LESSON 8: ELECTRONIC PAYMENT SYSTEMS

Learning Objectives By the end of this chapter the learner shall be able to;

i. Explain the Payment Revolution

ii. Explain the different payment cards that could be used to pay for the online transactions

iii. Explain other forms of e-payment

iv. Explain the different payment advertising methods

8.1 The Payment Revolution

According to Sapsford (2004), A currency can be anything that all members of a society agree it
should be.

Prior to the tenth century BC, shells often were used in trade and barter. Metal coins appeared in
Greece and India somewhere between the tenth and sixth centuries BC and dominated trade for
2,000 years. In the Middle Ages, Italian merchants introduced checks. In the United States, paper
money was first issued in Massachusetts in 1690. ln 1950, Diners Club introduced credit cards in
the United States. Until recently cash was king, at least for in—store payments; checks were the
dominant form of noncash payment.

Today we are in the midst of a payment revolution, with cards and electronic payments taking the
place of cash and checks.

In 2003, the combined use of credit and debit cards for in-store payments for the first time
exceeded the combined use of cash and checks (Gerdes et al. 2005).

By 2005, debit and credit cards accounted for 55 percent of in-store payments, with cash and
checks making up the rest. The growth in the use of plastic is attributable to the substantial growth
in the use of` debit cards and the decline in the use of` cash. For example, from 1999 to 2005, debit
card in—store payments went from 21 percent to 33 percent, while cash dropped from 39 percent
to 33 percent (Dove Consulting 2006). Similar trends are occurring in noncash payments of
recurring bills.

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In 2001, 78 percent of all recurring bills were paid by paper-based methods (e.g., paper checks),
while 22 percent of these payments were made electronically. By 2005, the percent of electronic
payments of recurring bills had grown to 45 percent (Dove Consulting 2006). This change in the
mix of payment methods is likely to continue.

 Electronic payment systems are central to on-line business process as companies look for
ways to serve customers faster and at lower cost.
 Emerging innovations in the payment for goods and services in electronic commerce
promise to offer a wide range of new business opportunities.
 Electronic payment systems and e-commerce are highly linked given that on-line
consumers must pay for products and services.
 Clearly, payment is an integral part of the mercantile process and prompt payment is
crucial.
 If the claims and debits of the various participants (consumers, companies and banks) are
not balanced because of payment delay, then the entire business chain is disrupted. Hence
an important aspect of e-commerce is prompt and secure payment, clearing, and settlement
of credit or debit claims.
 Electronic payment systems are becoming central to on-line business transactions
nowadays as companies look for various methods to serve customers faster and more cost
effectively.
 Electronic commerce brings a wide range of new worldwide business opportunities.
 There is no doubt that electronic payment systems are becoming more and more common
and will play an important role in the business world.
 Electronic payment always involves a payer and a payee who exchange money for goods
or services. At least one financial institution like a bank will act as the issuer (used by the
payer) and the acquirer (used by the payee).

Factors to Consider in Determining a Particular Method of E-Payment:

 Independence. Some forms of e—payment require specialized software or hardware to

make the payment. Almost all forms of e—payment require the seller or merchant to install
specialized software to receive and authorize a payment. Those e—payment methods that
require the payer to install specialized components are less likely to succeed.

