"Internet Commerce is Boosting Demand for E-Money"

Bauer: Electronic money in the sense of a wire transfer has, in fact, existed for a long time. But that only involves access to credit balances at a bank. In other words, we're talking about the transfer of money on account or deposit money. Something similar occurs with a credit card or a bank transfer. Today, the term e-money means something different—namely a unit of value that is stored on a particular medium and can be used for all kinds of payments. It's actually a completely new form of money that supplements cash and money on account. The units of value on the storage medium act as a pre-paid bearer instrument. Value is transferred from chip (or hard disk) to chip (or hard disk). It is no longer merely the transfer of information used to settle accounts. Instead, purchasing power is embodied in the electronic units. And that is completely new.

Bauer: For a start, there is card-based e-money. The European Central Bank defines this as plastic cards (SmartCards) whose chips store real purchasing power, paid for by the customer in advance. In other words, it's a type of electronic wallet. There is also software-based e-money, which involves special PC software. Here, the electronically stored units of value are transmitted via telecommunications networks like the Internet or mobile radio networks for cell phones. Cards are not involved in the process. In principle, though, card-readers can be used to turn card-based money into a means of payment on the Internet. Net money refers to any type of e-money that is transferred through networks, meaning it can be card-based or software-based. In the future, such distinctions will become increasingly blurred. It would therefore be best to speak simply of e-money.

Bauer: E-money definitely facilitates payment in certain areas. It can be used to pay small amounts economically, but without the need for cash—in retail stores or at automatic vending machines, for example. Although credit or debit cards (such as the EC card) are also suitable for this purpose, their use is too costly for payments of just a few euros. Another key area is the Internet, where payments of very small amounts could experience a strong upturn, as people can pay anonymously in a simple manner. Of course, e-money harbors risks as well. Like cash, it can be lost or destroyed. It also gives rise to a new type of counterfeiting risk. Whereas counterfeit cash can ultimately be identified by the central bank, electronic units of value could be copied illegally. Afterwards, it might not be possible to identify them as counterfeit. Other disadvantages arise from possible malfunctions of the system—if the card doesn't work properly, for example. Issuers of e-money could also go bankrupt, of course, which would reduce consumer confidence.

Bauer: As I said before, e-money is particularly suitable for very small payments. In the case of larger amounts, only payments through banks offer sufficient security. E-money is also a typical network product. As a result, the utility for the individual increases with the total number of users (as with telephones). A critical mass must be reached, and this has not yet happened. There simply aren't enough users and acceptors of e-money—in other words, customers and merchants. In addition, people tend to change their payment habits only gradually.

Bauer: The following figures are for e-money excluding the electronic transfer of money on account. In June 2001, the volume of e-money in Germany was 62 mill. €. In the EU, it was 140 mill. € in mid-2000, which corresponded to 0.04 % of all cash in circulation. It is difficult to make forecasts. I do expect, however, an increase, although it's not possible to predict how rapid this increase will be. The most important factors here are the fee and cost structures in comparison with other methods of payment—in other words, what a credit card transaction or a cash withdrawal costs. The more expensive those are, the more attractive e-money will become. But e-money already costs something too. There is a fee for the loading process and one for the merchant for every e-money transaction.

Bauer: I don't know whether the Delphi Report defines e-money in exactly the same way we do. But there is one assumption I share. If business on the Internet increases, e-money will be used to a greater extent to make payments, at least for small amounts. But even then, the majority of payments on the Internet will presumably continue to be made with money on account. Once again, we're dealing with a question of cost and benefit. When an e-money system is installed, high fixed costs are initially incurred. But the marginal costs are very low. The more people involved, the more profitable it becomes. Theoretically, the potential for expansion is very high, because e-money is attractive for everyone—for the banks, since the costs of cash handling are eliminated; for merchants, who no longer incur the costs for using and storing cash; and for the customer, who doesn't have to worry about having enough money or the right amount of change.

Bauer: I don't think that e-money will one day replace cash entirely. At most, it will replace it to a certain extent, perhaps more so coins than bank notes. The reasons for this have to do with the unique properties of cash, which are as yet unsurpassed. Cash is legal tender; there is an obligation to accept it; it is widely circulated and absolutely anonymous. To some extent, innovations also have a "cannibalistic" effect, in that they replace not only cash but also other instruments of cashless payment. Net money, for example, could partially replace the credit card as a means of payment on the Internet. Moreover, it is becoming more and more popular to pay with the EC Card as a debit card, a development that will probably reduce the future role of cash or e-money.

Bauer: I see fewer applications in B2B than in the case of private persons. Payments between companies are already carried out electronically to a very large extent, but not in the sense of our e-money definition. E-money will be used more in the private sphere, from parking lot management and local public transportation to the complete range of vending machine payments. If you pay for your bus ticket with e-money, for example, you don't have to go digging for change. Paying becomes simpler and more convenient. And discounts are already being offered. For example, "E-Geldkarte" users can get a 10 % discount in some parking garages in Frankfurt. Special discounts of this kind can definitely serve as incentives for using e-money. In addition, programs and services obtained via the Internet will probably not be free in the future. This would be another economically viable field of application for e-money.

Bauer: Theoretically, e-money could be used for money laundering or tax evasion. But these risks can be limited by maintaining a bookkeeping log of the payments. In other words, there won't be complete anonymity. Another option is allowing only small amounts to be loaded and transferred, or restricting direct transfers between private persons. All of this is currently possible.

Bauer: It's almost impossible to achieve both complete security and complete anonymity in an e-money system. The more anonymously a system is structured, the greater the risks are, and vice-versa. In current e-money systems, it is possible to identify the participants, since shadow accounting is normally conducted. But a bank as an issuer of e-money will hardly be interested in where the owner of a certain card has parked his or her car. If, however, more e-money than was previously loaded onto a card flows back from acceptors, then the bank will really want to know who the card owner is. Obviously, someone has succeeded in breaking through the security measures. Here, entries in shadow accounts help to increase security and avoid fraud. And that's in the interest of the buyer as well.

Bauer: The security and reliability of e-money are best guaranteed by restricting the issuance of it to credit institutions and implementing a system of continual monitoring. But convenience is very important as well. The easier it is to transfer e-money, the more it will be used for payment on the Internet. Computers equipped with scanning devices have an important role to play here.

Bauer: In Germany, the right to issue e-money is restricted to banks. At the EU level, non-bank enterprises are also allowed to issue e-money, but are then subject to the regulations of the banking supervisory authorities. They are thus designated as credit institutions, with all the consequences. Obligations involved cover many areas, including reporting, supervision, minimum reserves, the exchange of e-money back into central bank money, as well as direct refinancing at the central bank.

Bauer: If the demand for cash declines because it is being replaced by e-money, the dependence of the credit institutions on refinancing from the central banks will decrease. This would limit the central banks' ability to set and enforce money market interest rates. On the other hand, cash is already being replaced by money on account to a great extent, without any lasting disruption of monetary policy. Furthermore, the minimum reserve requirement also has a big effect on deposits. This rate is currently 2 % for money on account, and could be raised if the volume of cash in circulation should decline sharply. In this way, the demand for central bank money could be artificially increased. Another result of e-money could be increased volatility in the growth of the money supply, in other words, unexpected changes in the circulation velocity of money. But the volume of e-money is still much too small for it to present a problem for central banks. Nevertheless, they are watching developments very closely.