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A New Era in Payment Processing

By Brandes Elitch

If you asked an ISO, "What business are you in?" you would likely hear, "I'm in the payment-processing business." But what does "payment processing" mean? What do you think the world of payment processing might look like 10 years from now? Do you think it will be different from what it is now?

What if you were paid electronically and you bought everything you needed via the Web, with the help of your PDA, your cellular phone and your PC? You would not be using "money" as we traditionally think of it: coins, paper currency and checks drawn on a bank account. In fact, you might not even need a traditional bank account.

Instead of getting bills in the mail and writing a check, you might log onto your own personal Web site and review bills that are presented electronically, approving them so that an account somewhere would be automatically debited at a specific date.

Coins and currency might disappear; you would pay with a rechargeable card, or even with your fingerprint that is linked to an account with value. (Actually, all of these things are possible now!)

Now, how do you think the government would feel about this? Why would it care? Well, keep in mind that all money is what is called "fiat money." No, that doesn't mean that it is made by an Italian car company. (If so, it would probably rust!) It means that the money we use has no intrinsic value. It is valuable only because we all believe that it is!

Money is created by banks. A bank creates money because it is allowed to lend out a multiple of the money it has on deposit. (This is called a "fractional reserve system.") If the fraction is 10 percent, it means that the bank can have one million dollars in capital and surplus and lend out another nine million dollars.

This system works because 99% of the loans stay current and pay interest. There is a multiplier effect. The federal government tries to regulate the money supply to prevent inflation or to stimulate the economy, depending on where we are in the economic cycle.

It also can change the discount rate or alter reserve requirements, but keep in mind that it takes months or even years to see the results of these moves, and sometimes it is impossible to see the real effect at all.

It was easier for the government to regulate the money supply when all the money was in banks and could be counted. But what if money became digital debits and credits on the books of a non-bank? Not only would this make it difficult to regulate the money supply, it might even make it difficult, if not impossible, to tax it! Now this is serious! (I haven't even brought up the subject of money laundering, which after 9/11 is becoming not just a tax issue but a national-security issue, too.)

There are three types of businesses that process payments and are outside the scope of traditional banking: money transmitters (companies that send money via wire, such as Western Union), currency exchanges (companies that sell money orders, travelers' checks and stored-value cards and do foreign-currency exchanges), and check-cashing companies.

There also are providers of new types of Internet currency, which is referred to by a variety of names, such as digital currency, micropayments, etc. For example, PayPal, which can accept and hold deposits from customers to settle future transactions to third-party recipients, is acting like a bank and is covered by the new law. The government calls these Money Service Businesses (MSB).

Here in the U.S., there are about 200,000 MSBs. You may be doing business with one of them, or you may even be one. How do they compare to a bank? Well, a commercial bank is defined as an entity that takes deposits and makes loans. But don't some of these MSBs do that, too? For example, if you get a payday advance, isn't that a loan? If you buy a prepaid card at a check-cashing company, aren't you making a deposit?

Currently, these MSBs are governed by a patchwork quilt of different regulations in about half the states. This is the similar to what happened before the Uniform Commercial Code was adopted: Merchants had no way of knowing how their disputes would be handled in different states because there was no uniform body of law.

In August 2000, the National Conference of Commissioners on Uniform State Laws approved the Uniform Money Services Act. It requires MSBs to register with state regulators and adhere to safety and soundness requirements (just like banks).

It also places the new electronic and Internet forms of payment under one law. The MSBs have to obtain a state license and be subject to annual examinations.

The National Conference of Commissioners makes official recommendations, and it is up to the states to adopt what is designed to be a uniform code. Just last month the U.S. Treasury clarified the responsibilities of money-transfer firms (such as Western Union) because of implications for money laundering and even national security.

If you are in one of the three MSB categories or are just working with a company that is, you might want to study the recommendations to see how you might be impacted. This is particularly true if you are working in a multi-state environment. You can call the National Conference at 312-915-0195 if you want more information.

Today, an ISO processes money. Your definition of money will expand to cover transactions that, while not directly redeemable in money, serve as a medium of exchange and place the customer at risk of the provider's insolvency while the medium is outstanding. You will need to keep track of these changes so you can provide your customers with the products that they want.

Vermont was the first state to adopt this act, and other states will introduce legislation during this legislative cycle. You can see the final version on the Web at: www.law.upenn.edu/bll/ulc/moneyserv/UMSA2001final.htm If you have any questions or comments about this or any other cash-management subject, please write me at brandese@cross-check.com. I am working on a project involving check cashing and would like to talk to processors in that business.