TITLE: ELECTRONIC PAYMENT SYSTEM

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INTRODUCTION

Electronic commerce and finance are growing rapidly. New payments mechanisms designed to

aid electronic commerce have become routine. Predictions abound about the capabilities of the

information and communication technology to bring forth important tools for conducting

electronic commerce and payments. We are in the midst of a wave of innovation and change.

More recently, the proliferation of electronic payment mechanisms, the increase in the number of

players in the financial arena and the payment crises in quite a few countries and regions in the

1990s have focused attention on public policy issues related to the organization and operation of

payment systems.

Three main areas of public policy have guided payments system development and reform:

1. Protecting the rights of users of payment systems

2. Enhancing efficiency and competition, and

3. Ensuring a Safe, Secure and Sound payments system.

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Chapter 1

Definition:

Definition: Electronic Payment is a financial exchange that takes place online between

buyers and sellers. The content of this exchange is usually some form of digital financial

instrument (such as encrypted credit card numbers, electronic cheques or digital cash) that is

backed by a bank or an intermediary, or by a legal tender.

The various factors that have leaded the financial institutions to make use of electronic

payments are:

1. Decreasing technology cost:

The technology used in the networks is decreasing day by day, which is evident from

the fact that computers are now dirt-cheap and Internet is becoming free almost

everywhere in the world.

2. Reduced operational and processing cost:

Due to reduced technology cost the processing cost of various commerce activities

becomes very less. A very simple reason to prove this is the fact that in electronic

transactions we save both paper and time.

3. Increasing online commerce:

The above two factors have lead many institutions to go online and many others are

following them.

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A secure electronic financial transaction has to meet the following four requirements:

• Ensure that communications are private.

• Verify that the communications have not been changed in transmission.

• Ensure that the client and server are who each claims to be.

• Ensure that the data to be transferred was generated by the signed author.

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Properties of Electronic Payment Systems:

• Universally accepted.

• Transferable electronically.

• Divisible.

• Non-forgeable, non-steal able.

• Private (no one except parties know the amount).

• Anonymous (no one can identify the payer).

• Work off-line (no on-line verification needed).

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Overview of Electronic Payments:

The primary goal of any national payment system is to enable the circulation of money in its

economy. It is recognized worldwide that an efficient and secure payment system is an

enabler of economic activity. It provides the conduit essential for effecting payments and

transmission of monetary policy. Payment systems have encountered many challenges and

are constantly adapting to the rapidly changing payments landscape. More recently, the

proliferation of electronic payment mechanisms, the increase in the number of players in the

financial arena and the payment crises in quite a few countries and regions in the 1990s have

focused attention on public policy issues related to the organization and operation of payment

systems.

Three main areas of public policy have guided payments system development and reform:

1. Protecting the rights of users of payment systems

2. Enhancing efficiency and competition,

3. Ensuring a Safe, Secure and Sound payments system.

The availability of appropriate e-payment method is a crucial element of e- business.

Basic Assessment for the e-business owner/ management:

• Which methods of e-payment will the business be ready for – credit card, e-check, and e-

cash?

• Will traditional payment methods i.e. cash, paper checks be accepted?

• Or will a combination of both traditional and e-payment method be accepted?

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Emergence of E-Payment System:

In the four decades that have passed, important technological developments have taken place,

which on the one hand have expanded the possibilities of electronic payment systems and on

the other hand have created new business and social practice, which make the use of these

systems necessary. These changes, naturally, have affected the definition of electronic

payments, which is evolving depending on the needs of each period. In its most general form,

the term electronic payment includes any payment to businesses, bank or public services

from citizens or businesses, which are executed through a telecommunications or electronic

networks using modern technology. It is obvious that based on this definition, the electronic

payments that will be the objects of present result, are the payment that are executed by the

payer himself, whether the latter is a consumer or a business, without the intervention of the

another natural person. Furthermore, the payment is made from distance, without the physical

presence of the payer and naturally it does not include cash. By providing such definition for

the electronic payment system, researcher include the transfer of information concerning the

accounts of the parties involved in the e-commerce transactions, as well as the technological

means of distribution channels through which the transactions is executed.

