Electronic Payments and the U.S. Payments System
Report for Congress
Electronic Payments and
the U.S. Payments System
June 27, 2002
Walter W. Eubanks and Pauline H. Smale
Specialist in Economic Policy and Analyst in Financial Services
Government and Finance Division
Congressional Research Service ˜ The Library of Congress
Electronic Payments and the U.S. Payments System
The electronic and paper-based payments systems consist of the various means
buyers and sellers use to transfer monetary value among themselves. Electronic
payments have been playing a critical role on the wholesale side of the payments
system for decades. Trillions of dollars per day have been transferred routinely and
securely through the wholesale payments system among parties, such as banks,
corporations, the Federal Reserve, the Department of the Treasury, and other
government agencies. More recently, electronic payment technologies have
migrated to the retail side of the system, to households and individuals. In retail,
however, the most popular methods of payment remain the more costly paper-based
cash and check payments. In 2000, by one estimate, paper-based transactions
accounted for two-thirds of all consumer payments, despite the promise of cost
savings and convenience.
Nevertheless, the volume of electronic retail payments has increased more
rapidly during the last decade. The increase in the volume of electronic payments
using credit and debit cards grew from 14% of total consumer transactions in 1990
to 31% in 2000. Still, by 2010 consumers will still be making about 50% of their
payments with paper, according to the Nilson Report, an industry publication.
With the great majority of wholesale banking transactions (institution to
institution) being conducted electronically, the cost savings and convenience of
electronic payments are a normal part of wholesale banking. A major step towards
widespread electronic retail payments was the evolution of the automated clearing
house (ACH) system to process wholesale and retail payments. The prevalent
deployment of automated teller machines (ATMs) and point-of-sale (POS) terminals
has supported the progress. The Internet and other technologies have also
encouraged the use of electronic banking by individuals and households.
The migration of electronic banking to the retail side of the payments system
raises concerns about whether current laws and regulations will adequately cover new
technologies and new payment methods. Current statutes address consumer
protections in financial transactions involving credit cards and electronic funds
transfer. The regulatory agencies have focused on fostering safety and soundness
while minimizing their intrusion into the innovation process so as to allow the
marketplace flexibility for product development. In November of 2001 federal
regulators jointly issued a report, mandated by law (P.L. 106-102), that reviews
regulations affecting the delivery of financial products and services including online
delivery. However, the speed with which electronic payment technologies are being
developed increases the danger of being unprepared with the appropriate regulatory
and supervisory policy to protect electronic payments users and providers in time of
crisis. This report will be updated as legislative and financial developments warrant.
In troduction ......................................................1
The U.S. Payments System: An Overview..............................2
An Alternative Overview........................................3
Wholesale Electronic Payments...................................8
The Clearing House Interbank Payments System (CHIPS).........9
The Society for Worldwide Interbank Financial
Automated Clearing Houses (ACHs)..........................10
Retail Electronic Payments.....................................11
How the Credit Card Process Works......................13
ATM and POS Systems................................14
Electronic Funds Transfers at Point of Sale (POS) ...........15
Electronic Check Clearing..................................15
Internet Bill Paying...................................17
The Growth of Internet Banking.........................17
Other Instruments of Electronic Payments.....................18
Electronic Benefit Transfers (EBT).......................18
Regulating and Supervising Electronic Payments........................19
Report to Congress........................................20
List of Figures
Figure 1. Consumer Payment Transactions, 1990, 2000, 2010..............4
Figure 2. Consumer Dollar Payments, 1990, 2000, 2010...................5
Figure 3. Check Clearing Through the Federal Reserve System.............7
Electronic Payments and the
U.S. Payments System
The payments system consists of the various means buyers and sellers use to
transfer monetary value among themselves. Electronic banking has played a critical
role on the wholesale side of the payments system for decades. Trillions of dollars
per day have been transferred routinely and securely through the wholesale payment
system between parties, such as the Federal Reserve, the Department of the Treasury,
other government agencies, as well as financial institutions, and corporations. Now
this technology has migrated to the retail side of the system to households and
individuals, where the most popular methods of payment remain paper-based cash
Electronic delivery of financial services provides the promise of cost savings,
and convenience. The vast majority of wholesale payment transactions are conducted
electronically. The cost savings and convenience of electronic payments are a normal
part of wholesale operations. However, there remains a strong reliance on traditional
paper-based methods by individuals and households in the United States. Based on
one estimate, in 2000 cash and checks still accounted for 65% of total consumer
payment transactions. At the same time the volume of electronic retail payments has
increased rapidly during the last decade. The increase in the volume of card
transactions (including credit, debit, and stored-value) grew from 14% of total1
consumer payments in 1990 to 30.6% in 2000, according to the same estimate.
Congressional interest in new technologies, developments in electronic banking
and changes to the payments system has been expressed mainly through oversight
rather than legislation. Congress has held a number of hearings on specific issues of
concern and what actions might ensure orderly development.2 Most of the laws
protecting consumer financial transactions were passed in the 1960s and 1970s.
These laws addressed credit cards and electronic funds transfer. More recently,
Congress passed legislation to facilitate the use of electronic financial services and
products. The Debt Collection Improvement Act of 1996 (P.L. 104-134) requires
federal payments (other than IRS refunds) to be made by electronic funds transfer.
1 See “Consumer Payment System,” The Nilson Report, issue 753, Dec. 2001, p. 5.
2 An extensive set of hearings was held in the mid-1990s by the House Committee on
Financial Services, Subcommittee on Domestic and International Monetary Policy. Thethstnd
Future of Money. Hearings 104 Congress, 1 and 2 sessions. 4 parts. The most recent
hearings were held by the same subcommittee, The Future of Electronic Payments:thst
Roadblocks and Emerging Practices, 107 Cong., 1 sess., Sept. 19, 2000.
In the Gramm-Leach-Bliley Act of 1999 (P.L.106-102), Congress addressed the issue
of privacy and safeguarding customer information. The Act also required four
regulatory agencies (Federal Reserve, Federal Deposit Insurance Corporation, Office
of the Comptroller of Currency, and Office of Thrift Supervision) to conduct a study
of banking regulations regarding the delivery of financial products and services. The
Act also required that the regulators report on recommendations on adapting existing
legislative or regulatory requirements to online banking and lending. In 2000, the
Electronic Signatures in Global and National Commerce Act of 2000 (P.L. 106-229)
was enacted to facilitate the use of electronic records and signatures.
