An electronic payments system is one in which financial transactions are conducted via computer and electronic communications devices, without the need to transfer any physical token. It is the lack of a physical representation of money, such as coins or paper or some other physical commodity, which characterizes electronic payments systems. Instead, money is represented in purely electronic form, typically as various patterns of ”bits” (i.e. zeros and ones) in a computer’s memory or inside a packet of information in transit between two computers.
We can distinguish two major categories of electronic payments. The first is a direct transfer in which the transaction amount is immediately debited from the electronic account of the payer and credited to the electronic account of the payee. The two accounts can be in quite different banks at different geographic locations.
An important requirement for direct transfers is that the payer’s account should contain a balance at least equal to the transaction amount at the time the transaction takes place. Otherwise, the transaction is repudiated. In other words, direct transfers do not create additional credit. An increasingly widespread example of direct transfers is electronic funds transfer at point of sale (EFTPOS), a process allowing instant payment directly from deposit balances using a debit card.
The second type of electronic payment is the credit card or “pay later” approach. This is similar to the direct transfer except that additional credit is extended at the time of the transaction. This places an obligation upon the payer to repay the credit at a later date. Credit card transactions may be denied when the credit card operator refuses to extend further credit. An important characteristic of electronic transactions is the degree of privacy extended to the transacting parties. The degree of privacy depends upon any additional information which might be recorded. Examples include the time of the transaction and the identity of the two parties.
Although in principle there are many combinations of recorded information and therefore many degrees of privacy achievable, two major cases occur in practice. They are “complete information” and “complete privacy.” Typical debit card and credit card operations belong to the former, since the card operator records a large amount of information including the identity of both parties and, often, the type of goods or services which were bought.
In the non-electronic payments world, complete privacy is most commonly exemplified by cash transactions. An emerging electronic equivalent to cash is the stored-value or smart card. This is a “pay before” approach. Cards are charged with value electronically using an integrated circuit chip imbedded within the card. The stored value may then be drawn down at will by the user to effect purchases. The smart-card transaction preserves the privacy of the transacting parties. Neither the identity of the payer nor the payee nor any transaction detail is recorded.
It is estimated that at least 75 percent of all transactions are less than US$2.00 in value. For this reason, the number of cash-based trans actions vastly exceeds the number of other transaction types at the current time. It is believed that at least 10 percent of all transactions are currently electronic.
The figures are quite different when measured by value rather than volume. It is estimated that 90 percent (by value) of transactions are currently executed by cheque or by electronic means.
Accurate estimates of the cost of operating the cash-based payments system are difficult to come by. One estimate from the UK suggests that the cost of transporting cash exceeds £2 billion annually. To this must be added the cost of storage and security, and the cost of maintaining the quality of the note supply through regular sorting and reissue.
The greatest driving force behind the expansion of electronic payments systems is the low transaction cost which is achievable. The cost per transaction of using a credit card is estimated to be in the range US$0.80 to US$2 .50, that of a debit card US$0.50 to US$1.00, and that of a smart card US$0.05 to US$0.15.
For debit and credit cards, verification of credit or funds availability is undertaken prior to completing the transaction. Such a requirement is informationally demanding, and hence more expensive than the transaction cost for smart cards. The higher transaction cost for credit cards results from the costs of assessing creditworthiness, of debt collection, and of provision for bad debts. The marginal cost of using a stored-value card is at least 70 percent less than the cheapest card-based alternative.
Plastic cards are not the only embodiment of electronic payments systems. As the general public’s access to computer networks, such as the Internet, increases, more financial transactions will be carried out directly over the networks, with no physical cards required. This technological trend will herald a further reduction in electronic transaction costs.
Electronic payments systems have made rapid advances in recent years, and their application has become increasingly widespread. As the cost of computers and electronic communications continues to fall, and the volume of electronic payments continues to increase, the marginal cost of electronic payments will fall compared to the marginal cost of cash-based transactions. This will further fuel the acceleration of electronic payments systems. To the extent that cashless means of payment reduce transaction costs, resource savings will be realized which will, over time, add to national wealth. Resources released from the production and distribution of currency become available for more productive uses.
Perhaps of greater significance for overall resource allocation is the fact that the use of electronic payments systems can be explicitly costed. Faced with a clearer picture of the cost of using the payment system, transaction by transaction, agents can be expected to economize on their consumption of payments services. In addition, financial institutions will be in a better position to unbundle services and attach explicit prices to the payments component. This in turn encourages the production of payment services only up to the point where marginal benefit equals marginal cost.
The chief implications of electronic payments systems for financial institutions are (1) the ability to dispense with vaults, security screens , cash trucks, and the like; and (2) the need to compete in the provision of payments services with a range of non-financial institutions, including telecommunications companies, department stores, and supermarkets.
More so than is the case already, financial institutions will depend upon information technology to produce their services. Accordingly, their main competitors are likely to arise in the information and telecommunications industries.
The cash-based payments system is owned an d operated in most countries monopolistically by the central bank. Central banks earn profits by issuing currency, which pays no interest, and purchasing interest-bearing assets with the proceeds. Perhaps the most direct implication of a general move to cashless payments is the loss of these “seigniorage” profits. Governments may seek to replace this source of revenue by levying transaction taxes on the use of the electronic payments system.
An important economic implication of electronic payments technology is that the central bank’s currency monopoly will no longer be effective, since people have access to a perfect substitute in the form of smart cards. The advent of smart cards could stimulate a return to privately issued currency, something not observed since the early years of this century.
These considerations raise the policy issues of who should have the right to issue electronic money and under what regulatory conditions. With the advent of new payments technologies, it is time to review and overhaul the traditional role of central banks in the provision of payments services.
