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Friday, September 4, 2015

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Update Newsletter: Winter 2005

PCC Industry Specialists Contribute New Research

James C. McGrath: “Will Online Bill Payment Spell the Demise of Paper Checks?”

In the discussion paper “Will Online Bill Payment Spell the Demise of Paper Checks?,” PDF James McGrath examines the evolution of online bill payment and considers the role played by increased consumer adoption of this channel in the decline of paper checks.

According to Federal Reserve research, since 2000, the number of checks has declined, on average, 4.3 percent annually. Moreover, in 2003, for the first time, total consumer electronic payments surpassed check payments. McGrath notes that the use of electronic payments such as credit and debit cards at the point of sale has generally contributed to the decline in check use. He examines the phenomenon of check replacement in the context of bill payments to better understand whether this substitution effect is also occurring here and to what extent.

McGrath reviews the online bill payment market in detail to highlight characteristics that are influencing the speed with which consumers adopt electronic payment mechanisms for bill payment. McGrath notes that online bill payment technology is developing along two paths: the biller-direct model and the consolidator model. In the biller-direct model, consumers visit billers’ websites directly to pay a specific bill. In the consolidator model, typically offered by banks and other third parties as a one-stop-shop, consumers can instruct their bank to pay any number of bills. Each model has its own set of advantages and limitations, and for both, growth has been somewhat uneven.

In the future, McGrath expects the growth of online bill payment to be driven by “rapidly evolving technology, the many stakeholders, and the interplay between supply and demand factors.” As evidence of technology's role, he points to the increasing use of broadband—to gain access to the Internet—as having done much to improve the speed with which transactions can be conducted and making the online bill payment process more convenient for consumers.

Consumers are not the only stakeholders in this market; others include billers, banks, payment card issuers, networks, and third-party application providers. McGrath asserts that the more these entities are able to coordinate the bill payment offering, making it simpler for all involved, greater efficiencies will be realized and will speed the reduction of checks in the bill payment process. He also suggests that to encourage continued consumer adoption of online bill payment, market participants must address supply-side impediments, including the cost to provide the service and the scale needed to improve cost structures, and demand-side impediments involving ease of use and safety concerns.

In summary, given current trends in online bill payment adoption, McGrath believes that if gains in technology and efficiencies continue and market participants address supply-side and demand-side impediments, check usage for generally recurring bill payments will continue to decline.

McGrath’s paper was also highlighted in a recent Electronic Payments Week article titled “Online Bill Payment Connected to Check Decline.”

Julia S. Cheney: “Identity Theft: Do Definitions Still Matter?”

In the discussion paper “Identity Theft: Do Definitions Still Matter?,” PDF Julia Cheney examines four types of fraud that fall under the legal definition of identity theft. Based on the definition of identity theft in the Identity Theft and Assumption Deterrence Act of 1998 and later confirmed in the Fair and Accurate Credit Transactions Act of 2003 (FACT Act), identity theft occurs whenever a “means of identification,” i.e., a piece of identifying information such as a name, address, or payment card number, is compromised and used to perpetrate a crime. In the FACT Act, this definition is also the basis for triggering consumer rights and protections to assist victims in preventing identity theft and remedying its effects.

In her more nuanced analysis, Cheney delineates four subcategories of identity theft. By discussing the characteristics of each of these fraud types, she demonstrates that detection strategies, mitigation efforts, and victim responses will all require different actions, depending on the type of identity theft crime committed. In particular, several features, including the sort of data stolen, the type of account compromised, and the opportunity for financial gain, are key variations in the pattern of criminal behavior. The paper concludes by noting three areas that would benefit from more precise definitions and distinction among types of identity theft: measuring and monitoring the success of efforts to fight identity theft crime, educating consumers about the different risks and responses to this crime, and coordinating mitigation strategies across stakeholders and geographies.

Briefly, the four types of identity theft described in the paper are:

Fictitious identity fraud. This crime occurs when pieces of real data, from one or more consumers, are combined with made-up information to fabricate an identity that does not belong to any real person in order to create access to new credit. In most cases a completely new credit record is established and linked to the fabricated identity. A range of credit facilities are generally established under the fabricated identity before the borrower defaults on all. Typically, there is no consumer victim of this crime, but rather, lenders are faced with the associated financial loss.

