Chapter 4 Retail Financial Services Contents Page Introduction

Chapter 4 Retail Financial Services Contents Page Introduction...... 97

Deposit Function ...... 99 Direct Deposit ...... 100 Point-of-Sale Systems ...... 101 Lockbox Operations ...... 101 Demand Deposit Accounts ...... 102 Drafts ...... 102 Giro Transfers ...... 102 Traveler’s Checks ...... 103 Savings Accounts ...... 103 Insurance ...... 106 Accounts With Other Nondepository Institutions ...... 107

Extension of Credit ...... 108 Commercial Credit...... 110 Consumer Credit ...... 110

Electronic Funds Transfer ...... 114 Automated Teller Machines ...... 115 POS Full Funds Transfer ...... 123

Financial Information Services ...... 126 Check Authorization ...... 127 Credit Authorization ...... 127 Providers of Information Services ...... 127

Home Information Systems ...... 128 Technology of Home Information Services ...... 129 Developers of Home Information Systems...... 129 Costs of Home Information Systems ...... 131 The Market for Home Information Systems ...... 131 Implications of Home Information Systems ...... 131

Tables Table No. Page 3. Comparison of Depository Instruments and Accounts ...... 100 4.Nationwide ACH Volume ...... 101 5. Growth Projections for the CIRRUS Systems, Inc., National ATM Network...... 120 6. Principal Characteristics of HIS Users ...... 132 Figures Figure No. Page 6. Penetration of Direct Deposit Social Security Payments ...... 101 7. Relative Use of ATM Functions, 1974-$1 .. + ~ ...... 116

8. Number of ATMs in Use, 1973-81 ...... ● ...... 118 9. Average Number of Monthly Transactions Per ATM, 1974-81 ...... 118 10.ATMs in the United States ...... 121 11. Penetration Curve for Check Alternatives...... 133 .

Chapter 4 Retail Financial Services

Introduction

The retail financial service industry consists Historically, deposit-taking has been viewed of those organizations (e.g., banks, credit as a special activity in the economy, and de- unions, insurance companies, consumer fi- pository institutions have been viewed as oc- nance companies) that deliver products to end- cupying a unique place in the industry. Depos- users. * Consumers comprise the largest and itors place a very high degree of trust in the most visible single group of end-users of finan- institutions holding their funds. At the same cial services, but business and government time, because depository institutions play both have roles as customers for retail finan- such an important role of intermediation be- cial services. Included among retail financial tween sources of funds and those having need products are depository accounts, extensions of them, they are in a position to exert a meas- of credit, and payment services.** ure of control over virtually all other economic activities. According to 1982 figures, the industry en- compasses more than 90,000 business entities, Retail financial services, especially those of- including 15,000 commercial banks, 4,000 fered by banks, have been heavily regulated savings and loan associations, 1,000 mutual by both State and Federal Governments. savings banks, 22,000 credit unions, 1,000 in- Rates paid on deposits have been largely de- vestment banks, 5,000 broker/dealers, 1,000 regulated, but limits on the rates charged on mutual funds, 1,000 mortgage banks, 3,000 consumer loans remain in force. Depository in- pension funds and pension fund managers stitutions are generally limited to offering (other than banks and insurers), 2,000 life and prescribed products to predefined markets. health insurance companies, 3,000 property Banks, for example, are limited with regard and casualty insurance companies, and more to the geographic area served, while credit than 33,000 insurance brokerage agencies, as unions are limited to serving only groups well as numerous factoring companies,*** whose members share a common bond, such leasing companies, credit card or traveler’s as employment with a specific firm. Generally, check issuers, and finance companies. In 1980, bank holding companies are not permitted to the financial service industry (excluding real enter lines of commerce not closely associated estate) contributed $100.4 billion, or 5 percent, with banking. Depository institutions are ex- to the U.S. national income.1 amined to ensure that they are pursuing business in a manner consistent with preserving *For the purposes of this assessment, wholesale financial serv- institutional safety and soundness, and many ices, as contrasted to retail, are those provided by one finan- of their business decisions (e.g., effecting cial institution to another in a way that is largely invisible to the end-user. mergers, opening branches, offering new prod- **Customers of securities brokers are also users of retail fi- ucts) are reviewed by regulators prior to im- nancial services. However, because the security industry is plementation. governed by a body of policy unique to it that separates it from retail banking and other retail financial services, it is treated Depository institutions enjoy some unique in ch. 3 of this report. ***Factoring is the process of selling accounts receivable to benefits in exchange for heavy regulations. a third party, who then assumes the risk and costs of servic- Only they can take deposits and offer accounts ing them. that are federally insured. Depository institu- ‘State of New York, Report of the Executi\e Adtisor}. Comm- ission on Insurance lndustr?’ Regulator?’ Reform, May 6, tions are unique in having access to the vari- 1982, p. 101. ous systems used to transfer funds.

97 98 • Effects of Information Technology on Financial Services Systems

Today, insurance companies, providers of entrants who rely heavily on advanced tech- services such as credit cards and traveler’s nologies to implement their offerings gener- checks, consumer finance companies, dry ally fall outside the boundaries of existing reg- goods merchants, investment companies, and ulation. food retailers also provide retail financial services. Some, such as insurance companies, are The financial service industry is becoming regulated, while others, such as providers of homogenized to a significant degree, and dif- traveler’s checks, are virtually unregulated. ferentiation between products has become less All, to an ever-increasing degree, are broaden- apparent, particularly from the point of view ing their range of business activities and, to of individual consumers. Commercial banks some extent, are encroaching on areas pre- and savings and loan associations are now per- viously served by others, including those here- mitted to serve many of the same clientele. For tofore exclusively reserved to depository in- example, recent legislation gave savings and stitutions. loan associations the power to make some commercial loans, a product that could not Information processing and telecommunica- previously be offered. While securities broker/ tion technologies have contributed to the dealers are not permitted to offer depository broadening of product lines by providers of accounts, they do offer shares in money mar- retail financial services. New entrants have ket funds that have properties very similar to been able to develop and offer products that deposits. Insurance companies offer universal compete directly with those previously avail- life policies that share many properties with able only from depository institutions. Dis- self-directed investment accounts offered by tance and location have lost much of their sig- others. nificance as factors limiting the market served by a service provider. In addition, by using the VISA and MasterCard are the two principal technologies, new classes of products have bank card products offered nationwide. How- been developed. Foremost among these are ever, in addition to being offered by banks, those that deliver financial services to remote these are now issued by such varied organi- locations, such as the home, office, merchant’s zations as the American Automobile Associa- counter and unstaffed branches. Others, such tion and various brokerage houses that offer as services to facilitate collection and invest- them in conjunction with asset management ment of cash, are directed to the business com- accounts. Travel and entertainment cards can munit y. be used with automated teller machines (ATMs) to obtain either cash or traveler’s As noted, law and regulation are significant checks. In some cases, a plastic card is used forces shaping the financial service industry to access a depository account (e.g., checking). and guiding its day-to-day operations. The ex- Plastic cards can also be used to draw on a line isting legal regulatory structure dates largely of credit either to pay for a purchase or to ob- from the 1930’s and is built on the assump- tain a cash advance. The same card can be tion that specific types of institutions will be used for both purposes. However, the finance the only ones offering each type of service. For charges are assessed differently for the cash example, transaction accounts are assumed to advance and the credit purchase. be offered only by banks; and thrift institutions are assumed to focus their lending activ- One of the major developments of the 1980’s ities on home mortgages. Thus, even though has been the development and deployment of the intent was to regulate by function, the networks of ATMs. Some of these accept only focus of legislation has been on the institutions the card of one institution, while others per- rather than on the products they offer. As a mit access to accounts held in any one of a result, the offering of new products by unreg- number of institutions. Most of these net- ulated providers is often found to lie outside works are offered by depository institutions the existing legal/regulatory structure. New or consortia of depository institutions. How- Ch. 4—Retail Financial Services ● 99 ——— ————. .— ever, retail dry goods merchants, supermarket straints and therefore come to the market with chain operators, and operators of convenience varying strengths and weaknesses. Others, by stores are now establishing networks and of- way of contrast, seek to serve specific groups, fering financial institutions the opportunity such as members of the professions with prod- to access them. ucts tailored to their particular needs. The market appears ready to support service pro- More generally, telecommunication has been viders across the full spectrum of possible a major factor in the development of financial product menus. products in the 1980’s. Providing remote banking services has been a key area in the Fluidity in the structure of the financial ser- development of financial services. Publishing vice industry limits the utility of any descrip- companies are combining with financial serv- tion that focuses on the institutions that com- ice providers and communication companies prise it. A list of providers would almost to deliver financial services directly to the certainly omit some and include others that homes of consumers. Grocery chains are es- arguably could have been omitted. Because tablishing networks of ATMs that compete product lines of various classes of providers directly with those offered by banks. Banks of financial services are close substitutes for offer cash management services to business, one another, descriptions of each of the classes enabling corporate cash managers to control of providers would become redundant. funds on deposit with institutions worldwide and to manage them to the best advantage of Therefore, the approach taken to describing their employers. the retail financial service industry in this assessment is to focus on the functions per- Other developments of the 1980’s have been formed for the customers and then to relate the emergence of the financial supermarket those functions by way of example to the or- and the specialized supplier of financial serv- ganizations that provide them. The classes ices. Several organizations have used differ- of functions described are treated under the ing strategies to develop into horizontally in- headings: tegrated suppliers of financial services. The remarkable point is that some find their roots deposit/withdrawal function, in insurance, others in retailing, and yet others extension of credit, in banking. Under the existing 1egal/regula- electronic funds transfer, and tory structure, all operate within differing con- financial information services.

Deposit Function

Technically, the function of accepting depos- lowing methods: in person, by mail or tape, or its is strictly limited to depository institutions. electronically via ATM or other remote ter- Simply defined, a deposit is a placement of minal or by the Automated Clearing House cash, checks, or drafts with a financial insti- (ACH).* In paper-based systems, access to de- tution for credit to a customer’s account. De- posits depends on the physical transfer of posits become a liability to the financial insti- documents such as a check or draft.** How- tution since they represent an obligation to ever, electronic technologies have helped rev- repay funds. The deposit function is the tradi- olutionize this function. tional banking process by which funds are accepted for credit to a demand, savings, or time *The ACH is a computerized facility that helps clear funds transactions among participating institutions electronically. account. Deposits are accounts for holding * *Draft— A n order written on the funds of a third party to funds. The deposit is made by one of the fol- transfer the amount specified to the payee. 100 ● Effects of Information Technology on Financial Services Systems

In essence, a deposit differs from an invest- honored immediately. There may also be no ment in that the depositor expects to be able guarantee that shares will be redeemed at the to recover the amount deposited, often with price originally paid by the investor. However, some interest, with virtually no risk of loss. as long as institutions continue the practice The depository institution holds itself ready of operating near-deposit products in a man- to pay the amount of the deposit under con- ner that closely approximates the operation ditions that are consistent with the contract of a true deposit account, the customers will under which it was taken. In the case of a de- see the former as being a close substitute for mand deposit, for example, the depository in- the latter. stitution stands ready to pay on demand. On In this environment, not all of those offer- the other hand, if the owner of a certificate of ing deposit or near-deposit products operate deposit withdraws the funds prior to maturity, under the same set of rules. This variation in- a significant penalty is extracted that, in some troduces new elements into the calculus used cases, involves loss of principal as well as in- by those responsible for the safety and sound- terest. ness of the financial service industry and the In the present environment, firms other formulation and execution of fiscal and mone- than depository institutions offer products tary policy. In the sections that follow, the that are operationally similar to a deposit from various types of deposit-like products and the customer’s point of view. For example, associated deposit-taking services are de- securities broker/dealers and investment com- scribed. panies offer shares in money market mutual Table 3 presents a comparison of the vari- funds that include the option of redemption ous depository instruments and accounts dis- by means of a draft written against the in- cussed in more detail below. vestor’s holding. A whole-life insurance policy accumulates cash value that is available to the owner. Direct Deposit Some will tend to view these products as de- Direct deposit is most often used to effect posits because, operationally, the funds are payment from either private or public organi- available virtually on demand. The expecta- zations to recipients of salaries, pensions, and tion is that payment will be made by the pro- entitlements. It is actually a preauthorized vider even though there may be contractual credit arrangement between the party issuing provisions that an order to pay need not be the payment and the receiver and is commonly

