Split Bill Payment System


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Split Bill Payment System for pooling funds from several parties . A process and software system for carrying out transactions which involve a large pool of stakeholders .

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Split Bill Payment System

  1. 1. SPLIT-BILL PAYMENT SYSTEM By Aleksey Sundukovskiy A DISSERTATION Submitted to The University of Liverpool in partial fulfillment of the requirements for the degree of MASTER OF SCIENCE 19/11/ 2009
  2. 2. ABSTRACT SPLIT-BILL PAYMENT SYSTEM By ALEKSEY SUNDUKOVSKIY The project describes and presents a system designed and built with the intention of reducing paper-based transactions by taking advantage of the technology and recent legislature which allows the service to eliminate deficiencies associated with financial transactions settled via pa- per-based means. A split-bill payment system is a payment system flexible enough to perform traditional single-source funded payments as well as multi-source funded ones. Which means both associating several funding sources with an account belonging to the same system user, as well as allowing multiple account holders to fund the same purchase. The particular focus of the system is the centralization of all occasional and recurring bills including but not limited to rental, utility and home services; insurance and credit-card recurring bills; that is transactions where credit and debit cards are not the optimal form of payment (either for the merchant or the consumer), where several parties are beneficiaries of a product or a service, or where the con- sumer is given a grace period to settle his or her bills; however, the service is not designed for point-of-sale purchases. The analysis and design specification address the deficiencies in the settlement options by creating an architectural design for a software package which will provide the following gains: significant increase in automation within the banking system, decrease overheads through elimination of labor intensive tasks such as check processing, and more- over contribute to a higher e-banking usage among the consumers by satisfying a yet to be ad- dressed market need. The contributions of this financial communication, coordination, settle- ment and reporting tool can be extrapolated to more general payment needs of the consumers and not just bill payments, e.g. donations, money transfers, fund consolidation, escrow, and others which require that the monetary contribution be drawn from several sources simultane- ously on approval by the funding members. The settlement can be accomplished either via fund concentration technique or direct transfer.
  3. 3. DECLARATION I hereby certify that this dissertation constitutes my own product, that where the language of others is set forth, quotation marks so indicate, and that appropriate credit is given where I have used the language, ideas, expressions, or writings of another. I declare that the dissertation describes original work that has not previously been presented for the award of any other degree of any institution. Signed, Aleksey Sundukovskiy “This dissertation contains material that is confidential and/or commercially sensitive. It is in- cluded here on the understanding that this will not be revealed to any person not involved in the assessment process.”
  4. 4. ACKNOWLEDGEMENTS I would like to thank my family for all the support and Yongge Wang for the guidance and assistance in completing this dissertation.
  5. 5. v
  6. 6. TABLE OF CONTENTS Page LIST OF TABLES...................................................................................................viii Table 1 Distribution of Checks, by Presentment Method and Asset Size 10....viii Table 2 ACH Fee Schedule 53................................................................................viii Table 3 Check vs ACH transactions 65.................................................................viii LIST OF FIGURES...................................................................................................ix Figure 1 The Field of Finance 2................................................................................ix Figure 2 Retention Rates 12......................................................................................ix Figure 3 Electronic Payments By Year 14...............................................................ix Figure 4 Payment Transaction Volumes 23...........................................................ix Figure 5 Wescom DD Sample Form 31....................................................................ix Figure 6 ACH Direct Deposit Sequence 32.............................................................ix Figure 7 SBPS Sequence 33......................................................................................ix vi
  7. 7. By offering bill splitting services, fund coordination, payment triggers, and built in fraud protection features, SBPS will contribute to disuse of paper based settlement in cases where the only other alternative is using checks. Furthermore, in order to increase the convenience factor on one hand and for security considerations on the other, SPBS will allow users to use both recurring and “on demand”/”per approval” direct deposits and direct debits, respectively. Consumers cautious of fraudulent charges will be in control by not allowing automatic debit or credits and will approve any and every transaction to and from their account. However, for trusted merchants the very same users can chose to enable automatic debits and credits. For instance, a user may not trust the utility to draw money on his or her account without first reviewing the charges. On the other hand there is little reason to distrust the Internal Revenue Service for automatic Tax Refunds. The last but certainly not the least convenience consideration is the line of credit associated with credit cards. As Prager et al puts it: “At the end of a billing cycle, if the cardholder had no prior balance, he or she can pay the entire balance, thereby receiving an interest-free loan on transactions performed during the billing cycle.”(2009)[5] While SPBS allows for integration of any payment method including the credit card, to maximize the savings potential, the consumer may wish to delay the payment of the bill in the case where there is a grace period given by utility or service which issued the bill. SPBS will send out alerts and reminders as the deadline nears to avoid late payment. Figure 8 Volume of B2B Payment Types 54.............................................................ix Figure 9 Growth In Electronic Payments 66...........................................................ix Chapter 1. Introduction............................................................................................1 Chapter 2. Background and review of literature....................................................6 Chapter 3. Theory....................................................................................................20 Chapter 4. Analysis and Design..............................................................................21 Chapter 5. Methods and Realization ......................................................................44 5.4 D..........................................................................................................................50 Chapter 6. Results and Evaluation..........................................................................51 Chapter 7. Conclusions.............................................................................................57 REFERENCES CITED............................................................................................62 vii
  8. 8. LIST OF TABLES Page Table 1 Distribution of Checks, by Presentment Method and Asset Size ...........10 Table 2 ACH Fee Schedule.......................................................................................53 Table 3 Check vs ACH transactions........................................................................65 viii
  9. 9. LIST OF FIGURES Page Figure 1 The Field of Finance.....................................................................................2 Figure 2 Retention Rates...........................................................................................12 Figure 3 Electronic Payments By Year....................................................................14 Figure 4 Payment Transaction Volumes................................................................23 Figure 5 Wescom DD Sample Form.........................................................................31 Figure 6 ACH Direct Deposit Sequence ..................................................................32 Figure 7 SBPS Sequence............................................................................................33 By offering bill splitting services, fund coordination, payment triggers, and built in fraud protection features, SBPS will contribute to disuse of paper based settlement in cases where the only other alternative is using checks. Furthermore, in order to increase the convenience factor on one hand and for security considerations on the other, SPBS will allow users to use both recurring and “on demand”/”per approval” direct deposits and direct debits, respectively. Consumers cautious of fraudulent charges will be in control by not allowing automatic debit or credits and will approve any and every transaction to and from their account. However, for trusted merchants the very same users can chose to enable automatic debits and credits. For instance, a user may not trust the utility to draw money on his or her account without first reviewing the charges. On the other hand there is little reason to distrust the Internal Revenue Service for automatic Tax Refunds. The last but certainly not the least convenience consideration is the line of credit associated with credit cards. As Prager et al puts it: “At the end of a billing cycle, if the cardholder had no prior balance, he or she can pay the entire balance, thereby receiving an interest-free loan on transactions performed during the billing cycle.”(2009)[5] While SPBS allows for integration of any payment method including the credit card, to maximize the savings potential, the consumer may wish to delay the payment of the bill in the case where there is a grace period given by utility or service which issued the bill. SPBS will send out alerts and reminders as the deadline nears to avoid late payment. Figure 8 Volume of B2B Payment Types.................................................................54 Figure 9 Growth In Electronic Payments................................................................66 ix
