Getting Real (as in Real-Time Transactions)

BY KAREN EPPER HOFFMAN

Switching from traditional overnight batch processing of transactions to a more "real-time" process will take time — and lots of money.

| SYNOPSIS | "Real-time" transaction processing promises enormous gains for both financial providers and customers. But nine-figure transition costs and fear of disrupting other operations has kept most of the U.S. banking industry on the sidelines for now as they continue to use traditional batch processing. Still, some large institutions have taken small steps in the direction of real-time processing in order to satisfy speed-conscious customers who have grown to expect their transactions to clear in hours or minutes instead of days. And a number of foreign banks have engineered full transitions, with significant benefits.

Banks are already on the path to "real-time" transaction processing — but achieving a full transition will require overcoming some major obstacles.

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Many financial institutions today still follow the long-accepted practice of taking in deposits over the course of the day and processing them overnight in "batch" mode. But in recent years, technological and social shifts in the market have encouraged them to consider hastening this traditional processing cycle. Both consumers and small business owners, who have become used to the real-time environment of the Internet and the ATM network, are feeling entitled to receive that same immediacy in all their transactions.

"Over time, technology and customer demand will drive everything toward a real-time environment," says Jim Smith, executive vice president for Internet channel and products at San Francisco-based Wells Fargo & Co. "Right now, we're doing whatever we can to meet those expectations."

Several larger financial institutions in Europe and Asia, including Deutsche Bank AG of Frankfurt, Germany, and Banco Santander Central Hispano SA of Madrid, Spain, have undergone huge overhauls in order to make their systems real-time compliant. While the price-tag for such massive changes to the bank's core systems can add up to hundreds of millions of dollars, executives at these banks typically say the expense is quickly offset by reduced transaction and back-office costs, and a huge potential IT savings (see "Real Time Experiments — Over There").

In the U.S., many community banks, credit unions and thrifts are already operating in real-time, since they — as primarily retail institutions — historically haven't had to concern themselves with check processing internally as their commercial-oriented counterparts have.

Among the country's larger banks, the move to real-time is underway, but slowly. Financial institutions, such as Wells Fargo and Charlotte-based Bank of America Corp., are updating their systems in a piecemeal, evolutionary way, often by making funds available immediately — even if the transactions are not actually processed until that night — or increasing the number of times per day that they process transactions to multiple batches continuously throughout the day.

What's holding banks back from a wholesale transition are several issues, including cost, the effect this shift will have on basic transaction operations and the way banks interact with other players within the payment chain. "The majority of banks have talked about real-time. But there are a lot of things prohibiting it in the near future," says Tammy Krapf, vice president and manager of funds control for First Horizon Corp. of Memphis, Tenn.

Push for Faster Payments

Banks have been moving toward the faster clearing of payments since the 1980s, according to Ken Wengler, manager of business development for Hogan Systems, a unit of Austin, Texas-based Computer Sciences Corp. Hogan was one of the first vendors to offer a real-time capable online transaction processing system, Wengler says. The product appealed to thrift institutions and smaller banks that did not have to concern themselves with check clearing internally, he says.

But now the movement to real-time processing is accelerating. While U.S. consumers still write lots of checks, compared to their counterparts in Europe and Asia, the number of paper checks that flow through the payment system has been dropping dramatically in recent years as consumers opt to use their credit or debit cards, pay for bills or purchases online, or make last-minute "convenience" payments by telephone. Faster electronic payment options, which typically secure funds and post almost immediately, have led consumers to feel entitled to speedier transactions from their bank, experts say.

Dan Schatt, analyst for Boston, Mass.-based Celent LLC, says that this phenomenon will likely gain momentum as consumers conduct more of their transactions over the Internet, and make greater use of alternative payment schemes like PayPal or BillMeLater, which extends credit to qualifying online shoppers on the spot at the point of purchase. Schatt predicts that by the end of 2009, these alternative payment systems will account for more than one-quarter (26%) of the dollar volume of online retail payments.

The banking industry's own push to electronify its paper checks also plays a role. John Feldman, image and electronic processing services executive for Bank of America of Charlotte, N.C., says that while it's still "early days," the exponential growth of check imaging is leading banks to process batches of transactions more frequently throughout the day as they begin to move toward intra-day image exchange.

Additionally, as more U.S. businesses transact business throughout the world, their need to operate outside of the conventional "bank hours" and once-a-day batch processing of transactions becomes greater. "People are saying 'I have to be able to move money anywhere in the world,' in different time zones and at different times," says Mary Tobin, vice president of the strategic markets group for Milwaukee, Wisc.-based Metavante Corp. "That global business environment is placing demands on banks that they need to respond to."

Yet transitioning from batch processing is not likely to be sudden, simple or cheap to pull off. Krapf points out that in most cases, these transactional systems drive "a significant number of ledgers and sub-ledgers" within the bank, and are often intertwined in such a way that updating one system would necessitate updating many systems — creating a very expensive chain reaction. "It will just be a very, very costly process," she says.

Evolution, Not Revolution

In the absence of a full transition to real-time processing, many U.S. banks are taking steps to implement procedures and technology upgrades that take their processing to near-real-time, or closely mimic real-time. In this way, banks are appeasing the retail customers who are increasingly expecting immediacy in all forms of payment.

