A Changing Payment System: Implications for Utilities
Erik D. KiefelFederal Reserve Board
Utility Payments Conference
October 21, 2008
22
Discussion TopicsDiscussion Topics
Trends in the use of noncash retail payments
Trends in payment fraud
Industry payment initiatives
Legal and regulatory payment-related initiatives
What does it all mean for utilities?
DisclaimerDisclaimer
Views expressed are those of the presenter and do not necessarily reflect those of
the Board of Governors of the Federal Reserve System
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Trends in Noncash Retail PaymentsTrends in Noncash Retail Payments
The Federal Reserve has conducted surveys on the use of
checks and electronic payments for the years 2000, 2003,
and 2006.
Each survey collected data from: About 1,200-1,500 commercial banks, credit unions, and savings
institutions
Over 100 payment networks, card-issuers, and third-party
processors
The main goals have been to:
Produce accurate national totals
Measure trends
Special focus on
Substitution of electronic payments for checks
Migration of checks from paper-based to electronic processing
Reports are available at: http://www.federalreserve.gov/paymentsystems/paymentsresearch.htm
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Number of Noncash Retail PaymentsNumber of Noncash Retail Payments
2000 2003 2006
Checks
Checks
Checks
Electronics
Electronics
Electronics
Card
sA
CH
42
37
31
16 19 22
16
9
264
6
2
4
9
Card
sA
CH
Card
sA
CH
Debit
Credit
Credit
Debit
Credit
Debit
Credit
Debit
Credit
Debit
Credit
Debit
5
Note: Transfers over large-value interbank funds transfer systems are not included. Debit card payments include electronic benefits transfers (EBT).
66
Number of Noncash Retail PaymentsNumber of Noncash Retail Payments
Electronic payments are now
double the number of checks.
Electronic payments increased
to over 62 billion
Checks decreased to less than
31 billion
2000 2003 2006
Checks
Electronics
Card payments now more than half of all noncash
payments
Debit card now exceeds credit card.
Cash replacement likely one major reason.
77
Number of Noncash Retail PaymentsNumber of Noncash Retail Payments
0
10
20
30
40
50
60
2000 2003 2006
-3.8% -6.4%
Checks Decline in checks:
Ongoing—due to substitution
with electronic payments
Accelerating—due to growing
use of ACH conversion
Total noncash payments reached
over 93 billion
Rate of increase higher than
previous study
Increases driven by debit card
and ACH debit payments
3.9% 4.6%
2000 2003 2006
Total
88
1
Value of Noncash Retail PaymentsValue of Noncash Retail Payments
2000 2003 2006
Checks Checks Checks
Electronics
Electronics
Electronics
Card
sA
CH
40
42
210
918
12
10
12
13
Card
s
Card
sA
CH
DebitCredit
Credit
Debit
Credit
Debit
CreditDebit
Credit
Debit
CreditDebit
21
AC
H
41
Note: Transfers over large-value interbank funds transfer systems are not included. Debit card payments include electronic benefits transfers (EBT).
99
Value of Noncash Retail PaymentsValue of Noncash Retail Payments
Growth in total value $76 trillion in 2006 – up from $68 trillion in 2003 Electronic payments not yet caught up to check
Cards have smallest share Value of debit cards less than half the value of credit cards
Average value of ACH debits declined Primarily because of the increase in converted checks
2000 2003 2006
Average Value
2003 2006Annual Growth
Rate
Checks Paid 1,104 1,366 7%
ACH Debits 2,849 1,535 -19%
ACH Credits 2,668 2,974 4%
Debit Card 40 39 -1%
Credit Card 89 98 3%
Checks
Electronics
10
Trends in Payment Losses/FraudTrends in Payment Losses/Fraud
Source: Association for Financial Professionals (AFP) Payments Fraud (Risk) Surveys, 2005-2008
Payments-fraud losses are limited < .01% of revenues Banks bear as much
as two-thirds of payment losses
ACH-related fraud losses may be most common
Questions for audience How significant an issue
is payments fraud for your organization?
What are you doing to address it?
What should regulators be doing?