The federal financial regulators operate on the belief that the marketplace will
provide the flexibility needed for the evolution of retail payment systems. The
regulators have closely monitored electronic banking activities to ensure the safety
and soundness of financial institutions. In general, the regulators have been trying
to hold electronic payments products to existing consumer protections and revising
the regulatory standards of the paper-based payments system to meet electronic
This report provides a framework for understanding the paper-based and
electronic components of the current U.S. payments system. It begins with a basic
overview of the payments system, explaining the relative size and growth of various
methods of payment. The report discusses paper-based payments and then examines
the operations of wholesale and retail electronic payments. Finally, the report
discusses some of the major policy issues concerning the regulation and supervision
of electronic payments.
The U.S. Payments System: An Overview
Trillions of dollars through billions of payments between consumers,
businesses, and governments are conducted each year in the United States. The U.S.
payments system participants and operations are often divided into two broad
categories – wholesale and retail. The wholesale systems transfer funds, often large-
value payments, for financial institutions, corporations, and government agencies.
Moreover, wholesale operations are almost totally electronic. The number of
transactions is largest on the retail side, but these are generally smaller dollar value
transactions. Currency, coins, and paper checks still dominate retail payments.
Electronic transfers of funds through both traditional systems (e.g., credit and debit
cards) and new systems (e.g., smart cards and Internet banking) have had an
increasingly important part in retail payments.
Estimates of the total monetary value of the transactions in the payments system
and the exact number of them vary considerably among different sources. The data
are usually gathered through surveys conducted at irregular intervals using different
methods. No U.S. government agencies regularly collect data on the payments
system. The Federal Reserve plans to commission regular payment systems surveys
as follow-ups to its survey for 2000 (see below). Recently, for regulatory purposes,
it has become more critical to have accurate and consistent estimates of the different
modes of payment. Without better estimates of the growth of electronic payments,
which has rapidly changed the mix of electronic and paper-based payments,
regulating and supervising financial institutions could be less effective.
In November 2001 the Federal Reserve published the results of three
commissioned surveys of the U.S. Retail Payments System.3 Data were collected on
checks and electronic payment instruments. The studies did not include cash
payments or transactions at ATMs (mainly cash withdrawals), which is a significant
omission. According to the surveys, 80 billion noncash payments were made during
the year 2000 with a total value of $54.7 trillion. Checks accounted for an estimated
60% of all non-cash payments compared to 85% in 1979. Electronic payments
accounted for 38% of all non-cash payment or about 30 billion payments in 2000.
Even though checks have declined from about 85% to 60% of all non-cash payments,
the number of checks written has increased from an estimated 32 billion in 1979 to
Like most estimates of payments within the system, this study is faulted for most
likely underestimating the number of payments; further, the study does not clarify
whether or not the growth of check payments has begun to decline.4 It also does not
clearly distinguish between wholesale and retail transactions. For example, it
classifies automated clearinghouse (ACH) payments as only retail. Despite the lack
of universal acceptance of the accuracy of these estimates, they clearly indicate that
the mix of electronic payments and paper-based payments is changing. Retail
electronic payments are growing faster than paper-based payments. Still, paper-based
payments remain dominant, particularly if cash payments are included.
An Alternative Overview
An alternative to the Federal Reserve study is the Nilson Report. This study is
narrower in some respects but broader in others and is based on the Personal
Consumption Expenditures Reports of the Bureau of Economic Analysis of the U.S.
Department of Commerce.5 The Nilson study is narrow because its focus is on
consumer payments and therefore misses most, but not all business and government
payments. At the same time it is broader than the Federal Reserve study because it
includes cash payments (but not ATM cash withdrawals). Moreover, the Nilson
reports are based on a regularly conducted government survey, and they have been
published periodically since 1990.
3A Snapshot of the Retail Payments System: Research Results from the Federal Reserve.
Federal Reserve System, November, 2001. 21p.
4 Jennifer A. Kingson, Checks may be Losing Dominance, The American Banker, November
5 The Nilson report figures are considerably smaller than the Federal Reserve commissioned
study. The Nilson estimates are based on consumer expenditures data, while the Fed study’s
estimates are based on a survey of banking institutions’ transaction data. See “Consumer
Payment System,” The Nilson Report, issue 753, Dec. 2001, p. 5.
Figures 1 and 2 summarize the study’s estimates of the size of the payments
system and make projections to 2010. The figures show that electronic and card 6
forms of payment have become more popular and are an increasingly important part
of the retail payments system. However, Figure 1 shows that the paper transactions
– cash and checks – accounted for 85% of consumer payments in 1990. In 2000,
cash and checks accounted for 65% of total consumer transactions. (In the more
recent Federal Reserve study mentioned above, checks alone accounted for 60% of
all retail non-cash payments.) And by 2010, the Nilson report expects consumers
will be making about 50% of their payments by paper, and only 14% of all consumer
payments with paper checks.
Figure 1 also shows a distributive shift in paper-based transactions in 2010. It
projects that the growth in cash and check payments between 1990 and 2000 will turn
into a decline between 2000 and 2010, mostly because of a 34% drop in check
payments. The report suggests that payment cards will be used instead. In addition,
the figure shows the number of card transactions growing rapidly while other
electronic transactions increase at a more moderate rate.
Consumer Payment Transactions, 1990,
Number of Transactions in billions.
100120Elect r onic
2040Car d s
1990 2000Check s
Source: The Nilson ReportCash
The dollar value of the transactions in Figure 2 tells a similar story. Even
though there was a 12% growth in dollar value of check payments between 1990 and
2000, the dollar value of checks in 2010 is expected to decline 20%. Figure 2 also
shows that the dollar volume of transactions using cards is expected to accelerate.
Partly based on demographic changes, cash use is expected to increase, which may
indicate that cash may be substituted for the expected decline in check use.
While it is reasonable to expect that cards and electronic payments will
continue to grow, many in the past have overestimated the decline in the use of paper
6 Electronic payments are defined as remote and preauthorized transactions and card
payments include credit, debit, and stored-value.
and the growth of electronic payments. U.S. News and World Report announced in
19974 that, “ After years of being carefully planned and nurtured in the back rooms
of the nation’s financial community, electronic banking finally seems ready to
blossom into reality.”7
However, the introduction to a 1979 report by the Bank Administration Institute
recognized the failure of such predictions by making the following point:
In the 1960s, predictions of the growth of EFT [electronic funds transfer]
services were such that sizable reductions in cash transactions and check
transactions were expected within a decade, and a cashless, checkless society
seemed to be on the horizon. This, as everyone now knows, has not been the8
A closer examination of the operations of the paper-based payments system followed
by a similar examination of electronic payments may explain their relative positions
in today’s system.
