Translation and Commentary by Christopher Kuner
Translation copyright 1996 Christopher Kuner. Reproduction is permitted, provided that this translator's note, including the above copyright notice, is retained in its entirety.
Commentary: The following speech by Bundesbank director Edgar Meister was delivered in Frankfurt on November 28, 1996, and represents the German Central Bank's most authoritative policy statement yet on electronic cash and Internet payment issues. Meister's comments demonstrate the cautious attitude taken by the Bundesbank in this area, and stand in contrast to the less cautious stance taken by the US Federal Reserve. While the Bundesbank's general attitude to these issues is well-known, some of the warnings contained in Meister's speech sound overly cautious and have led to concern among companies interested in offering such products in the EU.
As Meister states, the Bundesbank sees the various types of electronic payment methods (including prepaid cards, "digital cash" on the Internet, and other such schemes) as holding serious implications for central banks in many areas, including the issuance of money, monetary policy, supervision of cashless payments, and supervision of the banking system. The Bundesbank seems concerned that increased use of such schemes could cause it to lose control over traditional techniques for influencing the German economy, and might call for measures such as incorporating electronic money into minimum reserve requirements or, as a last resort, the monopolization of their issuance by the Bundesbank. Meister also expresses concerns about the issues of security, liability, and money laundering, and indicates that an upcoming amendment to the German banking law will result in the issuance of what he calls "card money" (e.g. prepaid cards) and "net money" (e.g. digital cash) being limited to banks. In Meister's opinion, the issuance of "net money" should be limited to supervised banks, as is already the case with regard to prepaid cards. Finally, Meister discusses the extent to which such electronic payment methods are likely to find acceptance among the public as substitutes for cash.
Cybermoney, Prepaid Cards and the Euro:
Consequences for the Transport of Money and Valuables
Speech of Edgar Meister at the annual meeting of the Federal Association of German Money and Valuables Transport Companies on November 28, 1996 in Frankfurt
Ladies and Gentlemen,
the theme which I would like to speak about today concerns developments and changes in payments which will concern us to a great extent in the coming year. Cyber money and prepaid cards, i.e., electronic money, have a touch of science fiction and have become the subject of great interest also for this reason. The development of electronic and, therefore, no longer physically-tangible money thus represents a culmination in the process of the detmaterialization of money.
While the introduction of the Euro does not represent a new technological stage of development in payments, it is a very important event which everyone will feel in their daily life. With the Euro a whole variety of traditional European currencies will disappear. A basic problem which politics must solve in this regard is to see that such an historic development is accepted and mentally processed, in particular by the public, even if the Euro will not otherwise bring about many changes in the nature of cash and "cash handling".
Ladies and Gentlemen,
even though payment cards such as Eurocheque cards and credit cards are now indispensable in daily life, just about 80% of payments at the retail level in Germany are still made in cash, 83% of which are for under DM 50. The desire for coins and bills exists not only in Germany, but it is widely spread, even if the nature of currency differs in various countries. In particular such small payments in daily life represent a great potential which could be realized by prepaid cards and in part also by other electronic media.
The basic principal of prepaid cards is simple. You store a particular amount of money, which the owner of the card pays in advance to the issuing instance after storing value in it by cash or by debiting an account. The process of payment is marked by the fact that the party accepting the card (for example, a retail merchant) debits the amount of money which owed from the card. Thus, the card owner remains anonymous, and there is no expensive and time-consuming process of authorization for the card issuer. An examination of the authenticity of the card takes place with the help of cryptographic processes directly at the payment recipient's terminal. The electronic units of value which are received do not have to be collected individually, but can be collected together from the card issuer by means a debit.
Up to now, cards in circulation have mainly been single-use cards (such as telephone cards) or those with a very limited scope of use. It is only modern chip technology which makes possible, by means of increased storage capacity and improved security techniques, the development of multifunctional prepaid cards, or so-called "electronic purses". Such card systems are designed for an unlimited number of purposes, and can be used in any place where cash has been used up to now.
In Germany, the first field trial (the project "Monetary Card" of the banking industry in Baden-Württemberg) was quite successful. Banks can now began issuing new EC cards with an additional electronic purse function, and can begin acquiring networks of merchants and the necessary infrastructure. The EC cards will then be usable as debit and as payment cards. They will thus become more versatile, but at the same time will have a increased risk. A loss of a card has the same effect as a loss of cash: a dishonest finder or a thief can use the amount of money stored in the card without any limitations.
