Take On Payments

September 24, 2012

Alternative Financial Services Grow, and So Do the Unbanked and Underbanked

The just-released 2011 FDIC national survey on unbanked and underbanked households reports that this demographic segment has shown modest growth since the 2009 survey. Despite improvements in the general economy, 20.1 percent of U.S. households are underbanked and 8.2 percent are unbanked completely. According to the FDIC's definition, underbanked consumers may have a traditional bank account, but they rely heavily on alternative providers for financial services (shortened to AFS in the FDIC report). As we described in a previous post on nonbanks, the landscape for AFS today is a highly dynamic free-market environment that fosters creativity and innovation. Will the confluence of a growing underserved market and the ever-expanding role of nonbanks in our U.S. payments system fuel the fire for increased reliance upon AFS in general?

Growing use of alternative financial services
The growing reliance on AFS became more widespread between 2009 and 2011. According to the 2011 FDIC report, about 25 percent of all households, including the unbanked and underbanked, reported using AFS in the last year. These AFS users report finding nonbank financial services more convenient, faster, and less expensive than traditional banks.

Every day, many new types of nonbanks, including telecom firms, are entering the payments space, as we noted in this 2009 post on mobile money transfers. More recently, social networks like Facebook and PayPal-like payment business models such as Dwolla are entering the fray. Regulators of money transfer operators are working diligently to ensure that the myriad of new firms in the business are appropriately licensed and regulated. The fast pace of nonbank entry is creating a confusing regulatory environment and potential vulnerabilities that bad actors may find opportunities to exploit.

The growing appeal of prepaid
The 2011 FDIC report also notes that the unbanked and underbanked households rely on prepaid cards more than do fully banked households. One in 10 households overall reported the use of a prepaid card. The proportion of unbanked household that have used a prepaid card climbed from 12.2 percent in 2009 to 17.8 percent in the last survey.

The fact is, prepaid card adoption has been on the rise for some time. The Fed's last triennial payment study reported it to be the fastest growing retail payment method. The expanded functionality for prepaid payments today make them practical for many uses, including payroll, travel, and the provision of benefits. Consumers can purchase prepaid cards from merchants and other nonbank locales where they might be more comfortable than they would be in a traditional financial institution.

This is all good news in the context of financial inclusion and expanded opportunity for the unbanked to participate in the electronic economy and shift from more informal transfer methods. However, payments experts still have concerns. In particular, there is the risk that violators of money laundering laws may go undetected as stored-value payments move from the plastic card to other access devices such as mobile handsets. FinCEN and other regulators will need to keep these issues front of mind as adoption grows and more nonbanks participate in the prepaid industry.

Implications for policymakers and financial institutions
The report concludes that one particularly noteworthy lesson for banks to consider is the need to make traditional financial products more convenient, faster, and less expensive in order to compete with AFS. They should try harder to appeal to the under- and unbanked by providing expedited availability for deposited funds to compete with check cashers. The report even goes on to say that banks might find it useful to promote mobile technology to increase convenience, the most commonly reported reason that households use nonbank check cashiers. With the growing use of prepaid cards for both federal and state government benefits, astute financial institutions may recognize other opportunities to provide prepaid services that may eventually shift the unbanked and underbanked to more a formal banking economy.

However, one clear trend is that technology is driving entrepreneurship in payments delivery methods in unexpected ways, with new AFS services announced all the time. In the long run, AFS may not be considered alternative any more, shedding the negative reputation that label traditionally implies. If new payments are cheaper and faster, perhaps they deserve a less jaundiced eye.

By Cynthia Merritt, assistant director of the Retail Payments Risk Forum

• September 24, 2012 in
  • remittances
  • supervision and regulation
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September 17, 2012

Change Is the Only Constant: Section 1073 Set to Take Effect

If you are reading this post, then no doubt you are familiar with the passage of the Dodd-Frank Act, specifically Section 1073, which is the basis for the new rule pertaining to consumer-originated funds transfers from the United States to consumers or businesses in foreign countries. I recently attended a meeting where representatives from the remittance transfer industry discussed the responsibilities, complexities, and challenges of complying with the remittance transfer rule by the inaugural date of February 7, 2013. Not surprisingly, complying with the rule is a massive undertaking—when you consider that the remittance transfer business is, by definition, a business with a global reach.

One premise behind the rule was to create more transparency in remittance costs and thereby encourage competition in the market, to the ultimate benefit of the consumer. Today’s procedures for sending money abroad are basic. Locate one of more than a half-million domestic locations—in addition to many financial institutions, almost every gas station, drug store, and grocery store offer this service—complete a remittance form, hand money and form to a clerk, and wait a few minutes for confirmation. The funds are then made available to the receiver. A recent report published by the World Bank concluded that the United States currently maintains an average total cost to send a remittance below the global average (6.93 percent of the remittance amount versus 9.3 percent), thanks to the high volume and intense competition among the current large number of products and services available in the United States.

