Electronic payment systems : strategic and technical issues.
Date: 2011-07-22
Institutions: Institute for Prospective Technological Studies
Subjects: Joint Research Centre, consumer protection, electronic commerce, payment, research report

Institute for
Prospective Technological Studies
Directorate General Joint Research Centre
European Commission

Electronic Payment Systems
– Strategic and Technical Issues –

Background Paper No. 1
Electronic Payment Systems Observatory (ePSO)

December 2000

K. Böhle, M. Krueger, C. Herrmann, G. Carat, I. Maghiros

EUR 19933 EN

IPTS, World Trade Center, Isla de la Cartuja, s/n, E-41092, Seville, Spain
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URL : http://epso.jrc.es/

European Commission

Joint Research Centre (DG JRC)

Institute for Prospective Technological Studies
http://www.jrc.es

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Report EUR 19933 EN

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Abstract

The  first  Background  paper  of  the  Electronic  Payment  Systems  Observatory  (ePSO)

identifies the strategic and technical issues that will be discussed in the ePSO Forum – an

online  discussion  group  consisting  of  payment  systems  experts  and  a  broad  range  of

market  players.  The  discussion  will  concentrate  on  electronic  retail  payment  systems  -

focussing  on  the  needs  of  consumers,  merchants  and  SMEs.  While  in  principle  all

electronic  retail  payment  systems  will  be  analysed,  special  emphasis  will  be  given  to

payment  methods  in  the  context  of  electronic  commerce  on  the  Internet  and  the

development  of  cross-border  payment  systems.  The  issues  that  have  been  identified  are

grouped  around  eight  broad  categories:  e-money,  enhanced  access  products,

micropayment  solutions,  payment  systems  infrastructure,  regulation  and  innovation,

standardization  and  interoperability,  consumer  protection,  anonymity,  privacy  and

security  and  integration  of  payments  into  online  transactions.  Some  of  the  major  issues

are:

(cid:1) 

(cid:1) 

the availability of reliable data that are comparable across different countries

the  impact  of  the  EMI  Directive  and  its  implementation  on  payment  systems

innovation and the position of Europe in the field of global competition

(cid:1) 

the relationship between interoperability and standardisation and the role of bridging

technologies

(cid:1) 

the  potential  for  competition  between  bank-based  payment  networks  and  other

networks (e.g. mobile phone networks)

(cid:1) 

the  effects  of  cheaper  and  faster  online  connections  on  the  demand  for  off-line

payment solutions

(cid:1) 

the provision of privacy and security at reasonable cost and the possibility of offering

different trade-offs between costs and security

(cid:1) 

(cid:1) 

the implications of a functioning PKI for the various electronic payment schemes

feasibility  of  transaction-based  micro-payment  systems  and  the  potential  market  for

such solutions

(cid:1)  new access products and the position of banks vis á vis non-banks in payments

(cid:1)  current  changes  in  the  payment  system  and  the  effects  on  the  bridging  of  the  gap

between cross-border and national payments

(cid:1)  ownership of multi-application smart cards (the financial industry, the government or

the individual)

(cid:1)  payments in the wider context of shopping protocols and browser standards.

Contents

1
1.1
1.2

INTRODUCTION ................................................................................................ 1
Role of the background paper ........................................................................ 1
Scope of the issues........................................................................................ 1

2

2.1
2.2
2.3
2.4
2.5

3
3.1
3.2
3.3
3.4
3.5
3.6
3.7
3.8

PAYMENT SYSTEMS TRANSFORMATIONS – A MORE GENERAL
FRAMEWORK ................................................................................................... 3
Information society ......................................................................................... 3
Political dimension ......................................................................................... 3
Open network infrastructure ........................................................................... 4
Electronic payment systems – the second wave ............................................ 4
Electronic cash and cashless society ............................................................. 5

STRATEGIC AND TECHNICAL ISSUES ........................................................... 7
E-money ........................................................................................................ 7
Enhanced access products ............................................................................ 9
Micro-payments ........................................................................................... 10
Infrastructure................................................................................................ 11
Regulation and innovation: e-money ............................................................ 12
Standardization and interoperability ............................................................. 14
Consumer protection, anonymity, privacy and security................................. 15
Integration of payments into online transactions........................................... 17

BIBLIOGRAPHY ..................................................................................................... 21

1 

INTRODUCTION

1.1  ROLE OF THE BACKGROUND PAPER

This first background paper aims to structure the strategic and technical issues that will be

the  focus  of  the  electronic  Payment  Systems  Observatory  (ePSO).  Further  background

papers  will  be  devoted  to  selected  issues  of  this  agenda.  All  background  papers  are

reviewed  by  the  Steering  Group.  The  revised  versions  will  be  distributed  to  the  ePSO-

Forum where payment systems experts and a broad range of market players are invited to

further  discuss  the  issues  raised.  These  discussions  will  be  led  by  the  ePSO-team.  The

project’s  newsletter  ePSO-N,  which  addresses  the  same  issues,  prepares  the  ground  for

the production of ePSO-background papers and helps stimulate discussion in the Forum

(for  example  issues  1  &  2  of  ePSO-N  focussed  on  mobile  payment  systems    -  a  likely

topic for the next background paper).

S te e rin g  G ro u p

B a c k g ro u n d
P a p e r o n
is s u e  x

IP T S
e P S O -te a m

IT A S  &  n e tw o rk  o f
c o rre s p o n d e n ts

e P S O -N
N e w s le tte r o n
is s u e  x

e P S O -F o ru m  o f m a rk e t
e x p e rts  &  a c to rs

F ig u r e  1 : B ac kgro u n d  P a p e r in  co n te x t

1.2  SCOPE OF THE ISSUES

The  project’s  scope  is  limited  to  electronic  retail  payment  systems  focussing  on  the

needs  of  consumers,  merchants  and  SMEs.  While,  in  principle,  all  electronic  retail

payment systems will be analysed special emphasis will be given to payment methods in

the  context  of  electronic  commerce  on  the  Internet  and  the  development  of  cross-

border payment systems. Important topics such as B2B e-commerce or developments in

other continents are beyond the scope of the project. Nevertheless, as far as they affect the

issues covered by ePSO, they will be taken into account.

