How Could Mobile GSM Experiences be Used to Increase Card Payment Efficiency?
Efficiency in card payments is a topical issue. We currently see large cross-country differences in card payment usage as well as in standards and technology.1 Cash is still the main payment instrument used at point-of-sale (POS) in most countries, although it is commonly considered to be an expensive payment instrument for the economy, except for small payments and in special circumstances where card payments are not suitable.2 We have to ask ourselves why payment card usage has developed so slowly?
Mobile telephone developments have been an unparalleled success story. Soon almost every inhabitant on earth will have his/her own mobile phone and a SIM card in the phone. Old wire-based connections are starting to be closed down. Are there experiences in mobile GSM that could be useful in card payments?
Would it be possible to reach the same level of convenience for payment cards so that:
The basic differences between these industries in business models seem to be in the following areas:
Several comparisons will be made in this article between card payments and mobile phone services. There are of course clear differences in the services provided to customers, but essentially both are net-work-based transportation services. Electronic payment services could be made more efficient. Concrete examples will be presented to highlight new possibilities that have worked in other industries. These could show the way to increased benefits also in payments.
Card payments are typical debit pull transactions, in which the payer (cardholder) gives the payee (merchant) the right to debit the payer’s account. The card content is read by the merchant terminal to secure the transaction and retrieve the necessary transaction routing data. The processing of the payment is a data transfer task from the merchant, via the acquirer, to the issuer and a funds transfer task in the opposite direction, from payer’s account to payee’s account. All card systems perform exactly these same basic tasks. Could we create a wider scope of common card standards in order to increase efficiency in SEPA or even internationally?
In the GSM-world, every SIM card works in any handset due to the common standards. This would translate to any card usable with any POS terminal. In order to make this possible, cards and card-to-terminal interfaces need to be standardised. This would require common international interface standards. Visa and MasterCard created the EMV standards for chip-cards, but this standard needs to get ISO-level recognition and the current local/regional versions of that standard should be abolished.
Currently, we also have different interface and physical card types. Old cards are still based on magnetic stripes and are thus prone to physical forgery. There are new plastic (EMV) chip-cards with visible physical contacts, which are currently implemented, for example, in Europe. There are contactless plastic EMV cards based on wireless near-field-communication (NFC), which are distributed, for example, in the US and the Far East.
There are also trials and pilots with digital card information stored in mobile phones using identical EMV and NFC interfaces as contactless plastic cards. These interfaces are therefore usable as such in the same way as contactless EMV cards. One important difference between contactless and digital phone-carried cards is that the phones carry the PIN-pad as an integrated feature.
Several factors suggest that plastic cards will be replaced in future by digital cards stored in mobile phones. Both card usage and card management will become more convenient and efficient. Issuing and updating of card information can be done in real time over the air. The computer power of mobile phones can be used for payment processing. Phones can store the data for a large number of cards and automati-cally pick the one(s) to use in a given store. Digital cards in mobile phones will provide more convenience, better security, increased information and lower costs.
Currently, there are about 700-800 million payment cards issued in the EU area,3 which are renewed on average every second year at a unit cost of about €3-5. Most of the costs of filling our wallets with plastic could be saved by moving to digitalised cards and sharing the security features in GSM phones, because digital cards would carry comparatively very little variable costs. The digital cards could be look-alike images on the phone screens with even more interesting visual effects.
Moving to common standards for cards will provide economies of scale. As most new POS terminals will be PC-based or otherwise JAVA-capable, the new standards could be implemented by standardised JAVA modules and method libraries. This would eliminate a lot of programming work when the standardised modules/routines could be re-used by all software providers.
Figure 1 shows the overall data flow and card-to-terminal interface needs. Managing the data flow for cards must focus on technical standards and business models. The versatility of current mobile phones is due to the focus on common open technical standards. Clearly, we would need to have the same kind of interest in developing common open standards for cards and card payments in order to reach the same level of efficiency.
The merchants need to send their card transactions to an acquirer in order to be credited for their payments. For the merchants the best option would be that all transactions could be sent to a single acquirer. All card sales would be credited together and with good references and information on both credited and discarded payments.
In the GSM world, it is sufficient to have one phone contract to receive calls from anybody. This is possible due to the common standards and the linkages between all GSM service providers. Making this a reality in the card world would in the same way require common standards for the messages and sufficient service provider linkages.
The card transaction standard ISO 8583 is used in several countries and by some service providers. Unfortunately there are also local proprietary versions. However, it is a fairly old standard, which was created when there were severe restrictions on data communication and storage capacity. Today, these limitations have vanished and other payment instruments (for example credit transfers and direct debits) are moving to a modern XML (Extensible Mark-up Language) based standard called ISO 20022. Moving card payments to the same standard would create synergies, as all payments contain essentially the same data elements. XML is also the basic data description method used in the JAVA environment. Using the same data standard all through the process, as shown in Figure 1, would increase straight-through processing in the whole chain.