  10. 10. x
  11. 11. CHAPTER 1. INTRODUCTION Scope The entire financial system of the United States is vast and caters to a practically infinite number of various types of financial transactions. The focus of this effort is a certain subset of those transactions. (See: Figure 1)The project doesn’t argue for the establishment of new financial networks or alternative non-monetary means of transaction settlement. It only proposes a process and a software system for carrying transactions which involve a larger pool of stakeholders than the tra- ditional merchant and consumer model. Therefore, situations where a point of sale system is utilized are not in the scope of this effort. While credit card, debit card, and other means of settlement can be accepted as the funding sources for this sys- tem, the primary focus of the process is the reduction and if possible through vari- ous incentives (such as price, convenience, security, flexibility, and scalability) the elimination of various paper-based means of financial transaction settlement. The particular emphasis of this project is a service which would allow several par- ties to contribute funds collectively and only by electronic means of fund pooling for the purpose of funds dispersal i.e. settlement of payment debts. After present- ing a full statistical account of the trends within the industry follows a section ad- dressing the most pressing issues facing debit/credit field of financial transactions such as security, float, coordination, inter financial institutional communication and recognition, all of which up until now made certain subset of financial market transactions cumbersome, unsafe, or too expensive. Once the impediments to an entirely electronic system have been identified, a process, system design, and a prototype solution implementation were created. While a survey of global solu- tions will be used in the consideration, the focus of the project is on the solution which takes advantage of the legislation, financial networks, services, and pro- cesses established in United States, where the adoption of electronic payment op- tions is particularly low. The latter mentioned solution helps address the current needs in the market in a way which provides consumers with a secure, convenient, and relatively inexpensive service for their occasional and recurring bill payment needs. The system can be evaluated on the relative potential to decrease the con- 1
  12. 12. tinual reliance on paper based payment methods. The prototype will demonstrate the process which will allow the financial institutions and their customers to elimi- nate or substantially reduce the turn-around time, costs, resources utilized, fraud potential, and overdrafts associated with paper-based systems. Figure 1 The Field of Finance Finance Financial Markets Corporate Finance Personal Finance Public Finance Employment Credit and Debt Contractor Financial Planning Trade Credit Consumer Credit Credit Card Companies Banks E-Banks Methods for Funding Purchases Credit Cards Debit Cards Checking Account ATM E-checks E-Savings New Service Multi Party Electronic Transfers 2
  13. 13. Problem Statement Due to considerations such as cost, security, speed, and convenience this project considers non-electronic (i.e. paper based transactions) to be ineffi- cient and environmentally unfriendly. The challenge presented before this project can be summarized in one sentence as follows: “How to decrease the American reliance on paper based transactions using electronic financial networks and web-based tools through previously unavailable financial transaction settlement services?” Thus, the aim of this project was to identi- fy a significant US market within which paper based transactions are still prevalent. However, merely identifying the parties involved in such transac- tions was not sufficient. The various disadvantages associated with the aforementioned transactions had to be identified and a process designed for a solution which provides all the parties involved the needed incentives to perform a switch from paper based transactions to electronic means of fund transfer and payment settlement. 3
  14. 14. Approach Despite technological advances, the use of checks and cash transactions re- mains high, especially among private parties. The approach to solving the problem stemmed from the desire to create a solution which will not only offer benefits to individuals who at present have few alternatives to cash or checks for payment, but also to banks, and businesses which at present incur tremendous costs in processing checks, debit and credit cards payments. This solution takes into account the associated costs for banks and mer- chants because in the end those costs are passed down to consumers. Also the option in consideration had to be the most environmentally friendly, se- cure, and user friendly. Therefore, to solve the problem this project identi- fied and evaluated several approaches widely used for settling financial transactions. The identified positive and negative aspects for all the parties involved: the banks, the merchants, consumers were considered according to several criteria: cost, convenience, fraud potential, environmental impact. The chosen optimal approach – based on the findings and the data collected- was used to create electronic process for financial transaction settlement. Fi- nally, the dissertation provides a prototype built to satisfy the requirements of the process and which illustrates the process itself. 4
  15. 15. Outcome It’s immediately evident that cash is unsuitable for settling transaction which are frequent, large, and happen across wide geographical distances. Reducing reliance on paper based transactions has an enormously positive effect on the environment due to the fact that trees, energy and various chemicals used in the check manufacturing process and bill presentment would no longer be able to have a deleterious effect on the ecosystem. The CO2 emissions produced in transporting checks to bank branches and Feder- al Reserve Processing Units are reduced as well. Certainly fraud perpetrated by companies charging late fees due to postal delay or lost mail, and the in- herent non-determinism associated with payments which are not confirmed until the funds are debited are all factors which were considered in the de- sign of this solution. Furthermore, the convenience and the time saving ef- fects are undisputed for the consumer who needn’t spend time waiting in traffic or in-line to deposit the checks or waste money on the stamp and the envelope to mail them. The over-reliance on cash is also a heavy burden – which can be alleviated with increased use of a Split-Bill Payment System – on the Federal Reserve System as well as the ATM banking systems. Upon evaluating the pros and cons of each non-cash process it is evident that a system which eliminates checks is the most favorable for banks and merchants due to reduction of costs associated with processing them and the reduced fraud potential. A system where reliance on checks is reduced also benefits the consumer be- cause the bank and merchant cost saving are passed to the consumer. While profitable for the banks, credit card and debit card electronic systems are ex- tremely expensive for the merchants and consumers who eventually assume those costs; leave small businesses and non-business entities out of the elec- tronic transaction business; do not allow for splitting of the bill among sev- eral parties due to a model which doesn’t allow for centralized fund concen- tration for the purposes of collective bill settlement. The data collected in this work illustrates why the process and the system designed for implementing the process are the optimum choices for settling financial transaction which at present are being carried out with cash or checks by a large portion of the consumers in the United States. 5
  16. 16. CHAPTER 2. BACKGROUND AND REVIEW OF LITERATURE Related Work The desire to provide a service which could coordinate payments among several sources each of which is beneficiary requires the knowledge and review of the fi- nancial transaction settlement industry. Below are the topics which provide the general background necessary to analyze the industry, solutions, and various tech- nologies which will allow the Split-Bill Payment System to Function. Applicable Laws Check21 The belated effort by the United States government to introduce the much needed changes to encourage the transition from paper-based settlement to the more se- cure, cheap, speedy and convenient electronic options. In 2003 a report to congress on the relative success of the implementation was released. This official report discusses the progress and success of the check 21 measures which were supposed to decrease costs associated with processing checks; facilitate a move away from paper based transaction towards electronic means of payment settle- ment; facilitate measure for making fund availability more timely. The quote be- low illustrates the financial incentive for the legislature: “The financial losses as- sociated with processing checks that all banks incurred before any associated re- coveries were $1.0 billion in 2005.According to the ABA, commercial bank check-fraud losses (before recoveries) were approximately $679 million in 1999, $698 million in 2001, and $677 million in 2003, figures roughly comparable to the $718 million reported in the Board’s 2006 survey.” (Board of Governors of the Federal Reserve System, 2007) [1] 6
