Risk management and nonbank participation in the U.S. retail payments system

The retail payments system in the United States has changed significantly in recent years. Advances in technology have caused a greater reliance on electronic payment networks. And the industrial structure of the payment services industry has evolved, as more and more nonbanks deliver payment products to end users and supply back-end processing. In general, these changes have made the payments system more efficient and given more choices to consumers and more payment options to merchants and businesses. ; At the same time, however, the rapid pace of change has introduced new risks to the payments system. First, as more and more banks market payment services to nonbanks and outsource payments processing, the differences in information possessed by payments participants can magnify difficulties in managing risk. Second, electronic payments have a significantly different risk profile than paper checks. Third, greater complexity of the payments network potentially reduces incentives to manage risk and may cause difficulties in coordinating risk mitigation. ; Sullivan lays the groundwork for a dialogue on policy to control risk in the U.S. retail payments system. He concludes that a thorough review of supervisory authority relevant to retail payments would be valuable. In particular, the original authority to supervise nonbank payment processors was established over 40 years ago, when the primary reason for establishing that authority was the use of computer technology applied to bank accounting systems. Is that authority adequate given the revolutionary changes in the payments technology seen over the last four decades?Payment systems

The changing nature of U.S. card payment fraud: industry and public policy options

As credit and debit card payments have become the primary payment instrument in retail transactions, awareness of identity theft and concerns over the safety of payments has increased. Traditional forms of card payment fraud are still an important threat, but fraud resulting from unauthorized access to payment data appears to be rising, and we are only beginning to get a sense of the dimensions of the problem. ; Thus far, the role of public policy has been to encourage the card payment industry to limit fraud by developing its own standards and procedures. Whether this policy stance is sufficient depends on the effectiveness of industry efforts to limit fraud in light of the dramatic shift toward card payments. ; Sullivan provides an overview of card payment fraud in the United States. He develops a preliminary estimate of the rate of U.S. card payment fraud and suggests that such fraud is higher than in several other countries for which data are available. The U.S. payment industry is taking steps to combat payment fraud, but progress has been slowed by conflicts of interest, inadequate incentives, and lack of coordination. Thus, policymakers should monitor the card payment industry to see if it better coordinates security efforts, and if not, consider actions to help overcome barriers to effective development of security.

Performance and operation of commercial bank web sites

This article reviews banker experience with Internet banking based on responses to the 2001 Survey of Commercial Banks in the Tenth Federal Reserve District. The performance of bank Web sites (measured by customer enrollment, usage rate, fee revenues, and generation of new customers) has been modest but is similar to experience of most U.S. banks. Developing policies, working with vendors, regulatory requirements, security, and marketing and promotion head the list of activities that challenge banks when installing and operating Web sites. Long-term strategic factors, such as remaining competitive, retaining customers, and updating technology motivate banks to establish Web sites. Banks with Web sites have less immediate concern with reducing costs and adding revenue. In sharp contrast, high cost and lack of customer demand are most important for banks that have decided not to install a Web site. Despite their skepticism, most banks without a Web site plan to install one within the next few years. The concluding section discusses implications of these findings for bankers, bank supervisors, and policy makers.Banks and banking ; Internet banking ; Federal Reserve District, 10th

Can smart cards reduce payments fraud and identity theft?

In the United States, when a consumer presents a payment to a merchant, the merchant typically makes a request for authorization before accepting the payment. Personal information, such as an account number, address, or telephone number, are often enough to initiate a payment. A serious weakness of this system is that criminals who obtain the correct personal information can impersonate an honest consumer and commit payments fraud. ; A key to improving security-and reducing payments fraud-might be payment smart cards. Payment smart cards have an embedded computer chip that encrypts messages to aid authorization. If properly configured, payment smart cards could provide direct benefits to consumers, merchants, banks, and others. These groups would be less vulnerable to the effects of fraud and the cost of fraud prevention would fall. Smart cards could also provide indirect benefits to society by allowing a more efficient payment system. Smart cards have already been adopted in other countries, allowing a more secure payments process and a more efficient payments system. ; Sullivan explores why smart cards have the potential to provide strong payment authorization and thus put a substantial dent into the problems of payments fraud and identity theft. But adopting smart cards in the United States faces some significant challenges. First, the industry must adopt payment smart cards and their new security standards. Second, card issuers and others in the payments industry must agree on the specific forms of security protocols used in smart cards. In both steps the industry must overcome market incentives that can impede the adoption of payment smart cards or limit the strength of their security.

Interchange fees in credit and debit card markets : what role for public authorities

Credit and especially debit card transactions are on the rise worldwide. Interchange fees are an integral part of the pricing structure of credit and debit card transactions. Indirectly paid by merchants to card issuers, interchange fees in most countries are set by credit and debit card networks. But in one country, Australia, the central bank is regulating interchange fees, and in several other countries and areas, including the European Union, Mexico, the Netherlands, Spain, and the United Kingdom, public officials are taking, or considering taking, a more hands-on regulatory stance. In the United States, it is largely the court system that is debating interchange issues. ; The payments industry has a strong vested interest in interchange fees. They are a major portion of costs that merchants pay for processing debit and credit card payments and are a major source of revenue for banks that issue the cards. One reason for recent interest in interchange fees in the United States is a shift in retail payments away from checks. Research sponsored by the Federal Reserve documents a rise in electronic payments and a decline in the use of paper checks, with a milestone recently passed where the majority of noncash payments are now made using electronic instruments. This shift is also occurring in other countries. Since paper checks typically do not have an interchange fee while credit and debit payments do, the shift is a major reason why merchants face a rapidly rising cost of processing payments. Card issuers, on the other hand, rely on associated revenues to provide a return to their substantial investment in card payment networks. ; Pacheco and Sullivan summarize the proceedings of a conference sponsored by the Federal Reserve Bank of Kansas City, held in Santa Fe, New Mexico, in May 2005, which explored issues surrounding interchange fees. The conference brought together a distinguished group of industry participants, antitrust authorities, central bankers, and academics.Credit cards ; Debit cards ; Payment systems

