In this lecture, we are going to examine additional payment methods that consumers have historically relied upon. This includes debit and credit cards, as well as prepaid cards and money transmitters. We will also look at how financial institutions settle obligations with each other A process known as interbank fund transfers. Or you may not think of these payment methods as Fintech. You will see in the next lecture that many Fintech technologies utilize one or more of these payment methods that facilitate settlement. Let's begin with credit cards and debit cards, which supposed to have the same basic electronic payment structure meaning they operate through a card network. But the most common networks being visa and MasterCard. Visa and MasterCard serve as intermediaries in an open-loop process, meaning the card can be used to pay for goods anywhere the processing brand is accepted. Visa and MasterCard do not issue any credit cards, rather They license their payment brands to issuers and acquirers. Insuring banks are the entities that provide consumers with the credit cards in their pocket. Acquirers are the entities or merchants that process the transactions. American Express and Discover are a bit different in that they serve as both intermediaries and card issuing creditors. When Kate swipes her visa credit card at the Starbuck terminal, information is transmitted to the bank that issued the card to Kate. So the bank had determined the validity of the card, and the availability of credit sufficient to complete the transaction. And all this happens near instantaneously. At the end of business day Starbucks will send all approved authorizations in a batch to Starbucks's bank, who, in turn, routes this information to the Visa network for settlement. The credit card network forwards each approved transaction to the appropriate issuing bank. And then, usually, within 24 to 48 hours of the transaction, the issuing bank will transfer the funds, less an interchange fee, which it shares with the credit card network. The credit card network then pays Starbuck's bank who in turn credits Starbuck's account. Finally, the issuing bank posts a transaction to Kate's account and send her the monthly bill. Card network rules and federal law, governed credit card transactions. For bank to issue or a merchant to accept the card brand, be it Visa, American Express or some other brand. It must affiliate with the card network and agree to the rules by which it operates. Some of these rules directly benefit consumers and others can be relied on by banks to provide consumers with protections that exceed those required by law. The most widely advertised protection mandated by the card networks is a zero liability policy for fraudulent transaction. Both Visa and Mastercard require that all of their branded products, including credit, debit, and prepaid cards, carry this protection. Credit card transactions are also governed by federal law, specifically, the Credit Card Responsibility and Disclosure Act, or CARD Act, and the Truth and Lending Act. The CARD Act was enacted in 2009 to establish fair and transparent practices related to the extension of credit and the credit market thereby regulating both the underwriting and pricing of credit card accounts. The CARD Act prohibits credit card issuers from extending credit without assessing the consumer's ability to pay. And restricts the amount of upfront fees that an issuer can charge during the first year after an account is open. It also limits the instances in which issuers can charge back end penalty fees when a consumer makes a late payment or sees his or her credit limit. The Card Act also restricts the circumstances under which issuers can increase interest rates on credit cards, establishes procedures for doing so. The Truth and Lending Act or TLA was passed in the late 60's after congress determined that consumers needed assistance in understand important credit terms and protections against various credit practices determined to be unfair. Implemented by regulation Z which is jointly enforced by the federal reserve and the consumer protection bureau. TLA protects consumers users from liability from charges resulting from the unauthorized use of their credit cards. Requires creditors to investigate and promptly correct billing errors that consumers alleged have occurred in connection with their accounts. And entitles consumers to maintain against a creditor similar claims that they might assert against a merchant. connection with the purchase of defective or otherwise unsatisfactory goods and services. Unlike credit cards, debit cards don't involve interest rate worries, monthly bills or finance charges since they only use the money you actually have in your bank account. The disadvantage of debit cards is the amount of buying protection provided to you by law. Debit card transactions very much resemble cash transactions. The money changes hands quickly and it's difficult to get it back. If you want to return a broken or unsatisfactory item you purchased with a debit card, many businesses will only give you an exchange or store credit. That laws that govern stolen debit cards aren't as friendly as the laws that governs stolen credit cards. As a result, you may find it more difficult to get your money back when an unauthorized transaction occurs. Debit card transactions are regulated by the electronic fund transfer act, or EFTA, and it's implementing regulation, regulation E. The EFTA defines an electronic fund transfer as any transfer of funds other than a transaction originated by check Which is initiated through an electronic