Consumer Dollar Payments, 1990, 2000, 2010
Dollar Volume in Billions.
Source: The Nilson ReportCash
A major factor behind the slow penetration of electronic payments into retail
payment transactions is the high level of comfort and confidence the public has in
using paper-based payments in the United States. Cash and checks are tested
payment instruments accepted and used by governments, businesses, and consumers.
While the volume of retail electronic payments is rapidly increasing, it is still
difficult to attract customers away from time-tested and trusted paper-based systems.
7 U.S. News and World Report, August 5, 1974.
8 The Bank Administration Institute, Checking Account Usage in the United States: A
Research and Literature Survey, September 1979. p. xiii.
Cash and checks also function as a sometimes self-imposed restraint on spending –
compared, say, to credit cards – since they do not involve debt creation.
The use of coins and currency to pay for goods and services in the United States
has been extensive. In 1999, the amount of circulating coin and currency in the
country was about $183 billion or approximately $670 per capita.9 The use of cash
is expected to continue to grow steadily with population growth because it will
remain the most efficient and convenient way of making many types of payments.
Cash is legal tender which means that if a debt is paid with cash, the debt is legally
settled. The Treasury Department has the responsibility for money production in the
United States; the U.S. Mint manufactures the nation’s coins and the Bureau of
Engraving and Printing produces the currency. The Federal Reserve System
distributes coins and currency to the banking system for circulation. Payment is
carried out by the physical transfer of fixed-denomination coins and currency notes.
Access to cash through electronic banking terminals has become increasingly
commonplace over the last couple of decades. By March 2001, there were 324,000
ATMs (automated teller machines) operating in the United States.10 Thus, an
electronic delivery system has made cash conveniently available throughout the
country. Should the use of checks decline as many expect, cash, cards and other
electronic payments are expected to replace those check payments.
Paper checks are the oldest and most frequently used noncash method of
payment in the United States. The infrastructure supporting a check transaction is
reliably well established. According to the Nilson reports in 2000, there were more
than 30 billion transactions in which personal checks were used, with a value of $2.3
trillion. With almost half of all consumer expenditures payments by dollar value
made by checks, it would be helpful to review how payments by checks are cleared
and settled to understand how this critical part of the system works. Figure 3
graphically represents the process.
Let’s say Angela (the payer), pays Barry (the payee) by check, then Barry
deposits the check in his bank. It is possible that Angela and Barry have accounts in
the same bank, in which case, the check would be settled as an “on-us” item. In the
case of an on-us item, the depository institution would simply debit Angela’s account
and credit Barry’s account in the amount of the check. It is more likely that Angela
and Barry have accounts in different depository institutions. In the United States,
9 Edward Gramlich, Remarks at the Electronic Payment Symposium. Ann Arbor, Michigan.
September 17, 1999.[http://www.bog.frb.fed.us/speeches/htm]
10EFT Data Book. ATM & Debit News. September 13, 2001, p.3.
there are almost 20,000 depository institutions – banks, saving associations, and
Check Clearing Through the Federal Reserve System
Source: Federal Reserve Bank of Atlanta
There are a number of ways that depository institutions may clear and settle
checks among themselves by the rules of interbank check settlement.12 Over time the
large volume of checks and check settlement demands has resulted in the creation of
a complex infrastructure of processing mechanisms( including some that are
electronic) and procedures. After Barry deposits Angela’s check in his bank (bank
B or the collecting bank), bank B can return the check to Angela’s bank by mailing
the check directly to bank A or by sending it through an intermediary. There are
three categories of intermediaries: clearing house associations, correspondent banks,
and the Federal Reserve Banks. Banks joining a clearing house have a central
collection site to exchange checks with one another. Correspondent banks collect
and settle checks for other depository financial institutions. The Federal Reserve
System has a nationwide system, operated by the Reserve Banks, for clearing and
Whichever of these methods is selected by bank B, according to the rules of
interbank check settlement, in most cases the check must be physically returned to
bank A before the bank makes good on the check. This means that checks must be
physically transported to the bank they were drawn on before they are settled.
Consequently, the checking clearing process is subject to travel delays.
Another legal requirement is that checks that are presented for payment must be
paid at par value. Angela’s bank, bank A, must pay Barry’s bank, bank B, the full
amount of Angela’s check to Barry, despite incurring the bulk of the cost of
11 The 2001 Federal Reserve study on the payments system estimated that 30% of the checks
written in the United States are on-us items.
12 The rules for interbank check settlement are governed by articles 3 and 4 of the Uniform
Commercial Code and by the Federal Reserve Regulations J and CC.
collection. That cost cannot be deducted from the amount of the check as it once was
in the distant past.
The Float. An important byproduct of the check clearing process is the float.
The float is income earned by the writer of the check between the time a check is
received as payment and the time it is settled. The writer of the check earns interest
on the funds in the account on which the check is written during the time the check
is being cleared and settled. A writer of a large check with long clearing and
settlement delays is likely to find checks preferable to less costly means of payment
with faster clearing time. In the example above, if bank A and bank B are in the
same city, most likely Angela’s check would clear in the same day. However, if
Angela’s bank is in a remote location, it may take several days before Angela’s check
gets back to bank A. As a result, Angela gains several days of interest while Barry
loses several days of interest due to the delay in the process. If, in addition, Barry
delays in depositing the check, Angela gains interest income with each day he delays.
Predictions of a checkless, cashless society have not been realized, but the
figures above suggest the influence of electronic banking will continue to grow and
play a larger role in the payments system. Electronic payments of all forms (wire
transfers, automated clearing house, credit, and debit cards) accounted for 18% of all
non-cash payments in 1990 and this figure grew to 32% in 2000.13 In the Nilson
report’s forecast for 2010, it is expected that electronic payments14 and card payments
will account for 64% of all payments in 2010, with cards accounting for 49%. In the
November 14, 2001, Fed non-cash payments study, electronic payments accounted
for 38% of the 80 billion non-cash payments made in year 2000.
