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Update Newsletter: Spring 2002

Workshop Summaries

Following are summaries of selected workshops from our 2001-2002 Workshop Series. Full-text versions of these summaries, summaries of workshops not included here, and all of our discussion papers are available on this website.

Legal and Historical Precedents for Financial Privacy, Policy & Regulation

The Gramm-Leach-Bliley Act (GLB) broke down the remaining barriers between commercial and investment banking. While this provided potential advantages to many financial services firms and their customers, it also raised new concerns over the issue of privacy.

In May 2001, Anita Allen, a professor at the University of Pennsylvania Law School, led a discussion about privacy issues, particularly the privacy provisions included in GLB. Her remarks provided a chronological timeline for these issues and a context for the passage of the privacy provisions of GLB. Allen provided a detailed historical perspective on the evolution of privacy concerns in the U.S., from the Constitution's exclusion of the word "privacy," to the 1890 Harvard Law Review article citing privacy concerns associated with the newly invented camera and high-speed printing press, to modern-day concern over privacy on the Internet.

Legislative actions to address privacy concerns in the financial services arena did not emerge in the U.S. until the 1970s when Congress passed the Fair Credit Reporting Act, which applies to consumers and covers the allowable use of credit information. Later legislation further restricted access. For example, the 1974 Privacy Act mandated "fair information practices" and limited third-party access to personal records. That same year, the Freedom of Information Act gave the public access to government records (excluding medical and personnel files). Privacy rights were finally extended to banking and financial transactions with the Right to Financial Privacy Act in 1978.

Most recently, Congress passed GLB in 1999. The privacy provision in the act requires a financial institution to inform consumers that it may disclose "nonpublic personal information" to nonaffiliated third parties. However, consumers must be offered the opportunity to opt out of such disclosures. Allen advised caution when considering the question of how much protection consumers actually derive from the privacy provisions of GLB, which specifically permit information sharing among affiliated companies. With ever-increasing information processing capabilities, the consolidation of industry players, and an increasing number of companies with global affiliates, consumers' personal information could potentially be shared far more broadly than is the case today. At the same time, it may also be argued that responsive and responsible financial institutions will use new technologies to improve the delivery of value-added services.

Credit Cards, Interchange, and Payment Efficiency

Not very long ago, almost all consumer purchases were paid for with cash or checks. The introduction of the general-purpose credit card in 1966 changed the payments landscape. Since then, credit cards have become the preferred means of payment for many consumers' retail purchases, travel and entertainment expenditures, and even bill remittance.

Major credit cards, issued under the bankcard association brands of Visa and MasterCard, operate through an "open-loop" system. All transactions are processed through a centralized system, which must effectively authorize, transfer, and settle each transaction. Each transaction is part of a four-party system, which includes the merchant, the merchant's bank, the card-issuing bank, and the consumer or cardholder. In "closed-loop" systems, such as American Express and Discover Card, card issuing and the merchant-settlement processes are conducted by the same entity.

Interchange fees, which allocate costs and revenues between the issuing bank and the merchant's bank, were established by bankcard associations to provide a balanced incentive arrangement to encourage banks to issue cards to their retail customers and for merchants to agree to accept the cards. When merchants process a cardholder's purchase through their bank, they receive the purchase price less a discount. The acquiring bank then passes back a portion of this merchant discount, as an interchange fee, to the card-issuing bank.

Controversy and legal challenges have long surrounded interchange fees. Some critics have argued that cash and check payment mechanisms subsidize credit card users who do not pay an explicit price for transacting in the more costly medium. Others allege that interchange fees are anticompetitive because they encourage bankcard associations to exercise market power through the collective actions of their members.

This debate sparked the May 2001 workshop focusing on "Credit Cards, Interchange, and Payment Efficiency," led by David Humphrey of Flordia State University. He noted the many reasons consumers use credit cards: convenience, acceptability, delayed billing, perhaps even frequent flyer miles. But he questioned whether cardholders would continue to favor credit cards to the same extent if they — rather than the merchants — were explicitly charged the interchange fee used to compensate the issuing bank. Or in a world of explicit charges for the cost of payment vehicles — whether checks or debit and credit cards — would the market shift to a different and more efficient mix?

There is general agreement that interchange fees provided a very effective mechanism for establishing bankcard networks by providing an important balanced incentive to encourage early acceptance by all four parties in the "open-loop" bank card environments. The emerging debate in the U.S. and in several international markets is whether the interchange system will continue in the same form now that the bankcard network has matured and whether potential changes in pricing schemes will lead to a more efficient system overall.

