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Electronic Payment Systems, tronically, remain the exclusive domain of an Electronic Money and the Inter- electronic network that has been specifically designed for handling high value payments. net: The United Kingdom Expe- This paper is divided into six separate parts rience to Date including the Introduction. In the second sec- tion, I will examine some of the key elements associated with a modern payment system. by Andreas Credé, Science Policy Research Unit, University of Sussex Each payment system must satisfy certain minimum requirements in order to be able to operate successfully. The key issues include a The level of Internet access in the UK is ex- stable legal framework, agreed procedures for panding rapidly. Although the volume of settlement and clearing of payments as well as business being transacted using the Inter- net is currently insignificant in relation to measures that ensure payment messages are the overall UK economy, there is a general secure and that fraud is minimized. expectation that it will grow exponentially The paper then goes on to provide an over- over the next ten years. The future vision is view of the UK payment system and how it is of increasing volumes of business trans- divided into distinct and separate elements. The acted on the Internet using electronic meth- section highlights the sharp contrast between a ods of payment and eventually electronic same day electronic payment system that exists money in the form of electronic-cash. This largely to service the financial sector and the article reviews some of these developments other types of payment system. It identifies the in the overall context of the UK payment dominant role of cash as a payment medium system.1 It considers the current structure and examines some of the broader issues of and the other different types of payment system technological innovation that will need to be which service business and consumer require- considered before this future vision be- ments. comes more of a reality. The fourth section looks at the ways in which the payment sector is actually used by different segments, specifically the financial, business, personal and public sectors. This 1. Introduction leads directly to a discussion of the existing Electronic payment systems and in particular, alternative methods for making payments over methods of payment being developed to support the Internet and some of the implications in- Internet based commerce cannot be examined in volved in choosing between different alterna- isolation. A failure to place these developments tives. The section includes a discussion of some into proper context is likely to result in undue of the institutional barriers that are likely to focus on the various experimental initiatives to exist when trying to adopt new payment meth- develop electronic forms of payment without a ods that do not immediately resonate with ex- proper reflection on the broader implications for isting business practice. the existing payment systems. The reality of the The fifth section considers various current current UK payment system is that it is primar- initiatives in developing Internet based payment ily paper based with more than 80 % of all in- systems. The section discusses the viability of dividual payment transactions taking the form current electronic cash initiatives as well as the of cash payments, or other paper cred- development of smart card technology for small its. The majority of individual payment trans- payments. Existing industry initiatives to de- actions involve goods and services being ex- velop common smart card formats are also ad- changed for cash that are made face to face, i.e. dressed. The final section of the paper develops both buyer and seller are physically present. some conclusion from the discussion. Furthermore, a high percentage of individual non-cash payments continue to involve the ex- 2. Key Elements of the Payment System change of paper in some form. Electronic pay- ments in their purest form, where the instruc- Payment systems are central to the efficient tions to pay are generated and received elec- operation of the economy since they determine

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how quickly and how securely a seller of goods which will not be accepted by the and services will receive payment. The associ- buyer's ). Ideally, a seller prefers to be ated transaction costs will play a key role in protected against the risk that goods or services which payment system is selected from the released to the buyer will not ultimately be paid range of alternatives on offer. for. This is why credit cards offer a very effec- There are two basic types of exchange tive payment mechanism for Internet com- mechanism. Payments can be made in cash (i.e. merce. notes and/or coin) or they can involve the trans- The structure of a particular legal system fer of funds held with a bank. A third possibil- and the broader system of governance of which ity also applies (but is not taken into account it forms a part, will have important implications here), namely barter, where only goods are for how a payment system will operate on a day exchanged without any financial payment. to day basis. A payment system that has a Non cash payments require three separate strong statutory basis will depend on rules and elements. The buyer must have an agreed regulations previously defined in detail having means of payment authorisation and instructing the force of national law. The Central Bank will its bank to effect a transfer of funds. The seller's often have the power to change or amend regu- bank and the buyer's bank need an agreed lations with full statutory backing. Such a sys- method of exchanging payment instructions. tem is likely to offer the necessary transparency This is referred to as payment clearing. Finally in its normal operation but may encounter the buyer's bank and the seller's bank must have problems of definition and liability when there an authorised method