By Brandes Elitch
CrossCheck Inc.
As a new year starts, it is time for "payment experts" to predict what will happen in 2011. Rampant confusion and, frankly, misinformation exist out there regarding the "next big thing" in payments, so I will try to at least define the issues pertaining to card, check and automated clearing house (ACH) transactions - even if I can't predict the future.
Most everyone is aware that payments via social networks will lead to a series of innovations, particularly from nonbanks, which are not traditional players in the payments system. However, this article will talk about more conventional payments.
Let's start with the recently released 2010 Federal Reserve Payments Study, which covers the period from 2006 through 2009 and was released Dec. 7. The award for the most understated comment of the year goes to the Fed vice president who said, "It is likely that the results of the study reflect changing consumer behavior during difficult economic times." Well, all-righty then - do ya think?
What most observers will take from the study is the headline: "Electronic payments crowd out checks." But it would be a mistake to conclude that checks are not important. During this three-year period, checks dropped 7.2 percent. Even so, they still comprise 24.4 billion items a year, totaling $31.6 trillion.
This compares to total dollar volume for electronic payments of $40.7 trillion. To put it another way, dollars cleared by check are still three-quarters of total electronic payments, 25 years after the first Electronic Data Interchange initiatives by major banks.
Most business-to-business (B2B) payments are check-based and are likely to remain so for some time. One commentator, Dan O'Neill, writing in the excellent First Annapolis Navigator, suggested this is due to "long-held views on and desires for centralized control and physical specimen document imaging and retention, as well as organizational inertia."
Right now, the majority of invoices from suppliers are paper, not electronic, and some of the electronic ones are printed to initiate a paper-based payment process. And, of course, currently, there is no centralized database of payees, nor is there a convention for standardized line item detail capture.
But the key concept behind checks is that if you are taking a high-dollar payment (examples include brokerage, insurance, tax, title settlement or critical time-sensitive payments) you will want a check (or wire transfer), not an ACH credit, because you desire absolute finality of payment and the Uniform Commercial Code and 200 years of check law on your side, not Reg E and NACHA - The Electronic Payments Association's rules and regulations.
The Federal Reserve Bank of Chicago has received significant attention for the electronic payment order (EPO) concept. It would allow the consumer to write a check digitally, on a smart phone or other computer device, and then send the digital check (a debit push) to the payee, which would send it to the payee's bank to clear the way check images do now.
The EPO requires a digital signature signifying intent and authentication, unlike remotely created checks used by some merchants today. Since it is unclear as to which laws would apply to the EPO, it is likely banks will use an approach based on mutual agreements. Consumers like to write checks; why shouldn't they be able to write and clear them electronically?
There is an alternative, credit-push version of the digital check, (kind of like electronic bill payment) where the bank's account holder instructs the bank to transfer funds electronically to the payee bank, but the applicable law is uncertain here, too. In this case, the payment would not be made unless there were sufficient funds in the account, so the payee can be certain the funds are good upon receipt.
At this point, the Fed has not yet approved any of these new payment transfer methodologies, but you can see there is a lot of new thinking in this space. I think we can expect some ruling from the Fed in the coming year here.
The Fed study shows other noteworthy trends. One is that credit card balances dropped for the 26th consecutive month in October 2010. Revolving debt, which includes credit cards, dropped 7.6 percent to $800 billion from a year ago. In 2009, debit card usage surpassed credit card usage for the first time. Javelin Strategy & Research projected, assuming current trends continue, credit card use would fall below 50 percent by the end of 2010.
Another recent study revealed that only about 63 million Americans (out of a 300 million-plus total population) are actively using a credit card every month. Indeed, credit card volume actually declined 0.2 percent from 2006 through 2009 - the first decline since the Fed started tracking it. If you are selling credit card processing, think about this trend. There is less unsecured debt available from card issuers, and consumers are reducing their debt. These are long-term structural changes in the card industry.
