Standard formats are a classic public good: they can be used by multiple people at no marginal cost per user and it is difficult to exclude people from using them. Typically, public goods have to be provided by the government, because no individual firm has sufficient incentive to provide them privately. However, in the payments industry, standard payment formats have frequently been adopted without government intervention. Instead, private firms generally cooperate to develop payment standards through membership organizations like NACHA, the Accredited Standards Committee X9, and EMVCo. These organizations are direct competitors who choose to cooperate in developing shared industry utilities. Atlanta Fed payments risk expert Doug King has written extensively on industry efforts to implement the EMV payment card standard in the United States.

The payments industry might be able to supply its own public goods due to the relatively low transaction costs of doing so. While a small number of companies manage the majority of card payments across the globe, the U.S. industry includes several well-established companies and numerous smaller competitors as well as start-ups. Most of the companies are already members of established industry organizations that facilitate collaboration. This is much simpler than the market providing a public good like low pollution in a river, for example. Somehow the many consumers and firms who access that river must assemble and agree on the pollution level, develop an enforcement mechanism, and implement the agreement—and many of these stakeholders will likely never have worked together before.

The effect of payment standards on competition is unclear. It’s possible that standards increase competition in the payments industry by leveling the playing field between established firms and start-ups. However, some payments standards are proprietary and may inherently favor the companies that most influenced their development. For example, to the extent that the largest card networks dictate the specifications for the EMV standard, this may disadvantage smaller networks. Those smaller networks are left in the unenviable position of having to comply with standards in which they had little voice in developing. Thus, although the payments industry seems to have been effective in developing standards cooperatively, it’s possible that this market activity has favored the dominant players. How will the move to the EMV payment card standard affect competition in the U.S. market?

By Jennifer C. Windh, a senior payments risk analyst in the Retail Payments Risk Forum at the Atlanta Fed

The mobile handset is "just a device, not a payment," noted Mallory Duncan, senior vice president and general counsel at the National Retail Federation. Duncan, who spoke at the workshop "Paper, Plastic...or Mobile," hosted by the Federal Trade Commission, also said that regulation should be no more stringent than that of the underlying payment. In essence, the laws, regulations, and rule sets associated with a payment type—be it a credit card, debit card, or online payment—should follow that payment through the mobile channel for clearing and settlement. I offered similar conclusions in a previous Portals and Rails post on dispelling myths in mobile payments, adding that "while new networks...may emerge in the future, at present, the payment network systems remain the same."

Fragmented framework on an expanded landscape
One problem the payments industry faces as technology enables new intermediary payment methods (they all start off as something we already use: cash, checks, or cards) is that the legal and regulatory framework includes different consumer protections, disclosure requirements, and error resolution provisions depending on the payment type. While all these payments are used in an Internet environment—whether the Internet is accessed by phone or a traditional PC—the addition of the mobile channel and its telecom partners has seemingly created a tipping point for confusion and speculation. Many of the issues raised about consumer protection for prepaid cards, for example, exist now and have nothing to do with a consumer's ability to use a prepaid account with a mobile device.

Can existing regulatory infrastructure handle new mobile payment business models?
The United States has a more complicated banking system than most countries. National laws, for example, govern national banks, which are preempted from state law. State-chartered banks and nondepository money service businesses (like payday lenders and money transmitters), on the other hand, are responsible for complying with the laws of every state in which they do business. These laws are different from state to state, and sometimes even conflict.

Industry players in each of these separate chartering authorities are stepping into the mobile channel as a way to expand their footprint. While telecoms and technology firms are entering into partnerships with banks to establish new business models in the delivery of mobile payments, so far they're sticking to their knitting and leaving the clearing and settlement, and the extension of credit, to the financial services industry. As long as banks remain the payment issuers in these still nascent business models, caution in rethinking the regulatory infrastructure is probably a good idea as well.