Table 3.—Comparison of Depository Instruments and Accounts

Penalty Minimum Interest- Withdrawal Mandatory for early deposit or Instrument or type of account bearing notice request deposit period withdrawal balance Check ...... No No No No No Draft ...... Yes Optional No No No Traveler’s check ...... No No No No No Conventional savings account ...... Yes Optional No No No Credit union account ...... Yes Optional No No No Certificate of deposita ...... Yes Yes Yes Yes Yes Money market deposit account...... Yes Optional No No Yes NOW accountb ...... Yes Optional No No Optional Super NOW accountb ...... Yes Optional No No Yes Savings bond ...... Yes Yes Yes Yes Yes Savings certificate...... Yes N/A Yes N/A Yes

aEffe~t jve Oct 1, 19&3, Interest rate ceilings are eliminated on all time deposits with original maturity or requ i red periods of more than 31 days, and on time deposits of $2,500 or more with original maturity or required notice periods of 7 to 31 days

bNot available to commercial businesses N/A–Not applicable SOURCE Office of Technology Assessment Ch. 4—Retail Financial Services ● 101 —.. used for recurring payments. One of the Table 4.—Nationwide ACH Volume largest users of direct deposit is the U.S. De- — Government - partment of the Treasury, for Social Security Year Private (Social Security) payments. It is also widely used for mili- 1976 ...... 4,283,770 46,646,999 tary payroll and other regular Government 1977 ...... 10,344,192 69,694,741 payments. 1978 ...... 18,612,263 93,207,073 1979 ...... 331324,163 123,353,594 Figure 6 shows the increasing rate at which 1980 ...... , . . 63,362,597 144,112,204 Social Security recipients have been willing to 1981 ...... 117,019,927 164,157,190 1982 ...... 174,613,862 —-. 176,821,896 accept payment by direct deposit. In 1978, SOURCE National Clearing House Association only 11 percent were willing to make use of direct deposit; but this proportion had grown is expected that use of the ACH will increase to 33 percent by 1982. The Department of the once a critical volume has been achieved by Treasury hopes for further increases. the flows to and from large organizations. As this occurs, users with smaller volumes of Direct deposit transactions started as paper payments should gradually be absorbed into transactions, but the rising volume of such the system. payments has encouraged the use of the ACH network and systems, which depend heavily on the interchange of magnetic tape (see table Point-of-Sale Systems 4). The process involves coding payment in- Point-of-sale (POS) systems, discussed in formation in machine-readable form and mov- detail later in this chapter, also function as a ing it between banks on computer tapes or, in deposit-taking method. In some cases, retail some cases, over telephone lines. The paying clerks will accept funds for deposit to custom- bank or organization consolidates all its ers’ accounts. In others, the financial institu- payments for a certain date and submits them tion will operate a station or counter in the on magnetic tape through the ACH. The ACH retail store at which deposits are accepted. A then routes the payment information to each third alternative is the placement of an ATM receiving bank. The tape can be sent in ad- at the retail store location. The ultimate goal vance with the information predated. For ex- of POS implementation in the financial serv- ample, stock dividend checks could be proc- ice industry is to institute an electronic processed through the ACH for direct deposit. It ess through which transactions may be instantaneously debited/credited. Figure 6.— Penetration of Direct Deposit Social Security Payments Lockbox Operations

~ 500 In lockbox operations, payments go directly 250/o 280/o 330/0 UY 400 to a post office box that is controlled by the c 11 0/0 o payee’s financial institution. The services pro- .-= - vided include picking up the mail at the post E 300 m .-c office, opening it and crediting the funds, or UI receiving the opened letters and crediting the z 200 funds to the company’s account. A fee is im- E $ posed for each function the financial institu- Q 100 tion performs for the company.

0 1 Lockbox operations are used to speed the 1978 1979 1980 1981 1982 collection of remittances and reduce “float”* Direct deposit *An amount of money represented at any one time by checks outstanding and in the process of collection. The period of time 1’-] Checks between receipt of notification of payment by the creditor and SOURCE Economic Review Federal Reserve Bank of Atlanta, August 1983 p 33 the actual debiting of the consumer’s account. 102 ● Effects of Information Technology on Financial Services Systems —.-— - .-— — ——.——— — by eliminating the time required to transfer eral other types of accounts use a check to ac- payment from a company to the financial in- cess funds, these accounts are not considered stitution. Interestingly, lockbox operations are demand deposit accounts. offered by other institutions, also. For example, in July 1983, Sears Roebuck & Co. an- Drafts nounced that it would provide retail lockbox processing for Pittsburgh’s Mellon Bank in Drafts are essentially an expanded collection seven cities across the country. With its na- service, with funds being transferred when the tional presence, Sears is in a unique position payer orders the bank to pay the draft. They to offer such services. This arrangement will are used by credit unions, which technically not only reduce float for the bank’s corporate classify their transactions as purchases of customers but also decrease processing costs, shares in equity accounts and money market since a larger number of the checks received funds. Credit unions began to offer share draft could be processed locally and not as inter- accounts as a competitive tool against the regional items through the Federal Reserve checking accounts offered by banks. The draft Board’s check processing system. As noted in itself is debited against the individual’s ac- American Banker, “Interstate banking restric- count. Although to the consumer, a draft looks tions have prevented banks from opening of- and works much the same way as a check, it fices around the country to accept deposits, differs in two ways: 1) it may have a specified and thus most banks have operated lockboxes time constraint and can be drawn on an in- only within their own State. Lately, however, dividual, corporation, or bank; and 2) the in- a number of banks have begun to expand their itiative for payment of goods is taken by the geographic coverage through joint marketing seller, not the buyer. arrangements and correspondent relation- The three types of drafts are: 1) sight–pay- ships. ‘‘2 able immediately on presentation; 2) arrival— payable on arrival of goods; and 3) time— Demand Deposit Accounts payable at a fixed date. There is a consider- For users of demand deposit accounts, in- able amount of float associated with checks/ stitutions make funds explicitly available to drafts because funds need not be in the bank the user without any optional or contractual on which the item is drawn until the day the delay. Demand deposits represent a significant check/draft reaches the bank and is presented portion of the domestic money supply. As of for collection. Float in this case can work to December 31, 1981, demand deposits for all the advantage of the depositor in that funds commercial banks totaled $370 billion.3 A also do not sit idle. The company can trans- checking account is a demand deposit account. fer the amount needed to cover the check/ The check is the instrument that activates the draft, leaving the balance in higher yielding checking account and is the end-product of the investments. original written instructions used by an indi- Although presently a heavily paper-based vidual to make a payment from a credit bal- instrument, drafts are being converted into a ance. A written check is deposited into an ac- form of electronic billing service whereby ven- count (the collecting bank) by the creditor, dors can collect from customers by sending an wherein it circulates within the banking sys- electronic debit (draft) to their account. tem as an instrument to debit the account of the debtor at his bank (the paying bank). Giro Transfers By law, demand deposits do not yield interest for the account holder. Although sev- While checks are a way to effect a debit transfer, the giro, which is an instrument not ‘American Banker, July 29, 1983. used in the United States, is a way of making 3Federal Reserve Statistical Release, April 1983. a credit transfer. To effect a giro payment, the Ch. 4—Retail Financial Services ● 103 . . . — person making the payment instructs the in- ing the accumulation of funds sufficient for stitution holding his funds to transfer them supporting higher denomination and higher to the account of the payee in the name of yielding investments. They are also frequently another institution. This is in contrast to a used to establish and maintain a relationship check given to the creditor that is finally pre- with an institution for the purpose of even- sented at the debtor’s bank for payment. Giro tually using other services, such as loans and organizations usually send a statement to each check cashing. account holder every day on which transac- Savings accounts take the following forms: tions are recorded; this is expensive in postal costs. “The notable feature is that the aver- 1. Conventional savings accounts. Conven- age value of paper giro transfers is higher than tional savings accounts offered by depos- the average value of check payments in all itory institutions are designed primarily countries except the United Kingdom.”4 for individuals. Savings accounts may be issued in passbook or statement form and Traveler’s Checks involve the institution’s periodic issuance of summaries of deposits and withdraw- Another form of a deposit transaction is the als. Savings deposits do not have matur- traveler’s check. The traveler’s check is “paid ity dates, but a hold may be required for” in advance by the purchaser, generally before withdrawal-most often on depos- with a premium of 1 percent of the value. It its made by check, but possibly on cash is considered a deposit because the funds are deposits, also. This is rarely, if ever, im- held by the issuing company until the travel- posed, and for the most part, individuals er’s check is redeemed by the purchaser. This regard these accounts as being very liq- instrument works and is accepted, for the uid. As defined by the Federal Reserve, most part, like cash. It can be a universally a savings account from which more than accepted payment mechanism and is consid- three telephonic or preauthorized trans- ered a deposit instrument. fers are permitted per month is considered a transaction account, with the specific Savings Accounts exception of the money market deposit account. A savings account is an interest-bearing ac- Savings accounts presently have a reg- count used to accumulate and safekeep funds. ulated interest rate set by Federal author- Institutions retain the optional right to require ities and governed by the Depository written notice of an intended withdrawal, Institutions Deregulation Committee often not less than 14 days before withdrawal (DIDC). Until these ceilings are finally is made. phased out (scheduled for 1986), the ceil- Despite the notice requirement, a savings ing is imposed on interest rates for fed- account is in practice extremely liquid. Until erally insured banks and thrift institu- recently, most people used their savings actions. Effective January 1, 1984, the count as a long-term savings/investment vehi- differential interest rates on passbook cle, even though several alternatives offered savings accounts and 7- to 3 l-day depos- higher explicit interest. However, new options its under $2,500 at both thrifts and com- available have made the consumer more con- mercial banks were removed, with each cerned with earning explicit interest on his having a ceiling of 5% percent. money. As a result, savings accounts are be- Federal deposit insurance of up to ing increasingly used only as short-term repos- $100,000 per account holder is provided itories or as interim investment vehicles dur- in all but a very few depository institutions. The Federal Deposit Insurance Cor- 4 Jack Revel], Banking& EFT—A Study of the Implications, poration (FDIC) insures accounts in com- p. 143. mercial banks chartered by both the

35-505 0 - 84 - 8 : QL 3 104 •——- Effects — of Information Technology on Financial Services Systems

Federal and State Governments and in on deposits at federally insured commer- mutual savings banks. The Federal Sav- cial banks, savings and loan associations, ings and Loan Insurance Corporation in- and mutual savings banks to the DIDC, sures accounts in federally chartered sav- whose members are the Secretary of the ings and loan associations and savings Treasury; the Chairman of the Federal Re banks. The Credit Union National Admin- serve Board; representatives of FDIC, the istration (CUNA) insures accounts held in Federal Home Loan Bank Board, and federally chartered credit unions. In ad- CUNA; and the Comptroller of the Cur- dition, some States have insurance pro- rency, a nonvoting member. The law programs to cover deposits in State-char- vides for a 6-year phase-out of ceilings on tered institutions, such as savings and deposit rates, during which the commit- loan associations, that are not eligible for tee has the discretion to set ceiling rates Federal deposit insurance. on deposits based on economic conditions. Credit unions provide savings services (The committee has been given a schedule as well, including savings accounts (which for targeting the gradual phase-out of are insured up to $100,000 per member by such ceilings. ) During the transition CUNA, investment certificates, money period, credit unions are subject to sepa- market certificates, share savings ac- rate regulations. In 1986, all Regulation counts, and individual retirement ac- Q authority expires, CUNA’s authority counts. to set interest rate ceilings for credit un- 2. Time deposits. The owner of a time de- ions terminates, and the DIDC ceases to posit accepts limitations on his withdraw- exist. al rights. The account is established with Under DIDMCA, the committee has the idea that the funds are on deposit for eliminated (effective Oct. 1, 1983) all in- a negotiated period of time in return for terest rate ceilings on (a) all time depos- receiving an offered interest rate. Certif- its with original maturities or required icates of deposit (CDs) are interest-bear- notice periods of more than 31 days; and ing time deposit instruments issued by a (b) time deposits of $2,500 or more, with depository institution for amounts that original maturities or required notice peri- can vary from as little as $100 up to more ods of 7 to 31 days. Also, the committee than $100,000. CDs pay interest at matur- has eliminated other regulations on time ity and cannot be withdrawn from the deposits except for the minimum early bank without penalty prior to their withdrawal penalties; a minimum de- maturity date. The most commonly of- nomination of $2,500 for ceiling-free time fered maturities are 91 days, 180 days, deposits with original maturities or re- and 1 year. Although most CD rates are quired notice periods of 7 to 31 days; cur- tied to Treasury bills and longer term rent ceiling on time deposits of less than Treasury securities, some of the funds do $2,500, with original maturities or re- receive an unregulated market rate of in- quired notice periods of 7 to 31 days; and terest. Large CDs are typically issued in agency rules that require a l-percentage- negotiable form, so they may be traded point differential between a loan rate and in an organized market. the rate on a time deposit securing a loan. The Depository Institutions Deregula- DIDC also established new minimum tion and Monetary Control Act of 1980 early withdrawal penalties: for time de- (DIDMCA) was enacted to provide for the posits with original maturities or required orderly phase-out and the ultimate elim- notice periods of 32 days to 1 year, loss ination of ceilings on the maximum rates of 1 month’s simple interest; for time de- of interest and dividends that maybe paid posits with original maturities or required on deposit accounts. The act transferred notice periods of more than 1 year, loss the authority to set interest rate ceilings of 3 months’ simple interest. Ch. 4—Retail Financial Services ● 105 —————- ———..——

