Retail Payments Systems in the U.S.

International Workshop Retail Payments Câmara Interbancária de Pagamentos

São Paulo, Brazil June 1, 2007

James McKeeFederal Reserve Retail Payments Office

2

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

200072.5 billion transactions

Check57%

EBT1%

Credit Card22%

ACH9%

Online Debit4%

Offline Debit7%

200381.2 billion transactions

Check45%

Credit Card23%

ACH11%

Offline Debit13%

Online Debit7%

EBT1%

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Payments Markets Trends

WHILE USE OF CHECKS IS ON THE DECLINE, USE OF ACH IS ON THE RISE

0.00

2.00

4.00

6.00

8.00

10.00

12.00

2002 2003 2004 2005 2006 2007 2008 2009 2010

CashCheckMoney OrderCredit CardPIN-Less DebitDebit Card (Sig)ACH

Source: Celent and BearingPoint Analysis

Total Number of Consumer to Business Recurring Payments by Instrument

(Bill

ions

)

ACH

Check

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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

7

• Checks

8

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

Payee’s DFIPayor’s DFI

FLOW: Payor (Maker), Payee (Party due payment), Payee’s DFI (Collecting bank), Clearing House, Payor’s DFI

Federal Reserve Bank OR Correspondent Bank OR Local

Clearing House

Payee Company/Individual(Receives Check)

Payor (Writes Check)

Deposited

Cancelled

Forwarded

Presented for Payment

Payment through a debit to payment account

Payment through a debit

Payment through a credit

Payment through a credit to payee’s account account

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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

Check 21 Total Volume By Month

0

50

100

150

200

250

300

350

400

450

500

Mill

ions

Month (Business Days) Source - DASy

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Check 21 Statistics

Substitute Check Volume As % of Total Volume2006-2007

75.0%

77.5%

80.0%

82.5%

85.0%

87.5%

90.0%

92.5%

95.0%

97.5%

100.0%

December (20) January (21) February (19) March (22)Source - CORE and DASy

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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

0

2000

4000

6000

8000

10000

12000

14000

16000

1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

(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%)

21

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

Total ACH Network Volume Commercial Comm less on-us

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

-500

1,0001,5002,0002,5003,0003,5004,0004,5005,000

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

ARC POP RCK TEL WEB BOC

Item volume (in millions). Network volume excludes on-us items

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-

2,000

4,000

6,000

8,000

10,000

12,000

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

CCD PPD eCheck

Traditional ACH vs. eCheck2001 to 2012

Item volume (in millions). Network volume excludes on-us items

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ACH Processing Flow

Customer (Receiver)

Authorization

ORIGINATOR Company/Individual (CIE)

ODFI (Originating Depository Financial Institution)

Federal Reserve OR Private Sector Operator

(PSO)

ACH OPERATOR

RDFI (Receiving Depository Financial Institution)

ACH Transaction Flow (Picture shows five (5) participants)

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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 (1946–1963) 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

US online households that pay bills online

Actual Forecast# of households (millions) 5 year

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 growth rateGen Y 0.9 1.2 2.4 4.1 6.2 8.2 10.6 13.6 16.5 19.2 21.2 157%Gen X 3.7 4.8 6.4 7.6 10.1 12.3 14.3 15.5 15.8 16.6 17.4 42%

Boomer 4.5 5.9 7.0 8.5 10.7 12.0 13.1 13.9 14.5 15.7 16.8 39%Senior 1.7 2.1 2.2 2.5 3.5 3.9 4.2 4.3 4.1 4.0 4.1 3%Total 10.9 14.0 18.0 22.7 30.5 36.4 42.2 47.3 51.0 55.5 59.4 63%

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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 methods—e.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

• NACHA’s Online Payments Pilot– Advantage: keeps the consumer’s account info between consumer and

bank– Consumer’s 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– Driver’s 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

2010 Total = $543.1 Bil.

$124.2

$46.5

$68.2

$75.7

$211.2

$87.9

OnlineTelecomGiftPrepaid DebitEmployment-relatedRestricted Use Sources: Pelorus Group, Mercator, Financial Insights, Tower;

BBD Projections

2004 Total = $154.3 Bil.$20.1

$20.4

$32.0

$30.1

$27.5

$53.4

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Card Processing Flow

Consumer (Card-Holder)

National Credit Card Network

Merchant

Acquirer/Processor(Merchant Bank)

Card-Issuing Bank

Card Issuer

Consumer’s Acct

On-Line

Purchases Item

Sales Draft InfoSales Draft Info

Sales Draft Info

Authorization Authorization

Authorization

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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@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?subWeb=9

• Federal Reserve Bank of Chicago– http://www.chicagofed.org/emerging_payments_and_policy/

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_patterns/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

Practices—Positive 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