What is Electronic Payment System? Features, Issues, Funds Transfer

What is Electronic Payment System?

The e-payment system is defined as an e-commerce transaction for buying and selling products or services offered through the Internet. Advancements in technology have increased the scope of devices and processes to transact electronically, while the number of cash and cheque transactions continues to decrease.

Features of Electronic Payment

It is important to evaluate the various features of an e-payment method before finalizing one for a website. Some of the features of the e-payment method are as follows:

• Anonymity
  
• Security
  
• Overheads
  
• Divisibility
  
• Acceptability

Anonymity

The e-payment system should provide anonymity of transactions. A third party should not be able to trace any details related to the transaction.

Security

The e-payment method should offer the security of the transaction. It should be able to exclude all kinds of fraudulent activities, such as forged payments.

Overheads

The e-payment involves certain overhead costs. This cost should be justifiable to both the buyer and the seller, and not affect the benefits of online transactions.

Divisibility

The e-payment method should allow for paying in installments by dividing the original amount into several smaller amounts.

Acceptability

The e-payment method should allow for the global acceptability of transactions and not be confined to a closed group.

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Domestic and International Payment Systems

E-payment systems are used to discharge or collect cash for both domestic and international transactions, well supported by banks and other financial institutions. For example, international e-payment systems include credit cards and ATM networks via internationally accepted debit cards.

E-payments are also used to settle financial transactions for products in the equity markets, bond markets, derivatives markets, etc. E-payment is also used to transfer funds between financial institutions, both domestically and internationally.

The domestic e-payment system generally includes the use of:

• Credit and debit cards payment systems
  
• Real Time Gross Settlement (RTGS) system
  
• National Electronic Funds Transfer (NEFT) system

International payment systems use the Society for Worldwide Interbank Financial Telecommunication (SWIFT) network. SWIFT is a non-profit, cooperative organization. It enables financial institutions to exchange payment messages around the world. In addition, they also use credit or debit cards empowered with international usage for making global electronic payments.

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Issues With Electronic Payments

E-payments have certain benefits as well as challenges. Although e-payments can be less expensive to process than paper payments, there can be concerns related to the cost and security of electronic transactions.

Let us discuss the various issues related to e-payments in detail.

• Cost of Transactions
  
• Security of Transactions

Cost of Transactions

E-payments reduce transaction costs significantly because they minimize the use of paper resources. However, they do involve significant technical resources, such as high-speed Internet connections, secure servers, and computers capable of processing high-volume transactions, which may increase the cost of transactions.

Security of Transactions

The most paramount concern of customers in e-payments is the security of transactions. Their main issues are related to:

• Privacy: Customers are concerned about the privacy of their online transactions. When they pay for a product or service online, they share important information. They are concerned that this information should not be hacked or shared with others who are not authorized to use it.
  
  Banks and financial institutions involved in e-payments should keep the customers’ transaction information confidential and discourage its use without permission.
  
  
• Authentication and Authorization: The e-payment security system should be foolproof to prevent the theft of sensitive customer information from the unauthorized use of data with malicious intent. It is important to authenticate the individuals involved in the transactions.
  
  Authentication determines whether an individual making the payment or withdrawing funds through the Internet is actually who he claims to be.
  
  
• Integrity: Customers are also concerned about the integrity of online transactions. The e-payment system should change the information and transaction amount only after receiving the customer’s instructions.
  
  
• Non-repudiation: It is the assurance that an individual or a party to a contract or transaction cannot deny the authenticity of their signatures or disclosed information. The problem with e-payments is that a single tool is insufficient for non-repudiation.
  
  For example, digital signatures may not always guarantee non-repudiation. Therefore, multiple technologies need to be used to avoid repudiation, such as combining digital signatures with the biometric information of an individual.

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Electronic Payment Process

The e-payment process involves four main people, why are:

• Issuer: It refers to the bank or financial institution where the buyer and the seller have their accounts.
  
  
• Customer: It refers to the individual who makes a purchase and pays electronically.
  
  
• Merchant: It refers to the retailer who receives e-payment from the customer.
  
  
• Regulator: It refers to the government agency controlling the e-payment process.

The steps involved in the e-payment process between a customer and a merchant are as follows:

• A customer purchases goods from an online retailer. The customer is directed to a secure server where he enters a payment gateway.
  
  
• The customer enters the required information, which is encrypted using secured technologies.
  
  
• The customer’s information is directed to an online transaction server, where the customer’s bank authorizes or declines the payment, depending on whether the details are valid and the customer has adequate credit to pay for the purchase.
  
  
• If the information is valid and sufficient funds are available, the information is transmitted to the institution that receives the merchant’s payments; a deposit is made to the merchant’s bank account.
  
