Retail Payments: the role of central banks

On May 25, 2009 in Frankfurt, Thomas M. Hoenig (President, Federal Reserve Bank of Kansas City) gave a brief speech entitled The Future of Retail Banking and Payments – Developers in Global Markets: The Role of Central Banks. You can obtain a transcript of here.

Having read the transcript, more than once, there are few items i find particularly interesting and wish to expand upon. I will not discuss his core thesis…instead, I decided to analyze a few of the statements in the speech and, perhaps, expand upon their content.

It is, usually, important to understand the position of a speech prior to analyzing data. The quotes below represent a simple sampling of the content and, for full context, I recommend you read the entirety of the speech.

So, what is Mr. Hoenig’s position?

Today I will discuss my own view that the Federal Reserve should not be contemplating an exit from retail payments. – page 2

However, in part because of its unique history as an operator, I believe the Federal Reserve is well-positioned to leverage its traditional operater role to better enhance the integrity and efficiency of the payments system. – page 7

That information, and the title of the speech, give you a bit of insight into the position that Mr. Hoenig is espousing. His argument, and the layout thereof, is interesting…but isn’t really the topic of this post. Instead, I find particular interest in a few other quotes from the article.

Payments products and services require a critical mass of participants on two sides of a market. For example, a significant number of merchants must be willing to accept a speific form of payment before consumers will use it. Conversely, a substantial number of consumers must use that form of payment before merchants will consider installing any necessary equipment or software. – page 3

Mr. Hoenig continues to discuss that the challenge of adoption in a multi-sided market can “justify a public sector role in providing the role” when “individual benefits or costs do not coincide with those accruing to society…” I have written, in the past, about the concept of multi-sided markets and the challenge and opportunity that they present to participants in such an ecosystem. However, the importance of looking at both sides of the market cannot be understated. Many of the “emergent” payment types (which are arguably minor tweaks on an established payment service) espouse benefits to a single side of the market and either a) do not recognize the adoption challenge or b) choose not to discuss this challenge in their marketing messages.

How do you address a multi-sided market? As I’ve linked to before, the Catalyst Code team spends substantial time discussing in great detail. For now, I will say that you have 2 options. Either subsidize one side of the market to drive adoption on the second…or have a compelling enough solution that both sides of the market are equally motivated to adopt. Arguably, however, the payments market is about more than just the merchant and the consumer. It is important to consider the channel (ISO, Direct, Retailer) as well as the VAR* (Software Company, Hardware Provider, Reseller, etc).

Retail payments in the United States and worldwide have undergone an enormous transformation over the past decade driven by technology and, just as importantly, notable changes in consumer preference. We get a sense of this change from a recent Federal Reserve study indicating that electronic payments now exceed two-thirds of all noncash payments in the United States. The efficiency, convenience, speed and ease of use have fueled this transformation and will continue to do so for some time to come.

When I read the statement “electronic payments now exceed two-thirds of all noncash payments in the United States” I immediately recognized the source. For several training sessions that I have given on payments basics, I’ve used the 2007 Federal Reserve Payments Study: Noncash Paymennt Trends in the United States: 2003 – 2006 and that is one of my favourite quotes.

In terms of other data from the study I’ve put together the following diagramme.


There are a few items of note in the diagrmme if you haven’t dug through the study in great detail. Firstly, the percentage of non-cash payments that were credit remained stable (relatively) between 2003 and 2006. However, there were substantial spikes in Debit (8%) and ACH (5%). This is indicative of a shift in consumer preference and wider spread adoption of additional payment services (and, coincidently, ties in well with my postulation of secondary services in software being a compelling point of competition in the card acceptance space).

From the same study, we can find that ACH payments were only 15.6% of non-cash transactions but represented almost 41% of the value. Which makes sense considering the typical profile of an ACH transaction and its usage in the market.

For a bit of additional perspective, and from the same study, there were 93.3 Billion non-cash payments in 2006 with a value of 75.8 trillion…truly a staggering number. “Non-cash” covers check, debit (signature and PIN), credit, ACH, and EBT. Perhaps the most interesting statistic is the growth in these payment modalities. The Compound Annual Growth Rate (or CAGR) across the non-cash market was 4.6% between 2003 and 2006 and the only decrease was in checks (paid) at -6.4%.

To summarize, an interesting speech…and the core data that he references is equally compelling. Having spent many hours in that specific study, if you have additional questions you desire me to expand upon or research please feel free to ask.

What’s your perspective? Agree? Disagree? Anything to add? Critiques? The comment form is below…

*NOTE: The usage of the term VAR is a bit different in payments that in other markets. It isn’t a “Value-added Reseller” as typically understood…rather some who is providing a “value add” solution to the merchant…be it hardware or software or a combination of the two.

May 29, 2009

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