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Innovations :

Many new technologies, innovations have lead to use of E Payment System for the common

man also. We will now briefly enumerate these innovations based on whom they affected:

1. Affecting the consumers:

Credit cards, Debit Cards, ATMs (Automated Teller Machines), stored value cards, E-

Banking.

2. Enabling online commerce:

Digital Cash, E-Cash, Smart cards (or Electronic Purse) and encrypted Credit cards.

3. Affecting Companies:

The payment mechanisms that a bank provides to a company have changed drastically. The

Company can now directly deposit money into its employee’s bank account. These transfers

are done through Automated Transfer Houses.

Types of E-payments

• E-cash

• Electronic wallets

• Smart card

• Credit card

1. Electronic Cash (digital cash):

These are Digital forms of value storage and value exchange that have limited convertibility

into other forms of value and require intermediaries to convert.

E-cash Concept:

1. Consumer buys e-cash from Bank.

2. Bank sends e-cash bits to consumer.

3. Consumer sends e-cash to merchant.

4. A merchant check with Bank that e-cash is valid (check for forgery or fraud).

5. Bank verifies that e-cash is valid.

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6. Parties complete transaction: e.g., merchants present e-cash to issuing back for

deposit once goods or services are delivered.

Advantages:

• More efficient, eventually meaning lower prices.

• Lower transaction costs.

• Anybody can use it, unlike credit cards, and does not require special authorization.

Disadvantages

• Tax trail non-existent, like regular cash.

• Money laundering.

• Susceptible to forgery.

Electronic Cash Issues

• E-cash must allow spending only once.

• Must be anonymous, just like regular currency:

– Safeguards must be in place to prevent counterfeiting.

– Must be independent and freely transferable regardless of nationality or storage

mechanism.

• Divisibility and Convenience.

• Complex transaction (checking with Bank):

– Atomicity problem.

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2. Electronic Wallets

These are similar to physical wallets which stores credit card, electronic cash, owner

identification and address.

• Authenticates the consumer through the use of digital certificates or other encryption

methods, stores and transfers.

• Value and secures the payment process from the consumer to the merchant.

• Makes shopping easier and more efficient.

• Eliminates need to repeatedly enter identifying information into forms to purchase.

• Works in many different stores to speed checkout.

• Amazon.com one of the first online merchants to eliminate repeat form-filling for

purchases.

Agile Wallet:

– Developed by Cyber Cash.

– Allows customers to enter credit card and identifying information once, stored on a

central server.

E wallet:

– Developed by Launch pad Technologies.

– Free wallet software that stores credit card and personal information on users’

computer, not on a central server; info is dragged into payment form from e-Wallet.

Microsoft Wallet:

– Comes pre-installed in Internet Explorer.

– All information is encrypted and password protected.

– Microsoft Wallet Merchant directory shows merchants setup to accept Microsoft

Wallet.

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3. Smart Cards

Plastic card containing an embedded microchip.

Available for over 10 years.

So far not successful in U.S., but popular in Europe, Australia, and Japan.

Unsuccessful in U.S. partly because few card readers available.

Smart cards gradually reappearing in U.S.; success depends on:

• Critical mass of smart cards that support applications.

• Compatibility between smart cards, card-reader devices, and applications.

Advantages:

• Atomic, debt-free transactions.

• Feasible for very small transactions (information commerce).

• (Potentially) anonymous.

• Security of physical storage.

• (Potentially) currency-neutral.

Disadvantages:

• Low maximum transaction limit (not suitable for B2B or most B2C).

• High Infrastructure costs (not suitable for C2C).

Applications

• Ticketless travel.

- Seoul bus system: 4M cards, 1B transactions since 1996.

- Planned the SF Bay Area system.

• Authentication, ID

• Medical records

• E-cash

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• Store loyalty programs

• Personal profiles

• Government

- Licenses

• Mall parking

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4. Credit Cards

Credit card provides a card holder credit to make purchase up to amount fixed by a card

issuer.

In B2C business, it continues to be the most used form of payment system given its high

convenience.

