The Federal Reserve's Payments System Study

March 2014

Tom Heintjes: Welcome to the Federal Reserve Bank of Atlanta's EconSouth Now podcast. Today, we're joined by Geoff Gerdes, a senior economist at the Board of Governors of the Federal Reserve System. Geoff works in the Payment System Studies Section of the Division of Reserve Bank Operations and Payment Systems, and we're going to talk about the Fed's most recent payments study, which studies how people in the United States pay for goods and services and how those payment methods have changed over time.

Thanks you for joining us today, Geoff.

Geoff Gerdes: Hi, Tom. How are you doing?

Heintjes: Geoff, this is the fourth payments study that the Fed has conducted, and I believe you've been involved with all of them. I'd like to start by asking you if this year's study is different from those in the past.

Gerdes: Yeah. We stepped back and thought about all of the things that have been happening in the payment system recently and realized that our survey was a great opportunity to include some new information that the industry has been really needing to understand better, how things are changing in the payment system.

And if you want an example, we included unauthorized transactions. In general, in all of our surveys we ask for more underlying details because of the various developments in technology with cards for example. Now there are chip cards, and that is an important piece of the future of fraud prevention, for example. In most of the different payment categories we added additional questions, and we have been really lucky that our partners recognize the value of responding to these surveys.

Heintjes: Interesting. You know, as individuals I think the way we pay for things over time aren't really remarkable on a day-to-day basis, but seeing the study really brings the changes into sharp relief. Were the study's results as you expected? Did anything show up that you didn't anticipate?

Gerdes: Well, the big news, I think, for the decade has been the massive rise in debit card use, and that continued with the amount of use, which is getting close to 50 billion payments now. Nobody ever anticipated that usage might grow so fast and so large, and one would expect it to start to taper off at some point just by saturating the market. But it had the largest amount of growth during the past three years of any payment type.

Heintjes: Yes, the study indicates that card payments make up a really significant portion of all payments. Could you describe what is included in this type of payment?

Gerdes: Back in the early part of the 20th century cash was king—and to some extent maybe still is—but over time cash has been replaced by noncash payments. It's very difficult to measure the number of cash payments, but we could measure how other kinds of payments have changed. And the first kind of payment that really started to displace cash was paper checks, and after that, there were certainly retail store cards that were very popular in the past. The general purpose credit card started to take off, and that was a kind of card offered by banks. And then the debit card, which started out as really an ATM card for withdrawing cash ultimately started being accepted at the point of sale.

There is the ACH as well—that stands for automated clearinghouse—and that was begun in the late '60s as a replacement for check payments, where the payment goes as an electronic funds transfer between banks. People are familiar with ACH because often people are receiving what is called a direct deposit of their payroll check into a bank, and that is a very popular use of ACH. And some people even have mortgages or insurance payments debited automatically from their bank. That's another example of an ACH.

And then in more recent times we have had prepaid cards—which are like debit cards in a lot of ways but don't need the establishment of a traditional checking account—have become more popular. People that are known as the underbanked, who may not have as easy a time of getting a bank account or may not have as much of a reason to have a checking account, can now use these prepaid cards. And in addition to that, we also cover emerging payments. We collect information from about 100 or so different types of emerging-payment companies and we track things like internet payments. The mobile payment space is now becoming more important and hasn't taken off to a large extent in the U.S., but we are expecting that to become a popular method of payment in the future. And so we do the emerging payments to make sure that we are monitoring changes as they develop.

Heintjes: Geoff, what do the study results tell us about unauthorized transactions?

Gerdes: Well, unauthorized transactions, we named them that...what we are really facing in a lot of payment situations is opportunities for nefarious people to commit fraud. So it is very difficult really to define fraud. There are all sorts of types of fraud, and we wanted to focus in on payments fraud. So our classification calling it "unauthorized payments" and defining that as being the payments that are not authorized by either the card holder or the account holder and would have been made by a third party. So an example would be somebody stealing your credit card and taking it to the local electronics store and buying a stereo with it.

The variety of things that we covered was credit and debit cards at the point of sale and also when the card is not present. One example of a card-not-present situation is becoming more popular—buying things online from online retailers. And then we covered checks and ACH as well. So we had a uniform method of defining all the types of unauthorized payments.

Heintjes: Geoff, can you talk about the relative amount of fraud from the different payment types or different payment methods?

