Current Legal Issues Affecting Central Banks, Volume V
Chapter

COMMENT

Author(s):
Robert Effros
Published Date:
May 1998
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Author(s)
GREGOR C. HEINRICH

Electronic Money, Stored Value Cards, and Internet Payments: Legal and Policy Issues

Central banks show an interest in electronic money or e-money, cyber-cash, and electronic purses or e-purses, because these new developments may have a bearing on some of their functions. Lawyers are interested in these developments because they have to know whether and how existing legal rules can be applied to them, whether and how the rules need to be adapted, and whether new rules need to be drawn up. Central bank lawyers involved in areas such as payment system oversight, banking supervision, and perhaps even consumer protection or fraud prevention are in positions where they may need to offer guidance to governmental and institutional policymakers. In addition, lawyers, as private individuals and consumers, may soon be active users of e-money. Therefore, their interest in new payment instruments is not merely academic: it is also practical.

A market exists for e-money schemes in their various forms. There are “closed-loop schemes,” in which the e-money can be “spent” only once before it has to be redeemed by the issuing institution, and “open-loop schemes,” which allow for “purse-to-purse” transactions.1 Both users (that is, consumers) and issuers (for example, banks and card organizations) have an interest in this new market. The potential user base is growing, and e-money issuers see a huge profit potential in what could be a major financial innovation in the retail market.

A potential user base already exists in many countries, on the one hand among users of payment cards, on the other hand among users of personal computers (PCs), and, of course, a combination of the two is also conceivable. Many consumers today feel comfortable with using some form of plastic card for payments. The use of magnetic strips and, most recently, the advent of “intelligent chips” incorporated into a card have greatly increased the security and use potential of such plastic cards. The world market for smart cards is growing rapidly, as more home computers are being sold and as more PC users are linking up to communication networks. One forecaster expects it to reach four billion potential card users by the year 2000.2

In the future of banking, it is therefore assumed that most customers will have access to the “information super highway,” and it is said that smart card interfaces in PCs (a box linked to the PC so that smart cards can be read as they are now read by automatic teller machines) will become as standard as floppy disks. One of the predicted uses of an Internet e-money scheme is for payment of goods and services obtained or ordered through computer communication links (for example, the World Wide Web). Because banknotes and coins cannot be pushed through the telephone line and because transaction costs for the use of checks or credit cards in small value transactions may be just too high, there is an increasing need for these new payment instruments. In addition, there is a practical use for current e-purse schemes at the retail level too, with traditional low-value cash payments (for example, for parking meters, public transportation, kiosk purchases, taxis, and vending machines). In fact, most smart card developers aim at a market for transactions of less than $20.

How does the intended use of e-money as a cash replacement compare with the use of cash, both banknotes and coins, usually issued by the central bank; debit cards, which use electronic funds transfer for point-of-sale purchases; checks; and credit cards? One distinction is that checks, debit cards, and credit cards involve an instruction to a mutually trusted third party to make a payment on behalf of the purchaser, whereas cash may be handed over directly from the purchaser to the merchant.

By examining the characteristics of cash, one can notice that many proposed e-money schemes, at the least, try to emulate the functions and use of cash. Cash is a standard product and is therefore easily recognized and identified. It is risk free in the sense that the central bank gives it full backing. (Of course, cash can be risky to hold in that it can be lost or stolen, and there may be a risk of counterfeit.) It is fully negotiable. Possession of cash is ordinarily sufficient to establish a right of use, and it simply can be handed to someone else to execute a payment. Use of cash is anonymous and not directly traceable. Cash is convenient and efficient for making small payments. It is valid consideration in almost all places and circumstances, and, except where forgery is suspected, its status cannot be questioned. It is because of these attributes that cash is generally accepted and popular. Generally, in industrial countries cash transactions account for up to 80 percent or more of the volume of all payments,3 even though the total value of all cash transactions may be relatively small in many countries (compared, for instance, with cashless payments and settlement schemes). Even if cash is generally accepted at the consumer level, it may nevertheless, in the eyes of intermediaries, not always be the preferred method of payment, because use of cash involves handling, storage, and security costs, which may not arise to the same extent with other payment methods.

Consequently, it would be valuable if the convenience of cash could be combined with comparatively low-cost, high-tech mechanisms. E-money may therefore be of interest not only to consumers but also to the designers and operators of e-money schemes. As companies, the latter are not interested in the actual cash payment but in benefiting from the considerable float. Float makes possible the interest revenue for the issuer on funds received from the public in exchange for the e-money during the period of time between receipt of funds and presentation of e-money for redemption. By way of example, this phenomenon can be observed with simple prepaid cards such as phone cards, where the telephone company may benefit from funds before the prepaid call is made. In addition, e-money designers hope for additional revenue in that cards may be “branded” to show the logo of a commercial company. Revenue may also result through the use of loyalty schemes (such as the accumulation of frequent flyer miles) by the intelligent chip. Such additional revenue may even be larger than the revenue from float and may thus offset to a large extent the operating costs of e-money schemes.