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  Interoperability and Portability. All forms of EC run on specialized systems that are
interlinked with other enterprise systems and applications. An e-payment method must
mesh with these existing systems and applications and be supported by standard computing
platforms.
 Security. How safe is the transfer? What are the consequences of the transfer’s being
compromised? Again, if the risk for the payer is higher than the risk for the payee, then the
payer is not likely to accept the method.
 Anonymity. Unlike credit cards and checks, if a buyer uses cash, there is no way to trace
the cash back to the buyer. Some buyers want their identities and purchase patterns to
remain anonymous.
 Divisibility. Most sellers accept credit cards only for purchases within a minimum and
maximum range. If the cost of the item is too small - only a few dollars - a credit card will
not do. In addition, a credit card will not work if an item or set of items costs too much
(e.g., an airline company purchasing a new airplane). Any method that can address the
lower or higher end of the price continuum or that can span one of the extremes and the
middle has a chance of being widely accepted. Ease of Use. For B2C e—payments, credit
cards are the standard due to their ease of use. For B2B payments, the question is whether
the online e-payment methods can replace the existing offline methods of procurement.
 Transaction Fees. When a credit card is used for payment, the merchant pays a transaction
fee of up to percent of the item’s purchase price (above a minimum fixed fee). These fees
make it prohibitive to support smaller purchases with credit cards, which leaves room for
alternative forms of payment.

3.1 Types of Electronic Payment Systems:

A. Electronic Funds Transfer
Electronic payment systems are proliferating in banking, retail, health care, on-line markets,
and even government - in fact, anywhere money needs to change hands.

 Organizations are motivated by the need to deliver products and services more cost
effectively and to provide a higher quality of service to customers.

The emerging electronic payment technology labeled Electronic Funds Transfer (EFT).

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Electronic Funds Transfer (EFT).is defined as ―any transfer of funds initiated through an
electronic terminal telephonic instrument, or computer or magnetic tape so as to order, instruct,
or authorize a financial institution.
EFT can be segmented into three broad categories:

Banking and financial payments

 Large-scale or wholesale payments (e.g., bank-to-bank transfer).

 Small-scale or retail payments (e.g., automated teller

machines).

 Home banking (e.g., bill payment).

Retailing payments

 Credit Cards (e.g., VISA or MasterCard)

 Private label credit/debit cards (e.g., J.C. Penney Card)

 Charge Cards (e.g., American Express)

 On-line electronic commerce payments

 Token-based payment systems

Electronic cash (e.g., DigiCash)

Electronic checks (e.g., NetCheque)

Smart cards or debit cards (e.g., Mondex Electronic Currency Card)

 Credit card-based payments systems

 Encrypted Credit Cards (e.g., World Wide Web form-based encryption)
 Third-party authorization numbers (e.g., First Virtual).
B. Cash

 Legal tender defined by a national authority to represent value.

 Most common form of payment in terms of number of transactions.

 Instantly convertible into other forms of value without intermediation of any kind.

 Portable, requires no authentication, and provides instant purchasing power.

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 “Free” (no transaction fee), anonymous, low cognitive demands.

 Limitations: easily stolen, limited to smaller transaction, does not provide any float.

C. E-Cash/Digi Cash: Electronic cash is a general term that describes the attempts of several
companies to create value storage and exchange system that operates online in much the same
way that government-issued currency operates in the physical world.
 There are many ways that exist for implementing an e-cash system, all must incorporate a few
common features.
 Electronic Cash is based on cryptographic systems called ―digital signatures.
 This method involves a pair of numeric keys: one for locking (encoding) and the other for
unlocking (decoding).

E-cash must have the following four properties.

 Monetary value

 Interoperability

 Retrievability

 Security

• Concerns about electronic payment methods include:

 Privacy

 Security

 Independence

 Portability

Electronic Cash Storage

• Two methods

On-line

 Individual does not have possession personally of electronic cash.

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 Trusted third party, e.g. e-banking, bank holds customers’ cash accounts.

Off-line

 Customer holds cash on smart card or electronic wallet

 Fraud and double spending require tamper-proof encryption

The purchase of e-cash from an on-line currency server (or bank) involves two steps:

o Establishment of an account

o Maintaining enough money in the account to bank the purchase.

 Once the tokens are purchased, the e-cash software on the customer‘s PC stores digital money
undersigned by a bank.
 The users can spend the digital money at any shop accepting e-cash, without having to open
an account there or having to transmit credit card numbers.
 As soon as the customer wants to make a payment, the software collects the necessary amount
from the stored tokens.