We  suggest  exploring  and  discussing  eight  major  issues  that  may  be  grouped  as

follows:

1

(cid:1)  e-money
(cid:1)  enhanced access products
(cid:1)  micropayment solutions
(cid:1)  payment systems infrastructure

regulation and innovation

(cid:1) 
(cid:1)  standardisation and interoperability
(cid:1)  consumer protection, anonymity

(cid:1) 

privacy and security and
integration of payments into online
transactions

The first four issues deal with different types of payment systems and their corresponding

infrastructure.  The  analysis  however  is  not  system-oriented  but  procedural  and  issue

based. Attention will be paid to topics such as innovation and differentiation of payment

methods, the competitive position of new e-payment products like e-money vis à vis more

traditional  access  products  and  cash,  usage  patterns  for  given  payment  methods  in  real
world  situations,  and  competition  and  co-operation  with  regard  to  infrastructure.1  Apart

from e-money schemes, dedicated micropayment systems have been developed to handle
payments of small amounts2 on open networks in a cost efficient way. Microbilling and

indirect  revenue  streams  also  need  to  be  considered  as  alternative  solutions  for  the

micropayment problem of electronic commerce, i.e. trading low value intangible products

and services and getting paid.

The  remaining  four  issues  are  related  to  the  broader  framework  in  which  payment

systems operate, which is characterised by the demands of different actors who shape

and constrain the corridor of future retail payment systems. Special  attention will be

paid  to  the  requirements  set  by  policy  makers,  merchants,  SMEs  and  consumers.

Regulation  and  innovation  correspond  mainly  to  policy  making.  Issues  such  as

privacy,  anonymity,  security,  ease  of  use,  and  consumer  protection  are  naturally

related to the consumers’ point of view and the integration of the payment functions

in online transactions is especially important for merchants and SMEs. It goes without

saying that standards and interoperability are of interest to all parties involved.

Before going into detail concerning the strategic and technical issues, we try to set the

scene  by  offering  a  more  general  framework  to  better  understand  the  actual

transformation of the whole payment system and our selection of issues.

1  The distinction between access products and e-money used here goes back to the 1996 definition by  the
Bank  for  International  Settlements:  “E-money  products  are  defined  here  as  ‘stored-value’  or  ‘prepaid’
products in which a record of the funds or ‘value’ available to a consumer is stored on an electronic device
in the consumer's possession. … E-money as just defined differs from so-called access products, which are
products that allow consumers to use electronic means of communication to access otherwise conventional
payment services…” (Bank for International Settlements 1996, p 1).

2  Where ‘small’ can be anything between a fraction of a Cent and a few Euros.

2

                                                          
2  PAYMENT SYSTEMS TRANSFORMATIONS – A MORE GENERAL

FRAMEWORK

2.1 

INFORMATION SOCIETY

Globalisation, 

liberalisation,  deregulation 

(or: 

re-regulation),  digitisation 

and

informatisation are causing a shift from the traditional industrial society to a knowledge

or  information  society.  Payments  can  be  interpreted  as  a  highly  specialised  mode  of

communication.  Such  a  statement  would  be  true  even  without  the  existence  of  the

Internet.  The  advent  of  electronic  commerce,  however,  has  meant  that  retail  payment

systems  must  cope  with  new  requirements.  In  our  view,  there  are  three  obvious

challenges:

a)  the  integration  of  the  payment  function  into  e-commerce  procedures  overall

(shopping and more),

b)  the efficient management of (global) cross-border payments

c)  the  handling  of  high  volume/low  value  payments  for  the  purchase  of  intangible

goods and services.

2.2  POLITICAL DIMENSION

The  parallel  process  of  European  integration  explicitly  stresses  the  political  dimension

and gives high priority to the development of harmonised retail payment systems in both

the  real  and  the  virtual  world  (e.g.  cross-border  credit  transfers  within  EU,  e-money

settlement  cross-border).  The  juxtaposition  of  political  and  technical  transformation

processes can also be seen as a  window  of  opportunity  because  European integration at

the  level  of  payment  systems  requires  technological  innovation  and  implementation  of

applications  for  cross-border  e-payments.  The  European  Parliament  and  the  European

Commission are aware of this challenge (hence the eEurope initiative, the establishment

of  FIWG,  the  Financial  Issues  Working  Group,  recent  research  projects  like  SEMPER,

the  SmartEuro  projects,  and  relevant  directives  addressing  e-money,  distance  selling,

digital  signatures,  e-commerce).  Considering  the  enlargement  countries  and  transition

economies these challenges are growing.

In the light of globalisation, Europe-wide solutions are not enough. They should be

exportable.  The  question  is  how  European  solutions  can  succeed  internationally.

Although  European  leadership  in  e-payment  services  is  generally  taken  for  granted,

threats  from  abroad  should  not  be  underestimated.  It  is  also  worth  mentioning  that

3

globalisation should not be interpreted as implying the existence of only one solution.

The  opposite  is  true.  It  was  never  as  difficult  as  today  to  find  the  right  balance  of

local,  regional,  national,  trans-national  and  international  solutions.  Attempts  by

payment systems to achieve global reach coexist with other schemes aimed explicitly

at  local  environments.  The  different  geographical  levels  also  require  a  rethinking  of

the  different  mixes  of  the  payment  function  and  added  value  functions  (loyalty

points,  ticketing,  digital  signature  etc.).  In  addition,  it  is  safe  to  say  that  payment

culture matters and has to be taken into account.

2.3  OPEN NETWORK INFRASTRUCTURE

The Internet as an  open  network  infrastructure  has  several  implications  for  the  way

electronic  payment  systems  function.  As  with  all  truly  integrated  computerised  value

chains,  the  end  user  is  now  the  front  man  of  the  back-office.  The  shift  to  Internet

technologies  by  the  banking  sector  also  means  that  proprietary  technology  becomes

more and more obsolete (as evidenced by the substitution of a specialised POS-terminal

infrastructure by mobile phones and GSM network). The move to mainstream technology

also  signals  another  far-reaching  innovation  of  the  whole  back-office  computation:  the

gradual substitution of batch processing by real-time transactions. Another notable change

can be observed with respect to the technological arms of the payment service providers.

