Retail Payments Systems in the U.S.

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Retail Payments Systems in the U.S.
International Workshop Retail Payments Câmara
Interbancária de Pagamentos São Paulo, Brazil
June 1, 2007 James McKee Federal Reserve Retail
Payments Office
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Retail Payments in the United States

• Current period is one of transition and
  fast-paced change toward electronic payments
• Long promised check-less age arriving soon but
  not yet here
• Consumer behavior and preferences are changing

3
Federal Reserve Retail Payments Research Studies

• 2001 Study (2000 data)
• 41.9 billion checks paid
• 30.6 billion electronic payments
• 2004 Study (2003 data)
• 36.7 billion checks paid
• value of checks paid - 39.3 trillion
• 31.5 billion checks in 2005 (estimate)
• 44.5 billion electronic payments
• value of electronic payments - 27.4 trillion

New 2007 study in development
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Distribution of Non-Cash Payments
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Payments Markets Trends
Total Number of Consumer to Business Recurring
Payments by Instrument
12.00
ACH
10.00
Cash
Check
8.00
Money Order
Credit Card
(Billions)
PIN-Less Debit
6.00
Debit Card (Sig)
ACH
4.00
Check
2.00
0.00
2002
2003
2004
2005
2006
2007
2008
2009
2010
Source Celent and BearingPoint Analysis
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Strategic Outlook

• ACH projected to overtake check payments during
  2007
• Focus on end-to-end electronics
• Movement to full electronification will continue
  to evolve
• Electronifying the check as early in the
  collection process as is possible
• ACH offers several options for electronifying
  checks (ARC, POP, RCK, BOC)
• As paper check volume continues to decline,
  increasing pressure on all participants to manage
  costs
• Transition solutions to support the migration
  from check to electronic payments will be vital
• Enable end-to-end electronics while allowing for
  paper where needed

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• Checks

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Electronification of Paper Checks

• Check electronification is necessary
• Decline in paper check volume coupled with the
  fixed costs associated with transportation of
  paper checks
• Yet more payments are made by check than any
  other medium
• While in decline, checks are still at volumes
  impossible to shift from in the near future
• Checks account for 46 of PCE (Personal
  Consumption Expenditures) in the US
• Continued popularity of checks with consumers
  forces merchants to evaluate business case for
  check electronification as a way of continuing to
  accept checks profitably

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Check 21

• The Check Clearing for the 21st Century Act, or
  Check 21, was effective October 28, 2004.
• To make check collection process more efficient,
  Check 21 authorized use of new negotiable
  instrument called a substitute check.
• Provides for substitute check to be a paper
  reproduction of the original check and to be
  processed just like the original check
• Improves payment process by reducing
• Reliance on physical transportation of checks
• Number of times physical checks must be handled
• Costs through expedited handling within bank or
  customer operations and quicker collection and
  return of checks
• Same legal standing as original paper check

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Check Processing/Clearing Flow
Payor (Writes Check)
Payee Company/Individual (Receives Check)
Payment through a debit to payment account
Cancelled
Payment through a credit to payees account
account
Deposited
Federal Reserve Bank OR Correspondent Bank OR
Local Clearing House
Presented for Payment
Forwarded
Payment through a debit
Payment through a credit
Payees DFI
Payors DFI
FLOW Payor (Maker), Payee (Party due payment),
Payees DFI (Collecting bank), Clearing House,
Payors DFI
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Check Collection The Future Environment

• Where possible, originate all transactions
  electronically
• Business Solutions ACH, Wire Transfer
• Consumer Solutions Debit cards, credit cards,
  online bill payments, gift cards
• If it starts as a check, capture and convert to
  electronics as early as possible corporation,
  branch, ATM, lockbox
• Goal No movement of physical paper
• By 2010, clearing paper will be expensive, slow,
  and with poor availability

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Check 21 Statistics
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Check 21 Statistics
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• ACH

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ACH

• Continued migration of a large number of cash and
  check transactions to electronic payments
• ACH growth has shifted from recurring to one-time
  payments including debit (WEB, TEL)
  Check-to-ACH conversion payments (POP, ARC, RCK)
• Acceleration of electronic check processing (via
  check image exchange and back-office conversion)
• Non-bank service providers are riding ACH rails,
  largely to leverage its low cost (PayPal Pay By
  Touch Debitman Fastlane)

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ACH

• Banks will continue to wrestle with customers
  expectations for the privacy and security of
  their personal, account and transaction
  information
• Continued emphasis on risk management
• Wider use of ACH debit payments, especially
  one-time options with limited ability to know
  your customer, may increase risk of fraud
• Other initiatives to look at credit push and EBPP
  services are being pursued but business case is
  unknown

