Electronic Payments

The summer of 2010 will be a season of compliance, with deadlines looming for new statutes and regulations on electronic payments, including ATM, debit card and gift card transactions. Beyond the challenge of compliance is the quickly unfolding question of mobile banking, which, with the rapid leap from SMS to smart-phone formats, left some technology vendors playing catch-up on next-generation delivery, even before most banks added a first-generation offering. Meanwhile, web-based, non-bank services like PayPal and Square are pressing forward on mobile payments, with unclear consequences for commercial banks. . In response to these changes many banks are re-evaluating their product mix, hoping that as the deadline-laden summer passes their product lines will continue to be competitive as well as compliant.. "This summer, the payments sphere is really all about compliance," said Viveca Ware, senior vice president of regulatory policy for the Independent Community Bankers of America. Ware noted that more time spent on compliance generally means less time for innovation—a source of concern as the industry tries to keep up with consumer demand for a changing range of electronic payments. .Changing regs, new laws. Compliance deadlines for changes to Regulation E are coming up on July 1 and August 22. The rule changes pertain to overdraft services on ATM/debit card transactions, as well as disclosures, fees and expiration dates on gift cards.. "The rules only allow financial institutions to charge an overdraft fee for ATM and everyday debit card transactions if the consumer affirmatively opts in to the program," Ware said. "It's complex because in many instances overdrafts can still occur even though the bank does everything it can to avoid them. Those overdrafts occur due to the actual timing of the transactions," she said.. Although debit card transactions are processed in real time, there is a delay—sometimes of several days—in actual settlement. "Anything can happen during that delay," said Cary Whaley, ICBA's vice president of payments and technology policy. What often happens is that checks clear, pushing an account that had sufficient funds at the time of a card authorization into overdraft by settlement time.. "The bank has put itself on the hook for that transaction, and checks are clearing and coming in. So it will present exposure," Whaley said. "The difference is that when there is a fee, obviously banks can absorb some risk when there is a reward.". All big banks and many community banks process in real time, but some smaller banks still use batch and offline services, which could make them more susceptible to ATM and debit card overdrafts. . "The irony of all of this is that they weren't the banks that were charging exorbitant fees to their customers. And yet, they are the ones who are having to figure out how to decrease their exposure, and make back the revenue from overdrafts, or install systems that may be costly," Whaley said.. Even if all banks processed in real time, there would still be the challenge of incoming checks.. "There isn't a real-time system for checks. The bank only knows that a check was written when it is presented to them for payment," Ware said, adding that the Reg E rule changes could be confusing to consumers, who will be asked to opt in for ATM and debit cards but not for checks.. "Before this regulation, you either had overdraft protection or you didn't," Whaley added. "Now suddenly you have a fragmented product. From a banking product implementation perspective, you have taken a product that has always been explained to the consumer as a whole [product]; now it's in shards.". Ware said these changes differ from other regulatory updates in that they require a lot of staff training and consumer outreach. Banks have to inform their customers of the potential payment headaches associated with not opting in—but they have to do so without seeming to push or threaten customers and without altering terms for customers who choose not to opt in.. "It's certainly going to be very costly and onerous for community banks—really, financial institutions of all sizes—to comply," Ware said.. Beside the changes in Reg E, banks also face an August 22 implementation deadline for the third phase of the Credit CARD Act of 2009, which was signed into law a year ago by President Obama. Key provisions include restrictions on penalty fees for credit card payments. And, like the Reg E changes, the card law involves new rules for gift card programs.. In addition to defining standards for gift card disclosures, the new rules affect gift card expiration dates and inactivity fees. . "This severely cuts into the pricing and limits the amount of fees banks can charge," Whaley said. "The question in all these situations is: 'How does this change my product line?' Banks will re-examine their products and their pricing to figure how to deal with the changing revenue models." .Movement on mobile. Compliance pressure coupled with ongoing credit quality concerns and weaker earnings may make it hard for the banking industry to move as aggressively as it would like into mobile banking.. That concerns some community banking advocates, including Chris Nichols, CEO of Banc Investment Group (BIG), the San Francisco-based subsidiary of Pacific Coast Bankers' Bancshares, which serves 4,000 community banks nationwide through Pacific Coast Bankers' Bank. . "Banking isn't the easiest industry right now, and with everything on [bankers'] plates…mobile banking and marketing in particular have largely fallen off the top of the list," Nichols said.. "The industry was largely reactive to mobile banking when it was in SMS form," Nichols said. "When we saw the huge boon a year-and-a-half ago on the smart phone basis, with the Blackberry and iPhone in particular, and now with the Droid, it changed the mobile banking channel dramatically in our eyes.". Nichols said there is an urgency surrounding mobile banking.. "We said, 'if you've got a three-year plan you'd better move that up,'" Nichols said. "Banks need to make this decision, need to be in the marketplace within a year's time or 