Payment card fraud. This crime is committed when stolen payment cards or the account numbers (i.e., credit or debit card account numbers) of existing financial accounts are used to purchase goods and services. In this case, there is a consumer/victim, but industry experience and consumer protection regulations limit losses for these consumers.

Account takeover fraud. This crime happens when a thief establishes control over an existing financial account without the authority or knowledge of the legitimate account holder. Thieves attempt to steal the entire balance in a consumer’s demand deposit account or access the full credit line associated with a consumer’s credit account before the fraudulent activity can be detected. Account takeover fraud has the potential to victimize consumers more than payment fraud, although, as in the case with payment card fraud, existing federal regulations limit consumer liability for related fraudulent activity.

True name fraud. This crime is the wholesale assumption of another person’s identity in an effort to gain access to new credit. Thieves steal personal information — such as name, address, and Social Security number — that allows them to use the victim’s credit record when applying for new loans. This type of identity theft results in not only direct financial losses for its victims but also other damaging effects, such as a deterioration in credit scores, higher interest rates, and an inability to access new loans. In this case, the FACT Act provides important new rights and protections to consumers who become victims of this type of identity theft.

Each of these forms of identity theft presents different risk factors for victims and lenders, and they require nuanced strategies in response to these financial crimes. Cheney discusses how the variation in these crimes calls for differentiated responses by both consumers and lenders. She concludes by highlighting several areas where definitions do matter and greater differentiation among identity theft frauds would, in her opinion, aid efforts to develop effective solutions.

Cheney’s paper was also highlighted in a recent Associated Press article titled “Identity theft ill-defined, often misunderstood; Some experts say lawmakers and firms misdirect antifraud energies, make consumers overly fearful.”

Mark Furletti: “The Laws, Regulations, and Industry Practices That Protect Consumers Who Use Electronic Payment Systems: Policy Considerations”

“The Laws, Regulations, and Industry Practices That Protect Consumers Who Use Electronic Payment Systems: Policy Considerations” PDF is the third in a series of research papers examining the laws, regulations, and voluntary industry practices aiding consumers who contest an electronic transaction as being fraudulent, erroneous, or the subject of a dispute with a merchant.

Furletti considers how the protections associated with four electronic payment products — credit cards, debit cards, prepaid cards, and ACH e-checks — addressed in the series’ initial papers affect market participants. His analysis yields three conclusions: First, current protection mechanisms do not always work to encourage adoption of fraud reduction practices. Second, existing protections represent a significant cost to banks, merchants, processors, and consumers. Third, federal protection regulation is not consistent across payment types, and while the rule making approach may serve to foster market driven innovation, it may also lead to consumer confusion.

Furletti poses an “ideal” system of fraud risk allocation that would encourage consumer usage of card products, provide all parties with incentives to exercise due care, and incorporate risk sharing for any fraud reduction scheme that provides a net benefit to the system as a whole. He argues that the current consumer protection framework has been very successful in meeting the first of these goals, but market incentive structures are often in conflict with the remaining two goals. He concludes that the current protection mechanisms make it more difficult to encourage adoption of fraud reduction schemes.

In addition, Furletti considers whether market participants are accurately assessing the costs to support the current system of consumer protections, especially those mandated by federal regulation. He notes consumer protection support costs include both direct fraud losses and processing costs, which are costs related to maintaining systems to facilitate interaction between the various parties to an electronic transaction and any respective reversal of that charge as a result of fraud, error, or dispute. While such cost information is limited, his analysis suggests that the amounts are significant business factors. Furletti argues that more explicit attention needs to be paid to the costs and benefits associated with such regulation.

In conclusion, Furletti describes the evolution of federal consumer protection regulation and how it has resulted in regulation that is piecemeal and varies by product. This approach may be seen as purposely limited in scope and supportive of market innovation, but it also results in a lack of consistency across electronic payment mechanisms. It allows consumer protections to target the attributes and risk factors associated with particular payment applications. At the same time, consumers face a matrix of consumer protections that depend on the type of payment application and how it is used, making it potentially confusing for consumers when trying to understand the protections provided by payment tools that have similar functional outcomes.

Furletti’s series of papers addressing consumer protection are highlighted in a special section of the PCC’s website. (The first two papers in the series were cowritten with Stephen Smith of the Bank’s Legal Department.)