While these so-called network operators (often only one organisation in a given country)

worked in close relation with the banking sector, this has changed with Internet payments

services.  The  operators  of  private  networks  that  were  once  hidden  now  appear  as

service  providers  on  open  networks  in  their  own  right.  The  Internet  has  increased

competition  between  banks  and  non-banks,  and  has  also  enabled  many  forms  of  co-

operation and fruitful division of labour in the field of payment services.

2.4  ELECTRONIC PAYMENT SYSTEMS – THE SECOND WAVE

The lack of success of e-money schemes – in the real and virtual world – is an ongoing

topic  of  debate.  The  same  is  true  not  only  for  micro-payments  (e.g.  eCash,  CyberCash,

Millicent,  MiniPay,  First  Virtual etc.)  but  also  for  many  new  payment  mechanisms  that

have  been  developed  for  payments  on  the  Internet.  So  far,  traditional  payment

instruments  (access  products)  have  been  more  successful  on  the  Internet.  However,

attempts  to  make  them  safer  by  security  measures  like  SET  (Secure  Electronic

Transaction) have not taken off as anticipated. The current development in e-payments,

however, is characterised by new efforts to overcome misconceptions and failures in

4

a second run (e.g. server based wallets, virtual cards, mobile phones as user-friendly and

secure  interfaces).  Furthermore,  the  picture  is  made  more  complex  by  the  wealth  of

payment  methods  being  linked  to  an  increasing  number  of  communication  channels

which  can  be  used  for  electronic  payments,  i.e.  POS  transactions  and  e-commerce.  M-

payments  by  mobile  phones  especially  are  important  for  both  the  virtual  and  the

real world. The different channels for online-shopping like WAP access to the Internet or

digital TV, however, also have some potential.

The  more  the  payment  business  becomes  a  mere  matter  of  digital  information

exchange,  the  more  the  core  competencies  change.  When  the  use  of  a  payment

instrument is equivalent to the use of software, then application development and

human  factors  become  vital  for  the  success  of  electronic  payment  systems.  The

perception  of  payment  methods  as  secure,  user-friendly  application  software  leads

also  to  the  vision  of  a  homogenous  payment  software  that  allows  all  payment

methods to be  used easily.  Each payment instrument would  be  but  one  function  of

the  payment  application  to  be  further  specified  by  additional  features.  At  the  same

time computer technology  promises  to  make  the technology of  payment instruments

like cheques, credit transfer or direct debit obsolete.

2.5  ELECTRONIC CASH AND CASHLESS SOCIETY

The  new  developments  also  require  a  rethinking  of  cash  and  the  vision  of  a  cashless

society. In the sixties some of the drawbacks of cash became apparent and the vision of a

cashless society built on electronic means of payment emerged. But it took a long time –

more than 15 years – before new retail payment instruments took off, and even now cash

is by far the most popular retail payment instrument, partly due to the fact that costs of

cash are not visible to the customer. Electronic methods will have to prove themselves

to  be  convenient  and  effective  in  a  lot  more  real  world  situations  if  they  are  to  win  a

greater  market  share  from  cash.  With  respect  to  e-commerce,  an  important  question  is

whether there is demand for an electronic payment instrument with the properties of

cash.    

5

3  STRATEGIC AND TECHNICAL ISSUES

3.1  E-MONEY

The  future  of  e-money,  now  that  initial  enthusiasm  has  waned,  is  assessed  much  more

cautiously  than  it  was,  even a  year  ago.  It  is  no  longer  taken  for  granted  that  there  is  a

business  case  for  a  stand-alone  e-purse  scheme  or  purely  software-based  solutions.

Careful  analysis  of  whether  e-money  is  economically  viable  is  therefore  needed.

Consideration  has  to  be  given  to  whether  this  analysis  will  have  to  be  modified  in  the

light of expected technological changes.  Policy issues can then be identified.

3.1.1  The business case for e-money

a) In the real world: point-of-sale (manned or unmanned). There is widespread agreement

that  e-purses  are  more  efficient  than  cash  at  the  unmanned  POS  (vending  machines,

parking meters, public phones, ticketing, etc.). The business case for e-purses is less clear

at  the  manned  POS.  So  far,  there  has  been  a  noticeable  lack  of  enthusiasm  among

merchants  and  consumers.  This  is  partly  due  to  competition  by  other  payment

instruments. The main competitors are cash and debit cards. For small and medium sized

transactions,  customers  and  merchants  still  find  cash  convenient  and  cheap.  For  larger

purchases,  debit  cards  or  credit  cards  seem  to  be  superior  to  e-purses  for  a  number  of

reasons (e.g. loading limits for security).

b) In the virtual world. The comparative advantage of e-money is seen mainly in the area

of micro-payments. Currently, there is no generally accepted and cheap means of paying

for relatively low value goods. This is seen as a major drawback for e-commerce because

it is often believed that the Internet provides a huge market for low value goods, such as

single  newspaper  articles,  music,  cartoons  etc.  Further  demand  for  flexible  payment

schemes  is  expected  from  mobile  services  such  as  “location-sensitive”  information,  etc.

E-money  competes  with  a  large  number  of  other  methods.  In  the  virtual  world,  credit

cards,  electronic  direct  debit,  operator  billing  and  all  kinds  of  aggregation  schemes

compete  with  e-money.  Furthermore,  in  many  transactions,  old  methods  such  as

subscription and payment on delivery (or even payment after delivery) can be used.