By Cynthia Merritt, assistant director of the Retail Payments Risk Forum

This past weekend, a neighbor out for a leisurely weekend stroll stopped me and asked, "Why do I still have an embossed credit card?" I must admit that I was a bit stumped by the question and couldn't offer him a reasonable explanation. I could not recall the last time that I had seen a "knuckle buster" machine used to make an imprint of a card. And who hasn't struggled trying to read your embossed card numbers and expiration date to make an Internet or phone transaction? Still pondering the question a few hours later, I did recall the food delivery driver who brought the old carbon paper slip, along with our food, to the door and used a writing pen to make an imprint of my card. I am quite certain that over the past five years, this was the only time an imprint of my card has been made—and this includes using my cards for purchases in taxis, from food truck vendors, and in developing countries such as Honduras, and remote Caribbean islands.

One answer to the need for embossed cards lies with network chargeback rules. Both MasterCard and Visa subject merchants to chargebacks on key-entered card-present transactions with no manual imprint. A key-entered transaction takes place when the terminal cannot read a card's magnetic stripe, so the vendor has to input the card number and expiration date. Even when this occurs, I am not so sure merchants follow the network's chargeback procedures. Do you remember a merchant making an imprint of your card in the rare instance your card information had to be manually keyed? Maybe it's time for the card networks to re-visit their chargeback procedures.

Another reason for maintaining embossed cards is that apparently some merchants, both domestically and internationally, still rely on imprints for transactions. I do not think that I am alone when it comes to my extremely limited experience with manual card imprints over the past five to even 10 years. With highly reliable telecommunication systems and the ever-growing number of mobile card readers, perhaps the networks should require all transactions to be swiped (for mag stripe cards), dipped (for EMV chip cards), or tapped (for contactless cards).

So while I have several answers to my neighbor's question, I am not convinced any of them are reasonable explanations in this day and age. Cards are embossed primarily for legacy reasons, and this embossing is irrelevant for most transactions. Maybe as issuers transition to chip-embedded cards (hopefully), they could subsequently transition away from embossed cards. In a recent American Banker article, Andrew Kahr discussed one good reason to change to nonembossed cards, and that would be to allow banks to instantly issue cards. I am quite certain my eyes would appreciate that change!

By Douglas A. King, payments risk expert in the Retail Payments Risk Forum at the Atlanta Fed

An American Banker article described how a federal court in Pennsylvania dismissed a lawsuit brought against a credit union claiming that one of their ATMs lacked a mandatory Electronic Funds Transfer Act (EFTA) sticker disclosing fees. This was just one in a string of lawsuits filed by the same plaintiffs. Some financial institutions have decided to settle instead of taking their chances in court. Some of the plaintiffs mentioned in the American Banker article have apparently decided to make a living by scoping out ATMs where stickers have fallen off or been removed, making transactions at these machines, and then filing suit against the unsuspecting operator.

This consumer behavior represents a type of second-order compliance risk. In addition to the formal consequences of noncompliance with regulation, financial institutions (FI) must also consider that some bad actors may attempt to undermine their compliance efforts. As a practical matter, FIs can manage this risk by validating EFTA compliance each time the ATM is serviced. As the machine is being refilled with cash and receipt paper, servicers should check for the disclosure sticker and have extras on hand in case it has been removed. The FI should maintain records of verification and/or replacement.

These lawsuits also raise larger questions. The other week I blogged about how the Federal Reserve has at times attempted to correct market failures in the payments industry. However, the unintended consequences of legislation discussed in this post demonstrate that government failure is also a risk. Government failure is any time that a government intervention to overcome a market failure results in a less efficient outcome than if no action had been taken. The case of these ATM vigilantes shows that legislation meant to protect the consumer can sometimes be used to justify wasteful lawsuits. In addition to determining if there is a legitimate market failure to correct, policymakers also need to consider the potential for government failure and unintended consequences of regulation before passage.

By Jennifer C. Windh, a senior payments risk analyst in the Retail Payments Risk Forum at the Atlanta Fed