If all issuers and acquires use the same standards, the merchants could operate with just one terminal for all cards. However, if acquirers would accept just one set of cards, the merchants would need to send the transactions to different acquirers, when they accept most of the cards in the market. Creating a situation in which the merchant could send all his transaction to the same acquirer would require an open inter-operator card payment network. Issuers and acquirers would all contact the same network, and the issuers would be obliged to accept all transactions made using their cards. This is the situation in the GSM world and also for credit transfer types of payments. Card payments are currently processed in parallel ‘branded’ networks, which increase complexity and costs.
Opening of the card processing networks would probably require the same kind of authority interventions as in other network industries, calling for open access and separating infrastructural networks from service provision. This would be a most important step in order to open up competition in the card industry.
Customers would want their cards to work domestically in any shop, but also internationally in the same way as the GSM phone operates anywhere today. Having to check on which cards are acceptable in a gi-ven shop or having different cards for domestic and international use makes things more complex and increases costs. In the same way as you can call any merchant with your phone, you should be able to pay at the merchant’s POS terminal with any of the payment cards you have selected for use.
There are today three main barriers to open reachability:
The diversity of technical standards makes it more difficult for merchants to serve a large variety of cards and especially low-volume card schemes. Banks have established a large number of different card schemes and networks. Many countries have their national schemes operating only in the home country. The international cards often have exclusive local agents or centres, which have established local business rules and a national network with a gateway to the international network. This limits the international competition, which is at odds with the basic idea of a common single internal market in SEPA. The GSM world is more open to competition, as there are several interoperable networks on the national level, all of which have international gateways but operate within a common main scheme and set of business rules.
A card payment is a card payment, is a card payment. The customer card verifies the payment in all schemes. However, the merchant charges can differ greatly. Cards can be categorised as low-fee, mid-fee and high-fee cards. This would correspond in the GSM world to having different fees for calls depending on who is calling you or what kind of SIM card the caller has in his/her phone. In the current payment card environment merchants have to decide what kinds of cards they will accept due to different levels of merchant fees (and other cost increasing rules).
The payers, essentially the consumers, now see only a very small share of the payment costs as visible transparent charges. Most of the payment charges are collected in various forms of hidden fees. In most cases, cash and card payments look like free services. ATMs can mostly be used for free. Card payments carry no transaction tariffs, and even periodical fees are quite rare. However, there are generally quite high hidden fees, which are levied by banks and credit card companies via merchant fees.4 Any merchant fee will add to the merchant’s costs, which they have to surcharge transparently or embed non-transparently in their prices (see Figure 2).
The merchant card agreement often stipulates that the merchant may not surcharge separately for accept-ing cards (often called a non-surcharge rule). The agreement often also requires the merchant to honour all cards in a card scheme even if they may have varying merchant fees. Competition authorities in several countries view such rules as limiting the merchants’ free price setting rights and have forbidden them.
The debate over multilateral interchange fees (MIFs) is part of the call for greater transparency. When the issuing and acquiring banks (card service providers) agree on an interchange fee, it will increase the acquirers’ merchant fees and in turn increase the embedded consumer charges in merchants’ prices on goods and services. The issuer will receive more income via the acquirer, who charges the merchant, who passes the charges non-transparently to the card holder, instead of having the issuer to charge the card holder directly and transparently.
The general situation is that basic debit cards have the lowest merchant charges, traditional credit cards have mid-level charges and credit cards with rebates and extra service have the highest charges.5 This put customers in different positions. A debit card user with an overdraft limit on his current account would pay himself/herself for the credit used. The credit card user will get an almost-free overdraft limit, usually for 30-45 days because, due to the embedded average pass-through charge in product and service prices, the other customers will pay most of the charges.
It is often argued that credit cards would provide consumers with more purchasing power than other cards. However, a current account with an overdraft facility can make exactly the same credit available to the consumer via a debit card or even an ATM card. In all cases, the consumer and credit provider must agree on a credit line and how the overdrafts are repaid. In the case of a current account overdraft, the repay-ment is even more automated, as it happens directly with each salary payment. It would seem that it is just the non-transparent charging that makes current credit cards attractive to consumers. In the past, service providers have also preferred to segment international access mainly for credit cards, although interna-tional debit card offerings are currently on the increase.
Customers’ cash services are nowadays also mainly charged by the merchants’ cash servicing bank/company. In order to be neutral across payment instruments and promote a level playing field, cus-tomers’ cash services would also need to be charged transparently. If customers perceive cash as a free service and cards as costly, they will continue to use more cash than they would if the current hidden charges become transparent charges of the same magnitude.
There are basically two ways of achieving a transparent business model:
Transparent surcharging would require a price list at the POS specifying the (pass-through) fees applied to each payment instrument type. For example, debit cards might get a discount of x.xx%, cash customers pay according to price tags, credit card customers for card type A pay an extra of y.yy%, etc. The open price competition would probably over time reduce the items on the list, but at first the list could be quite long, when all credit card schemes have their own merchant fees.
