Electronic Point-of-Sale Payments

When American banks began issuing credit cards in the 1950s, the Federal Reserve's main responsibility related to these cards was through bank supervision and regulation, including enforcement of consumer protection laws. In the early 1970s, the Fed considered building infrastructure for credit cards and other electronic point-of-sale payments that were still in development, such as debit cards. Ultimately, however, following the recommendation of a commission appointed by Congress in 1977, the Fed left the development of point-of-sale payments infrastructure to the private sector. The Fed gained a new related responsibility in 2010 when section 920 of the Dodd-Frank Act required it to issue regulations on debit card fees, following the substantial growth in debit cards during the 1990s and 2000s.

Development of bank-issued credit cards in the 1950s and 1960s

Almost 100 banks began issuing credit cards in the 1950s (Federal Reserve 1968 p. 7). The origins of the Visa network, for example, trace to 1958 when Bank of America launched BankAmericard in California. Bank of America began licensing the credit card to other banks in the U.S. and abroad in 1966. BankAmericard was spun off into its own company in 1970 and rebranded as Visa in 1976. The MasterCard network began in 1966 under the name Interbank, a cooperative formed by several banks in New York. Many other banks also issued cards independently or as part of regional bank card networks that once existed, such as the Chicago-based Midwest Bank Card.

The roll-out of credit cards by banks raised consumer protection concerns. For example, some banks, in a bid to outpace competitors, mailed credit cards unsolicited to consumers in large-scale campaigns blanketing their markets. Congress passed an amendment to the 1968 Truth in Lending Act barring this and other practices, assigning enforcement responsibilities for bank-issued cards to the Federal Reserve and other bank regulators.

Besides banks, other credit card issuers included various merchants such as department stores, railroads, airlines, and gas stations, which had issued credit cards since the early 20^th century (Federal Reserve 1968, p. 7). Other issuers originally outside of the banking system included The Diners Club beginning in 1949, Carte Blanche and American Express in 1958, and Discover in 1985.

Early 1970s proposals for Fed-provided "switching" services to point-of-sale credit cards

Early bank-issued or merchant-issued credit cards had not required interbank communications since they did not involve more than one bank directly. An early bank-issued card would simply credit payments into accounts that local merchants kept at the bank. However, as merchants began to accept credit cards issued by multiple banks, in and out of their local markets, the need for interbank settlement arose. This settlement was initially paper-based and bilateral, as banks tabulated and mailed payment information to each other (Stearns 2007). Authorization technology was slow, requiring merchants to phone authorization centers.

Proposals to centralize these communications through the Fed grew out of its historic role in providing interbank payment services since its establishment in 1913. For example, in the check system, the Federal Reserve System was uniquely positioned to use its national scope to act as a central partner to collect and forward check payments among the country's thousands of local banks. In the late 1960s and early 1970s, the Fed evaluated whether to expand this role to include emerging electronic payments, including point-of-sale payments; they chose to start with automated clearing house (ACH) payments. In contrast to point-of-sale payments, which are initiated in real-time by consumers, ACH payments were intended for routine payments such as payrolls or monthly bills that could be planned and batched in advance.

The Federal Reserve Bank of San Francisco began operating the first ACH network in 1972, initiating the System's involvement in ACH payments that continues to this day. At the time, Fed officials suggested that their efforts in ACH "may pioneer a similar role in the experimental point-of-sale terminals" (Board of Governors 1972). ACH required interbank infrastructure essentially from the beginning, since payroll or social security benefits, for example, almost necessarily involved sending payments to a number of different banks.

The Federal Reserve Banks of Atlanta and Cleveland went the farthest in investigating point-of-sale infrastructure, in each instance at the request of banks in their districts. Ohio banks made a request to the Federal Reserve Bank of Cleveland in February 1973 that it run a point-of-sale communications "switch" (Federal Reserve Bank of Cleveland 1973). This request was informed in part by data gathered in an experiment run by a bank in Columbus, Ohio, in which point-of-sale requests at Columbus-area merchants were relayed to the bank over a telephone line. The image at the top of this article provides a stylized representation of the Cleveland Fed's proposed role, intermediating communications among banks and the two major bank-issued credit card networks at the time, Interbank and BankAmericard.