D. Checking Transfer
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 Funds transferred directly via a signed draft or check from a consumer’s checking account to
a merchant or other individual.
 Most common form of payment in terms of amount spent.
 Can be used for both small and large transactions.
 Some float.
 Not anonymous, require third-party intervention (banks).
 Introduce security risks for merchants (forgeries, stopped payments), so authentication
typically required.
E. Using Payment Cards Online

Payment cards are electronic cards that contain information that can be used for payment purposes.
They come in three forms:

 Credit cards. A credit card provides the holder with credit to make purchases up to a limit
fixed by the card issuer. Credit cards rarely have an annual fee. Instead, holders are charged
high interest--the annual percentage rate-on their average daily unpaid balances. Visa,
MasterCard, and EuroPay are the predominant credit cards.
o Credit card associations: Nonprofit associations (Visa, MasterCard) that set
standards for issuing banks
o Issuing banks: Issue cards and process transactions
o Processing centers (clearinghouses): Handle verification of accounts and
balances
 Charge cards. Accounts created by depositing funds into an account and from which funds are
paid out or withdrawn as needed. The balance on a charge card is supposed to be paid in full
upon receipt of the monthly statement. Technically, holders of a charge card receive a loan for
30 to 45 days equal to the balance of their statement. Such cards usually have annual fees.
Examples: Debit cards, gift certificates, prepaid cards, smart cards
 Debit cards. With a debit card, the money for a purchased item comes directly out of the
holder’s checking account (called a demand-deposit account). The actual transfer of funds from
the holder’s account to the merchant’s takes place within one to two days. MasterCard, Visa,
and EuroPay are the predominant debit cards. .

Processing Cards Online

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The processing of card payments has two major phases: authorization and settlement.

 Authorization determines whether a buyer’s card is active and whether the customer has
sufficient available credit line or funds.
 Settlement involves the transfer of money from the buyer’s to the merchant’s account.

The way in which these phases actually are performed varies somewhat depending on the type of
payment card. It also varies by the configuration of the system used by the merchant to process
payments.

There are three basic configurations for processing online payments.

The EC merchant may:

 Own the payment software. A merchant can purchase a payment-processing module and
integrate it with its other EC software. This module communicates with a payment gateway
run by an acquiring bank or another third party.
 Use a point of sale system (POS) operated by an acquirer. Merchants can redirect cardholders
to a POS run by an acquirer. The POS handles the complete payment process and directs the
cardholder back to the merchant site once payment is complete. In this case, the merchant
system only deals with order information. In this configuration, it is important to find an
acquirer that handles multiple cards and payment instruments. If not, the merchant will need
to connect with a multitude of acquirers.
 Use a POS operated by a payment service provider. Merchants can rely on servers operated
by third parties known as payment service providers (PSPs). In this case, the PSP connects
with the appropriate acquirers. PSPs must be registered with the various card associations they
support.

How an Online Credit Transaction Works

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The key participants in processing card payments online include the following:

 Acquiring bank. Offers a special account called an Internet Merchant Account that enables
card authorization and payment processing.
 Credit card association. The financial institution providing card services to banks (e.g., Visa
and MasterCard).
 Customer. The individual possessing the card.
 Issuing bank. The financial institution that provides the customer with a card.
 Merchant. A company that sells products or services.
 Payment processing service. The service provides connectivity among merchants, customers,
and financial networks that enables authorization and payments.
 Processor. The data center that processes card transactions and settles funds to merchants.

Digital Wallets

 Concept of digital wallet relevant to many of the new digital payment systems.

 Seeks to emulate the functionality of traditional wallet.

 Most important functions:

o Authenticate consumer through use of digital certificates or other encryption methods

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 o Store and transfer value

o Secure payment process from consumer to merchant

 Most common types are client-based software applications: MasterCard Wallet.