of payment settlement. are unforeseen problems or if new develop- Payment settlement can be done in a number of ments take place. Alternatively, the legal ways. It can involve adjusting accounts which framework can be contractually based. Instead the two have with each other, or it can be of depending on statute, the rules and regula- achieved through accounts each bank holds tions governing the operation of the payment with a third-party, often a Central Bank. It is system is based on a series of contracts. These important to distinguish between these three may be explicit and in written form, or the con- key elements when considering electronic pay- tracts may be implicit, based on legal precedent. ments using the Internet. Payment authorisation In the UK, the legal framework for payment and payment clearing essentially involve ex- systems is principally contract based although changing messages. The Internet is ideally in key areas, legal statutes have been enacted. suited to perform this role, providing there can As new methods of electronic payment using be sufficient security safeguards incorporated. the Internet are developed, the legal framework However, payment settlement is a separate pro- needs to be amended and adapted to fit the new cess which must be linked to existing payment circumstances. Both a statute based or contract mechanisms and which will have much broader based legal framework have certain advantages implications for financial stability and wider and disadvantages in this respect. A contract monetary policy. based systems can be more adaptable in its de- A payment system can only function suc- tailed application. However, a statute based cessfully when it operates within a secure legal system will be more effective at introducing environment. It can only function properly if step changes in the payment system, for exam- there are clearly defined rights and obligations ple when introducing the new Euro currency. governing the actions of the various parties In each of the major developed economies which are involved. A buyer giving payment there is a need to settle very large payment authorisation details must be secure in the amounts resulting from financial transactions. knowledge that this information will not be All of the major industrial countries have de- misused, that it will be acted upon promptly and veloped separate, same-day electronic payment that there will be adequate compensation if systems for handling these large payments. operational mistakes are made. Similarly, a They consist principally of foreign exchange seller has to be secure that there will be suffi- transactions, debt service on large loans (i.e. cient penalties attached to any fraudulent issu- payments of principal and interest) and the sale ance of payment authorisation (e.g. writing a and purchase of bonds or company shares. The

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need to make the corresponding payments re- payment which are discussed in greater detail sults in a diametrically opposed relationship below. between payment volume and the number of When considered in terms of the number payments. Electronic same day payments will of individual transactions, the UK payments typically account for over 90 % of payment system remains dominated by small cash pay- monetary value but will represent only a small ments consisting of notes and coins. In total, fraction of the total payment transactions car- cash represented 74 % of all payments ried out on any particular day. This is particu- amounting to an estimated 25.5 billion individ- larly true for the UK where the payment system ual transactions. The dominance of cash as a has to accommodate the large value payments payment medium also occurs in other major generated by financial institutions operating in industrial economies. In some countries like the City of London, arguably the largest and Japan, a large number of transactions involving most important international financial centre in larger payments are also made using cash. In the world. order to make cash payments, consumers and businesses have to acquire the cash from the 3. The UK Payment System : A Short banking system. Cash acquisition is an impor- Overview tant payment transaction category in its own right. In 1997 there were approximately 2.2 The UK payment system demonstrates the billion such transactions amounting to total sharp contrast between the different payment cash withdrawals of £156 billion. Cash acquisi- media when one contrasts numbers of individ- tion has increasingly involved using ATMs ual transactions with the volume of payments in rather than bank or branches. monetary terms. Each year an estimated 37+ In 1997, £89 billion was withdrawn from billion individual payment transactions take 23,000+ ATMs in the UK, compared to £16 place in the UK with a total monetary value of billion in 1986 when the number of ATM ma- around £39.3 trillion (i.e. 1.012 ). The amount is chines was restricted to only 10,500. significant in relation to the size of the total UK Non cash, non high value systems provide economy. It represents around 61 times the total the basic payment infrastructure which the UK UK GDP (Gross Domestic Product) or to put it economy requires to operate the business and another way, in a period of six days, the cumu- commercial sector as well as to service con- lative value of total payments being made is sumers. Payment methods include cheques, equivalent to the total annual output of the UK electronic transfers, credit cards and debit cards. economy. These figures are not peculiar to the Cheques and paper credits continue to represent UK. In the United States, it takes only 3 ¼ days the largest category with 3.5 billion transactions to achieve a payment volume equivalent to averaging less than £100 per cheque. Modern GDP and in Japan it is only 2 ½ days. cheque clearing in the UK remains a costly and These figures illustrate the fact that the UK labour intensive exercise. The UK unlike other payment system really consists