Chapter 4

Retail Financial Services

ContentsPage

Introduction. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 97

Deposit Function . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 99Direct Deposit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100Point-of-Sale Systems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ... ....... 101Lockbox Operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 101Demand Deposit Accounts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 102Drafts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 102Giro Transfers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 102Traveler’s Checks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 103Savings Accounts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 103Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 106Accounts With Other Nondepository Institutions . . . . . . . . . . . . . . . . . . 107

Extension of Credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 108Commercial Credit. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 110Consumer Credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 110

Electronic Funds Transfer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 114Automated Teller Machines . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 115POS Full Funds Transfer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 123

Financial Information Services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 126Check Authorization . . . . . . . . . . . . . . . . . . . .Credit Authorization . . . . . . . . . . . . . . . . . . . .Providers of Information Services . . . . . . . . .

Home Information Systems . . . . . . . . . . . . . . . .Technology of Home Information Services .Developers of Home Information Systems. .Costs of Home Information Systems . . . . . .The Market for Home Information SystemsImplications of Home Information Systems

TablesTable No.3. Comparison of Depository Instruments and4.Nationwide ACH Volume . . . . . . . . . . . . . . .

. . . . . . . . . . . . . . . . . . . . . . . 127

. . . . . . . . . . . . . . . . . . . . . . . 127

. . . . . . . . . . . . . . . . . . . . . . . 127

. . . . . . . . . . . . . . . . . . . . . . . 128

. . . . . . . . . . . . . . . . . . . . . . . 129

. . . . . . . . . . . . . . . . . . . . . . . 129

. . . . . . . . . . . . . . . . . . . . . . . 131

. . . . . . . . . . . . . . . . . . . . . . . 131

. . . . . . . . . . . . . . . . . . . . . . . 131

PageAccounts . . . . . . . . . . . . . . 100. . . . . . . . . . . . . . . . . . . . . . . 101

5. Growth Projections for the CIRRUS Systems, Inc., NationalATM Network.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 120

6. Principal Characteristics of HIS Users . . . . . . . . . . . . . . . . . . . . . . . . . . . 132

FiguresFigure No. Page

6. Penetration of Direct Deposit Social Security Payments . . . . . . . . . . . 1017. Relative Use of ATM Functions, 1974-$1 .. + ~ . . . . . . . . . . . . . ....... 1168. Number of ATMs in Use, 1973-81 . . . . . . . . . . . . . . . . ● . . . . . . . . . . . . . 1189. Average Number of Monthly Transactions Per ATM, 1974-81 . . . . . . . 118

10.ATMs in the United States . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12111. Penetration Curve for Check Alternatives. . . . . . . . ......... . . . . . . . 133

.

Chapter 4

Retail Financial Services

Introduction

The retail financial service industry consistsof those organizations (e.g., banks, creditunions, insurance companies, consumer fi-nance companies) that deliver products to end-users. * Consumers comprise the largest andmost visible single group of end-users of finan-cial services, but business and governmentboth have roles as customers for retail finan-cial services. Included among retail financialproducts are depository accounts, extensionsof credit, and payment services.**

According to 1982 figures, the industry en-compasses more than 90,000 business entities,including 15,000 commercial banks, 4,000savings and loan associations, 1,000 mutualsavings banks, 22,000 credit unions, 1,000 in-vestment banks, 5,000 broker/dealers, 1,000mutual funds, 1,000 mortgage banks, 3,000pension funds and pension fund managers(other than banks and insurers), 2,000 life andhealth insurance companies, 3,000 propertyand casualty insurance companies, and morethan 33,000 insurance brokerage agencies, aswell as numerous factoring companies,***leasing companies, credit card or traveler’scheck issuers, and finance companies. In 1980,the financial service industry (excluding realestate) contributed $100.4 billion, or 5 percent,to the U.S. national income.1

*For the purposes of this assessment, wholesale financial serv-ices, as contrasted to retail, are those provided by one finan-cial institution to another in a way that is largely invisible tothe end-user.

**Customers of securities brokers are also users of retail fi-nancial services. However, because the security industry isgoverned by a body of policy unique to it that separates it fromretail banking and other retail financial services, it is treatedin ch. 3 of this report.

***Factoring is the process of selling accounts receivable toa third party, who then assumes the risk and costs of servic-ing them.

‘State of New York, Report of the Executi\e Adtisor}. Comm-ission on Insurance lndustr?’ Regulator?’ Reform, May 6,1982, p. 101.

Historically, deposit-taking has been viewedas a special activity in the economy, and de-pository institutions have been viewed as oc-cupying a unique place in the industry. Depos-itors place a very high degree of trust in theinstitutions holding their funds. At the sametime, because depository institutions playsuch an important role of intermediation be-tween sources of funds and those having needof them, they are in a position to exert a meas-ure of control over virtually all other economicactivities.

Retail financial services, especially those of-fered by banks, have been heavily regulatedby both State and Federal Governments.Rates paid on deposits have been largely de-regulated, but limits on the rates charged onconsumer loans remain in force. Depository in-stitutions are generally limited to offeringprescribed products to predefined markets.Banks, for example, are limited with regardto the geographic area served, while creditunions are limited to serving only groupswhose members share a common bond, suchas employment with a specific firm. Generally,bank holding companies are not permitted toenter lines of commerce not closely associatedwith banking. Depository institutions are ex-amined to ensure that they are pursuing busi-ness in a manner consistent with preservinginstitutional safety and soundness, and manyof their business decisions (e.g., effectingmergers, opening branches, offering new prod-ucts) are reviewed by regulators prior to im-plementation.

Depository institutions enjoy some uniquebenefits in exchange for heavy regulations.Only they can take deposits and offer accountsthat are federally insured. Depository institu-tions are unique in having access to the vari-ous systems used to transfer funds.

97

98 • Effects of Information Technology on Financial Services Systems

Today, insurance companies, providers ofservices such as credit cards and traveler’schecks, consumer finance companies, drygoods merchants, investment companies, andfood retailers also provide retail financial serv-ices. Some, such as insurance companies, areregulated, while others, such as providers oftraveler’s checks, are virtually unregulated.All, to an ever-increasing degree, are broaden-ing their range of business activities and, tosome extent, are encroaching on areas pre-viously served by others, including those here-tofore exclusively reserved to depository in-stitutions.

Information processing and telecommunica-tion technologies have contributed to thebroadening of product lines by providers ofretail financial services. New entrants havebeen able to develop and offer products thatcompete directly with those previously avail-able only from depository institutions. Dis-tance and location have lost much of their sig-nificance as factors limiting the market servedby a service provider. In addition, by using thetechnologies, new classes of products havebeen developed. Foremost among these arethose that deliver financial services to remotelocations, such as the home, office, merchant’scounter and unstaffed branches. Others, suchas services to facilitate collection and invest-ment of cash, are directed to the business com-munit y.

As noted, law and regulation are significantforces shaping the financial service industryand guiding its day-to-day operations. The ex-isting legal regulatory structure dates largelyfrom the 1930’s and is built on the assump-tion that specific types of institutions will bethe only ones offering each type of service. Forexample, transaction accounts are assumed tobe offered only by banks; and thrift institu-tions are assumed to focus their lending activ-ities on home mortgages. Thus, even thoughthe intent was to regulate by function, thefocus of legislation has been on the institutionsrather than on the products they offer. As aresult, the offering of new products by unreg-ulated providers is often found to lie outsidethe existing legal/regulatory structure. New

entrants who rely heavily on advanced tech-nologies to implement their offerings gener-ally fall outside the boundaries of existing reg-ulation.

The financial service industry is becominghomogenized to a significant degree, and dif-ferentiation between products has become lessapparent, particularly from the point of viewof individual consumers. Commercial banksand savings and loan associations are now per-mitted to serve many of the same clientele. Forexample, recent legislation gave savings andloan associations the power to make somecommercial loans, a product that could notpreviously be offered. While securities broker/dealers are not permitted to offer depositoryaccounts, they do offer shares in money mar-ket funds that have properties very similar todeposits. Insurance companies offer universallife policies that share many properties withself-directed investment accounts offered byothers.

VISA and MasterCard are the two principalbank card products offered nationwide. How-ever, in addition to being offered by banks,these are now issued by such varied organi-zations as the American Automobile Associa-tion and various brokerage houses that offerthem in conjunction with asset managementaccounts. Travel and entertainment cards canbe used with automated teller machines(ATMs) to obtain either cash or traveler’schecks. In some cases, a plastic card is usedto access a depository account (e.g., checking).Plastic cards can also be used to draw on a lineof credit either to pay for a purchase or to ob-tain a cash advance. The same card can beused for both purposes. However, the financecharges are assessed differently for the cashadvance and the credit purchase.

One of the major developments of the 1980’shas been the development and deployment ofnetworks of ATMs. Some of these accept onlythe card of one institution, while others per-mit access to accounts held in any one of anumber of institutions. Most of these net-works are offered by depository institutionsor consortia of depository institutions. How-

Ch. 4—Retail Financial Services ● 9 9— — — — — — — . . —

ever, retail dry goods merchants, supermarketchain operators, and operators of conveniencestores are now establishing networks and of-fering financial institutions the opportunityto access them.

More generally, telecommunication has beena major factor in the development of financialproducts in the 1980’s. Providing remotebanking services has been a key area in thedevelopment of financial services. Publishingcompanies are combining with financial serv-ice providers and communication companiesto deliver financial services directly to thehomes of consumers. Grocery chains are es-tablishing networks of ATMs that competedirectly with those offered by banks. Banksoffer cash management services to business,enabling corporate cash managers to controlfunds on deposit with institutions worldwideand to manage them to the best advantage oftheir employers.

Other developments of the 1980’s have beenthe emergence of the financial supermarketand the specialized supplier of financial serv-ices. Several organizations have used differ-ing strategies to develop into horizontally in-tegrated suppliers of financial services. Theremarkable point is that some find their rootsin insurance, others in retailing, and yet othersin banking. Under the existing 1egal/regula-tory structure, all operate within differing con-

Deposit

Technically, the function of accepting depos-its is strictly limited to depository institutions.Simply defined, a deposit is a placement ofcash, checks, or drafts with a financial insti-tution for credit to a customer’s account. De-posits become a liability to the financial insti-tution since they represent an obligation torepay funds. The deposit function is the tradi-tional banking process by which funds are ac-cepted for credit to a demand, savings, or timeaccount. Deposits are accounts for holdingfunds. The deposit is made by one of the fol-

straints and therefore come to the market withvarying strengths and weaknesses. Others, byway of contrast, seek to serve specific groups,such as members of the professions with prod-ucts tailored to their particular needs. Themarket appears ready to support service pro-viders across the full spectrum of possibleproduct menus.

Fluidity in the structure of the financial ser-vice industry limits the utility of any descrip-tion that focuses on the institutions that com-prise it. A list of providers would almostcertainly omit some and include others thatarguably could have been omitted. Becauseproduct lines of various classes of providersof financial services are close substitutes forone another, descriptions of each of the classesof providers would become redundant.

Therefore, the approach taken to describingthe retail financial service industry in thisassessment is to focus on the functions per-formed for the customers and then to relatethose functions by way of example to the or-ganizations that provide them. The classesof functions described are treated under theheadings:

deposit/withdrawal function,extension of credit,electronic funds transfer, andfinancial information services.

Function

lowing methods: in person, by mail or tape, orelectronically via ATM or other remote ter-minal or by the Automated Clearing House(ACH).* In paper-based systems, access to de-posits depends on the physical transfer ofdocuments such as a check or draft.** How-ever, electronic technologies have helped rev-olutionize this function.

*The ACH is a computerized facility that helps clear fundstransactions among participating institutions electronically.

* *Draft— A n order written on the funds of a third party totransfer the amount specified to the payee.

100 ● Effects of Information Technology on Financial Services Systems

In essence, a deposit differs from an invest-ment in that the depositor expects to be ableto recover the amount deposited, often withsome interest, with virtually no risk of loss.The depository institution holds itself readyto pay the amount of the deposit under con-ditions that are consistent with the contractunder which it was taken. In the case of a de-mand deposit, for example, the depository in-stitution stands ready to pay on demand. Onthe other hand, if the owner of a certificate ofdeposit withdraws the funds prior to maturity,a significant penalty is extracted that, in somecases, involves loss of principal as well as in-terest.

In the present environment, firms otherthan depository institutions offer productsthat are operationally similar to a deposit fromthe customer’s point of view. For example,securities broker/dealers and investment com-panies offer shares in money market mutualfunds that include the option of redemptionby means of a draft written against the in-vestor’s holding. A whole-life insurance pol-icy accumulates cash value that is availableto the owner.

Some will tend to view these products as de-posits because, operationally, the funds areavailable virtually on demand. The expecta-tion is that payment will be made by the pro-vider even though there may be contractualprovisions that an order to pay need not be

honored immediately. There may also be noguarantee that shares will be redeemed at theprice originally paid by the investor. However,as long as institutions continue the practiceof operating near-deposit products in a man-ner that closely approximates the operationof a true deposit account, the customers willsee the former as being a close substitute forthe latter.

In this environment, not all of those offer-ing deposit or near-deposit products operateunder the same set of rules. This variation in-troduces new elements into the calculus usedby those responsible for the safety and sound-ness of the financial service industry and theformulation and execution of fiscal and mone-tary policy. In the sections that follow, thevarious types of deposit-like products andassociated deposit-taking services are de-scribed.

Table 3 presents a comparison of the vari-ous depository instruments and accounts dis-cussed in more detail below.