Multifunctional, prepaid cards are also being developed by various parties outside the banking industry; I will refer here only to the development of the "PayCard" which is most widely used, namely that used for telephoning, the payment of tickets, or small purchases in train stations. This is a joint project of the Telekom, the Bahn AG, and various public transport companies.
So much for prepaid cards and card money. Digital units of value stored on the hard disk of a computer are comparable to such card money in principle, and are often called "cyber money". Such units can be transferred to another computer, in the course of which cryptographic processes are to provide protection against falsification. The recipient can then use the cyber money for his own payments, as there is no need to involve a third party, such as a bank. Such money can thus indeed be passed on "from hand to hand" and anonymously, even over great distances and in great amounts, over the Internet.
The possibility of transferring money directly from computer to computer is also of great significance for other users in the Internet. Offerors of goods and services increasingly recognize the possibilities of direct contact with consumers over the Internet, with its approximately 50 million users at present. Through this a world-wide, gigantic marketplace of goods, services, and money is coming into being, which does not function anymore in the actual world, but in a cybernetic system of computers connected by networks.
The term "cyberspace", which was coined by the author William Gibson, is often used to described such a system. Gibson describes in his novel "Neuromancer" a world of the future in which the human consciousness can be connected to a computer and thus moves in a virtual world (cyberspace) which exists only in the imagination of the participant. In this sense, the cyber money which we presently know is by no means a type of virtual money which is independent from the outside world, but is rather, like card money, a type of prepaid money which is only issued in exchange for payment in national currencies. Thus, the term "net money" would probably be more suitable.
With net money we are only at the beginning of a very dynamic development. Here in Germany, the most well-known example is the "ecash" system of the Dutch firm "DigiCash", which is already being used by smaller banks. The Deutsche Bank wants, on the basis of this, to start a pilot project in the coming year. The participation of a large, internationally-active bank will give "cyber money" an additional impetus.
Let me describe the system briefly. In the ecash system the customer acquires "ecash coins" denominated in national currency from the issuing bank by debiting of his account, and thus pays in the bank's network anonymously as if by cash. The recipient can use ecash coins for his own payments or exchange them at the issuing bank for currency. Since ecash coins can easily be "duplicated" by copying the electronic files, each transaction needs a verification by the issuer in order to insure the coins' integrity. The risks associated with duplication of data and connection to the network of the issuer have this far hindered the universal use of net money. Thus, several security hurdles must still be cleared until net money can flow unhindered through computer networks like real "cybercash".
Ladies and Gentlemen,
electronic money affects central banks in many areas, in particular regarding the issuance of money, monetary policy, supervision of cashless payments, and supervision of the banking system.
Card money and net money can in part replace cash and accounting entries, and thus influence the monetary policy of central banks and their position as the sole issuers of bank notes. The circulation of money creates (in addition to the minimum reserve obligation existing with regard to certain book liabilities) a refinancing dependency of the banking system on the central bank. This system of refinance is the lever by which the central bank influences market interest rates and thus also indirectly the economy.
In addition, the need by banks for refinancing leads to interest income by the central bank. A diminished need for refinancing (caused by the substitution effect of electronic money) would therefore bring reduced profits to the central bank and decreased payments to the government. Thus, the effects of a wide use of prepaid cards and net money could become noticeable in the government budget as a decrease in income.
If electronic money were to cause a widespread replacement of cash and book entries, then central banks would have to react. Thus, the value of electronic units in circulation could be incorporated in the minimum reserve obligation, or could be subject to a particular duty of coverage by the central bank. As a last resort, the issuance of electronic units could be monopolized by the central bank, as is presently the case with regard to bank notes. Such a wide-ranging measure would also have to be seriously examined if it should unexpectedly happen that the private sector could not insure the degree of security of individual payment instruments necessary for the flow of payments.
In their function as the supervisors of cashless payments, central banks should be probably more concerned in the initial phase with the effects of electronic money on the security and integrity of non-cash payments than on its monetary and political effects. The most important factor is the security against forgery of stored electronic units of value. It has already been the case that systems which are generally considered secure can be broken fairly quickly. Since there is no absolute security, such systems must be designed in such a way that any forgery can be recognized and stopped as soon as possible.
