Academic journal article Chicago Fed Letter

Investing in Payment Innovations: Risks and Rewards

Academic journal article Chicago Fed Letter

Investing in Payment Innovations: Risks and Rewards

Article excerpt

Advances in technology have helped usher in new payment mechanisms catered to current demographic and cross-border demands. Yet these payment innovations also pose increasingly complex security challenges worldwide. Participants at a recent Chicago Fed conference discussed the implications of these developments for the payments industry.

Electronic payments now dominate noncash payments in the United States. Even so, the electronic payments space continues to evolve as the focus shifts from replacing paper instruments to creating the standard for the next generation of electronic payments or specializing technologies for customized applications. This migration is not always as dramatic as it may seem, since these innovations often leverage the existing platforms that support traditional payments systems.

The success of any payment innovation depends on its ability to attract a sufficient user base. To do this, several of the key participants, whether they are consumers, merchants, payment providers, or networks, need to benefit from its adoption. Two major forces persistently shape the demands of these constituents: demographics and globalization. As each new generation is exposed to more advanced technology, younger consumers often favor payment mechanisms that provide superior or combined functionality. Globalization of the payments market, facilitated by the Internet, is creating demand for new payment products that support cross-border trade.

Although globalization brings many opportunities, it also exposes the payments industry to complex security threats, as well as difficulties arising from varying payments standards across regions and countries. Regulators worldwide are thus faced with the challenge of promoting a more seamless and efficient payments system, while protecting users against inappropriate uses. To encourage discussions on these issues, the Chicago Fed hosted its sixth payments industry conference, titled "Investing in Payment Innovations: Risks and Rewards," on May 11-12, 2006. This Chicago Fed Letter summarizes the conference discussions concerning the benefits as well as underlying risks of payment innovations to all participants in domestic and international contexts.

Federal Reserve perspective

In their introductory remarks, Michael Moskow, Federal Reserve Bank of Chicago, and keynote speaker, Donald Kohn, Board of Governors of the Federal Reserve System, highlighted the Fed's role in the U.S. payments system. Kohn noted that although payment innovations may decrease risk within the payments system, they may also transfer risk to other participants or possibly increase it overall. He underscored the importance of managing risk collectively, as different payment silos become ever more integrated. Kohn said the Fed will continue to further efficiency of the nation's payments system through active participation, while remaining attentive to the impact of regulations in this evolving market.

Confronting security threats

The first panel addressed the evolving security threats to the payments community. This panel featured William Barouski, Federal Reserve Bank of Chicago; Mikko Hyppönen, F-Secure Corp.; Daniel Larkin, Federal Bureau of Investigation (FBI); Rick Siebenaler, Deloitte and Touche USA LLP; and John Stewart, Cisco Systems Inc. The panelists agreed that the threats facing the payments industry are becoming more sophisticated and that staying ahead of them is imperative. They also noted that participants are not always aware of appropriate security protocols in this fast changing digital environment; hence, they may inadvertently initiate security breaches.

Hyppönen described how security threats are changing in the global economy. He pinpointed a significant transformation of the "enemy" to January 2003, when it first became clear that primary sources of Internet security threats switched from teenaged hobbyists to organized criminals. …

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