  17. 17. THE ELECTRONIC FUND TRANSFER ACT The Electronic Fund Transfer ACT is a regulation which defines the responsibili- ties of the parties involved in the transaction as well the rights and liabilities of the consumers. The questions listed below address the concerns relating to the latter. “A check contains information that authorizes a bank to withdraw a certain amount of money from one person's account and pay that amount to another per- son. Most consumer questions center on the fact that EFT systems transmit the in- formation without the paper: • What record will I have of my transactions? • How do I correct errors? • What if someone steals money from my account? • What about mail solicitations for debit cards? • Do I have to use EFT services?” (http://www.federalreserve.gov/pubs/con- sumerhdbk/electronic.htm#loss, 2007) Recurring Billing Authorization EFT and use of ACH as approved by the federal government. The regulations governing authorizations for fund withdrawal and transaction settlement on recur- ring basis. “Section 205.10(b) provides that recurring electronic debits from a consumers’ ac- count may be authorized only by a writing signed or similarly authenticated by the consumer. The phrase similarly authenticated was added in 1996 (61 FR 19678, May 2, 1996), and was intended to permit electronic authorizations; comment 10(b)-5 was added to the staff commentary to provide guidance. Since that time, the issues of electronic authorization and authentication methods have been fur- ther addressed in Regulation E rulemakings published in March 1998 (63 FR 14528, March 25, 1998) and September 1999 (64 FR 49699, September 14, 1999), and commentators have made suggestions and sought further guidance. In addi- tion, the Electronic Signatures in Global and National Commerce Act, 15 U.S.C 7
  18. 18. 7001 et seq., (the E-Sign Act) addresses, among other things, the use and accep- tance of electronic signatures for electronic commerce in general.” (Johnson, 2001) [15] Remote Deposit Capture As part of facilitating the change the Federal Reserve Bank took into account the development of electronic data transfer methods and allowed the banks to substi- tute for the physical presentment of a check with its digital substitute. RDC or re- mote deposit implementations by various vendors take advantage of the new regu- lations to not only allow the digital image of the checks to be exchanged between the bank of deposit and the bank which holds the funds against which the check was written, but also between the party holding the check (the creditors) and their own bank of deposit. It is not the focus of this system to design a separate system and a process to facil- itate RDC as this dissertation considers RDC an inferior method to decrease amount of paper based transactions for the following reasons. 1. In the cases where the funds are to be drawn against the debtor account be- longing to the system user, SBPS considers routing and account informa- tion stored on file a preferred time saving approach. 2. In the case where the funds are to be drawn against the debtor account, not belonging to the system user, accepting checks from the creditor represents a great fraud risk which can only be reduced through integration of third party services. (frbservices.org/files/operations/pdf/FedACHOrigination.pdf, 2001) [17] These check conversion services are a possible integration point for SBPS as these services offer benefits like conversion with verification and guar- antee. However, such services are often quite expensive and the author of dissertation aims to show that cost is an essential factor in making an im- pact in reducing paper-based settlement transactions 3. The party which issues the check can more easily and conveniently trans- fer funds using the SBPS then go through the trouble of writing a check, 8
  19. 19. especially if the cost of writing the check doesn’t make sense from a finan- cial point of view. In the coming year the FRB will increase its check ser- vices by almost 50%. (Frierson, 2009)[16] The document makes it clear that the price increase is a measure designed to discourage check usage. 4. The statistics in the table below [Table 1]illustrate the limited success of RDC on the decrease of paper-based transactions. Besides, RDC is not completely paper-less: while a much more efficient process, a check is still written. “In just over two years, nearly a third of all banks in the United States have adopted RDC solutions. As of March, more than 2,900 financial institu- tions had implemented (or are implementing) RDC, according to Celent, which expects more than 4,000 institutions to be on board by the end of the year.” (http://content.ebscohost.com.ezproxy.liv.ac.uk/pdf19_22/pdf/2007/97U/01Se p07/26375570.pdf, 2007)[4] Direct result of Check21 which certainly helps cut costs down because the banks can no longer require the physical check. This helps cut down float, make funds available quicker, cuts down waste, and provide electronic backup for recovery in case of disasters. However, “But for all the activity involving bank adoption, client-level adop- tion has been unimpressive. Less than two percent of businesses have signed up for RDC, Celent reports.” (http://content.ebscohost.com.ezproxy.liv.ac.uk/pdf19_22/pdf/2007/97U/01Se p07/26375570.pdf, 2007)[4] 9
  20. 20. Table 1 Distribution of Checks, by Presentment Method and Asset Size As the table above shows only 5% of all checks were presented electronically. (Board of Governors of the Federal Reserve System, 2007)[1] Fraud and Fraud Prevention The quote below illustrates the reason why the Split-Bill System is needed to ad- dress issues with fraud associated with the paper-based settlement methods. “Protect financial institutions against the fastest growing source of fraudulent ac- tivity surrounding checks today, responsible for 28 percent of all check-related losses in banks—counterfeit checks. Banks, financial institutions, and retailers, now more than ever, need to make use of all mechanisms available to stop fraud before it happens. By utilizing a com- mon service, technology upgrades are easier and more economical, and guarantee that the latest fraud prevention tools are in place. Additionally, a shared service can offer a far more comprehensive database than any financial institution could acquire on its own. With the technology available, now is the time to utilize it.” Furthermore, the algorithms which SBPS considers for fraud detection and pre- vention are addressed in the same research paper: “Additionally, transactional- based fraud detection technology may analyze the item for suspect situations such as unusual check numbers, unusual velocity of transactions, or unusual check amounts.” (Fenton, 2009) 10
  21. 21. Wire Transfers These statistics presented in the research paper show how underutilized the ACH system. It seems that many businesses do not realize that system was specifically designed to facilitate the transition from checks to electronic payments. On the other hand if there were systems such as the one proposed which listed the specif- ic services which can be migrated from paper based methods to the cheaper and more convenient methods and marketed directly to the potential users, they would be more compelled to switch. Key Findings “1) Most corporate payments today remain paper-based2 and are likely to migrate to electronic payments such as wire transfer or Automated Clearing House (ACH) over time. While conventional wisdom holds that many of these check payments may migrate to ACH, statistical analysis of the survey data reveals that for at least a portion of these payments, wire transfers would be a potential substitute for checks if they were more convenient. Even if only 2 percent of the check volume moves to the wire transfer systems, that would represent a 47 percent increase in wire transfer volume. 2) The research shows that small and large companies alike want a more stream- lined process for making wire transfer payments and favor a single remittance in- formation standard to eliminate existing inefficiencies in the process. And, impor- tantly, these companies are willing to pay for such efficiencies.” (The Clearing House, n.d.)[11] 11
  22. 22. Electronic Billing Figure 2 Retention Rates (Gripenstraw, 2009)[14] This study (results of which are illustrated in Figure 2) shows the direct correla- tion between the means of bill presentment, the cost of processing the transaction and the corresponding customer retention rates. This is directly related to the re- search need to establish which payment network is the optimal choice for the sys- tem in question. Industry Sources Evolving Payment Trends The Roundtable An article which appeared in the community banker journal brings together sever- al prominent professionals: Rene Pelegro of PayPal, Tim Sloane of Mercator Ad- visory Practice, Woody Tyner a Payments Strategist from BB&T, Jack K. Walton II who is Associate Director at the Board of Governors of the Federal Reserve System. These industry leaders gave their thoughts on the future of the financial 12
  23. 23. transaction industry in a roundtable discussion about the need for a completely electronic system of payment settlement. Walton offers his opinion: “If that is clearly the case, at some point in the future, when the vast preponderance of checks are deposited and presented electronically, there may need to be legislative changes that result in a fully electronic check pro- cessing system.” (Kenneally, 2008)[2] Sloane for his part pitches on the drive towards debit and pre-paid and away from credit which is very costly for the merchant who in turn pass in the cost to the consumers by building in the transactions costs into the purchase price. “Two major trends will drive substantial change over the next ten years. The growing consumer adoption of debit and prepaid instruments over credit instru- ments will create new profitability challenges for Fis and large merchants. Non- banks, including merchants, will see this as an opportunity to provide a wider range of financial services, while banks will find it increasingly difficult to in- crease fees associated with debit transactions as competition increases.” (Kenneal- ly, 2008)[2] While Tyner focuses on the RDC and Check21 innovations and their drawbacks. “RDC enhances the efficiency of handling check deposits and creates convenience for consumers and businesses as well as new challenges and opportunities for bankers to sell products and services to clients that previously utilized the bank's branch network to make deposits. However, RDC also creates new opportunities for fraud and will require banks to develop image survivable check security fea- tures to combat fraud.” (Kenneally, 2008)[2] Statistical Breakdowns by Country The results of a survey released by the Federal Reserve contain statistics by year and country showing the trends in the payment systems. Also this paper contains statistics on returned checks and ACH payments important to consider in cost esti- mation. Figure 3 shows the share of the market in billions. 13
