Electronic Business Architecture and Design

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Payment Systems for Electronic Commerce

CHAPTER 11

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Learning Objectives

In this chapter, you will learn:

What the most common online payment systems are and how they function

How payment cards are used in online retail transactions

What stored-value cards are and how they are used in electronic commerce

What challenges and opportunities are presented by the use of digital cash

Learning Objectives

How digital wallets facilitate online transactions through computers and mobile devices

How the banking industry uses Internet technologies

Introduction

Financial technology (fintech) is the use of powerful Internet-connected computers that use tools to improve quality and reduce cost of services

Existing and entirely new financial products

Includes online payment system not operated by banks

Facilitates purchases and other money transfers

Convenient and becoming widely adopted

Has also revolutionized lending

Online loan services takes banks out of value chain at a reduced cost

Common Online Payment Methods

Cash, checks, credit cards, debit cards are the most common world methods used to pay for purchases

More than 90% of all US consumer payments

Electronic transfer is a small percentage

Mostly automated payments from checking accounts

Credit and debit cards used for more than 60% of online payments with alternative systems such as PayPal used for the remainder

Convenient for customers and cost effective for businesses and provides a significant environmental impact

FIGURE 11-1 Forms of payment for U.S. online transactions, estimates for 2018

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Electronic Bill Presentment and Payment Systems

Designed to deliver bills and accept payments

Success depends on ease of use and time required

Consumers choosing this option is increasing

70% of bills paid by check are now paid electronically which is a huge savings in paper, postage and time

Biller-direct systems are used by large companies who want to manage the systems themselves

Consolidator systems aggregate all a customer’s bills on one system mostly via banks

Not as attractive to billers because it requires a fee and delays receipt of funds

Micropayments and Small Payments

Micropayments are Internet payments for items costing few cents to a dollar

Barrier is people prefer to buy small value items in fixed price chunks rather than small payments in varying amounts

Many companies have developed micropayment systems but none gained broad acceptance

Small payments are payments of less than $10

Offered through mobile telephone carrier but held back by substantial charges for providing service

One of the largest markets is music downloads

Payment Cards

Payment cards are plastic cards used for purchases

Categories: credit cards, debit cards, charge cards, prepaid cards, and gift cards

Credit cards (Visa, MasterCard) have a spending limit based on user’s credit history

Pay off entire credit card balance or minimum amount with interest charged on unpaid balances

Widely accepted and provides consumer protection: 30-day dispute period

Card not present transactions include an extra degree of risk for merchant and bank

Payment Cards (cont’d.)

Debit card (electronic funds transfer at point of sale (EFTPOS) cards) removes funds from cardholder’s bank account and transfers it to seller’s account

Issued by bank with major credit card issuer's name

Charge card (American Express) has no spending limit with entire amount due at end of billing period

Retailers may offer their own store charge cards

Prepaid cards are called gift cards

Single-use cards had disposable numbers, valid for one transaction, but not adopted by consumers

Advantages and Disadvantages of Payment Cards

Advantage for merchants include fraud protection

Can authenticate and authorize purchases using a payment card processing network

Interchange network is a set of connections between banks and associations owning credit cards

Advantage for U.S. consumers is limited fraud liability of $50 which is often waived if card is stolen

Merchants view the per-transaction and monthly processing fees as a cost of doing business

Consumers pay a slightly higher cost for goods due to these cards and some charge an annual fee

Payment Acceptance and Processing

US online and mail order stores must ship merchandise within 30 days of charging payment

Significant violation penalties so most stores charge account when order shipped

Processing payment card transactions online is a two step process

Payment acceptance is establishing card validity and verifying card’s limit not exceeded by transaction

Clearing the transaction includes all steps to move funds from card holder’s bank account into the merchant’s bank account

Open and Closed Loop Systems

With a closed loop system the card issuer pays merchant directly without a bank or clearinghouse

American Express, Discover Card

Issue cards directly to consumers

Open loop systems add additional payment processing intermediaries to the closed loop system

Visa, MasterCard issued by local bank

Visa and MasterCard are credit card associations operated by customer issuing banks who evaluate credit standing, establish credit limits and absorb non-payment losses

FIGURE 11-2 Closed loop payment card system

FIGURE 11-3 Open loop payment card system

Merchant Accounts

Acquiring bank does business with sellers that want to accept payment cards

Business must set up a merchant account with acquiring bank to process Internet transactions

One type similar to a checking account with bank collecting accounts net of processing fees

Commonly account acts like a credit line where the acquiring bank makes a non-interest bearing loan in the amount of daily net receipts, reduced by collections

Obtaining account requires merchant to provide business information and the bank to assess risk

Merchant Accounts (cont’d.)