Type of fraud 2004 2005 2006 2007All types 55% 68% 72% 71%
Check 94% 94% 92% 94%ACH 37% 35% 38% 30-40%
Card payments 29% 23% 36% 14-24%Wire transfers N/A 1% 3% 3%
Percentage with losses 2004 2005 2006 2007All fraud types 51% N/A 58% 37%
Check N/A 19% 25% 17%ACH N/A 27% 20% 15-51%
Card payments N/A 54% 72% 33-66%Wire transfers N/A N/A N/A N/A
Type of corporation 2004 2005 2006 2007All corporations 26,600$ N/A 23,300$ 13,900$
Revenues > $1bn 37,600$ N/A 46,300$ 18,200$ Revenues < $1bn 18,100$ N/A 16,800$ 8,200$
Percentage of U.S. corporations reporting attempted or actual fraudTrends in payments-related fraud and losses
Trends in payments-related fraud and lossesMedian actual payments-fraud losses at U.S. corporations
Trends in payments-related fraud and lossesPercentage of U.S. corporations reporting attempted or actual fraud that
experienced payment losses
11
Banks’ check-related losses increased 13 percent to $1 billion between 2004 and 2005, returning to 2003 estimated levels Since 1995 study, losses have increased at a compounded
annual growth rate of 5 percent
Bank Check Losses2004 and 2005
(Comparison of check losses)
8971,018
0
200
400
600
800
1000
1200
2004 2005
$ m
illi
ons
13 percent growth
Source: FRB 2006 Check 21 survey: http://www.federalreserve.gov/pubs/reports_other.htm.
Trends in Payment Losses/Fraud: CheckTrends in Payment Losses/Fraud: Check
12
Questions for Group DiscussionQuestions for Group Discussion
Does your typical payments mix (use and acceptance) reflect these overall trends?What differs and why?
Which payment instruments are most important to your organization and why? Is cash still important?
13
Check Market CompositionCheck Market Composition
*Population is “prime pass” checks processed by nine large commercial banks. Estimates exclude 0.2% of checks that could not be classified.
“B” refers to business or government.Figures may not add due to rounding.
Casual
Income
32%
6%
13%
51%
C2B
16%
5%3%
25%
B2B C2C
7%
B2C
Remittance
Remit/POS
POS
17%
• Representative random sample of over 32,000 checks.
• Sample population is about 40% of “prime pass” checks.
• Consumers write 58% of checks paid.
• Businesses/government receive 76% of checks paid.
2006 distribution of checks by counterparty and purposePercent of sampled population of checks*
1414Note: The graph includes annualized figures from March and April 2007 data. Numbers may not add due to rounding.
Check Processing Increasingly ElectronicCheck Processing Increasingly Electronic
Electronic Check
Presentment30%
Original Check57%
Substitute Check13%
Paper70%
Two trends: “Electronification” of paper checks—Depository institutions
increasingly use electronic methods to process interbank checks.
ACH conversion of paper checks—Billers and merchants convert checks to ACH payments.
Checks by Presentment Method
15
Check 21 is facilitating rapid growth in the use of electronics within the check-collection system
Sources: 2006 Check 21 survey data and industry data
Check Presentments Check Images and Substitute Checks Presented to Paying Banks
0%
5%
10%
15%
20%
25%
30%
35%
March 2006--Allbanks
January 2007--Keyindustry participants
May 2007--Keyindustry participants
June 2008--Keyindustry participants
Perc
ent o
f all
che
cks
paid
Check images
Substitute checks
2%3%
12%8%
18%
9%
29%
10%
Check processing increasingly electronicCheck processing increasingly electronic
1616
Most ACH payments remain recurring bill and other payments Remittance type payments (C2B)
More than half of all ACH payments and about a quarter of total ACH value
Remittance/POS payments (C2B)
About a third of all ACH payments were converted consumer checks or one-time ACH consumer debits that accounted for 5 percent of total ACH value
Corporate payments (B2C/B)
Most of the rest of the ACH payments and accounted for about two-thirds of the total value
ACH market compositionACH market composition
•2007 Electronic Payments Survey
1717
Only about 40 percent of checks are eligible for conversion Business format checks are not eligible
Converted checks now: About 20 percent of total ACH payments
About 8 percent of checks
ACH Market Composition: ACH Market Composition: Check ConversionCheck Conversion
Growth in conversion
activity may be tapering
off
2003-2006 growth –
about doubling each year
2006-2007 growth –
about 30 percent
33.137.6
20062003
Converted to ACH
Checks Written*
37.330.6 Checks Paid
*Includes the use of checks as source documents.
