Economic Policy Review Executive Summary

Understanding Risk Management in Emerging Retail Payments

Recapping an article from the September 2008 issue
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of the Economic Policy Review, Volume 14, Number 2
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23 pages / 288 kb

Authors: Michele Braun, James McAndrews, William Roberds, and Richard Sullivan

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Index of executive summaries
  • Emerging payment mechanisms are making retail transactions less expensive and easier to process, while opening new commercial venues for the transactions.

  • As with more established forms of payment, the ultimate success of these emerging methods will depend on their ability to control risk; failure to do so can lead to rejection in the market.

  • The predominant types of risk faced by providers of emerging retail payment methods are operational, fraud, illicit use, and breaches of data security.

  • Braun et al. consider whether, in an evolving payment environment, providers of emerging payment methods have sufficient incentives and tools to control risk before its repercussions become widespread.

  • Their study presents an economic framework for understanding risk control in retail payments and finds that:

  • risk control is a special type of good because it can be consumed without diminishing the consumption of others

  • as a result, containment strategies are the dominant means of controlling payment risk

  • a critical containment strategy is the limiting of access to the payments system.

  • The authors apply the economic framework to the risk experiences of three types of payments:

  • general-purpose prepaid cards,

  • e-check payments made through the Automated Clearinghouse system, and

  • proprietary online balance-transfer systems.

  • The three payment types examined incorporate new technologies, new networks, and new rules to create an entirely new payment method. They are used in different venues, employ different means for initiating payments, and clear and settle transactions differently—yet they employ similar risk mitigation strategies.

  • The study suggests that a payments system can successfully contain risk if it:

  • recognizes problems quickly,

  • encourages commitment from all participants to control risk, and

  • uses an appropriate mix of market and public policy mechanisms to align risk management incentives.

  • An important lesson of the study is that products, services, rules, and technologies are changing at an accelerating rate—as are the ways to perpetrate fraud and other illicit activities. However, the techniques for mitigating the risks associated with these problems are also evolving.


About the Authors

Michele Braun is an officer and James McAndrews a senior vice president at the Federal Reserve Bank of New York; William Roberds is an economist and policy advisor at the Federal Reserve Bank of Atlanta; Richard Sullivan is a senior economist at the Federal Reserve Bank of Kansas City.

Disclaimer

The views expressed in this summary are those of the authors and do not necessarily reflect the position of the Federal Reserve Banks of Atlanta, Kansas City, New York, or the Federal Reserve System.