Rapid changes in technology have users of the U.S. financial system facing a 21st-century paradox: services such as Amazon can guarantee two-day delivery of goods, but consumers often wait longer than that for a deposited check to clear the bank payment system. An increasing number of voices in the U.S. – most critically including the Federal Reserve – are saying: that’s not fast enough.
While many bankers agree, the real issue is: how fast can the U.S. move to expedited or real-time payments, similar to what exists in many countries in Europe and East Asia, where money is available to the depositor immediately and moves end-to-end through the system without human involvement? “We’ll see a lot of different projects that move us toward the direction of real-time payments, but we’re not likely to see this system in our life time,” says Peter Ehmke, partner, chief financial officer, and head of North America, at Edgar Dunn & Co., an international consulting firm with payments expertise. “We will not see a movement where the whole industry comes together to build one central, faster payments hub, as was done in other countries.”
The problem, Ehmke explains, is that the U.S. payment system is decentralized and diverse, with thousands of banking institutions and two different clearing houses. That means the change process will be incremental, with some areas advancing faster than others, says Ehmke.
More Incentives Needed
While consumers would like to see faster payments, many financial institutions, including many banks, have less incentive to upgrade the system, says Paul Thomalla, senior vice president of global corporate relations and development, at Naples, Fla.-based ACI Worldwide, which provides electronic payments and banking for financial institutions, retailers, billers and processers. He notes that banks make about 40% of their profit from fees associated with the payment system. Other companies, such as those that provide payroll for corporations, move currency or provide invoice services, were created specifically to overcome the inefficiencies in the current system.
“Banks were built on the business model of making money from the payment system and changing all of this is hard,” Thomalla says. “A lot of businesses will disappear with real-time payments. Banks will need to change their business models away from the payment system and make some decisions about what their future will look like.”
Steve Ledford, senior vice president for New York-based The Clearing House, a payment system owned by 24 of the world’s largest commercial banks, agrees that moving to real-time payments will require more incentives for all parties involved. “The current system is very inexpensive to use and a new system has to have value beyond increased speed,” Ledford says. “The new infrastructure has to be flexible enough and adaptable enough to create new products and services.”
Ledford cites the example of the Internet, noting that companies such as Uber and Airbnb would never have come into existence without the Web. He says that the Clearing House is building its new infrastructure in a modular fashion so that it can readily adjust to changes in technology and in the market place. “We have no idea what the future will bring, but we are building an infrastructure that can adapt to it,” Ledford says. “We don’t want to be locked into the status quo of when the payment system was invented.”
Any new payments infrastructure must also be secure and adaptable enough to detect fast evolving fraud and money schemes. And it must include the best elements of the current system, especially certainty of payments, Ledford says. Amazon, for example, couldn’t promise to deliver packages within two days if it didn’t receive accurate information about whether funds were actually available.
“The entire transaction is completed in minutes or even seconds; they have confirmation of their payment and their goods can be on the way,” Ledford says. “There must be certainty that the payer can’t change their minds and that eliminates the risk of return. That’s an essential element of any payment system.”
New banking business models might emphasize value-added services, particularly those that center around the data associated with payments, Thomalla says. For large corporations sending thousands of invoices and payments across time zones and currencies, it’s beneficial to know, for example, when the money was sent, how much was sent, whether the right amounts were sent and where the funds reside currently.
“The data is important to corporations and can be profitable to banks,” Thomalla says. “Banks can make a future business model around services and the data around services.” Banks that decide to change their business models and are the first movers into the new system may benefit as they attract the best industry talent as well as customers seeking a more efficient way to move money, he adds.
Ehmke notes that the current payment system is labor intensive and requires a huge staff to deal with charge backs and other issues; by contrast, an automated, real-time system could reduce staff, saving the industry as much as $7 billion. “The debate is raging in the industry,” Ehmke says. “This is both an opportunity and a threat.”
The Federal Reserve is anxious to increase the efficiency of the payment system and last year established the Faster Payments Task Force to work toward that goal. The task force brings together industry stakeholders “to identify and evaluate alternative approaches for implementing safe, ubiquitous, faster payments capabilities in the United States,” according to the Fed.
However, the U.S. Fed has no regulatory authority to mandate that change the way central banks in some other countries do, Ehmke says. Near- time or real- time payment systems already exist in Singapore and the U.K., while the European Union and Australia are heading in that direction. In all, 17 countries have real-time, or near real-time payment systems, he says. In the U.S., the Fed can only keep the issue moving forward by pushing and influencing industry stakeholders.
“The Fed is doing a good job in moving the industry forward by helping everyone talk through this,” Ehmke says. “They have a tough task, as there are around 300 people in the working groups and in some ways that can be like herding cats.”
Congress does have the authority to demand a change but they have not moved in that direction, Ehmke says. So the work of the Federal Reserve remains the primary governmental force for change, he says. “Their work is absolutely necessary or the American core payment system runs the risk of no longer leading the class globally.”
In the meantime, the Fed and U.S. financial institutions can learn by watching what happens as other countries adopt a real-time payment system. In the U.K., for example, in the first year of the switchover, year-end tax payments overloaded the system, which also suffered a high level of fraud in the early stages. The U.S. must make sure there is enough system capacity to handle peak load times and should plan for how to handle security issues while it gets out the “kinks of the system,” Ehmke says.
“We can learn from other countries, but change is affected by habits and we can only learn by doing,” he adds. “This whole thing takes time and it won’t happen overnight.”
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