However, unknown to both parties at the time of origination is the exact dollar amount that the recipient will receive, because of hidden fees, taxes, and other costs not necessarily apparent. The rule will replace this "unknown" with a required hard copy receipt outlining, in any language used to market, advertise, or solicit business, all fees, commissions, taxes, the exact dollar amount netted to the receiver, and the time that the funds will be available for pickup. (There are other specifics, but no need to reiterate the entire law in this short blog!) A common pain point yet to be resolved in the compliance effort revolves around the ability of the sending entity to provide accurate receiving-end tax information. As an example, some countries have multiple and changing tax rates for different regions or a variable-fee structure on the receiving end based on the receiver’s status and relationship with the receiving entity. These tax and fee issues suitably demonstrate how achieving compliance will require cooperation from foreign entities in more than 213 country corridors, not under a remittance transfer provider’s control or subject to U.S. jurisdiction. Many in attendance suggested that a central database of tax information may be a way to address the conundrum. Whether provided by a third party in the industry or a government entity, a central database would provide consistent data and minimize research and upkeep costs for all transmitters.

In addition to cooperation, education for all players will be instrumental. Consumers should be made aware of their new right to cancel any transaction within 30 minutes of submitting and that they have contact information on their receipt in the event of any errors. At the same time, all remittance providers, including agents, need to be trained and educated to ensure compliance with this new rule.

With system changes required to produce the disclosures, will remittance providers reduce the number of channels used for remittances until they can modify their systems? With the number of contractual agreements required, will providers reduce the number of countries served or products offered? And given the cost, will remittance providers raise prices? And will U.S. consumers find alternative ways to send money? Only time will tell as the deadline for complying approaches.

The rule may eliminate some existing players from the game, as protection never comes without a price. At the same time, pioneering and innovative competitors might provide new channels and more products that will benefit consumers. Like anything that forces us to reinvent ourselves, change brings with it new threats and challenges, but the opportunities can be vast and rich. With a little imagination and a lot of hard work, the rewards can be enormous.

Remember, "The only thing that is constant is change" – Heraclitus

By Michelle Castell, senior payments risk analyst in the Retail Payments Risk Forum at the Atlanta Fed

• September 17, 2012 in
  • remittances
  • supervision and regulation
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January 9, 2012

Is what you see what you get? Proposed pricing disclosures for electronic remittances

In previous posts, we've talked about the state of regulatory reform for remittance payments. Other posts have looked at the evolving landscape for money transmitters—or remittance transfer providers (RTP), as the new Consumer Financial Protection Bureau (CFPB) refers to them.

This week's post speaks directly to a proposed consumer protection requirement that RTPs in the United States may have to comply with when they send electronic remittances to recipients in foreign countries. Specifically, the proposed rule would require RTPs to disclose clear and complete information about cross-border money transfer services, including all fees, the exchange rate, and the amount of currency the recipient will actually receive once the fees and exchange rate have been applied.

This sounds reasonable. Under the new rule, consumers would be able to determine the total price, and therefore would know the net proceeds available to the recipient. The rule would also establish error resolution rights for remittance senders, defining standards for the resolution process and procedures for cancelling transactions and refunding fees.

However, variables outside the RTP's control can complicate remittance transfer pricing. Many RTPs have reported that the new requirements threaten to drive consumers to less formal and sometimes illicit money transmitters.

Below, we summarize some of the issues that the CFPB must consider as it crafts the final rule provisions. At issue is whether the agency will effectively achieve its mission of improving transparency for consumers without also bringing about the unintended consequences of onerous regulatory compliance costs for RTPs or undesired process formality for unbanked and possibly less sophisticated consumers.

Why would remittance costs vary?
The following table shows how pricing can change depending on how RTPs combine the fees and foreign exchange costs.

Many commenters on the proposed rule contend that RTPs cannot always control the transaction from start to finish, so compliance with such a requirement could become very complicated. They argue that the sending RTP may not know the exact amount of taxes, fees, and other charges that intermediary firms and governments impose. The lack of such information would also complicate the error resolution process. Nearly all commenters suggested that the rule be modified to allow RTPs to estimate costs based on information available at the time of the transaction.

Disclosures may not be enough to do the job
The CFPB aptly notes that disclosures may be insufficient in the battle for improving transparency and customer awareness. Consumers often rely on shortcuts and opt for convenience when making decisions; they often do not make the most advantageous financial choices. Additionally, many consumers need some extra help to understand disclosures, however well-designed and articulated. The CFPB also therefore recommends augmenting disclosure practices with customer education and outreach campaigns.