Entities that involve in the credit card payment system include:

• Card holder

• Merchant (seller)

• Consumer bank

• Merchant Bank (merchant’s financial institution)

• Third party processor

Advantages

– Used for the majority of Internet purchases.

– Has a preset spending limit.

– Currently most convenient method.

– Most expensive e-payment mechanism.

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Disadvantages

– Does not work for small amount (too expensive).

– Does not work for large amount (too expensive).

Payment Acceptance and Processing

• Merchants must set up merchant accounts to accept payment cards.

• Law prohibits charging payment card until merchandise is shipped.

• Payment card transaction requires:

- Merchant to authenticate payment card.

- Merchant must check with card issuer to ensure funds are available and to put hold on

funds needed to make current charge.

• Settlement occurs in a few days when funds travel through banking system into

merchant’s account.

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Conventional vs. Electronic Payment System :

To get into the depth of electronic payment process, it is better to understand the processing

of conventional or traditional payment system.

A conventional process of payment and settlement involves a buyer-to-seller transfer of cash

or payment information (i.e., cheque and credit cards). The actual settlement of payment

takes place in the financial processing network. A cash payment requires a buyer’s

withdrawal from his/her bank account, a transfer of cash to the seller, and the sellers deposit

of payment to his/her account.

Non-cash payment mechanisms are settled by adjusting: i.e. crediting and debiting the

appropriate accounts between banks based on payment information conveyed via cheque or

credit cards.

Non-cash payment requires three separate elements:

1. The buyer must have an agreed means of payment authorization and instructing its

bank to affect a transfer of funds.

2. The seller’s bank and buyer’s bank need an agreed method of exchange payment

instructions. This is referred to as payment clearing.

3. Payments are finally settled between affected banks, who notionally adjust accounts

based on payment information.

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Benefits of Electronic Payment

Electronic payment is very convenient for the consumer. In most cases, you only need

to enter your account information -- such as your credit card number and shipping

address -- once. The information is then stored in a database on the retailer's Web

server. When you come back to the Web site, you just log in with your username and

password. Completing a transaction is as simple as clicking your mouse: All you have

to do is confirm your purchase and you're done.

Electronic payment lowers costs for businesses. The more payments they can process

electronically, the less they spend on paper and postage.

Offering electronic payment can also help businesses improve customer retention. A

customer is more likely to return to the same e-commerce site where his or her

information has already been entered and stored.

Scheduled payments confirmation screen

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With all the benefits of electronic payment, it's no wonder that its use is on the rise.

More than 12 billion ACH payments were made in 2004, a 20 percent increase from 2003.

The 2004 Federal Reserve Payments Study noted that from 2000 to 2003, electronic

payments grew as payment by check declined, which suggests that electronic payments are

replacing checks.

In order to better serve their customers, banks are swiftly moving to offer online bill

pay services. Grant Thornton's 2005 survey of bank executives found that 65 percent of

community banks and 94 percent of large banks offer 24/7 online bill payment. Most of these

services are free to members and coordinate easily with personal software programs such as

Quicken or MS Money. Alternatively, consumers can subscribe to online bill pay services

such as Pay trust or Yahoo! Bill Pay. These services charge a monthly fee in exchange for the

convenience of paperless bill paying.

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Success of E Payment System :

The factors which are critical for the success of e-commerce payment systems are

multifaceted. These include integrity, non-repudiation, authentication, authorization,

confidentiality and reliability which are discussed below:

Integrity: transaction data are transmitted and received unchanged and as intended.

Non-repudiation: transactions have the quality of non deniable proof or receipts.

Authentication: identities and attributes of parties engaged in commerce are established at

some tolerable level of risk.

Authorization: individuals are established and recognized as entitled to receive, send or view

transactions.

Confidentiality: transactions can be protected from view except by those who are

authorized.

Reliability: probability of failure in the transaction-send, receive, acknowledge-is low.

Given the limited users bases, e-cash is not a feasible payment option. Thus, there are

number of factors which affect the usage of e-commerce payment systems. Among all these

user base is most important.