Wholesale Electronic Payments
The wholesale payments system transfers, disburses, and collects funds for
depository financial institutions, corporations, and governmental agencies. These
are usually time-sensitive payments and electronic payments networks provide
security, efficiency, and convenience. There are two major large dollar electronic
payments networks, Fedwire and the Clearing House Interbank Payments System
(CHIPS). A network of Automated Clearing Houses (ACHs) processes smaller
dollar wholesale and retail electronic fund transfers. Electronic payments are
13U.S. Congress. House. Committee on Banking and Financial Services Subcommittee on
Domestic and International Monetary Policy. The Future of Electronic Payments:thnd
Roadblocks and Emerging Practices. Hearing, 106 Congress, 2 session. Sept. 19,2000.
14 The electronic payment instruments Nilson measured were remote and preauthorized
payments. Remote payments are made using a telephone, computer service, or the Internet.
Also included are check conversion and utility-bill payments made at automated teller
machines (ATMs), self-serve kiosks, and clerk-assisted electronic funds transfer machines
at supermarkets. Preauthorized payments, such as insurance premiums and mortgages are
handled electronically through an automated clearing house.
frequently facilitated by a private electronic message transfer system; the Society for
Worldwide Interbank Financial Telecommunications (SWIFT).
Fedwire. Fedwire is the Federal Reserve’s electronic funds and securities
transfer system. Fedwire is used by approximately 9,500 depository institutions as
well as the Treasury and other federal agencies. In addition, Fedwire offers net
settlement services for payments cleared by private clearing houses. To use Fedwire,
depository institutions must maintain a Federal Reserve account at a Federal Reserve
Bank. Depository institutions use Fedwire to transfer funds on their own behalf and
on behalf of their customers (including smaller institutions) to other institutions.
About 8,200 users are on-line; these institutions have computers or terminals that
communicate directly with the Fedwire system. These institutions account for over
99 % of total funds transfers. Depository institutions without an electronic
connection can originate transfers off-line via telephone instructions. Transfer fees
are based on monthly volume; they range from $0.17 to $0.33 per transaction. The
surcharge for an off-line transaction is $15.00.
Most Fedwire transactions are related to domestic payments. Because of its
speed and security, Fedwire is virtually always used for large payments. In 2000,
Fedwire averaged 380,000 transfers daily; the total daily transaction value was about15
$1.5 trillion and the average value per transaction was $3.5 million. All fund
transfers are completed on the day they are originated, usually within minutes. A
Fedwire payment is final and irrevocable. The Federal Reserve guarantees payment.
In an example, First Union Bank in Charlotte North Carolina wishes to pay Mellon
Bank of Pittsburgh Pennsylvania $50 million. An operator at First Union simply
types an instruction into a computer terminal telling its local Reserve Bank to send
a transfer order to Mellon’s Reserve Bank. The two Reserve Banks settle,
confirming the transfer of $50 million from First Union’s account at a Reserve Bank
to Mellon Bank’s account at a Reserve Bank. Mellon Bank’s computer is notified
that it has received the payment and the funds may be used immediately.
The Clearing House Interbank Payments System (CHIPS). CHIPS
is a large-value electronic payments network. This system is privately owned and
operated by the New York Clearing House Association. CHIPS was organized in
1970 to transfer and settle international dollar payments electronically. To be a
CHIPS participant a financial institution must have an office or subsidiary in New
York City. The computerized network has 59 members from 22 countries. CHIPS
members handle payments for themselves, for non-participating financial institutions,
and for corporate customers. Approximately 95% of all dollar international
electronic payments are processed by CHIPS. Payments are netted and settled in real
time throughout the day. The CHIPS central computer and the computers of the
individual banks track continuously each bank’s net position relative to all the other
To illustrate how this system works, suppose an Irish bank needs to pay a
French bank $100 million in U.S. dollars. The Irish bank executes a payment
15U.S. General Accounting Office, Payments, Clearance, and Settlement, GAO/GGD-97-73,
(Washington, June 1997), p. 18.
through its branch in New York, if it has one, or through a New York bank in which
it has a deposit. The payment is made to the New York branch of the French bank,
if it has one, or through a New York bank at which the French bank has a deposit.
Messages convey the information and payment instructions between the financial
institutions often using the SWIFT system (see explanation of SWIFT below).
At 4:30 p.m., the CHIPS computer sends each participant a summary of the
participant’s payments for the day and of its final net position. Upon receiving the
summary from CHIPS, each bank checks it against its own records for accuracy. If
it has a net debt, it must transfer funds over the Fedwire to a special account at the
Federal Reserve Bank of New York by 5:30 p.m. “Settling banks,” some 20 in
number, do this themselves; others have arrangements with the settling banks to do
this for them. By 6:00 p.m., banks that are owed money receive payment out of the
same special account.
In the past, CHIPS payments were like payment by checks or promises to pay.
The promise to pay might “bounce”; a bank might be “unable” to pay at the end of
the day. If this happened, all the banks which this bank owed would remain unpaid.
For this reason, there are safeguards which include bilateral credit and debit limits
between the banks. Moreover, all participants must post collateral. Today the entire
process is done in real time. Consequently, even though the number of checks being
cleared has grown, the average daily net payment has fallen over time. In 2000,
CHIPS handled more than 371,000 payments daily, averaging more than $1.6 trillion
a day. But, because of the netting out process these payments resulted in settlements
of only $5 billion a day.16
The Society for Worldwide Interbank Financial Telecommunications
(SWIFT). SWIFT is an industry owned co-operative electronic message transfer
service company headquartered in Brussels. It was created in 1973 to provide a
shared, worldwide data processing and communications links in a common language
for international transactions. The United States is one of the largest users of the
message transfer service. SWIFT facilitates the exchange of payment and other
financial messages for customers including banks, broker-dealers and investment
mangers. The network now supplies services to more than 7,000 financial
institutions in 194 countries. In 2000, SWIFT delivered 1.3 billion messages of all
types, and the average daily value of payment messages was $5 trillion.17 Fees for
these messages are competitive with other international financial messaging services.