The liability question must also be clarified. In particular, sufficient transparency must be created regarding the scope of liability and the parties liable for damages resulting from system errors, data manipulation, and incorrect data transmissions. In addition, it would be desirable to have a division of risk which took into account the proper interests of the parties and the customers' lack of influence on technical measures, and did not simply transfer damages to the customer.
As already stated, electronic money is prepaid money which the system users have put at the disposal of the issuer in advance. Such money must be administered securely and competently, and the willingness to pay of the instances which are to exchange electronic money must constantly be present. This requires that issuers have undoubted credit worthiness and liquidity. The collapse of a significant issuer or massive forgeries in the system could lead to a crisis of confidence which would affect the payment system in general.
Net money offers the possibility of transferring transfer large sums of money directly, anonymously and internationally. The Internet knows neither borders nor customs stations at which data and its transmitters must identify themselves. Thus, net money could be very attractive for illegal monetary transactions, such as money laundering. The duty to verify identity remains in place for the acceptance of large sums of cash, but afterwards cash converted into net money can be transferred anonymously over national boundaries. Thus, the so-called "paper trail" of traditional cashless transfers, which allows a further tracking of the money, no longer exists in a system of net money.
If it should happen that net money becomes used to a large extent for purposes of money laundering or in the scope of other criminal activities, then the State will have to ask whether transactions in net money should not be properly controlled and regulated.
Ladies and Gentlemen,
the issuance of the new electronic payment methods is at the present time not subject to particular regulations and is, therefore, allowed both for banks and non-banks. In order that these developments do not get out of hand, the central banks of the EU have already agreed a while ago that the issuance of multi-functional, pre-paid cards should be limited to banks. At the present time, it is also being considered whether a corresponding rule should be adopted for the issuance of net money.
The security and functionality of electronic money is in my opinion best guaranteed if its issuance is limited to (supervised) banks. They have not only significant experience in payments, but also are subject to continual supervision with regard to creditworthiness and liquidity, and maintain a liquidity reserve with the central bank. Bank supervisory authorities could also set requirements for organization of the card and net money business.
In Germany, we will in a course of the coming amendment of the banking law ("KWG"), the so-called "Sixth KWG Amendment", include the transfer of electronic money (both of card money and of net money) in the catalogue of banking transactions, and therefore limit the issuance of electronic payment methods as a basic principle to banks. There will be several exceptions for prepaid cards. The new rules include only prepaid cards with multiple uses, and contain wide-ranging exceptions from banking regulations for small card systems with a moderate volume of transactions. Such systems will mainly be subject to duties of notification and supervision.
We have, therefore, found a regulatory system for the issuance of pre-paid cards which gives banking supervisory authorities and the Bundesbank the necessary overview of the market, without interfering too much in the business.
Ladies and Gentlemen,
the effects of electronic money on central bank policies, the security and integrity of the payment system, and naturally also on single sectors such as companies engaged in the transport of money and valuables, depends mainly on the extent to which the new payment methods can replace cash.
In discussions about the introduction of new, cashless payment methods, it is often said that a cashless society is possible, and cash might be an endangered species. On the other hand, cash has proved to have many lives. Up to now, the introduction of salary accounts, transfers, cheques, Eurocheques, and credit cards has only limited the growth of the money in circulation; a lasting reduction in the use of cash has so far not been observed in the countries of the EU.
However, since electronic money has a number of important qualities and characteristics of cash, and since the European Monetary Union brings with it changes in many areas, a new age may be dawning.
The success of substitution will mainly depend on how well the qualities of cash can be replicated and on the areas in which electronic money is even superior to cash. In this regard, the main area will be prepaid cards which have been designed as substitutes for cash. Net money is not primarily designed to replace traditional payments at the point of sale. Transfers over a distance from computer to computer will, therefore, mainly result in substitution for cashless payments. However, even here, substitution of cash transactions is possible. For example, this might be the case regarding newspapers or entertainment programs which are offered in the Internet and which may cause some customers not to go out to the newspaper stand or to the cinema.
Let me comment further on the process of substitution in the context of several important qualities of cash.
- is a generally-accepted payment method,
- is exclusively issued by central banks, i.e., there is a state monopoly on issuance,
- can be transferred directly and anonymously, and
- makes it possible to detect forgeries with relative ease.