  24. 24. Figure 3 Electronic Payments By Year (Gerdes, 2008) [13] Costs to Merchants and Card Holders A federal study on “Interchange Fees and Payment Card Networks: Economics, Industry Developments, and Policy Issues” was important in the analysis and the design phase of this dissertation. This resource is important in showing that while there are electronic sources of processing payments the cost to the merchants and the card holders is quite high and may not be suitable for the purposes of this sys- tem. “Neither the total value of fees paid by merchants for card transactions, nor the to- tal value of interchange fee payments, is publicly available. Calculations by the authors suggest that the total value of interchange fee payments on the Visa and MasterCard credit, signature debit, and PIN debit card systems was approximately $35 billion to $45 billion in 2007. These estimates suggest a substantial increase as compared with an analogous calculation of around $20 billion in 2002.” (Prager et al, 2009)[5] Debit card usage currently stands at 58 % while credit card usage is at 42%. While the costs for merchants for accepting the debit cards is lower than for accepting credit cards the cost is still too high in comparison to ACH network due to the fact 14
  25. 25. that Credit Cards Networks and the Card Issuing Banks collect not only a flat fee per transaction but also a percentage of the entire purchase which makes it ex- tremely costly for large value purchases. For instance a 1000$ purchase will cost the merchant between 25$ using authorize.net services offered to online mer- chants. The authorize.net rates are considered one of the lowest in the industry. “At the same time, the number and value of credit card payments increased at an- nual rates of roughly six percent and nine percent, respectively. Given the relative- ly rapid growth in debit card use as compared with credit card use, the Federal Re- serve estimates that the number of debit card transactions exceeded the number of credit card transactions by 2006. However, because the average value of a credit card transaction substantially exceeds the average value of a debit card transac- tion, the total value of credit card transactions is still significantly larger than that of debit card transactions.” (Prager et al, 2009)[5] Electronic Payments The background study of the industry payment networks and instruments was es- pecially important as SBPS doesn’t have as one of its aims to suggest, design, or introduce a new network but instead leverage existing alternatives to achieve the afore stated aims. An older but still important research paper which provides historical perspective on the advent and adoption of electronic payments. “Numerous surveys of payment instrument use have demonstrated that just be- cause a new payment instrument is available does not mean that it will be adopted quickly. Indeed, in most countries the pace of change from established payment method( cash, check, paper giro)to new instrument(electronic giro, credit and debit cards)has been considerably slower than industry predictions. In part, this is due to a lack of strong explicit incentives, such as full cost-based pricing of each transaction, but it is also due to the fact that users are slow to adopt payment methods that differ from those they have been using successfully. This probably results both from force of habit and, particularly for electronic payments, resistance to new technology. Indeed, it is the youngest segment of the adult population that has the greatest adoption rate of new payment methods since this segment is also the group that has the least experience with established methods, 15
  26. 26. is more accepting of new technology, and thus more open to change given the incentives( including convenience) which may exist.” (Humphrey et al, 1996)[7] The above holds true for ACH payments, Figure 9 [6] shows that while ACH has been gaining in popularity, the number of transactions is still low in comparison to Credit and Debit. This is so despite the fact that ACH is the cheapest of the three. There are three major reasons for this, the convenience of using debit and credit; the fact that the American consumers are oblivious to the fact that the high price of card transactions is “packed” into the price of the goods they purchase; a large number of transactions is settled via various checks and cash due to the limited number of convenient options available. SBPS aims to address the third by identifying a fairly common need for multi-source funded payments as well as provided convenience such as fund coordination and reporting capabilities. Additionally, “Nonprice attributes are very important and concern increasing the availability of credit and debit card terminals at the point of sale, expanding the number of firms that can accept electronic bill payments, convincing employees to have their wages deposited electronically, and establishing dispute resolution policies for preauthorized direct debits to compensate for loss of user control over when a debit occurs. In this paper we examine the effect of additionally using price incentives to speed the shift to electronic payment.” (Kim et al, 2001) [8] The networks and fee schedules under the cover The guide released by the Federal Reserve makes it clear that using either the online or offline debit options is much cheaper than the credit transaction fees for the merchant. However, this is still quite significant and may not be low enough to attract the check using customers. Under a certain amount the percentage of the purchase price is not significant, however even one percent of a bill over a $100 is already significantly more expensive then the cost of postage stamp. Additionally, the costs charged by the third party providers of software packages that allow for use of the debit cards on the internet have to be added to the costs. FedWire and FedACH are both much cheaper options ; the former allows for next day settlement, the latter takes longer to settle. However, in the case of the utilities which allow for a month to settle the bill from the date of issue this is not a problem. 16
  27. 27. “In 2002 and early 2003, the Visa (Check Card) interchange fee for retail non- supermarket offline debit transactions was 10 cents plus 1.25 percent of the value of the transaction, and the MasterCard (MasterMoney) fee was 10 cents plus 1.40 percent of the value of the transaction. As a result, interchange from online (ed. pin) debit was much lower than that for offline (ed. signature) debit. (The pin fee is paid by the card holder) On a $50 non-supermarket online debit transaction, for example, the interchange on the major networks ranged from 9.5 to 45 cents. The same transaction as an of- fline debit through Visa’s network would earn the card issuer 72.5 cents, or 80 cents on MasterCard’s network. First, as previously described above, some banks are using PIN fees to encourage their cardholders to use offline debit. Banks prefer offline debit because they earn more interchange. Second, the relatively high interchange fee for offline debit was an important ele- ment in the antitrust lawsuit brought against Visa and MasterCard by merchants, led by Wal-Mart. The settlement of the lawsuit provides for a significant reduction in MasterCard and Visa interchange rates. Visa has announced that its offline debt interchange rate for non-supermarket transactions as of August 1, 2003, will be 0.77 percent of the transaction plus 10 cents. The resulting interchange on a $50 transaction would be 48.5 cents. This compares to a 72.5 cent fee on the transac- tion prior to the settlement.” (Hayashi et al, 2003) [10] Overdraft Penalties An important study which shows just how dependant smaller banks are on the revenue brought to them by the overdraft programs. The system to be build doesn’t favor banks and other financial institutions over bank customers be they private or commercial interests. The system seeks to provide the most benefit to both sides. Using ACH will lower the overdraft costs for bank customers. At the same time the banks which are likely to lose the revenue stream in any case due to 17
  28. 28. pending legislature which would explicitly prohibit banks from charging overdraft fees unless the customer approves the overdraft charges on their debit card and check transactions, would still be able to collect a fee - albeit smaller - on overdraft ACH transaction since the customers have to approve all ACH transaction (debits and credits) in advance. “Banks in the study population that reported fee-income data are estimated to have earned $1.97 billion in NSF-related fees in 2006, representing 74.0 percent of the $2.66 billion in service charges on deposit accounts reported by these banks in their Call Reports …The share was somewhat lower for large banks (72.6 percent) than for small and medium banks (79.5 percent and 78.1 percent, respectively). For study population banks with automated overdraft programs, NSF-related fee income accounted for a larger share of total service charges on deposit accounts (74.4 percent) compared with banks that operated only linked-account and overdraft LOC programs (69.4 percent). Study population banks that operated automated overdraft programs earned $1.77 billion in NSF fees in 2006, which represented 90.0 percent of total NSF-related fee-income earnings estimated for the entire study population. NSF-related fee income accounted for 24.8 percent of the total non-interest in- come earned in 2006 by study population banks. The share was lower for large banks, since more complex banks tended to have more sources of non-interest in- come.” (Federal Deposit Insurance Corporation, 2008)[9] 18
