DEMYSTIFYING DIGITAL

PAYMENTS
Amitabh Saxena
Managing Director, Digital Disruptions

November 12, 2014

We’ll spend the next 60 minutes going over two main topics.

1
Fundamentals of Card Payments
• Roles of Payment Networks
• Ecosystem Participants
• Transaction Processing
• Card Economics

 Based on Electronic Payment Systems 101 (available online)

2
Mobile Money as a Payment System
• Similarities and Differences to Card Network Schemes
• Interoperability: Benefits and Challenges

 Based on Electronic Payment Systems 201 (available online)

2
Electronic payments boost financial inclusion in two main areas.

Offers a safer, faster, cheaper, and more convenient way to

make and accept regular payments.
1. Enhances
Traditional Examples: a person-to-person transfer to a remote part of
Payments the country by text message; a merchant paying a supplier
through a debit card.

Allows additional utility or ease of access to standard bank

2. Enables products.
Standard
Examples: receiving government-funded social benefit
Banking transfers directly in a recipient’s bank account; storing
Products money on a prepaid card; using electronic transaction
history to help loan or insurance underwriting.

Electronic options are, on the whole, superior to cash and traditional

paper-based products such as checks and savings passbooks.
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Among all forms of payments, card networks offer the most promising
model for financial inclusion.

1970s Card Networks (near real-time, e-funds retail payments)

1970s Automated Clearing House (electronic batch process to automatically

debit or credit accounts)

1800s
Wire Transfer (real-time, usually large volume, e-funds transfer between
banks)

1500s Check (paper-based IOU)

700 BC Cash (notes, coins)

Global card networks offer security, speed, scale, and true ubiquity: accepted in (almost)
every country, at millions of merchants, with (almost) any bank, and on (almost) any device.

So a key question is: can this model be extended or adjusted for the underserved?

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A payment network is at the heart of so-called “Four-Party” Model,
connecting consumers, merchants, and their respective banks.

Four-Party Model

In reality, within this model there are other stakeholders who provide additional services,
such as loyalty and rewards, fraud reduction, POS terminal installation, as well as those
who take on outsourced activities, such as prepaid processing.

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Open-loop card networks like Visa and MasterCard perform three main
roles.

Visa and MasterCard are two payment networks that connect thousands of banks globally,
which in turn connect millions of consumers and merchants with each other. Domestic
network play much the same role at a local market level.

They are not financial institutions, do not directly interact with consumers and merchants,
and do not hold any funds.
1
Define membership Payment networks are open to member financial institutions,
rules and define the “rules of the game” for card payments.

2 Both consumers and merchants must have confidence that the

Build brand and
payment system will work – securely, quickly, and hassle-free –
trust
thus building trust, via brand promotion, is an on-going activity.
3
“Process” As tech companies in the payments industry, networks
Transactions provide key infrastructure to facilitate processing of card
payments.
Note that card networks such as American Express and Discover are, for the most part, “closed-loop” networks (i.e.,
not open to other bank members) and thus focus on #2 and #3.

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Authorization is when the issuing bank determines whether or not the
payment transaction goes through.

Step 1: Authorization

Note: Authentication occurs before transaction processing and is the act of verifying the
consumer’s identity. This usually happens by prompting the consumer to enter a Personal
Identification Number (PIN) or having the merchant compare the consumer’s signature on
the transaction receipt with the back of their card.

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The transaction is then cleared, i.e., sending the relevant financial
information of the transaction to the issuing and acquiring bank.

Step 2: Clearing

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Settlement is when the actual funds, net of any fees, between the two
banks are transferred and the merchant ‘s account is credited.

Step 3: Settlement

Note: This flow is for a credit card transaction. In the case of a debit or prepaid card
transaction, the cardholder’s account is debited immediately.

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Card network transaction economics are largely driven by two separate but
related features: merchant discount rate (MDR) and interchange.

Merchant Discount A fee, usually expressed a percentage of the sale (rate),

Rate that the acquiring bank charges the merchant for the
benefit to accept cards. This is the largest fee paid by
related but the merchant, and is set by the acquiring bank usually on
distinct a “cost-plus” pricing based on interchange.

A fee, usually expressed as a percentage of the sale (rate),

Interchange that the issuing bank charges the acquiring bank as a
“reimbursement” to take on certain activities and
financial risk (i.e., default, fraud) of the payment.

Interchange varies by card, merchant, and payment type,

and depending on the market, is set by the payment
network, a consortium of banks, or the government.
Note that closed-loop networks do not have interchange (as the issuing bank and acquiring bank is one and the
same), and thus keep all fees collected from the merchant.

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In the example below, the merchant fee is split between issuing (83%) and
acquiring banks (17%); both then pay “assessments” to the network.

Four-Party Model Transaction Economics

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Agenda

1
Fundamentals of Card Payments
• Roles of Payment Networks
• Ecosystem Participants
• Transaction Processing
• Card Economics

 Based on Electronic Payment Systems 101 (available online)

2
Mobile Money as a Payment System
• Similarities and Differences to Card Network Schemes
• Interoperability: Benefits and Challenges

 Based on Electronic Payment Systems 201 (available online)

12
Though not every deployment has yet been a success, mobile money
growth, on the whole, has been impressive and shows no sign of stopping.

Ubiquitous Card Network Model * Mobile Money Growth = Universal Financial Access?

Source: GSMA, MMU 2013 Mobile Financial Services State of the Industry Report. At time of publication, 13
deployment had more than 1M active users; 123 deployments offered mobile savings, insurance, and credit.

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Mobile operator-led mobile money schemes appear to resemble a
traditional “Three-Party” payment model…

Four-Party Model

Three-Party Model Mobile Money Model

Direct relationship with end-users

Combined platform/account-management
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Closed-loop
…with three main differences.

1Mobile money does not require providing

2
additional “hardware” to the consumer and Mobile operators manage agents,
merchant. Transactions occur with the mobile not merchants, in mobile money.
handsets already owned by the end-users, This resembles more the way a
decreasing the overall costs of the payment bank manages its fleet of ATMs.
system.

3
The underlying consumer account is prepaid, rather than credit. With consumer
credit cards, issuing banks make the majority of their revenue first through interest,
then consumer fees, and lastly through interchange. In contrast, most* mobile
money MNOs make relatively little revenue directly through payment transaction
fees, but benefit through greater use of its core business of voice and data.
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While interoperability among payment programs is desirable for all
participants, technological and organizational issues have held it back.
Interoperability means a way for payment programs to interact with each other (for
example, mobile money program A with mobile money program B), or between payment
schemes (for example, a mobile money program with a traditional card payment scheme).

Generally, this is mutually beneficial for all stakeholders:

•provides additional relevance and utility for consumers and merchants
•increases the overall revenue pool
•reduces structural inefficiencies

Two obstacles have prevented broader interoperability thus far:

No standards exist to-date for mobile money interoperability, or
Technological between mobile money and other schemes, most notable card
networks and money transfer. While there are one-off projects,
there is no wide-spread interactions among programs.
It is challenging to get competing stakeholders to collaborate (e.g.,
Organizational banks) as well as those that are cross-sector (e.g., banks, MNOs,
vendors, governments), especially if there some stand to gain or
lose more than others.
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 Questions or
comments?

[email protected]