Can real-time payments make it in the U.S.? The Federal Reserve certainly seems to believe so and has been pushing the idea since 2013, when it released an influential white paper on the topic. In response, major U.S. banks have been discussing the matter among themselves and at industry conferences such as BAI Payments Connect 2015, where it will be prominent on the agenda.
One important aspect of the analysis will be factoring in the experience of other countries, such as the United Kingdom (U.K.), which has had real-time payments since 2008. Speaking at BAI Payments Connect 2015 on March 2 will be Ann Caple, business proposition manager at VocaLink, which runs the real-time payments infrastructure in the U.K. In the following interview, Caple provides some highlights from her upcoming presentation, including some advice for U.S. banks as they consider the opportunities and challenges of migrating to a faster payments system.
Q: What were the drivers for faster payments in the U.K.; why was this effort considered necessary?
Caple: Back in 2004, the U.K. government put together a payment systems task force to look at bringing more competition to our payment systems. This task force issued a report advocating a same-day clearing service because there was demand not only from consumers, but also from certain areas of business, particularly involving the payment of wages. The problem was that paying people a weekly wage didn’t really coincide with the three-day payment cycle here and same-day payment would be more accurate. The task force anticipated that a same day payment service would drive innovation in payments.
Q: And today, what are faster payments used for?
Caple: The banks went further and introduced a near real-time service rather than the same-day service recommended in the report. Initially, when faster payments went live in the U.K., it was a predominately person-to-person payment system for people paying their friends and families as a substitute for cash. But we also found that businesses used it for wages almost immediately.
One of the things that happened rapidly in the U.K. was that some loan companies saw an opportunity to make short-term credits, what we call “pay-day loans.” For the first time, you were able to apply for a loan and then get money in your account within 15 to 30 minutes. More recently, our government has used the service for urgent benefit payments, such as for crisis payments to people who really are short of money. It’s also become popular among small businesses to make trade payments and for consumers to pay bills such as credit cards and taxes.
We’ve also introduced a new mobile payment service, where people can pay each other using just phone numbers, rather than account numbers. That went live in April 2014 and we now have 16 banks offering that in the U.K.
Q: Technically speaking, how does the U.K.’s faster payment system work? How does an individual or business initiate a payment?
Caple: It’s a bank-to-bank payment. Individuals and businesses log on to their Internet banking package, set up the details of the person they want to pay, and instruct their bank to make the payment. Their bank performs the necessary checks and then sends the transaction through to the central Faster Payments infrastructure, which routes it straight to the beneficiary’s bank. The second way is to use your phone to call your bank and they’ll make the payment on your behalf.
And the third way, which I mentioned previously, is to use a mobile banking app to send the payment using the mobile number of the beneficiary as a proxy for the sort code and account number; you just put that information into your mobile banking app on your phone and the transaction goes bank to bank.
Q: Is there an organization behind the scenes that administers the system?
Caple: The Faster Payments Scheme manages the participation requirements, the operational rules and the Scheme members. The Scheme contracts with my company, VocaLink, to run the infrastructure on their behalf.
Q: What challenges did the industry face in delivering faster payments?
Caple: Initially, the idea was to just focus on same-day payments. But the banks opted to go for a faster service, which is near real time. The challenge with that, though, was that on the whole, the banking systems in the U.K. were pretty archaic; most institutions dealt only with batch processing. Moving to something that delivers single payments in real time required major reengineering for a number of the banks, so big cost pressures on them as well.
The second challenge was starting from a blank piece of paper. It wasn’t a case of simply re-engineering something that we already had; we needed a complete design from the ground up. And managing a group of banks to produce something like this is a challenge in itself.
Q: Of course, in the States we have more banks …
Caple: Yes, so it will be even more challenging. However, as with the U.K., I believe that in the U.S., the vast majority of accounts are held by a relatively small number of the largest banks. Once you have the top 10 or the top 20 banks involved, you have roughly 80% to 90% coverage.
There needs to be options available for the smaller banks to participate, but the cost of these options should reflect the size of the customer base and the transaction volumes these banks will generate. It will be incumbent on the service administrator and software vendors to create rules and products that enable even the smallest banks to participate.
In the U.K., we have a tiered banking system. At the top, you have a small number of “member” banks that are directly connected to the central infrastructure for faster payments. Then, we have what we call “agency banks,” whose services typically go through some of these member banks; it’s much more challenging for them to get the near real-time service. So, you end up with a two-tier service for customers where customers of the member banks are able to get payments almost immediately and those with the agency banks would get it same day, but not as fast as the member banks are offering. That has been a challenge, which is largely being addressed now.
Q: Generally, what worked well and what didn’t work so well in your move to faster payments?
Caple: Managing banks is something the industry is pretty good at over here, so we did put in a very strong governance structure. We had a strong steering group, we had deadlines to work to, and that’s absolutely critical. You need hard deadlines, otherwise these things just drift. The regulatory pressure also helped deliver this service in the time required.
One thing that we didn’t do as well as we should have was to engage everybody within the banks. This wasn’t just a payments system build; it also touched many other departments in the bank, such as product and fraud teams. Some of those groups really weren’t engaged at the beginning of the process. We opted for a soft launch with a handful of banks being able to send payments and no brand launch. Each bank set its own limits on the transaction values. Each bank offered a different user experience and there was no ubiquity. Banks may argue that this is an area for differentiation and competition but in reality it leads to confusion among customers. Perhaps, if product people had been involved at the outset as well as payments people, we might have adopted a different approach.
Q: What would be your top recommendations for the U.S. to try to implement something like this, keeping in mind the different regulatory environment and different industry environments?
Caple: There are some basics that need to be thought about.
First, start with the user experience so that this is at the center of the service. One of the things with faster payments is that, you can get money out of people’s accounts very rapidly should you choose to do so. In the U.K., the liability for the payment rests with the sending bank so validating the customer is really important. But there is a trade-off between the layers of security and usability of the service: too little and the customers’ account may be at risk of account takeover while too much and the service becomes too cumbersome to use. Look at ways to design out fraud rather than treating it as an after-thought.
Secondly, consult with a broad range of industry stakeholders, including businesses, payroll bureaus, consumer groups and technology providers to give the best chance of designing a service that provides the most value.
Third, introduce a brand for the service which delivers a consistent experience across the banks.
Fourth, consider the technical formats of the payments. When we built faster payments, we built it on the card standard of 8583 and we did that because ISO20022 really wasn’t a fully formed standard. Going forward, and this is what you see across the world, the majority of systems are now looking at using ISO20022 because this allows greater flexibility in the information that travels with the payment.
Build in open access for all financial institutions so that all customers get the same service and interoperability with other near real-time schemes from the start. In this way, the U.S. could gradually introduce faster payments through a number of schemes rather than one for the entire nation.
In the U.K., we adopted a deferred net settlement approach and banks settle three times a day during the week. This puts a level of risk in the service so the U.K. is moving to a pre-funded settlement model and I’d recommend this approach for the U.S.
Q: Overall, do you think it’s doable in the U.S.?
Caple: Absolutely. Managing all the stakeholders is the challenge and a strong governance model for any project along with some regulatory and consumer pressure would certainly help.
Mr. Cline is managing editor of BAI Banking Strategies and can be reached at [email protected].