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Electronic Money
What are electronic payments and what are their advantages? Thirty years ago, some predicted we were on the verge of a cashless society. Paper currency and checks would join the Edsel and the black-and-white television as antiquated symbols of the past. Consumers would embrace a new alternative for making payments: electronic money. As it turned out, consumers have been reluctant to give up on currency and checks. In recent years, however, consumers seem to be changing their minds. Cash and checks are still widely used. Currency is used for the vast majority of payments, mainly for smaller purchases. And checks are the payment choice for about 10 percent of transactions each year. But the percentage of transactions done electronically is growing dramatically. The important role of electronic payments can be seen by looking at the value of payment transactions. Electronic payments account for more than 90 percent of the dollar value of transactions. This growth is made possible by electronic payment networks, which move funds in and out of accounts using electronic messages. Electronic payment systems range from the now-familiar automated teller machines (ATM) to Internet bill payments. This essay discusses the different types of electronic payment systems and looks at the future of electronic money. ATM and Debit Systems The most common form of electronic money transfer is the ATM, or automated teller machine, which enables consumers to access existing accounts and make deposits, obtain cash, and transfer funds between accounts. To access an account from an ATM, a consumer must first get an ATM card from his or her bank or financial institution. Some other types of cards, such as credit cards and some stored value cards, can also be used at ATMs to get cash. The consumer inserts or swipes the card into the machine, enters a PIN (personal identification number) on the keypad, and then can perform the transaction. When the transaction is completed, the consumer receives a receipt showing the date, the dollar amount and the type of transaction. Make Guessing Your Pin Like Finding a Needle in a Haystack
A new type of ATM is being introduced offering services that may be useful for people who do not have checking accounts. It is available in a few locations such as convenience stores. These machines allow consumers to do things like cash checks and pay utility bills electronically. A variation of the ATM system is online, or PIN, debit. With PIN debit, consumers use an access card (often their ATM card) to transfer funds immediately from their account to a merchant's account. In this way, a PIN debit transaction is different from a credit card transaction in which payment is postponed. To make a PIN debit payment, a consumer simply passes a debit card through the merchant's card reader and enters a PIN on the keypad, much like at an ATM. The consumer receives a printed receipt after the transaction is completed. Some debit transactions are "offline." These transactions are carried over the credit card networks rather than the ATM networks. For this reason, consumers endorse the payment with their signature, as they would with a credit card, rather than with their PIN. The merchants submit their debit card sales slips to their financial institution along with their charge slips. The amount of the transaction is deducted by the consumer's financial institution when the sales slip is received, rather than when the transaction takes place, and appears on the consumer's account statement. During the 1990s, the number of merchants who accept PIN debit increased dramatically to include such retail outlets as grocery stores, convenience stores, and even movie theaters. In fact, most places that take a major credit card will take a debit card. The level of electronic payments and electronic banking has grown considerably in recent years. One area of significant growth is debit card payments, which increased dramatically in the mid-1990s as retailers began installing and using debit technology.
When ATMs and PIN debit were first introduced, consumers could use only machines that carried the logos of the networks used by their financial institutions. This is no longer true. All of the ATM networks are now linked together, and consumers can use their ATM or debit card at any machine. However, there are frequently fees associated with doing so. Until recently, the credit card networks required merchants to accept signature debit cards if they accepted credit cards. While merchants no longer have to accept signature debit cards, most still do. Merchants have to pay fees to their financial institutions to process payment card transactions, and the fees for PIN debit are typically lower than those for signature debit or credit card payments. For this reason, many merchants are trying to push their customers toward PIN debit, while financial institutions are encouraging their customers to use signature debit. Debit cards are a useful payment alternative because they allow a swift transfer of funds between the buyer and seller. The seller does not have to worry about a bounced check. For the buyer, debit can be more convenient than writing a check, and is safer than carrying cash. Some consumers also like debit because they find that being limited by the amount of money in their account helps them to control their spending. The federal government has been a big proponent of this technology. Many state and federal benefits, such as Social Security and food stamps, are distributed electronically. For example, many states issue food stamps as value stored on a card that works like a debit card, and Social Security and welfare benefits are typically paid by direct deposit. Electronic distribution of benefits has advantages for both the government and the recipients. It is less expensive than using paper checks and reduces opportunities for fraud. It is more secure for recipients because they don't have to worry that their check will get stolen, and they avoid the hassle of cashing the check. Direct Deposit and Automatic Bill Payment Two forms of electronic payment are direct deposit and automatic bill payment. Both are usually cleared through Automated Clearing Houses (ACH) operated by the Federal Reserve System or a private provider. Direct deposits are automated credits or increases to the consumer's account. Automatic bill payments are automated debits or reductions. Unlike ATM and debit card transactions, no access card is needed. Direct deposits are regularly used by employers, government agencies and other organizations that make regular payments, such as wages and dividends, to individuals. According to 2003 figures from the National Automated Clearing House Association (NACHA), about 68 percent of U.S. households receive their wages via direct deposit. The U.S. government is the largest single user of direct deposit. Approximately 98 percent of government workers use direct deposit. And many of the government's benefits are paid electronically. The Social Security Administration alone uses direct deposit to make payments to approximately 37 million recipients every month. The number of benefit payments made electronically increased dramatically after the passage of EFT '99, which required that most federal payments be made electronically after January 2, 1999. It is easy to receive funds by direct deposit. A consumer first must authorize the deposit. The party making the payments, usually an employer, then creates an electronic message. This message specifies the amount of the payment and identifies the financial institution and account to be credited. This data is transmitted by the employer's financial institution to the ACH, which collects and sorts the information. The ACH then transmits the account and payment information to the consumer's financial institution. In turn, that institution credits the consumer's account. Automatic bill payment uses the same system, but in reverse. In an automatic bill payment arrangement, a consumer authorizes a biller, such as a utility company, to deduct funds automatically from the consumer's account for the regular payment of bills. Automatic bill payment may also be referred to as direct payment or direct debit.