These changes helped reduce the com- the offering institution can impose a hold petitive edge previously enjoyed by non- before honoring the withdrawal, although depositor institutions against depository it is a restriction unlikely to be enforced. institutions because a large number of fi- Individuals regard these accounts as rath- nancial services being offered by the non- er liquid, and most are probably unaware depositor institutions were attractive, of the restrictions that can be enforced. offered higher interest rate return, and The NOW account does not legally re- were not subject to regulation. Funds quire a minimum to open the account, al- placed outside of the depository institu- though most institutions require a mini- tions are not federally insured; however, mum balance of $500. the individual appears to be more con- The Super NOW account is primarily cerned with return on investment than a combination of the NOW account and the risk associated with placing funds out- the money market deposit account. The side of federally insured depository insti- Super NOW, which DIDC authorized as tutions. a financial instrument as of January 1983, 3. Money market deposit account. The requires a minimum initial deposit of money market deposit account, a high- $2,500 and an average balance in any yielding liquid account, was authorized by month of $2,500. The account has no in- the Garn-St Germain Depository Institu- terest rate ceiling, although the funds re- tions Act of 1982 to allow commercial vert to a conventional savings account banks and thrift institutions to compete yielding the regulated interest z-ate under with money market mutual funds. The ac- Regulation Q if the account falls below count is available to all depositors, in- the minimum balance. Additionally, a 7- cluding businesses. It requires an initial day notice of withdrawal maybe required. balance of at least $2,500 and has no in- Because the notice of withdrawal require- terest rate ceiling. A ‘7-day hold on with- ment applies to such funds, they are cate- drawal can be imposed by the depository gorized not as demand deposits, but as institution. Additionally, the money mar- savings deposits. These accounts are not ket account allows for up to six third- available to for-profit businesses. They party transfers, including up to three by are available to Federal, State, and local draft and up to three preauthorized trans- governments, as well as to nonprofit orga- fers per month. There are no restrictions nizations and individuals. on making withdrawals from the account in person, by messenger or mail, or by 5. Savings bonds. Savings bonds are sold by ATM. The funds are federally insured. If the U.S. Government to generate revenue. the minimum balance falls below $2,500, They are issued at a discount and appre- the interest on the funds reverts to the ciate at a rising rate in specified incre- ments to a stated value at maturity. statement/passbook rate and remains at that rate until the balance is brought up Bonds may be redeemed before maturity, to $2,500. Unlike some restrictions im- but the interest rate becomes higher the posed by the money market funds, there longer the bond is held. is no minimum on the size of an account 6. Savings certificates. Tailored to the needs withdrawals or deposits. of individuals in terms of deposit time 4 Negotiable order of withdrawal (NOW) (generally 90 days, 5 years, 10 years), sav- and Super NOW account. NOW and ings certificates have interest rates that Super NOW accounts are unique savings are dependent on maturity time and cur- instruments because they are interest- rent rates. Savings certificates are not earning transaction accounts. Although negotiable and are issued by depository they can be accessed by a check, they are institutions for $100 up to $100,000. not considered demand accounts because There is a penalty for early withdrawal. 106 . Effects of Information Technology on Financial Services Systems ——— — —.——.....——

The latest figures’ indicate deposits, as of ily by the desire for family financial protection October 1983, in various savings instruments: in the event of death; and third, it is ordinarily expected to be left intact until the death of the Super NOW accounts: $27 billion insured rather than withdrawn for some con- NOW accounts: $100 billion sumer expenditure. money market deposit accounts: $369 billion Insurance policies exist in almost every money market funds: $138 billion* household. They take such forms as automobile insurance, property insurance, and health Insurance insurance. Such a strong presence permits the industry to introduce and market new finan- In today’s competitive environment, com- cial products and services with relative ease. mercial banks, savings and loan associations, Insurance companies now offer several prod- and savings banks not only vie with one ucts that are treated like deposits. Two new another to attract new deposits, but also com- products introduced into the market in 1983 pete with many nondepository organizations. are quite interesting—one works like a cash One of the largest providers of financial serv- management plan for businesses under $10 ices is the insurance industry. It has a sizable million; the other works as a securities and customer base (insurance products are used in cash management service. These accounts almost every household or business) and is a feature money market funds, checking ac- major lender of funds to businesses. The in- counts with unlimited access, lines of credit, surance industry has access to an enormous an overdraft, and a Gold MasterCard, which amount of capital. Insurance companies are does not carry a line of credit. The customers’ enormous financial intermediaries in that they money market accounts are debited each collect and invest vast amounts of premiums month to cover card charges. The checking on policies. Life insurance companies collect and charge card operations are handled by a premiums from policyholders, invest the re- local bank for the insurance company. The in- ceipts until needed, pay death benefits to heirs vestment accounts are offered in conjunction of those who die, and make payments to those with an investment firm. Both products re- who redeem policies and/or take out loans quire a minimum of $10,000, and customers against their cash value. are penalized whenever their monthly average Insurance companies channel funds into va- drops below $5,000 for 2 consecutive months. rious investment outlets and qualify as signif- Another instrument of the insurance indus- icant allocators of financial resources in the try is universal life insurance, which is an in- economy. Their investments are made in vestment vehicle. It functions like a deposi- almost every sector of the capital market and tory instrument and is a flexible investment in a wide array of investment outlets. Their vehicle with access to mutual funds. It offers investment decisions are based on a philoso- the policyholder flexibility because the cash phy of maximizing their rate of return within value buildup or funding phase—-which makes the bounds of State investment laws and on it appear to be a savings instrument-and the the principle of safeguarding the security of pure life insurance phase of the traditional the funds invested. whole-life insurance policy are separated. A Life insurance saving differs fundamentally company can declare competitive interest from saving through deposit-type institutions rates on the funding phase, and the policyhold- for at least three reasons: first, it is long-term er can vary the amount and frequency of pre- and contractual in nature and is therefore mium payments and the amount of death more stable; second, it is motivated primar- benefits. —— —.— Whole life insurance provides a constant ‘Federal Reserve Statistical Release, Dec. 16, 1983. amount of insurance for the same premium *These funds are not federally insured. over a lifetime. It is payable to a beneficiary Ch, 4—Retail Financial Services • 107 ——..—— ——— at the death of the policyholder, and premiums business themselves. Many large networks are are payable for a specified number of years or being developed that enable the agent to ob- a lifetime. A policyholder is entitled to the cash tain pertinent information online as well as value if he cancels the policy. Since the poli- directly relay information to the carrier. cyholder may borrow from the insurance com- Technology is used to support other serv- pany against the cash value of the policy, pol- ices of the insurance industry as well. Claims icy reserves may be viewed equally as a legal services, for example, are now becoming auto- liability of the insurance company and as an mated. The claims process, which is heavily investment of the policyholder. Life insurance paper-based, is being handled by converting companies make loans against the cash value the information electronically and transmit- of whole-life insurance policies. These accounts ting it online to the carrier, allowing the car- play a significant role in the insurance com- rier to deal with the claim more effectively and panies’ lending ability. The policyholder has to maintain more control over the settlement the right to borrow from the insurance com- process. pany any amount up to the cash value, at a specified rate of interest. Moreover, earnings The automation of risk management serv- on insurance are partially tax-exempt. ices for large corporations allows them to handle in-house insurance analysis. These com- Just as insurers will increasingly compete panies are able to tie into networks that in the provision of financial services, other provide important and timely information financial service providers will increasingly used to assess and manage risk. compete with insurers in the provision of insurance. The unbundling of insurance products has revealed that there are significant Accounts With Other functions in the operation of insurance that Nondepository Institutions involve the performance of noninsurance Insurance companies, large retailers, and services. virtually every kind of financial service orga- The insurance industry is in a position to ex- nization offer individual retirement accounts pand its service offerings to include a myriad (IRAs), money market funds, and a myriad of of financial products. This is possible for sev- investment services. Although the funds in- eral reasons. As discussed, some insurance vested by individuals into nondepository insti- products being offered resemble existing prod- tutions are not federally insured, this fact has ucts being offered by depository institutions. not prevented individuals from investing in Also, modifying software for existing systems these instruments. The amount of money that enables the company to create new products has shifted from depository institutions into and services. For example, insurance com- nondepository institutions has been signifi- panies could easily offer a money market fund cant. Previously, these types of institutions and additional services that can be imple- were very different from each other. When the mented with relative ease and minimal capital. concept of commercial banking was first con- ceived, commercial bankers made little or no The insurance industry is adapting automa- effort to attract individual deposits, concen- tion in many ways. Insurance agents, for ex- trating primarily on attracting demand depos- ample, are internally incorporating automa- its from businesses. Conversely, the savings tion to manage office functions, such as client banks and savings and loan organizations information and accounts receivable and pay- were not authorized to offer checking ac- able. They are applying automation to increase counts, and their range of time and savings efficiency and to improve marketing. Exter- deposits was limited. nally, communication and information technologies are used to tie into carriers where they Today, that has changed drastically. Com- are able to obtain quotes and to underwrite mercial banks fiercely compete with other de- 108 ● Effects of Information Technology on Financial Services Systems pository institutions, insurance companies, payouts on their liabilities and reduced cus- and brokerage houses/investment firms for tomer earnings on short-term asset holdings consumer deposits. All of these organizations in depository institutions. Since depository in- offer accounts that can serve the customer in stitutions could not compete on interest rates, similar ways. However, the range of services they competed on the basis of services, which available to the customer are not as markedly were actually subsidized by the spread be- different from the customer’s point of view as tween interest paid on money in savings and the products seem from the point of view of received on money loaned. The spread resulted regulators or the providers themselves. An in- from below-market rates paid because of the dividual can easily establish an IRA or Keogh regulatory environment. This is changing. (retirement) account, obtain a loan, and use a Zero-balance accounts are becoming wide- checking or checklike account or savings ac- spread. Financial service providers have come count from any depository institution. He/she to rely more heavily on fee income from can obtain similar instruments from nondepos- services. itor institutions such as insurance com- Large financial service providers have the panies, retailers, and investment firms with privilege of offering several types of financial cash management accounts. products. For example, the use of information Prior to the introduction of money market technologies enables firms such as American deposit accounts and Super NOW accounts, Express, which owns Fireman’s Fund Ameri- depository institutions were restricted as to can Life Insurance Co., to market additional the maximum interest payable on demand de- services directly to their strong credit card posit accounts and savings accounts, with the base. They can offer insurance services and exception of jumbo CDs and similar instru- have the premiums be added directly to the ments. These restrictions helped reduce bank American Express card account.