of two distinct countries including Germany has only recently elements. On the one hand, there are the pay- started to permit "truncation", that is the re- ment networks and systems that service the placing the physical presentation of cheques non-financial economy consisting of goods and with the transfer of data in its electronic form. services that are produced, sold or consumed This meant that in order to process cheque within the UK. These include primarily cash payments, an arcane system of moving each payments, cheques, debit cards, credit cards as individual cheque from the recipient of the well as electronic direct debits and credits. The payment, to a central clearing location and then total individual number of payments included to the branch where it was issued was required. under these headings amounted to 37.4 billion The requirement to return cheques in their in 1997, i.e. 99.97 % of the total figure. Within physical form to the branch where they have this group of payment systems, further distinc- been drawn, was dictated by a piece of 19th tions can be made between paper based and century legislation, the Bills of Exchange Act, electronic payment systems as well as between 1882 which has only recently been repealed. A cash based and non cash based methods of new electronic method of truncation called

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IBDE (Inter Bank Data Exchange) was initiated counted for 26 % of the total compared to by APACS in February 1996. While it has re- 71 % in 1996. Conversely, wages made in placed some physical movement of cheques, a cash now only represent 15 % of the total move to a more comprehensive electronically compared to 58 % in 1976. based system has been delayed by the uncer- 3. Direct debit – A pre-authorised debit on a tainties which are associated with the replace- customers account which can be initiated ment of Sterling by the Euro as the national by the entity (i.e. the payee) which is due currency. to receive payment. It is a highly efficient Electronic transfers made using BACS method of payment that has grown dra- (Bankers' Automated Clearing Services Lim- matically over the past 10 years. It now ited) represent an increasingly important com- represents 58 % of all BACS transactions ponent and averaged 2.8 billion transactions in compared to 44 % in 1986. Its operation 1997. BACS was created by the major UK depends on the trust and confidence which clearing banks as a competitive response to the customers have in the safeguards that are creation of National Girobank in 1968 by the provided and in the integrity of the payee. Labour Government led by . It is largely used to pay utility bills (gas, The Wilson Government wanted to establish an water, telephone, electricity) as well as institution which would provide cheap money other forms of regular but variable pay- transfer facilities for the large majority of the ments. population which at that time did not have bank accounts. BACS initially provided electronic Finally, a look at credit and debit card transac- clearing services based on banks supplying tions. These each amounted to 1.1 billion and computer tapes which would then be copied to 1.5 billion transactions respectively. In the UK, the BACS mainframe computer. While the credit cards were first introduced in 1966 while technology has been updated, most recently debit cards were introduced in 1987. Debit using Tandem computers, the basic structure of cards now account for 60 % of all card pay- the service remains largely unchanged. All ments. Over 83 % of all UK adults now hold processing is batch based and the system is either a credit or debit card. There are presently constrained by the fact that payment messages 97 million cards in issue. Total card purchases are limited to no more than 128 characters, amounted to 2.6 billion transactions in 1997. although an extended format, EFS is finally due However, while growing in importance, both to be implemented later in 1998. A limited debit and payment transactions still message length constrains the capabilities of the represent a relatively small proportion of all system for making unique individual as oppo- non-cash payments by value (£144 billion). sed to regular payments. The legacies of the This figure compares with the £489 billion in BACS process also dictate a delayed three day cheque payments alone which consumers make clearing and settlement cycle. BACS provides each year. three types of payments: In contrast to the mostly paper/cash based payment methods which services the non- 1. Standing orders – An instruction to make a financial sector, is a sophisticated, electroni- regular fixed payment (such as an install- cally based, same day settlement system that is ment on a loan or investment policy). closely monitored by the Bank of England. This 2. Customer credit – A credit made to a cus- system is called CHAPS (Clearing House tomer account. Customer credits consist Automated Payment Systems) and was estab- primarily of wages and salaries paid by lished in 1984. CHAPS is a highly secure elec- businesses, as well as a number of Gov- tronic network that provides nation-wide credit ernment related payments (e.g. State pen- transfers for same day UK sterling payments. It sions, social security etc.). The percentage operates using what are now relatively dated of employees being paid by BACS cus- X.25 protocols and a dedicated proprietary net- tomer credit has increased substantially work provided by British Telecom. The over the past twenty years. In 1976 this CHAPS network links its 17 direct members method of wage/salary payment only ac- and the 400 CHAPS participants, all of which