Added to this, success of e-commerce payment systems also depends on consumer

preferences, ease of use, cost, industry agreement, authorization, security, authentication,

non-refutability, accessibility and reliability and anonymity and public policy.

Concerns about Electronic Payment

The main drawbacks to electronic payments are concerns over privacy and the possibility

of identity theft. Fortunately, there are many safeguards available to protect your sensitive

personal information from falling into the wrong hands.

Safeguards:

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• You can defend yourself against identity theft by using virus protection software and

a firewall on your computer.

• You should also make sure that you send your credit card information over a secure

server.

• Your Internet browser will notify you when a server is secure by showing a lock or

key icon.

• In addition, the URL on a secure site is usually designated by the prefix "https"

instead of "http."

• Retailers do their part by using data encryption, which codes your information in such

a way that only the key holder can decode it.

Privacy concerns aside, some people simply dislike making electronic payments. They find

the setup too time-consuming and don't want more logons and passwords to remember.

Others simply prefer the familiarity of writing checks and dropping envelopes in the mail.

Regardless of these concerns, electronic payment will likely continue to rise in popularity.

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Electronic Payment Transaction:

Global v/s Indian:

Indian scenario:

Is there an increasing acceptance of electronic payment and collection systems in the

public sector and utilities?

An excellent example is the online booking of train tickets at www.irctc.co.in, which

shows how the Railways has solved the problem faced by consumers, of waiting in long

queues. This has also caused a spurt in rail travel which is cheaper and now made easier too.

Payment of water, telephone and electricity bills is possible through ‘bill junction’ in

an online mode through your credit card. Property taxes can be paid online now. Soon we

will see toll collection from motor vehicles on the National and inter-State highways taking

place through contact-less card payments. Fare collection on Metro Rail is already taking

place in Delhi through a contact-less Visa card.

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Oil companies are issuing prepaid cards called Petro cards for usage at petrol pumps. Airline

tickets are purchased online. Smart cards are being issued by some States for driving license.

The Indian Government is taking a pioneering step in having a Unique ID for each Indian and

issuing a smart card for the same.

In services offered by the Government / the public sector for the masses, the adoption of

electronic payments will be high. An easy and secure payment method can result in huge

convenience to the common man.

Does the growth of e-commerce suffer from perceived risks in transacting online? How

can these risks be effectively mitigated?

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As of August 1, 2009, electronic transactions at any of the online portals in India can

be made only if the cardholder has a Visa 3 D or Master Card Secure Code to be keyed in

during the transaction.

This is a third level of security that has been introduced by the banks. This has been

mandated across the country by the RBI. Earlier there were only two checks being

made –

CVV and expiry date.

The consumer has to first register his card with the issuing bank and obtain a

Visa/Master Card secure code. Only then can he transact at the online portal. This is required

even to do inter-bank transfers. This has put the onus for security on the merchant who

should not allow transactions on his portal without the secure code.

Apart from these, banks / payment gateways implement rigorous risk mitigation

algorithms to detect credit card fraud in online transactions. IP address checks, transaction

limit checks, number of transaction/day checks, number of failed authorization checks/day

are some of the checks built in to detect fraud. An online fraud score is aggregated for a

payment transaction after it goes through 30-35 checks built in the system. Then, based on

the threshold set by the Risk Management Officer, the transaction gets passed or rejected.

Over the years, the inhibition in giving one’s credit card details on an online portal

has decreased in India. The cumbersome manual methods of payment and the time consumed

in such activities have pushed people towards online transactions.

Are any changes required in our rules and regulations to make mobile payments and

banking more popular?

Today, the RBI has mandated that there is a per-transaction limit of Rs 2,500 for

mobile payment transactions, and a per-day limit of Rs 5,000 per customer. In India, only

banks which are licensed and supervised in India and have a physical presence in India are

permitted to offer mobile banking services. The services can only be extended to customers

of banks and holders of credit/debit cards issued under the RBI guidelines.

These rules are different from the way in which mobile payments work in the US or Europe.

