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A Changing Payment System: Implications for Utilities Erik D. Kiefel Federal Reserve Board Utility Payments Conference October 21, 2008
Discussion 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? 2
Disclaimer Views expressed are those of the presenter and do not necessarily reflect those of the Board of Governors of the Federal Reserve System
Trends 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 4
Number of Noncash Retail Payments Electronics ACH Debit 9 Credit 6 Electronics Checks ACH Debit 4 42 Checks Credit 5 37 Debit Electronics ACH Checks Debit 2 31 Credit 4 Cards Debit 26 16 Cards Debit 9 Cards Credit Credit Credit 16 22 19 2000 2003 2006 Note: Transfers over large-value interbank funds transfer systems are not included. Debit card payments include electronic benefits transfers (EBT). 5
Checks Electronics 2000 2003 2006 Number 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 • Card payments now more than half of all noncash payments • Debit card now exceeds credit card. • Cash replacement likely one major reason. 6
4.6% 3.9% 2000 2003 2006 Number of Noncash Retail Payments • Total noncash payments reached over 93 billion • Rate of increase higher than previous study • Increases driven by debit card and ACH debit payments Total Checks • Decline in checks: • Ongoing—due to substitution with electronic payments • Accelerating—due to growing use of ACH conversion -3.8% -6.4% 7
Value of Noncash Retail Payments Checks Checks Checks 42 41 40 Electronics Electronics Debit 13 Electronics ACH Debit ACH 12 ACH Debit 10 Credit Credit 18 Credit 12 9 Cards 1 Cards Debit Cards 1 Debit 0 Debit 2 Credit Credit 1 Credit 2 2000 2003 2006 Note: Transfers over large-value interbank funds transfer systems are not included. Debit card payments include electronic benefits transfers (EBT). 8
Checks Electronics 2000 2003 2006 Value 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 9
Trends in Payment Losses/Fraud • 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? Source: Association for Financial Professionals (AFP) Payments Fraud (Risk) Surveys, 2005-2008
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 Trends in Payment Losses/Fraud: Check Source: FRB 2006 Check 21 survey: http://www.federalreserve.gov/pubs/reports_other.htm.
Questions 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?
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. 0 Check Market Composition 2006 distribution of checks by counterparty and purpose Percent of sampled population of checks* 51% Remittance Remit/POS 32% POS 25% Income 17% Casual 6% 16% 7% 13% 5% 3% C2C C2B B2B B2C “B” refers to business or government. Figures may not add due to rounding. * Population is “prime pass” checks processed by nine large commercial banks. Estimates exclude 0.2% of checks that could not be classified.
Check Processing Increasingly Electronic • 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 Note: The graph includes annualized figures from March and April 2007 data. Numbers may not add due to rounding. 14
Check 21 is facilitating rapid growth in the use of electronics within the check-collection system Check processing increasingly electronic Sources: 2006 Check 21 survey data and industry data
ACH market composition • 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 16 • 2007 Electronic Payments Survey
Checks Written* 37.6 33.1 Converted to ACH 37.3 Checks Paid 30.6 2003 2006 ACH Market Composition: Check Conversion • 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 • Growth in conversion activity may be tapering off • 2003-2006 growth – about doubling each year • 2006-2007 growth – about 30 percent 17 *Includes the use of checks as source documents.
Credit card market composition • 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 18 • 2007 Electronic Payments Survey
Debit card market composition • 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 19 • 2007 Electronic Payments Survey
Emerging payments market composition • 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 20 • 2007 Electronic Payments Survey
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 Some 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 Some potential implications
Questions 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?
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 Industry initiatives
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? Industry initiatives: Check
Industry Initiatives: CheckFederal Reserve Check infrastructure (2010) Seattle Helena Minneapolis Windsor Locks Cleveland Chicago Philadelphia Des Moines San Francisco Denver Cincinnati Baltimore Kansas City St. Louis Los Angeles Charlotte Memphis Atlanta Dallas Jacksonville Full-service check processing site Substitute check print site Check image capture and Substitute check print site See: http://www.federalreserve.gov/newsevents/press/other/20080331a.htm
Industry 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
Industry 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?
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? Industry 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 Legal and regulatory initiatives
Legal 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?
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
Legal 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/
Legal and regulatory initiatives: Identity 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
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? Legal and regulatory initiatives
Questions? Erik D. Kiefel Project Leader Board of Governors of the Federal Reserve System 202.721.4559 Erik.firstname.lastname@example.org