Q. Payment Systems

Traditional Types of Payment
There are five generic types of payment systems, each with different characteristics, that
are exist in physical world.
 Cash is legal tender defined by a national authority to
represent value.
 Most common form of payment in terms of number of
 Why is cash still so popular today? Cash is portable,
requires no authentication, and provides instant
purchasing power for those who possess it.
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Slide 5-1
 The advantages
of using cash as a form of
payment are:
 Instantly convertible into other forms of value without
 Cash allow micro payments (payments of small amounts)
 There is no financial risk for the merchant.
 The sale cannot be repudiated (an advantage for the
 No expensive special hardware is required to complete a
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 The disadvantages
of using cash as a form of
payment are:
 There is financial risk to the consumer in carrying cash for
purchases as it can be easily lost or stolen.
 It does not provide any float time for the consumer: there
is no time period between the purchase of the item and
the actual payment.
 Cash purchases tend to be final and irreversible
(permanent ) unless the seller agrees upon a return policy.
 There is no security against unauthorized use.
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Checking transfer
 Second most common payment form.
A checking transfer, which represents funds transferred directly via a
signed draft or check from a consumer’s (customer) checking account
to a merchant or other individual.
 Checks can be used for small and large transactions but
not for micro payments (less than $1).
 Checks have some float . (time to clear) as Dubai Islamic
Bank takes 3 days after deposit in Pakistan.
 Check also introduce security risks for merchants.
Forged more easily than a cash
They also cancelled before they clear
They may bounce if there is not enough money in the account
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Slide 5-4
Credit card
 A credit card represents an account that extends credit to
consumers, permits consumers to purchase items while
deferring (postpone) payments.
 Credit card associations such as Visa and MasterCard are
nonprofit organizations that set the standards for the
banks that issue the credit cards.
 The banks (issuing banks) are the institutions that actually
issue the cards, process the transactions, receive and
calculate the payments, and charge and receive the
 Third party processing centers or clearinghouses usually
handle verification of accounts and balances.
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Slide 5-5
Clearing House Concept
First, a consumer presents credit card information to the merchant. The merchant
transmits this data, along with their merchant ID code, to a clearinghouse (also
referred to as a processor or acquirer). The clearinghouse might be the bank that
has issued the merchant their credit card account, but it is more likely a firm that
has contracted with the merchant's bank to clear charges in exchange for a flat
fee and a percentage of every charge processed.
The data is transmitted by reading the card and merchant numbers over the
phone, by using a credit card POS (point of sale) terminal, or some other piece of
software to transmit the information from a computer.
The clearinghouse contacts the bank that issued the consumer's credit card and
verifies that the charge is acceptable. If it is accepted, the clearinghouse then
sends a confirmation message to the merchant. At the same time, the available
credit from the customer's credit card is frozen by the amount of the transaction.
At the end of a business day, the merchant (actually, the merchant's computer or
credit card terminal) calls the clearinghouse and verifies all transactions for that
day to ensure that the merchant's system and the clearinghouse agree on the
transactions that have occurred during that day. Once the merchant and the
clearinghouse agree on the day's transactions, the clearinghouse starts the
process of transferring the money from the credit card bank to the merchant's
bank account.
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Credit cards offer consumers a line of credit and the
ability to make small and large purchases instantly.
They are widely accepted as a form of payment,
reduce the risk of theft associated with carrying
cash, and increase consumer convenience.
Credit card also offer consumers considerable float.
With a credit card, for instance, a consumer typically
need not actually pay for goods purchased until
receiving a credit card bill 30 days after. Issuer bank
also charge transaction fee from merchant.
Credit cards have less finality than other payment
systems because consumers can refute or repudiate
purchases under certain circumstances (such as card
It increase risk for merchant and issuer bank.
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Stored Value (stored value cards)
Stored value payment systems are created by depositing funds into
accounts from which funds can be withdrawn as needed.
They are similar to checking transfers in that funds are stored and
withdrawn, but a paper check need not be written.
Stored value payment systems include prepaid phone cards, debit
cards, gift certificates, and smart cards (ARY digital card).
Both stored value payment systems and checking transfers are dependent
upon funds being available in an account. Neither is convertible without
intermediation, and both involve only a small transaction fee for large
However, stored value systems do not give the consumer any float
time, and they are more expensive for the merchant because special
hardware is required to read and process the stored numbers on the
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Slide 5-8
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Accumulating Balance
 A method and a system facilitate payments.
 Accounts that accumulate expenditures and to which
consumers make period payments
 Traditional examples include utility and phone bills, all of
which accumulate balances, usually over a specified period
(typically a month), and then are paid in full at the end of
the period.
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Accumulated Balance Just Concept
A credit card is not considered an
accumulating balance system because the
balance accumulated is not restricted to a
certain time period. Utility or phone accounts
accumulate a balance which must be paid in
full at the end of a time period (usually one
 while credit cards permit purchases to be
made on a deferred payment plan with no
restriction on time and interest charged on
the balance due.