A consumer first enrolls in the biller's automatic bill payment program, usually by filling out a form on the bill or on the biller's Web site. This form indicates when payments are to be made, a specific dollar amount or the balance due, and the account from which the funds will be paid. This form is then sent to the biller, who makes arrangements with the consumer's financial institution. Before a payment is deducted from the consumer's account, the biller will send a notification of payment to the consumer, usually a week or two in advance. This notification is itemized just like a regular bill. The consumer can check the charges and contact the biller if there is an error. If the consumer wishes, he or she can stop the electronic payment by notifying the creditor and the financial institution. Automatic payment is most commonly used for recurring payments such as a mortgage or rent, utility bills, loans, and insurance premiums. Though automatic bill payment has not been as popular as direct deposit, 54 percent of households were using it at least once a month in 2002. A recent study found that the number of automatic payments made by consumers more than doubled between 1997 and 2002, to 2.8 billion payments per year. The advantage of this method for businesses is its increased efficiency. Electronic transactions cost less to process because there are no paper checks to be transported, handled, or reconciled. The efficiency of electronic payments can reduce costs for both businesses and the financial institutions that process the transaction. For the consumer, it means faster processing leading to quick and certain payments and receipts. Another advantage for the consumer is not having to worry about paying a bill "too early" or sending the payment "too late."
Internet Banking and Electronic Bill Payment Consumers can also make electronic bill payments over the Internet. This type of electronic bill payment can be made either at their biller's Web site or at the Web site of a bill consolidator such as a financial institution. Consumers can often choose to receive their bills electronically, too, either via e-mail or online. In order to pay a bill electronically at the Web site of a biller who offers this option, a consumer must first visit the biller's Web site. There the consumer can enroll in the system, which will typically mean providing some identifying information and choosing a username and password. Once their identity has been verified, consumers can log on to the site, review their bill and pay it electronically. Some billers offer consumers several different ways to pay their bill electronically. A common method is a one-time transaction that takes place over the same system that processes automatic payments and direct deposit. The consumer fills out an online form that includes information such as the amount they want to pay and the number of the account from which they want the bill to be paid, usually the number written at the bottom of their paper checks. The consumer then authorizes the biller to deduct the payment from the consumer's account. Another way that consumers can pay their bills online is with a credit or signature debit card that does not require a PIN, though not all billers offer this option. Consumers must first visit the biller's Web site to enroll and verify their identity. When they select the payment method, they indicate which type of card they want to pay with, their account number and the expiration date. Some billers also require the consumer to enter the three- or four-digit security code usually written on the signature stripe on the back of the card. Most large financial institutions and many smaller ones offer online banking and telephone banking, which allow their customers who enroll to do things such as view account information like current balance and recent transactions, transfer balances from one account to another, pay bills, and even apply for a loan. Many financial institutions and other companies also offer a service that allows consumers to pay several or all of their bills at one Web site. To enroll in online banking, consumers usually go to their financial institution's Web site and enter their name and account information. Some financial institutions offer this service for free to their customers, but others charge a small fee. Financial institutions use a variety of methods to make sure their customers' banking information is kept private, and online banking is considered to be very secure. Currently, more than 60 million Americans pay bills online, and many experts think this number will increase significantly in the next few years. International Payments Many people in the U.S. regularly send money to family and friends living in other countries. In 2002, remittances to Latin America totaled more than $32 billion. Until recently, almost all of these payments were sent electronically through companies with agents located near both the sender and receiver. More and more, other companies are offering similar services. Some financial institutions have introduced programs that allow someone in the U.S. to put money into an account that can be accessed at an ATM in another country by the recipient. These services are often available to everyone, even people who don't have an account at the financial institution. In the last several years, the number of companies competing for this business has grown, and the cost of sending money internationally has begun to fall. The central banks of the U.S. and Mexico recently announced plans to set up an ACH system between the two countries, which should make sending money to Mexico even less expensive. Stored-Value Cards One electronic payment method that is becoming increasingly popular is the stored-value card. Stored-value cards provide a convenient substitute for cash and checks. The cards contain a magnetic strip