Extension of Credit

One of the principal functions of the finan- regulation of the rates paid on deposits has cial service industry is intermediation between been to narrow this differential and cause fi- holders of assets and those in need of funds. nancial service providers to look elsewhere for Funds are gathered through the deposit-tak- revenue. They have turned to information ing activities described in the preceding sec- processing and telecommunication technol- tion. Extending credit, described in the follow- ogies to improve the efficiency of their inter- ing pages, is one of the mechanisms used to nal operations and as the foundation on which make funds available to those requiring new revenue-generating products can be built. them. * One of the most promising opportunities for cost saving is converting as many paper- Historically, credit extension has been one based transactions as possible to electronic of the principal sources of revenue for the fi- processes. nancial service industry. The rate differential between that paid on deposits and that Interest rate fluctuations, such as those ex- charged on loans was sufficiently great to sup- perienced over the past several years, have port many of the services offered by financial made the problem of portfolio management institutions. However, one of the effects of de- more difficult for financial service providers. .—— *FundS are ~so made available by investors who take an Some found themselves faced with the prob- equity position in the organization requiring funds. Equity in- lem of supporting long-term, fixed-rate loan struments and the markets for them are described in ch. 3. portfolios with short-term, expensive depos- Ch. 4—Retail Financial Services ● 109 — -. its and few options for correcting the im- out the technologies. Paper is truncated early balance. Congress increased the powers of sav- in the processing cycle as one factor in con- ings and loan associations to help them trolling costs of processing and to facilitate overcome this problem. the timely posting of transactions to customers’ accounts. Some merchants submit trans- One of the responses of the financial serv- action data electronically to card issuers to fa- ice industry to the disappearance of the in- cilitate processing. terest spread has been to encourage individuals and businesses to view all of their liabilities Credit has long been a tool of the retail in- and assets as a total package and to manage dustry. Card bases have been created on the them as such. The goal of some institutions assumption that they help create and main- is to place themselves in the role of financial tain customer loyalty and facilitate impulse advisor to their customers. On the one hand, purchases. Advertisements are regularly in- these institutions would like to generate rev- cluded with customer bills. While most retail- enue by providing advisory services for which ers do not rely heavily on revenues generated a fee may be charged or services that would from retail receivables, the funds generated attract business and customer loyalty, result- can be considerable. ing in most financial service needs being pur- chased from a single organization. Some retailers see third-party cards such as those offered by banks as an interference in To this end, service providers are using their their relationship with their customers. Retail- credit products to increase the effective li- ers feel they should know when a customer is quidity of assets held by consumers. In addi- activating a line of credit so that an alterna- tion to such traditional offerings as credit tive can be offered. Also, retailers question the cards, they are creating lines of credit secured propriety of card issuers charging the same by a variety of assets that range from home discount for a card transaction, whether it acti- equity to securities portfolios. Ease of ac- vates a line of credit (credit card) or is used tivating lines of credit is emphasized. In the to access a transaction account (debit card) in case of an overdraft account, the same check lieu of a check. or debit card that is used to draw funds from a transaction account is the instrument used While individuals make extensive use of a to activate the line of credit when the funds variety of credit services, businesses and in the account are exhausted. Some institu- governments are also major users of credit. tions issue checks that can be used to draw Generally, these users are quite sophisticated against home equity at the convenience of the and use a number of services that are not avail- customer. The customer benefits by being in able to the general public. The Federal Govern- a position to take advantage of opportunities ment is active in the primary credit markets to make either purchases or investments on as an issuer of debt. Also, one of the primary favorable terms that may be available only for means used to implement monetary policy is limited periods. trading by the Federal Reserve System in Federal Government securities in the open Information processing and telecommunica- market. tion technologies are key elements in supporting the viability of the credit products that are Further complicating the credit markets is now offered. One of the reasons a credit card the multiplicity of providers of credit services. issuer can guarantee payment to the merchant Depository institutions and retail merchants accepting it is the ability to keep track of ac- have been mentioned. However, among other count activity and effectively to halt its use participants in the market are consumer finan- almost instantaneously if circumstances re- cial companies, mortgage bankers, insurance quire. The processing and clearing of credit companies, pension funds, and acceptance cor- card drafts would be virtually impossible with- porations, such as those operated by major 110 Ž Effects of Information Technology on Financial Services Systems —— . ———.— automobile and appliance companies. Private vances, the cardholder can pay the entire individuals also make loans, as is the case amount due without finance charges. when the seller of a home takes a second mortgage from the buyer for a portion of the pur- Commercial Credit chase price. Commercial credit is the credit extended to Credit is extended in the following ways: businesses by various lenders. Commercial 1. 1nstallment credit—a direct loan to an in- banks are the primary funders of commercial dividual or business, repaid in fixed, peri- credit, but recent legislation gave savings and odic payments; it is a type of closed-ended loan associations limited power to participate credit. A typical example is a car payment in this market. Others, such as acceptance cor- loan. porations, leasing companies, and factoring 2. Open-ended credit, often called revolving companies are also active. Generally, the debt credit—funds that are available under an is short term and is used to meet requirements agreement that allows the borrower to for working capital, such as the funding of re- borrow several times, up to specified ceivables or inventory. credit limits, with interest and without Much commercial lending activity is conven- further investigation of creditworthiness. tionally viewed in the category of wholesale Many charge accounts at department rather than retail financial services. For exam- stores and credit card accounts are ex- ple, commercial banks will purchase consumer amples. Since part of the loan is repaid debt from consumer finance companies, which over time, the borrower can again draw then lend the funds to individuals at higher against the line up to the predefine limit. rates than banks charge. Commercial lenders This type of credit is often open-ended also finance capital acquisitions through third- with respect to time and the total amount party leases that cover such items as aircraft of credit available, Minimum payments and computers. are required, and the maximum amount of credit extended is limited. Commercial organizations will also float 3. Closed-ended credit—a loan that is ex- debt in the open market, where it may be pur- tended for a predetermined amount. The chased by any variety of lenders. One is short- borrower cannot reopen it by obtaining term commercial paper; but, as discussed in extra funds under the original lending the chapter on the securities industry, long- agreement. term bonds are also issued. 4. Line of credit–the amount of credit a lender will extend to a borrower over a Consumer Credit period of time, where the borrower can draw on the lineup to some fixed limit at Consumer credit is a specified amount of his/her discretion. Generally it involves a credit that is extended to individuals primar- specified amount of money a customer ily for personal, family, or household purposes may borrow without filing a new loan ap- by a number of types of institutions that in- plication. A personal line of credit on clude issuers of travel and entertainment checking accounts is one example; the cards, retail merchants, consumer finance com- credit card with a line of credit is another. panies, and acceptance corporations. Early on, Each month, the individual cardholder depository institutions began to recognize that chooses between complete payment of the consumer loans were not only an asset to the invoice or extended credit, with the choice bank, but also a contribution to the overall of making a minimum payment. The cred- economy. Consumer credit loans are extended it is used not only for purchases and credit to individuals or small businesses and provide payment, but also for obtaining cash ad- for repayment either monthly, quarterly, an- vances. With the exception of cash ad- nually, or in full at maturity. Consumer credit Ch. 4—Retail Financial Services Ž 111 —— — — — — .—————— ——— — can be extended through loans, overdrafts, time of use. Credit card checks are treated as credit card checks, and credit cards. cash advances, with the monthly statement reflecting the advance. When used, interest is Loans paid on money borrowed from the day the check is written. Merchants do not have to pay The extension of credit is perhaps best rec- the discount and service fee associated with ognized in the form of a loan. Simply defined, all card transactions when credit card checks a loan is money lent, generally to be repaid are used. with interest. Loans can be made on a secured basis, where the funds are protected by pledged The development of credit cards has helped collateral, or on an unsecured basis, where the satisfy the demand from consumers for a more funds are extended with no pledge of collater- convenient way to finance their day-to-day al. Loans are made to consumers and busi- credit needs. nesses on a regular basis. A loan is an agreement between two parties. The lender does not Credit Cards have to be a financial institution. Loans can With the advent of electronic banking sys- be secured by life insurance, contracts, depos- tems, the plastic card has become common- its in financial institutions, securities, or per- place in today’s financial institutions and sonal and real property. Banks, acceptance retail organizations. Nearly all customer/bank corporations, consumer finance companies, communication terminals—ATMs, remote and credit unions are major lenders of con- service units, POS terminals-use card tech- sumer credit. nology in some form. The card is used to access funds in various accounts and as a me- Overdrafts dium to extend credit. Today, almost 600 Credit can also be extended through an over- million credit card accounts exist in the United draft, which is a check or payment order writ- States, and 7 out of 10 households have at ten against a demand deposit or transaction least one credit card. Outstanding balances account for funds in excess of the balance. It on credit card accounts total more than $75 must be arranged in advance, and when hon- billion.’ ored by the depository institution, the over- Electronic processing has helped minimize draft creates a loan. If approval for overdraft the amount of paper used in handling credit privileges has not been obtained in advance, cards, and online credit authorization has overdrafts are prohibited. Basically, the over- helped encourage card use because it entails draft can be defined as an instrument that less of a waiting period. The transaction can operates with a credit limit, fixed by the in- be approved and completed within a time stitution for each customer and reviewed peri- frame that is acceptable to the customer. odically. Since the application of an overdraft Today, there are many online POS terminals is typically for personal use, it is rarely se- for credit authorization throughout the United cured. The arrangements for repayment of the States. Generally, any credit card can be ac- overdraft are set by each institution. cepted by the systems, which operate over standard telephone lines. Credit Card Checks Credit cards offer the individual the ability Credit card checks are special drafts writ- to defer payment of part of the balance due ten against a credit card account rather than as part of an extension of credit. A dollar, or a demand deposit account. They are issued in floor, limit is established, which permits using conjunction with a credit card account and access a credit line. They work just like a per- ‘Federal Reser\’e Board, L’redit Cards in the U.S. Eccmon]L\r— sonal check; however, the amount is charged Their impact on Costs, I]rices and Retail Saies, July 27, 1983, automatically to the credit card balance at p. 1. 112 ● Effects of Information Technology on Financial Services Systems the card without credit authorization at the ates a worldwide electronic data communica- time of purchase. For purchases over the re- tion system that transferred nearly 1 billion quired floor limit, credit approval is necessary. transactions between member institutions in Ceilings are generally set on the total amount 1983.7 the cardholder may have outstanding. For processing purposes there is no distinc- Over the past several years, many of the tion between a VISA debit or credit card. The card-issuing organizations have imposed an- same processing procedures apply for both nual fees to the cardholder for use of the card. cards; therefore, only the card-issuing institu- Interest paid on outstanding balances falls tion and the cardholder are familiar with the under State usury laws. Certain State laws, function of a particular VISA card. however, place rigid standards on such ac- Each card-issuing financial institution sets tions. The result has been: 1) higher annual in- the policies for its own customers in the VISA terest rate charges to the cardholder, where system. These policies are regulated by appli- permitted by usury laws; or 2) the relocation cable State laws that limit maximum charges by the card-distributing organization of its on credit card accounts, the method of as- credit card processing facilities into States sessment of finance charges, and minimum such as Delaware and South Dakota, which charges that can be imposed on credit card ac- permit higher interest, card fees, or both, so counts. Different card-issuing banks nation- that the card-distributing organization is able ally may compete with one another and may to operate under the banking laws of the State have slightly different policies. Generally, the where the processing is done. most important competition exists between Card-issuing organizations impose annual banks as they attempt to sign consumer and fees on credit cards as a way to generate ad- merchant accounts. The merchant discount of- ditional income. These funds were needed be- fered to encourage acceptance of the card at cause of the high interest rates financial insti- an establishment is one of the primary com- tutions were paying for funds. Additionally, petition tools. the annual fee charge is a way to generate in- Bank credit cards have become subject to come from those individuals who use the bank credit controls because of their role in extend- credit card as a convenience mechanism and ing consumer credit. They are recognized as who pay the monthly statement charges in full instruments for installment lending to con- and therefore do not incur interest charges. sumers and as loans by banks. The controls Basically, there are three kinds of credit tend generally to be the ones applying from cards: bank cards, travel and entertainment time to time to consumer credit. The controls cards, and retail and nonbank cards. include compliance in usury limits and truth in lending as set forth in Regulation Z. Bank Cards.-The bank credit card has become an integral part of the American life- To examine critically the national bank card style. Bank credit card systems have a struc- systems and the member institution’s role as ture all their own. The two major bank credit an extender of credit in the financial service card systems are VISA and MasterCard. industry requires some analysis. Inherent in VISA International is owned by over 15,000 every payment device are two separate and member financial institutions located in distinct services. The first is payment for almost 100 countries. Over 100 million cards goods and services, and the second is the ex- have been issued, allowing consumers access tension of credit. The first has traditionally to checking accounts, savings accounts, in- been priced in free and open competition and vestments, and lines of credit. VISA U.S.A. has not been subject to usury laws. The sec- is jointly owned by U.S. financial institutions, 7 including banks, savings and loans, credit VISA, U. S. A., Credit Controls and Bank Cards Analysis and unions, and mutual savings banks. VISA oper- Proposal, March 1980. ...

Ch. 4—Retail Financial Services . 113 — — ond has traditionally been subject to usury these cards are intended mostly for travel and laws. Whether the card is used solely as a pay- business use. Travel and entertainment card ment device or as a credit device, by deferring companies generally follow more stringent payment of the full balance, is determined by guidelines in issuing the charge card than do the cardholder. The use of electronic technol- issuers of other cards. ogy and plastic cards has made it possible to Several elite versions of the travel and en- combine multiple functions in a single device, tertainment card exist; for example, the Amer- blurring the distinction between what con- ican Express Gold Card. These elite cards of- stitutes payment service and what constitutes fer check-writing privileges and a higher floor extension of credit. limit for purchasing goods (which exceed those The national card systems have also ex- for the conventional card). Both the Gold and panded their use to include card access to conventional cards provide access to ATMs ATM networks. Several ATM systems estab- and traveler’s check dispensers and ease of lished by banks use VISA or MasterCard as check cashing at hotels and American Express the access card to a proprietary system. How- offices. ever, both VISA and MasterCard have also set up their own national ATM networks to compete with national interchanges. They are in the process, like other national ATM interchange networks, of attracting ATM networks from across the United States to join their systems. VISA also plans to establish a global ATM network. Because Delaware and South Dakota allow higher interest charges or annual fees for the bank card, a number of depository institutions have moved their processing centers to these States. Although technically it makes no difference where the actual processing is done, the critical elements are the type and location of the organization issuing the card and the laws that govern the State where the cards are being distributed. Credit cards are also distributed by nondepository organizations, such as the American Automobile Association, and by brokerage houses. These cards are, however, tied to a financial institution for processing and credit extension. Travel and Entertainment Cards. -Travel and entertainment cards serve the general public in relatively the same manner as a bank card. They offer the possibility of deferring payment. Generally, the monthly limit associated with these cards is far greater than that of the bank card; some are issued with no preset expenditure limit. The cardholder is charged an annual fee, and the monthly state- Photo credit: American Express Co ment must be paid in full. As the name implies, Automated traveler’s check dispenser 114 ● Effects of Information Technology on Financial Services Systems —.———-——.—— .—— — —— . ——. ———

Travel and entertainment card transactions major retailer, accepts not only the J. C. Pen- are consummated in the same manner as with ney proprietary credit card but also VISA and bank cards. The difference is, however, that MasterCard. J. C. Penney, for example, has a the drafts are accumulated and billed monthly very complex electronic network system, ena- to the consumer, with the full amount due bling it to service accounts online throughout within a specified period after billing. Since the country. The Penney system supports this process is considered a payment service, 35,000 online terminals, allowing access to the its cost is unrelated to the funds outstanding, VISA system directly without the need for a which are not considered a loan of money with financial institution intermediary. It is the respect to usury statutes or annual percent- only retailer to do so. Retailers continue to en- age rate disclosures. Usury statutes apply courage the use of their proprietary credit only when the cardholder elects to pay in cards for several reasons: 1) to provide conve- installments through a prearranged line of nience to their customers, 2) to tie their cus- credit with a financial institution. tomer base to their stores, and 3) to facilitate impulse purchases. Retail and Nonbank Cards. -Retail credit cards are distributed by both large and small Card operations can also cross companies. retail and service organizations, which have J. C. Penney, for example, processes credit been in the business of extending credit to in- transactions for oil companies. The authoriza- dividuals and organizations for some time and tion is accomplished by running dedicated were the leaders in establishing the credit card. lines from the service station to the nearest Large chains of retail stores, gas/oil com- Penney store. The signal is then sent over the panies, and hotel and travel businesses run main trunk line to the data center where the their own credit card operations. Sears Roe- authorization file is maintained. The informa- buck, the largest issuer of retail credit cards tion is captured and transmitted to provide a in the United States, accepts only the Sears basis for generating customer invoices. credit card in its stores.8 J. C. Penney, also a

‘Nilson Report, June 1983.

