Policy and Regulation

Digital Transformation Of The Financial Sector: The Impact Of Fintech Firms

Bob Chakravorti presented at Payments Canada 2018 in Toronto on May 9, 2018. He discussed the response of incumbents to entry of FinTech firms. Specifically, he discussed payment, lending, wealth management and cryptocurrency segments. He touched on the role of regulation and discussed the lack of banking services in the U.S. because of regulatory asymmetries.

What Is The Role Of Public Authorities In Retail Payment Systems?

Bolt, Carbó, Chakravorti, Gorjón, and Rodríguez organized conference at the University of Granada that brought together policymakers, academics, and industry practitioners to discuss evolving retail payment systems and the role of public authorities, with several panels focusing on the Single Euro Payments Area. Three major themes emerged from this conference.First, despite increasing usage of electronic payments, cash usage remains high in Europe. Well-designed incentives may be required to change payment behavior of consumers and merchants. Second, the implementation of SEPA should decrease processing costs and lower payment fees for end-users, although challenges remain regarding competition and coordination across national borders. And third, more research is needed on the underlying economic forces of retail payment systems to support the development of sound economic and regulatory policies.

Regulating Retail Payment Systems: The Case Of Payment Cards

Bolt and Chakravorti discuss different types of market interventions by public authorities in retail payment markets . They concentrate on three types of market interventions. First, they analyze the impact of removing pricing restrictions placed on merchants that prevent them from setting different prices based on the payment instrument used to make purchases. Second, they summarize the impact of public authorities mandating caps on interchange fees – the fees paid by the payer’s financial institution to the payee’s financial institution – on the adoption and usage of payment cards. Third, they discuss the forced acceptance of all types of payment cards belonging to a single payment network (ie, credit, debit and prepaid) when merchants enter into contracts with acquirers. Such rules are often called honor-all-cards rules. While their focus is on payment cards, various pricing policies used to reach critical mass and steal market share from other payment instruments may also be valid for other types of payment instruments.

Economics Of Payment Cards: A Status Report

Bolt and Chakravorti explain how a payment network operates. Having established the payment network framework, they discuss the costs and benefits of providing and using payment cards relative to various other types of payment instruments. Next, they review the key contributions to the theoretical payment card literature. They consider papers with models that focus on interchange fees, price differentiation at the point of sale, network competition, the role of credit, and the pricing of payment services when a bank provides competing payment instruments. They also discuss the impact of these factors on social welfare.

Consumer Choice And Merchant Acceptance Of Payment Media

Bolt and Chakravorti study the ability of banks and merchants to influence the consumer's payment instrument choice. Consumers participate in payment card networks to insure themselves against three types of shocks - income, theft and their merchant match. Merchants choose which payment instruments to accept based on their production costs and increased profit opportunities. The authors' key results can be summarized as follows. The structure of prices is determined by the banks cost to provide payment services including the aggregate credit loss, the probability of theft, and the timing of income flows. They also identify equilibria where the bank finds it profitable to offer debit or credit cards or both. Finally, they compare welfare-maximizing price structures to those that result from the bank's profit-maximizing price structure.

Analysis Of Systemic Risk In Multilateral Net Settlement Systems

Chakravorti studies systemic risk in multilateral net settlement systems is investigated using a four-period model. The model focuses on the tradeoff between systemic risk and the cost of interbank transfers along with the importance of the overnight money markets that was a key factor in the most recent financial crisis. Banks optimize their reserve holdings at the central bank, the settlement medium, based on a future random liquidity shock and payment system parameters such as total asset and collateral requirements, and net debit caps. The model’s results are as follows. The model determines the maximum number of bank defaults that can be sustained without a stoppage in the clearance and settlement process. An interbank funds market increases the efficiency of the payment system. The payment system operator can reduce systemic risk by imposing asset and collateral requirements, and debit caps. The central bank can provide sufficient liquidity to prevent a systemic collapse but may face high costs.

A Theory Of Credit Cards

Chakravorti and To construct a two-period model to study the interactions among consumers, merchants, and a card issuer. The model yields the following results. First, if the issuer's cost of funds is not too high and the merchant's profit margin is sufficiently high, in every equilibrium of our model the issuer extends credit to qualified consumers, merchants accept credit cards and consumers face a positive probability of default. Second, the issuer's ability to charge higher merchant discount fees depends on the number of customers gained when credit cards are accepted. Thus, credit cards exhibit characteristics of network goods. Third, each merchant faces a prisoner's dilemma where each independently chooses to accept credit cards, however all merchants' two-period profits are reduced because of intertemporal business stealing across industries.

Universal Access, Cost Recovery, and Payment Services

Chakravorti, Gunther, and Moore suggest a subtle, yet far-reaching, tension in the objectives specified by the Monetary Control Act of 1980 (MCA) for the Federal Reserve’s role in providing retail payment services, such as check processing. Specifically, we argue that the requirement of an overall cost-revenue match, coupled with the goal of ensuring equitable access on a universal basis, partially shifted the burden of cost recovery from high-cost to low-cost service points during the MCA’s early years, thereby allowing private-sector competitors to enter the low-cost segment of the market and undercut the relatively uniform prices charged by the Fed. To illustrate this conflict, we develop a voter model for what begins as a monopoly setting in which a regulatory regime that establishes a uniform price irrespective of cost differences, and restricts total profits to zero, initially dominates through majority rule both deregulation and regulation that sets price equal to cost on a bank-by-bank basis. Uniform pricing is dropped in this model once cream skimming has subsumed half the market. These results help illumine the Federal Reserve’s experience in retail payments under the MCA, particularly the movement over time to a less uniform fee structure for check processing.

The Evolving Payments Landscape And Its Implications For Monetary Policy

The key questions that Chakravorti asks in this book chapter are: (1) How is the payment system evolving? (2) What are the economic forces driving the adoption of new payment instruments? (3) Would recent developments in the payment system limit the central bank from conducting monetary policy? He argues that the migration to cash substitutes will not impact monetary policy unless final interbank settlement of most transactions occurs in non-central bank issued reserves. Furthermore, if the central bank maintains price stability and provides sufficient quantities of currency, the likelihood of its currency not being the generally-accepted medium of exchange is negligible.


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