Gerdes: Our estimate was that total fraud in 2012 was about $6.1 billion, and that was from about 31 million unauthorized transactions overall, but cards had the lion's share, almost two-thirds of the fraud by value. And when you look at the picture of payments, most value is transferred using the ACH system and the check system, which are usually used for large-value payments. Cards are smaller value, but even under those circumstances, most fraud is perpetrated by cards.

A couple of interesting points about different ways that fraud could be perpetrated in cards: It is much more difficult to obtain, for example, a personal identification number, or PIN, that you type in when you are either withdrawing cash from the ATM or using it to purchase at a point of sale. And that was much lower than what we would classify as signature kinds of payments where either a signature is collected, and nowadays often, for example, in a fast-food situation, a card could be swiped and the person is not even asked for a signature.

Heintjes: Right. Yeah, I thought those results from the study were especially interesting. Geoff, I wanted to talk about checks for a minute. I know that for myself, a pack of checks lasts a lot longer than it use to, and judging from the study, I'm not the only one who is writing fewer checks. The study shows a continuing decline in check usage. Is there any new aspect of check usage in the results to your eyes?

Gerdes: Checks have been steadily declining since we began the study back in 2000, at roughly 2 billion checks per year. As I said, it's pretty steady, but over time what we see is that the mix of how those checks are being used has changed, and one classification of checks that has been very difficult to be replaced by electronic payments, for example, is consumer-to-consumer payments, which were flat in recent years and actually had gone up during the period even while checks overall were declining. So that's one example of a difficult type of check to replace. People find checks very convenient for those things. Although we have not really seen evidence of the decline tapering at this point, one would expect that it would kind of reduce in the future. I would expect that checks will be around for some time.

Heintjes: Right. Geoff, how will the results of the payment study be used?

Gerdes: Really, the point of producing these results is so that the industry has a shared understanding and a baseline for looking at the payment system, and it has been difficult for any one entity to go out there and get the right set of information. I think that with the Fed's relationships within the banking and payments industry we were in a unique position to be able to provide a very transparent, well-defined, and very accurate picture of how things are going on. And so it's ultimately served as the baseline of what people in the industry use to understand what's happening in the payment system.

Heintjes: Right. So how might the Fed use this information to shape the strategy for Federal Reserve payment operations?

Gerdes: Well, just like any, either private company that has an interest in serving the market, or even consumers that are trying to make choices in the payment system, it is important to know what's being offered and how much of it is being used. And the Fed is, obviously, with its important role in helping shape and develop the efficiency of the payment system, we will use it like everybody else to be able to better understand how people make their choices in the payments system and what may happen in the future, and what kinds of developments, contributions the Fed can make to assist in making the payment system smoother, more efficient, and a safer way of promoting economic commerce.

Heintjes: Well, you mentioned before that you have been involved in conducting the study since the year 2000 and so you have had a really courtside seat to seeing all these changes taking place, and I'm sure it's been fascinating to watch the evolution of the payments system.

Gerdes: Yeah, it sure has. I think when we started the study, the understanding in the industry was that checks were continuing to rise, and there was this sort of sense that there might be a bit of a paperwork crisis in that having to fly those checks around and get them settled quickly was a very expensive process and, to some extent, not as safe as doing things electronically. And when we conducted our first study people were surprised at how low the total number of checks had come in. There were projections being made, but they were much higher than what turned out to be the case. And then we were able to actually look at data that were collected in the mid-'90s at the Board and use that to relate checks between that decade and 2000, and we found for the first time we were able to show conclusively that checks were declining at that point.

And that really changed the way that the whole industry started thinking about what was happening in the payments industry, and the Fed itself started responding to the fact that checks were declining and looked for ways to consolidate infrastructure and save money. And that helped to contribute also to the electronification of checks using the Check 21 Act, which allows banks now to clear all checks by image instead of paper. And there are a lot of steps along the way and there are many different events that have contributed to what has happened over the last 15 years that I've been looking at the data.

Heintjes: Right. I'm sure it has been quite a fascinating journey. Geoff, I just want to conclude by thanking you so much for sharing your time and insights with us today.

Gerdes: Oh, thank you very much. It was a good experience.

Heintjes: Again, we've been speaking today with Geoff Gerdes of the Federal Reserve Board of Governors. This concludes our EconSouth Now podcast on the Fed's most recent payments system study

For more information, please see the first 2014 issue of EconSouth. On our website, frbatlanta.org, you can read our article about the payments study. Thanks for listening and please return for more podcasts. If you have comments, please send us email at podcast@frbatlanta.org.