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are major international banks. It handles all the Each CHAPS member uses special CHAPS very large value payments within the financial Gateway software for their connection to the system but also associated smaller amounts (for main system. In order to make a payment, a example interest and fees payable on loans) member transmits a message which is then for- linked to underlying financial transactions. In warded by the system to the Bank of England 1997 CHAPS accounted for only 14 million for settlement. Once settlement has occurred a payment transactions, equivalent to an average message is sent back to the CHAPS member of 60,000 per day and around 0.03 % of the and the whole message is forwarded to the individual payment transaction total. However, CHAPS member/participating bank. In this if the total monetary value of these payments way, a receiving bank obtains a pre-settled are taken, then the figures are almost effectively payment. Since the payments handled are so reversed. CHAPS payments in 1997 were large, special settlement procedures in the form equivalent to £600 billion per week or £36 tril- of RTGS (Real Time Gross Settlement) have lion per year. These numbers completely dwarf had to be instituted in order to avoid the dan- all the other payment methods combined, repre- gers of system failure. senting around 91 % of the total. RTGS was introduced in April 1996. It in- volves each CHAPS payment being settled in 4. Servicing the Payment Requirements of real time across Bank of England settlement the Economy accounts. This prevents the problems which are associated with the previous system of "net- The different elements of the UK payment sy- ting". Netting involved adding total incoming stem service the particular requirements of dif- and total outgoing payments and settling the net ferent constituencies and sectors of the eco- difference at the end of each working day. Net- nomy. Payment requirements can be split into ting has the potential to create unacceptably four general groupings. high intra-day exposures to other counter- parties. This can create the potential for system 1. The financial sector: This has specific failure as even the largest financial institutions requirements for same day settlement of exceed certain previously agreed exposure li- large value payments. mits. However while addressing certain key risk 2. The business sector: This has to make issues, the introduction of RTGS and the sy- payments to trade purchasers and trade stem requirements of CHAPS as a whole, have suppliers as well as to its employees. increased its unsuitability as an electronic pay- 3. The personal sector: This comprises indi- ment system for lower value amounts. viduals and consumers who need to make Other payment requirements include the payments for the purchases of goods, pay- need to pay salaries and meet trade payments. ment of regular obligations (such as elec- The UK financial sector accounts for a large tricity payments, mortgage installments, percentage of the UK workforce which almost life insurance policies etc.) and certain in- exclusively receive payment by direct debit ter-personal transfers. using the BACS system. Payments to trade 4. The public sector: This has to make pay- suppliers will typically be made by cheque or ments to trade purchasers and suppliers, bankers draft. employees and to the very large number of recipients of various state benefits. 4.2 The Business Sector

4.1 The Financial Sector Despite the existence of BACS since 1968 and the creation of CHAPS in 1984, the UK busi- The payment requirements of the financial sec- ness sector remains predominately a user of tor to a large extent define the architecture of paper cheques for making business to business the system as a whole. Although only accoun- trade payments. At present over 65 % of busi- ting for 0.3 % of the total number of payment ness to business payments are made by cheque. transactions, CHAPS dominates in terms of Given the needs of the financial sector it would monetary value, with around 91 % of the total. in any event be impractical to switch large vo-

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lumes of business payments to the CHAPS to 4 % in 1976. payment network. While the business sector A small minority within the personal sector will typically write over 1.1 billion cheques in the UK has started to make purchases using annually, only 15 % of CHAPS transfers are the Internet. To date, trading has been restricted initiated by industry and commerce, numbering to a limited number of niche areas including less than 2.1 million. Some of these payments travel, books, CDs and some publications. represent payments to the financial sector (e.g. Payments are predominately made using credit payments of interest and principal on loans). cards although debit cards are also used in cer- Furthermore, the fact that in 1997 the average tain circumstances. CHAPS payment amount was £2 million de- monstrates that normal trade payments are pri- 4.4 The Public (Government) Sector marily serviced in other parts of the payment system. Given its proportionate share of economic ac- In addition to using cheques, the business tivity, the Government sector makes extensive sector is also an active user of electronic pay- use of all the key elements of the payment sys- ment services provided by BACS. The majority tem. Very large payments are effected using of all wage and salary payments are now made CHAPS while BACS is used extensively to using BACS electronic credit. Businesses are make credit transfers. Cheques also continue to also increasingly using BACS to settle trade play an important role when payments are made transactions but while the number of transacti- by local and central Government to the business ons has trebled (from a low base) in the past sector. Wages and salaries are predominately four years, the rate of transition is still slow. made using BACS based electronic credits. While overall use of paper cheques has declined Although various initiatives have been since 1990 when a peak volume of 3.7 billion taking place to switch to electronic means of cheque payments was reached, business use of payment, a very large proportion of payments, cheques is actually growing. In 1996, use of specifically pensions and social security bene- cheques by businesses increased by 4 % compa- fits