3.1.2  The business case for multi-application cards

One  way  to  strengthen  the  business  case  for  e-purses  is  to  use  smart  cards  for  a

number  of  different  functions.  A  new  generation  of  smart  cards  that  allows  the

implementation  of  various  applications  (‘multi-application  smart  cards’)  is  reaching

7

the market. Such cards have the advantage of spreading costs over many applications,

thus enhancing the  business case.  They  also  reduce  the  number  of  cards  a  customer

has  to  carry  –  an  important  point  for  cardholders.  The  drawback  is  that  a  move  to

multi-application  cards  increases  problems  such  as  co-ordination,  standardization,

security,  branding  and  liability.  Agreement  no  longer  has  to  be  reached  within

industries but across industries.

3.1.3  Long-term effects of innovation

At  present,  it  is  not  clear  how  e-money  will  profit  from  technological  advances.  With

respect  to  security,  there  is  a  trade-off.  On  the  one  hand,  the  price  of  chip-based

computing power can be expected to fall. This by itself should make e-purses safer and

cheaper. On the other hand, cheaper computing power will also benefit those who try to

attack the system. Whether new solutions such as voice-recognition or bio-metric systems

will  provide  efficient  means  to  improve  security  remains  to  be  seen.  It  is  evident,

however, that the falling prices of information transmission will make online transactions

cheaper.  This  implies  that  competing  technologies  such  as  the  debit  card  will  become

more  competitive  vis-à-vis  e-purse  payments.  Indeed,  it  has  been  argued  that  the  low

usage of e-purses in the US can be explained by the low telecommunication costs in the

US. Thus, innovation may also work against e-money. However, smart cards  in  general

will profit from innovation because technical progress widens the set of applications and

makes it easier to implement multiple applications on one card.

Issues

(cid:1)  The availability of reliable data, as well as missing data in many cases, constitutes a

problem  area.  Moreover,  even  if  data  on  e-payments  do  exist,  they  are  often  not

comparable across different countries. Thus, an important issue is to identify sources

of data and types of data that are needed by policy makers and market players.

(cid:1)  What  effect  will cheaper  and  faster  online  connections  have  on  the demand  for  off-

line payment solutions?

(cid:1) 

If  smart  cards  offering  payments  as  a  stand-alone  function  are  not  viable,  the  way

forward  may  be  multi-application  smart  cards.  A  move  towards  multi-application

smart cards would create complicated problems beyond technical questions of design.

In particular, questions such as ‘who owns the card and thus controls the relationship

with  the  customer?’  would  have  to  be  answered.  If  cards  offer  payment  functions,

financial  institutions  will  wish  to  remain  in  charge.  However,  customers  will  be

8

concerned  about  data  protection  and  privacy  and  may  be  reluctant  to  surrender

ownership of a card that stores a wide range of confidential information. In addition,

governments  may  demand  ownership  of  smart  cards  that  serve  as  a  substitute  for

today’s IDs and passports.

(cid:1)  Multi-application smart cards also make it harder to find cross-border solutions since

it is unlikely that local ticketing solutions etc. will all be compatible. Furthermore, the

more functions are stored on a card, the less willing customers may be to take such a

card with them when they are travelling.

(cid:1)  To what extent should multi-application smart cards be regulated? If a health insurer

teams up with a public transport company to issue a smart card that can also be used

for low-value payments, do they fall under the e-money directive?

3.2  ENHANCED ACCESS PRODUCTS

In the past, innovations in the payment system almost always enhanced the efficiency of

account-based  forms  of  payment.  With  the  emergence  of  products  such  as  eCash  and

Mondex  this  trend  appeared  to  be  reversed.  New,  seemingly  unaccountable  forms  of

payment entered the stage. These forms of payment appeared to be ideally suited for the

Internet, in particular for low-value or micro-payments. However, they failed to pass the

market  test.  Furthermore,  new accountable  schemes  are  currently  being  implemented  to

make  secure  and  low-cost  transactions  possible.  Virtual  cards  or  wallets  and  pseudo

numbers are designed to reduce the risk of sending account information over the Internet,

without having to use a cumbersome and expensive process to secure the data transfer. In

addition, with falling costs of data transmission, real time online giro transfers have to be

considered more and more as a plausible solution for the future. In the evolving area of

m-payments most of the existing schemes rely on access products that allow bank account

holders to use their deposits to make payments.

Access  products  have  not  just  been  enhanced  but  also  combined  with  other  services.

Thus, home banking offers the possibility of initiating credit transfers with a whole range

of  other  financial  services.  Electronic  Bill  Presentment  and  Payment  (EBPP)  is  another

example of this bundling of services.

Issues

(cid:1)  While  it  is  possible  that  the  payment  system  will  change  in  fundamental  ways,  one

may  have  to  contemplate  the  possibility  that  the  ultimate  payment  system  will  look

9

more or less like the current one.  The only difference will be that people will access

their bank accounts via the Internet, phone or mobile phone and they will no longer

have to wait for days until a payment is cleared and settled. Enhanced access products

provide new business opportunities for banks and non-banks. The question is whether

they will ultimately allow non-banks a larger role in payments.

(cid:1)  The  combination  of  e-payments  with  other  services  implies  that  the  evolution  of  e-

payments  may  be  shaped  by  developments in  these  areas.  In  particular, advances  in

home  banking  and  bill  presentment  may  influence  the  evolution  of  e-payment

methods and standards.

3.3  MICRO-PAYMENTS

It is often assumed that there is an enormous potential for small-value purchases on  the

Internet.  Examples  are  purchases  of  software,  news  items,  articles,  photos,  cartoons,

music etc. The main problem for these markets is usually seen in the lack of a convenient,

secure and  cheap  means  of  payment,  in  short,  the  lack  of  an efficient  means  for  micro-

payments. Various attempts have been made to establish such a system but so far there is

no  transaction-based  micro-payment  system  operating  successfully.  The  question  of

whether such a scheme is really needed requires further investigation. On the one hand,

micro-payments  could  constitute  a  catalyst  for  e-commerce  of  intangible  products  and

services on the Internet in the sense that property rights, and consequently the improved

chances of getting paid, could bring new and better products to the market. On the other

hand, the numbers of freely available products in this sector might only allow a niche for

paid  goods.  Often  indirect  revenue  streams  (for  instance  from  banner  advertising)  are

decisive for these businesses.