If e-money is to replace physical cash and e-money issuers are to benefit from the float, then those who previously benefited from the float on physical cash may lose revenue. This is precisely the concern that some central banks have voiced with regard to their “seigniorage” income.4 Seigniorage is the income a central bank (and the government, if the latter receives a share in the profits of its central bank) receives as a result of its monopoly on the issuing of banknotes.5 This is one of the reasons why the recent development of e-money products and their potential effect on policy issues are currently being discussed at the Bank for International Settlements. The main committee in charge of these discussions is the Committee on Payment and Settlement Systems (CPSS), a forum in which experts from the central banks of the Group of Ten countries convene in order to discuss topics of common interest.6

The term “electronic money” is used by the CPSS to cover a number of new or proposed payment products generally designed for retail use, including both card schemes (so-called electronic purses or multipurpose prepaid cards) and computer network or software-based schemes (in particular, various proposals to offer nonstandard payment services on computer networks such as the Internet). In November 1995, the central bank governors of the Group of Ten countries commissioned studies on the monetary policy and seigniorage implications of the development of electronic money, the security aspects of the schemes, the challenges they could pose to law enforcement, the legal and contractual framework for the development of the new services, and issues relating to the different potential categories of providers of such new products. The studies are being undertaken by several special task forces. In addition, a group of legal experts from these central banks is examining legal issues related to e-money.

Although there may be a number of descriptive articles regarding the various experimental e-money schemes, there is still little literature on the legal issues,7 and it appears that no e-money scheme has yet been tested in a court. In addition, the market is still evolving. It is difficult to assess whether one or another scheme will find wide acceptance with users and merchants. Furthermore, without more information, it is difficult to judge what effect schemes may have on the safety and soundness of the financial system and on the individual consumer.

Lawyers will have to arrive at an opinion as to whether e-money schemes—like any other arrangement for making monetary payments—have satisfactory legal underpinnings. It is important that all the parties to a payment involving e-money (that is, the payer/user; the recipient/merchant; and any other party, such as issuers, banks, or clearing systems that may be involved as intermediaries) understand their rights and obligations, as well as any risks that they may face. Further study of the aspects of e-money will aid in the development of applicable law.

Issues

The following issues are worthy of consideration:

  • Why are banknotes and coins legal tender? Can e-money be legal tender? If not, what are the consequences?

  • If there is a market for instruments replacing banknotes and cash, should this market be for central banks, commercial banks, or private companies (nonbanks)? Are there legal rules that would allow or prevent the issuance of e-money by any of the above?

  • Why are banknotes “negotiable instruments” under some laws? Is it essential for e-money to have a similar status? Does e-money have this status under existing legislation?

  • Some central banks have suggested that replacing traditional cash with e-money would deprive governments and central banks of their seigniorage revenues. Is this correct? Are there laws allocating seigniorage to government authorities and central banks? What types of legal mechanisms may be conceived for recovering lost seigniorage, if any, in connection with e-money schemes?

  • Could retail banks still afford to handle cash transactions if e-money becomes popular? Should central banks intervene to correct any market distortion, and how can this be done? Is there a danger that calls for a “right to a bank account” might one day be modified to a “right to use physical cash”?

  • Use of a computer can be recorded, and transaction data can be stored for later analysis. Use of e-money schemes involving computers may therefore create “usage patterns” of individuals or groups of users. Should the storage, use, or dissemination of such information be protected? Do current rules offer satisfactory protection?

  • Counterfeiting banknotes and coins, as well as making use of such counterfeited instruments, is an offense punishable under criminal law. What similar offenses might apply to e-money schemes? Could existing anticounterfeiting rules apply to counterfeiting e-money? If not, which other rules of national legislation may help to prevent fraud?

  • Where a country has exchange controls and/or reporting requirements for foreign exchange transactions, how could those rules apply to e-money?

  • Encryption standards and cryptographic mechanisms in both card-based and network-based payment schemes provide an apparently effective protection against fraud, allow for safer transmission of information, and thus increase the reliability of a scheme and make it more attractive to the user. Should governments, central banks, commercial banks, and/or other entities (for example, trustees and certification authorities) retain control of such mechanisms? Are there any legal methods to enhance or prevent such control?

  • In many countries, a parallel economy exists in that not all cash transactions pass through the books of merchants that provide goods or services. This may reduce the state’s tax revenues and may also distort economic statistics. What effect might e-money have on such phenomena?

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