Can existing payment networks meet future needs? A conference summary

Chicago Fed Letter, Oct 2003 by Chakravorti, Sujit, Ciesielski, Thomas, Clark, Carol, Davis, Erin

The proportion of retail, non-cash payments made electronically in the U.S. grew from 15% in 1979 to 40% in 2000. A recent Chicago Fed conference addressed the important question of whether today's payment networks can adequately support emerging payment technologies.

The last few years have seen a steady decline in check volumes and explosive growth in electronic payments. However, not all payment innovations have gained market acceptance and not all market segments have enthusiastically abandoned paper-based instruments. Changes in the U.S. payment industry landscape are most dramatically evidenced by a fivefold increase in the combined number of credit card, debit card, and automated clearing house (ACH) payments annually since 1979, with debit cards growing significantly toward the end of that period. The proportion of retail, non-cash payments made electronically grew from 15 percent in 1979 to 40 percent in 2000. Near term, businesses and financial institutions will need to maintain both paper and electronic payment processing systems, while the migration toward electronic instruments will likely drive future investments in technology and the payment infrastructure, raising the question: Can today's payment networks support emerging payment technologies or will new networks emerge?

On May 29-30, 2003, the Federal Reserve Bank of Chicago hosted an industry conference titled "Can Existing Payment Networks Meet Future Needs?" The conference brought together approximately 150 participants, including representatives from financial institutions, payment networks, corporations, retailers, and government, with the objective of fostering dialogue on the development and adoption of more efficient payment methods. This Chicago Fed Letter summarizes the presentations and views expressed by conference participants, who focused on opportunities to improve the payment system while addressing the challenge of balancing end-users' needs and the profitability goals of payment service providers. Speaker biographies and presentations are available at www.chicagofed.org/paymentsystems/conferences.cfm. The conference centered on the following questions:

* Why invest in payment technology?

* What are the costs and benefits to end-users of using and accepting various payment instruments?

* How can networks leverage their existing infrastructure to meet the evolving demands of payment system participants?

* How will the payment landscape evolve?

* What is the role for the Federal Reserve in promoting a more efficient payment system?

In his introductory remarks, Gordon Werkema, first vice president and chief operating officer, Federal Reserve Bank of Chicago, emphasized the Federal Reserve's mission to foster efficiency in the payment system through facilitating discussion among payment industry participants. He went on to introduce the keynote speaker, Carl Rutstein, vice president and head of Americas Payment Practice, Boston Consulting Group. Rutstein argued that technology alone is not sufficient for successful market adoption of payment innovations. He stressed the importance of execution and the need for financial institutions to direct their efforts toward areas where they have sustainable competitive advantages and where their customers will benefit. For example, a bank's online bill-pay service has the potential to attract and retain more profitable and loyal customers if it is integrated with the bank's other products, such as loans, deposit account services, and investment services. Banks can leverage this broader access to customers' financial information to find cross-selling opportunities, tailor more products to customers' needs and, consequently, increase their share of customers' "wallets."

Investing in payments

The first conference panel featured Collin Roche, principal, GTCR Golder Rauner, LLC; John Perry, chief executive officer (CEO), InterCept Payment Solutions; Nick Alex, senior vice president, Bank of America Corporation; and David Roberts, senior vice president, First Data Corporation. The discussion focused on when, why, and how firms invest in payments. The panelists emphasized that profitable opportunities do exist. Payment services generally produce stable revenue streams and account for about one-third of profits at the largest banks. Despite the importance of payments to their businesses, the panelists' firms were reluctant to invest in innovative but unproven payment products. Importantly, they choose to wait to invest until the product has established sufficient market demand.

This panel also addressed the role of joint ventures in the evolution of the payment system. While the panelists recognized that joint ventures could aid in the development of industry standards, distribute development and implementation costs among partners, and potentially achieve the critical mass necessary for adoption, several panelists also cited some challenges. Perry, formerly the CEO of Spectrum, suggested that joint ventures can provide immediate scale and speed to market, but may have high indirect management costs and potential risk to the reputations of the participants. While emphasizing the value of information and risk sharing, Alex argued that large institutions might have greater influence than smaller members in such partnerships, which may diminish the venture's value to smaller participants.