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ACH Network Volume Growth
(Items Processed Millions)
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Present DayWho Is Using ACH?
Consumers
143 Million
Corporations
4.8 Million
Federal Government Employees
99.8 Percent
Private Sector Employees
71.0 Percent
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2006 4th Quarter StatisticsCommercial Debits
vs. Commercial Credits
Commercial Debits 1,925,318,112 (64.1)
Commercial Credits 1,078,026,550 (35.9)
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2006 4th Quarter StatisticsCommercial Volume
vs. Government Volume
Commercial Volume 3,003,344,662 (92.5)
Government Volume 242,766,839 (7.5)
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Total ACH Network Volume - 1992 to 2012 (Actual
volume through 2006, projections 2007 2012)
Item volume (in millions). Network volume
excludes on-us items
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Network Volume eCheck2001 to 2012
Item volume (in millions). Network volume
excludes on-us items
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Traditional ACH vs. eCheck2001 to 2012
Item volume (in millions). Network volume
excludes on-us items
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ACH Processing Flow
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• Electronic Bill Payment

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Key Trends On-Line

• Internet initiated consumer payments
• Three broad categories
• Bill-payments
• Ad hoc purchases
• Account to account person to person (A2A P2P)
• Four types of payment methods
• Signature-based payment cards
• PIN-based network settlement of ATM/debit cards
  (PIN-less debit)
• Intermediaries such as PayPal, Bill Me Later
• Direct DDA transactions via ACH (e-checks)
  checks (demand drafts)

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New Entrants Growing Fast
PayPal account growth continues (100 million
accounts in 1Q06 40 annual transaction volume
growth) along with service offerings (PayPal
Mobile Text to Buy) international reach (55
countries)
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Trends in Electronic Bill Payment

• Biller survey suggests the credit and debit card
  share of biller direct payments will grow from
  14 in 2004
• Meanwhile, the share of biller direct payments
  processed by the ACH will decline from 85 in
  2004
• Billers tend to be satisfied with the current
  level of adoption of EBPP
• However, there is a gap between the goals billers
  have set and their current level of success
• Particularly paper and postage savings
• Call center deflection
• Customer satisfaction and retention
• Still a number of major billers that do not
  support online bill payment via bank Web sites,
  nor bill presentment through bank Web sites

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EBPP Forecast 2006 to 2011 Forrester Research,
01/27/2007

• The number of EBPP users will grow by 66 during
  the next 6 years
• In 2005, 38 of online households paid bills
  online
• By 2011, 63 of online households will pay bills
  online
• Households paying bills online will grow to more
  than 59 million
• Growth NOT spread evenly across generations
• Gen Yers (1976 1990) will propel EBPP adoption
  growth
• Gen Xers (1964 1975) will provide sizable
  adoption growth
• Boomers (19461963) will be a smaller portion of
  the EBPP pie
• Seniors (1900 1945) will supply a paltry
  portion of EBPP adoption growth

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EBPP Forecast 2006 to 2011 Forrester Research,
01/27/2007
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• ATM Cards

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Cards

• Fastest growing U.S. payment method
• Debit card volumes have eclipsed credit cards
• Stored value is fastest growing type of debit
  card
• P-Card growing in B2B
• Significant innovation in features functions
• Supports other front-end payment methodse.g.,
  on-line bill payment, PayPal, etc.
• Growth has stimulated fierce debate on
  interchange fees
• Law suits ongoing search for alternatives

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ATMs, Debit Cards and ACH FRB Kansas 2006
updated Guide to the ATM and Debit Card Industry

• ATM use is declining and key players retrenching
• Debit card use is rapidly expanding, with new
  players, products and markets
• Debit will become battleground between signature
  debit and PIN debit
• Both types of debit face strong challenge from
  ACH, which is developing numerous payment options
  as debit card substitutes

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ACH Debit Card Substitutes

• NACHAs Online Payments Pilot
• Advantage keeps the consumers account info
  between consumer and bank
• Consumers bank authenticates customer and
  guarantees payment to merchant
• Applications to initiate ACH at the Point of Sale
  (POS)
• Debitman (Tempo) agreements with retailers
  (WalMart, Burger King, Best Buy, Shell,
  Walgreens)
• Retail private label credit cards issuing cards
  on behalf of merchants
• First Data testing ACH debit card with Stop and
  Shop grocery chain
• Drivers licenses to initiate POS payments
  settled on the ACH system
• Online retailers using e-check to allow consumers
  to make an ACH payment (including Amazon.com)

