Explaining adoption and use of payment instruments by US consumers

• Published date: 01 May 2016
• Author: Marc Rysman,Joanna Stavins,Sergei Koulayev,Scott Schuh
• Date: 01 May 2016
• DOI: http://doi.org/10.1111/1756-2171.12129

RAND Journal of Economics

Vol.47, No. 2, Summer 2016

pp. 293–325

Explaining adoption and use of payment

instruments by US consumers

Sergei Koulayev∗

Marc Rysman∗∗

Scott Schuh∗∗∗

and

Joanna Stavins∗∗∗

Motivated by recent policy intervention into payments markets, we develop and estimate a struc-

tural model of adoption and use of payment instruments by U.S.consumers. Our structural model

differentiates between the adoption and use of payment instruments. We evaluate substitution

among payment instruments and welfare implications. Cash is the most significant substitute to

debit cards in retail settings, whereas checks are the most significant in bill-pay settings. Further-

more, low income consumers lose proportionally more than high income consumers when debit

cards become more expensive, whereas the reverse is true when credit cards do.

1. Introduction

We use the Survey of Consumer Payment Choice to estimate the effect of payment policies

on payment use and on social welfare.

The goal of this article is to estimate substitution patterns between payment instruments

for US consumers. We analyze substitution in response to change in the value of usage and

the cost of adoption of payment instruments. This issue is important because, during the past

three decades, the US payments system has been undergoing a transformation from article to

electronic means of payment. Modern consumers have access to ATM machines, debit and

prepaid cards, and online banking. Because governments have a responsibility to deliver a

safe and efficient payments system, understanding substitution patterns is important. More

∗Consumer Financial Protection Bureau; sergei.koulayev@gmail.com.

∗∗Boston University; mrysman@bu.edu.

∗∗∗Federal Reserve Bank of Boston; scott.schuh@bos.frb.org, Joanna.Stavins@bos.frb.org.

We thank Wilko Bolt, Beth Kiser, Ariel Pakes, and Bob Triest, as well as numerous seminar audiences for insightful

comments on the article. Wealso thank Mingli Chen, Vikram Jambulapati, Sarojini Rao, and Hanbing Zhang for excellent

research assistance. The comments of the Editor and two anonymous referees greatly improved the article. The views

presented here are those of the authors only and do not necessarily represent the views of the Federal Reserve Bank of

Boston, Federal Reserve System, or the Consumer Financial Protection Bureau.

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specifically, our research is motivated by recent regulation of the debit card interchange fee,

further described below, that has the potential to make debit cards less attractive to consumers,

either via bank-imposed usage charges or adoption charges. Recent regulation also allows

merchants to surcharge for cards. Understanding how consumers will substitute in response to

these changes is important for evaluating the impact of these policies.

Our article makes use of a new public data set, the Survey of Consumer Payment Choice

(SCPC, described in Foster, Meijer, Schuh, and Zabek, 2009) specifically designed to address

these topics. In the SCPC, participants report their number of transactions that month by payment

instrument: cash, check, credit and debit, prepaid cards, online banking, direct bank account

deductions, and direct income deductions. In addition, for each instrument, the participant

indicates how many transactions were used in each payment context, such as traditional retail,

online retail, and bill-pay.The data set also includes infor mation about participant demographics

such as age, income, and education. The survey asks respondents to evaluate instruments, on a

numerical scale, along several dimensions, such as security, ease of use, and setup cost, which

turn out to be important predictors of choice. A drawback of the SCPC is that it does not track

transaction values, so our model studies only the number of transactions, not the values.

To estimate substitution patterns, this article develops and estimates a new structural model

of adoption and use of payment instruments. In our two-stage model, consumers first adopt

a portfolio of payment instruments, such as debit, credit, cash, and check. Then, consumers

choose how much to use each instrument in different contexts, such as online, essential retail,

and nonessential retail. The model has several important technical features. A strength of our

model is that it allows for flexible substitution patterns. Our model allows for correlation in

unobserved terms across instruments and contexts, so for instance, one consumer may prefer

to use a credit card in online and retail payments, whereas another may prefer to shop online,

whether it be with a credit card or a debit card. Wefurther allow for correlation to affect adoption

and usage for a given instrument, which thus allows for a selection effect: consumers who

adopt an instrument for unobserved reasons may also have high usage of that instrument for

unobserved reasons. Because consumers in the adoption stage perceive a portion of the terms in

usage that are unobserved to the researcher, our model allows consumers to know more than the

researcher about their usage when the consumers make their adoption decisions. We believe this

is an attractive and realistic feature in the adoption of payments instruments. As usage value and

adoption cost are modelled in a simultaneous equations framework, we use exclusionrestrictions

based on consumer ratings of instruments to achieve identification. Our model generates a

computationally complex likelihood function, which we address with simulation techniques.