  
• Once the merchant’s bank receives the payment, the same is communicated to the merchant, who, in turn, confirms the same to the customer and initiates the shipping of goods.

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Need for Internet-based Payments

There are specific requirements for Internet-based payment systems, which are as follows:

• Payment Security
  
• Transaction Privacy
  
• Payment System Integrity
  
• Authentication
  
• Indivisibility
  
• Isolation
  
• Mutual Agreement
  
• Reversible
  
• Standardization
  
• Economical
  
• Scalability

Payment Security

The payment should have secure authorization, which is free from tampering by hackers.

Transaction Privacy

The transaction should be private. Third parties involved in a transaction should not know what goods or services are being bought. The credit card or debit card or Internet banking numbers should be kept safe.

Payment System Integrity

The buyer and the seller have to abide by their commitments made for the transaction.

Authentication

The parties involved in the transaction, the buyer as well as the seller, should be able to verify each other’s identities.

Indivisibility

The transaction should be conducted as a whole; it must start and end without any interruptions or glitches. In case a transaction is interrupted before it is completed, the entire transaction must be aborted and a new transaction must be restarted.

Isolation

Each transaction must be carried out independently.

Mutual Agreement

Both parties in an online transaction must be aware of the transaction and they must agree to the terms and conditions of the transaction.

Reversible

If there are errors during or after a transaction, or if the terms and conditions of the transactions are not met, then both parties should be able to reverse the payment and go back to the initial state.

Standardization

A particular payment system must be able to operate across all computing platforms. The payment scheme must be designed to allow interoperability among various platforms.

Economical

The cost of any transaction should ideally be zero or minimum in non-ideal scenarios.

Scalability

A particular e-payment website or any e-merchant website must be able to handle various transactions at any given point in time. The system should also have the capability to treat each customer’s transactions separately.

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Electronic Payment Media

To support an e-payment system, an organization should have Internet facilities, a well-designed payment system, and a medium in which a buyer can make the payment to the seller. In most cases, this medium is a banking network.

E-commerce plays diverse and important roles in banking. Most banks are adopting new technologies to improve efficiency and decrease costs. Advanced technology can replace or facilitate and speed up financial activities, such as cheque writing, filing taxes, and transferring funds through:

• Online bank brochures and marketing information
  
• Bank statement in electronic form
  
• Online bill generation and payment
  
• Multiple financial software products with ‘memory’
  
• Online payments using credit cards for transferring payment instructions among merchants, banks, and customer

Technology has also made it possible for non-banking organizations to enter the banking business. There is an ever-increasing demand for new innovative financial products, and it is not always possible for banking organizations to cater to this demand.

Previously, new entrants rarely ventured into the banking market due to the huge investments required for entry. However, the latest technology has eased the process of setting up virtual financial organizations. Banks have to compete with these virtual financial organizations. The products of virtual organizations have a life cycle of six to nine months, while bank products have a life cycle of 12 to 18 months.

To overcome this competition from virtual financial organizations, banks have to fully utilize their technological capabilities as well as their online strategies.

Technology will enable banks to not only face competition from non-financial virtual institutions but also provide the following benefits to the customers by enabling them to:

• Download their account data faster
  
• Use personal finance software
  
• Transfer funds and pay bills online

In addition, banks must guarantee the privacy and confidentiality of customers. They must also reach out to the customers through various means, such as branches, e-mails, postage emails, advertisements, and telephones. These methods are quite expensive.

Electronic banking or e-banking is a new, inexpensive, and convenient method that enables banks to reach out to a large segment of customers, thereby opening new avenues for serving customer needs and selling their products.

However, the advent of e-banking has left bankers concerned about the future of banks and their organizational structures. To safeguard their future, bankers are now considering developing e-cash, smart cards, and digital money. They also recommend lowering the initial costs of setting up the banking infrastructure.

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Electronic Funds Transfer

Electronic Funds Transfer (EFT) refers to the direct transfer of funds from one bank account to another from the same bank or another bank or financial institution using electronic media. These funds are usually transferred in less than 24 hours after the payment is made. For example, an individual wants to make a payment to another individual or institution

The individual can contact his bank and make a cash payment or give instructions or authorization for the transfer of funds from his account to the bank account of the beneficiary using EFT. For this purpose, the individual needs to provide details, such as the receiver’s name, bank account number, account type (savings or current account), bank name, and branch name at the time of requesting a transfer.

