Will a digital wallet be the game changer for mobile payments in the US ?

This is the first in a planned series of articles about reports of developments in new types of payments that will appear from time to time in Currency News. We will explore technology developments as well as policy initiatives affecting payment alternatives.

Earlier this year, the Federal Reserve Banks of Boston and Atlanta jointly published a paper entitled 'Mobile Payments in the United States Mapping out the Road Ahead'(www.frbatlanta.org/documents/rprf/rprf_pubs/110325_wp.pdf). This reported on work done with various parties in the mobile phone and card payment areas to identify the current state of mobile payments, and the issues that should be addressed to establish a successful mobile phone payment environment. 

The Federal Reserve convened and facilitated meetings of the Mobile Payments Industry Workgroup over 15 months. Participants included representatives from mobile carriers, financial institutions, card brands, payments processors, credential manufacturers, trade associations, mobile software manufacturers and online payment service providers. The group concluded that the optimal means of moving forward in the US would be an 'open mobile wallet.'

Interoperability is Key

The open mobile wallet is described in the paper as a mobile handset that can store identity and payment information and provide a secure channel to payment services. Key to this concept is interoperability - one system that would facilitate all types of payment alternatives, just as a physical wallet holds currency, coins, payment cards and loyalty cards.

The authors touched on the conditions that can exist in developing countries where mobile payments have been successful, bringing financial inclusion to people who otherwise have little or no access to banking. By contrast, US consumers have many payment alternatives available to them. As a result, the need for mobile payments has not been pressing, and those interested in establishing them have not been able to define a convincing business model.

Significant Barriers

Having said that, the paper suggests that smart phone users may be the jumping-off point for mobile payments: 34% of US consumers were reported to own a smart phone now, with a compound annual growth rate of 17%. Nevertheless, there are numerous significant barriers to the imminent implementation of the open mobile wallet concept.

There are challenges related to open mobile wallets for each set of stakeholders in the mobile phone, financial, and regulatory sectors. Mobile communications system operators want to expand product offerings through their customer billings; financial institutions don't see an immediate business case but want to remain at the center of their customers' account relationships; handset manufacturers have to address functionality and security issues; third parties called Trusted Service Managers will have to handle the downloads of applications to mobile wallets; merchants want secure payments at the point of sale, timely settlement, and manageable costs  for the terminals and hardware; card and payment networks have chosen varying paths for moving forward; an alphabet soup of financial and communications regulators in the US must define their roles; and finally, consumers must see incentives that cause them to change their payment habits.

Four Major Obstacles

The Federal Reserve authors described four major obstacles to implementation of an open digital wallet: (1) costs of deployment, (2) lack of adoption of contactless cards, (3) disruptive changes to the payments parties status quo, and (4) lack of business models and sources of funding for changes to the mobile and payments infrastructure.

The first and fourth factors are closely related: the costs of change are substantial and the business model is unclear. The difficulty of making change a reality is evident in the lack of take-up of contactless payments in the US. The authors report that, over the past 50 years, new payment options have been developed, but none have been eliminated. They further state that it took ten years for US consumers to use ATMs in meaningful numbers, and while point of sale payment systems using cards were available as long ago as the 1970s, it took 20 years before they were widely used.

Mobile Wallet Pilot

Despite the dizzying complexity and enormous challenges of implementing an open mobile wallet, in November 2010, a group of several US national wireless carriers and card companies announced the formation of a pilot named Isis for a national mobile commerce network and a mobile wallet, scheduled for introduction in spring 2012. It claims diversity as its strength: multiple payment networks, multiple issuers, multiple handsets, multiple operating systems, and multiple manufacturers. 

Over the near term of 3-5 years, the Federal Reserve authors projected that there would be a wide variety of such initiatives in the mobile ecosystem as the stakeholders gather information upon which to base future action. Given the long trajectories that led to full ATM or payment card utilization, it may be quite some time before the open mobile wallet becomes a significant element of life in the US.

But the authors caution that a shock to the system such as government intervention, industry convergence, or the emergence of a 'killer app' (a truly new, highly useful functionality,) might change the pace of transformation.