  29. 29. Terms PAH – Primary Account Holder APR – Annual Percentage Rate ACH – Automated Clearing House EFT – Electronic Funds Transfer RDC – Remote Deposit Capture Rubber or Bounced Check – A check written for an amount not available in the account of the check issuing party. POS – Point of Sale POP – Point of Purchase FRB – Federal Reserve Bank ODFI - Originating Depository Financial Institution RDFI – Receiving Depository Financial Institution NACHA - National Automated Clearing House Association WEB – “An Internet-Initiated (“WEB”) entry is created when a consumer autho- rizes a merchant or other payee, via the Internet, to debit the consumer’s account.”5(Furst K. and Nolle D, 2005) 19
  30. 30. CHAPTER 3. THEORY 3.1 A The biggest assumption of this project is that electronic transactions, networks and means of settlement are superior to the paper based paper-based transactions. For the purposes of this paper the term “superior” assumes the benefits which provide the means to relatively cheaply, securely, and conveniently settle financial trans- actions between two or more parties. B The second assumption is that the number and proportion of paper based transactions is unacceptably high in United States as compared to other highly industrialized countries with well developed banking and free-market systems. C The theory behind the implementation portion of this project is that if a cheap, secure and convenient alternative existed, the use of checks and cash would decrease. D The theory behind the system is that paper based transactions which lead to inefficiencies in the American financial system are often the only means of fund exchange between parties which either do not accept credit/debit or find it cost prohibitive. Specifically such situations arise in situations where several parties have the need to settle a single bill collectively (e.g. room- mates). 20
  31. 31. F It then follows from 3.3 that a flexible, cheap, and convenient tool which can centralize all the bills presentment, settlement, and reporting functions in one common system accessible to all the parties involved in the financial transactions will reduce the use of paper-based alternatives. G Assumptions for relative terms: Flexible : a system which can do recurring/periodic, one-time, pre-ap- proved, per-approval payments which can be settled via a choice of debit, credit, ACH, Wiretransfer, e-check. Cheap : a system which can process financial transactions at a lower rate than the price of the stamp or the rates charged by debit and credit card net- works. Fast : a system which can settle transaction at the speed desired by the con- sumers (e.g. immediate via credit card, next day via e-check or FedWire, 1-2 days via ACH) and service providers aka merchants. Convenient : a system which reduces the number of passwords the con- sumers have to remember; reduces paper based transactions which require considerable resource investment from all parties involved; increases trans- parency into financial transactions for all parties involved. Secure: a system which can reduce fraud associated with paper based trans- actions; a system which doesn’t allow the unauthorized credit or debit of an account belonging to any user. Scalable: a system which can retain all of the above benefits even as the number of participants involved in the same financial transaction increases. CHAPTER 4. ANALYSIS AND DESIGN For several decades the funds transfer environment has been undergoing drastic changes across the globe. The pace of changes has accelerated due to advances in technology which allow for quicker, cheaper and more secure funds clearing transactions locally, nationally, and internationally. Unfortunately, the full poten- tial of electronic payments options has not been achieved in several large non-Eu- 21
  32. 32. ropean economic powerhouses, namely, Japan and United States. Consider this statistic for instance: 28,248.0 (million checks) have been written out in 2007 for the total amount of 40,946.1 (in billions of dollars) in United States while only 34,000 (in billions of dollars) has been processed by ACH (an electronic means of funds transfer administered by the Federal Reserve). Contrast those figures for US with Germany a country with a lower GDP and a declining population less than a third of the United States where for the total number of checks processed in 2007 was around 74 million ( close to 400 times less) and the number of EFT was around 13,000 million for the total amount of around 78,000 (in billions of Euros). [for US data see Table 2] (Committee on Payment and Settlement Systems, 2009) [12] Lack of innovative solutions for certain kinds of transactions is certainly part of the problem which prevents a complete switch from cash based transactions prevalent in Japan and paper (e.g. negotiable instruments including checks) based transactions still extremely popular in United States, however it is not an exclu- sive one. Therefore, the focus of the research will be not only to provide the back- ground of the industry and the evolution of electronic payments across the globe but uncover deficiencies within the existing solutions, both electronic and other- wise. The particular emphasis of this project is a service which would allow sever- al parties to provide funds collectively and only by electronic means of fund pool- ing for the purpose of funds dispersal i.e. settlement of payment debts. The payments and settlement systems are undergoing a large scale transformation in United States. Even as the research data for this dissertation was gathered the media reported a monumental shift in consumer protection legislature being enact- ed to curtail some of the unfair practices carried out by banks, and credit/debit card processing networks. 1, 2 “ 1. The Federal Reserve Board on Thursday announced final rules that prohibit financial institutions from charging consumers fees for paying overdrafts on automated teller machine (ATM) and one-time debit card transactions, unless a consumer consents, or opts in, to the overdraft service for those types of trans- actions.” (http://www.federalreserve.gov/newsevents/press/bcreg/20091112a.htm, 2009) 2. “The Federal Reserve Board on Tuesday proposed rules amending Regulation Z (Truth in Lending) to protect consumers who use credit cards from a number of potentially costly practices.” (http://www.fed- eralreserve.gov/newsevents/press/bcreg/20090929a.htm, 2009) These two important regulatory changes were instituted in response to testimony, political pressure, lawsuits, and consumer protection concern presented before the American Federal Reserve. For instance the United States Government Account- 22
  33. 33. ability Office found that in “2006, consumers paid over $36 billion in fees associ- ated with checking and savings accounts” with the average overdraft fee of $26. ( United States Government Accountability Office, 2008)[22] These developments are important for the considerations of this dissertation because due to the new regulations the banks and credit cards already hit hard by the toxic housing assets and rising delinquencies, respectively, will likely pass the cost to consumers. For instance the recent rise in APR interest rate charged by the credit cards has risen dramatically to offset the lost revenue as the result of the above mentioned legisla- ture which prohibits the issuance of credit cards to anyone under the age of 21 and the anti-trust lawsuits against Visa and Master Card.3 The banks for their part will inevitably raise prices on their services. 3. “The relatively high interchange fee for offline debit was an important element in the antitrust lawsuit brought against Visa and MasterCard by merchants, led by Wal-Mart. The settlement of the lawsuit pro- vides for a significant reduction in MasterCard and Visa interchange rates. Visa has announced that its offline debt interchange rate for nonsupermarket transactions as of August 1, 2003, will be 0.77 percent of the transaction plus 10 cents. The resulting interchange on a $50 transaction would be 48.5 cents. This compares to a 72.5 cent fee on the transaction prior to the settlement.” (Hayashi et al, 2003) [10] These are unwelcome developments because as can be seen historically the expen- sive, unsafe, inconvenient settlement systems lose the market consider the Figure 4 with the billions of various transaction types plotted against each other. Figure 4 Payment Transaction Volumes The figure above clearly illustrates that the use of credit cards has hit a plateau since it is the most expensive method for merchant to process transactions. At the same time the use of debit - a cheaper option - and ACH has skyrocketed to over- take the credit card by volume of transactions. The falling popularity of the check 23
  34. 34. is due to the high cost of processing the check, the inconvenience for both the cus- tomer and the merchant, and due to the speed of fund clearance as well as other innate weaknesses.4 4. The merchant can verify the existence of the bank account but not the funds available in it, therefore leaving the merchant exposed to fraud and insufficient funds. In contrast upon processing the credit card the merchant can verify the amount of the credit extended by the credit card company to card holder. The downward trend of drastic reduction in the number of paper based transac- tions, however, will be interrupted as the result of previously stated market condi- tions. Consequences: 1. Credit Cards will raise their monthly fees and APR even further. 2. Banks will charge more for their services, such as money transfers, ATM withdrawals, and account holding services. 2.1 Banks will increase fees for NSF for those customers who do opt-in. 2.2 Banks will incur greater expenses for check processing and fraud. 3. All those under age 21 will be forced to use cash and checks where ever possible to settle financial transactions as many will have no other alterna- tive. Increasing the burden on the ATMs, the banks, and the Federal Re- serve the latter of which will be required to increase the amount cash in circulation as well as process greater number of checks. The last of the two actions will cause the cost as percentage of GDP spent on processing checks to increase and will of course be assumed by the tax payers that is the consumers themselves. 4. The increase of paper based transactions will have a negative environmen- tal impact due to increased pollution and use of non-renewable resources used in the process of check and cash production as well as transportation and processing. New banking products. The experience of Norway, Germany and Canada shows that under the right con- ditions – those being monetary incentives, services, and convenience factors – the reliance on paper-based financial solutions can be reversed in favor of electronic 24