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Types of E-commerce Payment Systems
 Special electronic payment systems have
been developed to pay for goods
electronically on the Internet. Electronic
payment systems for the Internet include
the following systems:
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Slide 5-15
 Credit cards
 Credit cards are the dominant form of online payment.
Credit cards account for 55 percent of online payments in the United States
and about 50 percent of online purchases outside the United States.
Online credit card transactions are processed in much the
same way that in-store purchases are, with the major
differences being that
 online merchants never see the actual card being used,
no card impression is taken, and no signature is available.
These type of purchases are also called CNP (Card Not
Present) transactions.
Major difference is, since the merchant never sees the credit card,
nor receives a hand – signed agreement to pay from the consumer,
when disputes arise, the merchant faces the risk that the transaction
may be disallowed and reversed, even though he has already shipped
the goods or the user had downloaded a digital product.
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Slide 5-16
Figure Below illustrates the online credit card purchasing cycle.
There are 5 parties involved in an online credit card purchase:
Consumer, Consumer Bank, Merchant ,Merchant Bank (or acquiring
Bank) and Clearing House.
In order to accept payments by credit card, online merchants mush have
a merchant account established with a bank or financial institution.
A merchant account is simply a bank account that allows companies to
process credit card payments and receive funds from those transaction.
An online transaction begins with a purchase.
1) When a consumer wants to make a purchase, he or she adds the item to the merchant’s site shopping
cart. When consumer comes on payment step, a secure tunnel through the Internet is created using SSL.
2) If SSL is not implemented by a Certification Authority, then there is no authentication between the
merchant or the consumer. The transaction parties have to trust one another.
3) Once received credit card information by the merchant, the merchant software contacts a clearing
house. Clearing House contacts the issuing bank to authenticate and verify the account information.
4) Once verified, the issuing bank credits the account of the merchant at the merchant’s bank (usually its
end of the day – in a batch process)
5) The debit to the consumer account is transmitted to the consumer in a monthly statement.
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How an Online Credit Transaction Works
Figure 5.16, Page 315
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Slide 5-18
 Credit cards Enablers
Companies that have a merchant account still need to buy or build
a means of handling the online transaction; securing the merchant
account is only step one in a two part process.
Second step is Internet payment service provider (Clearing house)
who provide the software for online credit card transaction
For example, Authorize.net is an Internet payment service
provider. It helps a merchant secure an account with on of its
merchant account provider partners (usually Merchant Bank), and
then provides payment processing software for installation on the
merchant's server.
The software collects the transaction information from the
merchant’s site and then routes it via the Authorize.net “payment
gateway” to the appropriate bank (customer bank), ensuring that
customers are authorized to make their purchases. Then funds for
the transaction are transferred to the merchant’s bank account.
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Slide 5-19
Limitations of Online Credit cards Payments Sys
 Security
Neither the merchant nor the consumer can be fully authenticated
if SSL is not implemented by CA’s authority.
SSL provide only merchant’s verification but not client (its
SET provide two way authentication , but its difficult to implement
by merchant and client because to much complex.
 Repudiation: Consumer can repudiate online transaction.
 Cost – Transaction fee is charge from merchant.
 Social equity – Millions of customers do not have credit cards.
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Slide 5-20
Digital wallets
 Emulates functionality of wallet by authenticating
consumer, storing and transferring value, and securing
payment process from consumer to merchant.
Digital wallets make paying for purchases over the Web
more efficient by eliminating the need for shoppers to
enter their address and credit card information repeatedly
each time they buy something.
 A digital wallet securely stores credit card and owner
identification information and provides that information at
an electronic commerce site’s “checkout counter.”
 The digital wallet enters the shopper’s name, credit card
number, and shipping information automatically when
invoked to complete the purchase.
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Slide 5-21
 Example:
Amazon.com’s 1-Click Shopping, which enables a consumer to fill in
shipping and credit card information automatically by clicking one
button, uses electronic wallet technology.
MSN Wallet, MasterCard Wallet, Google checkout and America
Online’s Quick Checkout are other digital wallet systems.
The merchant receives some additional transaction guarantees that
the user has been authenticated by Google or other trusted identity.
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Digital cash (Electronic cash or e – cash )
An alternative payment system developed for e- commerce in which
unique, authenticated tokens representing cash value are transmitted
from consumer to merchants.
In these scheme, users would deposit money in a bank or provide a
credit card. Banks would issue digital tokens (unique encrypted
numbers) for various denominations of cash, and consumers could
“spend” these at merchants sites. In return merchants submit these
electronic token in its bank.
Digital cash can also be used for micropayments or larger purchases.
Digital cash is currency represented in electronic form that moves
outside the normal network of money (paper currency, coins, checks,
credit cards).
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Slide 5-25
Users are supplied with client software and can exchange money with
another e-cash user over the Internet or with a retailer accepting ecash.
eCoin.net is an example of a digital cash service. In addition to
facilitating micropayments, digital cash can be useful for people who
do not have credit cards and wish to make Web purchases.
Other examples include, E – gold, DigiCash, First Virtual and millicent
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Online stored value systems (online payment account)
Stored value payment systems enable consumers to make instant
online payments to merchants and other individuals based on value
stored in a digital account.
