Electronic Payment - Essay Example

With the advent of quicker communications technology and advances in the internet, the economy of the United States and even the world is transitioning from the traditional paper payment style to electronic. This is done through the use of debit/credit cards and electronic checks. Greater advances, means more rules and greater communication are needed between merchants, users, and the networks using them. There also become more complex economic patterns that rely on different kinds of fees and transactions between respective parties.

The three principal ways of electronic payment are credit, signature debit, and PIN debit. Most card companies operate on the four-party system. The four-party system consists of three entities: the consumer, the issuer, and the acquirer. When transactions occur, the network coordinates information transmission between the issuing and acquiring sides of the market. As soon as a cardholder presents his card to the merchant for the transaction, information is transmitted from the merchant to the acquirer to the network and then the network relays the information to the card institution. The card institution then looks at the accounts and personal information on the card and decides whether to accept or decline the request for the transaction. The response is then transferred along the same path but in reverse order.

Once this procedure has occurred, the topic of interchange fees comes into play. Interchange fees are when a payment from a merchant’s bank to a card user’s bank for each debit card or credit card transaction, are determined at the network level, and are the same for all banks participating in a network. The interchange fee is paid by the merchant acquirer to the card issuer. This can be done by either a flat fee paid per transaction, a fee paid as a percentage of the total sale, or a combination of the two.  Interchange fees also play a role in the rewards that are given to customers for using the card such as lower payback options, reward points, SkyMiles, etc. The fees are also influenced by the volume of purchases. Maximization of profit for merchants does not lead to constant interchange fees. Also, the free interchange is based on an unequal market and is not dependent on the cost of the card-based transaction.

Common interchange fees play an economic role in influencing merchants to honor cards. There are two policies in particular by which this is achieved: the honor-all-cards rule and the no-surcharge rule. The honor-all-cards rule is where a merchant will accept any and all cards on a particular network regardless of the type of card i.e. Visa, Visa Reward, etc. The no-surcharge rule is when there are no fees for the customer based on the type of card the customer is using. This is how the networks in the payment process function.

The payment card market is two-sided.  In order to agree on a set limit, the provision is that the value of a product must be agreed upon mutually by two different users. There is also the possibility of externalities. The first is when an agent affects the welfare of another agent without the intent of giving them any compensation. Each party in a given transaction evaluates its own policies without regard or courtesy for the other party. Also, large cardholder bases make it more valuable for merchants to use and the broader merchant acceptance of a particular card makes it more attractive for customers to use.

This has led to conflicts between merchants and networks when it comes to profit. Merchants claim that interchange fees become too inflated because there is no standardization required for these fees and that the networks seem to make more than average profits from the institution of interchange fees. The network argues by saying that interchange fees are a critical and vital component that drives the economic circuit. In addition, they say that accepting their type of card it will increase their customer base which will in turn lead to more profit.