Need to make business case Need to make business case

U.S. Business Payments Study Federal Reserve study undertaken in Federal Reserve study undertaken in Interviewed representatives of roughly fifty organizations, including corporate end users, technology firms, banks, and private- sector providers Interviewed representatives of roughly fifty organizations, including corporate end users, technology firms, banks, and private- sector providers Sought views on longer-term payments system developments Sought views on longer-term payments system developments

U.S. Business Payments Study (cont.) “Corporations’ accounts payable, accounts receivable, payments, and reconcilement systems continue to be less integrated than necessary for seamless handling of invoice and electronic payments information.” “Corporations’ accounts payable, accounts receivable, payments, and reconcilement systems continue to be less integrated than necessary for seamless handling of invoice and electronic payments information.” “The existence of multiple payment-message formats, such as the formats for ACH, wire transfers, and other electronic payments, increases the cost and complexity of payments processing.” “The existence of multiple payment-message formats, such as the formats for ACH, wire transfers, and other electronic payments, increases the cost and complexity of payments processing.”

Closing Remarks Payments instruments and systems are undergoing dramatic, even profound, change Payments instruments and systems are undergoing dramatic, even profound, change Meeting the needs of end-users will at times be challenging, but those end-users will go a long way in determining for themselves what will be successful and what will not Meeting the needs of end-users will at times be challenging, but those end-users will go a long way in determining for themselves what will be successful and what will not Safety, efficiency, accessibility, and critical mass will be key elements of success Safety, efficiency, accessibility, and critical mass will be key elements of success

References BIS, “Statistics on Payment and Settlement Systems in Selected Countries,” 2003 BIS, “Statistics on Payment and Settlement Systems in Selected Countries,” 2003 Bradford-Davies-Weiner, Nonbanks in the Payments System, Bradford-Davies-Weiner, Nonbanks in the Payments System, Federal Reserve Board, “The Future of Retail Electronic Payments Systems,” 2002 Federal Reserve Board, “The Future of Retail Electronic Payments Systems,” 2002 Hayashi-Klee, “Technology Adoption and Consumer Payments,” Hayashi-Klee, “Technology Adoption and Consumer Payments,” Hayashi-Sullivan-Weiner, A Guide to the ATM and Debit Card Industry, Hayashi-Sullivan-Weiner, A Guide to the ATM and Debit Card Industry, Hoenig, “Payments and Settlement Systems,” BAI Money Transfer Conference, Hoenig, “Payments and Settlement Systems,” BAI Money Transfer Conference, Stavins, “Effect of Consumer Characteristics on the Use of Payments Instruments,” Stavins, “Effect of Consumer Characteristics on the Use of Payments Instruments,” 2001.

Contact Information Stuart E. Weiner Stuart E. Weiner Payments System Research Payments System Research Federal Reserve Bank of Kansas City Federal Reserve Bank of Kansas City 925 Grand Blvd. 925 Grand Blvd. Kansas City, Missouri USA Kansas City, Missouri USA