FinTech: Overview, Payments, and Regulation
Professor Sarin Introduction
Natasha Sarin, Assistant Professor of Law, Assistant Professor of Finance
FinTech: Overview, Payments, and Regulation
History of Payment Methods
Natasha Sarin, Assistant Professor of Law, Assistant Professor of Finance
Overview
• History of Payment Methods
• Two-Sided Payment Markets
• Growth of Credit Cards
• Problems in the Credit Card Payment System
• Regulation in Payments
• Future of Payment Networks and Payment FinTech
History of Payment Methods
Bartering Era
Problems
• No common standards of value
• Inefficient exchange
Image Source: Wirecard
History of Payment Methods
Metals/Coins Era
Problems
• Fluctuation of metal value
• Burdensome to weigh and carry
Image Source: Wirecard
History of Payment Methods
Paper Money Era
Problems
• Theft
• Forgery
Image Source: Wirecard
History of Payment Methods
Credit Card Era
Problems
• Fees
• Credit Card Oligopoly
Image Source: Wirecard
FinTech: Overview, Payments, and Regulation
Current Global Trends in Payment Methods
Natasha Sarin, Assistant Professor of Law, Assistant Professor of Finance
Current Global Trends in Payment Methods
• In the early 1990s, almost 90% of non-cash transactions were done with
check
• Check usage has declined as debit and credit card usage has increased
Current Global Trends in Payment Methods
Source: Worldpay; ** Predicted
Payment Instrument Distribution
• Cash:
• Predominately used by low-income consumers
• Debit Cards:
• Predominately used by low-income and middle-income consumers
• Credit Cards:
• Predominately used by higher-income consumers
Current Global Trends in Payment Methods
Source: WalletHub
Current Global Trends in Payment Methods
UnionPay
• UnionPay (also called China UnionPay)
• Payment processor established in China with the
blessing of the Chinese government
• UnionPay has a monopoly on the Chinese market
and grew rapidly as the wider Chinese economy
flourished
UnionPay
• For many years, Visa and Mastercard cards in
China were dual-badged with UnionPay
• A 2017 regulation prohibited dual-badging
• All Chinese cards issued for domestic use must be
UnionPay-branded, and banks are typically
issuing UnionPay-only cards to replace existing
dual-badged ones
• Visa and Mastercard’s ability to complete in the
Chinese market has all but been depleted
UnionPay
• As the Chinese appetite for international tourism
has grown, so has the number of countries where
UnionPay is accepted
• UnionPay can now be used in over 150 countries
Trends in Non-cash Payments
Source: Federal Reserve
Share of Total Card Payments in the U.S.
Source: Federal Reserve
Post-Great Recession
• Debit card share of payments has been growing
• There appear to be generational reasons for reduced use of credit cards:
• 69 percent of millennials believe that debit cards are as safe or safer
than credit cards (Source: Lending Tree Survey)
• A 2013 report by the Federal Reserve Bank of New York stated that:
• “[the] net loss of 120 million credit card accounts [post-Recession] does
not, in itself, tell us whether consumers are choosing to reduce the
number of credit cards they hold—and presumably their available
credit—or whether lenders are restricting new credit and terminating old
borrowing relationships in the aftermath of the crisis, or both.”
FinTech: Overview, Payments, and Regulation
Two-Sided Payment Markets
Natasha Sarin, Assistant Professor of Law, Assistant Professor of Finance
Two-Sided Markets
Source: Järvi et al. (2018). The Business of Open Innovation Intermediaries
Two-Sided Markets
Source: Toulouse School of Economics
Two-Sided Markets
Source: Toulouse School of Economics
Setting Up a Two-Sided Market
• In two-sided markets - like Uber, Ebay, Airbnb, etc. - the platform recruits
buyers and sellers
• While this is done in the credit card market, the treatment of buyers
(cardholders) and sellers (merchants) is quite different
Two-Sided Payment Markets
Merchants Cardholder
Benefits Customers that don’t Credit care rewards
carry cash can buy (points, airline miles,
products/services etc.)
Cash-based theft Ease-of-payment
reduced
A credit line
Costs Pay 1-3% of transaction Possibility of fraud
value in fees
Interest if late on a
statement payment
Growth of Card Usage
• Growth of e-commerce
Growth of Card Usage
Growth of Card Usage
• Growth of e-commerce
• Expansion of credit card reward programs
“ We find that consumers generally spend more and increase
their debt when gffereced one percent cash-back rewards…
evidence from credit bureau data confirms that consumers
substitute their spending from other cards to the car with
cash-back and decrease debt on their other cards.”