Issues

(cid:1) 

In  the  real  world,  cash  is  still  a  widely  used  means  of  payment  for  small-value

payments. Often, these low value payments (ticketing,  parking,  etc.)  are  assumed  to

be one of the most promising uses for e-purses.

(cid:1)  The  feasibility  of  transaction-based  micro-payment  systems,  and  their  existing

alternatives,  should  be  further  investigated.  At  the  same  time  an  assessment  of  the

potential  market  for  low  priced  goods  and  services  on  the  Internet  requiring  micro-

payments should be made.

(cid:1)  As  there  are  great  opportunities  in  this  field  for  new  entrants,  a  high  level  of

competition can be expected. Micro-payment systems to be watched include prepaid

10

(“ticker  systems”)  and  post-paid  (micro-billing)  approaches  (sometimes  also  called

“aggregating  systems”  or  “metering  systems”).  Attention  needs  also  to  be  drawn  to

micro-payment schemes based on value points (“private currencies”). In addition, the

potential and the limits of competing indirect income models have to be assessed.

(cid:1)  Once  again,  an  important  issue  is  the  availability  of  reliable  data  on  the  use  of

payment schemes such as subscription or indirect income.

3.4 

INFRASTRUCTURE

3.4.1  The role of banks in final settlement

Traditionally banks have provided most payment services. In particular, they provide the

“backbone”  of  the  payment  system.  Ultimately,  non-banks  will  use  the  banking  system

(and occasionally cash) to settle credits and debits. This implies that all payment solutions

depend to a certain extent on the efficiency of the payment system run by banks. For the

moment, any challenge to the banks’ position in this field is inconceivable. Firstly, only

banks  have  access  to  central  bank  credit.  Secondly,  for  many  payments,  in  particular

regular payments with known counterparts, direct debits or credits and standing orders are

highly efficient and will not be replaced in the near future. Thirdly, banks are still the one

institution consumers  trust most.  Thus, the  flow  of  income  payments  will  remain  bank-

based.

3.4.2  Competing infrastructures

Just  like  telephone  services,  payment  services  are  a  good  with  strong  network  effects.

From  the  point  of  view  of  the  users  the  implications  are  straightforward:  the  larger  the

network, i.e. the more people participate in the network, the better for each of them. From

the point of view of the suppliers, the case is less straightforward. On the one hand, they

profit from an increase in the network because that drives down unit costs and makes it

less  likely  that  other  networks  will  be  able  to  compete.  However,  members  of  an

established network also have an incentive to deny access to other suppliers of payment

services since new entrants would increase supply and drive prices down. Thus, there may

be  an  incentive  to  restrict  access  to  the  network  for  new  suppliers  in  order  to  restrict

competition.  For  instance,  a  ‘virtual  bank’  that  cannot  offer  its  customers  access  to  the

ATM network would have little chance of succeeding in the market. To a certain extent,

this problem is reduced by newly created competition between networks. For instance, e-

purses  can  also  be  reloaded,  at  least  in  principle,  via  ‘smart  phones’  (including  public

phones  and  mobile  phones)  and  via  the  Internet  (using  a  PC  with  a  card  reader).  Thus,

11

nowadays, a new provider of an e-purse scheme is less dependent on access to an ATM

network.

Although  different  payment  networks  exist  (credit  card  networks,  mobile  and  terrestrial

phone networks, the Internet, ATM networks, POS networks), all of these depend to some

extent on the banking system.  Credit cards can be used as an example - in the end, the

cardholder has to transfer funds into the bank account of the credit card company and the

credit card company has to transfer funds to the merchant’s bank account. Thus, though

the use of alternative payment networks and aggregation reduces the dependence on the

banking network, it does not eliminate it.

Issues

(cid:1)  Even  if  there  is,  to  some  extent,  competition  between  networks,  payments  may

involve  anti-trust  issues.  Firstly,  competition  is  far  from  perfect.  There  are  few

networks and many of them are dominated by the same players. Secondly, setting up

these  networks  requires  co-operation  on  standards.  Such  co-operation  can  easily

extend to areas such as fees, where co-operation is likely to be harmful for customers

and competitors. However, it is not always clear where to draw the line between co-

operation and collusion. For instance, the role of interchange fees  still  needs  further

discussion.

(cid:1)  So  far,  cross-border  retail  payments  are  time-consuming  and  expensive.  Banks  are

trying  to  make  these  payments  more  efficient.  The  question  remains  whether  these

attempts will eliminate the difference between cross-border and national payments.

(cid:1)  Another issue to be addressed is the potential competition by other networks such as

mobile phone networks.

3.5  REGULATION AND INNOVATION: E-MONEY

3.5.1  The E-money Directive and its implementation

On 27 October, 2000 the E-money Directive was published in the Official Journal of the

European Commission. Member states have until April, 2002 to convert the Directive into

national  law.  The  Directive  defines  the  term  ‘electronic  money’  and  regulates  which

institutions  are  allowed  to  issue  e-money.  It  provides  an  important  framework  for  all

players  in  the  market  for  payment  services  and  may  have  a  strong  impact  on  the

competitive position of European payment service providers. The effects of the E-money

12

Directive on the future of e-money will largely depend on its translation into national law

and its practical implementation. Therefore, at the moment, it is not entirely obvious how

the Directive will affect the market for e-payments and the different  groups  of  payment

providers.

One of the open questions is how extended loyalty schemes, bonus points and electronic

barter  schemes  would  be  affected  by  the  Directive.  Though  such  schemes  are  usually

fairly limited in scope, they could potentially grow into an alternative monetary system.

3.5.2  Vertical integration versus increasing division of labour: implications for

regulation

At the moment there seems to be a strong drive towards vertical integration. Non-banks

such as Telecommunications Operators (TOs), ISPs,  supermarkets  or  software  firms  are

moving into the area of financial services (including payments). At the same time, banks

are  starting  to  offer  Internet  services  to  their  customers.  In  addition,  players  from  both

groups are working on the construction of a Public Key Infrastructure. However, on close

inspection, in many cases an increased division of labour can be observed. While a large

number of services are often marketed under a single brand – they are in fact produced by

specialised firms. Banks have begun to spin-off back-office activities, they outsource IT-

functions,  they  buy  software  and  communication  services,  etc.  Non-banks  that  offer

payment services will often outsource the ‘doing’ to banks.