1818
Primarily C2B payments at the POS or for remittances, but with increasing use of purchasing cards for B2B payments
Private label (retailers, oil & gas, or fleet cards)
2.8 billion transactions valued at $253.6 billion, with an average spend of $91.59
Oil company cards (in-house) totaled 191.3 million transactions valued at $7 billion, with an average spend of $36.49
General purpose
19 billion transactions valued at $1.9 trillion, with an average spend of $98.68
Credit card market compositionCredit card market composition
•2007 Electronic Payments Survey
1919
Supports C2B payments, usually POS and some remittances
Signature debit
16 billion transactions valued at $637.2 billion, with an average spend of $39.93
PIN debit
9.4 billion transactions valued at $348.6 billion, with an average spend of $37.20
Prepaid cards
Open loop (subcategory of debit): 321.8 million transactions valued at $13.3 billion, with an average spend of $41.30
Closed loop (separate category): 3.1 billion transactions valued at $36.6 billion, with an average spend of $11.90
Amounts to about 3 percent of all noncash retail payments and less than 1/10th of one percent of the value
Debit card market compositionDebit card market composition
•2007 Electronic Payments Survey
2020
Emerging payments use ACH or cards to complete the payment
Online bill payment: 3.4 billion transactions valued at $1.2 trillion, with an average payment of $345
RFID transponders: 2.1 billion transactions valued at $3.6 billion, with an average payment of $2
Other new payment types: 532.1 million transactions valued at $35.5 billion, with an average payment of $67
Includes person-to-person, proprietary ACH cards, mobile payments, and deferred payment transactions
Put together, these payments account for less than 7 percent of all noncash retail transactions and less than 2 percent of the value of those transactions
Emerging payments market compositionEmerging payments market composition
•2007 Electronic Payments Survey
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Some potential implicationsSome potential implications
Operational Physical payment
receipt centers Reliance on back-office
and lock-box operations Reliance on more
electronic processes and need to tie to existing paper processes
Risk Data management and
security risks Legal and regulatory
compliance
Technological New technology
investments Multiple platforms Reliance on paper-
based technologies
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Some potential implicationsSome potential implications
Financial Customer float Bank fees with ACH
transactions Bank fees with CC/DR Opportunities and
challenges for A/R, A/P Effects on cash flow Funding and priority for
payments initiatives Reconcilement needs
within treasury operations
Customer service Payment choices and
means to initiate payments
Touch points with customers/cross-selling
Self-service opportunities (cost reductions)
Opportunities and challenges for quality of service
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Questions for group discussionQuestions for group discussion
What are the key challenges for your organization in the payments area?
Where is your organization focusing its efforts?
What priority do these payment initiatives have within your organization?
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Industry initiativesIndustry initiatives
Check Remote deposit
capture (RDC) Reserve Bank check
restructuring Check and ACH
convergence
Cards Decoupled debit Prepaid Mobile and contactless
ACH EBIDS Secure Vault Direct exchanges
Wire transfers (RTGS) Remittance standards
25
Industry initiatives: CheckIndustry initiatives: Check Remote deposit capture (RDC)
Scanning (capturing) check images outside the bank’s back office (may also include ACH check conversion deposits)
Merchant, ATM, Branch, Retail customer level
Issues Merchant/customer selection (KYC) Warranties and liabilities Retention/destruction of original checks Security of check images
FFIEC Examiner guidance on RDC upcoming
Questions for audience Are you using RDC? How are you and your bank addressing these issues?
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Dallas
Denver
Helena
Chicago
Atlanta
Memphis
Seattle
Baltimore
Charlotte
Cleveland
St. Louis
Cincinnati
Des Moines
Kansas City
Minneapolis
Los Angeles
Philadelphia
Jacksonville
Windsor Locks
San Francisco
Full-service check processing site
Substitute check print site
Check image capture and Substitute check print site
Industry Initiatives: CheckIndustry Initiatives: CheckFederal Reserve Check infrastructure (2010)Federal Reserve Check infrastructure (2010)
See: http://www.federalreserve.gov/newsevents/press/other/20080331a.htm
27
Industry initiatives: CardsIndustry initiatives: Cards
ACH debit cards Merchant issued payment card ultimately linked to DDA but cleared and
settled via ACH
Decoupled debit cards Debit card issued by a bank (or potentially non-bank institution) other than the
bank holding the customer’s demand deposit account (DDA) Capital One’s decoupled debit card (MasterCard branded) Tempo has expanded to decoupled debit as well
Funds ultimately debited via ACH from cardholder’s DDA at another bank Status of Capital One effort: more pilots and testing
Significant challenge to traditional bank account-based debit card relationship Industry concerns have led to NACHA rules changes to require a one-for-one
linkage between ACH debits and decoupled debit card transactions http://www.nacha.org/ACH_Rules/ach_rules.htm
Question for audience What is your company’s position on decoupled debit
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Industry initiatives: ACHIndustry initiatives: ACH
EBIDS NACHA-sponsored pilot (developed jointly with the Federal Reserve Banks)
that uses the ACH system to present and pay bills and invoices via on-line banking systems
Pilot began in August and will run through December 2009 Handful of bank and corporate participants, including telecommunications
companies, banks, and the Federal Reserve Bank of Cleveland Experience to date of customers appears good
For more information: http://www.nacha.org/ebids/ Secure Vault Payments (SVP)
NACHA-sponsored pilot that uses the ACH to provide an alternative payment authorization and settlement for on-line purchases via on-line banking systems
Pilot began in May but remains limited First use of interchange fees associated with ACH payments
For more information: http://www.securevaultpayments.org/ Question for audience
Is your company considering participation in these pilots?