A request to the Atlanta Fed came in June 1973 from a group of banks in Atlanta known as the Committee on Paperless Entries (COPE) after an extensive technical study (Federal Reserve Bank of Atlanta 1973). COPE considered alternative arrangements, including a joint venture among banks or the establishment of a third-party company, but worried about antitrust implications of those options. Both the Atlanta and Cleveland proposals envisioned that the Fed-run network would communicate both credit card and debit-card-like payments.

The Atlanta request was an historic one as it was perhaps the last time the Fed formally evaluated a proposal for it to provide point-of-sale payment infrastructure. The Board of Governors denied the request in June 1974, noting that it had not yet settled on a policy for whether the Fed would provide point-of-sale services and that it anticipated Congress would soon establish a commission to consider what role the Fed System should have in such activities (Board of Governors 1974). In 1977, that commission, the National Commission on Electronic Funds Transfers, recommended against a role for the Fed, and the Fed does not appear to have seriously revisited the issue since.

Debating the merits of a role for the Fed

Vice Chairman of the Board of Governors George W. Mitchell had envisioned in 1974 how point-of-sale infrastructure might develop:

"Various parties are being discussed as potential candidates for the ownership role in a point-of-sale system, including a consortium of banks, a dominant bank, a third party non bank entity, the Federal Reserve, and various unregulated entities such as credit card companies. I have no problem with this list—provided the public interest in service, convenience and cost is effectively policed by regulation, competition or public participation."

Mitchell identified some key factors that were at the center of the debate over point-of-sale infrastructure: competition and its implications for costs and access by banks and merchants. The Board's position was that "there should be a single, integrated nationwide mechanism for efficient transfer of funds," in the words of Governor Jeffrey Bucher (Bucher 1973). A single network would have given significant economic power to the operator of that network, which the Board suggested would be accompanied by an expectation to run the network in the public interest with broad accessibility and low costs.

The Board solicited public comment in 1973 on the question of its potential role in electronic funds transfers, including point-of-sale. Smaller banks tended to support a role for the Fed, concerned that privately run networks would push small banks to the side, since they could not make the same infrastructure investment as larger banks. For example, an official at National Bank and Trust in Columbus, Ohio, John Fisher, argued that the Fed was "the only current agent that can settle between banks while instilling both competition and cooperation among members" (Fisher 1974).

In contrast, large banks and credit card networks that had already begun making some significant investments disliked the prospect of the Fed as a potential competitor and suggested they would pull back on further investment in response. Dee Hock, the head of BankAmericard, said "there would be no BASE II and no INAS today had the Federal Reserve said yes" to requests that it provide infrastructure; BASE and INAS refer to communication systems developed by BankAmericard and Interbank (Hock 1974). Likewise, John Reed, head of First National City Bank in New York (later named Citibank), championed a vision of competing private sector communication networks in which merchants and consumers would choose which point-of-sale network to use (Reed 1974).

The U.S. Department of Justice also envisioned an ecosystem of competing point-of-sale networks and opposed a role for the Fed (Department of Justice 1974). Antitrust officials saw little evidence that a monopoly would develop, given the competition among BankAmericard, Interbank, and other cards issued by individual banks or local groups of banks. DOJ officials suggested small banks could compete by offering better local service, by forming joint ventures, or by buying access into systems developed by others, and they disagreed that small banks needed "some vast public utility serving them" (Baker 1973).

The National Commission came to similar conclusions (National Commission, pp. 16, 217). Yet the Commission did not rule out a potential future role for the Fed, suggesting that such a role could become necessary if the private sector did not develop the infrastructure quickly enough, if a natural monopoly were to develop, or if some banks or areas of the country had limited access.