terminal, telephonic instrument or computer so as to order, instruct, or authorize a financial institution to debit or credit an account. The term includes but is not limited to point-of-sale transfers, ATM transactions, direct deposits, or withdrawals of funds and transfers initiated by telephone Regulation E establishes rights and responsibilities for consumers as pertains to electronic fund transfers. For lost or stolen debit cards regulation E stipulates that as long as you report your card stolen within 2 days you won't lose more than $50 of the money a thief draws on your account. If you report it after two days or within 60 days you could be liable for as much as $500 And if you report it outside of 60 days, you face unlimited liability. However, Visa and MasterCard, as well as many card issuing banks may not hold you liable for debit transactions you did not authorize. As you saw, credit and debit card transactions achieve settlement by riding through the banking system, which requires the payer to have a bank account. But what about consumers who don't have access to a bank account. In 2015 approximately 15.6 million adults in the US did not have a checking or savings account. An additional 51.1 million adults were underbanked, meaning that they had an account at an insured institution but also obtained financial services and products outside the banking system. For these people conducting payments can be challenging. With many of them using cash more frequently than your average consumer and incurring high fees to use other noncash payment systems such as money transfers. One payment option available to these consumers are prepaid cards which are like a debit card except they are not linked to an individually owned bank account. Prepaid cards have grown in popularity in recent years and now account for seven and a half percent of all non-cash transactions. Some employers are paying their employees who don’t have bank accounts by issuing them general purpose prepaid cards that run on the Visa or MasterCard network. In addition, many state and federal government assistance programs offer benefits through prepaid cards. For many years, the regulatory framework applicable to prepaid cards was different to that of debit cards, with consumers having far fewer protections available to them. But in 2016, the Consumer Financial Protection Bureau finalized a rule that gives prepaid account consumers important protections on the Electronic Fund Transfer Act. Protections that are similar to those for checking accounts and debit cards. They include free and easy access to account information, error resolution rights, and protections for lost cards and unauthorized transactions. The unbanked and underbanked have historically been frequent users of money transfer services such as those provided by companies like Western Union. Many foreigners and new immigrants use money transmitters to send money home to support their families and relatives. These cross-border payments, known as remittances, totaled $575 billion in 2016. Remittances take much longer to process than domestic payments and carry a much higher transaction fee. A payment often goes through a complex network of international and intermediary banks each charging a fee before it reaches the final recipient. The World Bank estimates that the global average cost of sending a $200 remittance at the end of 2017 was $14.26 New tech payment developments hold the potential to lower these costs. You'll recall from our discussion on regulating cryptocurrency as money, that the states have their own money transmitter laws, and examine transmitters for their state banking departments. In fact, until passage of the Dodd-Frank act in 2010, No federal consumer protection law directly regulated foreign remittance transfers. This changed when Congress amended the Electronic Fund Transfer Act in the Dodd-Frank to add a new section to the EFTA, which created four new compliance requirements for foreign remittance transfers. These include the establishment of Disclosures about important transaction terms, error resolution and cancellation, error resolution procedures, cancellation and refund policies, and a remittance transfer provider's liability for the acts of its agents. The CFPB has amended regulation e several times to implement these new requirements. Most of the payment methods we have discussed thus far involve at some point the transfer of funds between the payer's bank and the payee's bank. So I'd like to briefly talk about how these interbank funds transfers occur, because as we will soon see, several Fintech payment applications are designed to integrate into this framework or supplant it entirely. Interbank funds transfer system are arrangements through which funds transfers are made between banks for their account or on behalf of their customers. Their built on private contractors statute with common rules and standardized procedures. There are two types of interbank funds transfer systems, retail and wholesale. Retail funds transfer systems handle a large volume of payments in relatively low value in such forms is checks, credit transfer, automatic credit transactions, and electronic funds transfers at the point of sale. The average size of transfers who hold sale funds transfers systems is substantial. And the transfers are typically more time-critical, because many of the payments are in settlement of financial market transactions. In the US, the most prevalent retail inter-bank funds transfer system is the automated clearing house, or ACH. ACH moves money and information from one bank account to another through direct