Chargeback occurs when cardholder successfully contests charge

Acquiring bank must retrieve money from merchant account which may have funds on deposit

Acquirer fees are charges for providing payment card processing service

Per month and transaction, set by the acquiring bank

Interchange fees are charged at rates that depend on the merchant’s industry

Set by card association, charged to acquiring bank and usually passed along to merchant

Merchant Accounts (cont’d.)

Level of fraud is higher online

Under 15% of all credit card transactions responsible for 64% percent of total dollar amount of credit card fraud (declining since 2008)

Antifraud measures include

Scoring services that provide risk ratings for individual transactions in real time

Shipping only to card billing address and requiring card card verification numbers (CVNs) for card not present transactions

Three- or four-digit number printed on the credit card but not encoded on the card’s magnetic strip

Payment Card Transaction Processing

Most online merchants accept both closed loop and open loop system cards and some accept direct deductions from customers’ checking accounts

Automated Clearing House (ACH) is a network of banks involved in direct deduction transactions

Processing depends on size of business

Large build and manage their own systems

Mid-size use purchased software with skilled staff to manage system

Small rely on service payment processing service providers

Payment Card Transaction Processing (cont’d.)

Front-end processor (payment gateway) obtains and stores transaction authorization

Back-end processor takes front-end processor transactions and coordinates information flows

Handles chargebacks, other reconciliation items through the interchange network and acquiring and issuing banks, including ACH transfers

Some processors handle all elements of payment processing and others specialize in one element or a particular industry

Known company provides level of comfort to buyers

Stored-Value Cards

Plastic card with embedded microchip that can store information and perform calculations

Most incorporate near field communication (NFC) technology which allows for contactless data transmissions over short distances

Allows interacts with readers and other devices

Can hold much more data than a magnetic card

Safer because data can be encrypted

Used in Europe and Asia but less successful in U.S.

U.S. use has increased in recent years but still not widespread

Digital Cash

Also called electronic cash or e-cash

Describes any value storage and exchange system created by private (nongovernmental) entity

Does not use paper documents or coins

Can serve as substitute for government-issued physical currency

No common standard adopted so far

None adopted so far

Can be held in online storage or offline storage

Digital Cash (cont’d.)

With online cash storage consumer has no personal possession of digital cash

Trusted third party (online bank) involved in all transfers, holds consumers’ cash accounts

Merchant contacts consumer’s bank for payment

Helps prevent fraud (confirm valid cash)

Fills a need in developing countries that rely on cash as they conduct B2C electronic commerce

Need does not exist here because U.S. consumers already have payment cards

Digital Cash (cont’d.)

Bitcoin is the most well-known provider today

Online ledger book that tracks balances while participants remain anonymous

Public-key cryptography is used (cryptocurrency)

Large percentage of uses involve illegal purchases and currency speculation

Concerns include privacy and security, independence, portability, convenience

Must be impossible to spend more than once, easy to use and not traceable to the person who spent it

Anonymous digital cash

The Double-Spending Issue

Spending electronic cash twice by submitting the same electronic currency to two different vendors

Not enough time to prevent fraudulent act

Main deterrent is threat of detection and prosecution so system must provide traceability back to origin

Two-part lock provides anonymous security and signals an attempt to double-spend cash

FIGURE 11-4 Detecting double spending of electronic cash

Advantages and Disadvantages of Digital Cash

Can be more efficient (less costly) than traditional payment methods

Less than processing credit card transactions or conventional money exchange systems

Does not require authorization

No audit trail (similar to physical cash) makes it non-traceable which can lead to money laundering

Convert illegally-obtained money into money spendable without being linked to illegal activity

Digital Wallets and Software-Based Digital Wallets

Allows customer to store name, address, credit card information on an electronic device or software

Benefit is customer enters information just once

Server-side digital wallet stores information on remote server of merchant or wallet publisher

Security breach can reveal thousands of users’ personal information to unauthorized parties

Google Wallet, Microsoft Windows Live ID, Yahoo! Wallet

Client-side digital wallet stores information on consumers computers

Must download wallet software onto every computer

Hardware-Based Digital Wallets

Implemented using smart phones or tablets

Store owner’s identity credentials (driver’s license, medical insurance card, store loyalty cards, etc.)