continue to be made in cash. A new Bene- red to the previous year. The proportion of all fits Card was introduced in 1996 aimed at cheques written by businesses has increased slowly replacing the existing cash based sys- from 30 % in 1991 to 38 % in 1996. tem. At present recipients of benefits receive a cheque or benefits book which entitles 4.3 The Personal Sector them to draw cash from any post office. The current method of paying benefits constitutes a The personal sector uses the widest range of significant component of the overall cash based different payment mechanisms. Cash dominates payment system. It requires a massive logistical in terms of the volume of individual transac- operation whereby cash spent in the retail sector tions while BACS based standing orders repre- is recycled to Post Offices so that it can be used sents the largest payment category by value. to pay unemployment, social security, pensions Consumers have become increasingly sophisti- and other forms of state benefit. The new sys- cated in switching to non paper based payment tem that will be introduced will gradually aim methods. Unlike the business sector, the use of to convert these cash payments to electronic personal cheques has been sharply in decline credits made through the BACS system. As since 1990. Payment transactions that previ- well as saving significant costs, the new system ously involved payment by cheque have been is intended to reduce the level of fraud. steadily replaced by debit card transactions which have grown dramatically at a compound 5. Internet Payment Systems annual rate of 37 % from 192 million transac- tions in 1990 to 1.27 billion in 1996. Similar, There is evidence that there is an increasing cash acquisition using ATMs has also steadily volume of goods and services which are being increased. In overall terms, non-cash methods traded electronically on the Internet. Although of payment have increased to encompass 23 % there have been various initiatives to create new of all individual transactions in 1996 compared payment systems, the purchase and sale of

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goods is predominately handled within the minately credit card rather than debit card context of the existing payment structures. The based, this further restricts the available volume of merchandise currently being traded customer pool. In 1997, 58 % of the UK on the Internet in the UK is estimated at around adult population did not have a cre- £500 million per year. This is still a very small dit/charge card. figure compared to the overall turnover of con- sumer goods sector of the economy. The level A number of new pilot programs have been of business taking place on the Internet in the initiated for new payment methods on the Inter- UK is still too small to be registered by stan- net. These include various types of smart card dard surveys carried out on consumer expendi- initiative, experiments with electronic-cash ture. The practical reality of trading on the In- systems as well as the development of new ternet in the UK requires the majority of types of security to prevent credit/debit card purchases to be either pre-funded (i.e. funds are details being used fraudulently. The following transferred separately to an account which can section provides a summary of the key initiati- then be debited) or for payment to be made ves to date where they are relevant to the UK: using a credit or debit card. Some initial reluc- The ICC Project: The ICC (Integrated Cir- tance to provide credit card details on the Inter- cuit Card) project involves the creation of an net is now giving way to a realisation that the integrated credit and debit smart card which can SSL security standards already built into the also be used to withdraw cash from ATMs. It standard Internet browsers provided by Micro- involves creating a new standard that will ex- soft and Netscape, may be adequate to prevent pand the degree of functionality which is most direct fraudulent use of card details. available and that will be more effective at pre- Nevertheless, credit and debit cards expe- venting fraud. The ICC project is a co-operative rience a number of limitations that prevent them project which has been running for 3 ½ years. It from offering a universal payment mechanism includes banks that are members of APACS, for the Internet. The key issues are as follows: several credit card schemes, two ATM supp- liers, three EPOS (Electronic Point of Sale) 1. Firstly, the transaction charges are relati- terminal suppliers and four producers of credit vely high, particularly for smaller pay- cards. Public trials of the newly designed cards ments. Credit cards charge an ad valorem started in October 1997 and are due to finish in amount which reflects the specific arran- 1998. The trials involve over 100,000 smart gement with the seller. In the UK, the cards and 450 terminals in two pilots taking charge may be as high as 3-5 % of the face place in Northampton and Dunfermline. When value of the transaction. the trials are completed, individual APACS 2. Secondly, only accredited merchants can members will be able to decide how quickly the process card payments. Businesses seeking new cards are to be introduced and what speci- to sell their goods and services must first fic additional services should be included on satisfy the requirements of the merchant each card. The new smart card standard is pri- acquirer who will be responsible for marily aimed at fraud but has the potential of processing payments. Merchant acquirers incorporating additional services including In- take certain risks in accepting new custo- ternet related payment systems. mers and therefore will exercise their right BACS PKS Project: In conjunction with its to refuse an applicant. plans to provide EFS (Extended Format Ser- 3. Thirdly, while credit and debit card usage vice), BACS is presently planning a pilot for has significantly increased over the past 10 the PKS (Public Key Security) service that is years, there is still a significant proportion designed to improve security for banks and of the UK adult population (17 %) which other organisations that use the BACSTEL does not hold either a debit or credit card. network. BACSTEL is dial-up telecommunica- Furthermore, credit card issuers have histo- tions network which is used to send computer rically been reluctant to issue cards to in- files containing electronic payment instructions dividuals which do not meet their require- to BACS. Prior to the creation of BACSTEL, ments. Since Internet payments are predo- these files were send on computer tape which