Electronic Funds Transfer

Funds transfer is defined as any transfer of to a communication system that facilitates an funds by means of a check, draft, or similar immediate debit or credit). paper instrument or by electronic means Electronic funds transfer (EFT) enables con- through a terminal, telephone, computer, or sumers to carry out financial transactions via magnetic tape so as to order, instruct, or electronic devices instead of using paper mon- authorize a financial institution to debit or ey or checks. Electronic funds transfers can credit an account. A transaction can take sev- be carried out through use of an ACH, a home eral forms: cash purchase, charge purchase, banking system, an ATM, or a POS system. purchase by check or draft, deposit to an ac- One example of an EFT transaction is the use count, withdrawal from an account, or a debit of an access card, a plastic card encoded with from one account to another account owned an identification number to trigger the elec- by the same party, interbank, or intrabank. tronic impulses. Although debit cards allow A currency-based funds transfer uses cash or access to an account with adequate funds, coin. A paper-based transfer of funds is ac- some debit cards may also be used to borrow tivated by check, draft, or bank card/charge money, thus becoming all-purpose transaction card (when the transaction is not tied directly cards. — -— ——

Ch. 4—Retail financial Services ● 115 ————- —. — -- -— —— .—

Automation and electronic payment sys- credit, obtain a cash advance on a credit card, tems have often been at the forefront of recent pay bills, transfer funds from one account to changes in financial service organizations. Cer- another, and inquire about account balances. tainly one main effect of these changes lies in (The relative use of ATM functions is illus- the cost reductions that have been made pos- trated in fig. 7.) Credit can be obtained either sible by the elimination of paper-based trans- by granting of overdraft limits or, in some actions, which are personnel-intensive and, cases, through using a credit card rather than therefore, costly. Electronic financial services, a debit card to activate the machine to obtain however, are not pervasive. While the deploy- a cash advance. Systems vary, however; some ment of ATMs, for example, appears to be are merely cash dispensers, although the tech- prevalent in major cities, smaller towns and nology of the different systems is basically the remote areas of the country still rely on tradi- same. tional systems for delivering financial services, The plastic card’s magnetic stripe is the although this picture is rapidly changing. “key” that unlocks the machine for use. The While individuals depend on traditional serv- way the data are encoded and what items of ices, many of the financial service providers information are placed on the magnetic stripe rely on automation for the ease and efficiency varies. A great deal of attention has been paid of operating the services. Network systems to the standards being developed for the plas- continue to expand because communication tic card. and information technologies enable a broader geographic base to be served and allow in- Although the cost of ATMs has fallen sig- creased transaction volume without a propor- nificantly since their introduction, “the cost tional increase in costs. of ATMs is unlikely to fall as rapidly as that of many other parts of an electronic funds EFT has come to play an important role in transfer system because of the various me- the financial service industry. Although EFT chanical parts that are necessary. The capacity systems have been operational since the late to process transactions and information will 1960’s, it wasn’t until the mid-1970’s that become much cheaper as intelligent terminals their acceptance became more obvious. Elec- are developed, with display screens and key- tronically transferring funds today involves boards being largely electronic. There are several methods: direct deposit, credit and many mechanical parts in the dispensing of check authorization at point of sale, and most cash, in the printer, and in the mechanisms for notably, use of the ATM. To some degree, al- accepting funds. A further result of the me- though they have not penetrated the market chanical nature of cash dispensing is the short- as greatly as the ATM, the POS terminal and er life of currency because it quickly becomes remote information systems, such as home g unsuitable for use in cash dispensers’ ‘ banking, also play significant roles. With the ever-increasing operating costs for Automated Teller Machines traditional delivery systems, the customer demand for new services, and the competition The first applications of automation in cus- from new as well as traditional sources, most tomer services were very simple cash dispens- organizations in the financial service industry ers that provided the user with a fixed sum realize the need to use automated banking sys- of cash in a single denomination. These systems. The initial cost of establishing an ATM tems generally operated off-line, so the trans- is high, but it is far less expensive than build- action was not a direct debit. Now ATM sys- ing a branch bank. And, unlike a branch, it can tems offer most of the same transaction be operated around the clock at a fairly low capabilities as a branch bank, allowing con- incremental cost. Therefore, many bankers feel sumers to withdraw cash from a bank account, make deposits, borrow cash against a line of 9Revel], op. cit., p. 44. 116 . Effects of Information Technology on Financial Services Systems —-—-.—— —.

Figure 7.— Relative Use of ATM Functions,a 1974-81 that ATMs will provide both competitive ad- 1974 vantage and significant return on investment over the next decade. To soften the high cost Cash withdra of such systems, especially ATM networks, 75 ”/0 many financial institutions have entered into sharing arrangements. The ATM, which is operated by the custom- Payments er, can be located in a variety of places. In the 2% United States many are installed either in the main banking space of bank offices, in lobbies posits partitioned off from branches, or on the ex- 19 ”/0 terior of a building. They can also be located away from the main bank, at shopping centers, Balance transfers grocery stores, gas stations, offices, and fac- 4% tories. Almost all systems are or will be online. The customer’s plastic card allows him/her to gain access to the ATM location outside bank- 1976 ing hours and to conduct his banking business in relative security. c:ash withdra 74 ”/0 The large success of ATM deployment has created another trend in bank branching. In- stead of building large, full-service branches that are personnel-intensive and very costly, Payments many organizations are replacing these struc- 2% tures with satellite branches, which are small- scale, highly automated, full-service, and generally require management by only two or osits 1% three personnel. ATMs, for the most part, re- place the teller; personnel are there to handle Balance transfers 3% general information or other personal business. Figure 8 illustrates the growth in the number of ATMs in use from 1974 to 1981. 1981 Figure 9 illustrates the increases in the average number of transactions performed at each lithdr ATM. 760/o ATM Systems ATM services can be offered in one of four nts ways: a proprietary system, a shared system, an interchange system, and a piggyback system. In a proprietary system, or “single institution” system, only the customers of the bank that developed and installed the ATM system may use the machines. In a shared sys- Balance transfers tem, a group of financial institutions mutually 4% a researches, installs, markets, and operates the Excluding balance lnquiries. Includes only Years for which estimates based on field research are available system. In an interchange system, separate in- SOURCE Economic Review Federal Reserve Bank of Atlanta, August 1983 stitutions with ATM programs or even sepa- . . . .

Ch. 4—Retail Financial Services ● 117 r — .- J

—— .—

t– — — J Photo credits: Steven Rothenberg Consumers can obtain cash through a variety of service delivery systems 118 ● Effects of Information Technology on Financial Services Systems

Figure 8.— Number of ATMs in Use, 1973-81 Shared ATM Systems “ 50 Annual growth rate The number of shared and interchange sys- 45 tems is growing rapidly. As national ATM in- / terchange proliferates, shared systems such 40 as Plus and CIRRUS allow customers access . A to their funds on a national basis. National in- 35 . terchange systems, however, are not being run 1 only by banking organizations. ADP, Inc., and American Express have also begun developing and marketing national ATM interchange networks. Supermarkets and retailers are also 1973 1975 1977 1979 1981 positioning themselves in the ATM arena. Average annual growth rate, 1973-81 34.780/o There are, however, limitations to the kinds of services available through the national net- SOURCE Economic Review, Federal Reserve Bank of Atlanta, August 1983, p 16. works. Presently, because Federal regulation prohibits interstate deposit-taking,* most sys- Figure 9.—Average Number of Monthly Transactions tems serve as cash dispensers and provide in- per ATM,a 1974-81 formation about account balances. The fees imposed for using national ATM systems are 7 ’ 000~ set by the individual networks and range from 6,000 $0.75 to $1.30 per transaction. A portion of t the fee goes to the financial institution whose machine is being used, and a portion goes to the organization running the system. Not all ATM systems are run by banking c .- organizations. With the advent of regional and national ATM networks, ownership of these networks by third parties has become a major business. The systems operate in two ways: the third-party company can own, deploy, and operate the ATM network, with the financial organization paying a transaction fee each 1974 1976 1981 time its customers use the machine, or the aDoes not include balance inquiries, includes only years for which estimates third party can be the switch operator, receiv- based on field research are available SOURCE Economic Review, Federal Reserve Bank of Atlanta, August 1983, p 16 ing either a percentage of the transaction fee or a fixed monthly fee for its processing ef- rate, shared systems allow one another’s forts. These systems are developed on a local, customers to use their machines. The term regional, and national basis and are in direct “shared system” is associated with an inter- competition with bank-run systems. change system. Generally, there is an inter- Safeway–an Oakland, Calif., supermarket change fee associated with using another insti- chain-has announced plans to develop and tution’s ATMs. A piggyback system occurs market a national ATM network. Presently, when one institution with equipment allows Safeway participates in a shared interchange the customers of other institutions to use its machines .10 *Reciprocity agreement,g exist among several states. ‘he — Massachusetts Legislature passed a bill in 1983 entitled “An ‘“Norman Penny and Donald Baker, The Law of Electronic Act Relative to Branch Offices and Acquisitions of Financial Funds Transfer Systems, (Boston, Mass.: Warren, Gorham & Institutions, ” that permits interstate deployment of ATMs and Lament, year), p. 6.03. deposit-taking among five New England States. Ch. 4—Retail Financial Services ● 119 .——. network, owned and operated by the Network dedicated data circuit and modems, the Exchange of metropolitan Washington, D.C. institution pays a service fee for the The objective of the Safeway program for in- stand-in processing option. store ATMs is to increase store traffic and 3. Full stand-in processing. NTSI maintains sales by providing customers with full-service, the participating institution’s cardhold- one-stop shopping convenience. Safeway has er file online at NTSI. NTSI verifies the committed to installing common-access ATMs cardholder’s personal identification num- in key stores throughout California. The ber and authorizes or denies the card- Washington, D. C., program, however, is pres- holder’s Safeway Cash Machine trans- ently not a participant of the Safeway ATM action in accordance with the institution’s program being developed in Oakland. To at- authorization parameters and cardholder tract the maximum number of prospective positive file information, updated daily by shoppers, Safeway will promote both the avail- the institution’s processor. The institu- ability of the ATM services at its stores and tion pays an additional service fee for this the financial institution cards that can access stand-in processing option. the machines. Safeway is also prepared to assist the participating financial institutions Merrill Lynch, Pierce, Fenner, & Smith Inc., in generating new accounts that can access the has signed an agreement with Safeway Stores, in-store ATM services. Inc., that will enable the brokerage concern’s customers to tie into the Safeway ATM net- Participation in the program is on a trans- work. Merrill Lynch customers who have one action-fee basis. National Transaction Sys- of its Cash Management Accounts, which link tems, Inc. (NTSI), will provide ATMs; install, a securities account and money market funds maintain, and service them; and perform all with “check” writing privileges and a VISA required transaction processing, funds trans- card, can use the VISA card to obtain cash at fer, settlement accounting, billing, and cus- Safeway stores. This is expected to begin in tomer service operations required to support early March 1984; it will be limited, for the the Safeway ATM program. Safeway cash present time, to California locations. However, machines will be linked to NTSI switching Merrill Lynch expects to expand the services and processing system via leased telephone to include nationwide access. data circuit. Other leased data circuits will link the switch with the participating institutions’ In Florida, Publix supermarkets has also es- host computers. Initially, the only function tablished its own ATM network, which it of- available will be cash dispensing, selected by fers for use to any bank in the State (operated the financial institutions from the following on a piggyback basis). Fees are imposed for three service-level options: every transaction a customer makes at a Pub- lix terminal. In addition to deploying the 1. Direct host link. The participating insti- ATM, Publix also runs the switch that oper- tution’s computer is linked directly to the ates the system. NTSI switching processor. The institution pays for the dedicated data circuit Shared systems exist primarily on a local/re- and modems associated with its host com- gional basis. The Tyme Corp. of Wisconsin has puter link to the NTSI switch. operated as one of the first shared systems in 2. Direct host fink with “stand-in “process- the United States, and in Washington, D. C., ing. NTSI maintains a cardholder author- the Money Exchange has operated as one of ization file and control parameters on the the first shared networks on an interstate NTSI computer for processing the partic- basis. Shared/interchange systems allow the ipating financial institution’s cardholder small institution to compete with other finan- Safeway Cash Machine withdrawal trans- cial institutions in the ATM competition. The actions when the institution’s host com- feasibility of all financial institutions operat- puter is not available. In addition to the ing switches and deploying ATMs within a