— FEDERAL RESERVE BANK OF BOSTON
FinTech: Overview, Payments, and Regulation
Complexity of Payment Process
Natasha Sarin, Assistant Professor of Law, Assistant Professor of Finance
Complex Payment Process
• Complex authorization, authentication, clearing, and settlement process
(that is not real-time)
Complex Payment Process
Source: WalletHub
Complex Payment Process
Source: WalletHub
Complex Payment Process
Source: WalletHub
“ Consumers and businesses increasingly expect to be able to send
and immediately receive payments at any time of the day, any day of
the year. A 24/7 economy with 24/7 real-time payments needs
24/7 real-time settlement. That is where we believe that the
Federal Reserve and the private sector together need to make
investments for the future.”
— LAEL BRAINARD, FEDERAL RESERVE BOARD GOVERNOR
Complex Payment Process
• Most existing real-time payment systems offer:
• An instant, 24/7, interbank electronic fund transfer service
• Can be initiated through one of many channels - smart phones, tablets,
digital wallets, and the web
• In such a scheme, a low value real-time payment request is initiated that
enables an interbank account-to-account payment fund transfer and secure
transaction posting with much less complexity
FinTech: Overview, Payments, and Regulation
Cost Burden for Merchants
Natasha Sarin, Assistant Professor of Law, Assistant Professor of Finance
Cost Burden for Merchants
Source: ToastTab
Cost Burden for Merchants
Promising Solutions
FinTech companies that use e-payment systems to (1) lower and stabilize the
merchant’s swipe fee rates and (2) eliminate the inconvenience of card
minimums for customers
• A mobile app where consumers buy a “gift card” to load into
their mobile wallet, reducing transaction fees
• A mobile app first used for sending cash quickly to other
users (P2P) now used to pay merchants (C2B) with no fees
• A cloud-based billing & payment platform for B2B
companies that is trying to improve B2B payments and
reduce transaction fees
“ Ifaway
we’re gonna move to a cashless society, we need to move
from fees. This will be done by investing in the technology
of decentralized networks without penalizing merchants for
receiving their funds.”
— JEREMY ALMOND, FOUNDER AND CEO, PAYSTAND
FinTech: Overview, Payments, and Regulation
Who Pays for Credit Card Rewards
Natasha Sarin, Assistant Professor of Law, Assistant Professor of Finance
Credit Card Rewards
• Rewards cards encourage transactions by providing incentives to use
these particular instruments - for example, airline miles or cashback
• Who bears the cost associated with credit card rewards?
• Regressive transfer in reward benefits
Regressive Transfer in Reward Benefits
• Merchants face barriers on ability to set different prices for different
consumers depending on the type of payment instrument they use
• When a consumer uses cash, there is no transaction fee
• When a consumer uses a credit or debit card, the merchant pays an often
significant fee
• Barriers from:
• Card networks
• Legislation
• In response, merchants increase the cost of retail goods for all consumers
“ Merchant fees and reward programs generate an implicit monetary transfer to credit
card users from non-card (or “cash”) users because merchants generally do not set
differential prices for card users to recoup the costs of fees and rewards. On average,
each cash-using household pays $151 to card-using households and each card-
using household receives $1,482 from cash users every year [a total transfer of
$1,633 from the average cash payer to the average card payer]. Because credit card
spending and rewards are positively correlated with household income, the payment
instrument transfer also induces a regressive transfer from low-income to high-
income households in general.”
— FEDERAL RESERVE BANK OF BOSTON
“ Policies that would allow and encourage merchants to charge
differential prices according to the costs imposed by payment
instruments could help to reduce the transfers by reducing payment cross
subsidies…Policies that would require merchants, banks, or credit
card companies to fully disclose fees, costs, and price markups to
consumers could help to reduce transfers by giving consumers the
incentive to make optimal payment choices.”
