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Week 1 – Lecture 1: Setting the stageMotivation:
• What make payment markets so special?
o Payment is the quintessential economic activity that binds together the gains
from trade. It is a crucial part of the financial infrastructure
® no well-functioning economy can do without
o The (hidden) ‘plumbing’ of the economy: if the plumbing is not right, the
economy cannot do well
• Task for the ESCB: the promotion of a sound and safe payment system
o Oversight = looks at reliability, safety and security of payment systems
o Regulation = correct market frictions in payment markets
Trust
Trust plays an important role for payment systems. You accept money for a supplied service
or activity, because I trust that I can use that money tomorrow for payments
• Guest speaker will talk about this
• Trust also plays a role in payment systems, if you don’t trust your credit card or if
online banking system fails frequently, you will not use it anymore and go back to
cash
Cybercrime
Trust is affected by security and reliability… You don’t want hacks and malfunctions.
If criminal activities get the overhand, people might lose their trust in economic payments
and the payment systems.
Dissatisfaction and no ‘free’ lunch
Lots of things happen behind the scenes. People take for granted that these payment
systems work. Only when things go wrong, e.g. when you’re at the shop and the machine
doesn’t work, people get annoyed ® dissatisfied. They won’t notice when things go right,
it’s an automatic activity. However, this whole thing of going right is not for free, payment
systems are no ‘free’ lunch, behind the scenes a lot of things are happening.
• To run a retail payment system, it costs about 0.5-1% of GDP.
• Profits ® VISA makes more than $10 billion per year
You have costs but also huge profits: Important issue of payment efficiency.
A lot of business dynamics
New technologies, changing consumer preferences, more regulations.
Most FinTech is geared towards payment industry. GAFAA (=Google, Amazon, Facebook,
Apple, Alibaba) is just ‘waiting’ to enter the payment market.
Open question:
What is the future of payments? Who is going to make money from payments? Traditional
banks or the new players entering the scene? We don’t know the answer yet!
Amazon Go Video ® three years ago showed this video and it was so new, while now you
are already used to the possibility.
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,Payment systems are highly complex:
• Many players (‘old’ and ‘new’)
• Conflicts of interests
• Changing user preferences ® we want things now, fast and safe and I don’t want to
pay for it
• New technologies and innovation
• Competition versus cooperation ® all these parties in the payment markets compete
with each other, but from money to A to B, you also have to cooperate on a surface
• Many (new) regulations
• Scale and network effects: winner takes all ® if you get to grow, get your network
right, you can take it all ® dangerous conditions on pricing and efficiency
® all in the mix!
We need to understand the complexity and its economic consequences. This defines
‘payment economics’
Evans, 2004: “Payment economics lies at the intersection of monetary theory, banking and
industrial organization.” ® loose definition which is very accurate.
• Monetary theory studies the role of money in the real economy
• Money is at root of every payment
• Banking ® only banks are allowed to offer bank and checking accounts – they are
still main providers of payment services
• Markets may fail and market power must be kept in check. Industrial Organization
studies the exercise and control of market power
o FinTech
o The Godfather of Industrial Organisation is Jean Tirole (Nobel prize winner of
Economics) ® derived a pricing test (Tourist Test) that is used now by the
European Commission to check if the payment server providers keep their
prices under control
A few definitions
• Money: anything that is generally accepted in payments for goods or services or in
the repayment of debts.
• Payment: the payer’s transfer of funds to the payee to discharge a monetary claim.
Typically, these funds take the form of banknotes (= physical, public money) or
deposit balances (= electronic, private money) held at a financial institution or at a
central bank
• Payment instrument: any instrument that enables the holder/user to transfer funds
(e.g. cash, debit card, ‘giro’ transfer, direct debit etc.)
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, Payment system: everything that ensures the circulation of money.
‘Everything’ = payment instruments, digital/physical infrastructure, banking procedures,
technical standards, interbank funds transfer system.
Two types of payment systems:
• Large-value payment systems (LVPS):
o Transfer system between banks and central banks (huge payments)
o Main issues: access, liquidity, system risk (as trillions are paid), settlement
• Retail payment systems:
o Transfer systems between consumers, merchants and banks
o Main issues: Pricing (= who’s paying for it), competition (is the market
competitive enough), regulation, innovation, fraud
Our focus in this course is on retail systems!
But one of the guest speakers will present a talk on Large-value payment systems (LVPS).
Main trends:
1. Move toward mobile and online payments. Less cash!
o Doesn’t hold for every country, but overall, the use is declining
2. Rapid digitization and faster payments (we don’t want to wait a night)
3. Increasing access and use of (big) data and privacy issues
4. Fintech, new players and increasing competition
5. New regulations (which one is huge? E.g., PSD2)
6. Lots of innovations
7. ‘Old question in new technology jacket’: private versus public money in terms of
issuance? (crypto, Libra, stable coins, Central Bank Digital Currency (CBDC…)
o Bitcoin issues private money, banks only create money, they don’t issue
money. They only use lending and borrowing to multiply the money supply
1. Move toward mobile and online payments. Less cash!
Usage at the point-of-sale in the Netherlands:
1990 ® 2019: huge increase in use of
debit card (pin), 300 payments per year
Number of payments
per person.
Contactless ® adopted right from the
start
Cash use is going down quickly
Light blue line: chipknip ® didn’t take off, why?
Green line: credit cards ® why not frequently used?
Ignition of pin from 1993 onwards: There were a lot armed robberies at gasoline stations,
they therefore wanted to change from cash to electronics. In Netherlands, Albert Heijn
started to accept the Debit card in the Netherlands as the first supermarket, had to spend
less on cash management. Other supermarkets followed, and accepted to pay the debit
card, more consumers started to use it ® domino effect that kicked off this growth.
Egg and the chicken problem: two sides of the market have to be convinced.
3
, Usage of remote payments:
Number of payments
(Payments that you do on a distance, e.g. rent)
Yellow line also includes Tikkie!
5. Payment Serves Directive 2 (PSD2):
• Aim: fostering competition and innovation in EU payment market
• How: Banks must give access to third parties to payment and account information of
their clients
o Third parties need to have a license
o Consumers need to give their consent that third parties access their data
• PSD2 could very well be a game changer and we are in the midst of it…!
6. Lots of innovations and changes at the same time:
• Mobile banking and payments
• Contactless payments
• Alipay, Google Pay, Apple Pay
• Tikkie
• E-commerce
• Entry of (non-banks) FinTechs and BigTechs (e.g. Adyen ® Dutch FinTech)
• The biggest innovations? ® Blockchain? Bitcoin?
o Blockchain technology has proven that you can process and settle payments
in a secure and safe way, without the help of a trusted intermediary, that is
revolutionary
o There have been criminal activities regarding bitcoins, doesn’t have to do with
the blockchain technology, but thieves managed to get bitcoins
Main policy questions
• What drives consumer and merchant payment behaviour?
• Who benefits and who bears the costs? Who makes money from payments? What
about optimal pricing?
• Will competition in payment markets do any good? Can prices to go up! Why?
• Can the market on its own deliver ‘fair’ and efficient outcomes or is regulation
needed because there are frictions and complications? What is its impact?
• Given new technologies, innovations and new (non-bank) ‘FinTech’ players – what
will be the future business model to provide payment services?
To answer these key questions, we need an appropriate economic framework!
Understand ‘platform economics’ and the theory of ‘two-sided markets’.
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