35-505 0 - 84 - 9 : QL 3 120 . Effects of Information Technology on Financial Services Systems ———— —.— ——.——— — contained area is uneconomical. By operating ATM deployed by any CIRRUS member, a in a shared/interchange environment, the fi- customer can make a withdrawal from his sav- nancial institution can extend the geographic ings or checking account, check balances, and reach of its market and earn income from the access a line of credit. All CIRRUS ATMs ATM. must accept the cards of every CIRRUS member; however, individual members may set CIRRUS—National ATM Network limits on the amount of cash their customers may withdraw at a time. CIRRUS ATMs The CIRRUS System, Inc., is a not-for-pro- must also be online in order to authorize trans- fit membership corporation that allows its actions. The CIRRUS switch, maintained by members to offer their customers the conven- the National Bank of Detroit, does not provide ience of nationwide ATM access. Incorporated backup authorizations for its members. The in June 1982, CIRRUS is headquartered in network ensures against switching downtime Oak Brook, Ill. When fully operational, it will by utilizing an ACI/Tandem computer. serve 41 States. Growth projections for the system are summarized in table 5. Individual CIRRUS members are responsi- Membership in CIRRUS is exclusively re- ble for the cost of hooking up to the switch served for banks, savings and loans, and credit and maintaining the connection. They must unions. Associate membership is limited to also pay for hardware and software modifica- banks. CIRRUS does not preclude its mem- tions necessary to comply with the network’s bers from joining other networks, nor does it operating rules. require the sharing of other electronic services, such as POS terminals. There are three classes Associate members pay a one-time entrance of membership for the CIRRUS System: fee of $25,000 to join the network, connect with the switch, and reserve the right to li- 1. Principal. Principal members have ex- cense correspondent members. Correspondent clusive marketing rights in their terri- members’ entrance fees are set by agreement tories. They may share their link to the with the licensing banks. Ongoing member- CIRRUS switch, run by the National Bank ship fees for the CIRRUS System are $2,500 of Detroit, by licensing correspondent per month for associate members; correspon- members. Principal members are required dent members pay the membership fees set by to add their ATMs to the network. their licensing bank. There are also process- 2. Associate. Associate members also have ing and interchange fees. Each time a CIRRUS a direct link to the CIRRUS switch and cardholder uses his ATM card at a bank other may share their connection with the cor- than his own, the card issuer pays the switch respondent members they license. $0.25 for processing the transaction. For with- 3. Correspondent. Correspondent members drawals and for accessing a line of credit, the are linked to the CIRRUS stitch through card issuer also pays the institution deploy- the principal or associate members who ing the ATM an additional $0.50 interchange license them. fee per transaction. For balance inquiries and CIRRUS allows its members to offer their other transactions, the card issuer pays the customers the convenience of nationwide machine-deploying institution a $0.25 inter- ATM access. Using a CIRRUS card at an change fee.

Table 5.—Growth Projections for the CIRRUS System, Inc., National ATM Network

1982 1983 1984 1985 Number of CIRRUS participants ...... 682 862 1,760 2,297

Number of CIRRUS ATMs deployed ...... 3,364 5)015 7,210 8,839 Number of CIRRUS cardholders ...... 14,600,000 18,000,000 28,900,000 32,700,000 SOURCE The CIRRUS System, Inc . .—

Ch. 4—Retail Financial Services ● 121

ATM-deploying institutions earn revenue tomers. The national ATM switch is designed from interchange fees every time another in- to handle at least two transactions per second. stitution’s cardholder uses their machines to This represents a daily capacity of 173,000 transact banking business. Card-issuing insti- transactions.11 tutions are permitted to charge their customers for the privilege of being linked to the ATM Deployment Legislation CIRRUS network. Associate members can Deployment of ATMs remains dependent on share their direct link to the CIRRUS switch State-by-State banking legislation. Figure 10 with other institutions for a fee, and no mat- ter how many correspondents an associate shows the number of ATMs in each of the States in 1983. Certain States, such as Illinois, signs up, it never has to pay more than its flat have very strict, off-premise deployment laws. monthly membership fee. Members of the Illinois permits State-chartered banks to CIRRUS network are free to join other establish ATMs subject to a number of geo- networks. graphic, time, and number restrictions. First, When fully operational, CIRRUS will link over 5,200 ATMs serving over 16 million cus- “CIRRUS Systems, Inc., Oak Brook, Ill.

Figure IO.— ATMs in the United States

Legend Total ATMs

1700 to 4000 700 to 1700 500 to 700 300 to 500 200 to 300 B Less than 100 1 1 1 SOURCE Economic Review, Federal Reserve Bank of Atlanta, August 1983, p 13 122 ● Effects of Information Technology on Financial Services Systems —

prior to January 1, 1980, a bank may estab- Financial Institutions, ” the act establishes lish not more than two ATMs, each no more new authority for mergers, branching, elec- than 3,500 yards from its main office. Second, tronic branching, and mortgage lending by commencing January 1, 1980, a bank may es- Massachusetts financial institutions. While tablish an additional eight ATMs, at the rate the act is generally limited in its operation to of two per year. Third, prior to January 1, activities involving five New England States, 1981, these ATMs maybe located only within the EFT provisions are expressly exempted the county of a bank’s main office. Finally, from such limitations. Under prior law, no out- subsequent to January 1, 1981, a maximum of-State financial institution nor bank holding of four of the eight ATMs may be located company was permitted to purchase, estab- within an adjacent county. ATMs located not lish, install, lease, use, or share an ATM in more than 3,500 yards from the bank’s prem- Massachusetts. The sole exception was al- ises need not be shared, but those located more lowed in a grandfather clause that exempted than 3,500 yards from the bank’s main prem- from the prohibition certain electronic ises must be made available on a nondiscrim- branches established before December 31, inatory basis for use by customers of any other 1981. To qualify for the exception, the ATM bank that would be permitted (under the stat- had to dispense only cash, traveler’s checks, utory geographic restrictions) to establish an or both, and had to be limited solely to the use ATM at that particular location. ’z of customers of the financial institution that In sharp contrast to the restrictive Illinois established it. law is Wisconsin legislation on terminal de- The new law empowers Massachusetts insti- ployment and usage: tutions to link their ATMs to regional or national networks. It also permits a financial Facilities established under the Wisconsin EFT statutory provisions must be available institution, organization, or bank holding com- on a nondiscriminatory basis for use by any pany, or its subsidiary organized outside of like institution which has its principal place Massachusetts, to share any ATM established of business in the State, or by any other like and used by a Massachusetts financial insti- institution which obtains the consent of a like tution or organization, provided that the shar- State, or by a national institution which has ing entity limits its customers to cash with- its principal place of business in the State and drawals, advances against preauthorized lines which is using the terminal. of credit, and check cashing. Moreover, any The statute requires that regulations pro- out-of-State nondepository financial institu- hibit, with regard to a shared terminal, any tion that establishes electronic branches that advertising that suggests or implies exclusive dispense only traveler’s checks and are limited ownership or control of the terminal by a fi- to use by the nondepository’s own customers, nancial institution or group of institutions. 13 such as American Express’s Express Cash Wisconsin law made possible the first shared Program, are allowed to establish, use, or ATM network in the United States and one share electronic branches in Massachusetts. of the largest. Finally, the new law authorizes financial in- Massachusetts went one step further. In stitutions, organizations, and bank holding early 1983 a law was passed that, for the first companies in Conneticut, Maine, New Hamp- time, permits Massachusetts financial insti- shire, Rhode Island, and Vermont to purchase, tutions to link their ATMs to regional and na- establish, install, operate, lease, or use elec- tional interchanges. Entitled “An Act Rela- tronic branches. That is, whereas the prior law tive to Branch Offices and Acquisitions of permitted institutions from any State to share ATMs established and used by Massachusetts “Robert C. Zimmer and Theresa A. 13inhom, The Law of Ekc- institutions, the new law allows New England tronic Funds Transfer, Card Services, inc., 1980, pp. I 1-11 to I 1-13. institutions themselves to establish and use “Ibid., p. WI-1. ATMs in Massachusetts, whether or not a -—— —=—— . .—

Ch. 4—Retail Financial Services ● 123 — — ..————— — ———.—

Massachusetts institution is involved. ” All of ment funds. The card may also have an over- the participating States passed legislation ap- draft credit line. There has been much cus- proving the interstate branching. tomer resistance to using a debit card at the point of sale because the customer associates There are no uniform guidelines on ATM de- the use of a plastic card with the elimination ployment that each State follows in making of float, which allows a grace period before ac- its EFT deployment laws. Each State’s legis- tual payment is required. Also, many people lature determines what approach will be best in the industry have referred to the debit card for the consumer and the banking community. as a paperless check, which is one of the reasons that retailers have been reluctant to ac- POS Full Funds Transfer cept it. Presently, retailers can accept accept The term “point of sale” covers a variety of and process checks for less than the fee im- services rendered through machines located at posed for processing a debit or credit card retail establishments. POS terminals are gen- transaction. These differences have resulted erally clerk-operated devices located at the in controversy between the retailer and card- checkout or convenience counter of retail es- issuing institutions. tablishments. Electronic cash register ver- Another form of debit card transaction at sions of these terminals have been in opera- point of sale gives the cardholder a rebate, tion for several years, maintaining store which encourages use of direct debit at point records on sales, inventories, accounts of sale. Customers use the card, which works receivable, and the like. Now, POS devices online, to debit their account directly to any have been linked to financial institution com- participating retailer. The retailer receives in- puters, allowing retail customers to receive ap- stant credit, and the customer receives a re- proval for check cashing and electronically ini- bate, ranging anywhere from 2 to 5 percent, tiate transfers from their accounts to the directly credited to his savings account. One retailer’s, the latter being POS full funds of the most successful of these programs is transfer. In some installations, customers can that of the Wilmington (Delaware) Savings make deposits to their accounts. POS devices Fund Society. Most of the other programs, accept either a plastic credit card or a plastic however, have been unsuccessful. First of all, debit card, depending on whether the cus- a significant card base was not represented. tomer wants to delay payment by charging the Second, many of the stores that signed up for purchase or wants the purchase deducted di- the program were inconvenient to the majority rectly from his/her account. As electronic POS of the cardholders, and these stores also systems proliferate, their use will probably re- tended to sell products at a higher cost than place many of the paper transactions accom- did discount stores. plished through cash payments and check and credit transactions. Direct Debit POS The debit card, another means of facilitating Retail Stores.–Although previously not funds transfer at point of sale, functions much many POS systems operated in retail stores, the same way a credit card functions except there is tremendous potential for their use. that when the transaction is received by the One of the most successful direct debit POS issuing financial institution, it is debited to the programs is in Des Moines, Iowa. There, Dahls cardholder’s account, which may be a check- and Hy-Vee supermarkets operate direct debit ing, savings, NOW, or other form of deposi- POS systems at the checkout counter, the first tory account. Some securities firms have such systems in the United States. Custom- distributed debit cards to access cash manage- ers of these supermarkets can pay for groceries with a proprietary debit card issued by Nor- —. —.. west Bank, which automatically debits the 41+:lc~tr0niC F’und< Transfer Association, llrashin~~ton Report, tJan, 11, 19H3. cardholder’s account. ITS, Inc., operates the 124 ● Effects of Information Technology on Financial Services Systems — computer switch that makes EFT possible for alternative method of payment. Most of the some of the 205 participating Iowa banks, sav- tests at the service station involve agreements ings and loans, and credit unions. The Hy-Vee between oil companies and financial institu- supermarket does about 4,000 POS trans- tions under which customers can pay for pur- actions per month; Dahl’s does about 2,000 per chases using bank debit cards that automat- month. Each location paid about $18,000 to ically debit the amount of purchase from their install magnetic stripe readers and keyboard checking accounts. However, there is addition- add-ons to the NCR cash registers and to buy al interest in proprietary credit card trans- the processors and software. However, volume actions at points of sale. Mobil Oil Co., for ex- sales of the systems should cut costs. More- ample, has 2,400 POS terminals linked to its over, the store receives good funds the next Kansas City processing center, which captures day. all transaction information via electronic draft capture. Since the system is online the infor- Retailers and banks both benefit by having mation is transmitted immediately. This POS access to the customer’s float, and both the system enables Mobil to capture billing infor- retailer and the bank are assured the funds are mation electronically, saving internal costs by good. “To encourage direct debit use, bankers reducing the amount of paper used in such will price check transactions higher than their transactions. Mobil implemented a credit POS debit card counterparts to nudge consumers system, which could easily convert to a hybrid along. The cost of processing one check is esti- system supporting both debit and credit, to mated at about 50@, and an EFT transaction maintain its loyal customer base and to gen- costs about 30©. The higher the volume in erate new business. Mobil representatives feel EFT, the lower the per transaction cost be- 15 that direct debit at this stage would alienate cause of the high fixed overhead. ” customers. Oil and Gas Companies.–The gasoline sta- The POS transaction begins by the service tion is currently the focus of much POS activ- station clerk inserting the card into a POS ter- ity because it generates more transaction vol- 16 minal. In some cases, the customer inserts the ume than any other kind of retailer. Many card into an automated pump and then keys large oil and gas companies are installing POS in his own personal identification number terminals at service stations. A few direct (PIN). By implementing direct debit POS ter- debit POS terminals are being deployed di- minals, the customer’s account is automat- rectly into the gas pumps, although the ma- ically debited, and the retailer’s account is gen- jority are stand-alone terminals. erally credited immediately or the next day. While still in its infancy, the idea of deploy- The benefits to both banks and oil companies ing POS terminals at service stations is be- are savings of millions of dollars. In most coming more accepted because of the increase cases, the bank or network operator receives in self-service gas stations, because more sta- a transaction fee for each purchase. The oil tions are remaining open 24 hours a day, and company saves by being assured of good funds because service stations are often vulnerable and by receiving payment immediately. This to robberies. To help reduce the tremendous is a significant issue because the general lag volume of cash generated each week by gaso- time for credit card sales draft, according to line purchases, major oil companies and banks a Mobil Oil Co. official, is 10 days. across the country are joining forces to test Some POS test situations currently under POS terminals at the pumps, using proprie- way are being done by AmeriTrust Bank, Shell tary credit cards or bank debit cards as an Oil, and Gastown in Cleveland, Wells Fargo Bank and Shell service stations in San Fran- “Forbes, Aug. 29, 1983, p. 46. loMmagement Information Systems Week, July 27, 1983, cisco, First City National Bank of Houston p. 81. and Exxon Co. Ch. 4—Retail Financial Services ● 125 -—— —— ——..————— —