Transmit portions of information using Bluetooth or wireless transmission to nearby terminal

Near field communication (NFC) technology can be used if equipped with NFC chip

Google Wallet, Android Pay and Apple Pay

Security and privacy are major concerns

Must prevent unauthorized access

Internet Technologies and the Banking Industry

Paper checks still the largest dollar volume of payments in the word today

Processed through world’s banking system

Other major payment forms also involve banks

Internet technologies are providing new tools and creating new threats for the banking industry

Check Processing

Old method of physical check processing

Person wrote check which was deposited by retailer and sent to clearinghouse to manage funds transfer

Paper check transported to consumer’s bank and cancelled check sent to consumer

Disadvantages include transportation cost and float

Delay between time check is written and clears

Check Clearing for the 21st Century Act (Check 21) permits bank to eliminate movement of physical checks and use image scanning technology

Instant check clearing eliminates float

Mobile Banking

Banks exploring mobile commerce potential

Most banks offer apps for mobile devices

Check and transfer balances between accounts

View statements

Find an ATM

Some bank apps allow checks to be deposited by taking a picture

Vendors such as GoPayment and Square offer a tiny credit card reader that can be attached to a mobile device to take payments

Payment System Threats: Phishing and Identity Theft

Online payment systems offer attractive arena for criminals and criminal enterprises

Phishing attacks are techniques for committing fraud against online businesses customers

Particular concern to financial institutions

Phishing Attacks

Attacker sends e-mail message to accounts with potential for an account at targeted Web site

E-mail message tells recipient account compromised and recipient must log in to correct problem

Includes link that appears to be Web site login page

Actually leads to perpetrator’s site so that victim’s log in information can be captured and used

Spear phishing is a carefully designed phishing attack targeting a particular person or organization

Requires considerable research which increases change of e-mail being opened

FIGURE 11-5 Phishing e-mail message

Phishing Attacks (cont’d.)

Example: 2008 government stimulus checks

Phishing e-mails that seemed to be from the IRS appeared within one week of passage

E-mail link disguise the real URL by using “@” which causes the Web site to ignore characters before it

https://[email protected]/fl/login.html

Phony site invisible due to JavaScript code

Pop-up windows look exactly like browser address bar including Web site graphics to make it even more convincing

Using Phishing Attacks for Identity Theft

Organized crime (racketeering) is unlawful activities conducted by highly organized, disciplined association for profit

Differentiated from less-organized groups

Internet providing new criminal activity opportunities

Generates spam, phishing, identity theft

Identity theft is a criminal act where perpetrator gathers victim’s personal information

Goal is to obtain credit

Perpetrator runs up account charges and disappears

FIGURE 11-6 Types of personal information most useful to identity thieves

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Using Phishing Attacks for Identity Theft (cont’d.)

Large criminal organizations can be highly efficient perpetrators of identity theft

Zombie farm is a large number of computers implanted with zombie programs

Pharming attack is the use of a zombie farm, often by organized crime, to launch a massive phishing attack

Phishing needs both collectors and cashers (users) of information which requires different skills

Crime organizations increase efficiency and volume by facilitating and participating in these transactions

Over a million victims and $1.5 billion lost annually

Phishing Attack Countermeasures

Spam is a key element of phishing attacks

Any protocol changes that improve e-mail recipients’ ability to identify message source reduces phishing

Educate Web site users

Contract with consulting firms specializing in anti-phishing work

Monitor online chat rooms used by criminals

Incidence of phishing has grown rapidly over the past two years and experts expect it will continue

Extremely profitable criminal activity