Our counterfactual analysis considers what would happen if debit cards became more

expensive to use or adopt. We find that cash and check are significant substitutes for debit cards,

more so than credit cards. These results differ by context—cash is a popular substitute in retail,

whereas checks are a popular substitute in bill-pay contexts. The coverage of bill payments

is unusual for data sets in the payments area, and we find that accounting for bill payments

is important. Overall, we find regulation that makes debit cards less attractive to consumers,

either to adopt or to use, moves consumers away from digital payment products such as credit

cards. This effect differs across demographics: we find that making debit cards less attractive

causes high-income and high-education consumers to substitute toward credit cards relatively

more than low-income and low-education consumers, who tend to move toward paper products,

such as cash and check. Similar to debit, we find that making credit cards less attractive causes

substantial substitution to paper products, though less so than in the case of debit.

We also perform welfare calculations. We find that when debit becomes less attractive, less

wealthy consumers suffer relatively more, as they use debit more intensively and may not have

access to as many alternative instruments. In contrast, making credit cards less attractive causes

wealthy consumers to suffer relatively more, as they are more likely to hold and use credit cards.

These results are important for the Board of Governors of the Federal Reserve System,

which was mandated by the Financial Reform Act of 2010 to regulate debit card interchange

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fees, leading to a substantial reduction in the overall fee level. Because we find that making

debit cards less attractive to consumers causes substitution toward paper products, the regulation

may increase the cost of the payments system. Furthermore, our result that regulating credit and

debit cards have different effects for different income groups implies that these policies have

distributional implications, and thus adds a further concern to policy intervention. Note that

we do not provide a full welfare calculation of all of the implications of these regulations, such

as how banks will pass through changes in the interchange fee or how merchants will respond.

Although we do not evaluate the policies overall, our article contributes to this evaluation.

Section 2 addresses that though there is a substantial body of literature on consumer pay-

ments, this is the first article with a structural model of payment adoption and use that allows

us to estimate the effects of regulatory changes. Section 3 uses the 2008 Survey of Consumer

Payment Choice, a representative survey of adult consumers in the U.S. that collects data on

payment method adoption, use, and assessments of payment instruments. Section 4 develops

a structural model of consumer adoption and use of payment instruments, where consumers

pick payment instruments to adopt in stage 1, and then decide on how to use them in stage 2.

Section 5 provides our parametric assumptions and our estimation strategy. Section 6 shows how

our model extends a general literature in which agents first make a discrete choice about adoption

and then adopters make an ordered or continuous choice over intensity of use, by allowing for

the structural identification of the effect of use on adoption. Section 7 presents the estimation

results, where the demographic attributes and consumer ratings affect the use and adoption of

payment instruments, both individually and as bundles. Section 8 shows how introducing a fee

on debit card use, resulting from a regulatory change, would affect consumer holding and use

of payment instruments, including how consumers would substitute away from debit cards and

how the reduction in debit card use would lower consumer welfare, especially for lower-income

consumers. Section 9 provides perspective on the effect of introducing interchange fees or sur-

charges on payment cards, and thus serves to inform future policy in this area, thus contributing

to the analysis of this complex policy question.

2. Policy setting and literature review

Although there is a substantial body of literature on consumer payments, this is the first

paper with a structural model of payment adoption and use that allows us to estimate the effects

of regulatory changes.

Understanding consumer substitution patterns between payment instruments is an important

policy issue. Consumers face few explicit costs of using an instrument, and so consumers may

receive poor signals about the social cost of their choice. For this reason, and a variety of others,

government intervention is common in these markets, and understanding substitution patterns

is important for designing and evaluating these policies. For example, central banks typically

consider payment cards to be more efficient than cash or check, as payment cards are a digital

mechanism. In this light, the effect of regulation that lowers the value of debit cards depends

on whether consumers switch to cash or to credit cards. Furthermore, substitution patterns may

depend on whether the regulation affects the adoption cost or usage value of debit cards, so it is

important to employ an approach that recognizes these differences.

Our emphasis on debit and credit cards is in part motivated by two recent policy actions in

the payments market. First, in the United States, recent legislation requires the Federal Reserve

to regulate the interchange fees of debit cards.1Note that regulation is common internationally:

1This regulation is part of the Dodd-Frank Wall Street Reform and Consumer Protection Act, signed into law

in July 2010. The specific section referring to debit interchange fees is often referred to as the Durbin Amendment. It

requires the Federal Reserve to regulate the interchange fees on debit cards based on bank variable costs. The current

policy,which became effective on October 1, 2011, sets the fee substantially below previouslyobser ved interchange fees,

particularly for signature debit cards. See the Board of Governors’ final rule, Regulation II, Debit Card Interchange Fees

and Routing (www.federalreserve.gov/newsevents/press/bcreg/20110629a.htm).

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