However, it is important that to start with we operate under stiffer regulations so that

these new technologies move in the right direction. Once the foundation is well laid out in

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terms of security, transaction limits can be increased. We can also see how mobile payments

can be used as an alternative mode of payments for the unbanked masses. The RBI has given

its endorsement to mobile banking and this has acted as a fillip to public sector banks which

are now taking bold steps to adopt the same.

What do you see as the current trends in payment solutions, globally and in India?

The payments business is a reliable revenue generator for banks. Global payment

revenues were at $805 billion in 2008, up from $654 billion in 2006, and are forecast to reach

$1.4 trillion by 2016.

In the US, credit card growth has slowed thanks to the sub-prime crisis. Debit cards

are realizing double-digit revenue growth. It is expected that banks will continue to grow

debit card issuance and also the usage of the card at every point of sale. Mobile banking is a

part of successful growth strategy for banks in the US. Here, the mobile phone becomes an

extension of online banking.

In Europe, SEPA (the Single Euro Payments Area) has been a major

initiative launched by the European banks. The whole idea was to create a pan-European

payments market in which consumers and companies can make cross-border payments at the

same level of cost and efficiency as in the case of domestic payments.

This would mean that businesses and consumers would carry out all payment activities in

Europe with just one bank account. The total cost projected for migration to full SEPA

standard for banks, corporate and processors is €5 billion. This is a level of investment that is

unlikely to be justified by additional benefits. Consequently, banks have only followed a

minimal investment strategy to ensure basic SEPA compliance. Whether SEPA will succeed

is, therefore, a question mark.

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Global scenario:

Demand will always exist for global payments services, which underpin and facilitate

a range of economic activities, including the transfer (often across borders) of goods and

services. However, the health of the global economy is obviously a key determinant of

which services are used, to what degree and by which constituents.

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The World Payments Report 2009 looks at the global payments arena against the backdrop of

the most severe financial crisis and economic downturn in recent memory. The key findings

are:

• The worldwide volume of payments made using non-cash instruments (direct debits,

credit transfers, cards and cheques) grew 8.6% to 250 billion transactions in 2007.

The use of cards continues to be the single strongest driver of volumes. Global card

transactions (credit and debit) grew 14.5% in 2007.

• The ten largest markets accounted for 92% of all non-cash payments transactions in

2007, with the global market dominated by the US and the Euro zone. Together, they

accounted for 61% of all transactions. Beyond these two, the market is still highly

fragmented, but developing economies are growing their share every year. In Europe,

countries that are committed to promoting and investing in non-cash payments have

achieved healthy growth in transactions numbers.

• Payments volumes held up in 2007, but only 2008 data will confirm how well the

numbers held up in the face of the financial crisis. Early indications suggest US and

European card usage was fairly strong in 2008, but 2008-09 data and forecasts on

activities such as workers’ remittances and world exports are showing signs of

weakness that could ultimately slow down growth in overall payments volumes.

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• A range of initiatives in Asia have demonstrated that payments innovation is a

potential source of revenue for banks. Emerging payment methods can also help banks to

attract and then retain new clients, reduce the use of cash, create new offers, reach unbanked

markets and decrease operational costs. But banks must fight to stay relevant and consider a

variety of business models or the benefits could be lost to other service providers.

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Case Studies:

Technology has inarguably made our lives easier. It has cut across distance, space and even

time. One of the technological innovations in banking, finance and commerce is the

Electronic Payments.

Electronic Payments refers to the technological breakthrough that enables us to perform

financial transactions electronically, thus avoiding long lines and other hassles.

Electronic Payments provides greater freedom to individuals in paying their taxes, licenses,

fees, fines and purchases at unconventional locations and at whichever time of the day, 365

days of the year.

On the basis of present study, despite the existence of variety of e-commerce payment

systems, credit cards are the most dominant payment system. This is consequences of

advantageous characteristics, most importantly the long established networks and very wide

users‟ base.

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Alternative e-commerce payment systems in some countries are debit cards. In fact, like

many other studies, present study also reveals that the smart card based e-commerce payment

system is best and it is expected that in the future smart cards will eventually replace the

other electronic payment systems.

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