Spurred by mobile expectations, the Federal Reserve works to make high-speed payments the norm
By Cary Whaley
There’s an app for the iPhone that lets you find out in real-time where your friends are located, anywhere in the world, like the package-tracking apps provided by shipping companies, but for people. Meanwhile, there’s another mobile app that lets you check on how many items of a given product many stores have on hand before you make a shopping trip out of your way.
While the widespread use of online and mobile channels is attributed to the millennial generation, a generation that cannot remember life without online and mobile technology, people of all ages have embraced this technology and use it day-to-day. This mobile technology comes with the expectation that it is highly connective and allows for instantaneous responses.
Except, of course, in the payments world. For instant payments, card numbers, dates and CVV (Card Validation Value) data need to be entered along with all sorts of details, or an account’s information needs to be turned over. The wait can seem long enough to watch the seasons change. PayPal states on its website that a funds transfer to a bank account “takes three to five days, depending on your bank’s policies.” (So that’s what it sounds like when a bank gets thrown under the bus.)
While all payments stakeholders including PayPal contribute to the overall speed of electronic payments transactions, financial institutions have to ask if traditional batch payment systems will remain relevant in a society that increasingly has real-time payment expectations. The Federal Reserve Banks have taken notice and are beginning to take steps to ensure no part of the mainstream U.S. payments system is left behind. This past fall the Fed began leading a public dialogue on the topic with a series of industry presentations, town hall meetings and a “request for public consultation on payments system modernization.” Responses to the request for public comments were due this past December.
The Fed received and published more than 200 responses from all sectors of the market, including banks, technology providers, merchants, consultants and others. This spring it also published a companion piece of end-user research that focused on consumers and merchants. That document was released late in 2013 along with an analytical summary of the responses.
Most of the public comments the Fed received on encouraging a faster payments system revealed a broad range of opinions about what specific role the Fed should play, ranging from active development and operation to only taking a regulatory role to only driving the discussion. Broad agreement was also indicated that the discussion should be expanded to include regulatory aspects of payments processing and a focus on ensuring that the payments system does not overlook consumers not using mainstream banking services. This is an important segment since these consumers don’t easily fit other models, and if overlooked they will continue to use nonbank services such as money transfer services and check-cashing stores.
One of the most startling points of survey was that consumers would like to see their accounts debited more quickly after transactions have been initiated.
The public comments that the Fed received showed there was general agreement that 10 years was too long to make the changes happen. While large banks tended to align with a cautious, measured approach to change, merchants and others want to accelerate the process of fostering faster payments. Overall, support for a faster payments system has clearly been demonstrated. Those outcomes have been initially defined by the Fed of ubiquity of access, improved payment speed, more timely payment notification, speedier confirmation of good funds at payment initiation and the ability to send payments without account information.
Opinions surrounding the role of merchants in the process were among the most polarized. Merchants that responded to the Fed’s consultation paper felt strongly that they should have a seat at the table, while most banks wanted to ensure that the payment franchise remained in a safe, secure and well-regulated banking system. Similar sharp divisions appeared over whether point-of-sale transactions should be part of the discussion.
When it came to solutions, many of the technology companies pointed to offerings that are already available, while banks generally felt that more research, study and discussion were necessary to define acceptable solutions.
The responses to the Fed’s consultation paper and its surveys also revealed little consensus over how a faster payments network should operate or what should be done to ensure good funds—essentially the assurance that a transaction could be acted on, such as for cash dispensed and goods shipped. This could largely be due to different perspectives on the payments marketplace. Understanding of the operation of different types of payment messages and the use and timing of acknowledgements varied widely. The functions of clearing, settlement, posting and notification were also understood by different audiences.
The Fed’s survey revealed broad discomfort with how account credentials are handled, both on the consumer and merchant side. Considering all of the recent breaches and resulting card reissue activity those concerns are not surprising.
One of the most startling points of survey was that consumers would like to see their accounts debited more quickly after transactions have been initiated. It seems the market feels that confusion resulting from delays between transaction origination and posting costs more than the benefits of float. So maybe float really is dead.
Notification through posting
The views of participants in the Fed’s faster-payments research and discussion were often revealed through the way they used a payment network’s functions. Survey respondents that had concerns about notifications were generally more familiar with older processing methods, like ACH, in which the originator assumes the process is successful unless notified otherwise. Participants from the card and EFT world that are familiar with almost instantaneous acknowledgement of transactions did not raise the issue.
Another aspect of this same debate is clearing, settlement and good funds. Clearing is generally defined as the processes that occur between transaction initiation and the final transfer of value, usually called settlement. In the ACH and check world, the clearing processes consume significant time due to their batch nature. Because returns flow through the same channel, the transfer of value cannot be ensured until after the return period expires, even though the bank receives value for the transaction at settlement.
The instant validation of good funds in a card or EFT model actually occurs before settlement, which is usually an end-of-day event. Banks operate on that assurance of good funds, and it is up to the receiving bank to secure funds, either by posting or some other means of debiting the customer’s account. Wire transfers are the only transactions in which all of these things happen at once, and the overhead associated with processing, acknowledging, clearing and settling each transaction individually keeps them in a necessary but expensive class by themselves.
How are things unfolding?
As public feedback was reviewed, the Fed decided that a deeper dive was necessary. It conducted further research on end-user demand, as well as performed a soup-to-nuts assessment on all aspects of faster payments, including design principles, use cases and design options.