Direct Deposit

Direct deposit is most often used to effectpayment from either private or public organi-zations to recipients of salaries, pensions, andentitlements. It is actually a preauthorizedcredit arrangement between the party issuingthe payment and the receiver and is commonly

Table 3.—Comparison of Depository Instruments and Accounts

Penalty MinimumInterest- Withdrawal Mandatory for early deposit or

Instrument or type of account bearing notice request deposit period withdrawal balanceCheck . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . No No No No NoDraft . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .Yes Optional No No NoTraveler’s check . . . . . . . . . . . . . . . . . . . . . . . . . . No No No No NoConventional savings account . . . . . . . . . . . . . Yes Optional No No NoCredit union account . . . . . . . . . . . . . . . . . . . . . Yes Optional No No NoCertificate of deposita . . . . . . . . . . . . . . . . . . . .Yes Yes Yes Yes YesMoney market deposit account. . . . . . . . . . . . . Yes Optional No No YesNOW accountb . . . . . . . . . . . . . . . . . . . . . . . . . . Yes Optional No No OptionalSuper NOW accountb . . . . . . . . . . . . . . . . . . . . . Yes Optional No No YesSavings bond . . . . . . . . . . . . . . . . . . . . . . . . . . . .Yes Yes Yes Yes YesSavings certificate. . . . . . . . . . . . . . . . . . . . . . . . Yes N/A Yes N/A YesaEffe~t jve Oct 1, 19&3, Interest rate ceilings are eliminated on all time deposits with original maturity or requ i red periods of more than 31 days, and on time deposits

of $2,500 or more with original maturity or required notice periods of 7 to 31 daysb Not available to commercial businessesN/A–Not applicable

SOURCE Office of Technology Assessment

— . .

used for recurring payments. One of thelargest users of direct deposit is the U.S. De-partment of the Treasury, for Social Securitypayments. It is also widely used for mili-tary payroll and other regular Governmentpayments.

Figure 6 shows the increasing rate at whichSocial Security recipients have been willing toaccept payment by direct deposit. In 1978,only 11 percent were willing to make use ofdirect deposit; but this proportion had grownto 33 percent by 1982. The Department of theTreasury hopes for further increases.

Direct deposit transactions started as papertransactions, but the rising volume of suchpayments has encouraged the use of the ACHnetwork and systems, which depend heavilyon the interchange of magnetic tape (see table4). The process involves coding payment in-formation in machine-readable form and mov-ing it between banks on computer tapes or, insome cases, over telephone lines. The payingbank or organization consolidates all itspayments for a certain date and submits themon magnetic tape through the ACH. The ACHthen routes the payment information to eachreceiving bank. The tape can be sent in ad-vance with the information predated. For ex-ample, stock dividend checks could be proc-essed through the ACH for direct deposit. It

Figure 6.— Penetration of Direct Deposit SocialSecurity Payments

5 0 0 ~

UY 400c

-

11 0/0o=.-E 300c.-UIz 200E$Q 100

0 11978

250/o 280/o 330/0

m

1979 1980 1981 1982

Direct deposit

1’-] Checks

SOURCE Economic Review Federal Reserve Bank of Atlanta, August 1983 p 33

Ch. 4—Retail Financial Services ● 101

Table 4.—Nationwide ACH Volume—

G o v e r n m e n t -

Year Private (Social Security)

1976 . . . . . . . . . 4,283,770 46,646,9991977 . . . . . . . . . 10,344,192 69,694,7411978 . . . . . . . 18,612,263 93,207,0731979 . . . . . . . . . 331324,163 123,353,5941980 ......, . . 63,362,597 144,112,2041981 . . . . . . . . . 117,019,927 164,157,1901982 . . . . . . . . . 174,613,862 176,821,896— - .SOURCE National Clearing House Association

is expected that use of the ACH will increaseonce a critical volume has been achieved bythe flows to and from large organizations. Asthis occurs, users with smaller volumes ofpayments should gradually be absorbed intothe system.

Point-of-Sale Systems

Point-of-sale (POS) systems, discussed indetail later in this chapter, also function as adeposit-taking method. In some cases, retailclerks will accept funds for deposit to custom-ers’ accounts. In others, the financial institu-tion will operate a station or counter in theretail store at which deposits are accepted. Athird alternative is the placement of an ATMat the retail store location. The ultimate goalof POS implementation in the financial serv-ice industry is to institute an electronic proc-ess through which transactions may be instan-taneously debited/credited.

Lockbox Operations

In lockbox operations, payments go directlyto a post office box that is controlled by thepayee’s financial institution. The services pro-vided include picking up the mail at the postoffice, opening it and crediting the funds, orreceiving the opened letters and crediting thefunds to the company’s account. A fee is im-posed for each function the financial institu-tion performs for the company.

Lockbox operations are used to speed thecollection of remittances and reduce “float”*

*An amount of money represented at any one time by checksoutstanding and in the process of collection. The period of timebetween receipt of notification of payment by the creditor andthe actual debiting of the consumer’s account.

102 ● Effects of Information Technology on Financial Services Systems—.-— - .-— — ——.———

by eliminating the time required to transferpayment from a company to the financial in-stitution. Interestingly, lockbox operations areoffered by other institutions, also. For exam-ple, in July 1983, Sears Roebuck & Co. an-nounced that it would provide retail lockboxprocessing for Pittsburgh’s Mellon Bank inseven cities across the country. With its na-tional presence, Sears is in a unique positionto offer such services. This arrangement willnot only reduce float for the bank’s corporatecustomers but also decrease processing costs,since a larger number of the checks receivedcould be processed locally and not as inter-regional items through the Federal ReserveBoard’s check processing system. As noted inAmerican Banker, “Interstate banking restric-tions have prevented banks from opening of-fices around the country to accept deposits,and thus most banks have operated lockboxesonly within their own State. Lately, however,a number of banks have begun to expand theirgeographic coverage through joint marketingarrangements and correspondent relation-ships. ‘‘2

Demand Deposit Accounts

For users of demand deposit accounts, in-stitutions make funds explicitly available tothe user without any optional or contractualdelay. Demand deposits represent a significantportion of the domestic money supply. As ofDecember 31, 1981, demand deposits for allcommercial banks totaled $370 billion.3 Achecking account is a demand deposit account.The check is the instrument that activates thechecking account and is the end-product of theoriginal written instructions used by an indi-vidual to make a payment from a credit bal-ance. A written check is deposited into an ac-count (the collecting bank) by the creditor,wherein it circulates within the banking sys-tem as an instrument to debit the account ofthe debtor at his bank (the paying bank).

By law, demand deposits do not yield in-terest for the account holder. Although sev-

‘American Banker, July 29, 1983.3Federal Reserve Statistical Release, April 1983.

—

eral other types of accounts use a check to ac-cess funds, these accounts are not considereddemand deposit accounts.

Drafts

Drafts are essentially an expanded collectionservice, with funds being transferred when thepayer orders the bank to pay the draft. Theyare used by credit unions, which technicallyclassify their transactions as purchases ofshares in equity accounts and money marketfunds. Credit unions began to offer share draftaccounts as a competitive tool against thechecking accounts offered by banks. The draftitself is debited against the individual’s ac-count. Although to the consumer, a draft looksand works much the same way as a check, itdiffers in two ways: 1) it may have a specifiedtime constraint and can be drawn on an in-dividual, corporation, or bank; and 2) the in-itiative for payment of goods is taken by theseller, not the buyer.

The three types of drafts are: 1) sight–pay-able immediately on presentation; 2) arrival—payable on arrival of goods; and 3) time—payable at a fixed date. There is a consider-able amount of float associated with checks/drafts because funds need not be in the bankon which the item is drawn until the day thecheck/draft reaches the bank and is presentedfor collection. Float in this case can work tothe advantage of the depositor in that fundsalso do not sit idle. The company can trans-fer the amount needed to cover the check/draft, leaving the balance in higher yieldinginvestments.

Although presently a heavily paper-basedinstrument, drafts are being converted into aform of electronic billing service whereby ven-dors can collect from customers by sending anelectronic debit (draft) to their account.

Giro Transfers

While checks are a way to effect a debittransfer, the giro, which is an instrument notused in the United States, is a way of makinga credit transfer. To effect a giro payment, the

Ch. 4—Retail Financial. . . —

person making the payment instructs the in-stitution holding his funds to transfer themto the account of the payee in the name ofanother institution. This is in contrast to acheck given to the creditor that is finally pre-sented at the debtor’s bank for payment. Giroorganizations usually send a statement to eachaccount holder every day on which transac-tions are recorded; this is expensive in postalcosts. “The notable feature is that the aver-age value of paper giro transfers is higher thanthe average value of check payments in allcountries except the United Kingdom.”4

Traveler’s Checks

Another form of a deposit transaction is thetraveler’s check. The traveler’s check is “paidfor” in advance by the purchaser, generallywith a premium of 1 percent of the value. Itis considered a deposit because the funds areheld by the issuing company until the travel-er’s check is redeemed by the purchaser. Thisinstrument works and is accepted, for themost part, like cash. It can be a universallyaccepted payment mechanism and is consid-ered a deposit instrument.

Savings Accounts

A savings account is an interest-bearing ac-count used to accumulate and safekeep funds.Institutions retain the optional right to requirewritten notice of an intended withdrawal,often not less than 14 days before withdrawalis made.

Despite the notice requirement, a savingsaccount is in practice extremely liquid. Untilrecently, most people used their savings ac-count as a long-term savings/investment vehi-cle, even though several alternatives offeredhigher explicit interest. However, new optionsavailable have made the consumer more con-cerned with earning explicit interest on hismoney. As a result, savings accounts are be-ing increasingly used only as short-term repos-itories or as interim investment vehicles dur-

4Jack Revel], Banking& EFT—A Study of the Implications,p. 143.

Services ● 103

ing the accumulation of funds sufficient forsupporting higher denomination and higheryielding investments. They are also frequentlyused to establish and maintain a relationshipwith an institution for the purpose of even-tually using other services, such as loans andcheck cashing.

Savings accounts take the following forms:

1. Conventional savings accounts. Conven-tional savings accounts offered by depos-itory institutions are designed primarilyfor individuals. Savings accounts may beissued in passbook or statement form andinvolve the institution’s periodic issuanceof summaries of deposits and withdraw-als. Savings deposits do not have matur-ity dates, but a hold may be requiredbefore withdrawal-most often on depos-its made by check, but possibly on cashdeposits, also. This is rarely, if ever, im-posed, and for the most part, individualsregard these accounts as being very liq-uid. As defined by the Federal Reserve,a savings account from which more thanthree telephonic or preauthorized trans-fers are permitted per month is considereda transaction account, with the specificexception of the money market depositaccount.

Savings accounts presently have a reg-ulated interest rate set by Federal author-ities and governed by the DepositoryInstitutions Deregulation Committee(DIDC). Until these ceilings are finallyphased out (scheduled for 1986), the ceil-ing is imposed on interest rates for fed-erally insured banks and thrift institu-tions. Effective January 1, 1984, thedifferential interest rates on passbooksavings accounts and 7- to 3 l-day depos-its under $2,500 at both thrifts and com-mercial banks were removed, with eachhaving a ceiling of 5% percent.

Federal deposit insurance of up to$100,000 per account holder is providedin all but a very few depository institu-tions. The Federal Deposit Insurance Cor-poration (FDIC) insures accounts in com-mercial banks chartered by both the

35-505 0 - 84 - 8 : QL 3

104 • Effects of Information Technology on Financial Services Systems

2.

——- —

Federal and State Governments and inmutual savings banks. The Federal Sav-ings and Loan Insurance Corporation in-sures accounts in federally chartered sav-ings and loan associations and savingsbanks. The Credit Union National Admin-istration (CUNA) insures accounts held infederally chartered credit unions. In ad-dition, some States have insurance pro-grams to cover deposits in State-char-tered institutions, such as savings andloan associations, that are not eligible forFederal deposit insurance.

Credit unions provide savings servicesas well, including savings accounts (whichare insured up to $100,000 per member byCUNA, investment certificates, moneymarket certificates, share savings ac-counts, and individual retirement ac-counts.Time deposits. The owner of a time de-posit accepts limitations on his withdraw-al rights. The account is established withthe idea that the funds are on deposit fora negotiated period of time in return forreceiving an offered interest rate. Certif-icates of deposit (CDs) are interest-bear-ing time deposit instruments issued by adepository institution for amounts thatcan vary from as little as $100 up to morethan $100,000. CDs pay interest at matur-ity and cannot be withdrawn from thebank without penalty prior to theirmaturity date. The most commonly of-fered maturities are 91 days, 180 days,and 1 year. Although most CD rates aretied to Treasury bills and longer termTreasury securities, some of the funds doreceive an unregulated market rate of in-terest. Large CDs are typically issued innegotiable form, so they may be tradedin an organized market.

The Depository Institutions Deregula-tion and Monetary Control Act of 1980(DIDMCA) was enacted to provide for theorderly phase-out and the ultimate elim-ination of ceilings on the maximum ratesof interest and dividends that maybe paidon deposit accounts. The act transferredthe authority to set interest rate ceilings

on deposits at federally insured commer-cial banks, savings and loan associations,and mutual savings banks to the DIDC,whose members are the Secretary of theTreasury; the Chairman of the Federal Reserve Board; representatives of FDIC, theFederal Home Loan Bank Board, andCUNA; and the Comptroller of the Cur-rency, a nonvoting member. The law pro-vides for a 6-year phase-out of ceilings ondeposit rates, during which the commit-tee has the discretion to set ceiling rateson deposits based on economic conditions.(The committee has been given a schedulefor targeting the gradual phase-out ofsuch ceilings. ) During the transitionperiod, credit unions are subject to sepa-rate regulations. In 1986, all RegulationQ authority expires, CUNA’s authorityto set interest rate ceilings for credit un-ions terminates, and the DIDC ceases toexist.

Under DIDMCA, the committee haseliminated (effective Oct. 1, 1983) all in-terest rate ceilings on (a) all time depos-its with original maturities or requirednotice periods of more than 31 days; and(b) time deposits of $2,500 or more, withoriginal maturities or required notice peri-ods of 7 to 31 days. Also, the committeehas eliminated other regulations on timedeposits except for the minimum earlywithdrawal penalties; a minimum de-nomination of $2,500 for ceiling-free timedeposits with original maturities or re-quired notice periods of 7 to 31 days; cur-rent ceiling on time deposits of less than$2,500, with original maturities or re-quired notice periods of 7 to 31 days; andagency rules that require a l-percentage-point differential between a loan rate andthe rate on a time deposit securing a loan.