EFT Industry Perspective & New Secure Payment Products

In June 2001, Paul Tomasofsky and Bruce Sussman of NYCE, the New York-based EFT network, led a workshop discussing the evolution of debit card applications and emerging Internet payment mechanisms.

The payment card industry has been a catalyst for innovation and the development of alternative payment mechanisms. One area that has been a major contributor to innovation is the electronic funds transfer (EFT) industry. As consumers' needs evolve and technology advances, the EFT industry continues to adapt and grow. From its early successes with ATMs to debit applications at the point of sale, the EFT industry has played an integral role in the payment card industry.

EFT networks such as NYCE provide support to issuers of online ATM and debit-card products. Transactions over these networks require the use of a PIN at the point of sale or at the ATM. This is in contrast to signature-based debit transactions that authorized and settled across the Visa or MasterCard networks in much the same way as a credit card transaction. The use of debit cards at the point of sale has grown rapidly in recent years as consumers have come to appreciate the convenience and sense of control over their finances that this product provides.

With over 40 percent of adults making online purchases in 2001, the Internet has become a viable market for developing payment vehicles. While the credit card is the payment mechanism of choice for Internet transactions, an absence of authentication capabilities exposes online retailers to increased risk of fraud.

One result has been the emergence of fraud detection services. While these services provide protection against fraud, they also increase the cost of doing business on the Internet. Accordingly, companies that sell over the Internet are looking for safer and cheaper payment mechanisms. At the same time, Tomasofsky noted that many consumers are concerned about the security limitations of credit card use on the Internet and have been reticent to shop through this medium, inhibiting sales growth. A number of innovative solutions to this problem are emerging in various sectors of the payment cards industry, including debit-card providers.

NYCE's SafeDebit was created to address these issues. This PIN-secured Internet debit payment product allows consumers to pay for purchases on the Internet with funds drawn directly from their checking accounts.

The Payment Cards Center continues to monitor these and other new developments, since we believe the creative application of payment cards to the Internet is an important means to improving the efficiency and effectiveness of the payments system.

Dynamics in the Consumer Credit Counseling Services

In July 2001, an expert panel led a discussion on the role of credit counseling firms mediating between financially troubled consumers and their unsecured credit card lenders. The workshop highlighted the activities of counseling services and the structure of their relationships with lending institutions.

The consumer credit counseling service (CCCS) firms represented at the workshop are part of a national association of nonprofit organizations that provide consumers with confidential money-management, homeowner-counseling, and education services. Jerome Johnson, president and CEO of CCCS of South Jersey, opened the discussion with a historical perspective of the credit counseling industry. He also described the agencies' economic model, which is based on "fair share" payments from creditors to the agencies in recognition of the agencies' work with creditors' borrowing customers. Since credit counseling is often an alternative to bankruptcy for financially strapped consumers, these agencies provide a clear benefit to creditors.

Panelists Ghyll Theurer, program manager of CCCS of South Jersey, and James Godfrey, executive vice president of CCCS of Maryland, shared insights on the changing dynamics leading to lower reimbursement rates paid to CCCS by the creditors they serve. According to Theurer and Godfrey, the greatest contributing factor to this change has been the rapid emergence of new, for-profit agencies.

The new entrants, focusing primarily on debt-management plans, tend to be more efficient and technologically advanced than their nonprofit counterparts. Moreover, their willingness to negotiate reduced reimbursement rates with issuers has enhanced their appeal. While this increased competition has had the positive result of forcing industry improvements in service and productivity, it has had negative ramifications as well. Unfortunately, in addition to legitimate new industry entrants, some organizations have set up dubious operations known as "debt mills." Unlike the nonprofit CCCS organizations and the for-profit agencies that take a holistic approach and emphasize education and behavioral changes, debt mills focus exclusively on profitable debt-management programs that often require consumers to pay high program set-up fees. Creditors have responded not only by lowering the level of payments to credit counseling agencies but also by enforcing stringent restrictions on applicants and tight concession terms. The panelists argued that a history of trust between creditors and counseling services has been eroded, increasing costs to both parties.

Patricia Hasson, president of CCCS of Delaware Valley, led the final segment of the workshop. She discussed proposed new bankruptcy legislation, which would require consumers to complete a financial education course before being allowed to declare bankruptcy. The immediate impact would provide CCCS agencies with more opportunities and the potential for a more proactive role in the industry, given these agencies' historic role in providing financial education.