Automated Clearing Houses (ACHs).The ACH system is a major part
of the U.S. payments infrastructure. The system can be used for wholesale or retail
payments. This system was developed to enable corporations and consumers to make
routine payments more efficiently than with paper checks. The ACH system is a large
volume electronic payment processing system. Payrolls, recurring bill payments, and
Social Security benefits are examples of typical ACH payments. The individual
payments are small dollar compared to Fedwire and CHIPS transactions. The fees
charged by ACH operators (to both the originator and receiver) for processing ACH
16See [http://www.chips.org], last visited Jan.10, 2002.
17 See [http://www.swift.com], visited January 8, 2002.
transactions are less than a penny. Because of its growing use, the ACH has become
a major force behind the move away from a paper-based intensive payments system.
The National Automated Clearing House Association (NACHA) was formed
in 1974 by the regional ACH associations to coordinate the establishment of rules to
facilitate the nationwide clearing of ACH payments. Currently there are 40 regional
ACH associations, whose participating members are all depository financial
institutions. There are four major ACH operators/processors that serve as central
clearing facilities; the Federal Reserve System and three private processors, the
Electronic Payments Network (EPN), American Clearing House Association, and
VISANET ACH. The Federal Reserve processes all government ACH payments and
the great majority (about 75 %) of commercial payments. In addition, in 1998, the
Federal Reserve extended its ACH services to Canadian depository institutions, and
they can be used by foreign banking with branches in the United States. EPN is the
largest private ACH operator/processor and like CHIPS is operated by the New York
Clearing House Association. NACHA statistics show that the ACH system
processed over 6.8 billion transactions in 2000 with a total volume of $20.3 trillion.18
The ACH system handles credit as well as debit transactions. As mentioned
earlier, ACH operations are suited for repeated periodic payments. Every transaction
has four participants; an originator, a receiver, an originating depository institution,
and a receiving depository institution. In an example of a debit transaction, a
homeowner authorizes her insurance company to take monthly payment from her
bank (bank A) deposit account. The insurance company will do this by having its
bank (bank B) send a withdrawal request for the funds each month via an electronic
file to bank B’s ACH operator. Bank B’s ACH transmits the debit to bank A’s ACH
operator which presents the debit to bank A. Bank A would deduct the payment from
the homeowner and send the transaction in an electronic file back through bank A’s
ACH for settlement, which is final when the insurance company’s account is
credited. An example of a credit transaction is a direct payroll deposit.
ACH payment instructions are usually executed over the computer networks.
Members prepare files detailing all the payments to be made to customers and/or
employees’ accounts in different depository institutions. After the ACH receives
these files, it collates them with their files of the depository institutions on their
computers and deducts or credits the local bank’s account at the Fed the amount of
the payment. Transactions are value-dated which means the originator of an ACH
transaction includes the settlement date in the payment instructions when it originates
the transactions. The network is also often used as the underlying settlement
mechanism for credit card, debit card, and ATM transactions. Net settlements
between ACH operators are often done through Fedwire.
Retail Electronic Payments
While the ACH system is the backbone of a growing electronic component of
retail payments, payment cards are the most familiar electronic payment instruments
18 The NACHA at [http://www.nacha.org/news/Stats/ACH_vs_Fed/ach_vs_fed.htm], visited
March 14, 2002.
for households and consumers. Credit cards have been widely used in the United
States for 40 years. Debit cards were introduced in the 1970s, but the volume of
debit card transactions during the last decade has increased significantly. The
deployment of electronic terminals, ATMs (automated teller machines) and POS
(terminals at the point-of-sale) have helped to mainstream electronic transfers of
funds in the United States.
Technological advances have introduced other new electronic payment
mechanisms as well. Stored-value cards have the potential of providing a wide
variety of financial and nonfinancial services. The Internet offers a new avenue for
conducting financial transactions. Electronic money products are emerging for
making payments over the Internet. Electronic check presentation could
fundamentally change the mix of paper-based check transaction and electronic
Credit Cards. Credit cards are well established and the most common form
of electronic payments. Credit cards are used for the purchase of goods and services
and for obtaining cash advances against a prearranged line of credit. One recent
estimate calculated the total number of cards (in the United States) at year-end 2000
to be 531 million and annual credit card transactions at 14 billion for 2000.19 Today
the two dominant types of credit cards are bank-issued universal purpose VISA and
MasterCard credit cards. General purpose cards are also issued by nonbanks (for
example, Discover card) and specialized credit cards are issued by merchants and
venders (for example, an oil company). The card issuer establishes the terms and
conditions for the cardholder including the grace period, interest rate, annual fees,
and penalties. Most credit card companies allow the cardholder to pay off the entire
balance each monthly cycle or to make a minimum or partial payment and carry the
interest-bearing balance forward. Discussions in this report are limited to bank
issued credit cards.
Most credit card transactions involve five parties, the cardholder, the merchant,
the card-issuing bank, the merchant’s bank (also called the acquirer) and a credit card
company. A typical transaction has three steps – authorization, clearance, and
settlement. When the cardholder makes a purchase, the merchant will seek
authorization from the card issuing bank, electronically, using an electronic data
capture terminal which reads the information embedded in the magnetic stripe on the20
back of the card. Clearing refers to the exchange of financial information.
Settlement refers to the exchange of funds for both the transaction and the associated
fees. MasterCard and VISA maintain the flow of information and funds between
card issuers and acquirers using their data processing networks and settlement
systems. Both VISA and MasterCard own and operate their own international
19EFT Data Book. ATM & Debit News. September 13, 2001, p.3. (Includes VISA,
MasterCard, American Express, and Discover)
20Merchants can maintain MOTO (mail order, telephone order) or CNP (card not present)
accounts with specific sets of rules that enable merchants to accept credit card payments by
phone or mail.
How the Credit Card Process Works. A cardholder hands the credit card
to the merchant to make a purchase. Once the switches determine that the credit
balance at the cardholder’s or issuing bank covers the purchase, the merchant bank
reimburses the merchant’s account for the purchase minus a fixed discount fee based
on a percentage of the purchase. The bank immediately credits the merchant’s
account the discounted amount of the purchase. The issuing bank submits a payment
of the full purchase minus “interchange” fee for the use of the VISA or MasterCard
network. The network immediately deducts a fee (based on negotiated arrangements)
for the exchange services it provided both banks and forwards a payment of the net
discounted amount to the merchant’s bank.21 The cardholder pays the issuing bank
the price of the purchase, or at least the minimum payment it requires and the
remaining balance is paid over time. It must be noted that the exchange fees are
sometimes not calculated on a per transaction basis, but are negotiated fixed at
various levels of transaction. In these cases, the cost may fall over certain the
number of transactions.