The other alternative, redemption at par, would abolish completely the need for merchant pass-through charging. The issuing service providers would need to charge their customers directly for payment services. This seems to be in line with the current trend in official regulations. The competition authorities in several countries have reduced or forbidden the use of interchange fees. This is also been the case for GSM calls in the EU area, on which an interchange limiting and abolishing directive has been passed. However, MIF abolishment will not be sufficient, if so-called three-party (that is when the issuer and ac-quirer is the same institution) schemes can keep high merchant fees. Redeeming at par has been the regulatory response in the US, to ensure sufficient competition in cheque processing among larger and smaller banks. Level-playing-field concerns would call for expanding this convention across instruments, which would increase competition within the card industry and across instruments.
In a transparent business-model the customer, who selects the payment instrument and its value-added services, should be charged transparently for the basic and bundled extra services used, that is for the payment itself, any added credit facility, and insurance, revoking and other services.
An open, transparent and competitive business model would very likely increase debit card payments rapidly and replace less efficient instruments. The charges for value-added service, such as credit lines, would also be charged in open competition. Although, the GSM world has not been completely without complex pricing plans, interchange fees and cross-subsidies, it has been at least sufficiently transparent and competitive to achieve a very rapid growth. Basically, the caller pays for the call he/she makes and the extra services he/she uses.
Currently we have several card payment schemes (MasterCard, Visa, Amex, Diners, domestic schemes, etc), all of which have established their own rules, standards and business conventions. These have also established parallel ‘branded’ or ‘silo’ type processing networks. Creating one common governance structure, establishing common set of international standards and developing an open non-branded processing network would reduce the costs of parallel institutions and increase competition in the markets and devel-opments.
The strength of the GSM industry has been an efficient balance between co-operation and service pro-vider competition. The current global GSM cooperation began as a joint development effort among Euro-pean post and telecommunication operators (CEPT), developed into a standardisation task within the European telecommunication standardisation institute (ETSI), and emerged as a global system for mobile communication with the GSM Association ensuring global access and operations. These common devel-opment efforts have continued to provide worldwide SMS, GPRS, 3G and mobile Internet services.
The parallel schemes in card payments have sometimes been seen as a competition-increasing factor, but, it seems that the opposite is the case as they support more competition barrier building by segmenting the market and reducing price competition. Would it be possible instead to have the same kind of global co-operation in card payments and especially mobile-based digital card payments? Could GSMA and the card industry together create a worldwide mobile payment infrastructure based on digital cards on terms benefiting everybody?
The current payment conventions at POS seem to operate far away from best practices. Considerable sav-ings could be achieved by introducing common technical standards, increased open competition and a transparent model. This would reduce costs/charges, move customers to more efficient choices of payment instruments and speed up payment developments. The potential savings are huge, due to the large volumes of POS payments. Even a one eurocent average saving per transaction for the more than 200 billion POS transaction in the EU (15) area would come to a big total and the average saving would clearly rise over the years.
The convention of hiding the true costs and charges from the paying consumer has several negative im-plications like reduced competition and slower developments. Consumers are the final decision-makers on choice of payment instrument. Hiding costs from consumers seems to translate quite directly into hiding and maintaining inefficiency. Getting the payment industry incentives in line with the incentives in competitive markets would probably be the fastest way to increased efficiency.
Cash and cards are in many payment situations competing instruments, and cards have clear advantages over cash, as for example improved security, straight-through processing possibility with references and invoicing data, less float and in most cases clearly lower costs. Moving towards more efficient payment habits would require that customers also see the full cost advantages of card versus cash payment.
The card payment developments and business models have been debated for quite a long time and we seem to be in route to change them. However, the pace has been quite slow, and these small piece-by-piece changes will increase the costs of change. Would we be ready in the payment card industry to fol-low the route of the GSM industry and make the leap to modern technology, open networks and standards with a transparent business model? Could we introduce digital cards in mobile phones for use by almost everyone for almost any kind of payment, also peer-to-peer? What would be the optimal degree of authority involvement?6
1For card statistics and system descriptions see the ECB’s Blue Book and for comparative charts Bank of Finland’s publication A:111 Payment habits and trends in the changing e-landscape 2010+
2 For payment instrument cost comparisons see Belgian, Dutch, Norwegian, Portuguese and Swedish Central Bank studies.
3ECB, Blue Book
4See for example the European Commission interim report on cards.
5See European Commission Report on retail banking sector inquiry and Interim report on cards.
6 The article has benefited from the comments made by Jarkko Anttiroiko, Paivi Heikkinen, Berit Lund, Kari Kemppainen and Leo van Hove. The views are those of the author and do not necessarily reflect the views of the Bank of Finland.