Development of competing private credit and debit networks

Since the Fed did not become involved in infrastructure for credit card payments, that infrastructure has been developed by the private sector. Debit card infrastructure has also grown. Several debit card pilot experiments occurred in the 1960s and 1970s but did not result in much adoption. Debit card payments began to represent a meaningful share of point-of-sale payments in the early 1990s and have surpassed credit card payments by volume since the mid-2000s (Caskey and Sellon 1994; Evans and Schmalensee 1999 chapter 12; Federal Reserve 2007).

The subject of whether point-of-sale payment networks are adequately competitive, accessible, and convenient has been the subject of much litigation since the 1970s. For example, a class action lawsuit brought by merchants in 2005 sought to lower interchange fees charged by card networks—i.e., the fees charged for use of the network (Stempel 2024). Other lawsuits have been initiated by banks, including, for example, an Arkansas-based bank that in 1973 successfully sought the ability to join more than one credit card network (McAndrews 1995; Evans and Schmalensee 1999 chapter 11). The Justice Department has also sought to ensure adequate competition, including, for example, a 2010 settlement altering the policies of major credit card issuers that prevented merchants from steering customers to lower-cost payment options.

Ensuring adequate competition has been a perennial subject in part because competition in payment networks can work very differently from competition in other types of markets. The high cost of establishing a payment network and the incentive for network participants to join well-established networks can limit the creation of competitive networks. Because there are multiple parties with interests in the transaction—the consumer, the merchant, the merchant's bank, the card issuer, and the card network—the market has a complex set of incentives. Moreover, competition among card issuers may actually arise from charging higher prices to merchants in order to pay higher rewards to cardholders (Prager et al. 2009).

The establishment of laws limiting credit card interchange fees have been proposed from time to time but never enacted. Debit card fees, however, have become regulated by the Federal Reserve under section 920 of the Dodd-Frank Act (Medley 2014, chapter 12). The Fed finalized a rule in 2011 that limited debit interchange transaction fees and put restrictions on the ability of debit card networks to mandate exclusivity arrangements or to limit the ability of merchants to route payments over less-expensive networks. In 2023 the Board proposed an update to this rule that would adjust debit interchange fees to reflect changes in issuer costs since the 2011 rule and to provide for ongoing adjustments based on how those costs change over time.

Conclusion

When the Federal Reserve considered building infrastructure to facilitate electronic payments in the early 1970s, the episode featured an extensive debate over competition, access, and cost. The Fed decided not to provide infrastructure for electronic point-of-sale payments but did begin providing ACH services. Similar factors have continued to influence the Fed's role in payment systems. In 2023 the Fed launched an instant payment service, FedNow, after considering whether such a service would promote the accessibility, safety, and efficiency of the U.S. payment system. To date it has made no decisions on whether to pursue or implement a central bank digital currency, as the Fed explores whether and how such a currency could improve the safety and efficiency of the U.S. payment system.

References

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Baker, Donald. "Competition, Monopoly and Electronic Banking." The Economics of a National Funds Transfer System, Federal Reserve Bank of Boston, 1974. Available online   

Board of Governors of the Federal Reserve System. "Evolution of the Payments Mechanism," Federal Reserve Bulletin, December 1972. Available on FRASER

Board of Governors of the Federal Reserve System. Letter to James Jarrell, Chairman, COPE Committee, Atlanta Payments Project, June 10, 1974. Available on FRASER

Bucher, Jeffrey M. Statement before the Subcommittee on Consumer Credit of the Committee on Banking, Housing and Urban Affairs, United States Senate, May 17, 1973. Available on FRASER

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Prager, Robin, Mark D. Manuszak, Elizabeth K. Kiser, and Ron Borzekowski. "Interchange Fees and Payment Card Networks: Economics, Industry Developments, and Policy Issues." Working paper, Federal Reserve Board, 2009 Available online

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Published September 25, 2024. Jonathan Rose contributed to this article. Please cite this essay as: Federal Reserve History. "Electronic Point-of-Sale Payments." September 25, 2024. See disclaimer and update policy.