Types of Electronic Payment Systems
Types of Electronic Payment Systems
Types of Electronic Payment Systems
Module 2
Electronic payment systems are proliferating in banking, retail, health care, on-line
markets, and even government—in fact, anywhere money needs to change hands.
Organizations are motivated by the need to deliver products and services more cost
effectively and to provide a higher quality of service to customers.
The emerging electronic payment technology was labeled electronic funds transfer
(EFT).
EFT is defined as “any transfer of funds initiated through an electronic terminal,
telephonic instrument, or computer or magnetic tape so as to order, instruct, or authorize
a financial institution.
Work on EFT can be segmented into three broad categories:
1. Banking and financial payments
Large-scale or wholesale payments (e.g., bank-to-bank transfer)
Small-scale or retail payments (e.g., automated teller machines)
Home banking (e.g., bill payment)
2. Retailing payments
Credit Cards (e.g., VISA or MasterCard)
Private label credit/debit cards (e.g., J.C. Penney Card)
Charge Cards (e.g., American Express)
3. On-line electronic commerce payments
a) Token-based payment systems
Electronic cash (e.g., DigiCash)
Electronic checks (e.g., NetCheque)
Smart cards or debit cards (e.g., Mondex Electronic Currency Card))
New forms of financial instruments are developed. One such new financial instrument is
“electronic tokens” in the form of electronic cash/money or checks.
1. Cash or Real-time
Transactions are settled with exchange of electronic currency.
Ex: on-line currency exchange is electronic cash (e-cash).
2. Debit or Prepaid
Users pay in advance for the privilege of getting information.
Ex: prepaid payment mechanisms are stored in smart cards and electronic purses
that store electronic money.
3. Credit or postpaid
The server authenticates the customers and verifies with the bank that funds are
adequate before purchase.
Ex: postpaid mechanisms are credit/debit cards and electronic checks.
1. Monetary value
2. Interoperability
3. Retrievability
4. Security
1. E-cash must have a monetary value; it must be backed by either cash, bank authorized credit
or a bank-certified cashier’s check. When e-cash created by one bank is accepted by others,
reconciliation must occur without any problems.
2. E-cash must be interoperable- that is, exchangeable as payment for other e-cash, paper cash,
goods or services, lines of credit, deposits in banking accounts, bank notes or obligations,
electronic benefits transfers.
3. E-cash must be storable and retrievable. Remote storage and retrieval (eg, from a telephone
or personal communications device) would allow users to exchange e-cash from home or office
or while travelling. The cash could be stored on a remote computer’s memory, in smart cards,
or in other easily transported standard or special-purpose devices. One example of a device that
can store e-cash is the Mondex card- a pocket-sized electronic wallet.
The purchase of e-cash from an on-line currency server (or bank) involves two steps:
Some customers might prefer to purchase e-cash with paper currency, either to maintain
anonymity or because they don’t have a bank account.
Once the tokens are purchased, the e-cash software on the customer’s PC stores digital
money undersigned by a bank.
The users can spend the digital money at any shop accepting e-cash, without having to
open an account there or having to transmit credit card numbers.
As soon as the customer wants to make a payment, the software collects the necessary
amount from the stored tokens.
Two types of transactions are possible: bilateral and trilateral.
Transactions involving cash are bilateral or two-party transactions, whereby the
merchant checks the veracity of the note’s digital signature by using the bank’s public
key.
Transactions involving financial instruments other than cash are usually trilateral or
three-party (buyer, seller and bank) transactions, whereby the “notes” are sent to the
merchant, who immediately sends them directly to the digital bank. The bank verifies
the validity of notes and that they have not been spent before. The account of the
merchant is credited.
In many business situations, the bilateral transaction is not feasible because of the
potential for double spending, which is equivalent to bouncing a check.
Double spending becomes possible because it is very easy to make copies of the e-cash,
forcing banks and merchants to take extra precautions.
To uncover double spending, banks must compare the note passed to it by the merchant
against a database of spent notes.
Electronic Checks
Smart cards have been in existence since the early 1980s and hold promise for secure
transactions using existing infrastructure.
Smart cards are credit and debit cards and other card products enhanced with
microprocessors capable of holding more information than the traditional magnetic
stripe.
The smart card technology is widely used in countries such as France, Germany, Japan,
and Singapore to pay for public phone calls, transportation, and shopper loyalty
programs.
Smart cards are basically two types:
Relationship-Based Smart Credit Cards
Electronic Purses, which replace money, are also known as debit cards and
electronic money.
It is an enhancement of existing cards services &/ or the addition of new services that
a financial institution delivers to its customers via a chip-based card or other device.
These services include access to multiple financial accounts, value-added marketing
programs, or other information card holders may want to store on their card.
It includes access to multiple accounts, such as debit, credit, cash access, bill payment
& multiple access options at multiple locations.
Electronic Purses
To replace cash and place a financial instrument are racing to introduce “electronic
purses”, wallet-sized smart cards embedded with programmable microchips that store
sums of money for people to use instead of cash for everything
The electronic purse works in the following manner:
1. After purse is loaded with money at an ATM, it can be used to pay for candy in
a vending machine with a card reader.
2. It verifies card is authentic & it has enough money, the value is deducted from
balance on the card & added to an e-cash & remaining balance is displayed by
the vending machine.
If consumers want to purchase a product or service, they send their credit card details
to the service provider involved and the credit card organization will handle this
payment.
Credit card payment on on-line networks can be divided into 3 categories:
1. Payments using plain credit card details: The easiest method of payment is the
exchange of unencrypted credit cards over a public network such as telephone lines
or the internet. But this is problematic as there is no security.
2. Payments using encrypted credit card details: in this method, encrypted credit card
details are sent on the network.