First Horizon, for example, runs multiple daily batch feeds, sometimes four or five per day, according to Krapf. Like many banks, First Horizon "memo posts" a large percentage of its transactions. This means that the transaction is not posted and the funds are not available, but the transaction is included in the current balance until the transaction is actually processed.

Wengler says this adoption of continuous or multiple batch processing started in earnest in the late 1990s, "simply due to the fact that banks were growing through mergers, transactions were growing, and banks were looking for a way to divert their transaction processing to other times throughout the day." Wengler says this method "approximates real-time." But, he adds, it can sometimes confuse customers, who often don't understand why their balance might carry a certain amount but some of that money is not available.

More check payments are being converted to Automated Clearing House (ACH) debits through account receivables conversion (ARC), or image through check truncation, Wengler says. And as these transaction volumes grow and more of these transactions can be processed without paper at all and, as banks begin to exchange images and do not require substitute checks as often, Wengler believes multiple batch processes will eventually give way to continuous processing.

Bank of America has already begun to do intra-day clearing with a number of bank partners, according to Feldman, who would not share specific details about how many checks are cleared through exchange or how many partners are involved. While Feldman admits this process is more a "hybrid of real-time and batch, not pure real-time," he believes such developments will pave the way for the faster clearing of funds that will be meaningful to customers. "It gives customers the look and feel of real-time," Feldman says.

Over the past decade, Internet transactions have segued from traditional processing to real-time. One of the early gripes customers in the mid-1990s had about so-called "electronic" bill payment was that it usually took their payments longer to process than if they had just sent a check by regular mail — often as long as 10 days. Now, more than 80% of online bill payments through Wells Fargo's service actually do occur electronically — processing in two days or less — compared to about 20% a decade ago, according to Smith.

Some of the most aggressive movement to real-time processing is occurring with core system vendors, who are typically supporting the small and mid-size banks that have been among the earliest pioneers in real-time adoption. As with check imaging, smaller banks and credit unions, along with some larger thrifts, have been able to embrace faster processing earlier on because they are not burdened with the complex core systems and check-clearing responsibilities of larger commercial banks.

Metavante, for example, offers two separate outsourcing services to banks that post transactions in real-time throughout the day, according to Tobin. Ironically, she reports, it's the regional and mid-tier banks — worried about getting squeezed by the large banks on one end and the smaller, more nimble rivals on the other — who are more concerned about moving their transactions to a faster process.

About 30 of Metavante's clients are talking about the move to faster transaction processing in the near future, but not all are approaching it the same way. Tobin says that some of these banks are hoping to overhaul their transaction processing operation, and remake it into a 24/7 operation, while others are merely "looking to move some of those day-two processes to day-one."

"The competitive pressure is there," says Tobin, "but there's no one unified plan."

If Not Now, Then When?

For most banks, the question of real-time processing is not an "if," but a "when." Most bankers and consultants see the eventual transition to real-time transaction processing as a fait accompli. But timing is a matter of debate.

The cost to bring a bank's core systems up to real-time capability could, by most estimates, run into the hundreds of millions of dollars. "I have not been involved in a lot of deep investigation, but everything in my digging tells me that this is a costly exercise," says Krapf of First Horizon. "And there's not the payback; I can't figure out a cost justification."

Krapf says she's referring to a lack of strategic justification to warrant uprooting and replacing a bank's most essential core systems. By contrast, she says, banks do have that business justification with image exchange.

Smith of Wells Fargo sees the banking industry "evolving" toward real-time for transactions. But he also adds, "It may never make sense to move to real-time for every transaction. There may be times when batch processing is better."

Bob Hunt, research director with MasterCard International's TowerGroup Inc. of Needham, Mass., says that despite the cost and "significant risk" of moving to real-time, large U.S. banks won't back away completely. Rather, he says, many will take a piecemeal approach, looking first to their "pain points" — the areas of the bank's transaction processing that are either most overtaxed or most in need of upgrade — and start there. "There's no perfect road map, but five years is a reasonable amount of time" to accomplish the transition, he says.

And the benefits could be huge, Hunt adds, citing savings on back-office efficiency and lowered transportation and processing costs. Also, he says, banks will realize immediate savings by moving from the old legacy system software and coding to new software that will be less costly to maintain. For example, Hunt says, many bank systems are still using older computer programming languages like COBOL that sometimes eat up to 80% of a bank's overall software costs.

"It's like trying to keep a 35-year-old car running well," Hunt says.

But moving to real-time will have other, potentially negative, ramifications. Check float, for example, would disappear with real-time processing and banks will need to run their back-office operation on a 24/7 basis. The transition will also likely require new approaches to fraud detection and prevention (see "The Fraud Factor").

All of these issues present hurdles that will encourage banks to re-examine not only how they process payments, but also how they make money. Tobin points out that some large banks still make millions in revenues from float and overdraft fees, for which they would have to find some revenue replacement.

"When we talk about the move to real-time transactions," says BofA's Feldman, "what we're really talking about is broader changes in transactions and banking."