The 2001 survey of commercial banks in the Tenth Federal Reserve District : changes and challenges

Periodically, the Federal Reserve Bank of Kansas City surveys District bankers for their views on a variety of matters. In February 2001, we solicited banker opinion on a number of topics pertaining to deposit and loan competition, management and staffing challenges, Internet banking activities, funding options, operational issues, the effects of the Gramm-Leach-Bliley Act, and near-term prospects. ; This essay briefly discusses the Tenth District’s geography, economics, and demographics and thereby provides context for the survey responses we received. It introduces subsequent articles that describe in more detail responses to survey topics. It also sets out the survey methodology and describes the applicability of survey results to the entire population of Tenth District banks. Broadly speaking, survey results can be generalized for all Tenth District banks. ; We also review what bankers told us about their environment, competition, and future challenges. The representative bank in the District is family owned and locally controlled. The economic and competitive environment that District banks face depends, in part, on growth prospects and diversification opportunities of the bank's communities. The most intense loan and deposits competitors are other community banks. Problems that most challenge survey respondents involve basic aspects of successfully managing a bank: funding, income sources, and meeting competition. Despite identifying many problems, all but a few bankers expect their banks will remain in business and succeed.Federal Reserve District, 10th ; Banks and banking

Nonbanks in the payments system: innovation, competition, and risk - a conference summary

From the early days of automated card sorting to the more recent times of the Internet and check imaging, payments and payments processing have continually embraced new technology. At the same time, the industry has been shaped by its share of entry and exit, through startups, mergers, and the reorganization of businesses seeking the proper scope of horizontal and vertical integration. ; These changes have enabled nonbank organizations to play a larger role in the payments system. Nonbanks have followed a number of pathways to more prominence: purchasing bank payment processing subsidiaries, carving out niches in the payments market through innovation, and taking advantage of economies of scale made possible by shifting to electronic forms of payment. ; Nonbanks have introduced some of the most far-reaching innovations to the payments system in recent years, leading to greater efficiencies in payments processing. At the same time, nonbanks have changed the dynamics of competition in payments, leading to a significant change in the system’s risk profile. ; Sullivan and Wang summarize the proceedings of a conference on nonbanks in the payments system held by the Federal Reserve Bank of Kansas City in Santa Fe, New Mexico, on May 2-4, 2007. The conference addressed many of the key questions raised by the growing presence of nonbanks in payments, including: Have recent payment innovations been more likely to come from nonbanks? Have nonbanks improved or harmed competition in payments? Have nonbanks increased risk or helped to develop tools to manage it? How should public policy respond as increasingly more activity in payments lies outside of the banking system?Payment systems ; Nonbank financial institutions

Financial innovation, strategic real options and endogenous competition : theory and an application to Internet banking

Innovations in financial services continuously influence the scope of financial intermediation and the nature of competition between intermediaries. This paper examines the optimal exercise of strategic real options to invest in such an innovation, Internet banking technology, within a two-stage game, parameterized by the distribution of bank size and uncertainty over the profitability of investment, and empirically tests the results on a novel data set. Unlike traditional options, in which the distribution of the future value of the underlying asset is exogenous and the timing of exercise affects only the return to the option holder, the timing of the exercise of real options in a strategic context allows the option holder to manipulate the distribution of returns to all players. The value of the strategic investment option in our model, as a consequence, depends on both expected future profits as well as the variance of those profits. Expected profits to an entrant depend, in equilibrium, on its size, as measured by existing market share (concentration) or total assets, relative to its rivals. Conditional on the degree of uncertainty, larger banks should, as a consequence, exercise their options earlier than smaller banks, for purely strategic advantages, and act as market leaders in the provision of Internet banking services. Like ordinary options, however, the value of the strategic investment option to both large and small banks increases in uncertainty, implying that early exercise will be more likely the more information is available about potential demand. We test these hypotheses on investment in Internet banking services with data from a sample of 1,618 commercial banks in the tenth Federal Reserve District during 1999. Evidence indicates that relative bank size, as measured by either market share or asset size, positively influences the likelihood of entry into Internet banking, and trend-adjusted variation in income per person (a proxy for uncertainty of demand) negatively influences the likelihood of entry into Internet banking. In addition, market concentration of a bank's competitive rivals has a negative relationship with the likelihood of entering the market for Internet banking services. These relations are evident in both bivariate analysis and in multivariate logit regression analysis.Competition ; Internet ; Internet banking

Internet banking: an exploration in technology diffusion and impact

This paper studies endogenous diffusion and impact of a cost-saving technological innovation -- Internet Banking. When the innovation is initially introduced, large banks have an advantage to adopt it first and enjoy further growth of size. Over time, as the innovation diffuses into smaller banks, the aggregate bank size distribution increases stochastically towards a new steady state. Applying the theory to a panel study of Internet Banking diffusion across 50 US states, we examine the technological, economic and institutional factors governing the process. The empirical findings allow us to disentangle the interrelationship between Internet Banking adoption and growth of average bank size, and explain the variation of diffusion rates across geographic regions.Internet ; Internet banking ; Technology