The real story is the 14.8 percent growth in debit card transactions over the study's period. Some observers believe that PIN debit (ATM transaction with no interchange charged) will ultimately overpower signature debit (interchange based and running on the Visa Inc. and MasterCard Worldwide rails). The cost differential is too great for this not to happen. Yes, consumers will still use checks to make recurring payments, but ACH and home banking will inevitably make significant inroads here.
The key thing to remember is that most consumers want to pay with their checking accounts rather than credit cards. It's just that (at the POS) they are using their debit cards rather than writing checks, but the money is still coming out of the checking account.
ACH transactions increased 9.3 percent during the Fed study's time period, but remember that ACH is a batch, store-and-forward, next-day settlement system primarily used by very large billers. Most ACH transactions are for recurring debits, preauthorized by the consumer. ACH volume at the POS and over the Internet is still small because there is no easy way for consumers to pay with a one-time ACH, at least, not yet.
There are also issues involving the authorization process for one-time transactions. Some very smart people at NACHA are working on this. Some people believe the growth in ACH will be a big trend in 2011 and cite NACHA's Secure Vault product for one-time payments.
This product allows a consumer to buy something (in what we used to call a "card not present" environment) without a debit or credit card, using his or her bank's online banking platform. The bank authenticates the consumer and provides the business with real-time authentication and payment confirmation. The payment is made by the consumer's bank directly to the merchant, so the merchant doesn't need to collect the consumer's personal financial information.
For this to work, the consumer would have to be on the bank's electronic banking platform, the merchant would have to be signed up with the Secure Vault network and all parties would have to use banks that were members of this network. I don't know about this - it reminds me of the Visa POS product, which Visa has flogged for years now, with very little traction in the marketplace.
The Fed proposed substantial debit interchange rate cuts in December 2010, which could cause debit card issuer revenue to fall dramatically. Remember, the regulators have already changed how banks can collect overdraft fees, previously the single biggest fee-based income source for financial institutions.
Now they are looking into interchange rates. No one in our industry wants interchange rates to be regulated by the government. But in the past, income from interchange and overdraft fees was so substantial that it allowed the banks to subsidize other transactions, such as ACH.
Smaller banks have always complained about the "free ride" that ACH transactions get, because the cost to large originators is only a few cents per transaction. When I worked for a major cash management bank, our executive vice president said, "No bank has ever made money in the ACH business and no bank ever will." This is probably truer today than it was then. If major banks see their revenue decline precipitously from both credit and debit cards, they will make up the shortfall somewhere else, and ACH processing looks like a logical place.
There is one more payment product that has been heavily promoted by the card brands for many years: payment cards for B2B transactions. In spite of millions of dollars in advertising, payment cards have been a nonstarter.
I predict they will continue to be. Almost every study I have read about this product is replete with references to payment fraud; employees with access to these cards somehow managed to make fraudulent purchases with them.
While such payment cards might work for a small to midsize business, why a large enterprise would want to pay interchange for accounts payable mystifies me (and most other people in this space, apparently). As an ISO or merchant level salesperson, I wouldn't devote much time to this product.
I want to close with a comment by Adolfo Nicolas, the Jesuits' Superior General. In an article in my alumni magazine (Santa Clara University), Nicolas talks about the "globalization of superficiality." He believes the way people work today on the web short-circuits the laborious, painstaking work of serious, critical thinking. He feels we are overwhelmed with a "dizzying pluralism of choices and values and beliefs and visions of life" and is calling for new ways to promote depth of thought and imagination.
He noted that the Japanese Ministry of Education found its curriculum had made great advances in science, technology, mathematics and memory work. However, it had become weaker in teaching imagination, creativity and critical thinking, the three points that are essential to Jesuit education. In managing and growing your business, where will you focus in 2011?
Brandes Elitch, Director of Partner Acquisition for CrossCheck Inc., has been a cash management practitioner for several Fortune 500 companies, sold cash management services for major banks and served as a consultant to bankcard acquirers. A Certified Cash Manager and Accredited ACH Professional, Brandes has a Master's in Business Administration from New York University and a Juris Doctor from Santa Clara University. He can be reached at brandese@cross-check.com.
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