  35. 35. alternatives. 1. The federal authorities can take steps to increase, institute fees for using checks and the latest release from the FRB shows the trend towards just such a policy: “For the traditional paper check products, the Reserve Banks will increase forward paper check collection fees 47 percent and paper return fees 33 percent These in- creases are designed to encourage the continued adoption of Check 21 services.”(Frierson, 2009)[16] The fees will either force the banks to create and market new products or pass the expenses to the users via service charges. This dissertation argues that the former approach is the more favorable for the banks and for the consumers. By raising the prices the banks risk losing even more busi- ness then the 60 million of Americans who are considered unbanked or under- banked due to high fees associated with the checking account services. At the same time the price increase is only “6 percent for checks presented electronically and 17 percent for checks presented as substitute.” Meanwhile, “With the 2010 fees, the price index for the FedACH service will have decreased 36 percent since 2000.” (Frierson, 2009) and (Mont, 2009)[16] and [21] 2. Waning popularity of Credit Just as lowering of the debit fees from average of 72.5 cents to 48.5 for a $75 dol- lar purchase contributed tot the declining usage of credit cards (see Figure 2) the expansion of ACH based services will allow banks to attract more consumers looking for lower rates including POS and POP transactions. 3. The average cost of processing a check. “Today, the cost of moving checks through the banking system is estimated to be about $3.00 per check, including the costs of paper, printing, and mailing.” (http://www.federalreserve.gov/pubs/consumerhdbk/electronic.htm#loss, 2007)[23] 4. The amount spent on processing checks and dealing/preventing fraud. “The financial losses associated with processing checks that all banks incurred be- fore any associated recoveries were $1.0 billion in 2005. According to the ABA, commercial bank check-fraud losses (before recoveries) were approximately $679 million in 1999, $698 million in 2001, and $677 million 25
  36. 36. in 2003, figures roughly comparable to the $718 million reported in the Board’s 2006 survey.”(Board of Governors of the Federal Reserve System, 2007)[1] 5. Showing the impact on the GDP. This dissertation doesn’t consider any one of the following parties the credit cards, banks, ODFI/RDFIs, the fed reserve, merchants and service providers, or private users to be the sole beneficiary of the benefits provided by the split-bill payment system. The system provides benefits to all by providing convenient ser- vices at the lowest possible price. This is accomplished by eliminating inefficien- cies in the financial system associated with paper based-solutions that waste time, money, and precious natural resource. “The cost of making payments can account for 3 percent of GDP. Since an electronic payment often only costs from one-third to one-half as much as a paper-based transaction (a check or paper giro), consider- able social benefits can be realized by promoting the use of electronics.”(Kim et al, 2001) [8] 6. A cheap and reliable alternative. Pos and Pop can both be accomplished using check conversion and debit cards re- spectively. Automated Clearing House system is used for converting the check into an ACH transaction and for performing debits/credits using a bank debit card with a pin or pin-less transaction. In other words since all the non-credit based transactions between banks and other banks, banks and merchants/service providers, merchants/service providers and banks, merchants/service providers and their consumers have to be cleared through the Federal Banking System, the Fed system is then a natural choice for processing SBPS transactions. And since the cheapest, yet comparable or faster service (entire turn around time from fund request, to fund clearance, to fund availability) provided by the Fed is the Auto- mated Clearing House, it follows that ACH standard is the prime candidate as the optimum candidate to replace paper-based transactions instruments. How the system works (Sections Below) Bill Presentment. A recent article in the Wall Street Journal examined the rising popularity in ser- vices which consolidate the electronic presentment of bill for many different utili- 26
  37. 37. ties and recurring service providers under one account. This is a natural progres- sion from the already popular and widely accepted direct debit options provided by utility companies holding a DD authorization from their customers. Quicken Bill Pay, PayTrust and MyCheckFree were reviewed in Wall Street Journal (Pilon, 2008) [24]. There are several benefits to this approach and weakness as listed below: Advantages: For service providers: 1. The debit is performed as soon as the bill is issued. 2. Cost savings associated with mailing (printing, etc.). For the consumers: 1. Not having to remember many different passwords to view many different bills on line. 2. Cost savings associated with mailing (stamp, etc.). 3. Avoiding penalties due to lost or late mail, or simply forgetting to pay by mail or via the web alternatives. General: Reduced environmental impact, reduced work load on mail, reduced workload on the banks and the Federal Reserve. Disadvantages: For service providers: 1. The service provider has to pay for the debit. 2. Fees associated with NSF and expired payments. For the consumers: 1. Inability to review and dispute the bill before a debit is made. 2. Fees associated with NSF and expired payments. 3. Eliminated grace periods used for collecting funds from other sources (e.g. roommates) to fund the bill before issuing a payment. General: 1. Systems are pricy for both consumers and providers if administered/created by a third party. 2. Such service either only offer debits or fund transfers initiated by sharing sensi- tive information. 27
  38. 38. The design of the split-bill payment systems as far as bill presentment is con- cerned retains all the advantages while eliminating the disadvantages and weak- ness of the currently available services. Splitting the Bill via Amount Assignment. A win for the banks and the customers. The traditional models of bill settlement for many years have not taken into ac- count the market needs and the complexities of the changing billing environment. While Quicken Bill Pay, PayTrust and MyCheckFree do a good job of consolidating the “paper work” for the user who is considered the account holder, they fail to take into account that several other paying parties may also be the beneficiaries of the service/product. The unique approach of this project is to allow the primary account holder to break the bill into several portions to allow other parties to contribute funds to settle the bill. This can be considered a value added service which can be offered by banks or other financial institutions. In order to understand why this may be a good idea, let’s consider the following: Some of the services which in the years prior had to be carried out at the bank branch are now being performed remotely, chief among them check deposit via a RDC and money transfer via ACH and Wire transfer initiated over the web. Banks who offer such services see a greater customer acquisition and retention. A recent study performed by Mercatus group shows that “Banks offering mobile fi- nancial services can increase new customer acquisition by as much as sixty per- cent” (Merkatus, 2009) [25] The results of a survey carried out by Zogby Interna- tional in 2007 indicate a rise in popularity for online banking. “Three-quarters of respondents in the panel of computer users said they do online banking, and a 53% majority of those panelists with access to computers and the Internet said they preferred to do their banking online. One in three, meanwhile, still prefer do- ing banking face-to-face.” (Zogby Interactive, 2007) The latter group is the main target of this effort. Another study meanwhile noted that at least 60 million Amer- icans are considered “unbanked” or banking sparingly, and instead chose to per- form various paper-based settlement methods. (Mont, 2009)[21] They too are con- sidered as the potential market of this effort. 28
  39. 39. Communication The main deficiency associated with the bill notification systems most commonly used for bill presentment is the inability to communicate the relevant information to all the beneficiaries. The Split-Bill payment allows all the stakeholders who contribute the funds for bill settlement to access all the relevant information and stay informed about any penalties or refunds associated with the bill as well as see the status of the schedules transaction not only for their own scheduled payment but also for other participants. These important factors allow for transparency and thus decrease mistrust between parties involved in any of the available financial service offered by the system. Individual Bill Presentment This sub-process of the communication steps allows the bill administrator – that is the party or individual which is the primary account holder with service provider – to assign and possibly cancel and reassign the payees who will participate in the bill settlement process. Additionally, depending on financial responsibility each party carries, the system allows the bill administrator to split the bill accordingly: either evenly, or by different amount for each individual. The system will verify that the total of the sum of the assigned amounts does not exceed the amount of the bill in addition to any penalties and late fees incurred. Preventing Fraud through transparency The last point in each of the last two sections highlights the ability of the split-bill payment system to build confidence between parties exchanging funds and finan- cial information. The process and system are designed to prevent fraud often asso- ciated with paper based settlement methods especially fraud stemming from: 1. Certainly fraud perpetrated by companies charging late fees by falsely claiming that due to postal delay or lost mail the payments arrived late or not at all. The inherent non-determinism associated with payments (paper based payments) which are not confirmed until the funds are debited make the reporting capabilities which show the exact dates of fund transfer much more reliable and transparent. 2. Fraud associated with stolen or forged checks. 29