National POS Systems ative file or by having the retailer check a man- Large-scale communication networks are be- ual that lists card numbers of bad credit risks. ing developed, primarily by the major credit In the United States, POS experiments have card industry, to connect thousands of POS been conducted since 1974. Very few systems retail terminals with financial institutions involving instant transfer have survived, and within a State, region, and, ultimately, the Na- the most important functions of POS, until tion. These networks will include computerized online direct debit systems were in place, have switching centers and a base for clearing set- been check verification and credit card author- tlements. ization. One explanation for this very limited In addition, oil companies, banks, and other success could be that the experiments have retailers are considering national POS net- generally looked for evidence of profitability works. Tests are being conducted by Liberty within a few months of installation, whereas National Bank & Trust Co. of Oklahoma City the change in social habits involved in mov- and a Southwest oil dealer whereby terminals ing from cash and checks to instant transfer will be deployed at stations offering the fol- takes a great deal longer. lowing services: automated dispensing at the pump, an ATM inside the station for purchas- Costs of POS Systems ing convenience items, and a commercial de- For several years merchants and financial pository that is wired to the ATM so that institutions have been at an impasse over how high-volume stations can make deposits. to implement electronic payment systems, At the present time, POS systems are be- especially retail EFT systems. The differing ing allowed by regulators to access time and perspectives reflect differences in technologies savings accounts; however, this could change. being used, in terminal ownership, in customer Regulation D* is not being strictly interpreted bases, and in approaches in pricing the service. with respect to POS activity. However, if the One of the main concerns associated with regulation were strictly interpreted, a large implementing POS systems is the cost to be number of financial institutions, savings and borne by retailers and banks. Another is the loans, and savings banks, would be prohibited concern about merchant discount fees. Most from actively participating in a POS system. banks charge the merchant the same fee for debit card transactions as they do for credit Other Uses of POS Systems card transactions. The argument made by the The POS terminal can also be used for check merchant is that debit cards function in lieu authorization, permitting the customer to ob- of a paper check and therefore the merchant tain approval of a check for payment by run- should not pay the same discount fee. A POS ning a verification of the check-cashing record system can all but eliminate float, reduce through a computer. Likewise, the POS sys- credit risks, require the merchant to keep less tem enables merchants to verify the availabil- cash on hand, and ease check approval. ity of funds in a customer’s account or his ac- Technology has also been a basis for conflict cess to credit before completing the sale. As between the merchants and POS operators. Fi- with ATMs, customer access to POS terminals nancial institutions typically base their debit is usually by plastic card and PIN. This is an cards on the magnetic stripe technology used alternative to manual authorization and veri- for years on bank credit cards. Grocery retail- fication, which is handled by accessing a neg- ers, on the other hand, typically base their technology on an optical scanner that reads *Regulation D is a uniform reserve requirement on all depos- bar codes on product labels and transmits the itory institutions with transaction accounts or on personal time information to an electronic cash register deposits. It requires submitting reports on all deposits to the Federal Reserve Board and sets phase-in schedules for reserve (ECR). Department stores typically prefer op- requirements. tical character recognition characters read 126 • Effects of Information Technology on Financial Services Systems —

from merchandise tags and proprietary credit in an area and that provide for the recruitment cards with a handheld wand. Product and cus- of most retail outlets stand the greatest tomer information is fed into an ECR to ef- chance of success. fect electronic payments. POS systems will undoubtedly increase dur- Financial institutions tend to prefer owning ing the next decade, with many new systems the necessary terminals and charging mer- being built upon existing ATM networks. chants a user’s fee for making transactions Both the banks and retailers stand to gain through them. On the other hand, retailers from the resulting reduction in the volume of tend to prefer devices that are integral com- paper transfers. However, merchants contend 17 ponents of their own ECRS. Naturally, finan- that since a debit card transaction saves financial institutions and the merchants are wedded cial institutions time and money relative to a to their respective investments. It is unreal- check transaction, merchants should enjoy istic to expect the merchants to give up their some of the savings. It has become quite technology in order to accept electronic pay- apparent that in order for POS systems to de- ments. Developments such as VISA’s “elec- velop and operate efficiently, the systems tron card” are aimed at simplifying this must be designed in close cooperation with the problem. individual retailers, not just the markets the systems serve. Another issue with respect to POS systems is the volume of sales to be handled. It has The technology necessary to operate elec- been argued that to be viable economically, the tronic debit and facilitate POS transactions POS system must become competitive with exists today. It is the intention that electronic cash; otherwise, there is no incentive for the debit cards will substitute for check, credit retailer or the customer to use it. The customer card, and cash transactions. However, when is faced with loss of float, and the retailer is POS services become commonplace, the use faced with transaction fees, which cash pay- of cash and checks as a payment mechanism ments do not require. Under these conditions, will still exist. Disconcerting cost trends are systems that are shared among all the banks leading merchants and financial institutions —.- ——_—— to seek lower cost alternatives for POS trans- “’’Debit Cards at the Cross Roads, ” Economic Review, March actions. EFT is the method by which this goal 1983, pp. 37-38. can be reached.

Financial Information Services

There are many forms of information serv- eling tools, and various other analytical ices in the financial service industry. They in- packages. clude check or credit authorization/verification; status information on account balances; All financial service providers use informa- identification verification; billing and funds tion services. Retailers are perhaps one of the due information (e.g., preauthorized pay- largest users of specific information services, ments); accounting information with respect particularly check verification. Check verifi- to general ledger, payroll, accounts payable, cation validates the authenticity of the check accounts receivable; and modeling and analyti- or its presenter. This system is accessed online cal services, such as Chase Econometrics and through a telephone or terminal by the retailer. Wharton Econometrics, which provide access The retailer pays for this service, generally a to data bases, econometric models and mod- percentage of the value of the check. These Ch. 4—Retail Financial Services ● 127 —. systems are run by third-party organizations vide information in unique ways. For exam- and banks that maintain negative files. ple, the services they perform include providing status information to their customers on Check Authorization a very regular basis. The most familiar processes are inquiry of account balances or funds Check authorization systems may be pro- credited or inquiries regarding specific check vided and maintained by the party accepting clearing. Today, much of the status inquiry in- the check, by a financial institution, or by a formation is processed by online teller ter- third party engaged in such a business. The minals with direct access to the accounts be- systems may be designed to access bank rec- ing questioned. ords directly or may rely on secondary data sources. In some systems, check approval is Service organizations provide accounting in- accompanied by a guarantee of payment. In formation services to customers, such as in- an EFT system, a customer’s plastic card and formation services about payroll or accounts PIN can be used to access the system and ver- receivable/payable or other services necessary ify the available balance. This is accomplished for efficiently running the organization with- by placing the check into a terminal and key- out the added costs of implementing an auto- ing in the appropriate information. The check mated system in-house. A wide variety of is then validated and accepted at point of sale. firms, including financial service providers, offers these services. Credit Authorization Two other key information service providers in the financial service industry are invest- Credit authorization is yet another informa- ment brokers and insurance firms. (The bro- tion service vehicle available to the retailer. kerage industry is covered in ch. 3 of this re- It operates by allowing the customer’s credit port.) Insurance information is compiled by card to be read by a financial service terminal actuarial scientists and categorized by risk, while a central computer verifies that the card age, and the like. Much of this information is is valid and the customer’s account has suffi- available to individual brokers through online cient funds. This can also be accomplished videotex terminals. Insurance information re- manually by checking a printed document, dis- quires some customization in order to meet the tributed by the card companies, indicating lost specific needs of the party requesting the in- or stolen card numbers or by placing a call to surance, although premiums and risk are de- an operator who will authorize or refuse the termined by actuarial methods. transaction based on information from a data base. This inquiry process is supposed to re- The information provider in the insurance duce the risk of credit fraud or of extending industry is the insurance salesman. Although credit in excess of an imposed credit limit. much information about general insurance is accessed to data bases via terminals, the proc- Information service systems allow for real- essing of this information still requires the per- time access and reduction of risk at point of sonal interaction of the salesman and client to sale and ensure that the retailer will receive provide the service adequately. Some insur- the funds. The risk is transferred to the party ance information is provided through com- authorizing the funds. This service guarantees puter/CRT* terminals that display rates and payment to the retailer and is attractive de- also give an explanation of the types of insur- spite the fact that the retailer must pay a ance available. The insurance industry is look- premium to insure the funds. ing at further automating the delivery of insurance information. Providers of Information Services

Many kinds of organizations are information *CRT terminal—video terminals that display data on a cath- providers. Depository institutions use and pro- ode-ray tube. 128 ● Effects of Information Technology on Financial Services Systems

The following scenario may present itself in transfer funds efficiently from one account to the near future. Through videotex and home another. For example, in a corporate environ- information systems, insurance information ment, real-time access and videotex technol- can be transmitted and reviewed by an in- ogy allows a treasurer or financial advisor to dividual. If the need presented itself, for ex- manage and control all of the investment ac- ample, an individual would be able to increase counts. Through the same technology, invest- the amount of homeowner’s insurance for a ments can be transferred on a daily or perhaps specific period of time, say a weekend, if he even hourly basis. planned to be out of town. The insurance pol- Many organizations today conduct financial icy modifications could be done instantane- counseling programs for all ages and groups. ously, and the additional premium payment These groups organize to seek sound financial could be automatically debited from the cash guidance and to plan for long-range money value of other insurance policies. goals. Interestingly, these groups include not Several of the larger banks in the United only the affluent market but also young pro- States offer financial, securities, and invest- fessionals and middle-income individuals who ment analyses; payment products, models and have become far more educated and concerned data bases to corporations, other banks, insur- about how their finances are handled. ance companies, financial institutions, and Different sectors of the financial service in- government agencies. An example is terminal- dustry require different information services. based cash management for major corpora- For example, a bank loan officer may inven- tions and banks. tory data to assess liquidity and solvency. Fi- Mortgage servicing is another aspect of nancial analysts are concerned with equity in- financial information services. Mortgage bank- vestment decisions and are likely to place more ers and a growing number of commercial, mu- importance on earnings-per-share and capital tual savings bank, and savings and loan cus- account data. On the other hand, various fi- tomers use this type of service for servicing nancial service groups use the same informa- their portfolios of mortgage loans, which in- tion in different ways in the decision process. clude taxes, escrows, and insurance. Loan clos- Service industries, such as banking, securi- ing documentation and mortgage preparation ties, and insurance, whose business operations systems are available to help customers of the rely heavily on information services, are find- service keep track of inventories and financial ing that the whole environment in which they commitment needs. Batch transmission and operate is changing rapidly. Earlier develop- inquiry modes to a central location are used ments in information technology were such via dial-up and leased transmission lines. In that only large corporations could take advan- this manner, nationwide service is provided l8 tage of its capabilities. However, over the last from a single location. several years, technical innovation has con- Information services provide immediate ac- tinued at such a rapid pace that, for example, cess to financial information and are used to information processing power, which once

18 took a roomful of large equipment, is now Herbert A. Schulke, Jr., “Electronic Financial Systems, ” Innovations in Telecommunications, Academic Press, Inc., available in portable machinery. 1982, p. 1038.