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Trends in Cards
Sources Pelorus Group, Mercator, Financial
Insights, Tower BBD Projections
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Card Processing Flow
Purchases Item
Consumer (Card-Holder)
Card Issuer
Merchant
Consumers Acct
Sales Draft Info
Authorization
On-Line
Authorization
Authorization
Sales Draft Info
Sales Draft Info
Acquirer/Processor (Merchant Bank)
National Credit Card Network
Card-Issuing Bank
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• Payments
• Risk

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Trends in Risk

• Internet other new technologies have enabled
  new types of payments fraud other illicit
  activities
• Counterfeiting cash checks
• Cyber crime phishing, pharming, kiting, etc.
• ID theft
• Malicious hacking denial of service
• Global terrorism other international crimes
  have led to new laws regulations affecting
  payments
• OFAC, AML, USA Patriot Act
• Risk characteristics of emerging payment methods
  must be assessed to ensure controls are effective
  efficient

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Fraud and Risk in Retail Payments

• ACH
• Returns reporting gives Originating Depository
  Financial Institutions (ODFIs) a way to identify
  potential ACH fraud or problem accounts
• Risk origination monitoring service provides
  ODFIs with enhanced control, flexibility and
  automation in monitoring the risks associated
  with originating ACH payments
• Check 21
• FedReceipt/PlusSM reduces return risk by
  expediting items (for BOFD)
• FedReturnSM improves fraud mitigation through
  expedited return item clearing

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• Looking
• Forward

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Convergence Business Issues

• Which rule set will dominate? check law or ACH
  rules?
• How will business payments be integrated
  electronically?
• Which emerging payments will prevail?
• Are consumer needs and expectations being met?
• Other variables
• Inter-bank fees and services
• Ultimate cost benefit vis-à-vis other
  alternatives
• Managing across silos

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Payment Types that Meet Criteria will Dominate

• Productivity
• Efficiency, cost reduction, STP/fewer exceptions
• Value
• Mix of pricing, timing, settlement, high/low
  value will determine which payment types prevail
• Risk Mitigation
• Are the appropriate tools in place? Is the price
  right?

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Contact Information

• Jim McKee
• Senior Vice President
• Federal Reserve Retail Payments Office
• E-mail
• james.m.mckee_at_atl.frb.org
• Phone
• 404-498-8894

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• Additional Resources

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Payments Information On-Line

• Federal Reserve Board studies and regulations
• http//www.federalreserve.gov/paymentsys.htm
• Federal Reserve Bank of Kansas
• http//www.kansascityfed.org/home/subwebs.cfm?subW
  eb9
• Federal Reserve Bank of Chicago
• http//www.chicagofed.org/emerging_payments_and_po
  licy/emerging_payments_and_policy_index.cfm

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Payments Information On-Line

• Noncash Payments Trends in United States
  2000-2003
• Federal Reserve System, www.frbservices.org
• Barriers to Acceptance of Electronic Benefits
  Payments
• U.S. Treasury, www.ustreas.gov
• CyberAtlas
• http//www.clickz.com/stats/sectors/traffic_patter
  ns/article.php/3446641
• Business to Business Payments 2004 Survey of
  Members and Electronic Payments Study 2006
  Survey on Payments Risk
• Association for Financial Professionals (AFP),
  www.afponline.org
• Grant-Thornton 2005 Survey of U.S. Community
  Banks
• http//www.grantthornton.com/
• 2005 Cash Management Middle Market Monitor and
  Fraud and Disbursement PracticesPositive Pay
  Pays
• http//www.phoenixhecht.com/Publications.html
• ICBA 2005 Community Bank Technology survey
  results
• ICBA 2006 Community Bank Payments survey results
• http//www.icba.org/

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Payments Information On-Line

• Card-based Payment
• www.visa.com
• www.mastercard.com
• www.cardforum.com
• www.cardweb.com
• www.CardTechnology.com
• Electronic Payments
• www.epnn.com
• www.digitaltransactions.net
• www.nacha.org

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Federal Reserve Value-Added Services Check

• Check 21 Product Suite
• FedForwardSM supports electronic clearing
  process
• FedReceiptSM enables straight-through
  electronic check processing for a portion of
  inclearings or returns
• FedReceipt PlusSM presents all eligible items
  in an image cash letter in lieu of a paper cash
  letter presentment
• FedReturnSM helps customers transform their
  outbound returns processing operations
• Fore more information
• http//www.frbservices.org/Retail/Check21.html

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Federal Reserve Value-Added Services ACH

• Risk Management Services
• FedACH Risk Origination Monitoring Service
• FedACH Risk Returns Reporting Service
• FedACH International Services
• Canada ConnectionSM
• Directo a MéxicoSM
• Transatlantic Service
• New EDI conversion facility in development
• For more information
• http//www.frbservices.org/Retail/fedach.html