The regional credit card interchanges are now consolidated into two
international interchanges owned by VISA and MasterCard. Clearing is done by
using settlement banks over Fedwire and international clearings and settlements are
done through CHIPS. The credit card network computers track continuously each
bank’s net position relative to other banks and settle the accounts daily. The receipts
the cardholders sign at the point of sale rarely leave the retailer, except in rare cases
of fraud and inaccuracies.
Debit Cards. Debit cards are one of the fastest growing electronic payment
instruments. Despite the similarity in looks to a credit card, the debit card involves
no credit. A debit card transaction directly withdraws funds from an account as
opposed to providing a line of credit. The first debit cards were issued by financial
institutions to account holders as access cards for ATMs. To avoid confusion with
the next generation of debit cards used with POS systems these cards are now often
called bank cards or ATM cards. The cardholder uses the card in the terminal with
a Personal Identification Number (PIN) to conduct a transaction. A cardholder can
make cash withdrawals, pay bills, and transfer amounts between accounts, but the
majority of ATM transactions are cash withdrawals. Participants in an ATM
transaction include the customer, the cardholder’s bank, the ATM owner, and
communication networks. A seemingly simple cash withdrawal can involve a series
21 To illustrate the basic credit card process by making some assumptions about the fees,
Let’s say a cardholder hands the credit card to the merchant to make a $100.00 purchase.
Once the switches determine that the credit balance at the cardholder’s or issuing bank
covers the purchase, the merchant bank reimburses the merchant’s account for the purchase
minus a fixed discount fee: i.e., $1.90 for the $100 purchase. The bank immediately credits
the merchant’s account $98.10. The issuing bank submits a payment of a $100.00 minus
“interchange” fee of $1.30 to the VISA or MasterCard network. The network immediately
deducts its fee of 10 cents for the exchange services it provided both banks and forwards a
payment of $98.60 to the merchant’s bank. Thus, the merchant’s bank paid the merchant
$98.10, but received $98.60 from the network, which could mean a profit of 50 cents.
of complex interrelated processing steps. It is estimated that there were over 13
billion ATM transactions in 2001, almost equaling credit card transactions.22
In the 1980s and 1990s point-of-sale (POS) systems expanded the capabilities
of electronic terminals to allow the debit card to also be used in place of cash, check,
or credit card for transactions at the merchant location. With a POS transaction the
buyer’s account is debited and the merchant’s account is credited electronically. The
debit card overcomes the major problem with accepting checks (insufficient funds);
bad checks are eliminated because unless the purchaser has sufficient funds, the
transaction is not authorized. A debit card transaction denies the cardholder both the
float period for checks and the 25-day credit grace period of credit cards. Still,
customers like the convenience and efficiency of paying with a debit card. POS
systems can significantly reduce merchant administrative costs and accounts
receivable. In addition, because no credit is extended, debit card transaction fees are
lower than credit card fees. Fees paid by the merchant depend on network
POS debit transactions are made through interlinked electronic networks.
Participants in a POS transaction include consumers, merchants, card issuing banks,
and merchant’s banks. Debit card transactions can be online or offline. An online
transaction results in an immediate electronic transfer of funds and requires the use
of a PIN. A key factor in the recent growth of online POS is merchants allowing
debit cardholders to withdraw cash in excess of the sale. With an offline transaction
a debit is created against the buyer’s account but the settlement is not made
immediately. Instead, the debit is stored and processed within a few days (usually
2-3). Offline debit transactions require the customer to sign a receipt and
transactions usually require authorization. Almost all offline cards can be used as
online debit cards by entering a PIN instead of a signature. A key factor in the
growth in offline debit has been the emergence of VISA and MasterCard offline debit
networks which piggyback off their respective credit card infrastructures. The
companies initiated a massive TV advertising promotion in the late 1990s. In 1995,
there were 775.2 million online debit transactions; the annual total grew to 3.8 billion
in 2000. In 1995, there were 668 million offline debit transactions; the annual total
grew to 5.3 billion in 2000.23 As a result, debit card POS transactions are about 2/3
the size of credit card transactions in 2000.
ATM and POS Systems. Electronic funds transfer through terminals has
helped to expand public acceptance of electronic banking. The terminals have been
deployed in great numbers. In March of 2001 there were 324,000 ATM terminals
and 3,640,000 POS devices.24 They provide easy and convenient access to a variety
of financial services for millions of payment card holders. Depending on the
ownership and network arrangements, one machine or POS device can be operated
by several cards (both debit and credit).
22EFT Data Book. ATM & Debit News. September 13, 2001,p.3.
23Ibid. Offline are signature based VISA check and MasterCard Debit cards p. 3.
At first, ATMs were located on the premises of the depository financial
institutions that owned them. The development of regional and national
communication networks provided a way of sharing the costs of ATM technology
and with them the number of off-premise machines grew. Networks allowed
cardholders to access their accounts using ATMs owned and operated by institutions
or nonbanks with which they had no account relationship. Networks can also provide
switching services to facilitate connections between card issuers, terminal operators
and multiple networks. Networks can provide settlement services.
The most popular merchant locations for POS terminals are supermarkets, gas
stations, convenience stores, and fast food restaurants. Online POS systems use the
same networks as ATM transactions. Offline POS systems operate through credit
card networks. As network operations became more sophisticated so did the
structure of fees charged to participants (merchants, cardholders, financial
institutions, and terminal owners and operators). Fees associated with ATMs and
POS can include network membership, transaction, switch, interchange, clearing, and
Electronic Funds Transfers at Point of Sale (POS) . POS terminals
connect the retailers’ cash registers to the cardholders’ bank computers. Specifically,
these terminals are at the larger retail stores and supermarkets and are connected to
the cardholder banks’ computers through the ATM and credit card switches. During
the 1980s and 1990s, the POS systems expanded the capabilities of electronic
terminals to use debit cards along with cash, checks, or credit cards for transactions
at the retail location. POS terminals significantly reduce merchant administrative
costs and accounts receivable management.
POS debit transactions are made through interlinked electronic networks.