DIDC also established new minimumearly withdrawal penalties: for time de-posits with original maturities or requirednotice periods of 32 days to 1 year, lossof 1 month’s simple interest; for time de-posits with original maturities or requirednotice periods of more than 1 year, lossof 3 months’ simple interest.

3.

4

These changes helped reduce the com-petitive edge previously enjoyed by non-depositor institutions against depositoryinstitutions because a large number of fi-nancial services being offered by the non-depositor institutions were attractive,offered higher interest rate return, andwere not subject to regulation. Fundsplaced outside of the depository institu-tions are not federally insured; however,the individual appears to be more con-cerned with return on investment thanthe risk associated with placing funds out-side of federally insured depository insti-tutions.Money market deposit account. Themoney market deposit account, a high-yielding liquid account, was authorized bythe Garn-St Germain Depository Institu-tions Act of 1982 to allow commercialbanks and thrift institutions to competewith money market mutual funds. The ac-count is available to all depositors, in-cluding businesses. It requires an initialbalance of at least $2,500 and has no in-terest rate ceiling. A ‘7-day hold on with-drawal can be imposed by the depositoryinstitution. Additionally, the money mar-ket account allows for up to six third-party transfers, including up to three bydraft and up to three preauthorized trans-fers per month. There are no restrictionson making withdrawals from the accountin person, by messenger or mail, or byATM. The funds are federally insured. Ifthe minimum balance falls below $2,500,the interest on the funds reverts to thestatement/passbook rate and remains atthat rate until the balance is brought upto $2,500. Unlike some restrictions im-posed by the money market funds, thereis no minimum on the size of an accountwithdrawals or deposits.Negotiable order of withdrawal (NOW)and Super NOW account. NOW andSuper NOW accounts are unique savingsinstruments because they are interest-earning transaction accounts. Althoughthey can be accessed by a check, they arenot considered demand accounts because

5.

6.

Ch. 4—Retail Financial Services ● 105—————- — — — . . — —

the offering institution can impose a holdbefore honoring the withdrawal, althoughit is a restriction unlikely to be enforced.Individuals regard these accounts as rath-er liquid, and most are probably unawareof the restrictions that can be enforced.The NOW account does not legally re-quire a minimum to open the account, al-though most institutions require a mini-mum balance of $500.

The Super NOW account is primarilya combination of the NOW account andthe money market deposit account. TheSuper NOW, which DIDC authorized asa financial instrument as of January 1983,requires a minimum initial deposit of$2,500 and an average balance in anymonth of $2,500. The account has no in-terest rate ceiling, although the funds re-vert to a conventional savings accountyielding the regulated interest z-ate underRegulation Q if the account falls belowthe minimum balance. Additionally, a 7-day notice of withdrawal maybe required.Because the notice of withdrawal require-ment applies to such funds, they are cate-gorized not as demand deposits, but assavings deposits. These accounts are notavailable to for-profit businesses. Theyare available to Federal, State, and localgovernments, as well as to nonprofit orga-nizations and individuals.Savings bonds. Savings bonds are sold bythe U.S. Government to generate revenue.They are issued at a discount and appre-ciate at a rising rate in specified incre-ments to a stated value at maturity.Bonds may be redeemed before maturity,but the interest rate becomes higher thelonger the bond is held.Savings certificates. Tailored to the needsof individuals in terms of deposit time(generally 90 days, 5 years, 10 years), sav-ings certificates have interest rates thatare dependent on maturity time and cur-rent rates. Savings certificates are notnegotiable and are issued by depositoryinstitutions for $100 up to $100,000.There is a penalty for early withdrawal.

106 . Effects of Information Technology on Financial Services Systems— — — — — . — — . . . . . — —

The latest figures’ indicate deposits, as ofOctober 1983, in various savings instruments:

Super NOW accounts: $27 billionNOW accounts: $100 billionmoney market deposit accounts: $369

billionmoney market funds: $138 billion*

Insurance

In today’s competitive environment, com-mercial banks, savings and loan associations,and savings banks not only vie with oneanother to attract new deposits, but also com-pete with many nondepository organizations.One of the largest providers of financial serv-ices is the insurance industry. It has a sizablecustomer base (insurance products are used inalmost every household or business) and is amajor lender of funds to businesses. The in-surance industry has access to an enormousamount of capital. Insurance companies areenormous financial intermediaries in that theycollect and invest vast amounts of premiumson policies. Life insurance companies collectpremiums from policyholders, invest the re-ceipts until needed, pay death benefits to heirsof those who die, and make payments to thosewho redeem policies and/or take out loansagainst their cash value.

Insurance companies channel funds into va-rious investment outlets and qualify as signif-icant allocators of financial resources in theeconomy. Their investments are made inalmost every sector of the capital market andin a wide array of investment outlets. Theirinvestment decisions are based on a philoso-phy of maximizing their rate of return withinthe bounds of State investment laws and onthe principle of safeguarding the security ofthe funds invested.

Life insurance saving differs fundamentallyfrom saving through deposit-type institutionsfor at least three reasons: first, it is long-termand contractual in nature and is thereforemore stable; second, it is motivated primar-

—— —.—‘Federal Reserve Statistical Release, Dec. 16, 1983.*These funds are not federally insured.

ily by the desire for family financial protectionin the event of death; and third, it is ordinarilyexpected to be left intact until the death of theinsured rather than withdrawn for some con-sumer expenditure.

Insurance policies exist in almost everyhousehold. They take such forms as automo-bile insurance, property insurance, and healthinsurance. Such a strong presence permits theindustry to introduce and market new finan-cial products and services with relative ease.Insurance companies now offer several prod-ucts that are treated like deposits. Two newproducts introduced into the market in 1983are quite interesting—one works like a cashmanagement plan for businesses under $10million; the other works as a securities andcash management service. These accountsfeature money market funds, checking ac-counts with unlimited access, lines of credit,an overdraft, and a Gold MasterCard, whichdoes not carry a line of credit. The customers’money market accounts are debited eachmonth to cover card charges. The checkingand charge card operations are handled by alocal bank for the insurance company. The in-vestment accounts are offered in conjunctionwith an investment firm. Both products re-quire a minimum of $10,000, and customersare penalized whenever their monthly averagedrops below $5,000 for 2 consecutive months.

Another instrument of the insurance indus-try is universal life insurance, which is an in-vestment vehicle. It functions like a deposi-tory instrument and is a flexible investmentvehicle with access to mutual funds. It offersthe policyholder flexibility because the cashvalue buildup or funding phase—-which makesit appear to be a savings instrument-and thepure life insurance phase of the traditionalwhole-life insurance policy are separated. Acompany can declare competitive interestrates on the funding phase, and the policyhold-er can vary the amount and frequency of pre-mium payments and the amount of deathbenefits.

Whole life insurance provides a constantamount of insurance for the same premiumover a lifetime. It is payable to a beneficiary

——..——

at the death of the policyholder, and premiumsare payable for a specified number of years ora lifetime. A policyholder is entitled to the cashvalue if he cancels the policy. Since the poli-cyholder may borrow from the insurance com-pany against the cash value of the policy, pol-icy reserves may be viewed equally as a legalliability of the insurance company and as aninvestment of the policyholder. Life insurancecompanies make loans against the cash valueof whole-life insurance policies. These accountsplay a significant role in the insurance com-panies’ lending ability. The policyholder hasthe right to borrow from the insurance com-pany any amount up to the cash value, at aspecified rate of interest. Moreover, earningson insurance are partially tax-exempt.

Just as insurers will increasingly competein the provision of financial services, otherfinancial service providers will increasinglycompete with insurers in the provision of in-surance. The unbundling of insurance prod-ucts has revealed that there are significantfunctions in the operation of insurance thatinvolve the performance of noninsuranceservices.

The insurance industry is in a position to ex-pand its service offerings to include a myriadof financial products. This is possible for sev-eral reasons. As discussed, some insuranceproducts being offered resemble existing prod-ucts being offered by depository institutions.Also, modifying software for existing systemsenables the company to create new productsand services. For example, insurance com-panies could easily offer a money market fundand additional services that can be imple-mented with relative ease and minimal capital.

The insurance industry is adapting automa-tion in many ways. Insurance agents, for ex-ample, are internally incorporating automa-tion to manage office functions, such as clientinformation and accounts receivable and pay-able. They are applying automation to increaseefficiency and to improve marketing. Exter-nally, communication and information technol-ogies are used to tie into carriers where theyare able to obtain quotes and to underwrite

Ch, 4—Retail Financial Services • 107— — —

business themselves. Many large networks arebeing developed that enable the agent to ob-tain pertinent information online as well asdirectly relay information to the carrier.

Technology is used to support other serv-ices of the insurance industry as well. Claimsservices, for example, are now becoming auto-mated. The claims process, which is heavilypaper-based, is being handled by convertingthe information electronically and transmit-ting it online to the carrier, allowing the car-rier to deal with the claim more effectively andto maintain more control over the settlementprocess.

The automation of risk management serv-ices for large corporations allows them to han-dle in-house insurance analysis. These com-panies are able to tie into networks thatprovide important and timely informationused to assess and manage risk.

Accounts With OtherNondepository Institutions

Insurance companies, large retailers, andvirtually every kind of financial service orga-nization offer individual retirement accounts(IRAs), money market funds, and a myriad ofinvestment services. Although the funds in-vested by individuals into nondepository insti-tutions are not federally insured, this fact hasnot prevented individuals from investing inthese instruments. The amount of money thathas shifted from depository institutions intonondepository institutions has been signifi-cant. Previously, these types of institutionswere very different from each other. When theconcept of commercial banking was first con-ceived, commercial bankers made little or noeffort to attract individual deposits, concen-trating primarily on attracting demand depos-its from businesses. Conversely, the savingsbanks and savings and loan organizationswere not authorized to offer checking ac-counts, and their range of time and savingsdeposits was limited.

Today, that has changed drastically. Com-mercial banks fiercely compete with other de-

108 ● Effects of Information Technology on Financial Services Systems

pository institutions, insurance companies,and brokerage houses/investment firms forconsumer deposits. All of these organizationsoffer accounts that can serve the customer insimilar ways. However, the range of servicesavailable to the customer are not as markedlydifferent from the customer’s point of view asthe products seem from the point of view ofregulators or the providers themselves. An in-dividual can easily establish an IRA or Keogh(retirement) account, obtain a loan, and use achecking or checklike account or savings ac-count from any depository institution. He/shecan obtain similar instruments from nondepos-itor institutions such as insurance com-panies, retailers, and investment firms withcash management accounts.

Prior to the introduction of money marketdeposit accounts and Super NOW accounts,depository institutions were restricted as tothe maximum interest payable on demand de-posit accounts and savings accounts, with theexception of jumbo CDs and similar instru-ments. These restrictions helped reduce bank

payouts on their liabilities and reduced cus-tomer earnings on short-term asset holdingsin depository institutions. Since depository in-stitutions could not compete on interest rates,they competed on the basis of services, whichwere actually subsidized by the spread be-tween interest paid on money in savings andreceived on money loaned. The spread resultedfrom below-market rates paid because of theregulatory environment. This is changing.Zero-balance accounts are becoming wide-spread. Financial service providers have cometo rely more heavily on fee income fromservices.

Large financial service providers have theprivilege of offering several types of financialproducts. For example, the use of informationtechnologies enables firms such as AmericanExpress, which owns Fireman’s Fund Ameri-can Life Insurance Co., to market additionalservices directly to their strong credit cardbase. They can offer insurance services andhave the premiums be added directly to theAmerican Express card account.

Extension of Credit

One of the principal functions of the finan-cial service industry is intermediation betweenholders of assets and those in need of funds.Funds are gathered through the deposit-tak-ing activities described in the preceding sec-tion. Extending credit, described in the follow-ing pages, is one of the mechanisms used tomake funds available to those requiringthem. *

Historically, credit extension has been oneof the principal sources of revenue for the fi-nancial service industry. The rate differentialbetween that paid on deposits and thatcharged on loans was sufficiently great to sup-port many of the services offered by financialinstitutions. However, one of the effects of de-.——

*FundS are ~so made available by investors who take anequity position in the organization requiring funds. Equity in-struments and the markets for them are described in ch. 3.

regulation of the rates paid on deposits hasbeen to narrow this differential and cause fi-nancial service providers to look elsewhere forrevenue. They have turned to informationprocessing and telecommunication technol-ogies to improve the efficiency of their inter-nal operations and as the foundation on whichnew revenue-generating products can be built.One of the most promising opportunities forcost saving is converting as many paper-based transactions as possible to electronicprocesses.

Interest rate fluctuations, such as those ex-perienced over the past several years, havemade the problem of portfolio managementmore difficult for financial service providers.Some found themselves faced with the prob-lem of supporting long-term, fixed-rate loanportfolios with short-term, expensive depos-

Ch. 4—Retail Financial Services ● 109— -.

its and few options for correcting the im-balance. Congress increased the powers of sav-ings and loan associations to help themovercome this problem.

One of the responses of the financial serv-ice industry to the disappearance of the in-terest spread has been to encourage individu-als and businesses to view all of their liabilitiesand assets as a total package and to managethem as such. The goal of some institutionsis to place themselves in the role of financialadvisor to their customers. On the one hand,these institutions would like to generate rev-enue by providing advisory services for whicha fee may be charged or services that wouldattract business and customer loyalty, result-ing in most financial service needs being pur-chased from a single organization.

To this end, service providers are using theircredit products to increase the effective li-quidity of assets held by consumers. In addi-tion to such traditional offerings as creditcards, they are creating lines of credit securedby a variety of assets that range from homeequity to securities portfolios. Ease of ac-tivating lines of credit is emphasized. In thecase of an overdraft account, the same checkor debit card that is used to draw funds froma transaction account is the instrument usedto activate the line of credit when the fundsin the account are exhausted. Some institu-tions issue checks that can be used to drawagainst home equity at the convenience of thecustomer. The customer benefits by being ina position to take advantage of opportunitiesto make either purchases or investments onfavorable terms that may be available only forlimited periods.