— SCHUH ET AL. (2010). WHO GAINS AND WHO LOSES FROM CREDIT CARD
PAYMENTS? THEORY AND CALIBRATIONS
FinTech: Overview, Payments, and Regulation
Introduction to Regulation
Natasha Sarin, Assistant Professor of Law, Assistant Professor of Finance
Regulation of Credit and Debit Cards
Typically, regulation of the two-sided credit card payment system focuses on:
• Fairness -
• By disallowing certain practices that are unfair/abusive, such as allowing
a consumer to go overlimit and then imposing an overlimit fee or hiking
up the interest rate on an existing balance
• Transparency -
• By making the fees and rates for credit cards more transparent, so that
consumers can understand how much they are actually paying
• Systemic risk -
• Ensuring that credit cards and other payment platforms are operating
responsibly, so that systemic economic risk is reduced
Regulation of Credit and Debit Cards
• In the decade leading up to the financial crisis, the fastest growing source
of revenue for financial institutions was from fees they collected from their
customers
• Overdraft fees:
• Originally determined on a case-by-case basis
• Realizing the potential revenue from this product, financial institutions
began actively encouraging this product to consumers,
• Banks would order transactions in order to charge the maximal overdraft
fees
Overdraft
• After the financial crisis, popular attention focused on the overdraft process
• Troubling as a distributional matter:
• Only 10% of consumers are responsible for around 85% of overdraft
revenue
• These consumers are disproportionately low-income and less financially
sophisticated
• People did not realize they were about to overdraw - 70% of customers
reported that they wished the transactions had been declined rather than
completed with a significant overdraft fee
Overdraft
• Some large banks responded to this regulation by embracing it and even
going beyond the requirements of the new default rules:
• Eliminating overdraft entirely as a product
• Offer the ability to “rewind” overdrafts
Overdraft
• Concerned observers suggest the new opt-in rules haven’t gone far
enough
• Those who opt-in are disproportionately low-income, less financially
sophisticated consumers
• Financial institutions still targeting low-income consumers for overdraft
• An alternative explanation is that these customers like overdraft as a
product
FinTech: Overview, Payments, and Regulation
U.S. Credit Regulation
Natasha Sarin, Assistant Professor of Law, Assistant Professor of Finance
Concerns in the Credit Card Market
• Consumers tended to bear high delinquency fees for missing credit card
payments
• Financial institutions would increase interest rates without fair warning
• Highlighted by Elizabeth Warren in 2007 in calling for a Consumer
Financial Protection Bureau
• Toaster analogy
Approach to Regulating Payments (USA)
• 2009 - Credit Card Accountability, Responsibility and Disclosure (CARD)
Act
• Provide greater transparency for consumers on the actual price of the
credit they would have to pay
• Eliminated or reduced the ability to charge excessive late fees
• Limited the ability to increase interest rates significantly without fair
warning to customers
Approach to Regulating Payments (USA)
• Financial institutions said this regulation would actually hurt consumers
• Empirical evidence on the CARD Act suggests it actually helped
consumers quite significantly
Approach to Regulating Payments (USA)
• Interchange fees became a significantly large cost of operating for
merchants
• 2010 - Durbin Amendment
• Put a cap on the interchange fees charged to merchants every time they
swiped a debit card
• Left credit interchange fees unregulated
Approach to Regulating Payments (USA)
• In theory, financial institutions get revenue from checking accounts in one
of two ways:
• Monthly maintenance fee
• Interchange - every time consumers use their debit card as a means of
purchase
• Banks responded to revenues lost from the cap on interchange fees by:
• Directly charging customers a $5 fee per month for using their debit
card (proposed by Bank of America, but later walked back)
• Increasing account fees
Approach to Regulating Payments (USA)
• Prior to Durbin, about 80% of customers at large financial institutions had
access to a free checking account, no matter the size of the account
• Following the Durbin Amendment, banks put extra fees on consumers for
having accounts, specifically on accounts without a large balance or direct
deposit
• Estimates suggest that consumers as a group lose around $3.5 billion from
the Durbin Amendment
• Illustrates the effect of interchange regulation that economists long
suggested would occur
FinTech: Overview, Payments, and Regulation
International Credit Regulation
Natasha Sarin, Assistant Professor of Law, Assistant Professor of Finance
Approach to Regulating Payments (Australia)
• Australian regulators implemented a percentage cap
on credit interchange
• Result was a decrease proclivity of credit card
rewards and a decreased use of credit
• Surcharging became very common among Australian
merchants due to high interchange fees, so recent
regulation has limited the ability of merchants to
charge excessive surcharges to consumers
Approach to Regulating Payments (Australia)
• 2018 - Banking Measures Act
• Legislates responsible lending based on a
consumer’s ability to repay, limits unsolicited credit
offers, changes interest calculations, and gives
consumers the option to cancel cards or reduce
limits online
Approach to Regulating Payments (UK)
• 2011 - Electronic Money Regulations
• Created a clearer regulatory framework for issuers
of electronic money
Approach to Regulating Payments (China)
• While the payment regulation is a bit more opaque in
China, the People’s Bank of China has:
• Set a cap on payments by traditional QR codes in
an attempt to reduce fraud
• Raised the reserve fund ratio for e-payment
platforms
FinTech: Overview, Payments, and Regulation
Future of Payment Networks
Natasha Sarin, Assistant Professor of Law, Assistant Professor of Finance
Concerns about Payment Markets
• Fairness to consumers and merchants
• Efficiency of transactions
• Consumer fraud
Future of Payment Networks
Source: The Financial Brand
Future of Payment Networks
• Bitcoin and blockchain technology
• Person-to-Person mobile tech
Payment Innovation: Example 1
A growing number of stores,
like Starbucks, are creating
payment apps to avoid credit
card swipe fees
Payment Innovation: Example 2
Ripple provides a frictionless
experience to send money
globally using the power of
blockchain
Payment Innovation: Example 3
Integrated, low cost (or no fee)
app to enables users to pay
bills, recharge mobiles, make
purchases online, transfer
money to other users, and
make QR code payments at
merchant stores
Looking Forward: Key Questions
• Should payments be regulated in a way that’s distinct from the way they’re
regulated today?
• Should we try and think about some sort of global framework for financial
regulation in this particular manner?
• What does the future of payments look like?
• What are the security risks of payment FinTech innovations?