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was delivered by courier to BACS offices. read the cards and ultimately transfer any mo- BACSTEL accounted for 93 % of all submissi- ney received to another bank account. ons in 1997 and from the beginning of 1999 Given its design, Mondex permits money onwards, all submissions must use the network. held on the card to be transferred to another BACS also hopes to develop new services as a card directly. This is a unique feature compared result of the pilot that will give it the opportu- to other smart card initiatives. In effect it per- nity to develop its role as a provider of trusted mits a form of direct payment transfer for small third-party services over the Internet. value amounts which does not require the inter- CHAPS Euro: This is a new electronic sa- vention of a bank clearing system. Mondex me-day electronic payment service that is being have announced plans to utilise this particular developed jointly by CHAPS and the Bank of feature for making secure payments over the England. The developments for this service are Internet. A card holder would need to have a well underway and it will be launched as a live special reader linked to a PC which could then service on 4 January 1999. CHAPS Euro provi- transfer cash amounts from the card to another des the same large value payment settlement card + reader linked to a different PC. In De- services as are currently available for Sterling cember 1996, it was announced that Master- payments using CHAPS. The service will also Card would take a 51 % stake in Mondex. In be based on RTGS via accounts held with the effect, Mondex has become MasterCard's tech- Bank of England. CHAPS Euro is being acti- nical solution to providing an electronic cash vely marketed to European banks as an effecti- smart card which competes directly with initia- ve solution to their needs, once the Euro is tives to create VisaCash by the Visa credit card established in January 1999. CHAPS Euro will organisation. On 26 February 1998, Mondex permit connection to S.W.I.F.T., the proprietary announced the first successful trial international international messaging services that allows electronic cash transaction. Mondex continues member banks to send cross-border payment to operate different trials both in the UK and in instructions to each other. A number of new a number of other locations internationally. members have joined CHAPS, solely to have Large pilots are being conducted in New York, access to the Euro same day settlement service. Hong Kong and Guelph in Canada. The majo- CHAPS Euro is intended to provide internatio- rity of work associated with these pilot pro- nal banks operating in London with the infra- grammes is intended to test the ability of the structure which they require to process Euro Mondex card to substitute for face-to-face cash large value payments. However, its usage will payments made to retailers. Some unspecified therefore effectively be restricted to the finan- ongoing work is also associated with its capa- cial sector in the same way as CHAPS Sterling. bilities for making peer-to-peer digital cash Mondex Smart Card: Mondex has been in transfers. development for more than eight years and was The Mondex consortium have had some a project that was initiated by National West- degree of success in licensing, Multos, the ope- minster Bank (NatWest). Mondex involves rating system which underlies the Mondex card. creating a secure smart card that can hold cash A new grouping called Maosco Ltd has been electronically and be used to make small value formed to promote Multos as an open standard. payments that would otherwise involve pay- In February 1998, a group of 12 companies ments in coins and/or notes. Its main attraction involved in the development and manufacture is replacing the billions of small value cash of smart cards including Gemplus and Schlum- payments. Unlike other smart card initiatives berger made a commitment to supply smart like GeldKarte in Germany, Mondex was de- cards based on the Multos operating system. signed from the outside to provide complete CyberCoin Electronic-cash system: Cy- anonymity to its holder. Using a Mondex card berCash is a US based company that has been involves using special card readers that can be attempting various approaches to creating new linked via a telephone line or ATM to the hol- forms of payment that can be used to transact der's bank. Money is then down loaded on to Internet commerce. CyberCoin is designed as a the Mondex card and can then be spent at those Java application that will reside on an Internet retail locations which have the equipment to seller's web-site. Purchases would require first