Online value systems rely on the value stored in a consumer’s bank,
checking, or credit card account .
Ecount.com offers a prepaid debit account for online purchases.
 Other Exmaples: PayPal, smart cards
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Slide 5-28
Paypal is a Web-based peer-to-peer payment systems have
sprung up to serve people who want to send money to
vendors or individuals who are not set up to accept credit
card payments.
The party sending money uses his or her credit card / debit
card or to create an account with the designated payment at
a Web site (such as) dedicated to peer-to-peer payments.
The recipient (individual or merchant) “picks up” the payment
by visiting the Web site (paypal) and supplying information
about where to send the payment (a bank account or a
physical address).
PayPal has become a popular peer-to-peer payment system.
Paypal is now available in 190 countries and has about 165 million
account holders.
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A smart card is a plastic card the size of a credit card that stores
digital information. The smart card can store health records,
identification data, or telephone numbers, or it can serve as
an “electronic purse” in place of cash. The Mondex and
American Express Blue smart cards contain electronic cash
and can be used to transfer funds to merchants in physical
storefronts and to merchants on the Internet. Both are
contact smart cards that require use of special card-reading
devices whenever the cards need to transfer cash to either an
online or offline merchant. (Internet users must attach a
smart card reader to their PCs to use the card. To pay for a
Web purchase, the user would swipe the smart card through
the card reader.)
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Digital accumulated balance payment
 Accumulated balance digital payment systems
users to make micropayments and purchases on the Web,
accumulating a debit balance that they must pay
periodically on their credit card or telephone bills.
 It mean, Balances accumulate and customers are billed
monthly with their regular phone , credit card bill.
 IPIN has been widely adopted by online music sites that
sell music tracks for 99 cents. It invoices customers
through existing consumer billing services such as
telephone and wireless service companies, Internet
service providers, and banks.
 PaymentOne , payment plus (AOL service )and Trivnet
enable consumers to charge small purchases to their
monthly telephone bill.
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Slide 5-32
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Digital checking:
Digital checking payment systems, such as Western Union
MoneyZap and eCheck, extend the functionality of existing
checking accounts so they can be used for online shopping
payments. Digital checks are less expensive than credit cards
and much faster than traditional paper-based checking. These
checks are encrypted with a digital signature that can be
verified and used for payments in electronic commerce.
Electronic check systems are useful in business-to-business
electronic commerce.
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Slide 5-34
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Wireless Payment Systems
Mean payments through wireless devices such as mobiles. Use of mobile
handsets as payment devices well-established in Europe, Japan, South
Japanese mobile payment systems
E-money (stored value) , Mobile debit cards ,Mobile credit cards
Japanese cell phones act like mobile wallets, containing a variety of
payment mechanisms. Also Consumers can pay merchants by simply
waving the cell phone at a merchants payment device that accept
payments. Because Japanese cell phones can act as bar code reader.
Not fully established yet in the United States
Majority of purchases are digital content for use on cell phone
In Europe and asia, cell phone users can pay for a very wide variety of real
goods and services, and their, phones are integrated into a wide array of
financial institutions.
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Slide 5-36
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Electronic Billing Presentment and
Payment (EBPP)
Electronic billing presentment and payment systems
EBPPS are used for paying routine monthly bills. They enable users to
view their bills electronically and pay them through electronic fund
transfers from bank or credit card accounts.
These services support payment for online and physical store
purchases of goods or services after the purchase has taken place.
They notify purchasers about bills that are due, present the bills, and
process the payments.
40% + of households in 2009 used some EBPP; expected to grow significantly
also used in Pakistan various bank offer pay your utility bills online.
Companies implementing a biller – direct system can either develop their own
system in-house, install a system acquired from a third-party (outsource) EBPP
software vandor or by other mean such as from Application Service Provider.
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Slide 5-39
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Two competing EBPP business models:
Biller-direct (dominant model) Model
The biller – direct system was originally created by utility companies that send millions
fo bills each month. Their purpose is to make it easier for their customers to pay
their utility bills routinely online. Today, telephone and credit card companies also
often offer this service, as well as number of individual stores (such as in USA).
Consolidator Modlel
In this model, a third party, such as a financial institution (banks) or portal,
aggregates all bills for consumers and ideally permits on – stop bill payment.
Financial institutions have been more successful than portals (such as Yahoo! Bill
Pay) in attracting online bill payers.
There are two types
i. Think Consolidator
In thick consolidation, both the bill summary and bill detail are stored at the consolidator's
ii. Thin Consolidator
In thin Consolidation , only the summary bill information is available, and the consumer
must click on a link to access a detailed bill that is stored at another location, such as the
biller’s site or elsewhere.
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Consolidator model
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The consolidator Model faces several challenges.
For billers, using the consolidator model means an
increased time lag between billing an payment, and
also inserts an intermediary b/w the company and its
For consumers, security continues to be major issue.
Most consumers are unwilling to pay any kind of fee
to pay bills online, and many are concerned about
sharing personal financial information with non –
financial institutions.
Today more and more banks are offering online bill
payment free to some or all of their customers as an
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