Information processing and telecommunica-tion technologies are key elements in support-ing the viability of the credit products that arenow offered. One of the reasons a credit cardissuer can guarantee payment to the merchantaccepting it is the ability to keep track of ac-count activity and effectively to halt its usealmost instantaneously if circumstances re-quire. The processing and clearing of creditcard drafts would be virtually impossible with-

out the technologies. Paper is truncated earlyin the processing cycle as one factor in con-trolling costs of processing and to facilitatethe timely posting of transactions to custom-ers’ accounts. Some merchants submit trans-action data electronically to card issuers to fa-cilitate processing.

Credit has long been a tool of the retail in-dustry. Card bases have been created on theassumption that they help create and main-tain customer loyalty and facilitate impulsepurchases. Advertisements are regularly in-cluded with customer bills. While most retail-ers do not rely heavily on revenues generatedfrom retail receivables, the funds generatedcan be considerable.

Some retailers see third-party cards such asthose offered by banks as an interference intheir relationship with their customers. Retail-ers feel they should know when a customer isactivating a line of credit so that an alterna-tive can be offered. Also, retailers question thepropriety of card issuers charging the samediscount for a card transaction, whether it acti-vates a line of credit (credit card) or is usedto access a transaction account (debit card) inlieu of a check.

While individuals make extensive use of avariety of credit services, businesses andgovernments are also major users of credit.Generally, these users are quite sophisticatedand use a number of services that are not avail-able to the general public. The Federal Govern-ment is active in the primary credit marketsas an issuer of debt. Also, one of the primarymeans used to implement monetary policy istrading by the Federal Reserve System inFederal Government securities in the openmarket.

Further complicating the credit markets isthe multiplicity of providers of credit services.Depository institutions and retail merchantshave been mentioned. However, among otherparticipants in the market are consumer finan-cial companies, mortgage bankers, insurancecompanies, pension funds, and acceptance cor-porations, such as those operated by major

110 Ž Effects of Information Technology on Financial Services Systems— — . ———.—

automobile and appliance companies. Privateindividuals also make loans, as is the casewhen the seller of a home takes a second mort-gage from the buyer for a portion of the pur-chase price.

Credit is extended in the following ways:

1.

2.

3.

4.

1nstallment credit—a direct loan to an in-dividual or business, repaid in fixed, peri-odic payments; it is a type of closed-endedcredit. A typical example is a car paymentloan.Open-ended credit, often called revolvingcredit—funds that are available under anagreement that allows the borrower toborrow several times, up to specifiedcredit limits, with interest and withoutfurther investigation of creditworthiness.Many charge accounts at departmentstores and credit card accounts are ex-amples. Since part of the loan is repaidover time, the borrower can again drawagainst the line up to the predefine limit.This type of credit is often open-endedwith respect to time and the total amountof credit available, Minimum paymentsare required, and the maximum amountof credit extended is limited.Closed-ended credit—a loan that is ex-tended for a predetermined amount. Theborrower cannot reopen it by obtainingextra funds under the original lendingagreement.Line of credit–the amount of credit alender will extend to a borrower over aperiod of time, where the borrower candraw on the lineup to some fixed limit athis/her discretion. Generally it involves aspecified amount of money a customermay borrow without filing a new loan ap-plication. A personal line of credit onchecking accounts is one example; thecredit card with a line of credit is another.Each month, the individual cardholderchooses between complete payment of theinvoice or extended credit, with the choiceof making a minimum payment. The cred-it is used not only for purchases and creditpayment, but also for obtaining cash ad-vances. With the exception of cash ad-

vances, the cardholder can pay the entireamount due without finance charges.

Commercial Credit

Commercial credit is the credit extended tobusinesses by various lenders. Commercialbanks are the primary funders of commercialcredit, but recent legislation gave savings andloan associations limited power to participatein this market. Others, such as acceptance cor-porations, leasing companies, and factoringcompanies are also active. Generally, the debtis short term and is used to meet requirementsfor working capital, such as the funding of re-ceivables or inventory.

Much commercial lending activity is conven-tionally viewed in the category of wholesalerather than retail financial services. For exam-ple, commercial banks will purchase consumerdebt from consumer finance companies, whichthen lend the funds to individuals at higherrates than banks charge. Commercial lendersalso finance capital acquisitions through third-party leases that cover such items as aircraftand computers.

Commercial organizations will also floatdebt in the open market, where it may be pur-chased by any variety of lenders. One is short-term commercial paper; but, as discussed inthe chapter on the securities industry, long-term bonds are also issued.

Consumer Credit

Consumer credit is a specified amount ofcredit that is extended to individuals primar-ily for personal, family, or household purposesby a number of types of institutions that in-clude issuers of travel and entertainmentcards, retail merchants, consumer finance com-panies, and acceptance corporations. Early on,depository institutions began to recognize thatconsumer loans were not only an asset to thebank, but also a contribution to the overalleconomy. Consumer credit loans are extendedto individuals or small businesses and providefor repayment either monthly, quarterly, an-nually, or in full at maturity. Consumer credit

Ch. 4—Retail Financial Services Ž 111— — — — — — .—————— — — — —

can be extended through loans, overdrafts,credit card checks, and credit cards.

Loans

The extension of credit is perhaps best rec-ognized in the form of a loan. Simply defined,a loan is money lent, generally to be repaidwith interest. Loans can be made on a securedbasis, where the funds are protected by pledgedcollateral, or on an unsecured basis, where thefunds are extended with no pledge of collater-al. Loans are made to consumers and busi-nesses on a regular basis. A loan is an agree-ment between two parties. The lender does nothave to be a financial institution. Loans canbe secured by life insurance, contracts, depos-its in financial institutions, securities, or per-sonal and real property. Banks, acceptancecorporations, consumer finance companies,and credit unions are major lenders of con-sumer credit.

Overdrafts

Credit can also be extended through an over-draft, which is a check or payment order writ-ten against a demand deposit or transactionaccount for funds in excess of the balance. Itmust be arranged in advance, and when hon-ored by the depository institution, the over-draft creates a loan. If approval for overdraftprivileges has not been obtained in advance,overdrafts are prohibited. Basically, the over-draft can be defined as an instrument thatoperates with a credit limit, fixed by the in-stitution for each customer and reviewed peri-odically. Since the application of an overdraftis typically for personal use, it is rarely se-cured. The arrangements for repayment of theoverdraft are set by each institution.

Credit Card Checks

Credit card checks are special drafts writ-ten against a credit card account rather thana demand deposit account. They are issued inconjunction with a credit card account and ac-cess a credit line. They work just like a per-sonal check; however, the amount is chargedautomatically to the credit card balance at

time of use. Credit card checks are treated ascash advances, with the monthly statementreflecting the advance. When used, interest ispaid on money borrowed from the day thecheck is written. Merchants do not have to paythe discount and service fee associated withall card transactions when credit card checksare used.

The development of credit cards has helpedsatisfy the demand from consumers for a moreconvenient way to finance their day-to-daycredit needs.

Credit Cards

With the advent of electronic banking sys-tems, the plastic card has become common-place in today’s financial institutions andretail organizations. Nearly all customer/bankcommunication terminals—ATMs, remoteservice units, POS terminals-use card tech-nology in some form. The card is used to ac-cess funds in various accounts and as a me-dium to extend credit. Today, almost 600million credit card accounts exist in the UnitedStates, and 7 out of 10 households have atleast one credit card. Outstanding balanceson credit card accounts total more than $75billion.’

Electronic processing has helped minimizethe amount of paper used in handling creditcards, and online credit authorization hashelped encourage card use because it entailsless of a waiting period. The transaction canbe approved and completed within a timeframe that is acceptable to the customer.Today, there are many online POS terminalsfor credit authorization throughout the UnitedStates. Generally, any credit card can be ac-cepted by the systems, which operate overstandard telephone lines.

Credit cards offer the individual the abilityto defer payment of part of the balance dueas part of an extension of credit. A dollar, orfloor, limit is established, which permits using

‘Federal Reser\’e Board, L’redit Cards in the U.S. Eccmon]L\r—Their impact on Costs, I]rices and Retail Saies, July 27, 1983,p. 1.

112 ● Effects of Information Technology on Financial Services Systems

the card without credit authorization at thetime of purchase. For purchases over the re-quired floor limit, credit approval is necessary.Ceilings are generally set on the total amountthe cardholder may have outstanding.

Over the past several years, many of thecard-issuing organizations have imposed an-nual fees to the cardholder for use of the card.Interest paid on outstanding balances fallsunder State usury laws. Certain State laws,however, place rigid standards on such ac-tions. The result has been: 1) higher annual in-terest rate charges to the cardholder, wherepermitted by usury laws; or 2) the relocationby the card-distributing organization of itscredit card processing facilities into Statessuch as Delaware and South Dakota, whichpermit higher interest, card fees, or both, sothat the card-distributing organization is ableto operate under the banking laws of the Statewhere the processing is done.

Card-issuing organizations impose annualfees on credit cards as a way to generate ad-ditional income. These funds were needed be-cause of the high interest rates financial insti-tutions were paying for funds. Additionally,the annual fee charge is a way to generate in-come from those individuals who use the bankcredit card as a convenience mechanism andwho pay the monthly statement charges in fulland therefore do not incur interest charges.

Basically, there are three kinds of creditcards: bank cards, travel and entertainmentcards, and retail and nonbank cards.

Bank Cards.-The bank credit card hasbecome an integral part of the American life-style. Bank credit card systems have a struc-ture all their own. The two major bank creditcard systems are VISA and MasterCard.VISA International is owned by over 15,000member financial institutions located inalmost 100 countries. Over 100 million cardshave been issued, allowing consumers accessto checking accounts, savings accounts, in-vestments, and lines of credit. VISA U.S.A.is jointly owned by U.S. financial institutions,including banks, savings and loans, creditunions, and mutual savings banks. VISA oper-

ates a worldwide electronic data communica-tion system that transferred nearly 1 billiontransactions between member institutions in1983.7

For processing purposes there is no distinc-tion between a VISA debit or credit card. Thesame processing procedures apply for bothcards; therefore, only the card-issuing institu-tion and the cardholder are familiar with thefunction of a particular VISA card.

Each card-issuing financial institution setsthe policies for its own customers in the VISAsystem. These policies are regulated by appli-cable State laws that limit maximum chargeson credit card accounts, the method of as-sessment of finance charges, and minimumcharges that can be imposed on credit card ac-counts. Different card-issuing banks nation-ally may compete with one another and mayhave slightly different policies. Generally, themost important competition exists betweenbanks as they attempt to sign consumer andmerchant accounts. The merchant discount of-fered to encourage acceptance of the card atan establishment is one of the primary com-petition tools.

Bank credit cards have become subject tocredit controls because of their role in extend-ing consumer credit. They are recognized asinstruments for installment lending to con-sumers and as loans by banks. The controlstend generally to be the ones applying fromtime to time to consumer credit. The controlsinclude compliance in usury limits and truthin lending as set forth in Regulation Z.

To examine critically the national bank cardsystems and the member institution’s role asan extender of credit in the financial serviceindustry requires some analysis. Inherent inevery payment device are two separate anddistinct services. The first is payment forgoods and services, and the second is the ex-tension of credit. The first has traditionallybeen priced in free and open competition andhas not been subject to usury laws. The sec-

7VISA, U. S. A., Credit Controls and Bank Cards Analysis andProposal, March 1980.

. ..

Ch. 4—Retail Financial Services . 113— —

ond has traditionally been subject to usurylaws. Whether the card is used solely as a pay-ment device or as a credit device, by deferringpayment of the full balance, is determined bythe cardholder. The use of electronic technol-ogy and plastic cards has made it possible tocombine multiple functions in a single device,blurring the distinction between what con-stitutes payment service and what constitutesextension of credit.

The national card systems have also ex-panded their use to include card access toATM networks. Several ATM systems estab-lished by banks use VISA or MasterCard asthe access card to a proprietary system. How-ever, both VISA and MasterCard have also setup their own national ATM networks to com-pete with national interchanges. They are inthe process, like other national ATM inter-change networks, of attracting ATM networksfrom across the United States to join their sys-tems. VISA also plans to establish a globalATM network.

Because Delaware and South Dakota allowhigher interest charges or annual fees for thebank card, a number of depository institutionshave moved their processing centers to theseStates. Although technically it makes no dif-ference where the actual processing is done,the critical elements are the type and locationof the organization issuing the card and thelaws that govern the State where the cards arebeing distributed. Credit cards are also distrib-uted by nondepository organizations, such asthe American Automobile Association, and bybrokerage houses. These cards are, however,tied to a financial institution for processingand credit extension.

Travel and Entertainment Cards. -Traveland entertainment cards serve the generalpublic in relatively the same manner as a bankcard. They offer the possibility of deferringpayment. Generally, the monthly limit asso-ciated with these cards is far greater than thatof the bank card; some are issued with nopreset expenditure limit. The cardholder ischarged an annual fee, and the monthly state-ment must be paid in full. As the name implies,

these cards are intended mostly for travel andbusiness use. Travel and entertainment cardcompanies generally follow more stringentguidelines in issuing the charge card than doissuers of other cards.

Several elite versions of the travel and en-tertainment card exist; for example, the Amer-ican Express Gold Card. These elite cards of-fer check-writing privileges and a higher floorlimit for purchasing goods (which exceed thosefor the conventional card). Both the Gold andconventional cards provide access to ATMsand traveler’s check dispensers and ease ofcheck cashing at hotels and American Expressoffices.

Photo credit: American Express Co

Automated traveler’s check dispenser

114 ● Effects of Information Technology on Financial Services Systems— . — — — - — — . — — . — — — — — . — — . — — —

Travel and entertainment card transactionsare consummated in the same manner as withbank cards. The difference is, however, thatthe drafts are accumulated and billed monthlyto the consumer, with the full amount duewithin a specified period after billing. Sincethis process is considered a payment service,its cost is unrelated to the funds outstanding,which are not considered a loan of money withrespect to usury statutes or annual percent-age rate disclosures. Usury statutes applyonly when the cardholder elects to pay ininstallments through a prearranged line ofcredit with a financial institution.