Participants in a POS transaction include consumers, merchants, card issuing banks,
and merchants’ banks. Using a debit card at a POS, the amount of the purchase is
deducted immediately from the cardholder’s deposits and credited to the merchants’
deposit account minus bank and switch fees. Debit card use at a POS is particularly
popular with those retailers that operate on very narrow margins, leaving little room
for the discount charged for credit card transactions. Debit card fees are lower than
credit card fees. Furthermore, in the early 1980s when depository institutions and
MasterCard and VISA lowered their fees to these retailers with lower profit margins,
supermarkets also began accepting credit cards as well as debit cards. A credit card
purchase at a POS uses the same switches as a debit card to clear and settle the
Electronic Check Clearing. Some economists believe that a major step in
moving the payments system from the less technically efficient paper-based system
to the more efficient electronic-based system is to process paper checks
electronically. As pointed out earlier, checks remain the most popular non-cash
method of payment, accounting for approximately 60% of the total number of non-
cash payments in 2000. In that year alone an estimated 49.6 billion checks were
written in the United States.25 The Federal Reserve has proposed legislation to
Congress that would allow for universal adoption of electronic check presentation
(ECP),26 a process that electronically clears checks, thus eliminating the need to
physically present checks.
Electronic check presentation is a collection process that settles a payment
transaction by using electronic information encoded on the check instead of the paper
check itself. Another way to describe ECP is that each check is “truncated” at the
institution where it is first deposited. The information on the check is converted into
electronic form and the check remains at that institution. Only in cases of suspected
fraud and accounting inaccuracies would this check leave the first depository
Today, roughly 20% of the checks processed by the Federal Reserve are
presented electronically, either in truncated form or with checks to follow the ECP
process. In the case of checks to follow, the paper check is eventually sent to the
paying bank, negating some of the cost savings that result from full truncation but
still making the check collection process more efficient and certainly much faster.
However, the Fed handles only 25% to 30% of the checks processed nationally. The
majority are processed by private clearinghouses and large financial institutions.
Many of these checks are “on-us” transactions, business-to-business, merchant-to-
bank, or bank-to-bank transactions, which are less costly to clear and settle. Recent
financial institution mergers have also decreased check clearinghouse activities as
more check transactions are converted into on-us transactions.28 Thus, even though
the number of checks being written remains high, the number of checks being cleared
by the Fed and other clearing houses has fallen.
If the Check Truncation Act that is being proposed by the Fed becomes law, and
electronic check presentation is universally adopted, only the coins and currency part
of the paper-based system would remain. But, ECP would also eliminate major
consumer advantage of paying with checks – the float that benefits the payer. That
means that the banking industry as a whole would be the main beneficiary of the
lower processing cost.
Internet Banking. Internet banking could also significantly reduce the use
of paper checks. The term Internet banking refers to conducting banking business
25 A Snapshot of the Retail Payments System: Research Results from the Federal Reserve.
Federal Reserve System, Nov. 2001. 21p.
26Michele Heller, “Fed Offers Check Truncation Plan,” The American Banker, Dec. 28,
27 U.S. Library of Congress, Congressional Research Service, Electronic Banking: The
Check Truncation Issue, by Walter W. Eubanks, CRS Report RS21064 (Washington:
November 29, 2001), p. 4.
28Fed Check Volumes Fall, But Debits Role is Uncertain, ATM & Debit News, August 23,
over the Internet.29 Banking institutions that offer their customers Internet banking
are usually providing a range of services, including checking balances, transferring
funds between accounts, applying for credit, paying bills electronically, and
presenting bills for the bank to pay from the depositor’s account. In bill presentation
payees send their bills via the Internet to a payer’s bank, which pays it from the
payer’s account. Internet banks also often offer insurance, and brokerage services.
Businesses can apply for loans, initiate wire transfers, and use cash and payroll
Internet banking is conducted by depository institutions with physical offices
or with Web sites only. Most Internet banks are brick and mortar establishments
offering banking services through both channels. The other form of Internet banking
is also called “virtual” banking, which provides Internet access only. At the heart of
these institutions are computer servers which may or may not be located at the legal
address of the virtual bank. Virtual banks take deposits and allow withdrawals
primarily through automatic teller machines and through the U.S. Postal Service.
Internet Bill Paying. Banks usually provide the Internet banking channel of
services to customers free or at minimal cost. The customer is required to provide
an access number, usually a Social Security number, a personal identification
number, and a codeword. The bank sets up the Internet account, which the customer
accesses through an Internet service provider (ISP), such as America On Line (AOL)
or Microsoft Network (MSN). To pay bills the customer provides the bank with a
list of payees. With this list attached to the account (s), the customer may instruct the
bank to make fixed-amount periodic payments, i.e., monthly or quarterly, or pay bills
one at a time as they are received. This can be particularly convenient if the customer
also has direct deposit of paychecks and other income.
The Internet bill paying process usually has a minimum waiting period after the
bank receives the instruction to pay the bills. For example, if the customer requests
a bill to be paid on the first of the month, the earliest the bank may pay the bill may
be 5 to 10 business days after the request was made. Internet banks, as a rule, never
make the payment on the day that the customer requests it. In addition, the bank has
discretion in the instrument it uses to make the payment. If the bank uses e-pay
(electronic payment), the payee usually receives payment on the day that the bank
notifies the customer that the payment would be made. E-pay transfers money
directly into the account of the payees in other banking institutions through the
electronic networks. However, if the bank pays the bill with a check, the payee
would receive payment as much as a week later than the bank’s date of payment.
Since most banks deduct the funds from the customer’s account at the time the check
is presented for payment, the customer does not lose the float.
The Growth of Internet Banking. While growing rapidly, particularly after
the Terrorist attacks on New York and Washington and the Anthrax incidents,30
29CRS Report RL31327, Inernet Banking: Changing Expectations and Regulation, by
Walter Eubanks. 9p.
30Maria Bruno, “Coming of Age For e-Payments,”Bank Technology News, Jan. 2, 2002.
Internet banking transactions are not yet a significant part of the national payments
system. There are limited data on how widely Internet banking is being used.
However, a September 2000, Comptroller of the Currency study concludes that most
customers using Internet banking are concentrated in a few large banks. Five banks
account for about 36% of users. Furthermore, even the most successful banks
offering Internet banking are currently serving a relatively small share of their
customer base. It was estimated that the number of households with online banking
was about 5 million in 1999. This number is expected to grow to about 32 million
by the end of 2002, but it still would account for only about one-third of the 93
million households with banking relations. Most banking transactions today are
taking place at the branch, through the mail, by telephone or over ATM networks.