Other payment methods

 Person to person payments are newest and fastest growing e-payment schemes. Able to
transmit funds to anyone with an email address example is Paypal used in ebay.com
 Wireless payments such as ―M-pesa from safaricom or Zap from Airtel
 E-check: Electronic version of paper check
 E-charge: Charge purchases to local phone bill

Limitations of Online Credit Card Payment Systems

 Security: neither merchant nor consumer can be fully authenticated.

 Cost: for merchants, around 3.5% of purchase price plus transaction fee of 20 – 30 cents per
transaction.

 Social equity: many people do not have access to credit cards (young adults, other adults who
cannot afford cards or are considered poor risk).

B2B Payment Systems

 More complex than B2C

 Major types:

 Systems that replace traditional banks.

 Financial institutions hoping to extend to the B2B marketplace
 Credit card companies

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Security Requirements in Electronic Payment Systems:

Integrity and authorization

A payment system with integrity allows no money to be taken from a user without explicit
authorization by that user. It may also disallow the receipt of payment without explicit
consent, to prevent occurrences of things like unsolicited bribery. Authorization constitutes
the most important relationship in a payment system. Payment can be authorized in three
ways: via out-band authorization, passwords, and signature.
Out-band authorization
In this approach, the verifying party (typically a bank) notifies the authorizing party (the
payer) of a transaction. The authorizing party is required to approve or deny the payment
using a secure, out-band channel (such as via surface mail or the phone). This is the current
approach for credit cards involving mail orders and telephone orders: Anyone who knows a
user‘s credit card data can initiate transactions, and the legitimate user must check the
statement and actively complain about unauthorized transactions. If the user does not
complain within a certain time (usually 90 days), the transaction is considered ―approved‖ by
default.
Password authorization

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 A transaction protected by a password requires that every message from the authorizing party
include a cryptographic check value. The check value is computed using a secret known only
to the authorizing and verifying parties. This secret can be a personal identification number,
a password, or any form of shared secret. In addition, shared secrets that are short - like a six-
digit PIN - are inherently susceptible to various kinds of attacks. They cannot by themselves
provide a high degree of security. They should only be used to control access to a physical
token like a smart card (or a wallet) that performs the actual authorization using secure
cryptographic mechanisms, such as digital signatures.
Signature authorization
In this type of transaction, the verifying party requires a digital signature of the authorizing
party. Digital signatures provide non repudiation of origin.
Confidentiality
Some parties involved may wish confidentiality of transactions. Confidentiality in this
context means the restriction of the knowledge about various pieces of information related to
a transaction: the identity of payer/payee, purchase content, amount, and so on. Typically, the
confidentiality requirement dictates that this information be restricted only to the participants
involved. Where anonymity or un-traceability are desired, the requirement may be to limit
this knowledge to certain subsets of the participants only, as described later.
Availability and reliability
All parties require the ability to make or receive payments whenever necessary. Payment
transactions must be atomic: They occur entirely or not at all, but they never hang in an
unknown or inconsistent state. No payer would accept a loss of money (not a significant
amount, in any case) due to a network or system crash. Availability and reliability presume
that the underlying networking services and all software and hardware components are
sufficiently dependable. Recovery from crash failures requires some sort of stable storage at
all parties and specific resynchronization protocols. These fault tolerance issues are not
discussed here, because most payment systems do not address them explicitly.
Chapter Review Questions
1. Describe the factors that are critical for an e-payment method to achieve critical mass.
2. What is an E-Check?
3. Explain why Mpesa has become a very common form of e-payment in Kenya?