Retail and Nonbank Cards. -Retail creditcards are distributed by both large and smallretail and service organizations, which havebeen in the business of extending credit to in-dividuals and organizations for some time andwere the leaders in establishing the credit card.Large chains of retail stores, gas/oil com-panies, and hotel and travel businesses runtheir own credit card operations. Sears Roe-buck, the largest issuer of retail credit cardsin the United States, accepts only the Searscredit card in its stores.8 J. C. Penney, also a

‘Nilson Report, June 1983.

major retailer, accepts not only the J. C. Pen-ney proprietary credit card but also VISA andMasterCard. J. C. Penney, for example, has avery complex electronic network system, ena-bling it to service accounts online throughoutthe country. The Penney system supports35,000 online terminals, allowing access to theVISA system directly without the need for afinancial institution intermediary. It is theonly retailer to do so. Retailers continue to en-courage the use of their proprietary creditcards for several reasons: 1) to provide conve-nience to their customers, 2) to tie their cus-tomer base to their stores, and 3) to facilitateimpulse purchases.

Card operations can also cross companies.J. C. Penney, for example, processes credittransactions for oil companies. The authoriza-tion is accomplished by running dedicatedlines from the service station to the nearestPenney store. The signal is then sent over themain trunk line to the data center where theauthorization file is maintained. The informa-tion is captured and transmitted to provide abasis for generating customer invoices.

Electronic Funds Transfer

Funds transfer is defined as any transfer offunds by means of a check, draft, or similarpaper instrument or by electronic meansthrough a terminal, telephone, computer, ormagnetic tape so as to order, instruct, orauthorize a financial institution to debit orcredit an account. A transaction can take sev-eral forms: cash purchase, charge purchase,purchase by check or draft, deposit to an ac-count, withdrawal from an account, or a debitfrom one account to another account ownedby the same party, interbank, or intrabank.A currency-based funds transfer uses cash orcoin. A paper-based transfer of funds is ac-tivated by check, draft, or bank card/chargecard (when the transaction is not tied directly

to a communication system that facilitates animmediate debit or credit).

Electronic funds transfer (EFT) enables con-sumers to carry out financial transactions viaelectronic devices instead of using paper mon-ey or checks. Electronic funds transfers canbe carried out through use of an ACH, a homebanking system, an ATM, or a POS system.One example of an EFT transaction is the useof an access card, a plastic card encoded withan identification number to trigger the elec-tronic impulses. Although debit cards allowaccess to an account with adequate funds,some debit cards may also be used to borrowmoney, thus becoming all-purpose transactioncards.

— -— ——

Ch. 4—Retail financial Services ● 115— — — — - —. — -- -— —— .—

Automation and electronic payment sys-tems have often been at the forefront of recentchanges in financial service organizations. Cer-tainly one main effect of these changes lies inthe cost reductions that have been made pos-sible by the elimination of paper-based trans-actions, which are personnel-intensive and,therefore, costly. Electronic financial services,however, are not pervasive. While the deploy-ment of ATMs, for example, appears to beprevalent in major cities, smaller towns andremote areas of the country still rely on tradi-tional systems for delivering financial services,although this picture is rapidly changing.While individuals depend on traditional serv-ices, many of the financial service providersrely on automation for the ease and efficiencyof operating the services. Network systemscontinue to expand because communicationand information technologies enable a broadergeographic base to be served and allow in-creased transaction volume without a propor-tional increase in costs.

EFT has come to play an important role inthe financial service industry. Although EFTsystems have been operational since the late1960’s, it wasn’t until the mid-1970’s thattheir acceptance became more obvious. Elec-tronically transferring funds today involvesseveral methods: direct deposit, credit andcheck authorization at point of sale, and mostnotably, use of the ATM. To some degree, al-though they have not penetrated the marketas greatly as the ATM, the POS terminal andremote information systems, such as homebanking, also play significant roles.

Automated Teller Machines

The first applications of automation in cus-tomer services were very simple cash dispens-ers that provided the user with a fixed sumof cash in a single denomination. These sys-tems generally operated off-line, so the trans-action was not a direct debit. Now ATM sys-tems offer most of the same transactioncapabilities as a branch bank, allowing con-sumers to withdraw cash from a bank account,make deposits, borrow cash against a line of

credit, obtain a cash advance on a credit card,pay bills, transfer funds from one account toanother, and inquire about account balances.(The relative use of ATM functions is illus-trated in fig. 7.) Credit can be obtained eitherby granting of overdraft limits or, in somecases, through using a credit card rather thana debit card to activate the machine to obtaina cash advance. Systems vary, however; someare merely cash dispensers, although the tech-nology of the different systems is basically thesame.

The plastic card’s magnetic stripe is the“key” that unlocks the machine for use. Theway the data are encoded and what items ofinformation are placed on the magnetic stripevaries. A great deal of attention has been paidto the standards being developed for the plas-tic card.

Although the cost of ATMs has fallen sig-nificantly since their introduction, “the costof ATMs is unlikely to fall as rapidly as thatof many other parts of an electronic fundstransfer system because of the various me-chanical parts that are necessary. The capacityto process transactions and information willbecome much cheaper as intelligent terminalsare developed, with display screens and key-boards being largely electronic. There aremany mechanical parts in the dispensing ofcash, in the printer, and in the mechanisms foraccepting funds. A further result of the me-chanical nature of cash dispensing is the short-er life of currency because it quickly becomesunsuitable for use in cash dispensers’ ‘g

With the ever-increasing operating costs fortraditional delivery systems, the customer de-mand for new services, and the competitionfrom new as well as traditional sources, mostorganizations in the financial service industryrealize the need to use automated banking sys-tems. The initial cost of establishing an ATMis high, but it is far less expensive than build-ing a branch bank. And, unlike a branch, it canbe operated around the clock at a fairly lowincremental cost. Therefore, many bankers feel

9Revel], op. cit., p. 44.

116 . Effects of Information Technology on Financial Services Systems—-—-.—— —.

Figure 7.— Relative Use of ATM Functions,a 1974-81

1974

Cash

c

withdra75 ”/0

Balance transfers4 %

1976

:ash withdra74 ”/0

Balance transfers3%

1981

lithdr760/o

Payments2%

p osits19 ”/0

Payments2%

osits1%

nts

Balance transfers4%

aExcluding balance lnquiries. Includes only Years for which estimates based onfield research are available

SOURCE Economic Review Federal Reserve Bank of Atlanta, August 1983

that ATMs will provide both competitive ad-vantage and significant return on investmentover the next decade. To soften the high costof such systems, especially ATM networks,many financial institutions have entered intosharing arrangements.

The ATM, which is operated by the custom-er, can be located in a variety of places. In theUnited States many are installed either in themain banking space of bank offices, in lobbiespartitioned off from branches, or on the ex-terior of a building. They can also be locatedaway from the main bank, at shopping centers,grocery stores, gas stations, offices, and fac-tories. Almost all systems are or will be online.The customer’s plastic card allows him/her togain access to the ATM location outside bank-ing hours and to conduct his banking businessin relative security.

The large success of ATM deployment hascreated another trend in bank branching. In-stead of building large, full-service branchesthat are personnel-intensive and very costly,many organizations are replacing these struc-tures with satellite branches, which are small-scale, highly automated, full-service, and gen-erally require management by only two orthree personnel. ATMs, for the most part, re-place the teller; personnel are there to handlegeneral information or other personal busi-ness. Figure 8 illustrates the growth in thenumber of ATMs in use from 1974 to 1981.Figure 9 illustrates the increases in the aver-age number of transactions performed at eachATM.

ATM Systems

ATM services can be offered in one of fourways: a proprietary system, a shared system,an interchange system, and a piggyback sys-tem. In a proprietary system, or “single insti-tution” system, only the customers of thebank that developed and installed the ATMsystem may use the machines. In a shared sys-tem, a group of financial institutions mutuallyresearches, installs, markets, and operates thesystem. In an interchange system, separate in-stitutions with ATM programs or even sepa-

. . . .

Ch. 4—Retail Financial Services ● 117

r— .- J

—— .—

t– — — J

Photo credits: Steven Rothenberg

Consumers can obtain cash through a variety of service delivery systems

118 ● Effects of Information Technology on Financial Services Systems

Figure 8.— Number of ATMs in Use, 1973-81

“ 50Annual growth rate

/45

. A

.1

40

35

1973 1975 1977 1979 1981

Average annual growth rate, 1973-81

34.780/o

SOURCE Economic Review, Federal Reserve Bank of Atlanta, August 1983, p 16.

Figure 9.—Average Number of Monthly Transactionsper ATM,a 1974-81

7 ’ 0 0 0~6,000

t

c.-

1974 1976 1981aDoes not include balance inquiries, includes only years for which estimates

based on field research are available

SOURCE Economic Review, Federal Reserve Bank of Atlanta, August 1983, p 16

rate, shared systems allow one another’scustomers to use their machines. The term“shared system” is associated with an inter-change system. Generally, there is an inter-change fee associated with using another insti-tution’s ATMs. A piggyback system occurswhen one institution with equipment allowsthe customers of other institutions to use itsmachines .10—

‘“Norman Penny and Donald Baker, The Law of ElectronicFunds Transfer Systems, (Boston, Mass.: Warren, Gorham &Lament, year), p. 6.03.

Shared ATM Systems

The number of shared and interchange sys-tems is growing rapidly. As national ATM in-terchange proliferates, shared systems suchas Plus and CIRRUS allow customers accessto their funds on a national basis. National in-terchange systems, however, are not being runonly by banking organizations. ADP, Inc., andAmerican Express have also begun develop-ing and marketing national ATM interchangenetworks. Supermarkets and retailers are alsopositioning themselves in the ATM arena.

There are, however, limitations to the kindsof services available through the national net-works. Presently, because Federal regulationprohibits interstate deposit-taking,* most sys-tems serve as cash dispensers and provide in-formation about account balances. The feesimposed for using national ATM systems areset by the individual networks and range from$0.75 to $1.30 per transaction. A portion ofthe fee goes to the financial institution whosemachine is being used, and a portion goes tothe organization running the system.

Not all ATM systems are run by bankingorganizations. With the advent of regional andnational ATM networks, ownership of thesenetworks by third parties has become a ma-jor business. The systems operate in two ways:the third-party company can own, deploy, andoperate the ATM network, with the financialorganization paying a transaction fee eachtime its customers use the machine, or thethird party can be the switch operator, receiv-ing either a percentage of the transaction feeor a fixed monthly fee for its processing ef-forts. These systems are developed on a local,regional, and national basis and are in directcompetition with bank-run systems.

Safeway–an Oakland, Calif., supermarketchain-has announced plans to develop andmarket a national ATM network. Presently,Safeway participates in a shared interchange

*Reciprocity agreement,g exist among several states. ‘heMassachusetts Legislature passed a bill in 1983 entitled “AnAct Relative to Branch Offices and Acquisitions of FinancialInstitutions, ” that permits interstate deployment of ATMs anddeposit-taking among five New England States.

Ch. 4—Retail Financial Services ● 119.——.

network, owned and operated by the NetworkExchange of metropolitan Washington, D.C.The objective of the Safeway program for in-store ATMs is to increase store traffic andsales by providing customers with full-service,one-stop shopping convenience. Safeway hascommitted to installing common-access ATMsin key stores throughout California. TheWashington, D. C., program, however, is pres-ently not a participant of the Safeway ATMprogram being developed in Oakland. To at-tract the maximum number of prospectiveshoppers, Safeway will promote both the avail-ability of the ATM services at its stores andthe financial institution cards that can accessthe machines. Safeway is also prepared toassist the participating financial institutionsin generating new accounts that can access thein-store ATM services.

Participation in the program is on a trans-action-fee basis. National Transaction Sys-tems, Inc. (NTSI), will provide ATMs; install,maintain, and service them; and perform allrequired transaction processing, funds trans-fer, settlement accounting, billing, and cus-tomer service operations required to supportthe Safeway ATM program. Safeway cashmachines will be linked to NTSI switchingand processing system via leased telephonedata circuit. Other leased data circuits will linkthe switch with the participating institutions’host computers. Initially, the only functionavailable will be cash dispensing, selected bythe financial institutions from the followingthree service-level options:

1.

2.

Direct host link. The participating insti-tution’s computer is linked directly to theNTSI switching processor. The institu-tion pays for the dedicated data circuitand modems associated with its host com-puter link to the NTSI switch.Direct host fink with “stand-in “process-ing. NTSI maintains a cardholder author-ization file and control parameters on theNTSI computer for processing the partic-ipating financial institution’s cardholderSafeway Cash Machine withdrawal trans-actions when the institution’s host com-puter is not available. In addition to the

3.

dedicated data circuit and modems, theinstitution pays a service fee for thestand-in processing option.Full stand-in processing. NTSI maintainsthe participating institution’s cardhold-er file online at NTSI. NTSI verifies thecardholder’s personal identification num-ber and authorizes or denies the card-holder’s Safeway Cash Machine trans-action in accordance with the institution’sauthorization parameters and cardholderpositive file information, updated daily bythe institution’s processor. The institu-tion pays an additional service fee for thisstand-in processing option.

Merrill Lynch, Pierce, Fenner, & Smith Inc.,has signed an agreement with Safeway Stores,Inc., that will enable the brokerage concern’scustomers to tie into the Safeway ATM net-work. Merrill Lynch customers who have oneof its Cash Management Accounts, which linka securities account and money market fundswith “check” writing privileges and a VISAcard, can use the VISA card to obtain cash atSafeway stores. This is expected to begin inearly March 1984; it will be limited, for thepresent time, to California locations. However,Merrill Lynch expects to expand the servicesto include nationwide access.

In Florida, Publix supermarkets has also es-tablished its own ATM network, which it of-fers for use to any bank in the State (operatedon a piggyback basis). Fees are imposed forevery transaction a customer makes at a Pub-lix terminal. In addition to deploying theATM, Publix also runs the switch that oper-ates the system.