General acceptance of legal payment methods would have to be replaced in the case of electronic money by a variety of contractually-bound places of acceptance. Furthermore, it must be attractive for those involved to use electronic money, i.e., it must be cheap, easy, and secure. In order to increase the acceptance of prepaid cards, in the introductory phase there would have to be a number of incentives for payments by card money, such as for example a discount on fees or a bonus for the use of prepaid cards. Such incentives cost money and can wholly or partially eliminate the cost advantage which is expected from card money.
Card money circulates in closed payment and settlement systems; transfer between such systems it not contemplated at present. The co-existence of different systems would, however, diminish the efficiency and acceptance of the individual cards as multi-functional payment methods. The more cards are necessary to be able to pay on a wide scale, the more difficult a rational system of bookkeeping becomes. This also increases the risk of loss for the individual card holder.
The coming years will be marked by the introduction of such incompatible and unintegrated (i.e. competing) card systems. In such competition, the main question would be whether one or a few systems will get the upper hand and can gain for themselves a level of acceptance similar to cash. If this does not occur, then card money will fall behind cash with regard to its use as a payment method.
Prepaid cards compete also with other non-cash payment methods, such as credit cards or debit cards, and will therefore be used mainly for small amounts, such as for example at machines or for quick transactions. Larger amounts will, on the other hand, continue to be paid with credit and debit cards.
The direct transfer of card money is more difficult compared with cash, since a particular means of transfer will always be necessary. This also means that transfers will only be possible if the technical means are present or can be created in a way which is economically feasible. While anonymous transfers are in principle possible in the case of card money, the systems also allow many different gradations. The available information begins with knowledge of the actual amount of money in the purse, and can in an extreme case even go too far. So, for example, a "transparent" customer is indeed possible about whom a profile of expenditures could be created based on card payments.
Against such disadvantages, however, there must be set a number of advantages. Card money is endlessly divisible and exact payments are always possible. This makes possible the rational and speedy settlement of payments, so that there is no counting or mistakes in counting, and no change need be given. Particularly with regard to vending machines, card money can indeed demonstrate its advantages over coins. Finally, card money, which needs neither processing nor transport, is also cheaper to handle than cash.
A word now to security against forgery. While bank notes and coins can be directly checked for authenticity upon acceptance, this is only partially possible in the case of electronic units of value, in which case one has to rely on the software of the means of transfer. The central banks invest significant sums in the secure technical design of bank notes. Security of cash is, therefore, at the present time higher than that of cashless forms of payment, even though in the last few years the number and quality of forgeries has been gradually increasing based on advances in production techniques. The real test of security against forgery for electronic money is still to come.
For the user of electronic money, the question also arises whether the issuer of the units of value will always remain solvent. In the case of cash, there is no problem with creditworthiness, since in the country of issue cash is always accepted at par value. If, on the other hand, an issuer of electronic units of value could no longer fulfill his obligations, then the claims of the card holders and the owners of that money would be unprotected. There is also no deposit insurance for electronic money, since the stored units of money do not constitute deposits in a legal sense. It cannot be positively determined at present whether particular security measures might be necessary in the area of card money and net money. To a great extent this would depend on how high the amount is which can be used electronically and whether there is success in keeping non-banks out of this new area of business.
I have described several aspects of the coming competition between cash and card money which, in my opinion, also have consequences for companies engaged in the transport of cash and valuables. Even if no final judgment can be made in this regards, then at least one thing is certain: card money will not have an easy time against cash. Electronic money has advantages in facilitating the handling of money and will, it seems, gain a place among payment methods. This can be seen, for example, with regard to the circulation of coins, which at the present time is stagnating, since coins are partially being replaced by prepaid cards (this began with the telephone card). Electronic money could also gain importance with regard to the Euro. The fact that at the beginning of the common currency on January 1, 1999 the Euro will not be available in cash form could give cashless payment methods a significant boost. This would in particular help card money, for which the monetary union, whether or not intended, would turn out to be a promotional program.
If private households become used to prepaid cards because of the lack of bank notes and coins in the new Euro-currency, then the present preference for cash could decrease. However, in my view in the main this will not result in a rapid and significant substitution of card money for cash.
Thus, the spread of electronic money will not be wholly without consequences for the transport of money and valuables. At least the constant growth of money in circulation which has been occurring up to now does not seem that it can continue indefinitely. The pressure of competition can also in the main become greater. On the other hand, I do not anticipate any basic changes for companies transporting money and valuables. In my view, there is still a lot to be done. This can be seen also with regard to conversion to the Euro.
[Translator's note: the remainder of the speech deals with the single European currency and is therefore not translated here].