The Green Sheet Online Edition
March 23, 2015 • Issue 15:03:02
Fed looks to online real-time payments, eventually
The Federal Reserve has created a road map for making payments faster and safer. And it wants financial institutions (FIs) and other businesses to bring those plans to fruition. So it is establishing task forces from stakeholder communities to sort out what can be done to make payments faster and to render the associated information less prone to fraud.
The Fed also has a multiyear plan to align net settlement services with real-time processing schedules. The Fed's net settlement services are used to effect final settlements between FIs that exchange payments through the automated clearing house (ACH), electronic check clearing house, wire transfer and other payment networks.
"A safer, more efficient and faster payment system contributes to public confidence and economic growth," said Federal Reserve Board Governor Jerome H. Powell, who is overseeing the initiative. The Fed unveiled its road map in late January 2015 in a document titled Strategies for Improving the U.S. Payment System.
"The Federal Reserve believes that the U.S. payment system is at a critical juncture in its evolution [and] developments illustrate a rare confluence of factors that create favorable conditions for change," the paper stated. "Through its Strategies for Improving the U.S. Payment System paper, the Federal Reserve is calling on all stakeholders to seize this opportunity and join together to improve the payment system."
The Fed's plan is getting some blowback, however, as FIs and their business customers grapple with the financial investments and other resources required to migrate entrenched check writing to electronic alternatives. Of equal concern, the planning horizon – seven to 10 years – is longer than most profit-oriented businesses will accept, said David Walker, President of ECCHO, a national bank-owned clearing house for electronic check exchanges. "Not many banks will accept seven to 10 years for returns on their investments," Walker said.
It's too early to estimate costs, but data is available on what happened when other countries embraced similar strategies. In 2008, for example, the United Kingdom created what it dubbed the Faster Payments Service (FPS) network, an online system that operates 24/7/365 and can process consumer and business payments on a same-day basis. According to analysis by the Federal Reserve Bank of Boston, it cost over $300 million to build and operate FPS for the first seven years; the cost to each participating bank for connecting to the network was about $77 million.
It's not just an issue of cost. Checks are entrenched. "Businesses in the United States, and Canada too, consistently say that checks are not a problem," Walker said. "The check system works. It works very well."
The Federal Reserve is unique among central banks. In addition to setting and implementing monetary policy, the Fed (through a system of 12 regional Federal Reserve Banks) regulates and examines commercial banking companies. It also oversees the nation's payment system through the Reserve Bank System, setting policies and providing back-end support (clearing and settling ACH, check and wire transfers between FIs).
The Fed's present role as gatekeeper of the U.S. payment system was spelled out in a package of banking bills passed by Congress in 1980. Known as the Monetary Control Act of 1980, that legislation instructed the Federal Reserve Banks to make payment services available to every federally regulated FI in the United States that wanted access, and to price those services as though they were a correspondent bank selling into downstream markets. It also tasked the Fed with setting policies that promote better efficiencies in payment mechanisms.
The Fed's latest initiative, described in Strategies for Improving the U.S. Payment System, is the culmination of three years of research and consultation with banks and end-users, as well as nearly 200 letters of comment on a public consultation paper issued in 2013. The goal is to prod the industry to retool and support the migration of check payments to faster and safer electronic payments.
Fed officials have stated consistently at industry events that the central bank's focus is on encouraging industry action and providing ancillary support through changes to ACH and check services. It has no plans to actually build new networks or issue regulatory edicts. The Fed took a similar approach to speeding up check clearing, beginning in the 1980s. The migration to check image exchange was one result.
The Fed's road map
The 58-page document the Fed published in January sets forth five "desired outcomes" for the evolution of the U.S. payment system over the next seven to 10 years. Specifically, it wants:
- A ubiquitous, safe, faster (near real-time) and cost-effective means for payment clearing and settlement groups to settle their positions rapidly and with finality
- Payment system security that is strong, public confidence that is high, and protections and incident response practices that keep pace with the rapidly evolving and expanding threat environment
- A "greater proportion of payments" being originated and received electronically, thereby reducing the end-to-end (societal) costs of payments
- Better, cheaper choices for businesses and consumers to send and receive cross-border payments in a timely manner
- Necessary payment system improvements that "are collectively identified and embraced by a broad array of payment participants, with material progress" toward implementing those improvements
Faster, safer payments
"Security and speed have been the top two items with everyone we have spoken with in the last 18 months," said Sean Rodriguez, Senior Vice President, Industry Relations at the Federal Reserve Bank of Chicago. Rodriguez was one of several Fed executives who helped craft the Fed's road map; he was dispatched to the BAI Payments Connect conference in March 2015 to explain the Fed's vision.
Several initiatives are underway that would expedite the clearing and settlement of payments to something approximating near-real time. One would extend the hours of operation for Fed net settlement services, which currently operate between 7:30 a.m. and 5:30 p.m. Eastern Standard Time, Monday through Friday.
Cheryl Venable, Senior Vice President and Retail Payments Product Manager at the Federal Reserve Bank of Atlanta, stated during a presentation at BAI Payments Connect that the Reserve Banks are preparing to expand that operating window, over time. "We're exploring the demand for 24/7," she said. "There's a lot of work to be done on that front. It's not a small undertaking."
Meanwhile, NACHA – The Electronic Payments Association (which sets rules for ACH payments), laid out a phased implementation plan for same-day ACH payments. The ACH was developed as a batch processing system; as a result, ACH payments typically settle one or two days following initiation.
