Innovations, Incentives, and Regulation: Forces Shaping the Payments Environment
Chakravorti, Sujit, Jankowski, Carrie, Chicago Fed Letter
The migration to more efficient payment mechanisms is affected by innovations, incentives, and regulation. While advances in technology have yielded numerous payment method alternatives, many have not been widely adopted. A recent Chicago Fed conference explored why certain payment innovations have been more successful than others.
While the migration from paper-based to electronic payments in the United States is occurring faster than before, cash and checks continue to be used for a significant number of transactions. A recent survey showed that while the number of electronic payments in the United States reached 44.5 billion in 2003, the number of check payments remained substantial at 36.7 billion.1 In addition to promoting the substitution of electronic payment alternatives for checks, various payment processors are encouraging the presentment of electronic check images and the conversion of checks to automated clearing house (ACH) payments. Furthermore, cash transactions continue to decrease as a proportion of the total number of in-store purchases.2
Three main forces continue to affect the migration to more efficient payment mechanisms: innovations, incentives, and regulation. Advances in technology have resulted in numerous payment method innovations. However, many have not been widely adopted because many payment system participants lacked sufficient incentives to change their behavior. Also, as the payment system evolves, policymakers should continue to reevaluate the existing legal and regulatory infrastructure and, where appropriate, reduce barriers inhibiting the widespread adoption of efficient payment mechanisms.
To foster a dialogue on these topics, the Federal Reserve Bank of Chicago hosted its fifth payments industry conference, titled "Innovations, Incentives, and Regulation; Forces Shaping the Payments Environment," on May 18-19, 2005. This Chicago Fed Letter summarizes participants' responses to the following questions:
* What emerging innovations have the greatest potential to improve the payment system?
* Why have certain payment innovations been more successful than others?
* How does the current legal and regulatory framework affect the adoption of efficient payment mechanisms?
Innovations keynote address
In his introductory remarks, Charles Evans, Federal Reserve Bank of Chicago, observed that the increase in online purchases has led to some innovative payment solutions. One such solution is provided by PayPal, a wholly owned subsidiary of eBay. Jeff Jordan, PayPal, stated that over 900 million people are using the Internet, many of them to buy and sell goods and services accounting for $236 billion in 2004. He estimated that over 500,000 U.S. residents make a part or all of their income selling products on eBay.
Jordan recalled that an early obstacle to eBay's growth was the processing of payments. For extremely small businesses, traditional electronic payment alternatives were often cost prohibitive. Instead of creating a new payment network, PayPal provided merchants with access to existing, familiar networks, such as ACH and payment card networks. While PayPal was able to simplify the payment process for buyers and sellers, it also made it easier to commit fraud. In response to the rapidly growing fraud threat, PayPal devised various risk-management and fraud detection systems. Today, PayPal's loss rates are around 26 basis points, well below the over 100 basis points experienced in the fall of 2000.
The evolving payments landscape
The first panel discussed developments in the provision of payment services, including their costs and benefits to endusers as well as their differing legal protections against fraud losses. While the panelists disagreed about the pricing of some payment services, they generally agreed that payment cards are more efficient than cash and checks. This panel featured Oliver Ireland (moderator), Morrison and Foerster, L. …