deposit and direct payment via ACH transactions, including ACH credit and debit transactions, recurring and one-time payments, government, consumer and business-to-business transactions, and international payments. Each year ACH transfers over $43 trillion for more than 25 billion electronic financial transactions. In ACH transfer begins when an originator Whether it's an individual, corporation, or another entity, initiates either a direct deposit or direct payment transaction using the ACH network. These ACH entries are entered and transmitted electronically, and can be either credit or debit payments. They commonly include direct deposit of payroll, government and Social Security benefits, mortgage and bill payments, online banking payments, person to person, and business to business payments. An initiation occurs when an originator notifies that the depository financial institution, or ODFI or originating depository financial institution. The depository institution will then either get payment from customers, and transmit them in bunches at regular predetermine intervals to an ACH operator. One of two ACH operators, either the federal reserve or the clearing house, will receive batches of ACH entries from the originating depository institutions. The ACH transactions are then sorted and then made available by the ACH operator who receiving depository financial institution or RDFI. Then the receiver's account is debited or credited by the receiving depository financial institution, according to the type of ACH entry, individuals, businesses, and other entities can all be receivers. Each ACH credit transaction settles in one to two business days. And each debit transaction settles in just one business day. ACH payments are regulated by the Electronic Fund Transfer Act and its implementing regulation, Regulation E. In addition the Electronic Payments Association known as NACHA is a self-governing not-for-profit institution that establishes common rules and standards for ACH payments. These rules and standards govern the rights and obligations of banks that use the ACH network. Some key points to keep in mind, are that under regulation E, if an unauthorized transfer occurs, then the consumer is not liable for that payment, absent certain conditions. In addition, unlike credit card law, the NACHA rules do not permit later rejection of a credit entry for reasons such as the originators or sellers unsatisfactory performance of an underlying contractual obligation. Which basically means that our buyer can't stop or reverse a transaction if he is not happy with the goods purchased or the performance of the seller. Finally, it is worth mentioning the the two major wholesale interbank funds transfer systems in the US are Fedwire and CHIPS. If you've ever had to send a bank wire It's likely gone through one of these two systems. Fedwire is operated by the Federal Reserve and allows depository institutions, and certain other financial institutions that hold and account with the Federal Reserve Bank to instruct the Federal Reserve to debit funds from its own account, and credit funds to the account of another participant. Participants may originate funds transfers online, By initiating a secure electronic message or offline via telephone procedures. Each transfer is final and irrevocable when a receiving depository institutions is notified of it. Payment transactions of the Federal Reserve's Fedwire funds transfer system are govern by the Federal Reserve's Regulation which to find some rights and responsibilities of financial institutions that use Fedwire, as well as the rights and responsibility of the Federal Reserve. The Clearing House Interbank Payment System, or CHIPS is a primary clearing house in the US for large banking transactions. And it's operated by the Clearing House Association. The payments transferred over CHIPS are often related to international interbank transactions, including the dollar payments resulting from foreign currency transactions. Under CHIPS, participating depository institutions exchange information throughout the day about individual transfers. The CHIPS system takes the orders and continuously tries to match or net these orders against offsetting orders. These payment orders are settled on the books of CHIPS, who in turn has a pre-funded account to facilitate this settlement at the federal reserve bank in New York. Fund transfers made through CHIPS are subject to CHIPS rules and procedures. The CHIPS rules stipulate that the laws of the state of New York which include article 4A of the Uniform Commercial Code apply to CHIPS transactions. In addition federal reserve regulation CC also regulates the time within which a depository institution Receiving a Fedwire or CHIPS fund transfer on the behalf of the customer must make those funds available to their customer. I realize this information is complex and you may be wondering why it's important. As confusing as it may be, the US is fragmented payment system is precisely why there is so much potential for FinTech payment firms. Many Fintech firms are attempting to build on top of the current framework in order to improve the customer experience or provide needed efficiencies. Other fintech firms, primarily those in distributed ledger technology, are attempting to bypass the system altogether and start from scratch. Regardless of the future path of the U.S. payments industry, There is widespread recognition that things need to change. US payments technology lags far behind that in use in many European and Asian countries. As we will talk about later on there is effort afoot to bring the US up to speed.