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establishing an account with CyberCash with ICE.com operates as a secure third part pay- the relevant credit card, bank account or debit ments agent. VPS operates in a similar way to a card details. This would then permit small value number of other small value systems. Individual purchases to be made that would in turn involve users are required to open an account and pro- reimbursement by CyberCash and more infre- vide their credit card details. VPS has signed a quent debits to the credit card, debit card or contract with Royal Bank of Scotland as bank account specified by the CyberCoin ac- Merchant Acquirer as well as with Dialog Cor- count holder. CyberCash recently launched a poration, one of the largest providers of on-line bid to acquire ICVerify. ICVerify has also de- electronic information. veloped complementary credit card based Inter- VisaCash Smart Card: VisaCash is an al- net payment systems. If the bid becomes effec- ternative smart card technology to MasterCard's tive it will expand the existing network of po- Mondex being developed and promoted by tential companies prepared to accept micro- Visa. It is involved in a number of pilot studies payments from 3,000 to more than 250,000. around the world. Current test sites include CyberCash is conducting unspecified trials of Taiwan, Norway and Sydney as well as the UK. its CyberCoin system in the UK as well as in Unlike Mondex which is based on a proprietary Germany, Japan and the US. A number of US operating system, VisaCash is based on the retailers are using CyberCash including large Java programming language developed by Sun retailers like Macy's. Microsystems. SET (Secure Electronic Transaction Pro- tocol): SET was an initiative which was begun 6. Discussion and Conclusions by MasterCard and Visa. Its aim was to provide a secure form of sending credit card details over The new initiatives which are underway and the Internet using proprietary encryption. IBM that are seeking to test various new concepts for has become a strong supporter of the proposed payments are therefore numerous. However, it standards with 50 customers piloting a number must be emphasised that various trials and pilot of different schemes around the world including programmes have been taking place for a num- the UK. There have recently been some doubts ber of years. For example, certain smart card expressed regarding the long-term viability of initiatives aimed at replacing small cash pay- SET given that SSL (Secure Sockets Layer) has ments have been under discussion for ten years already provided the basic security require- or more and smart card technology itself is as ments necessary for electronic commerce to old as the PC. New pilot programmes often start to emerge. SET continues to figure promi- create a certain level of excitement and interest nently in attempts to create secure business to in the media. They are seen as useful additional business payment systems based on the Inter- publicity which serve to identify the relevant net. Although its original purpose was to ensu- financial institutions as being at the forefront of re secure transmission of credit card details, its technological developments. The banks and longer term application may well be to ensure other financial institutions that are sponsoring secure electronic trading between individual these projects often view them as a form of companies linked in supply chains. insurance against being caught unawares by Europay SCCP: In February 1998, Bar- developments in this area. For some initiatives, claycard, the largest issuer of credit cards in the partial implementation may be considered pro- UK announced that it was undertaking a new viding that the project can be scaled up in sta- trial involving Europay International's SCCP ges. This means that the associated business (Smart Card Payment Protocol). The trial will risks can be controlled by building up the pro- involve staff employed by Barclaycard making ject on a step by step basis. In reality, major purchases on the Internet using SCCP at a spe- commercial banks already have significant in- cially created kiosk. vestments in the existing structure of the pay- Ice.com VPS System: A new UK start-up ment system. They are likely to be wary of in- company, Ice.com has launched a new payment troducing new initiatives which may simply system, VPS (Virtual Payment System) for low serve to increase their cost base without gene- value transactions on the Internet. In effect rating incremental revenue.

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A number of the new initiatives offer exci- services. Banks then discovered that with ting possibilities for the future. In particular, the an initial investment cost of £20,000 to Mondex card has the potential to offer an effec- £30,000 and annual operating costs of a tive alternative to using cash for small pay- similar magnitude, an ATM only repre- ments as well as a means of transferring small sented an economic investment if it could value payments over the Internet. However, generate at least 5,000 to 8,000 transacti- actual implementation of new systems will need ons per month. The result has been that to overcome a number of obstacles, which in- ATMs have added to, rather than displaced clude some of the following: part of the overall cost base. ATM withdrawals have been growing at faster 1. Firstly, the experience of technological rate than new installations. However, it development in payment systems in the was only in 1991 that an average volume UK demonstrates the complexity of tech- of 5,000 transactions per month was achie- nological change in this area. The key ved. The average UK ATM currently re- changes that still need to take place are ceives 6,500 transactions per month, ensu- largely institutional and organisational in ring that ATM networks continue to repre- nature rather than technically based. The sent a valued customer service rather than advances in micro-electronics that permit offering more tangible financial returns. payment information to be communicated 4. Fourthly, there is immense inertia in the and processed securely in electronic form current system. The percentage of adults in are more than 25 years old. For example, the UK with a bank or building society BACS was established in 1968 and ac- current account has slowly increased from counts for by far the greatest number of in- 44 % of the population in 1976 to 83 % in dividual electronic payments in the UK. 1996. With over 37 billion individual pay- While usage has grown dramatically in the ment transactions each year, 76 % of intervening years, the basic core technolo- which relate to cash, there are identifiable gies remain basically unchanged. obstacles to making any significant