The Fed supports same-day ACH. In fact, it provides a same-day settlement option for banks that process ACH payments through the Reserve Bank System. But the Fed Board raised concerns about NACHA's plans, notably a proposed 8.2-cent fee assessment, paid by originators to receiving banks for each same-day payment cleared through the ACH.
"Through its effect on fees to originators, the interbank fee will likely reduce usage of the same-day ACH service from what it would be absent a fee, and ultimately limit the benefits that end users derive from it," Louise Roseman, Director, Division of Reserve Bank Operations and Payment Systems at the Fed Board, wrote in the Fed's comment letter to NACHA.
Merchants have balked at NACHA's proposed fee structure as well. The National Association of Convenience Stores said in a comment letter that the proposed fee "appears suspiciously similar to a swipe fee, and would ultimately undermine the ACH as a low-cost alternative to cards."
Meanwhile, The Clearing House said it is building an online real-time payment system that supports both consumer and commercial payments. The Clearing House, originally known as the New York Clearing House, is owned by a consortium of the nation's largest banks. It provides ACH, check image exchange and large-dollar fund transfer services to FIs in direct competition with Federal Reserve Banks.
The Clearing House has been short on specifics, but in a statement released in late 2014, the group said it would require "a multi-year effort" to create a real-time payment system. It added that the system "will be designed to address gaps in payment processing and will enable consumers and businesses to securely send and receive immediate payments directly from their accounts at financial institutions." Benefits would include:
- Better data security through the use of tokens to protect accountholder information in transit
- Better fraud protection through immediate notifications of payments, thereby eliminating return risks
- Improved cash management tools for businesses and consumers
- Support for online and mobile banking
Push and pull
One common theme that can be found in the Fed's suggestions and private sector initiatives for faster payments is that very little has been planned for further improving check payments. In detailing its road map, the Fed stated that "persistent check usage, challenges in moving the unbanked population to electronic payments and the benefits of promoting innovation are key drivers" of its efforts.
Walker sees this as a shortcoming. "There are an awful lot of checks being written by businesses," he said, despite the existence of electronic alternatives like the ACH. "You have to be practical when it comes to payments," he added.
In its paper, the Fed pointed to other problems with checks, which it describes as "debit-pull payments." In a debit-pull scenario, the payer supplies account information to the payee, and using that information, the payee's bank "pulls" money from the payer's bank account. ACH transactions and wire transfers are "credit-push" payments; payers must obtain a payee's bank routing and account numbers to initiate a payment request.
"Credit-push systems allow the paying bank to authenticate the customer and confirm 'good funds' are available to support the transaction, thus creating a more predictable payment cycle from payer to payee. However, the desire to use credit-push payments creates challenges to implementing electronic solutions that are ubiquitous. In many cases the payer will revert to check or cash," the Fed wrote.
One possible solution to this problem, the Fed suggested, would be for it to create directories. The idea would be to store individual and business account information in a trusted location that could be accessed when needed to push payments over the ACH or some other system. "To the extent that payment aliases are widely known or can be looked up by any payer in the directory, then the electronic credit-push payment method has the potential to become ubiquitous," the Fed stated.
U.S. businesses and consumers wrote more than 18 billion checks in 2012, according to the Fed's triennial survey of noncash payments. Check writing is especially entrenched with businesses. Phoenix-Hecht, which keeps tabs on corporate payment trends, reported that 64.6 percent of business-to-business (B2B) payments were made by check in 2013. The Fed estimated that 28 percent of checks (or 5.9 billion) paid in 2012 were B2B payments, and 46 percent (or 7.1 billion) were consumer-to-business payments; the remainder were business-to-consumer (15 percent) and consumer-to-consumer (12 percent) payments.
Businesses cite a variety of reasons for using checks instead of the ACH or other systems. One compelling reason is that corporate payables and receivables systems have been designed to accommodate checks and the robust remittance information that can accompany check payments. Efforts to promote the ACH as a B2B payment mechanism have met with limited support, in part, because of limitations on how much data can accompany an ACH payment.
General Motors Corp. was a strong proponent of electronic payments back in the 1980s, when it was a manufacturing powerhouse. It mandated that all trading partners use electronic data interchange (EDI) for ordering, fulfillment, billing and remittances or risk losing GM's business.
Several large trading partners complied, but eventually the program was scrapped after dozens of key, yet small, specialty suppliers refused to invest in EDI. "GM wasn't big enough" to force businesses to abandon checks, Walker said. And the Fed doesn't hold the economic carrot GM offered, he added.
SIDE NOTE: India boosts financial inclusion with debit cards
The Federal Reserve, in advancing its vision for online payments that settle in near real-time, said it would make it more compelling for the unbanked to join the banking mainstream. Government efforts to promote banking among the disenfranchised are not without precedent.
Consider the situation in India, where roughly 40 percent of households (or about 520 million people) are unbanked: individuals in those households have never held bank accounts, nor have they used payment cards. A program introduced in 2014 by India's newly elected Prime Minister Narendra Modi would change that scenario with state-issued debit cards.
Taking a cue from the successful use of electronic benefit cards in the United States, the Indian government decreed that welfare payments be made directly to bank accounts backing the cards. Transactions on state-issued debit cards clear and settle via RuPay, a state-run system designed as an alternative to the MasterCard Worldwide and Visa Inc. networks. In various reports describing the program, Modi has been quoted as saying he would like RuPay to evolve as a global brand on par with MasterCard and Visa.
At least 75 million accounts have been opened by previously unbanked consumers since the program went live last fall, the Indian government reported.
Patti Murphy is Senior Editor of The Green Sheet and President of ProScribes Inc. She is also the founder of InsideMicrofinance.com. Email her at email@example.com.
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