How does one get started in a deeper and complex domain like FinTech? This book “Payments Systems in the US: A Guide for the Payments Professional” by Russ Jones, Carol Coye Benson and Scott Loftesness stays true to its title and provides a fundamental understanding of payments systems in the United States. However, the basic principles can be applied for other nations also, with certain allowance for regulatory and historical context specific to a country
The book starts with an overview of the payments system, salient features of open and closed loop payments models – which operate without any intermediaries. Scalability and effective means for allocation of liabilities for the former, simplicity for the latter. Also in an open loop network, it’s always a bank which is responsible for a transaction to the network
Without assuming any background from the reader, authors describe that any payment system must provide for 3 basic functions – processing (switching and settlement), operating rules and Brand (communication with each other on how they will pay). Simple concepts around push and pull transactions are explained including why push payments are fundamentally less risky. Managing risk (credit, fraud and liquidity) and float concepts (money earned over period of time) are also explained lucidly
There are fundamentally five types of payments systems – cash, checking system, card system, automatic clearing house (ACH) and wire transfer system. A network system OTOH writes rules for its network e.g. Mastercard card network
A. Checks
- The bank of the first deposit is under no legal or regulatory obligation to clear the check in a specific way
- Check guarantee service can make economics of check poorer for a retailer
B. ACH
- Only payment system that can handle both push and pull transactions
- A business receiving an unauthorized ACH debit does not have the same regulatory protection as a consumer has
- There is no interchange in the ACH system, no float and no lending revenue
C. Cards
- Card issuing bank (serving consumers) often have more power than card acquiring (serving merchants) banks
- Most card networks offer credit and debit cards with the exception of AmEx (a closed loop network) which doesn’t offer a debit card
- Interchange is the mechanism by which value-receiving merchants compensate the cost -incurring issuers for expenses on each transaction and tries to restore balance. It’s part of a larger merchant discount rate imposed by the acquiring bank on the merchant. OTOH closed loop networks don’t have an interchange fee
- Chargeback happens when a card issuer reverses a merchant credit transaction. Can be of 3 types – fraud, service (no product received) and technical
- Gateway is a specialized processor that serves needs of a specific merchant group
- Payments facilitators are sometimes called as aggregators since they aggregate a number of merchants to be processed by a single acquirer
D. Cash
- Merchants are not required by law to accept cash. Legal tender actually means settlement of a debt using cash
E. Wire Transfer
- Open loop system, a wire transfer cannot be repudiated without consent of the receiver
- SWIFT is not a payment system but a global financial service messaging platform which is secure and structured
Some insights from the book that stood out for me
- Ad valorem fees are better than flat fees
- Businesses pay to be paid, banked customers don’t pay for payment while unbanked ones do
- There are two ways to effect change in consumer behavior: increase in convenience or financial gain
- Extra security doesn’t lead to extra adoption
- Solutions that help merchants reduce costs are relatively less important to merchants than those that increase revenue
- For banks, payments business is more stable and less risky than lending business
- Payments innovation can happen in any of the 3 steps – payment initiation, funding and completion
- It’s easier to drive adoption if only one party between consumer and merchant is required to change
Excellent book, must read if you are interested in knowing what goes on the wire when you swipe your card, scan that QR code at a merchant or when you order stuff online! You can order the book on Amazon
PS: Thanks to Mohsen, our co-founder at Tamara for suggesting the book. It’s been a terrific find 🙂
The Learning Curve: Interesting Readings for Product Leaders 