Issues

(cid:1) 

In order to study the impact of the E-money Directive on the future development of

electronic  payments,  questions  like  the  following  need  be  considered:  What  impact

will the Directive have on payment systems innovation? How will the implementation

process be shaped in different payment cultures? How does this  Directive  affect  the

position of Europe in the field of global competition? To what extent is the Directive

applicable  to  loyalty  schemes,  barter  schemes,  etc.?  During  the  Directive’s

implementation process, the answers to these questions can provide valuable guidance

for member countries.

(cid:1)  The increased division of labour makes money and banking more complex to regulate

and supervise because it is now more difficult to decide which institutions should be

regulated  and  supervised.  Furthermore,  this  development  suggests  that  the  overall

13

regulatory strategy should be reviewed. Rather than regulate particular institutions it

might be preferable to regulate functions such as payments.

(cid:1)  Can value points develop into private currencies – challenging the current monetary

order?

3.6  STANDARDIZATION AND INTEROPERABILITY

There is a strong political commitment to a common “virtual Euro”. However, due to the

complex  structure  of  the  problem,  interoperability  of  e-payments  has  not  been  achieved

yet. This implies that different interoperable e-purse and e-money schemes exist side by

side – largely along national lines. Many players have established their own systems and

do  not  wish  to  make  large  changes  (partly  because  this  would  upset  their  customers:

merchants and consumers). Given this complexity, an attempt to enforce standardization

would  entail  enormous  risks.  The  success  with  the  GSM  standard  for  mobile  phones  or

DVB may induce regulators to try a similar strategy in the field of e-payments. However,

the  GSM  example  is  not  directly  applicable  to  the  payment  sector.  Furthermore,  the

shortcomings of HDTV should serve as a warning.

Success  and  failure  of  payment  instruments  can  be  described  in  terms  of  network

externalities. Where there is no single dominating actor, positive network effects depend

on  a  certain  degree  of  standardization  and  interoperability.  Standardization  seems  to  be

the  obvious  route  to  interoperability.  It  should  be  remembered,  however,  that

standardisation  is  neither  essential,  nor  sufficient  to  achieve  this  goal.  There  are  many

paths  to  interoperability.  A  common  standard  is  just  one  of  them.  Sometimes  a  set  of

requirements allowing interoperability, the development of a “universal terminal” that can

cope with different schemes, or the intermediation of payment service providers bridging

between systems (e.g. SmartAxis in the case of e-purses) is appropriate. However, none

of  these  strategies  is  sufficient  in  itself.  Interoperability  is  not  just  a  question  of  cards,

card  readers  and  the  respective  software.  Interoperability  also  requires  business

agreements  and  a  common  clearing  and  settlement  system,  which  may  require  co-

operation between banks and non-banks and across borders.

Issues

(cid:1)  Standardisation  and  interoperability  efforts  take  place  at  the  level  of  all  types  of

payment  systems.  The  EMV  standard  provides  the  basic  requirements  for  physical,

mechanical  and  electrical  compatibility  of  smart  card  based  payment  schemes.  This

14

makes the complex and time-consuming migration to EMV worth while if the use of

electronic  payment  systems  is  to  spread.  With  regard  to  e-commerce,  work  on

interoperability  of  e-purses,  which  so  far  has  produced  the  EMV-based  Common

Electronic  Purse  Specifications  (CEPS),  is  vital.  Achievement  of  interoperability

depends on four critical factors:

i) 

Market demand. Given the low volume of cross-border retail payments, it is

not  yet  clear  if  there  is  a  business  case  for  an  international  interoperable  e-

purse.

ii) 

Economies  of  scale.  Even  if  demand  is  small,  economies  of  scale  on  the

supply side might induce operators to find an interoperable solution.

iii) 

Innovation  and  exclusion.  Does  the  scheme  agreed  upon  by  major  players

slow  down  more  advanced  technical  solutions,  and  in  what  way  does  it

influence  competition?  At  worst,  standards  might  be  misused  for  strategic

reasons by some actors to exclude others.

iv) 

Implementation, since migration to a developed interoperable scheme may be

a tedious process.

(cid:1)  Could  the  use  of  bridging  technologies  provide  a  cheaper  and  faster  way  towards

interoperability?

(cid:1)  Normally  the  standardisation  of  micro-payment  systems  is  not  addressed  at  the

European level, although there are committees at the level of IETF, and W3C. These

standards are obviously not banking standards. This raises the question whether there

is  a  lack  of  European  involvement  in  these  standardisation  processes.  Such  concern

might be generalised with respect to financial applications of XML.

3.7  CONSUMER PROTECTION, ANONYMITY, PRIVACY AND SECURITY

Currently,  many  different  payment  media  are  entering  the  market  to  compete  with

existing payment schemes in the real and virtual world. This is good news for customers.

However,  payments  have  the  characteristics  of  a  network  good.  It  remains  to  be  seen

whether  whether  competition  will  be  enhanced  in  the  long  run,  as  it  is  probable  that

sooner or later only a few surviving payment schemes will remain.

The  widespread  use  of  cash  in  the  real  economy  indicates  that  consumers  do  value

anonymity and do not like to have all transactions “on the record”. Thus, there may be a

need  for  further  regulation,  protecting  sensitive  payment  data.  Shopping  and  paying  on

15

the  Internet  make  it  possible,  in  principle,  to  gather  large  amounts  of  data  and  create

personal  profiles,  or,  even  worse,  “identity  theft”.  However,  before  further  regulation  is

considered,  anonymity  and  data  protection  should  be  seen  in  the  wider  context  of

protection  of  personal  data  on  the  Internet  (including  the  thorny  issue  of  international

agreements on data protection). Furthermore, in the case of payments, there may be fairly

simple solutions. It is possible to design prepaid payment schemes in a way that provides

anonymity.

