By Brandes Elitch
CrossCheck Inc.
It's bud break time in Sonoma County's vineyards. Bud break occurs when the spurs and canes pruned during the winter start to break open, and you can see where new shoots will develop from the buds.
Pruning is important; you want to optimize the number of buds on each grapevine, in terms of quality and yield. The evenness of the bud break determines the evenness of the harvest - you want all the grapes to mature at the same time, so you can pick them all at once. Pruning theories abound; everybody's an "expert."
We are experiencing our own kind of bud break in the payments industry. Just like in the wine industry, a lot of "experts" have theories about how to proceed.
One such "expert" recently stated that if she were to build a new payment system from scratch, it would be a real-time, credit-push system. I take issue with that and will explain why.
The only real-time credit push system is the Federal Reserve Bank wire system. When the bank wire transfer department fills out the Fedwire template, it receives a Fed reference number and time, and that transaction is final. For this, banks typically charge originators around $25; receivers incur comparable charges from their banks.
Banks can justify such large fees because of the risk involved. These are typically high-dollar transfers that need to move today, not tomorrow.
When I worked in the corporate cash management department at a large California bank, I had to carry a beeper at all times (this was before cell phones) so I could personally approve daylight overdrafts for outgoing wire transfers.
I had to call clients, get the details and report back to the department manager right away. My job depended on my getting it right.
The automated clearing house (ACH) is not a same-day transfer system. It is a batch, store and forward, next business-day settlement system.
There are big risks with the ACH system, because it has never incorporated the same risk-exposure management controls as wire transfer, probably because there is no risk-based pricing.
A bank typically charges a dime to originate an ACH, whether the amount is $100 or $1 million.
Banks have taken huge losses from fraudulent ACH debits, or ACH credit pushes that could not be covered by originators. The most spectacular such incident I witnessed involved a company called Hamilton-Taft. In 1991, The Wall Street Journal called it "the white collar scandal of the decade."
Ultimately, about $80 million of client funds went missing, and the originating depository financial institutions took the hit. So when I hear people talking about "same-day ACH," I know this will not happen for some time. There are simply too many risks and no pricing to justify it.
There are many ACH return reason codes. Common ones include: 01 NSF, 02 Account Closed, 03 No Account, 04 Invalid Account, 07 Authorization Revoked, 08 Stop Payment and 10 Not Authorized.
With a check, the money is there or it isn't, but we can do a previous day query of the account to see if it is open and valid, so we are not subject to these kinds of return reason codes in the check world.
One issue with taking ACH payments is verifying that the consumers requesting that accounts be debited are who they say they are. This can be tricky in the MO/TO and e-commerce spheres.
How do you know if the account number the person is giving you on the web really belongs to him or her? How do you know that if you originate an ACH debit today, the funds will be there to cover it tomorrow?
This is not an issue with credit cards because the consumer has a credit line; it is not an issue with checks either. When a consumer pays with a check, it is not disputed later as an unauthorized debit.
The rare exception is when someone steals a person's checkbook and driver's license and forges the signature. Yes, some percentage of checks will bounce, but the majority will clear in the second presentment, and less than 1 percent will fail again.
About a dozen merchant categories typically involve high-dollar check amounts, and those merchants absolutely need finality of payment.
That is what check guarantee is for. In the auto dealer, auto aftermarket, building supply, veterinarian and other areas, the merchants have found it is easier and ultimately cheaper to let a check guarantee company do the heavy lifting, particularly when multiple checks will be deposited in the future for a sale made today.
This facilitates sales that would not occur otherwise. For this, merchants pay two to three times less than they would pay to accept credit card transactions.
Regarding the idea that the new wave of payment capabilities is made up of "better, faster and cheaper credit-push systems," that involve same-day batch settlement, the expert's assumption seems to be that merely pushing money solves all the issues around "pulling" money via an ACH debit.
The only option, other than ACH, would be a book transfer within the same bank, which would require all the players to bank at the same financial institution. I suppose a clearing house would solve this issue.
There are same-day "midnight swap" arrangements between banks, primarily to get the float (a nonearning asset) off the balance sheet, but there is no same-day clearing house arrangement that I know of. The expert also said there are same-day bill pay systems that use a credit push concept. Today, when this occurs, the bill pay provider assumes the risk that the money will not be there when it debits the consumer account and pays the vendor.
This is a very real risk. It's not such a big risk if you are paying the gas company or cable provider, but it is a big risk for nonrecurring transactions with merchants you do not underwrite.
And that is the real story here, because the risks of mass-marketing fraud and identity theft are enormous. A recent study in Canada showed that 80 percent of mass-marketing fraud - using the telephone, mail, or Internet to reach a large pool of potential victims - is conducted by organized crime groups and is the second most-common criminal activity funding terrorist activities.
Huge cyber security issues exist, and no clear solution addresses the confidence, security and interoperability needed for the burgeoning, mobile access to data, applications and services in the cloud. High-end security has to be maintained over multiple applications, including government ID, transportation and payments.
Each consumer has multiple e-identities to manage, and the payment originator will need effective and appropriate authentication systems to manage the payment risk. Aite Group LLC said card fraud alone cost the U.S. payments industry about $68 billion in 2012. Do you want to push money in real time under these circumstances? So, while the "bud break" continues in the areas of the mobile wallet, mobile security, electronic ID, smart cards, prepaid cards, near field communication, Europay/MasterCard/Visa, and many others, remember that all payments start and end in the demand deposit account.
I would not rely on current online banking technology to be highly secure, as long as some information is still in the browser.
The best approach is for banks to issue all accountholders who use home banking a hardware device that plugs into a PC and performs triple DES encryption. The large banks don't want to spend the $10 or so per user required to do this, just as they have dragged their feet for decades to defend mag stripe cards.
The expert whose ideas I've been discussing also stated, "Interchange, although controversial, is a reasonable method to enable one side of a payment transaction to receive compensation from the other, value-receiving side."
I attended the NACHA Electronic Check Council meeting in Rancho Bernardo, Calif., probably a dozen years ago, when merchant members brought up the idea of using interchange for ACH transactions.
NACHA executives immediately shut down this discussion and have kept it closed. So I don't see interchange as the solution here either.
But, just like with grapes, when bud break happens, you don't know what the result will be. It will emerge in time, having been nurtured and coaxed, and meticulously blended and groomed for final consumption.
Brandes Elitch, Director of Partner Acquisition for CrossCheck Inc., has been a cash management practitioner for several Fortune 500 companies, sold cash management services for major banks and served as a consultant to bankcard acquirers. A Certified Cash Manager and Accredited ACH Professional, Brandes has a Master's in Business Administration from New York University and a Juris Doctor from Santa Clara University. He can be reached at brandese@cross-check.com.
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