Home Information Systems

Home information services are a way by Home information systems (HIS) started in which financial information services can be de- a relatively minor way in the United States livered to users of home computer terminals. several years ago with the introduction of bill Ch. 4—Retail Financial Services • 129 .——. —. —. —.—— — —- paying by telephone. The original impetus or cable lines. Some systems provide a hybrid came from thrift institutions, which saw telecommunication delivery, using cable for in- phone bill payment as a way to offer trans- coming information and the telephone for out- action accounts, thereby partially circumvent- going information. In-place cable lines are pri- ing the law forbidding payment of interest on marily one-way communication lines, although demand deposits. Soon commercial banks be- most new cable lines being laid today are two- gan offering the service. When the telephone way cable lines. bill payment service was first introduced, most Home computers also allow interaction with of the systems required the customer to call HIS and are becoming popular for receiving in and give oral instructions over the telephone the services. A modem** can be used to tie to an operator to perform banking services, the home computer to the information source specifically bill payment. Automation was in- by telephone lines. A CRT or television screen troduced and made available to customers acts as the visual display terminal. The home with touch-tone phones, although most sys- banking software which runs the system is dis- tems still relied on operators during the busi- tributed by the participating financial insti- ness hours and on recorded messages at other tution. times. Telephone bill paying services did not attract a large customer base, and many of the As stated, cable plays an increasing role in early programs have come to a halt. the delivery of home information services. “The latest cable television systems now be- Technology of Home ing developed will transform the technology Information Services of videotex and the economics of home banking. The use of coaxial or fiber optic cables The introduction of videotex played a key gives much greater bandwidth, which provides role in the development of home information three substantial technical advantages: 1) the systems. Videotex—a generic term that refers possibility of carrying a large number of chan- to computer-based information retrieval sys- nels, up to 100 or more; 2) a more satisfactory tems that display text and graphics via video and speedy interactive facility; and 3) a much screen—is a product of the convergence of improved ability to produce pictures (impor- telecommunications and computing technol- tant in using home shopping).’’” Direct broad- ogies. Through teletex* and videotex, one-way casting by satellite, which is being developed, and two-way computer-based retrieval sys- is another method by which information can tems, information can be widely disseminated be transmitted into the home. for viewing on modified television sets or on personal computers. In the last year or so, full Developers of Home Information Systems videotex systems have become operational in several countries, giving the user the ability Home information systems are being devel- to send communications to the system com- oped by a myriad of organizations that include puter for onward transmission. Because the depository institutions (presently Bank of videotex system is interactive, it can be used America and Chemical Bank are marketing to facilitate financial transactions. The system systems that are up and running), information functions in several ways. One way uses a companies, entertainment companies, and the videotex terminal and a television (which acts like. Several systems are being developed as as a visual display unit); the communication cosponsored, joint ventures by consortia of with the system is supplied by telephone lines major banks and corporations. One example

*Teletex is a one-way system that displays alphabetic and **A modem transmits digital or computer information over graphic information on a modified television set. Videotex dis- telephone lines by manipulating it electronically and also pro- plays the same sorts of information as teletex but also provides tects the lines from undesirable signals that might cause in- a communication path for the user to interact with the service terference with other users. provider. 19Revel], op. cit., p. 50. 130 ● Effects of Information Technology on Financial Services Systems —. —

of a major project is the Viewtron Program Applause, the home banking software of- in Miami, Fla. The Viewtron system will be fered by VideoFinancial Services, will supply supported by computers from seven major cor- a variety of services. The home banking activ- porations from around the country and will be ities include bill payment, funds transfer and linked to Viewdata Corp. ’s Viewtron com- account information, and special financial re- puters in Miami. The gateways are American quests. VideoFinancial Services also provides Express—subscribers will have access to a va- credit authorization and settlement for credit riety of services offered by this company; Com- card shopping orders placed on Viewtron. The modity News Services—subscribers will be system permits each participating financial provided with instant and delayed stock mar- organization to specify unique features within ket and commodity price quotations; and E. the system standard, including the use of in- F. Hutton–subscribers will be able to track dividual colors and graphics. Presently, 12 their personal investments and receive invest- Florida banks and savings and loans will pro- ment advice with “Huttonline,” the first elec- vide home banking to Viewtron subscribers tronic information service offered by a retail via VideoFinancial Services’ computers in Or- brokerage house. E. F. Hutton customers will lando, Fla. be able to access Hutton’s computers in New As a financial gateway, VideoFinancial pro- York City for information about their ac- poses to provide the Applause service to all counts, such as cash management and margin sections of the country through any videotex balances, portfolio positions and market val- network. To support such an objective, Video- ues, open orders, and recent transactions. All Financial expects to establish regional data Viewtron subscribers will be able to order centers, where practical and necessary, to in- E. F. Hutton market comments and invest- terconnect the financial industry to the re- ment advice and send electronic mail to E. F. gional network operator. The system will be Hutton offices. Viewtron subscribers will also streamlined. First, the home terminals will tie be able to order J. C. Penney catalog merchan- directly to the network operator, who will be dise by using a direct link to J. C. Penney com- fully responsible for promoting, enrolling, and puters in Atlanta. They will receive online or- billing the consumer for the network service. der confirmation upon completion of their Communications, terminals, and data base order. If the requested item is not available management will be provided and managed by in the color requested, the J. C. Penney com- the service provider. The network will then puter will offer the Viewtron subscriber other feed into the VideoFinancial computer system. color possibilities. The J. C. Penney catalog VideoFinancial will either connect online with inventory system is immediately and automat- or provide batch processing for subscribing fi- ically updated. In addition to processing the nancial organizations and will be responsible catalog order, the gateway to J. C. Penney will for developing and maintaining the home bank- also provide for credit authorization for the J. ing software package. The VideoFinancial C. Penney card, as well as for VISA and Mas- computer system will tie in directly to the fi- tercard. In addition, information from The nancial organizations offering the service. Official Airline Guide and Grolier Academic These financial institutions will assist the net- American Encylopedia will also be available. work operator in enrolling the consumer and The financial gateway to the system, Video- will provide the data to VideoFinancial to sup- Financial Services, is jointly owned by four port the home terminal request. major bank holding companies: Southeast Over 50 information providers, including Banking Corp., Miami; Wachovia Corp., Win- major wire services, educational organizations, ston-Salem, N. C.; Bane One Corp., Columbus, reference and financial book publishers, uni- Ohio; and Security Pacific Corp., Los Angeles, versities, libraries, and professional organiza- Calif. tions provide information for Viewtron. —

Ch. 4—Retail Financial Services . 131 —-—— —. -. —. . .———...—————— —— —

Interestingly, the advent of HIS has en- Systems now in operation serve interactive couraged cooperation instead of competition facilities, providing travel services, sports, and among the various financial service providers. general entertainment information (e.g., res- taurant and movie guides); stock exchange in- Costs of Home Information Systems formation; shopping capabilities; and banking applications in a form similar to that of self- Cost is one of the major issues associated service banking. Users of these systems can with the success of the HIS program. The pay bills, transfer funds, check balances, re- Viewtron videotex costs are as follows: view banking statements, and keep up-to-date financial records. ● Subscription to the Viewtron service: $12 per month for access to nearly all View- The elderly may be another target market tron services. for such systems. The ease of being able to • Communication charges to access View- accomplish shopping and banking from the tron: approximately $14 per month (ap- home, it seems, would be very appealing. proximately $1 per hour to access View- There are problems, however, with respect to tron). acceptance of the system, hardware and com- A serious consideration is the influence of munication costs, and, most importantly, local communication costs and their impact on changing behavior patterns. Principal charac- HIS. It is possible that communication costs teristics of HIS users are listed in table 6. could increase to such a degree that the cost For consumers to adopt and use home infor- of making a local call discourages use or forces mation innovation, it must be associated with development of new types of local links. such advantages as convenience, compatibil- Consumer acceptance of home banking/ ity, or specificity. home information systems will be based on several other factors besides the natural in- Implications of clination toward using these services. These Home Information Systems factors include price of obtaining the hardware/software needed to use these services, It appears likely that home banking systems price of using the services, and availability of will be tied to other services such as informa- these services. * tion services, entertainment, and even business uses. Also, any institution, whether financial or nonfinancial, will be in a position to The Market for Home provide financial services through a videotex Information Systems network and to support these services in much Much speculation has been associated with the same way as Merrill Lynch operates its the home information market. Several leading cash management accounts. authorities have targeted the affluent segment Home banking and its impact on branch of the population as the major users of the banking has some major consequences. With home terminal. Their claim is that many con- a single investment in a computer installation, sumers with incomes over $40,000 per year a new entrant to the retail banking market has have an insatiable need for information of the whole national market open to it. As long various types. The home terminal has great as it has the necessary computing capacity to potential as the major investment, shopping, handle the accounts of its customers, any bank and news information source for affluent con- will be able to leap over geographic barriers sumers. Additionally, it has been stated that and offer payment services nationwide. * By many affluent consumers feel strongly that the same token, nonbank operators will be able they can conduct their own financial trans- ..-. .— actions better than bank personnel can, and *Banks have long been able to conduct business nationwide some find it enjoyable. by opening offices (usually via holding company affiliates or —.. t subsidiary corporations) for business loans. This is also true * Informa ion from Reistad Corp.—research conclusions. for mortgage companies and consumer finance companies. 132 ● Effects of Information Technology on Financial Services Systems

Table 6.—Principal Characteristics of HIS Users

Level of Characteristic importance Comments Age High Research studies indicate most potential customers of HIS/home banking can be clearly identified by age. Two principal groups are 18-34 and 35-49. Sex Low Research indicates sex is not an identifier for potential customers of HIS/home banking. Men and women rank about equally in intent to purchase. PRONTO pilot research shows, however, men were more frequent users. Education Moderate Research indicates as the level of education increases, the propensity to purchase HIS/home banking increases. In all studies the majority who are interested in HIS have attained a college degree or higher. Occupation Low Research indicates interest in HIS/home banking is not dependent on occupation. Blue collar workers and professional alike are likely to be interested in HIS. Interest increases gradually from a lower level among housewives to high levels among managerial employees. Those working in the home or retired are less likely to be interested. Family status Low Research indicates married and not married, with family or without, are equally likely to be interested in HIS/home banking. Income Moderate Research indicates as income increases, the likelihood to high of interest in HIS/home banking increases. However, among very high income households ($50,000/year and up) the likelihood of interest in home banking declines somewhat. Financial Moderate Research indicates that users of ATMs, Telephone BiII services Paying, and frequent check writers are more likely to users be interested in HIS. However, a substantial number of those interested do not use these services. Electronic Moderate Research indicates personal computer owners, cable TV communication subscribers and those attracted by electronic gadgetry product users are somewhat more likely to be interested in HIS. However, a large portion of those interested in HIS do not own or intend to purchase a personal computer. Among PRONTO pilot users, half had computer terminals (outside the home) prior to participating in the test. SOURCE The Reistad Corp , Clearwater, Fla to compete with banks in these services to the checks has declined during the last several extent that they are legally permitted to do so. years and check usage in absolute terms may begin to fall between now and the end of the It is important to note that ATM, POS, and century, no one expects checks to be totally HIS will work together in the future. POS sys- replaced. tems and ATMs will share network lines, and these systems will eventually reach out to in- Historically, usage of new consumer prod- corporate other remote terminal activity such ucts has grown slowly during the first years as HISS. following introduction. For successful products, this has been followed by a period of The various systems that have been and are rapid growth. Then, as the level of saturation being implemented for effecting payments are is approached, growth again slows. Overall, ” essentially designed to be substitutes for the this creates the “S” curve shown in figure 11. paper check. While the rate of growth of This being the case, two questions relating to Ch. 4—Retail Financial Services ● 133 ———

Figure 11 .—Penetration Curve for Check Alternatives penetration for a home banking service today that requires a terminal costing several hun- dred dollars may be quite different from what it will be for a derivative of that service that is implemented using a terminal that costs less than $100. The time constants that determine the steep- ness of the curve may also vary in response to events in the market. For example, the rate of growth in some electronically delivered services may increase in response to a requirement that all employees of firms over a specified size be paid by direct deposit. On the other hand, 1977 78 79 80 81 82 83 84 85 86 a series of events that demonstrate inherent SOURCE Economic Review, Federal Reserve Bank of Atlanta August 1983 p 33 weaknesses in advanced payment systems could slow the rate of growth of some products. In general, the impacts of events are the substitution of new payment products for most likely to vary from product to product the paper check remain unanswered. First, at in the mix that comprises the offerings of the what rate will new services grow? Second, at financial service industry. what level of penetration by each product will the market become effectively saturated? In the past, great promise has been held out for various payment products that has yet to Not all potential users of a service will use materialize. However, increasing use of com- that service. It has taken decades for the level puters and telecommunication throughout so- of penetration for checking accounts to reach ciety and the dynamism of the financial serv- the 85- to 90-percent penetration level, where ice industry may be creating an environment it now rests. Further, it is not reasonable to more favorable to the adoption of new systems assume that the level of maximum market for delivering financial services. Thus, there penetration is the same for all products. Over is a higher degree of confidence than in the the long term, for example, the proportion that past that the middle stage of the “S” curve uses ATMs may far exceed that which uses will be reached, but the timing continues to home information and banking services. be uncertain. The problem becomes one of Further, the level of maximum penetration closely monitoring developments in the finan- may vary with time. As technology evolves cial service industry to identify those areas and its costs continue to drop, and as the prod- most likely to reach a critical mass and to ucts are funded, the proportion of potential assess on an ongoing basis the benefits and users who actually become buyers may change. costs to society of the changes that are ex- For example, the maximum potential market pected.