Other Instruments of Electronic Payments.
Electronic Benefit Transfers (EBT). POS systems are being used for
Electronic Benefit Transfer programs. This electronic payment system was created
in the 1990s for the delivery of state-administered government benefits. Currently,
electronic benefit transfer systems are the primary delivery vehicles for food stamp
payments. Some states are using EBT for other benefit programs, such as the
supplemental nutrition program for women, infants and children (WIC). EBT
systems use POS terminals to debit a recipient’s account for purchases made, and
credit the retailer’s bank account.
To illustrate how the system works, once a food stamp applicant has been
accepted into the food stamp program, an account is established in the participant’s
name and the benefits are deposited electronically each month. The recipients use
an access card with a PIN number at the POS terminals to purchase groceries. Food
stores and other outlets are approved for participation by the Department of
Agriculture. States work with EBT vendors to set up EBT systems. There are
federal regulations covering EBT system deployment and performance. The federal
government shares the costs of the food stamp program with the states. Recently, the
Treasury Department began working on a program that provides the option of
accessing both direct federal payments (such as Social Security) and state
administered benefits with one card.
Stored-Value Cards. The stored-value card is an emerging electronic
method of payments that has not yet generated widespread interest in the United
States, especially in its most sophisticated form. This instrument allows a prepaid
balance of funds to be recorded electronically on a card. Cards can be reloaded with
additional funds. The technology can use a magnetic strip or embedded computer
chips. The chips can turn stored-value cards into smart cards that can be used for a
great variety of purposes, such as providing access to financial and nonfinancial
services, as well as storing and monitoring information such as medical and
employment records. Most stored-value cards are single-purpose cards, such as
telephone cards or mass transit cards. Value from the card is electronically
transferred by equipment contained in the phone or tollbooth, for example.
[http://www.Banktechnews.com/btn/articles/btnjan02-03.sht]. Last visited Jan. 15, 2002.
Multipurpose cards are relatively expensive to manufacture and involve greater
investment by the merchants in the infrastructure to process the transactions and
therefore require a large pool of users to be successful.
Electronic Money. Electronic money products are being created for
payments over the Internet. A variety of electronic cash products are being
developed and tested to allow payments to be transferred over widely accessible
computer networks. These methods of payment include digital cash, electronic
currency and electronic checks. Electronic money will enable payments between
consumers and merchants, and consumer to consumer without the services of a
financial institution. A number of these arrangements have been tried; one that has
become prominent among computer users is known as “pay pal.” Clearing and
settlement processes are also under development that would allow consumers to load
credit from their bank account onto an internet card, which could be downloaded
directly into the Internet merchant’s account. While these instruments are available,
there is significant consumer resistance to them, because of the concerns regarding
Regulating and Supervising Electronic Payments
Federal financial regulatory agencies have traditionally exercised restraint in
regulating innovative changes in the financial services industry. This policy has not
changed with the ongoing migration of electronic payments to the paper-based retail
side of the payments system. But, some analysts believe that the regulatory agencies
should take a more proactive role than they have because changes in the current
electronic payments environment are occurring at increasingly rapid cycles.31
Corrective enforcement actions in case of financial stress might be too late to prevent
serious damage to the payments system if regulators and supervisory agencies are too
removed from the market development of electronic payments.
On the other hand, premature regulation could stifle innovation by locking the
industry into technologies that may be less efficient, convenient, and safe. For
example, if regulatory agencies had developed regulations tailored strictly to
telephone lines, those regulations might not be fully applicable to wireless financial
transactions. While either system could be made to operate successfully, they might
be subject to different privacy and security concerns: for example, wireless banking
transactions could introduce the necessity for protecting radio frequencies from
interception. Each innovation brings different and often new risk exposures to the32
Federal financial regulators have closely monitored developments in retail
electronic banking activities to ensure they are conducted consistent with bank safety
31 Osterberg, William P. and James B. Thomson, Network Externalities: The Catch-22 of
Retail Payment Innovations, Federal Reserve Bank of Cleveland Research Department,
32Stewart, Jamie B. Jr., Changing Technology and the Payments System, Federal Reserve
of New York Current Issue, Oct. 2000, p. 1.
and soundness. In addition, they have sought to reduce uncertainty over permissible
activities and to guard against unreasonable risks. In this regard the Board of
Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation
(FDIC), the Office of the Comptroller of the Currency (OCC), and the Office of
Thrift Supervision (OTS) both individually and jointly have issued compliance
guidance and clarification of rules concerning electronic financial products and
services. In addition, in conjunction with the Federal Financial Institutions
Examination Council (FFIEC) the agencies have reviewed regulations and issued
guidance. Examples of supervisory issues covered include security monitoring of
computer networks, authentication in an electronic banking environment, electronic
banking examination procedures, and security risks associated with the Internet.
Each agency provided an overview of steps taken in the report discussed below.
Report to Congress. The Gramm-Leach-Bliley (GLB) Act of 1999 required
the Federal Reserve, FDIC, OCC, and OTS to conduct a study of banking regulations
regarding the delivery of financial products and services. The report was to include
recommendations on adapting existing legislative or regulatory requirements to
online banking and lending. The agencies published the report on November 13,33
2001. In it each agency summarized the initiatives already undertaken to adapt
regulations to facilitate, support and ensure safety and soundness in electronic
banking activities. Also included in the report is information on the privacy
provisions of GLB. The agencies discussed other steps taken such as the formation
of task force groups (within the different agencies) that focus on electronic banking
concerns, consumer protection, and the publication of comprehensive handbooks on
business and technical issues. Each agency outlined the methodology used to satisfy
the requirements of the GLB ACT for the report. This included separate federal
register requests for comments on how individual agency banking regulations affect
the electronic delivery of financial products and services. The agencies summarized
the comments they received and plans for further modifications in response.
The agencies concluded that existing regulations generally accommodate the
electronic delivery of financial products and services. They stated that they would
continue to monitor developments in banking practices and technology. In addition,
the agencies remain committed to updating their respective regulations and guidance
as needed. Finally, the agencies stated they will continue to work to foster the growth
of electronic banking activities in a safe and sound manner and to ensure both
consumer protection and access.
33Federal Reserve, FDIC, OCC, and OTS, Report to Congress on Review of Regulations
Affecting Online Delivery of Financial Products ans Services. 89p. Report can be found
on the web sites of the four agencies.