Shared systems exist primarily on a local/re-gional basis. The Tyme Corp. of Wisconsin hasoperated as one of the first shared systems inthe United States, and in Washington, D. C.,the Money Exchange has operated as one ofthe first shared networks on an interstatebasis. Shared/interchange systems allow thesmall institution to compete with other finan-cial institutions in the ATM competition. Thefeasibility of all financial institutions operat-ing switches and deploying ATMs within a

35-505 0 - 84 - 9 : QL 3

120 . Effects of Information Technology on Financial Services Systems———— —.— ——.——— —

contained area is uneconomical. By operatingin a shared/interchange environment, the fi-nancial institution can extend the geographicreach of its market and earn income from theATM.

CIRRUS—National ATM Network

The CIRRUS System, Inc., is a not-for-pro-fit membership corporation that allows itsmembers to offer their customers the conven-ience of nationwide ATM access. Incorporatedin June 1982, CIRRUS is headquartered inOak Brook, Ill. When fully operational, it willserve 41 States. Growth projections for thesystem are summarized in table 5.

Membership in CIRRUS is exclusively re-served for banks, savings and loans, and creditunions. Associate membership is limited tobanks. CIRRUS does not preclude its mem-bers from joining other networks, nor does itrequire the sharing of other electronic services,such as POS terminals. There are three classesof membership for the CIRRUS System:

1. Principal. Principal members have ex-clusive marketing rights in their terri-tories. They may share their link to theCIRRUS switch, run by the National Bankof Detroit, by licensing correspondentmembers. Principal members are requiredto add their ATMs to the network.

2. Associate. Associate members also havea direct link to the CIRRUS switch andmay share their connection with the cor-respondent members they license.

3. Correspondent. Correspondent membersare linked to the CIRRUS stitch throughthe principal or associate members wholicense them.

CIRRUS allows its members to offer theircustomers the convenience of nationwideATM access. Using a CIRRUS card at an

ATM deployed by any CIRRUS member, acustomer can make a withdrawal from his sav-ings or checking account, check balances, andaccess a line of credit. All CIRRUS ATMsmust accept the cards of every CIRRUS mem-ber; however, individual members may setlimits on the amount of cash their customersmay withdraw at a time. CIRRUS ATMsmust also be online in order to authorize trans-actions. The CIRRUS switch, maintained bythe National Bank of Detroit, does not providebackup authorizations for its members. Thenetwork ensures against switching downtimeby utilizing an ACI/Tandem computer.

Individual CIRRUS members are responsi-ble for the cost of hooking up to the switchand maintaining the connection. They mustalso pay for hardware and software modifica-tions necessary to comply with the network’soperating rules.

Associate members pay a one-time entrancefee of $25,000 to join the network, connectwith the switch, and reserve the right to li-cense correspondent members. Correspondentmembers’ entrance fees are set by agreementwith the licensing banks. Ongoing member-ship fees for the CIRRUS System are $2,500per month for associate members; correspon-dent members pay the membership fees set bytheir licensing bank. There are also process-ing and interchange fees. Each time a CIRRUScardholder uses his ATM card at a bank otherthan his own, the card issuer pays the switch$0.25 for processing the transaction. For with-drawals and for accessing a line of credit, thecard issuer also pays the institution deploy-ing the ATM an additional $0.50 interchangefee per transaction. For balance inquiries andother transactions, the card issuer pays themachine-deploying institution a $0.25 inter-change fee.

Table 5.—Growth Projections for the CIRRUS System, Inc., National ATM Network

1982 1983 1984 1985Number of CIRRUS participants . . . . . . . . . 682 862 1,760 2,297Number of CIRRUS ATMs deployed . . . . . . 3,364 5)015 7,210 8,839Number of CIRRUS cardholders . . . . . . . . . 14,600,000 18,000,000 28,900,000 32,700,000SOURCE The CIRRUS System, Inc

. .—

Ch. 4—Retail Financial Services ● 121

ATM-deploying institutions earn revenuefrom interchange fees every time another in-stitution’s cardholder uses their machines totransact banking business. Card-issuing insti-tutions are permitted to charge their custom-ers for the privilege of being linked to theCIRRUS network. Associate members canshare their direct link to the CIRRUS switchwith other institutions for a fee, and no mat-ter how many correspondents an associatesigns up, it never has to pay more than its flatmonthly membership fee. Members of theCIRRUS network are free to join othernetworks.

When fully operational, CIRRUS will linkover 5,200 ATMs serving over 16 million cus-

tomers. The national ATM switch is designedto handle at least two transactions per second.This represents a daily capacity of 173,000transactions.11

ATM Deployment Legislation

Deployment of ATMs remains dependent onState-by-State banking legislation. Figure 10shows the number of ATMs in each of theStates in 1983. Certain States, such as Illinois,have very strict, off-premise deployment laws.Illinois permits State-chartered banks toestablish ATMs subject to a number of geo-graphic, time, and number restrictions. First,

“CIRRUS Systems, Inc., Oak Brook, Ill.

Figure IO.— ATMs in the United States

1 1 1

SOURCE Economic Review, Federal Reserve Bank of Atlanta, August 1983, p 13

Legend Total ATMs

B

1700 to 4000700 to 1700500 to 700300 to 500200 to 300

Less than 100

122 ● Effects of Information Technology on Financial Services Systems—

prior to January 1, 1980, a bank may estab-lish not more than two ATMs, each no morethan 3,500 yards from its main office. Second,commencing January 1, 1980, a bank may es-tablish an additional eight ATMs, at the rateof two per year. Third, prior to January 1,1981, these ATMs maybe located only withinthe county of a bank’s main office. Finally,subsequent to January 1, 1981, a maximumof four of the eight ATMs may be locatedwithin an adjacent county. ATMs located notmore than 3,500 yards from the bank’s prem-ises need not be shared, but those located morethan 3,500 yards from the bank’s main prem-ises must be made available on a nondiscrim-inatory basis for use by customers of any otherbank that would be permitted (under the stat-utory geographic restrictions) to establish anATM at that particular location. ’z

In sharp contrast to the restrictive Illinoislaw is Wisconsin legislation on terminal de-ployment and usage:

Facilities established under the WisconsinEFT statutory provisions must be availableon a nondiscriminatory basis for use by anylike institution which has its principal placeof business in the State, or by any other likeinstitution which obtains the consent of a likeState, or by a national institution which hasits principal place of business in the State andwhich is using the terminal.

The statute requires that regulations pro-hibit, with regard to a shared terminal, anyadvertising that suggests or implies exclusiveownership or control of the terminal by a fi-nancial institution or group of institutions. 13

Wisconsin law made possible the first sharedATM network in the United States and oneof the largest.

Massachusetts went one step further. Inearly 1983 a law was passed that, for the firsttime, permits Massachusetts financial insti-tutions to link their ATMs to regional and na-tional interchanges. Entitled “An Act Rela-tive to Branch Offices and Acquisitions of

“Robert C. Zimmer and Theresa A. 13inhom, The Law of Ekc-tronic Funds Transfer, Card Services, inc., 1980, pp. I 1-11 toI 1-13.

“Ibid., p. WI-1.

Financial Institutions, ” the act establishesnew authority for mergers, branching, elec-tronic branching, and mortgage lending byMassachusetts financial institutions. Whilethe act is generally limited in its operation toactivities involving five New England States,the EFT provisions are expressly exemptedfrom such limitations. Under prior law, no out-of-State financial institution nor bank holdingcompany was permitted to purchase, estab-lish, install, lease, use, or share an ATM inMassachusetts. The sole exception was al-lowed in a grandfather clause that exemptedfrom the prohibition certain electronicbranches established before December 31,1981. To qualify for the exception, the ATMhad to dispense only cash, traveler’s checks,or both, and had to be limited solely to the useof customers of the financial institution thatestablished it.

The new law empowers Massachusetts insti-tutions to link their ATMs to regional or na-tional networks. It also permits a financialinstitution, organization, or bank holding com-pany, or its subsidiary organized outside ofMassachusetts, to share any ATM establishedand used by a Massachusetts financial insti-tution or organization, provided that the shar-ing entity limits its customers to cash with-drawals, advances against preauthorized linesof credit, and check cashing. Moreover, anyout-of-State nondepository financial institu-tion that establishes electronic branches thatdispense only traveler’s checks and are limitedto use by the nondepository’s own customers,such as American Express’s Express CashProgram, are allowed to establish, use, orshare electronic branches in Massachusetts.

Finally, the new law authorizes financial in-stitutions, organizations, and bank holdingcompanies in Conneticut, Maine, New Hamp-shire, Rhode Island, and Vermont to purchase,establish, install, operate, lease, or use elec-tronic branches. That is, whereas the prior lawpermitted institutions from any State to shareATMs established and used by Massachusettsinstitutions, the new law allows New Englandinstitutions themselves to establish and useATMs in Massachusetts, whether or not a

-—— —=—— . .—

Ch. 4—Retail Financial Services ● 123— — . . — — — — —— ———.—

Massachusetts institution is involved. ” All ofthe participating States passed legislation ap-proving the interstate branching.

There are no uniform guidelines on ATM de-ployment that each State follows in makingits EFT deployment laws. Each State’s legis-lature determines what approach will be bestfor the consumer and the banking community.

POS Full Funds Transfer

The term “point of sale” covers a variety ofservices rendered through machines located atretail establishments. POS terminals are gen-erally clerk-operated devices located at thecheckout or convenience counter of retail es-tablishments. Electronic cash register ver-sions of these terminals have been in opera-tion for several years, maintaining storerecords on sales, inventories, accountsreceivable, and the like. Now, POS deviceshave been linked to financial institution com-puters, allowing retail customers to receive ap-proval for check cashing and electronically ini-tiate transfers from their accounts to theretailer’s, the latter being POS full fundstransfer. In some installations, customers canmake deposits to their accounts. POS devicesaccept either a plastic credit card or a plasticdebit card, depending on whether the cus-tomer wants to delay payment by charging thepurchase or wants the purchase deducted di-rectly from his/her account. As electronic POSsystems proliferate, their use will probably re-place many of the paper transactions accom-plished through cash payments and check andcredit transactions.

The debit card, another means of facilitatingfunds transfer at point of sale, functions muchthe same way a credit card functions exceptthat when the transaction is received by theissuing financial institution, it is debited to thecardholder’s account, which may be a check-ing, savings, NOW, or other form of deposi-tory account. Some securities firms havedistributed debit cards to access cash manage-

—. —..41+:lc~tr0niC F’und< Transfer Association, llrashin~~ton Report,

tJan, 11, 19H3.

ment funds. The card may also have an over-draft credit line. There has been much cus-tomer resistance to using a debit card at thepoint of sale because the customer associatesthe use of a plastic card with the eliminationof float, which allows a grace period before ac-tual payment is required. Also, many peoplein the industry have referred to the debit cardas a paperless check, which is one of the rea-sons that retailers have been reluctant to ac-cept it. Presently, retailers can accept acceptand process checks for less than the fee im-posed for processing a debit or credit cardtransaction. These differences have resultedin controversy between the retailer and card-issuing institutions.

Another form of debit card transaction atpoint of sale gives the cardholder a rebate,which encourages use of direct debit at pointof sale. Customers use the card, which worksonline, to debit their account directly to anyparticipating retailer. The retailer receives in-stant credit, and the customer receives a re-bate, ranging anywhere from 2 to 5 percent,directly credited to his savings account. Oneof the most successful of these programs isthat of the Wilmington (Delaware) SavingsFund Society. Most of the other programs,however, have been unsuccessful. First of all,a significant card base was not represented.Second, many of the stores that signed up forthe program were inconvenient to the majorityof the cardholders, and these stores alsotended to sell products at a higher cost thandid discount stores.

Direct Debit POS

Retail Stores.–Although previously notmany POS systems operated in retail stores,there is tremendous potential for their use.One of the most successful direct debit POSprograms is in Des Moines, Iowa. There, Dahlsand Hy-Vee supermarkets operate direct debitPOS systems at the checkout counter, the firstsuch systems in the United States. Custom-ers of these supermarkets can pay for grocerieswith a proprietary debit card issued by Nor-west Bank, which automatically debits thecardholder’s account. ITS, Inc., operates the

124 ● Effects of Information Technology on Financial Services Systems

computer switch that makes EFT possible forsome of the 205 participating Iowa banks, sav-ings and loans, and credit unions. The Hy-Veesupermarket does about 4,000 POS trans-actions per month; Dahl’s does about 2,000 permonth. Each location paid about $18,000 toinstall magnetic stripe readers and keyboardadd-ons to the NCR cash registers and to buythe processors and software. However, volumesales of the systems should cut costs. More-over, the store receives good funds the nextday.

Retailers and banks both benefit by havingaccess to the customer’s float, and both theretailer and the bank are assured the funds aregood. “To encourage direct debit use, bankerswill price check transactions higher than theirdebit card counterparts to nudge consumersalong. The cost of processing one check is esti-mated at about 50@, and an EFT transactioncosts about 30©. The higher the volume inEFT, the lower the per transaction cost be-cause of the high fixed overhead. ”15

Oil and Gas Companies.–The gasoline sta-tion is currently the focus of much POS activ-ity because it generates more transaction vol-ume than any other kind of retailer.16 Manylarge oil and gas companies are installing POSterminals at service stations. A few directdebit POS terminals are being deployed di-rectly into the gas pumps, although the ma-jority are stand-alone terminals.

While still in its infancy, the idea of deploy-ing POS terminals at service stations is be-coming more accepted because of the increasein self-service gas stations, because more sta-tions are remaining open 24 hours a day, andbecause service stations are often vulnerableto robberies. To help reduce the tremendousvolume of cash generated each week by gaso-line purchases, major oil companies and banksacross the country are joining forces to testPOS terminals at the pumps, using proprie-tary credit cards or bank debit cards as an

“Forbes, Aug. 29, 1983, p. 46.loMmagement Information Systems Week, July 27, 1983,

p. 81.