3. Payments using third-party verification: one solution to security and verification
problems is the introduction of a third party: a company that collects and approves
payments from one client to another.
5. The customer’s bank returns the credit card data, charge authentication, and
authorization to the merchant.
In this scheme, each consumer and each vendor generates a public key and a secret key.
The public key is sent to the credit card company and put on its public key server.
The secret key is re-encrypted with a password, and the unencrypted version is erased.
To steal a credit card, a thief would have to get access to both a consumer’s encrypted
secret key and password.
Nobody can cheat this system. The consumer can’t claim that he didn’t agree to the
transaction, because he signed it.
The vendor can’t invent fake charges, because he doesn’t have access to the consumer’s
key.
In third party processing, consumers register with a third party on the Internet to verify
electronic microtransactions.
Verification mechanisms can be designed with many of the attributes of electronic
tokens.
They differ from electronic token systems in that
1. They depend on existing financial instruments
2. They require the on-line involvement of at least one additional party, and in some
cases multiple parties to ensure extra security.
Payments can be made by credit card or by debiting a demand deposit account via the
automated clearinghouse, this is referred as on-line third-party processors (OTPPs).
4. The OTPP payment server verifies the customer’s account number for the vendor
and checks for sufficient funds.
5. The OTPP payment server sends an electronic message to the buyer. This message
could be an automatic WWW form that is sent by the OTPP server or could be a
simple e-mail. The buyer responds to the form or e-mail in one of three ways: Yes,
I agree to pay; No, I will not pay; or Fraud, I never asked for this.
6. If the OTPP payment server gets a Yes from the customer, the merchant is informed
and the customer is allowed to download the material immediately.
7. The OTPP will not debit the buyer’s account until it receives confirmation of
purchase completion. Abuse by byers who receive information or a product and
decline to pay can result in account suspension.
Customer's risks
1. Stolen credentials or password
2. Dishonest merchant
3. Disputes over transaction
4. Inappropriate use of transaction details
Merchant’s risk
1. Forged or copied instruments
2. Disputed charges
3. Insufficient funds in customer’s account
4. Unauthorized redistribution of purchased items
Main issue: Secure payment scheme
Benefits of EDI
• Cost & time savings, Speed, Accuracy, Security, System Integration, Just-In-Time
Support.
• Reduced paper-based systems, i.e. record maintenance, space, paper, postage costs.
• Improved problem resolution & customer service.
• Expanded customer/supplier base or suppliers with no EDI program lose business.
• The EDI sematic layer describes the business application. For a procurement
application, this translates into requests for quotes, price quotes, purchase orders,
acknowledgements, and invoices. This layer is specific to a company and the software
it uses.
• The information seen at the EDI semantic layer must be translated from a company
specific form to a more generic or universal form so that it can be send to various trading
partners, who could be using a variety of software applications at their end.
• EDI standards specify business form structure so that information can be exchanged.
• Two competing standards
American National Standards Institute(ANSI)X12
EDIFACT developed by UN/ECE, Working Party for the Facilitation of
International Trade Procedures.
• The EDI transport layer corresponds closely in sending a business form from one
company to another. The business form could be sent via regular postal service,
registered mail, certified mail or private carrier such as UPS (United Parcel Service).
• EDI document transport is far more complex than simply sending e-mail messages or
sharing files through a network, a modem, or a bulletin board.
• The relationship between EDI and e-mail can be ambiguous as e-mail systems become
very sophisticated and incorporate more and more form-based features.
EDI in Action:
• The idea behind EDI is very simple. EDI takes manually prepared form or a form from
a business application, translates that data into a standard electronic format and
translates it.
• The fig shows the information flow when paper documents are shuffled between
organizations via the mailroom.
• When the buyer sends a purchase order, then relevant data extracted & recorded on a
hard copy.
• This hard copy is then forwarded to the seller after passing through several steps and at
last manually entered into system by the data entry operators.
• This process is somewhat overhead in labor costs & time delays.
EDI can substantially automate the information flow and facilitate management of the business
process as shown in below figure.
The EDI transactions for a purchase, shipment and corresponding payment are as follows:
• EDI has always been very closely linked with international trade.
• Trade efficiency, which allows faster, simpler, broader & less costly transactions is a
necessity thing.
• EFTS is credit transfers between banks where funds flow directly from the payer’s bank
to the payee’s bank.
• The two biggest funds transfer services in the United States are the Federal Reserve’s
system, Fed wire, & the Clearing House Interbank Payments System (CHIPS) of the
New York clearing house
• ACH transfers are used to process high volumes of relatively small-dollar payments for
settlement in one or two business days.
• It provides services: preauthorized debits, such as repetitive bill payments; & consumer
initiated payments.
Companies using JIT & EDI calculates how many parts are needed each day based on
the production schedule & electronically transmit orders.
Delivery has to be responsive, or it will cost too much in money & time.
A major benefit of JIT & EDI is a streamlined cash flow.
For the customer, QR means better service & availability of a wider range of products.
For the retailer & supplier, QR may mean survival in a competitive marketplace.
Much focus of QR is in reduction of lead times using event-driven EDI.
In QR, EDI documents include purchase orders, shipping notices, invoices, inventory
position, catalogs, & order status.
EDI software has four layers, business application, internal format conversion, EDI
translator, and EDI envelope for document messaging.
These 4 layers package the information & send it over the value-added network to the
target business, which then reverses the process to obtain the original information.
Prices for EDI products vary form no cost to several thousands of dollars for full-
function applications.
The final cost depends on several factors:
1. The expected volume of electronic documents.
2. Economics of the EDI translation software.
3. Implementation time.
Maintenance fees and VAN charges can vary and affect the cost of EDI systems.
**************