Werner's Blog — Opinion, Analysis, Commentary
Canadian banks should embrace electronic funds transfer

Canadians are still using cheques—a lot. However, using cheques as a method of payment is antiquated in our modern digital world. Printing cheques, mailing them, depositing and processing them, makes this form of payment expensive and slow. And if a cheque has been lost in the mail, cancelling a lost cheque and replacing it is even more expensive. Of course, there is an easier way: bank-account-to-bank-account transfers, or more precisely Electronic Funds Transfer (EFT). Only gradually is this method catching on mostly in the form of preauthorized debit (PAD) for utility bills, and to a much larger extent for payroll direct deposit (PDD). Nevertheless, cheque use is still widespread despite the growth of electronic payments. In 2011, a study by the Canadian Payments Association found that cheques are used for 4% of payments by volume but 40% by value. Electronic Funds Transfer (EFT) accounted for 8% by volume and 32% by value. It is time for Canadian banks to make a concerted effort to retire cheques for good. The key to making this happen is to enable their clients to transfer funds easily from one Canadian bank account to another regardless of which bank is involved. Instead of focusing on EFT, banks have wasted much effort on making cheques easier to deposit. It is now possible to scan a cheque with a smartphone camera and deposit it instantaneously. Nice, but definitely a second-best solution. By comparison, EFT is precise, instantaneous, and effortless, and saves banks significant cost for processing cheques. So why aren't banks embracing EFT as a replacement for cheques?

The first step for bringing Canada's banking system up to speed is to introduce International Bank Account Numbers (IBAN). Originally developed in the European Union, it is now an international standard (ISO 13616:2007) and 68 countries have already adopted it. An IBAN consists of up to 34 characters that comprise a two-letter country code, two verification characters, and a combination of numbers. Actual IBAN codes are usually shorter. For example, in the United Kingdom and Germany, IBANs have 22 characters. In Canada we are used to a 3-digit bank code, a 5-digit branch/transit code, and a bank account number that may vary in length between 7 and 12 digits. It is quite trivial to convert these into IBANs. Great Britain has made the switch easily. Canada should follow Europe's lead.

If you are curious what a Canadian IBAN might look like, below is an example. The first two characters would show the country, "CA" for Canada. The next two characters are check digits that are computed to verify the integrity of the character string, thus preventing errors on data entry or scanning. The last three groups contain the three-digits financial institution code, the 5-digit branch transit number, and a 9-digit account number. Account numbers that are shorter than 9 digits are padded with zeros on the left.

IBAN for Canada - Demonstration

click on image for high-resolution PDF version

‘Interac e-Transfer is yesterday's technology.’

In the absence of true EFT, cumbersome substitutes have sprung up in Canada. Recently, Canadian banks have started facilitating cross-bank payments using a service called Interac e-Transfer®, which the company claims to be "simple, convenient, and secure". Some banks also claim it's fast. I have no reason to dispute the claim that this service is secure, but it is neither simple nor convenient, and whether it is fast is relative. First, the system uses e-mail to deliver funds. Really. E-mail—that reliable method of communication where half your mail gets swallowed by your spam filter. Mistype the e-mail address, and your funds transfer goes nowhere. If the recipient doesn't have online banking, additional fees apply. It will cost you $1.00 at most banks to initiate an e-transfer, although usually nothing to deposit. It is only fast if the recipient processes the transfer promptly. Compare this to EFT: funds are transferred truly in real time and there is no delay between sending and receiving funds. Oh, and just to make you worry even more: the e-transfer expires after 30 days if not claimed by the recipient. It is possible to cancel the payment, but if you miss a 15-day window there is usually a hefty reclaim fee. To make the service even more cumbersome, it involves a security question that needs to be exchanged between sender and recipient. To be clear: the e-mail messages sent with interac e-transfer do not contain money. They simply contain instructions on how to retrieve the funds that are sent. As e-mail messages are routed through several servers before they reach a recipient, they are also easily intercepted and read. Even though Interac e-transfer is secure, it performs poorly on metrics for privacy.

Let me be frank: Interac e-Transfer is yesterday's technology that ought to be put on the scrap heap of banking history. There is a better way to do EFT: use IBANs and allow bank-to-bank deposits that are instantaneously processed, safe, and free of charge. Yes: free of charge. The marginal cost of processing an EFT is virtually zero, so banks should not put a price on EFT that would amount to rent-seeking. Processing EFTs incurs mostly fixed cost in terms of software and hardware.

‘Adopting IBANs and giro transfers in Canada will benefit consumers and industry alike.’

Europeans call an account-to-account electronic funds transfer a giro or giro transfer. Why can't we have modern banking technology in Canada and the United States? That Canadian Banks can be ahead of their US competitors they have demonstrated with the adoption of credit card chips—those that enable you to complete a purchase with your memorized PIN. In the United States, merchants were still "striping" your credit card and asking for a signature until October 1, 2015. Swiping and signing was prone to fraud, and thus costly to banks and merchants, and ultimately consumers. Another useful innovation was Interac Flash®, which allows you to "tap" your debit card to pay. Contactless payment can make the checkout lines move faster. Interac Flash uses RF-enabled proximity card technology (following ISO standard 14443) and should not be confused with RFID technology, which is used in modern biometric passports and can be read at much larger distance. Proximity cards require less than 4 centimeters to be read. Enhanced versions of contactless payment have made their way into smartphones. For example, Apple Pay has arrived in Canada, but currently only in cooperation with American Express. Why Apple Pay's Canadian launch bypassed banks is attributed to a clash of interests between Apple and the credit card companies. Arguably, Apple Pay is more secure than tapping your credit card because it uses a binary security method: physical presence of the phone and your fingerprint. Consumers are eager to embrace innovations into payment systems that make their lives easier. Canadian banks should not hesitate to embrace international standards. Unlike our southern neighbour, Canada has embraced metrication, at least up to a point. Adopting IBANs and giro transfers in Canada will benefit consumers and industry alike. Canadian consumers should demand more from our Canadian banks than tinkering with second-best solutions such as cheque-scanning and Interac e-Transfers.

Sources and further readings:

Technical note about calculating IBANs: In the discussion above you may have wondered about how the check digits in the Canadian IBAN are calculated. It involves a relatively simple set of calculations. (1.) Concatenate the financial institution code, transit number, and account numbers. (2.) Move the country code and "00" to the end, converting alphabetical characters into numbers so that A=10, B=11, C=12, and so on. This amounts to appending "121000" at the end of the string create in the first step. (3.) Calculate the modulo-97 of the number, i.e., take the remainder of a division by 97. Because the number is very long, this may involve a short algorithm. (4.) Take the result of the previous step and deduct from 98. If the result is less than 10, pad with a leading zero. (5.) Rearrange the IBAN in the sequence shown in the figure above. To reverse the process and check that an IBAN is correct, move the first four characters to the end and replace the alphabetical characters with two-digit numbers. Then calculate the modulo-97. The result must be equal to 1 for the IBAN to be correct. For some of the algorithms you may need consult rosettacode.org.

Posted on Tuesday, February 2, 2016 at 17:30 — #Finance
© 2018  Prof. Werner Antweiler, University of British Columbia. Contact me at: werner.antweiler@ubc.ca | valid HTML | Home
[Sauder School of Business] [The University of British Columbia]