—

alternative method of payment. Most of thetests at the service station involve agreementsbetween oil companies and financial institu-tions under which customers can pay for pur-chases using bank debit cards that automat-ically debit the amount of purchase from theirchecking accounts. However, there is addition-al interest in proprietary credit card trans-actions at points of sale. Mobil Oil Co., for ex-ample, has 2,400 POS terminals linked to itsKansas City processing center, which capturesall transaction information via electronic draftcapture. Since the system is online the infor-mation is transmitted immediately. This POSsystem enables Mobil to capture billing infor-mation electronically, saving internal costs byreducing the amount of paper used in suchtransactions. Mobil implemented a credit POSsystem, which could easily convert to a hybridsystem supporting both debit and credit, tomaintain its loyal customer base and to gen-erate new business. Mobil representatives feelthat direct debit at this stage would alienatecustomers.

The POS transaction begins by the servicestation clerk inserting the card into a POS ter-minal. In some cases, the customer inserts thecard into an automated pump and then keysin his own personal identification number(PIN). By implementing direct debit POS ter-minals, the customer’s account is automat-ically debited, and the retailer’s account is gen-erally credited immediately or the next day.The benefits to both banks and oil companiesare savings of millions of dollars. In mostcases, the bank or network operator receivesa transaction fee for each purchase. The oilcompany saves by being assured of good fundsand by receiving payment immediately. Thisis a significant issue because the general lagtime for credit card sales draft, according toa Mobil Oil Co. official, is 10 days.

Some POS test situations currently underway are being done by AmeriTrust Bank, ShellOil, and Gastown in Cleveland, Wells FargoBank and Shell service stations in San Fran-cisco, First City National Bank of Houstonand Exxon Co.

Ch. 4—Retail Financial Services ● 125-—— —— — — . . ————— —

National POS Systems

Large-scale communication networks are be-ing developed, primarily by the major creditcard industry, to connect thousands of POSretail terminals with financial institutionswithin a State, region, and, ultimately, the Na-tion. These networks will include computerizedswitching centers and a base for clearing set-tlements.

In addition, oil companies, banks, and otherretailers are considering national POS net-works. Tests are being conducted by LibertyNational Bank & Trust Co. of Oklahoma Cityand a Southwest oil dealer whereby terminalswill be deployed at stations offering the fol-lowing services: automated dispensing at thepump, an ATM inside the station for purchas-ing convenience items, and a commercial de-pository that is wired to the ATM so thathigh-volume stations can make deposits.

At the present time, POS systems are be-ing allowed by regulators to access time andsavings accounts; however, this could change.Regulation D* is not being strictly interpretedwith respect to POS activity. However, if theregulation were strictly interpreted, a largenumber of financial institutions, savings andloans, and savings banks, would be prohibitedfrom actively participating in a POS system.

Other Uses of POS Systems

The POS terminal can also be used for checkauthorization, permitting the customer to ob-tain approval of a check for payment by run-ning a verification of the check-cashing recordthrough a computer. Likewise, the POS sys-tem enables merchants to verify the availabil-ity of funds in a customer’s account or his ac-cess to credit before completing the sale. Aswith ATMs, customer access to POS terminalsis usually by plastic card and PIN. This is analternative to manual authorization and veri-fication, which is handled by accessing a neg-

*Regulation D is a uniform reserve requirement on all depos-itory institutions with transaction accounts or on personal timedeposits. It requires submitting reports on all deposits to theFederal Reserve Board and sets phase-in schedules for reserverequirements.

ative file or by having the retailer check a man-ual that lists card numbers of bad credit risks.

In the United States, POS experiments havebeen conducted since 1974. Very few systemsinvolving instant transfer have survived, andthe most important functions of POS, untilonline direct debit systems were in place, havebeen check verification and credit card author-ization. One explanation for this very limitedsuccess could be that the experiments havegenerally looked for evidence of profitabilitywithin a few months of installation, whereasthe change in social habits involved in mov-ing from cash and checks to instant transfertakes a great deal longer.

Costs of POS Systems

For several years merchants and financialinstitutions have been at an impasse over howto implement electronic payment systems,especially retail EFT systems. The differingperspectives reflect differences in technologiesbeing used, in terminal ownership, in customerbases, and in approaches in pricing the service.

One of the main concerns associated withimplementing POS systems is the cost to beborne by retailers and banks. Another is theconcern about merchant discount fees. Mostbanks charge the merchant the same fee fordebit card transactions as they do for creditcard transactions. The argument made by themerchant is that debit cards function in lieuof a paper check and therefore the merchantshould not pay the same discount fee. A POSsystem can all but eliminate float, reducecredit risks, require the merchant to keep lesscash on hand, and ease check approval.

Technology has also been a basis for conflictbetween the merchants and POS operators. Fi-nancial institutions typically base their debitcards on the magnetic stripe technology usedfor years on bank credit cards. Grocery retail-ers, on the other hand, typically base theirtechnology on an optical scanner that readsbar codes on product labels and transmits theinformation to an electronic cash register(ECR). Department stores typically prefer op-tical character recognition characters read

126 • Effects of Information Technology on Financial Services Systems—

from merchandise tags and proprietary creditcards with a handheld wand. Product and cus-tomer information is fed into an ECR to ef-fect electronic payments.

Financial institutions tend to prefer owningthe necessary terminals and charging mer-chants a user’s fee for making transactionsthrough them. On the other hand, retailerstend to prefer devices that are integral com-ponents of their own ECRS.17 Naturally, finan-cial institutions and the merchants are weddedto their respective investments. It is unreal-istic to expect the merchants to give up theirtechnology in order to accept electronic pay-ments. Developments such as VISA’s “elec-tron card” are aimed at simplifying thisproblem.

Another issue with respect to POS systemsis the volume of sales to be handled. It hasbeen argued that to be viable economically, thePOS system must become competitive withcash; otherwise, there is no incentive for theretailer or the customer to use it. The customeris faced with loss of float, and the retailer isfaced with transaction fees, which cash pay-ments do not require. Under these conditions,systems that are shared among all the banks—.- ——_——

“’’Debit Cards at the Cross Roads, ” Economic Review, March1983, pp. 37-38.

in an area and that provide for the recruitmentof most retail outlets stand the greatestchance of success.

POS systems will undoubtedly increase dur-ing the next decade, with many new systemsbeing built upon existing ATM networks.Both the banks and retailers stand to gainfrom the resulting reduction in the volume ofpaper transfers. However, merchants contendthat since a debit card transaction saves finan-cial institutions time and money relative to acheck transaction, merchants should enjoysome of the savings. It has become quiteapparent that in order for POS systems to de-velop and operate efficiently, the systemsmust be designed in close cooperation with theindividual retailers, not just the markets thesystems serve.

The technology necessary to operate elec-tronic debit and facilitate POS transactionsexists today. It is the intention that electronicdebit cards will substitute for check, creditcard, and cash transactions. However, whenPOS services become commonplace, the useof cash and checks as a payment mechanismwill still exist. Disconcerting cost trends areleading merchants and financial institutionsto seek lower cost alternatives for POS trans-actions. EFT is the method by which this goalcan be reached.

Financial Information Services

There are many forms of information serv-ices in the financial service industry. They in-clude check or credit authorization/verifica-tion; status information on account balances;identification verification; billing and fundsdue information (e.g., preauthorized pay-ments); accounting information with respectto general ledger, payroll, accounts payable,accounts receivable; and modeling and analyti-cal services, such as Chase Econometrics andWharton Econometrics, which provide accessto data bases, econometric models and mod-

eling tools, and various other analyticalpackages.

All financial service providers use informa-tion services. Retailers are perhaps one of thelargest users of specific information services,particularly check verification. Check verifi-cation validates the authenticity of the checkor its presenter. This system is accessed onlinethrough a telephone or terminal by the retailer.The retailer pays for this service, generally apercentage of the value of the check. These

Ch. 4—Retail Financial Services ● 127— .

systems are run by third-party organizationsand banks that maintain negative files.

Check Authorization

Check authorization systems may be pro-vided and maintained by the party acceptingthe check, by a financial institution, or by athird party engaged in such a business. Thesystems may be designed to access bank rec-ords directly or may rely on secondary datasources. In some systems, check approval isaccompanied by a guarantee of payment. Inan EFT system, a customer’s plastic card andPIN can be used to access the system and ver-ify the available balance. This is accomplishedby placing the check into a terminal and key-ing in the appropriate information. The checkis then validated and accepted at point of sale.

Credit Authorization

Credit authorization is yet another informa-tion service vehicle available to the retailer.It operates by allowing the customer’s creditcard to be read by a financial service terminalwhile a central computer verifies that the cardis valid and the customer’s account has suffi-cient funds. This can also be accomplishedmanually by checking a printed document, dis-tributed by the card companies, indicating lostor stolen card numbers or by placing a call toan operator who will authorize or refuse thetransaction based on information from a database. This inquiry process is supposed to re-duce the risk of credit fraud or of extendingcredit in excess of an imposed credit limit.

Information service systems allow for real-time access and reduction of risk at point ofsale and ensure that the retailer will receivethe funds. The risk is transferred to the partyauthorizing the funds. This service guaranteespayment to the retailer and is attractive de-spite the fact that the retailer must pay apremium to insure the funds.

Providers of Information Services

Many kinds of organizations are informationproviders. Depository institutions use and pro-

vide information in unique ways. For exam-ple, the services they perform include provid-ing status information to their customers ona very regular basis. The most familiar proc-esses are inquiry of account balances or fundscredited or inquiries regarding specific checkclearing. Today, much of the status inquiry in-formation is processed by online teller ter-minals with direct access to the accounts be-ing questioned.

Service organizations provide accounting in-formation services to customers, such as in-formation services about payroll or accountsreceivable/payable or other services necessaryfor efficiently running the organization with-out the added costs of implementing an auto-mated system in-house. A wide variety offirms, including financial service providers, of-fers these services.

Two other key information service providersin the financial service industry are invest-ment brokers and insurance firms. (The bro-kerage industry is covered in ch. 3 of this re-port.) Insurance information is compiled byactuarial scientists and categorized by risk,age, and the like. Much of this information isavailable to individual brokers through onlinevideotex terminals. Insurance information re-quires some customization in order to meet thespecific needs of the party requesting the in-surance, although premiums and risk are de-termined by actuarial methods.

The information provider in the insuranceindustry is the insurance salesman. Althoughmuch information about general insurance isaccessed to data bases via terminals, the proc-essing of this information still requires the per-sonal interaction of the salesman and client toprovide the service adequately. Some insur-ance information is provided through com-puter/CRT* terminals that display rates andalso give an explanation of the types of insur-ance available. The insurance industry is look-ing at further automating the delivery of in-surance information.

*CRT terminal—video terminals that display data on a cath-ode-ray tube.

128 ● Effects of Information Technology on Financial Services Systems

The following scenario may present itself inthe near future. Through videotex and homeinformation systems, insurance informationcan be transmitted and reviewed by an in-dividual. If the need presented itself, for ex-ample, an individual would be able to increasethe amount of homeowner’s insurance for aspecific period of time, say a weekend, if heplanned to be out of town. The insurance pol-icy modifications could be done instantane-ously, and the additional premium paymentcould be automatically debited from the cashvalue of other insurance policies.

Several of the larger banks in the UnitedStates offer financial, securities, and invest-ment analyses; payment products, models anddata bases to corporations, other banks, insur-ance companies, financial institutions, andgovernment agencies. An example is terminal-based cash management for major corpora-tions and banks.

Mortgage servicing is another aspect offinancial information services. Mortgage bank-ers and a growing number of commercial, mu-tual savings bank, and savings and loan cus-tomers use this type of service for servicingtheir portfolios of mortgage loans, which in-clude taxes, escrows, and insurance. Loan clos-ing documentation and mortgage preparationsystems are available to help customers of theservice keep track of inventories and financialcommitment needs. Batch transmission andinquiry modes to a central location are usedvia dial-up and leased transmission lines. Inthis manner, nationwide service is providedfrom a single location.l8

Information services provide immediate ac-cess to financial information and are used to

18 Herbert A. Schulke, Jr., “Electronic Financial Systems, ”Innovations in Telecommunications, Academic Press, Inc.,1982, p. 1038.

transfer funds efficiently from one account toanother. For example, in a corporate environ-ment, real-time access and videotex technol-ogy allows a treasurer or financial advisor tomanage and control all of the investment ac-counts. Through the same technology, invest-ments can be transferred on a daily or perhapseven hourly basis.

Many organizations today conduct financialcounseling programs for all ages and groups.These groups organize to seek sound financialguidance and to plan for long-range moneygoals. Interestingly, these groups include notonly the affluent market but also young pro-fessionals and middle-income individuals whohave become far more educated and concernedabout how their finances are handled.

Different sectors of the financial service in-dustry require different information services.For example, a bank loan officer may inven-tory data to assess liquidity and solvency. Fi-nancial analysts are concerned with equity in-vestment decisions and are likely to place moreimportance on earnings-per-share and capitalaccount data. On the other hand, various fi-nancial service groups use the same informa-tion in different ways in the decision process.

Service industries, such as banking, securi-ties, and insurance, whose business operationsrely heavily on information services, are find-ing that the whole environment in which theyoperate is changing rapidly. Earlier develop-ments in information technology were suchthat only large corporations could take advan-tage of its capabilities. However, over the lastseveral years, technical innovation has con-tinued at such a rapid pace that, for example,information processing power, which oncetook a roomful of large equipment, is nowavailable in portable machinery.

Home Information Systems

Home information services are a way by Home information systems (HIS) started inwhich financial information services can be de- a relatively minor way in the United Stateslivered to users of home computer terminals. several years ago with the introduction of bill

Ch. 4—Retail Financial Services • 129. — — . —. —. —.—— — — -

paying by telephone. The original impetuscame from thrift institutions, which saw tele-phone bill payment as a way to offer trans-action accounts, thereby partially circumvent-ing the law forbidding payment of interest ondemand deposits. Soon commercial banks be-gan offering the service. When the telephonebill payment service was first introduced, mostof the systems required the customer to callin and give oral instructions over the telephoneto an operator to perform banking services,specifically bill payment. Automation was in-troduced and made available to customerswith touch-tone phones, although most sys-tems still relied on operators during the busi-ness hours and on recorded messages at othertimes. Telephone bill paying services did notattract a large customer base, and many of theearly programs have come to a halt.