  40. 40. 3. Fraud stemming from false payment claims. 4. Non-paper based fraud. Stolen debit/credit cards used for purchases or cash withdrawal. With the split bill payment systems the security and fraud concerns are addressed through a process which requires that the users presented with a bill approve the requested amount, before the payment is processed. Shifting the Risk While bounced checks do not strictly fall under the rubric of fraud it is possible that unscrupulous individuals may write checks against funds which they do not possess to avoid financial responsibility. Often either the bank of deposit and creditor pay the penalty of a bounced check not only in the way of not being able to obtain the funds associated with a rubber check but also through penalties charged. While Split-Bill Payment System can’t guarantee fund availability - un- less the payment method is a credit or debit card where the financial networks which carry the cards can indicate the availability of funds or available credit at request time – it does shift the responsibility to the account holder – the issuing party - whose account is not in good standing as opposed to penalizing the fund depositing party. Benefits of this approach: 1. The party which deposits the rubber check and bank of deposit are saved the time, money, and effort of requesting funds from an accounting in poor standing. 2. The penalties as the result of intentional fraud are only assessed against those who initiate transactions against unavailable funds. 3. Certainly not all NSF situations are the result of intentional fraud. The EFT systems offer a much cheaper rate for transactions which result in NSF. “Price Per Return: 0-5,000 returns per month .99 5,001 – 25,000 per month .89 30
  41. 41. 25,001 – 100,000 per month .79 100,001 + .69” (Lewis, 2009) These rates seem very reasonable as compared to the average NSF service fees charged by the banks $26.( United States Government Accountability Office, 2008)[22].In view of Gwen Bezard of Aite Group the 60 million Americans who are considered either as " unbanked and underbanked are primarily so for practical reasons rather than attitudinal ones. Greater education and marketing wizardry will never succeed to stuff more checking-account relationships down their throats. The only way for banks to seriously compete is simply to deliver a better product and value proposition." (Mont, 2009)[21] Funding source association and transaction approval As an intermediary the Split-bill payment system allows many parties to take ad- vantage of direct fund transfer, fund concentration, bill coordination and settle- ment, multi-source funding and conversion services. The bill administrator can limit the number and the kind of payment options available to the payee based on the history of previous transactions. (Payees who have transactions against their accounts frequently return as NSF may be forced to use credit/debit cards) The system also algorithmically determines which payment options to make available based on the average settlement periods for various payment methods and the deadline date by which the funds have to be collected. For transaction approval standard industry forms for direct debit and direct credit are used and kept on file for authorizing recurring transactions. Figure 5 Wescom DD Sample Form 31
  42. 42. (Wescom Credit Union, n.d.) [18] For the institution which initiates the direct deposit this form contains the needed authorization and the information required to transfer money via an ACH transac- tion from their own bank of deposit to the payee’s bank (Wescom Credit Union in this particular case). The social security number and account number at the credit union uniquely identifies the individual. The routing and the transit numbers uni- quely identify the institution (i.e. Wescom) and allow for the Federal Reserve Bank to initiate a credit to the account specified. The entire model of operation is described below in Figure 6. Figure 6 ACH Direct Deposit Sequence 32
  43. 43. (frbservices.org/files/operations/pdf/FedACHOrigination.pdf, 2001) [17] The ODFIs and RDFIs are institutions that adhere to NACHA rules and function as financial institutions authorized to transmit ACH files to the Federal Reserve. The ODFIs and RDFIs do not have to be banks but the biggest are banks e.g. Wa- chovia, Bank of America, Chase. Design Each of the above sections represents a system onto itself. Today no process exists that accounts for all the steps required to complete a multi-sourced funded finan- cial transaction. The diagram below reiterates the components (mentioned in sec- tions above) which comprise the entire system and puts them in sequence. Figure 7 SBPS Sequence 33
  44. 44. Split-Bill Payment System 1 2 3 4 3.1 3.2 4.1 4.2 4.3 1. Bill Presentment 2. Bill Assignment 3.Communication 3.1 Individual Presentment 3.2 Individual and Group Notification on Financial Transaction Completion 4.Payment 4.1Funding source association 4.2Transaction approval 4.3 Debit and Credit transactions Before delving further into the use cases which are the basis for the prototype it is useful to point out a detail about WEB ACH transactions which as the result of the analysis are considered to be the optimal option upon taking into consideration the speed, price, security, convenience, flexibility, and scalability factors associated with the most common payment/financial settlement instruments. 5 5. “In contrast to other forms of e-checks, WEB payments can be used for pre-authorized transactions, as for example when a consumer “signs” with an electronic signature via the Internet an agreement for recurring automatic debits to his account for repayment of a loan. However, many WEB transactions are single-entry. These single-entry WEB transactions may be with a merchant or other originator new to the consumer, or the consumer may have an estab- lished relationship with an originator, as for example when a consumer authorizes the payment of his credit card bill online at the credit card issuer’s website.” (Furst K. and Nolle D, 2005) Every Ach transaction involves a debit and a credit as has been previously men- tioned; however, it is also important to distinguish between “deposit” and “with- drawal”. A deposit in the context of an ACH system requires two accounts, an ac- count from which the money is drawn and the account to which the money is 34
  45. 45. transferred. Same is true for a withdrawal, since money is drawn from one account and transferred to another. Therefore, as far as SBPS is concerned there is always a pull (debit) followed by a push (credit). Without the funding source destination and the target destination an Ach transaction can’t be completed. This is particu- larly important to note due to innate security considerations of the SPBS which re- veals financial and personal data only to the primary system user. In the scenario where a primary account holder responsible for paying a utility bill there are sev- eral security barriers. 1. The bill presenter (the utility) doesn’t have the capability to draw funds from primary account holder account until the primary account holder au- thorizes a payment. And even for pre-approved recurring payments the service provider only requests the money but has no ability to submit an Ach transaction on its own since it knows nothing of the bank account be- longing to the primary account holder. This is a design decision intended to protect the SBPS system users from fraud. 2. Just as the merchant/service provider doesn’t have the ability to credit or debit customer account directly, the primary account holder can’t draw on funds from other users who have agreed to split the bill with PAH until they’ve authorized payments. 3. SBPS users can chose from two options “individual authorization” or “all in authorization”. The latter requires that all participants agree to the amounts they owe and willing to pay before any of the accounts are debit- ed, the former does not. 4. Finally, only the SBPS system itself knows about the funding source desti- nation account(s) and the target destination account(s). This design feature should significantly decrease fraud potential. In particular, the prototype has the following distinguishing features: 1. The ability for several parties to combine their funds for the purpose of paying recurring or occasional bills using procedures allowed under the US laws. 35