18-months' time because this market is developing so fast that you don't want to drive your customers to another channel.". Bankers are getting the message, at least according to a nationwide survey BIG released in April. When asked what initiatives they were undertaking in 2010, the highest percentage—44 percent—of community bank respondents said they were interested in purchasing or upgrading a mobile banking platform. Mobile banking significantly outpaced online cash management or CRM platforms, the next most popular initiatives, which 22 percent of the 687 respondents cited as their top priority.. Among respondents who already had mobile banking, 89 percent said they were "considering some form of enhancement to their mobile banking platform." The most-cited enhancement, at 54 percent, was an application for smart phones.. Nichols said about 9 percent of respondents planned to change their vendors, and 4 percent planned to discontinue their mobile banking service. In both cases vendor readiness was a factor.. "A lot of it was integration issues. A lot of it was, for example, text or SMS technology where the markets really evolved to a smart-phone format and the vendor they chose didn't keep up. So they're questioning that: did they miss the boat or did they pick the wrong vendor, or when will the vendor come up to speed?" Nichols said.. Whaley also noted that vendor readiness is an issue.. "Anecdotally, I know of at least 10 cases of banks that are just waiting for their vendors to get their products mature," he said. .Getting Square. But Whaley and Nichols both expect significant increases in mobile banking penetration over the next 18 months.. Whaley runs his own annual technology survey and said that in last year's results about 11 percent of community banks were offering mobile banking; the figure rose to 14 percent among banks with $500 million or more in assets. But 30 percent of respondents said they planned to increase their spending on mobile banking. When new results are released this fall, Whaley predicts that "these numbers will go up significantly," particularly among banks with $250 million or more in assets.. Nichols's forecast is similar: "There's about a 10-percent penetration right now for all customers, and it's really at small stages. But growth will be extremely fast, also in the 10- to 12-percent range, coming up," he said. Growth is primarily being propelled by Baby Boomers, he said.. "Banks may think they need online applications or mobile banking applications to capture that 20-something crowd…but that's not really where your market is," he said. "The growth of the iPhone is driven by the Baby Boom generation. Facebook, same thing, social media. It's not the 20-something crowd that's driving that phenomenon. It's the Baby Boomers who are picking it up and running with it, and those are really the customers we want as community banks.". The key strategic question is, as customers get accustomed to communicating with their banks or managing accounts with their cell phones, will they then demand full payment capabilities—what Whaley describes as the "mobile phone as wallet rather than just a method of communicating with the bank?". Web-based services such as PayPal and Square are developing that market already, with smart phone applications that help users make and receive payments through their phones. Square, which was developed by Twitter creator Jack Dorsey, turns iPhones into credit card terminals using a peripheral card reader that plugs into the headphone jack. Square also made a much touted debut on Apple's recently launched iPad.. Keeping up with, and defining a role in, mobile payments will be an ongoing challenge for banks.. "Square, PayPal, other person-to-person or person-to-business payment systems that are outside banking, keep us up at night," Nichols said. "Banks have a trust factor, have the infrastructure, the knowledge base to really dominate this market, and we feel that if community banks in particular don't move quickly, we're going to lose out to these payment companies." .Sidebar: Industry fights bill affecting interchange fees. The banking industry trade groups are working to oppose the Credit Card Fair Fee Act (H.R. 2695), which would restrict banks' ability to charge interchange fees on credit and debit card transactions. If passed, community banks would no longer be able to provide payment system services on a par with larger competitors, effectively eliminating them from this marketplace.. Kenneth Clayton, senior vice president and general counsel for the American Bankers Association, issued the following statement on April 28, the date of a hearing on the legislation by the House Judiciary Committee:. "The American Bankers Association remains opposed to legislation that would disrupt our nation's properly functioning electronic payments system. The Credit Card Fair Fee Act represents yet another attempt by the merchant community to try, at the behest of large retailers, to get Congress to lower their cost of doing business, all to the detriment of consumers and the broader economy.. "Banks of all sizes – from the largest global financial institutions to the smallest community banks throughout the country – take on significant risks and costs when they issue both debit and credit cards. These include extensive infrastructure costs, fraud costs and the real risk of non-payment. Interchange fees compensate banks for taking on these burdens and make it possible for banks to offer consumers better services, more competitive choices, and lower prices.. "The legislation under consideration would take away these benefits and inappropriately shift the cost burdens on to consumers. It is simply another attempt by retailers to get government to intervene on their behalf in what are clearly business-to-business transactions.. "Congress should see right through this thinly-veiled effort of retailers to artificially increase their profits. The cumulative impact of this bill and the multitude of new regulations that traditional banks are facing would significantly impact their ability to serve their local communities and get our economy moving again."