When  considering  security  issues,  a  public  key  infrastructure  (PKI)  that  can  provide

secure  authentication  on  the  Internet  is  an  important  step  towards  secure  Internet

transactions – including secure Internet payments. It can help build trust (a precondition

for  flourishing  e-commerce),  reduce  the  potential  for  fraud,  ensure  privacy  and  provide

merchants  with  non-repudiation.  In  particular,  lack  of  trust  on  the  side  of  potential

consumers is often seen as a major problem for the development of e-commerce.

The  general  implementation  of  PKI  infrastructure  and  the  development  of  schemes

covering the whole B2C business process, from pre-sales to post-sales services, are vital.

Both  evolve  in  a  type  of  co-evolution.  The  building  up  of  an  all-purpose  public  key

infrastructure on the one hand and a dedicated infrastructure for the financial sector on the

other  hand  are  not  independent  of  each  other.  Co-ordination  may  be  required  to  avoid

confusion and bureaucratic overheads. If someone has obtained a digital certificate from a

credit institution (e.g. applying for SET participation) why should he or she not use it in

other fields of society and vice versa?

The creation of a properly functioning PKI is not an easy task. It is not just a question of

establishing a hierarchy of trusted centres. All of these centres must demonstrate that they

follow  secure  procedures.  Security  has  at  least  as  much  to  do  with  implementation  and

procedures  as  with  encryption.  It  has  yet  to  be  seen,  therefore,  whether  a  vertically

integrated world wide PKI is a realistic scenario.

Issues

(cid:1)  Cash-like  e-money  schemes  are  technically  feasible.  They  have  the  advantage  of

providing  a  high  level  of  privacy  and  making  person-to-person  payments  possible.

They would, therefore, reduce the data protection problem and provide a high degree

of  convenience  to  customers.  However,  it  is  still  not  known  how  highly  customers

value these attributes. High-security payment systems are usually more cumbersome

16

to  use  and  ultimately  more  expensive  than  low-security  systems.  Thus,  there  is  a

trade-off between  security  and  costs  (time  and  money).  Current  experience  suggests

that customers put a high value on convenience. As a result, such cash-like schemes

may not be economically viable. If these schemes fail the market test, the question of

achieving a sufficient level of privacy arises.

(cid:1)  To a certain extent, security is a subjective concept. The assessment of security may

vary  between  customers.  Therefore,  another  important  issue  is  whether  and  to  what

extent different levels of security can be offered.

(cid:1)  Consumer behaviour may not be guided just by objective measures of risk but also by

risk perceptions. Thus, there is a highly subjective component in the whole problem

of risk and risk-reduction – an issue that needs further exploration.

(cid:1)  While consumers value privacy, merchants wish to learn more about their customers.

They would like to collect and analyse customer data. This raises the issue of how the

interests  of  merchants  and  consumers  can  be  reconciled.  Again,  a  system  that

provides flexibility seems desirable.

(cid:1)  Once  again,  an  important  issue  is  the  availability  of  reliable  data,  especially  on

fraudulent use of payment schemes.

(cid:1)  On  a  conceptual  level,  a  unified  world-wide  PKI  seems  to  be  the  best  solution.

However,  the  question  of  whether  such  a  system  is  feasible  needs  to  be  addressed.

Furthermore, possible alternatives have to be explored.

(cid:1)  The  implications  of  the  implementation  of  a  PKI  on  the  various  electronic  payment

schemes still need to be investigated. While it seems certain that smart cards will play

a prominent role in such an infrastructure, it is  not clear  yet  how  the  demand  for  e-

purses will be affected.

3.8 

INTEGRATION OF PAYMENTS INTO ONLINE TRANSACTIONS

Last but not least, the payment function cannot be seen in  isolation.  Banking  standards,

standards  on  the  Internet,  processing  of  information  within  firms,  and  the  way  the

payment function is embedded in more complex business processes also have to be taken

into  account.  From  this  point  of  view,  the  payment  system,  one  element  in  a  chain  of

exchanges between trading parties, becomes an embedded tool in a larger environment of

17

business transactions. These include ordering, billing, delivery, offers and receipts as well

as the payment process itself. Although the integration of all these steps in an overarching

architecture  might  be  more  urgent  in  the  B2B-sector  than  in  the  retail  B2C  sector,  it  is

also highly relevant for online-shopping on the Internet. With so many processes involved

in  a  business  transaction,  the  foremost  concerns  are  those  of  interoperability  and

harmonised  architectures.  Standards  and  architectures  have  already  been  elaborated  by

consortia such as OTP (open trading protocol) or OBI (open buying protocol). There have

also been major efforts by the European Commission to foster research in this area, e.g.

the  SEMPER  project  which  has  developed  an  open  security  platform  for  the  different

modules of e-commerce. However, their role and impact with regard to today’s Internet-

commerce and their further prospects are still unknown.

Issues

(cid:1)  Obviously  one  of  the  developments  to  be  observed  is  the  integration  of  payment

systems  into  more  complex  shopping  applications.  This  inevitably  raises  questions

about the main players in this field - the technology providers, and the solutions they

offer.  What  are  the  levels  of  standardisation,  current  and  potential?  Are  there

harmonised  standards  for  the  whole  process  or  is  there  an  uncoordinated  spread  of

“would-like-to-be” standards? What role do these standards actually play with regard

to today’s Internet-commerce? Is there a demand or need for government regulation?

Given the wide range of activities spread over global markets, which include a large

number  of  processes  and  players  operating  under  different  regulatory  regimes,  how

can  policy  makers  foster  the  common  understanding  and  development  of  viable

platforms and standards?

(cid:1)  Furthermore, there are at least two hypotheses worth further consideration:

i) 

that the B2C developments in this field largely depend on browser standards,

shopping protocols, etc. and

ii) 

that a straightforward development of a legal framework for e-commerce can

be assumed and hence online-payments will get less important over time. For

example,  supposing  a  legal  framework  allowing  easy  online  contracting

between  merchants  and  consumers  existed,  the  need  for  immediate  online

payments  would  drastically  change.  Another  scenario  to  consider  would  be

that  of  a  trusted  third  party  payment  service  acting  as  a  building  block  in  a

18

developed e-commerce platform which would overcome the instant payment

bottleneck.