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FACTORS TO CONSIDER IN CHOOSING AN E-PAYMENT SYSTEM
The success of any e-payment system indeed depends on multiple factors. These
factors ensure the system is secure, user-friendly, reliable, and widely accepted. Here
are key factors that justify this statement:
1. Security
Encryption and Fraud Prevention

 Data Protection: The e-payment system must use robust encryption protocols (e.g.,
SSL/TLS) to protect sensitive information such as credit card details and personal
data.
 Fraud Detection: Advanced fraud detection mechanisms are crucial to identify and
prevent fraudulent activities. Systems like tokenization and multi-factor
authentication (MFA) add additional layers of security.
Compliance with Standards

 PCI DSS Compliance: Adherence to Payment Card Industry Data Security Standards
(PCI DSS) ensures that the e-payment system maintains a secure environment for
handling cardholder data.
2. User-Friendliness
Ease of Use

 Intuitive Interface: The e-payment system should have a simple and intuitive user
interface that makes it easy for users to navigate and complete transactions.
 Streamlined Process: Reducing the number of steps required to complete a payment
enhances the user experience and reduces cart abandonment rates.
Mobile Compatibility

 Responsive Design: With the increasing use of mobile devices for online shopping,
the e-payment system must be optimized for mobile use, offering a seamless
experience across all devices.
3. Reliability
System Uptime and Availability

 Consistent Performance: The e-payment system must ensure high availability and
reliability to handle transactions without downtime or delays.
 Redundancy and Backup: Implementing redundancy and backup systems ensures
that the e-payment system remains operational even in the event of a hardware failure
or other issues.
4. Speed
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Transaction Speed

 Quick Processing: The system should process transactions quickly, minimizing the
time taken for payment authorization and settlement.
 Real-Time Updates: Providing real-time updates on transaction status helps build
trust and confidence among users.
5. Wide Acceptance
Merchant and Customer Adoption

 Broad Merchant Network: For an e-payment system to be successful, it must be

accepted by a wide range of merchants, both online and offline.
 Customer Trust: Building customer trust through security, reliability, and ease of use
encourages more users to adopt the system.
Multi-Currency and International Support

 Global Reach: Supporting multiple currencies and international transactions expands

the e-payment system's reach and usability across different regions.
6. Cost-Effectiveness
Transaction Fees

 Competitive Pricing: Keeping transaction fees low encourages both merchants and
customers to use the system. High fees can be a deterrent.
 Transparent Pricing: Clear and transparent pricing structures help avoid unexpected
costs and build trust with users.
7. Integration and Compatibility
Seamless Integration

 API and SDK Availability: Providing robust APIs and SDKs allows merchants to
easily integrate the e-payment system into their websites and applications.
 Compatibility with Other Systems: Compatibility with various shopping cart
systems, accounting software, and other business tools ensures smooth operations for
merchants.
8. Customer Support
Responsive Support

 24/7 Support: Offering round-the-clock customer support helps address any issues or
concerns promptly, enhancing user satisfaction.
 Comprehensive Resources: Providing comprehensive documentation, FAQs, and
tutorials helps users troubleshoot and understand the system better.

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9. Innovation and Scalability
Adapting to Trends

 Continuous Improvement: Regular updates and improvements to the e-payment

system, including adopting new technologies like blockchain, enhance its
functionality and security.
 Scalability: The ability to scale and handle increasing transaction volumes is essential
for the long-term success of the e-payment system.
10. Legal and Regulatory Compliance
Adherence to Laws

 Data Privacy Laws: Compliance with data privacy laws such as GDPR ensures that
user data is handled responsibly and legally.
 Regulatory Requirements: Meeting all relevant regulatory requirements helps avoid
legal issues and builds credibility.
Examples of Successful E-Payment Systems

 PayPal: Known for its ease of use, wide acceptance, robust security features, and
excellent customer support.
 Stripe: Popular among developers for its powerful APIs and seamless integration
capabilities, along with strong security measures.
 Apple Pay: Highly secure with features like biometric authentication and widely
accepted at numerous retailers.

Each of these systems demonstrates how the combination of these factors contributes to
their success. Therefore, for an e-payment system to be successful, it must excel in these
areas, ensuring a secure, reliable, and user-friendly experience that meets the needs of
both merchants and consumers.

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