EFT includes the following transactions:

• Electronic deposit and withdrawal of money
  
• ATM withdrawals
  
• Wired transactions
  
• Online bill payment

In India, the Reserve Bank of India (RBI) supports EFT. Electronic transactions are processed through the Automated Clearing House (ACH) network, which is the secure transfer system of the RBI that connects all banks and financial institutions.

For example, when an individual uses his debit card to purchase at an online store, the transaction is processed through the EFT system. This is quite similar to an ATM withdrawal, enabling instantaneous payment to the merchant and deduction from the customer’s bank account.

As illustrated a customer or the payer makes a payment, which is verified by the financial institution having the customer’s account. This payment is further verified and cleared by the ACH network that transfers the same payment to the financial institution, which has the merchant’s account.

As illustrated a customer or the payer makes a payment, which is verified by the financial institution having the customer’s account. This payment is further verified and cleared by the ACH network that transfers the same payment to the financial institution, which has the merchant’s account.

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E-payment Standards

For successful e-Commerce transactions, it is necessary to standardize e-payment mechanisms. The Payment Card Industry (PCI) has established a PCI Security Standards Council, which is an open, global forum to enhance data security during online transactions. The founder members of the council are:

• American Express
  
• Discover Financial Services
  
• JCB International
  
• MasterCard Worldwide
  
• Visa Inc.

The council has developed PCI Data Security Standards (PCI DSS) to help merchants ensure the safe handling of customer information. To become PCI DSS compliant, merchants need to fill out a self-assessment security questionnaire and conduct a quarterly vulnerability scanning of their servers and network connections to report any loopholes.

Irrespective of the size or type of business, compliance with the PCI DSS standards is essential for all merchants who accept payments through electronic exchange. Some of the benefits of compliance with PCI DDS are:

• It ensures that the merchant’s payment systems are secure. This helps in building customers’ trust to share sensitive payment card information.
  
  
• It mitigates the financial risks associated with account payment data compromises.

Electronic transactions can be secured using three key standards. Let us now study these standards in detail in the subsequent sections.

• OFX
  
• JALDA
  
• EMV

OFX

This standard was developed in 1997 by Intuit, Microsoft, and Checkfree. It is a unified and open standard for the secure, electronic transfer of financial data among customers, financial institutes, and merchants through the web. It is based on networking and Internet standards accepted worldwide. It is used by more than 5,500 banks and payroll processing organizations.

JALDA

It is an open and global payment method jointly developed by Ericsson and Hewlett-Packard companies. It enables customers to make payments through a computer, a mobile phone, or a wireless device with an Internet connection. It is equally beneficial for both small and large transactions.

To use Jalda, both the customer and the retailer should be connected to a special account. Jalda uses digital certificates for authentication. It conducts all the communication through a Secure Sockets Layer (SSL), which is a protocol for managing the security of a message transmission on the Internet.

Jalda’s Application Programming Interface (API) appears as a payment standard on the merchant’s website. It is connected to a server controlled by the Internet payment provider. When a transaction occurs between the customer and the merchant, it travels from the customer’s device to the merchant’s API and finally to the Internet payment provider.

EMV

Europay, MasterCard, and Visa (EMV) were developed in 1999. It is a global standard for the inter-operation of integrated circuit cards or chip cards, which can be used at Point of Sale (POS) terminals and ATMs to develop specifications for secure payment transactions. A chip card or integrated circuit card is a card with embedded integrated circuits, such as a smart card.

EMV standards for electronic payments outline the interaction between IC cards and IC card processing devices for financial transactions with physical, electronic, data, and application levels.

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Open-loop and Closed-loop Payment Systems

E-payment systems, whether for general purposes or limited purposes, primarily operate under two different models.

Let us now study these payment systems in detail:

• Open-loop Payment System
  
• Closed-loop Payment System

Open-loop Payment System

This system connects a bank or financial institution that issues a payment card, such as Visa or MasterCard to a customer (the issuer) with the one that provides banking facilities to the retailer (the acquirer). This system controls the flow of information and funds between them. Some main features of open-loop network operators, such as Visa, are:

• They do not issue payment cards or determine interest rates that are charged to the customer for using their cards. This is the responsibility of the issuer banks.
  
  
• They do not determine the fees that merchants are charged for accepting payments through cards or the merchant discount rate. This is the responsibility of acquirer banks.

Closed-loop Payment System

This system does not require the involvement of a third-party financial institution or bank. Unlike the open-loop payment system, in a closed-loop payment network, the network owner directly delivers the payment services to merchants and cardholders. No third party is involved in the process.

An example of a closed-loop payment system is American Express which issues payment cards directly to customers for use at different merchant stores, while also enabling the merchants to accept payments using these cards. The other form of closed-loop network is limited-purpose payment cards issued to customers by individual merchants.