  46. 46. 2. Offering a less costly alternative to using automated payments to e-bank- ing sites such as PayPal, gateways such as Authorize.net, and major credit cards such as Visa. 3. The system securely (using appropriate cryptographic standards) handles payments from multiple parties which can occur at different times or not at all. 4. The system makes sure that one user can be part of several groups simulta- neously but not use the funds meant for one purchase as a substitute fund- ing source for another (due to bill payment timing constraints). 5. The system does not expose private information to the rest of the payment group members. 6. The system contains an algorithm which will order payments in the queue for individual account holders in the most optimal way to prevent possible overdrafts. 7. Prevents fraud by mandating account fund availability checks for amounts greater than $5,000. 8. Allows for transfer of administrator responsibilities to another member of a multi-payment group. 9. Contains an invite, search, join functionality for various groups and indi- viduals similar in function to the ones used by social networking sites. 10. Implementation of two types of transfers a push and a pull. 11. Implementation of recurring and one-time payments. 12. User preferred UI’s which will allow the admin to enter amounts either as part/percentage of the whole or a specific amount. 13. Elegant resolution of situations of non-payment by one or more party who are members of the same group 14. Elegant resolution of issues of non-sufficient funds in the account of one or more party who are members of the same group. 15. An approach to resolving issues with scheduled payment dates which do not provide sufficient time for transaction turn-around. The first scenario is not elegant since it has several potentially disastrous points of failure. 36
  47. 47. 1. The user1 has to physically meet the other parties which are involved in the transaction to collect funds. Alternatively, user1 has to pay all the costs out of pocket and “hunt” down the other participants who may not be available. 1.1 The other users do not have electronic record of the transaction and proof of payment. 1.2 Potential for fraud is high since in the event of refund only the user1 is aware of the funds or any amount thereof being returned by the service provider. 2. The check may never reach the service provider. 3. The check may not be honored by the Customer Bank due to insufficient funds. Additionally: 4. The check must be mailed or converted to an electronic representation. This process is costly and the costs are assumed by the bank, the customer, or the service provider or all three. 5. The amount of paper used in this process contributes significantly to pollu- tion. Advantage: 6. The entire operation from the issue of the bill to the funds withdrawal by the service provider is significantly cheaper than using debit or credit cards. Scenario1 37
  48. 48. 1.2 The customer collects funds from other parties Scenario 1: Process Flow Fund Request 1.1 Bill issued The process of collecting funds lacks elegance User2 Cash Cash User1 Gas Bill Company 1.3 The customer Mails the Check Fund Request 2. The service provider User3 deposits the check Check $ $ The deposited check must clear with account holder text bank i.e. the customer Bank of Depost Federal Reserve Customer Bank bank . The second scenario, like the first one has all the disadvantages listed; however, the processes is even more cumbersome since it requires that the user who has the account with service provider deposit checks with his/her bank to obtain funds owed to him/her by the other users. The same points of failure are apparent here. But obviously as the number of user/participants increases so does the chance of failure. Scenario2 38
  49. 49. 1.2 The customer collects funds from other parties Scenario2: Process Flow 1.1 Bill issued The process of collecting funds lacks elegance User2 User1 Check Gas Bill Company 1.4 The customer Mails the Check User3 2. The service provider 1.3 Several deposits the check Text Check Text Check Deposits Check $ $ The deposited check must clear with account holder bank i.e. the customer bank . Bank of Depost Federal Reserve Customer Bank The scenario three takes advantage of some of the available technology and laws that allow for beneficiaries to receive the funds by initiating a “pull” transfer. Advantages: 1. The customer doesn’t have to authorize every individual withdrawal by signing a general Direct Debit Mandate which allows the merchant/service provider/institutional beneficiary to pull money from the customer account 2. The customer is safeguarded against fraud by Derict Debit Guarantee which offers protection against unauthorized debits. Disadvantages: 1. The customer may wish to dispute the charge. If the withdrawal is automatic, the dispute is only postfactum. 2. The funds may not be available for withdrawal at the time the automatic debit transaction is processed, especially if the customer relies on the parties who share the cost to transfer money first. 3. Such a system requires that the parties who share the costs know the account information of the customer who has the account with the utility. This is po- tentially dangerous. 4. The other parties are still in the dark about any disputes, refunds, etc. which can occur between the account holder and the beneficiary. 5. The cost of initiating wire transfers is still quite high. 6. There is a greater amount of automation, but the account holder still needs to communicate with the rest of the parties who share the cost of the transaction. 39
  50. 50. Those in turn have to initiate direct debits. However, people are prone to for- get their responsibilities and pay incorrect amounts which they owe. (Solution: greater automation, coordination, reminders, consensus among parties, verifi- cation by the system) 7. It is not possible for a private party (the beneficiary i.e. the service provider) to submit Direct Debit Mandate (filled out by the customer) under current laws to establish a Direct Debit fund transfer. Thus, a landlord or a private contractor of any kind can’t take advantage of the process flow described in scenario 8. Purchases between private parties (sale of a car, house, boat, work of art) can’t are similarly restricted. (Usual Solution: escrow companies which charge exorbitant rates. New Solution: The direct debit is broken into several steps de- scribed in process flow 4) Scenario3 1.2 The customer collects funds from other parties Scenario3: Process Flow Fund Request 1.1 e-Bill issued User2 EFT EFT User1 Gas Fund Request Company 1.3 Direct Debit User3 DD Request $ $ The funds are transferred without the overhead of clearing the checks . Note: There is no request text issued by the bank of Bank of Depost Federal Reserve Customer Bank deposit . The funds are directly drawn from customer bank . Scenario 4. 40
  51. 51. Scenario4: Process Flow 1.2 Email Request Recurring Bill (Payment) 1.1 e-Bill issued SplitTheBill 1 3 2 $ 1.3 Individual Authorization $ Gas EFT Customer Bank $ Company EFT 1.4 Direct Debit Customer 2 Bank EFT Customer 3 Bank DD Request $ $ Since SplitTheBill only facilitates the payment it can’t allow the Gas Company and its Bank of Deposit to perform Direct text Debit. It initiates a Direct Bank of Depost Federal Reserve SplitTheBill Bank Deposit as soon as the funds are collected from all of the participating customers . Scenario4: Process Flow 1.2 Email Request Recurring Bill (Payment ) Fragment 1.1 e-Bill issued If any of the parties disputes the bill the SplitTheBill 1 3 transaction will not 2 occur, until the sum 1.3 Individual Authorization of the funds is equal to the sum of the bill in question . Gas Company Insufficient Funds 1.2 Email Request 1.3 Individual Authorization End Of Sufficient Funds Transaction 1.1 e-Bill issued EFT (DD/DIRECT DEBIT 1 2 3 SplitTheBill $ $ $ Gas Company Once all the Customer Bank Customer 2 Bank Customer 3 Bank parties agree the authorization triggers DD from Authorize == True the respective Scenario4: Process Flow accounts. Recurring Bill (Payment) Fragment 2 In this process flow diagram it is clear there are several advantages to using this approach. 1. The Customer gets to review the bill for any discrepancies before agreeing to pay it. 2. The utility company (any other company) is only paid after the funds have been collected from the parties involved. 41
  52. 52. 3. The DDM presenter can be a private party because the debit takes place in- directly and only once the user has authorized it. In other words since the DDM happens through an intermediary – the Split Bill Payment System – a private party (landlord, independent contractor, etc.) can take advantage of the mandate. 4. Neither party has to share any private information about their bank ac- counts. 4.1 The customer who is the primary account holder with utility doesn’t have to 1. Get in touch with other parties 2. Ask them to perform a direct debit, collect cash, or checks (the worst case because these checks can bounce and depositing checks requires a trip to the bank) 5. Never at any point is there paper of any sort being passed between the par- ties involved. 6. All the parties involved are made aware if there is a problem of any kind or a refund pending because the communication from the utility is avail- able for review to all the paying parties. 7. The system leaves a permanent electronic trail; no party can dispute any action because every transaction is recorded. 8. The system operates on the consensus principle, either all parties agree to the amounts or the transaction doesn’t happen. 9. Unlike scenario three the danger of having money being debited before the funds are credited to the account (belonging to the primary transaction ini- tiator) by the other parties is not an issue because the funds are drawn from all accounts simultaneously. In other words PAH (primary account holder) doesn’t have to wait for funds from other people, or assume the risk of paying the bills of on his/her own, because the funds are collected from ev- ery participant. 10. Using ACH or FedWire systems for transfer this is the cheapest, fastest, and most secure way for all parties involved. 11. Additionally, the system allows for upgraded services through integration from third party providers: 1. Verification of the identity of the entity which presented the e-bill. 42
  53. 53. 2. Verification of the account “good-standing” for all parties involved us- ing third party services when amounts exceed $5000. 3. Blacklisting accounts which are in poor standing. 4. Request to verify fund availability before the actual withdrawal is made to prevent bank-account overdrafts. 12. If the funds are insufficient in any of the participating accounts the cus- tomers have the ability to either have the money be refunded back to their respective accounts or add another party to the list of the participants, con- tribute extra funds themselves. 43