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Industry initiativesIndustry initiatives
Check Check and ACH
convergence
Cards Prepaid Mobile and contactless
ACH Direct exchanges
Wire transfers (RTGS) Remittance standards
Questions for audience How important are these
initiatives to your payment strategies?
What concerns or suggestions do you have regarding these or other industry initiatives?
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Legal and regulatory initiativesLegal and regulatory initiatives
Check Remotely created
checks (RCCs) Funds availability
legislation Regulation CC return rules
Cards Regulation Z proposals Legislation updates
ACH NACHA risk
management initiative International ACH
Transaction (IAT) rule
BSA/AML (FinCEN) Cross-border wires MSB definitions Other recent guidance of
interest
Identity theft FACTA Red Flag
requirements
31
Legal and Regulatory Initiatives: CheckLegal and Regulatory Initiatives: Check Remotely created checks (RCCs)
Consumer provides his/her account information to allow a business to create a check (draft) drawn on the consumer’s account.
The check bears the consumer’s printed name or a statement that it was authorized rather than a signature
Various concerns about potential use of fraudulent RCCs
FRB amendments to Regulation CC help address these concerns without prohibiting the legitimate use of RCCs
Amendments shift liability for unauthorized RCC payments to the depositary bank Regulatory changes appear to be working, with the number of unauthorized RCCs flowing
through the Reserve Banks decreasing http://www.federalreserve.gov/boarddocs/press/bcreg/2005/20051121/default.htm
Reserve Banks do not accept image RCCs that were never a paper check (OC-3 changes)
http://www.frbservices.org/communications/customer_communications.html
Questions for audience To what extent and for what purpose does your company use RCCs? Do you or your customers have any fraud or other concerns with their use?
32
Legal and Regulatory Initiatives: ACH Legal and Regulatory Initiatives: ACH
NACHA risk management initiative NACHA approved a risk management strategy for the
ACH network and is in the process of enacting associated new rules to address those risks
Network rules enforcement Company name identification requirements Risk management and rules compliance audits Prohibitions on use of the ACH for illegal Internet
transactions
NACHA considering new data reporting requirements to support broader risk management and monitoring efforts
For more information: http://www.nacha.org/OtherResources/riskmgmt/riskmgmt.html http://www.nacha.org/ACH_Rules/ach_rules.htm
33
Legal and regulatory initiatives: ACHLegal and regulatory initiatives: ACH
NACHA IAT rule Result of industry concern about OFAC responsibilities for
inbound international ACH transactions Definition of international ACH unclear along with RDFI’s
OFAC responsibilities for inbound transactions
New NACHA rules established to meet OFAC requirements Establishes broader definition of “international ACH
transaction” or IAT An ACH entry that is part of a payment transaction involving a
financial agency’s (an institution authorized by law to accept deposits, issue money orders or transfer funds) office that is not located in U.S. territorial jurisdiction.
Expands IAT format to include “travel rule” information, but ONLY for purposes of complying with OFAC requirements
Effective date extended to September 18, 2009 http://www.nacha.org/IAT_Industry_Information/
34
Legal and regulatory initiatives: Legal and regulatory initiatives: Identity TheftIdentity Theft FACT Act of 2003
Regulation requires 3 things Written ID theft prevention program Address validation for card issuers Verification of consumer address (related to use of
credit reports)
Financial institution must determine whether to cover business accounts
Guidelines How to identify/detect “red flags” for ID theft How to prevent/mitigate ID theft
Implementation date: November 1, 2008
35
Legal and regulatory initiatives
Check Funds availability
legislation Regulation CC return rules
Cards Regulation Z proposals Legislation updates
ACH ACH debit posting times
BSA/AML (FinCEN) Cross-border wires MSB definitions Other recent guidance of
interest
Questions for audience How important are these
initiatives to your company?
What concerns/suggestions do you have regarding these or other initiatives?
36
Questions?Questions?
Erik D. KiefelProject Leader
Board of Governors of the Federal Reserve System