19

BIBLIOGRAPHY

Bank for International Settlements
Implications  for  Central  Banks  of  the  Development  of  Electronic  Money,  Basle  October  1996
http://www.bis.org/publ/index.htm

[“This report provides a definition of electronic money and a description of its key features. It discusses
the  factors  influencing  the  development  of  e-money  products.  Finally,  it  reviews  the  policy  issues
raised by e-money developments, as seen from a central bank perspective, and discusses the possible
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Böhle, Knud; Riehm, Ulrich
Elektronische  Geldbörsen  in  Zeiten  des  Internet  -  Ein  Beitrag  zur  sozialen  Gestaltung  der  E-Geld-
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war'  between  banks  and  non-banks,  and,  thus,  between  accounted  and  unaccounted  (cash-like)
electronic purse products. Specifically, they argue that CEPS is a bank standard designed to deter entry
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Böhle, Knud; Rader, Michael; Riehm, Ulrich (Eds.)
Electronic Payment Systems in European Countries. Country Synthesis Report. Karlsruhe: 1999
http://www.jrc.es/pages/projects/docs/Final-EPS-Vol.1.pdf

[A survey on electronic payment systems in ten European countries with cross-country comparison and
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Parliament]

Böhle, Knud; Riehm, Ulrich
Blütenträume  -  Über  Zahlungssysteminnovationen  und  Internet-Handel  in  Deutschland.  Karlsruhe:
Forschungszentrum Karlsruhe. Wissenschaftliche Berichte, FZKA 6161 (Dezember 1998) 1998
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Carat, Gerard
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Survey  of  Electronic  Money  Developments,  Bank  for  International  Settlements,  Basle,  Switzerland,
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Cruickshank, Don
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[Independent investigation of banking services in the UK, set up by the government in November 1998,
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21

European Central Bank
Improving cross-border retail payment services - Progress report  European Central Bank, Frankfurt a.
M. 2000
http://www.ecb.int/pub/pdf/retailps2000report.pdf

[“Fees for retail cross-border payments remain substantially higher than for domestic payments, … the
service  level  for  such  payments  needs  to  be  further  improved  and,  the  unlawful  double-charging
practices need to be eliminated as required by the Cross-border Credit Transfer Directive” are some of
the results of this ECB report.]

Godschalk, Hugo; Krueger Malte
Why e-money still fails – chances of e-money within a competitive payment instrument market. Paper
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[“This  study  analysis  the  current  performance  of  e-purse  schemes  and  the  role  of  regulation.  In
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Goldfinger, Charles
Economics of financial applications of the smart card: a summary overview. Brussels 1999
http://www.ispo.cec.be/fiwg/fasc.htm

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applications of smart cards]

Krueger, Malte; Godschalk, Hugo
Herausforderung  des  bestehenden  Geldsystems  im  Zuge  seiner  Digitalisierung  –  Chancen  für
Innovationen?  Gutachten  der  PaySys  GmbH.  Karlsruhe:  Forschungszentrum  Wissenschaftliche
Berichte, FZKA 6160 (November 1998) 1998

[Analysis of the interrelationship between technical innovation and institutional challenges and changes
in the payment sector]

Lelieveldt, Simon L.
Standardizing  Retail  Payment  Instruments.  In:  Jakobs,  Kai  (Ed.):  Information  Technology  Standards
and Standardization: A global perspective. Hershey PA and London 2000, pp. 186-197.

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for regulators, because implementation experiences should not be ignored and true competition within
the markets should tend to produce adequate standards by itself.]

OECD
OECD  Information  Technology  Outlook  2000:  ICTs,  E-commerce  and  the  Information  Economy,
March 2000.

[The  Outlook  contains  four  chapters  about  technological  and  policy  issues  surrounding  electronic
settlement of payments]

Papameletiou, Demosthenes
Study  on  Electronic  Payment  Systems  for  the  Committee  on  Economic  and  Monetary  Affairs  and
Industrial Policy of the European Parliament. Brussels and Luxembourg 1999
http://www.jrc.es/pages/projects/docs/ESTOCSRfinal.pdf

[Results of  an  expert  survey  (written  questionnaire)  embarking  more  than  500  persons.  The  report  is
one of the deliverables of the IPTS project on behalf of the European Parliament]

Riehm, Ulrich; Böhle, Knud
Geschäftsmodelle für den Handel mit niedrigpreisigen Gütern im Internet. In: Thießen, F. (Hrsg.):
Bezahlsysteme im Internet. Frankfurt am Main: Knapp 1999, S. 194-206

[The  article  focuses  on  indirect  income  models  for  providers  of  digital  goods  and  services  on  the
Internet]

22

SmartEuro project partners (on behalf of EUROSMART)
The Euro in the Electronic Purse. Interoperability issues of smartcard based e-payments in Europe. A
White Paper. Paris: ARTTIC 2000
http://www.eurosmart.com/download/WhitePaper.pdf

[Opinion paper of the European smartcard industry about e-purse interoperability and introduction of
the Euro. Technical constraints of the migration process are indicated and special emphasis is laid on
the  problem  of  clearing  and  settlement  of  e-money  in  Euroland,  a  problem  previously  not  taken  into
account sufficiently]

Van Hove, Leo
Electronic Purses, Interoperability, and the Internet. First Monday Vol. 4 No. 4 - April 5th. 1999
http://www.firstmonday.dk/issues/issue4_4/vanhove/index.html

[Rigorous analysis and interpretation of e-purse developments in the light of network economics]

Van Hove, Leo
Electronic Purses: (Which) Way to Go? First Monday Volume 5, Number 7 - July 3rd 2000
http://www.firstmonday.dk/issues/issue5_7/hove/index.html

[Scrutinised analysis of the deployment and the  use of  most e-purse  schemes in Europe based on the
data available]

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