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Cost recovery and pricing of payment services

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  • Humphrey, David B.
  • Keppler, Robert H.
  • Montes-Negret, Fernando
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    Abstract

    A modern payment system is essential for promoting domestic and international trade and exchange as well as developing financial markets. Payment users will be directed toward the most efficient payment methods when the costs of producing those services are reflected in the prices paid. Resources are being wasted in the United States because consumers see no important difference in transaction prices or bank costs between using a check or using electronic direct debit in paying a bill, even though the social costs of these two instruments are different. Electronic payments cost only a third to half as much as paper-based payments. An estimated $100 billion (or 1.5 percent of GDP) is being lost by the continued use of paper-based checks. When payment instruments are not appropriately priced, the costs must be covered elsewhere. One common solution is to let loan revenues cover part of payment expenses (keeping loan rates higher to compensate). When prices reflect the full cost of producing the service, users demand the services that use the fewest real resources. The authors give examples of payment prices and price schedules and show how underlying cost data are used to"build up"to a price. They outline how payment services may best be structured to: a) Appropriately reflect economies of scale or scope in the production of payment services; b) Adjust cost recovery percentages to accommodate how much demand conditions associated with start-up differ from those associated with mature operation. (During a new system's early years of operation, the transaction volume may be low and some form of underrecovery of costs may be required to encourage use of the system. But any such underrecovery must be built into future pricing arrangements oncethe systems are established and traffic volumes are at a level where full cost recovery is practical. To ensure fairness, the pricing structure must also guarantee that latecomers to the system not get more favorable treatment than the initial user group.); and c) Induce efficient use of scarce resources. They note the economic principles that recommend certain pricing methods over others and apply equally to payment services provided by the private sector or through a government agency. They show why costs should be recovered through user transaction fees.

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    Bibliographic Info

    Paper provided by The World Bank in its series Policy Research Working Paper Series with number 1833.

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    Date of creation: 01 Oct 1997
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    Handle: RePEc:wbk:wbrwps:1833

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    Related research

    Keywords: Banks&Banking Reform; Payment Systems&Infrastructure; Economic Theory&Research; Markets and Market Access; Decentralization; Payment Systems&Infrastructure; Economic Theory&Research; Banks&Banking Reform; Environmental Economics&Policies; Markets and Market Access;

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    1. Paul W. Bauer, 1993. "Efficiency and technical progress in check processing," Economic Review, Federal Reserve Bank of Cleveland, issue Q III, pages 24-38.
    2. Kirstin E. Wells, 1996. "Are checks overused?," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall, pages 2-12.
    3. Humphrey, David B & Pulley, Lawrence B & Vesala, Jukka M, 1996. "Cash, Paper, and Electronic Payments: A Cross-Country Analysis," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 28(4), pages 914-39, November.
    4. David B. Humphrey & Lawrence B. Pulley & Jukka M. Vesala, 1996. "Cash, paper, and electronic payments: a cross-country analysis," Proceedings, Board of Governors of the Federal Reserve System (U.S.), pages 914-941.
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    Cited by:
    1. W. Bolt, 2003. "Retail Payments in the Netherlands: some Facts and Some Theory," WO Research Memoranda (discontinued) 722, Netherlands Central Bank, Research Department.
    2. Wilko Bolt & David B. Humphrey, 2005. "Public Good Aspects of TARGET: Natural Monopoly, Scale Economies, and Cost Allocation," DNB Working Papers 036, Netherlands Central Bank, Research Department.
    3. Kari Kemppainen, 2004. "Competition and regulation in European retail payment systems," Microeconomics 0404008, EconWPA.
    4. Tanai Khiaonarong, 2004. "Payment systems efficiency, policy approaches, and the role of the central bank," Finance 0405004, EconWPA.
    5. Yiting Li, 2011. "Currency and Checking Deposits as Means of Payment," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 14(2), pages 403-417, April.

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