Despite the fanfare ushering in new payment technologies such as e-cash, smart cards, and credit card transactions on the Internet, the economic significance of the payments industry and the structural changes it is experiencing are seldom fully appreciated. Few even view payment products and services as an industry. But $84 billion a year is generated by the US payments system (Exhibit 1)—equivalent to 40 percent of the total revenues earned by commercial banks, savings and loans, and credit unions in America today.

Almost $33 billion is earned by intermediaries such as banks, credit card processors, and payment networks from the fees paid by consumers and businesses to make their transactions. The remaining $51 billion comes from the interest earned on customers’ balances. Traditional financial institutions and payment processors still control 99.9 percent of these revenues. Yet the explosive growth of technology and the arrival of nonbank entrants are bound to erode this dominance with the shift to electronic payments, rendering much of today’s costly banking infrastructure obsolete.

Surprisingly, senior executives at financial institutions have been slow to grasp the importance of the changes that lie ahead, perhaps because they still...