By Patti Murphy
The Federal Reserve wants to build a real-time payment network that features round-the-clock access and near-instantaneous exchanges of money. It's not a novel idea. The Fed has been promoting real-time payments for about six years.
However, now that it has decided to build its own network – one that can be accessed by 11,000-plus financial institutions that already clear check, automated clearing house (ACH) and wire payments through the Fed – it will probably take another six years before the FedNow network is fully operational. Meanwhile, the Fed is declining to support initiatives that could deliver near-instantaneous exchanges of funds with an electronified version of the old-fashioned check.
Despite predictions to the contrary, checks are alive and well, with more than 40 million a day clearing between U.S. financial institutions. Unlike when the clearing and settlement process for a single check required up to a dozen physical handoffs across multiple days, checks today clear and settle as electronic image files. Often, thanks to remote deposit capture services, even the process of getting checks to banks has been digitized.
The next logical step, then, is to digitize the check-writing process. It's possible. In fact, it's being done every day. Not in huge numbers – about 80 million a year, according to one analysis. These so-called electronically created items (or ECIs) clear through the banking system as electronic files, the same as payments that start out as paper checks, which makes the two indistinguishable. In effect, checks become fully electronic payments.
Most ECIs are used for business-to-business payments; they could just as easily be adopted for consumer payments. It wouldn't be a technological stretch for financial institutions to offer consumers smartphone apps for initiating debit payments from their checking accounts.
The only obstacle to wide adoption of ECIs is the Fed, which last year amended its check collection rule set (Regulation J) to ban the clearing of ECIs through the Reserve Bank System. While the prohibition on ECIs doesn't apply to private-sector clearing arrangements, the move was largely seen as stymieing broad adoption of ECIs, as there is no way of knowing whether financial institutions in the collection stream use the Fed or private clearing arrangements.
An irony surrounding check payments is that the underlying technologies that support electronic alternatives to check payments (for example, high-speed data networks) also support faster check clearing, helping to compress the time required to clear and post check payments to a day or less.
This places the time it takes to process a check payment on par with that required for ACH payments, an electronic payment system created in the 1970s as an alternative to checks.
Faster check clearing, paired with access to real-time information and decision-making capabilities, also has served to substantially reduce check fraud losses. A report published in 2018 by the Fed, for example, revealed an overall rise in the amount and value of fraud involving nearly all noncash payment methods between 2012 and 2015. The lone exception was check fraud, which fell in terms of number and value of fraud incidents, according to the Fed.
Shoaib Shafquat, founder and CEO of QCheque Corp., believes losses to check fraud can be reduced further through tokenization. Tokenization has been used to help secure electronic payments for years, most recently for card payments. In the credit card world, tokens (randomly generated numbers) replace actual card numbers, and only valid credit card processors hold the cryptographic keys needed to re-associate those tokens with the actual account information.
QCheque has been working with a handful of financial institutions testing a scheme to tokenize check magnetic ink character recognition lines. Shafquat likened the tokenization process to "putting a chip on a check." Doing so takes a big chunk out of check fraud, particularly counterfeit checks, he suggested.
An idea put forth in "Tokenization Use Case: Cheques" published May 18, 2018, in Programmable Economics, is to couple tokenization with blockchain technologies. Under this scenario, blockchain would not be used as a store of money, but merely the technology used to exchange tokenized check images.
Alex Osh, the article's author, explained that turbocharging checks with tokens, blockchain and mobile technologies could drive greater benefits at lower cost than replacing the check payment system outright with a new real-time payment system. "We believe the illusion of an instant payment settlement is greatly overvalued"," he wrote. "From a user perspective, a modern check payment app is as 'instant' as any e-money; should a problematic transaction occur, all fiat payments are reversible to the same extent, be it check or not."
Nonetheless, the Fed and a growing army of banks are intent on building new real-time payment networks, at significant cost to financial institutions, and potentially businesses, which continue to write and collect billions of checks a year.
The Fed said it expects completion of its planned new FedNow system within five years. But that would seem an optimistic timeline, considering all that needs to be done and the Fed's history of moving slowly to change payment regulations and procedures.
Like other Fed payment and settlement services, FedNow would settle payments in Federal Reserve master accounts. But unlike other services, FedNow requires changes in operating hours for the Fed's National Settlement service, which currently is only available from 7:30 a.m. to 5:30 p.m. Eastern and not on weekends or national holidays. The Fed said it's working to support that. It also said it's working to support exchanges of payment-related information (think invoice details) that are common in business-to-business payments via FedNow.
But if the objective is to move more B2B payments away from checks, FedNow may fall short, as payments will be capped at $25,000, at least initially, the Fed said.
"There's a basic problem of, how do you fund this system without business payments?" said David Walker, president of the consultancy Tiller Endeavors. "I don't see anything here that encourages businesses to do this [from the perspective of] making payments."
After all, checks already clear fast. Adding ECIs to the mix creates the potential to settle checks with the same speed and efficiency offered by a real-time service like FedNow.
Patti Murphy is senior editor at The Green Sheet and president of ProScribes Inc. Follow her on Twitter @GS_PayMaven.
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