There is yet another issue to consider. As we've noted in previous posts, technology is helping create new business models for money transmitters and opening new channels for delivering remittance services. As a result, RTPs will need to modify their disclosure practices for multiple channels as remittance transfers continue to evolve into new innovative products and services. As the new regulator for ensuring that nonbank RTPs are ensuring adequate consumer protections, the CFPB must also assume an adaptive posture in the highly dynamic remittance service market.

By Cynthia Merritt, assistant director of the Retail Payments Risk Forum

• January 9, 2012 in
  • remittances
  • supervision and regulation
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October 24, 2011

Keeping pace as money transmitters proliferate

As the United States migrates from paper-based retail payments to electronically enabled methods, we are witnessing a proliferation of entrepreneurial and innovative nonbank stakeholders entering the retail payments market. As my colleague discussed in a previous post, these nonbanks provide a variety of services that banks can use to create more efficient payment systems. But the fast pace of technological change and the ease with which these new companies can enter the retail payments arena may also be translating into new risk vulnerabilities for the nation's retail payments systems.

There are many different types of nonbanks in U.S. payments systems today, including technology developers, aggregators, agents, third-party service providers, and money service businesses (MSB) and transmitters. As technology enables more nimble and innovative payments, the role of MSBs and, in particular, money transmitters is growing more important.

Am I an MSB?
According to this table from the Financial Crimes Enforcement Network (FinCEN), certain products or service offerings may dictate the capacities in which a business might fit the definition of an MSB. Note that money transmitters represent a specific type of MSB that engages primarily in funds transfer services.

Source: "Am I an MSB?," www.fincen.gov/financial_institutions/msb/amimsb.html

The innovations that PayPal introduced illustrate the value that transmitters add to the payment system through the provision of nimble service offerings that respond to consumer payment needs. Over time, PayPal has evolved into a mainstream payment service provider and household name, and has demonstrated a commitment to risk management and regulatory compliance across all the jurisdictions in which it operates. But PayPal's commitment contrasts with the overall state of the industry of MSBs, whose efforts are not completely transparent. MSBs and transmitters today operate in a fragmented regulatory environment determined by the specific governing laws, licensing requirements, and permissible business activities of each U.S. state.

As money transmitters become more prevalent players in our nation's payment system, is it time to reassess their regulatory environment and consider the potential benefits of a national supervisory framework?

Transmitters and the U.S. regulatory structure
Money transmitters are required to register with FinCEN and to comply with federal laws for anti-money-laundering and counterterrorist-financing provisions of the Bank Secrecy Act. In addition, 48 states require the licensing of money transmitters before they can do business. For money transmitters that operate in more than one state and across state lines, differences in state legal requirements create challenges to developing effective enterprise-wide compliance and risk-management programs. Furthermore, monitoring changes in various state legal regimes can be extremely complicated, not to mention costly.

Ironically, state regulatory authorities governing money transmitter businesses are generally budget-strapped in today's economically distressed environment, and lack the financial resources for taking action against all but the most egregious of bad actors. Unlike the prudential regulatory governance employed by the agencies of the Federal Financial Institutions Examination Council for the nation's mainstream financial institutions, regulatory response for the oversight of money transmitters is prompted instead by complaints to state authorities, or by the filing of suspicious activity reports to FinCEN.

Future regulatory considerations
There are many risks to consider in this nascent segment of the retail payments industry. With the ease of entry into the market for money transmitters and the potential lack of funding in some states for comprehensive regulatory oversight, some startups may circumvent licensing and capital requirements by merely opening for business, undetected by state authorities. FinCEN has issued advisories requesting that financial institutions that discover such businesses file suspicious activity reports (SARs) as a means of mitigating unlicensed and potentially illegal activity. Unfortunately, as technology supports more sophisticated advancements in electronic payments as well as new alliances between carriers and money transmitters, regulatory efforts will become increasingly difficult.

The newly established Consumer Financial Protection Bureau is empowered to exercise enforcement authority for improper conduct on behalf of money transmitters, but the task is daunting, considering the disproportionate state-by-state regulatory framework currently in place. Is it time to consider a more consistent, national approach to the legal and regulatory oversight of money transmitters? And, considering the onerous compliance costs that the current environment imposes, would money transmitters in fact welcome a more consistent, uniform environment?

By Cindy Merritt, assistant director of the Retail Payments Risk Forum

• October 24, 2011 in
  • payments risk
  • remittances
  • supervision and regulation
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