Technology of HomeInformation Services

The introduction of videotex played a keyrole in the development of home informationsystems. Videotex—a generic term that refersto computer-based information retrieval sys-tems that display text and graphics via videoscreen—is a product of the convergence oftelecommunications and computing technol-ogies. Through teletex* and videotex, one-wayand two-way computer-based retrieval sys-tems, information can be widely disseminatedfor viewing on modified television sets or onpersonal computers. In the last year or so, fullvideotex systems have become operational inseveral countries, giving the user the abilityto send communications to the system com-puter for onward transmission. Because thevideotex system is interactive, it can be usedto facilitate financial transactions. The systemfunctions in several ways. One way uses avideotex terminal and a television (which actsas a visual display unit); the communicationwith the system is supplied by telephone lines

*Teletex is a one-way system that displays alphabetic andgraphic information on a modified television set. Videotex dis-plays the same sorts of information as teletex but also providesa communication path for the user to interact with the serviceprovider.

or cable lines. Some systems provide a hybridcommunication delivery, using cable for in-coming information and the telephone for out-going information. In-place cable lines are pri-marily one-way communication lines, althoughmost new cable lines being laid today are two-way cable lines.

Home computers also allow interaction withHIS and are becoming popular for receivingthe services. A modem** can be used to tiethe home computer to the information sourceby telephone lines. A CRT or television screenacts as the visual display terminal. The homebanking software which runs the system is dis-tributed by the participating financial insti-tution.

As stated, cable plays an increasing role inthe delivery of home information services.“The latest cable television systems now be-ing developed will transform the technologyof videotex and the economics of home bank-ing. The use of coaxial or fiber optic cablesgives much greater bandwidth, which providesthree substantial technical advantages: 1) thepossibility of carrying a large number of chan-nels, up to 100 or more; 2) a more satisfactoryand speedy interactive facility; and 3) a muchimproved ability to produce pictures (impor-tant in using home shopping).’’” Direct broad-casting by satellite, which is being developed,is another method by which information canbe transmitted into the home.

Developers of Home Information Systems

Home information systems are being devel-oped by a myriad of organizations that includedepository institutions (presently Bank ofAmerica and Chemical Bank are marketingsystems that are up and running), informationcompanies, entertainment companies, and thelike. Several systems are being developed ascosponsored, joint ventures by consortia ofmajor banks and corporations. One example

**A modem transmits digital or computer information overtelephone lines by manipulating it electronically and also pro-tects the lines from undesirable signals that might cause in-terference with other users.

19Revel], op. cit., p. 50.

130 ● Effects of Information Technology on Financial Services Systems—. —

of a major project is the Viewtron Programin Miami, Fla. The Viewtron system will besupported by computers from seven major cor-porations from around the country and will belinked to Viewdata Corp. ’s Viewtron com-puters in Miami. The gateways are AmericanExpress—subscribers will have access to a va-riety of services offered by this company; Com-modity News Services—subscribers will beprovided with instant and delayed stock mar-ket and commodity price quotations; and E.F. Hutton–subscribers will be able to tracktheir personal investments and receive invest-ment advice with “Huttonline,” the first elec-tronic information service offered by a retailbrokerage house. E. F. Hutton customers willbe able to access Hutton’s computers in NewYork City for information about their ac-counts, such as cash management and marginbalances, portfolio positions and market val-ues, open orders, and recent transactions. AllViewtron subscribers will be able to orderE. F. Hutton market comments and invest-ment advice and send electronic mail to E. F.Hutton offices. Viewtron subscribers will alsobe able to order J. C. Penney catalog merchan-dise by using a direct link to J. C. Penney com-puters in Atlanta. They will receive online or-der confirmation upon completion of theirorder. If the requested item is not availablein the color requested, the J. C. Penney com-puter will offer the Viewtron subscriber othercolor possibilities. The J. C. Penney cataloginventory system is immediately and automat-ically updated. In addition to processing thecatalog order, the gateway to J. C. Penney willalso provide for credit authorization for the J.C. Penney card, as well as for VISA and Mas-tercard. In addition, information from TheOfficial Airline Guide and Grolier AcademicAmerican Encylopedia will also be available.

The financial gateway to the system, Video-Financial Services, is jointly owned by fourmajor bank holding companies: SoutheastBanking Corp., Miami; Wachovia Corp., Win-ston-Salem, N. C.; Bane One Corp., Columbus,Ohio; and Security Pacific Corp., Los Angeles,Calif.

Applause, the home banking software of-fered by VideoFinancial Services, will supplya variety of services. The home banking activ-ities include bill payment, funds transfer andaccount information, and special financial re-quests. VideoFinancial Services also providescredit authorization and settlement for creditcard shopping orders placed on Viewtron. Thesystem permits each participating financialorganization to specify unique features withinthe system standard, including the use of in-dividual colors and graphics. Presently, 12Florida banks and savings and loans will pro-vide home banking to Viewtron subscribersvia VideoFinancial Services’ computers in Or-lando, Fla.

As a financial gateway, VideoFinancial pro-poses to provide the Applause service to allsections of the country through any videotexnetwork. To support such an objective, Video-Financial expects to establish regional datacenters, where practical and necessary, to in-terconnect the financial industry to the re-gional network operator. The system will bestreamlined. First, the home terminals will tiedirectly to the network operator, who will befully responsible for promoting, enrolling, andbilling the consumer for the network service.Communications, terminals, and data basemanagement will be provided and managed bythe service provider. The network will thenfeed into the VideoFinancial computer system.VideoFinancial will either connect online withor provide batch processing for subscribing fi-nancial organizations and will be responsiblefor developing and maintaining the home bank-ing software package. The VideoFinancialcomputer system will tie in directly to the fi-nancial organizations offering the service.These financial institutions will assist the net-work operator in enrolling the consumer andwill provide the data to VideoFinancial to sup-port the home terminal request.

Over 50 information providers, includingmajor wire services, educational organizations,reference and financial book publishers, uni-versities, libraries, and professional organiza-tions provide information for Viewtron.

—

—-—— —.

Interestingly, the advent of HIS has en-couraged cooperation instead of competitionamong the various financial service providers.

Costs of Home Information Systems

Cost is one of the major issues associatedwith the success of the HIS program. TheViewtron videotex costs are as follows:

● Subscription to the Viewtron service: $12per month for access to nearly all View-tron services.

• Communication charges to access View-tron: approximately $14 per month (ap-proximately $1 per hour to access View-tron).

A serious consideration is the influence oflocal communication costs and their impact onHIS. It is possible that communication costscould increase to such a degree that the costof making a local call discourages use or forcesdevelopment of new types of local links.

Consumer acceptance of home banking/home information systems will be based onseveral other factors besides the natural in-clination toward using these services. Thesefactors include price of obtaining the hard-ware/software needed to use these services,price of using the services, and availability ofthese services. *

The Market for HomeInformation Systems

Much speculation has been associated withthe home information market. Several leadingauthorities have targeted the affluent segmentof the population as the major users of thehome terminal. Their claim is that many con-sumers with incomes over $40,000 per yearhave an insatiable need for information ofvarious types. The home terminal has greatpotential as the major investment, shopping,and news information source for affluent con-sumers. Additionally, it has been stated thatmany affluent consumers feel strongly thatthey can conduct their own financial trans-actions better than bank personnel can, andsome find it enjoyable.— . .

* Information from Reistad Corp.—research conclusions.

Ch. 4—Retail Financial Services . 131-. —. . .— — — . . . — — — — — — —— —

Systems now in operation serve interactivefacilities, providing travel services, sports, andgeneral entertainment information (e.g., res-taurant and movie guides); stock exchange in-formation; shopping capabilities; and bankingapplications in a form similar to that of self-service banking. Users of these systems canpay bills, transfer funds, check balances, re-view banking statements, and keep up-to-datefinancial records.

The elderly may be another target marketfor such systems. The ease of being able toaccomplish shopping and banking from thehome, it seems, would be very appealing.There are problems, however, with respect toacceptance of the system, hardware and com-munication costs, and, most importantly,changing behavior patterns. Principal charac-teristics of HIS users are listed in table 6.

For consumers to adopt and use home infor-mation innovation, it must be associated withsuch advantages as convenience, compatibil-ity, or specificity.

Implications ofHome Information Systems

It appears likely that home banking systemswill be tied to other services such as informa-tion services, entertainment, and even busi-ness uses. Also, any institution, whether finan-cial or nonfinancial, will be in a position toprovide financial services through a videotexnetwork and to support these services in muchthe same way as Merrill Lynch operates itscash management accounts.

Home banking and its impact on branchbanking has some major consequences. Witha single investment in a computer installation,a new entrant to the retail banking market hasthe whole national market open to it. As longas it has the necessary computing capacity tohandle the accounts of its customers, any bankwill be able to leap over geographic barriersand offer payment services nationwide. * Bythe same token, nonbank operators will be able

..-. .—*Banks have long been able to conduct business nationwide

by opening offices (usually via holding company affiliates orsubsidiary corporations) for business loans. This is also truefor mortgage companies and consumer finance companies.

132 ● Effects of Information Technology on Financial Services Systems

Table 6.—Principal Characteristics of HIS Users

Level ofCharacteristic importance Comments

Age High Research studies indicate most potential customers ofHIS/home banking can be clearly identified by age.Two principal groups are 18-34 and 35-49.

Sex Low Research indicates sex is not an identifier for potentialcustomers of HIS/home banking. Men and women rankabout equally in intent to purchase.

PRONTO pilot research shows, however, men were morefrequent users.

Education Moderate Research indicates as the level of education increases,the propensity to purchase HIS/home bankingincreases.

In all studies the majority who are interested in HIS haveattained a college degree or higher.

Occupation Low Research indicates interest in HIS/home banking is notdependent on occupation. Blue collar workers andprofessional alike are likely to be interested in HIS.Interest increases gradually from a lower level amonghousewives to high levels among managerialemployees. Those working in the home or retired areless likely to be interested.

Family status Low Research indicates married and not married, with familyor without, are equally likely to be interested inHIS/home banking.

Income Moderate Research indicates as income increases, the likelihoodto high of interest in HIS/home banking increases. However,

among very high income households ($50,000/year andup) the likelihood of interest in home bankingdeclines somewhat.

Financial Moderate Research indicates that users of ATMs, Telephone BiIIservices Paying, and frequent check writers are more likely tousers be interested in HIS. However, a substantial number

of those interested do not use these services.

Electronic Moderate Research indicates personal computer owners, cable TVcommunication subscribers and those attracted by electronic gadgetryproduct users are somewhat more likely to be interested in HIS.

However, a large portion of those interested in HIS donot own or intend to purchase a personal computer.Among PRONTO pilot users, half had computerterminals (outside the home) prior to participating inthe test.

SOURCE The Reistad Corp , Clearwater, Fla

to compete with banks in these services to theextent that they are legally permitted to do so.

It is important to note that ATM, POS, andHIS will work together in the future. POS sys-tems and ATMs will share network lines, andthese systems will eventually reach out to in-corporate other remote terminal activity suchas HISS.

The various systems that have been and arebeing implemented for effecting payments areessentially designed to be substitutes for thepaper check. While the rate of growth of

checks has declined during the last severalyears and check usage in absolute terms maybegin to fall between now and the end of thecentury, no one expects checks to be totallyreplaced.

Historically, usage of new consumer prod-ucts has grown slowly during the first yearsfollowing introduction. For successful prod-ucts, this has been followed by a period ofrapid growth. Then, as the level of saturationis approached, growth again slows. Overall, ”this creates the “S” curve shown in figure 11.This being the case, two questions relating to

Ch. 4—Retail Financial Services ● 133———

Figure 11 .—Penetration Curve for Check Alternatives

1977 78 79 80 81 82 83 84 85 86

SOURCE Economic Review, Federal Reserve Bank of Atlanta August 1983 p 33

the substitution of new payment products forthe paper check remain unanswered. First, atwhat rate will new services grow? Second, atwhat level of penetration by each product willthe market become effectively saturated?

Not all potential users of a service will usethat service. It has taken decades for the levelof penetration for checking accounts to reachthe 85- to 90-percent penetration level, whereit now rests. Further, it is not reasonable toassume that the level of maximum marketpenetration is the same for all products. Overthe long term, for example, the proportion thatuses ATMs may far exceed that which useshome information and banking services.

Further, the level of maximum penetrationmay vary with time. As technology evolvesand its costs continue to drop, and as the prod-ucts are funded, the proportion of potentialusers who actually become buyers may change.For example, the maximum potential market

penetration for a home banking service todaythat requires a terminal costing several hun-dred dollars may be quite different from whatit will be for a derivative of that service thatis implemented using a terminal that costs lessthan $100.

The time constants that determine the steep-ness of the curve may also vary in responseto events in the market. For example, the rateof growth in some electronically delivered serv-ices may increase in response to a requirementthat all employees of firms over a specified sizebe paid by direct deposit. On the other hand,a series of events that demonstrate inherentweaknesses in advanced payment systemscould slow the rate of growth of some prod-ucts. In general, the impacts of events aremost likely to vary from product to productin the mix that comprises the offerings of thefinancial service industry.

In the past, great promise has been held outfor various payment products that has yet tomaterialize. However, increasing use of com-puters and telecommunication throughout so-ciety and the dynamism of the financial serv-ice industry may be creating an environmentmore favorable to the adoption of new systemsfor delivering financial services. Thus, thereis a higher degree of confidence than in thepast that the middle stage of the “S” curvewill be reached, but the timing continues tobe uncertain. The problem becomes one ofclosely monitoring developments in the finan-cial service industry to identify those areasmost likely to reach a critical mass and toassess on an ongoing basis the benefits andcosts to society of the changes that are ex-pected.