that records a dollar balance. A variation on this system is the smart card, which contains a computer chip that records information about the card's balance, usage and other data. The card's balance is either predetermined or established by the consumer when the card is purchased. The dollar value of each transaction is deducted until the balance reaches zero. Some stored value cards can be reloaded with money at special terminals and are reusable. Most of these cards are referred to as "closed-system" cards. That means the cards can be used only for certain transactions in specific locations. Public transit systems in many large cities use these cards, as do some universities and retailers. Consumers can purchase stored-value cards in many locations for use at public telephones. Stored value technology is even used on many toll roads and highways to allow cars to quickly pass through toll stations. Not all stored-value cards work on closed systems. Some, such as payroll cards and gift cards, work just like debit cards, and can be used anywhere debit cards are accepted. Each time the consumer makes a purchase using the card, or withdraws money from an ATM, money is deducted from an account holding the card's value for the consumer. Consumer Resistance Electronic money is increasingly popular. Nevertheless, many consumers are reluctant to abandon cash and checks. Some consumers hesitate to use electronic banking because a canceled check provides proof of payment. However, checks are not the only proof of payment. The receipt provided by retailers as part of any electronic transaction also performs a similar function. In addition, many financial institutions now offer a service where they will keep an electronic copy of all canceled checks on their computers. This eliminates the need for a consumer to store old checks. In this type of system, an image of the canceled check is often returned with the depositor's account statement rather than the actual piece of paper. This reduces storage problems for the consumer and handling costs for the financial institution. And if the consumer needs a copy of a canceled check for proof of payment, the financial institution can provide a valid, legal copy that works the same way as a canceled check. Electronic transactions also appear on the regular statements that consumers receive from their financial institutions. Automated deposits and payments, and ATM and debit transactions, all appear on the statement. It should be checked for accuracy, just as checks are verified. Errors should be brought to the attention of the financial institution, which must work with the consumer to resolve any errors. Another reason some individuals prefer checks is "float" - the lag between the time a check is received and deposited and the time the funds are actually subtracted from the consumer's account. But float is shrinking. In most cases, once a consumer's check is presented to a financial institution by a retailer or creditor, the payments are cleared electronically within 24 hours, with the paper check arriving later. In some cases, only a facsimile of the check is actually transferred between the financial institutions involved. Regardless of float, many people simply like using checks. They feel they have more control over their finances by depositing paychecks and writing personal checks to pay bills. These same people often feel they lose control by using methods such as direct deposit and automated payment. Their sense of unease is increased by concerns about the security and privacy of electronic banking. Some fear that a criminal will be able to tap into telecommunication lines and steal their money. Others worry that a stranger might be able to access personal information. Some simply want to avoid using the technology they increasingly face in day-to-day life, from programmable VCRs to microwave ovens. And some who are comfortable with technology simply have not taken the time to switch to electronic payments. They recognize the advantages of electronic payments but haven't been motivated enough to make a change. Consumer Acceptance While there is continued resistance, many consumers enjoy the benefits of electronic payments. The convenience and certainty of electronic payments are attractive to many. And the float that can be an advantage to those paying a bill can turn into a disadvantage for those expecting payment. Nobody likes to be told that "the check is in the mail." Consumers using automatic payments don't have to worry about paying additional interest or a late fee because of a late payment. Likewise, consumers with direct deposit don't have to make a special trip to deposit their paycheck in order to keep other payments from "bouncing." Resistance to electronic money may be diminishing also as consumers become more aware of security features. Some evidence supporting this is that the number of checks written in the U.S. has been falling for several years, and the number of electronic transactions is growing rapidly. The initial efforts in this area came when financial institutions began storing information in computers, long before Internet banking was even a dream. Institutions have enhanced the security of all their information by establishing strict procedures requiring special identification to enter computer areas. Security has also been improved through special audit controls and electronic encryption, which make messages meaningless if they are intercepted by an intruder. PINs provide an additional safety precaution. Regulations also provide protection for consumers. In 1978, Congress passed the Electronic Funds Transfer (EFT) Act, directing the Federal Reserve to develop a legal framework for identifying the rights and responsibilities of consumers and financial institutions in the use of EFT. The resulting Federal Reserve Regulation E requires that financial institutions provide:
The Federal Reserve is considering new rules that extend these protections to newer electronic banking tools. Rules also extend protections to federal electronic payment programs. State electronic benefits transfer programs are allowed to develop their own rules and protections. Another factor encouraging consumer acceptance is the low cost of processing electronic transfers compared with the higher cost of clearing checks. To a large extent this difference reflects the high cost of physically handling and storing checks as opposed to simply transmitting an electronic impulse. For example, the National Automated Clearing House Association estimates that it is 10 times more expensive to issue and process a paper paycheck than to process a direct deposit payment. In the past, when most financial institutions offered "free" checking services to consumers, these costs did not directly affect depositors. Now, however, many consumers receive interest on their checking deposits while paying a greater portion of the actual costs of checking. This is often done through service charges, higher minimum balances, or per-check printing fees. As consumers become more aware of the costs of processing and moving paper, the advantages of electronic banking may become more apparent. However, electronic banking isn't a free service. Electronic banking requires a considerable upfront investment in technology. And there are costs for maintaining and improving electronic banking on an ongoing basis. Consequently, financial institutions may pass on the costs associated with Internet banking and electronic payments. For example, consumers may not have to pay a fee for withdrawals from ATMs if the machine is proprietary (owned by the consumer's financial institution), but there may be a charge if consumers use an ATM maintained by a financial institution where they are not a customer. Just as with any banking service, consumers should "shop around" for the best deal. They should match the services offered by the financial institution to their needs. Finally, a factor contributing to consumer acceptance is familiarity. Simply put, as more and more people grow up with or learn about electronic payments, they will feel more "at home" with the idea. The familiarity issue is related to the learning curve of technology. Microwaves and VCRs faced the same obstacle. But as people were introduced to the technology, they began to see advantages. Just as there are people who refuse to use VCRs and microwaves, there may always be some people who are hesitant to use electronic money. What Does the Future Offer? Despite some continuing hesitancy, consumers seem to like the convenience of electronic payments. The widespread use of ATMs has paved the way for greater acceptance of other forms of electronic money such as debit and credit cards. Direct deposit, and to a lesser extent, electronic bill payment, are gaining in popularity. During 2002, half of all Internet users paid a bill online. All of these factors are affecting the payments process. Already the percentage of transaction dollars moving electronically is increasing dramatically, indicating that consumers are changing their payment habits. Legislation such as Check 21 may further increase the popularity of electronic payments. What is Happening to Paper Checks? More and more, paper checks are being processed electronically. One way this happens is when a merchant puts a consumer's check through a special reader that reads the check's account information and matches it against a list of accounts that have recently had bad checks written against them. The reader helps the merchant decide whether the check is likely to be paid and whether to accept it. More recently, some billers have started scanning paper checks and turning them into electronic transactions. Billers do this because it makes the check less expensive and faster to process. Checks can be turned into electronic transactions both when they are mailed to the biller and at the point of sale. Once a check is turned into an electronic transaction at the point of sale, it can be handed back to the consumer. Checks processed electronically can show up in a different section on a consumer's monthly checking account statement, but are otherwise the same as other checks. Legislation, called "Check 21," was recently enacted that is expected to increase financial institutions' ability to process paper checks electronically. Electronic processing would greatly increase the efficiency of the system, but would mean that consumers would not be able to get their checks returned to them once they are cleared. Instead, consumers would get a special copy of the cleared check that would legally be the same as the original. The shift to electronic payments offers clear benefits to society. Processing checks is a labor-intensive, relatively inefficient process. American consumers and businesses currently write about 40 billion checks every year, down from an estimated 50 billion in 1995. A shift to electronics would allow the money needed to process these checks to be used in more productive ways. As economic incentives to change intensify, and as consumers become more familiar with new electronic systems, electronic payments may eventually equal or even surpass cash or checks as the convenient and accepted means of paying for goods and services. Electronic payments are rapidly gathering momentum. But a cashless or checkless financial system is still not in the foreseeable future. Glossary Automated Clearing House (ACH) Automated Teller Machine (ATM) Automatic Bill Payment Debit Cards Direct Deposit Electronic Benefits Transfer (EBT) Electronic Funds Transfer (EFT) EFT '99 FedWire Internet Banking Personal Identification Number (PIN) Point-of-Sale (POS) Network Smart Card |
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