impact 2. Secondly, payment systems cannot be iso- on the current system. This point is illu- lated from the complex, often highly per- strated by the issues that have to be consi- sonal business/consumer/personal transac- dered when and if the Euro becomes the tion of which they form a part. This point established currency and all existing notes is clearly illustrated by the predominant and coins have to be replaced. APACS use of cheques by UK businesses for sett- estimate that £22 billion of bank notes and ling trade payments. An electronic, lower coins worth £2.6 billion and weighing an cost alternative has been available for 30 estimated 100,000 tonnes will have to be years. However, businesses prefer the pa- withdrawn from circulation and replaced per based alternative since it fits existing with their equivalent in Euros. organisational routines, gives greater con- 5. Fifthly, there are growing doubts about the trol over when payments are actually made business model for micro-transactions that and because they often lack the competen- has driven much of the development of cies which are needed to manage an elec- new Internet payment technologies. New tronically based system. start-up companies like CyberCash and 3. Thirdly, financial institutions have experi- Digicash originally had great expectations enced the impact of what can be described for creating new small value payment sy- as "competitive technology pull". They stems on the Internet. However, consumer may therefore be resistant to change for acceptance has been muted. In practice, the sound economic reasons. The implementa- US experience suggests that consumers tion of ATM technology to facilitate more prefer to pay indirectly through advertising flexible cash acquisition provides a good or by subscriptions to services that give demonstration of this effect. Banks initially them unlimited access. Content providers welcomed ATM technology as a way in have quickly discovered that micro-trans- which they could automate certain banking actions can quickly upset their best custo-

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mers who feel that they are being penalised ties for new payment systems using the Internet. at the expense of the infrequent selective 45th Annual Conference of the International Com- customer that gets the service at a very low munication Association, Albuquerque, New Mexico, cost. Many of the more recent initiatives USA. in micro-payments simply provide aggre- Credé, A. (1997): Technological Change and the gation of small amounts that then have to Information Society: An examination of Credit Risk be settled by credit card anyway. If the Assessment and Cash Handling Procedures in Banks. Unpublished thesis, Science Policy Research business model for micro-transactions is Unit, Brighton, Sussex. not viable, then it is unlikely that there will be the same requirement for the associated Gandy, D.A. and D.C. Chapman (1996): The Elec- tronic Bank - Banking and IT in Partnership. Lon- small value payment systems. don, The Chartered Institute of Banking. International, E.P. (1996): "The Growing Impact of Note the Internet." Electronic Payments International 1 Details of UK payment statistics have been ob- (March 1996). tained from APACS (The Association for Pay- Kutler, J. (1998): "Digital Frontiers (Smart Cards): ment Clearing Services) which publishes a num- Multos Smart Card System gaining support." Ame- ber of documents which are listed in the biblio- rican Banker (25 February 1998). graphy. APACS is an association made up of 23 Kutler, J. (1998): "Smart Cards: After 15 years of Full Members and 19 Associate Members. Its hard sell, future stays cloudy." American Banker (29 membership comprises all the major UK banks April 1998). as well as a number of international banks which M2 Presswire (1998): Ice.com launches revolutiona- include Deutsche Bank AG, Credit Lyonnais SA ry new Internet payment system, M2 Presswire. and Citibank N.A. 1998. M2 Presswire (1998): "MasterCard: Demonstration Bibliography of Mondex chip card's multi-currency capability APACS (1996): Annual Review 1996. London, provides glimpse of future." M2 Presswire (26 Fe- Association for Payment Clearing Services. bruary 1998). APACS (1996): Yearbook of Payment Statistics Malecki, A. (1995): The UK Payments Industry: A 1996. London, Association for Payment Clearing Review of the Principal Strategic Pressures & Forces Services. for Change. APACS 10th Anniversary Conference APACS (1997): Annual Review 1997. London, Proceedings, London, APACS. Association for Payment Clearing Services. Media Daily (1998): "Micropayments Remain more APACS (1997): Yearbook of Payment Statistics a Dream Than Reality." Media Daily (16 April 1997. London, Association for Payment Clearing 1998). Services. Networking Briefing (1998): "UK Internet payment APACS (1998): CHAPS, the Gateway to London, start-up ICE.com wins Dialog deal." Network Brie- and Beyond. London, Association for Pay- fing (30 Jan. 1998). ment Clearing Services. Sheppard, D. (1996): Payment Systems. London, Block, V. (1998): "Smart Cards: Despite Rival's Centre for Central Banking Studies - Bank of Eng- Publicity, Visa has two dozen pilots, millions of land. cards", American Banker (20 May 1997). Close, R. (1995): Challenge of Change for UK Pay- Contact ment Systems: BACS. APACS 10th Anniversary Dr. Andreas Credé Conference Proceedings, London, APACS. Science Policy Research Unit Computergram International (1998): "Barclaycard to University of Sussex at Brighton test Europay's E-Commerce Solution." Computer- Mantell Building, Falmer, gram International (19 February 1998). Brighton, East Sussex BN1 9RF, UK Tel.: + 44 (0) 1273/686758 Computergram International (1998): "More Evi- Fax: + 44 (0) 1273/685865 dence that SET might not make it." Computergram E-mail: [email protected] International (9 March 1998). http://www.susx.ac.uk/spru/ Credé, A. (1995): Electronic Commerce and the Banking Industry: The requirement and opportuni- «

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