The Fed’s research on end-user demand concluded that faster payments are preferred. When presented with a choice between payment speeds of instant, one hour to 12 hours, 12 to 24 hours, or two to three business days, 69 percent of consumer payers and 75 percent of business payees preferred instant or one-hour payments speed. More than 70 percent of consumers and 80 percent of businesses stated that it is important to receive timely notification that payment has been made and of when the payment was received by the payee. Additionally, 75 percent of businesses and 33 percent of consumers expressed willingness to pay a fee for payments that have faster availability to the payee.
The Fed’s faster payments assessment aims to identify target use cases for faster payments, develop design options for improving the speed of the U.S. payment system, assess each design option, including business and technical requirements, and provide implementation plans for the path forward. The assessment identified ubiquity and access, speed, security, efficiency and cost, and flexibility as the key design principles for faster payments.
The Fed’s assessment concluded that there were five use cases, comprising 12 percent of total payments, that could benefit from faster authorization and clearing:
- business-to-business payments with ad-hoc low value (just-in-time supplier payments);
- business-to-business payments with ad-hoc high value (current claims, legal settlements);
- person-to-person fund transfers (gifts or person-to-person reimbursements);
- business-to-person payments with ad-hoc low value (temporary employee wages); and
- person-to-business payments with ad-hoc remote requirements (emergency bill pay).
While 12 percent may not seem like a critical mass, these use cases are key drivers. According to the latest Fed payments study, businesses and person-to-person payments account for a significant volume of the checks still written, a volume that will likely migrate to digital payments if the Fed’s effort succeeds. The person-to-person and ad-hoc areas are also likely to grow as the millennial generation imprints its behavior patterns on the payments system.
The Fed excluded point-of-sale payments as a possible use case for a near real-time payment system, although many participants at the Fed’s town halls urged it to consider bringing this into the scope of the near real-time payment system. On the other hand, electronic commerce transactions, especially those that don’t involve a card, are considered another area of interest for these improvement efforts.
The Fed’s design-option assessment identified nine design options that fit into three broad categories: 1) evolve the existing payments infrastructure, 2) leverage the emerging payments infrastructure and 3) build a new payments infrastructure.
The Fed also targeted four models for additional evaluation:
- evolve ACH to same-day capabilities;
- evolve ATM/PIN debit infrastructure to leverage existing real-time functionality;
- direct clearing between financial institutions using common protocols and public IP networks; and
- build new infrastructure to support faster payments:
- a single-item clearing infrastructure that leverages existing payment systems for settlement (e.g., United Kingdom’s faster payments initiative);
- clearing settlement platforms for retail payments; and
- clearing and settlement platforms for all payments (e.g., Australia’s new payment platform).
While accelerating ACH seems to be an appealing option there are inherent problems in leveraging it for near real-time processing. The time required to provide a full cycle of presentment and return-batch transactions to ensure good funds will almost certainly not be fast enough for the market. Modification of the EFT networks can achieve the goal of good funds, but there is debate about whether the message format (ISO 8583) is robust enough to handle the information requirements of business transactions and consumer transactions like bill payment. A direct clearing model may present challenges to smaller banks, since the cost to adopt an entirely new model is fairly inflexible. What makes business sense for the nation’s largest banks may be cost-prohibitive to community and regional banks, and ubiquity is a critical factor for success.
Since new infrastructure will need to be built to support faster payments, the question is whether the industry should build a limited solution, such as the system in the United Kingdom, that solves one or two use cases or develops a clearing and settlement platform for all five use cases (e.g., Australia’s new payment platform). The Fed seems to favor a new build approach mostly for these reasons. The next few months will see debate on this issue.
In June 2014 the Fed held another series of town hall meetings to vet the results of the end-user study and faster payments assessment with all payments stakeholders. It is planning to release a faster payments white paper in September 2014. This would put the Fed on track to release initial design specifications in mid-2015.
The question is whether that is a fast enough path to faster payments. Momentum is accelerating toward this idea and all payments stakeholders need to mobilize to build the necessary infrastructure to support faster payments. While short-term expenditures will be required from all stakeholders, the strategic case is compelling.
ICBA strongly supports the Federal Reserve as it strives to improve the payments system to meet the needs of consumers and businesses.
At its town hall meetings, the Fed proposed the creation of a number of groups to encourage industry participation and stay aligned with stakeholders. These include a faster payments council, a directory working group, a business-to-business vendor council, a payments security council and a mobile payments security working group. Each group would be expected to provide input and content on their designated area. ICBA plans to coordinate member representation on these groups to ensure a balanced perspective.
ICBA strongly supports the Federal Reserve as it strives to improve the payments system to meet the needs of consumers and businesses in a dynamic and innovative environment of commerce fueled by the emergence of smartphones, tablets and other mobile devices. While this is a costly effort, it provides all financial institutions the opportunity to be relevant participants in payments for generations to come.
The Federal Reserve has chosen a good time to step into the debate and add an element of leadership in the payments market. Its involvement provides significant assurance that whatever solution the market settles on next, it will be ubiquitous, safe and effective for the millennials and other online and mobile commerce adopters.
Cary Whaley (email@example.com) is ICBA’s vice president for payments and technology policy. Whaley serves as staff secretary for ICBA’s Bank Operations and Payments and is ICBA’s expert on the online and mobile delivery of financial services and payments. His expertise ranges from checks, debit and credit cards, and ACH transactions to currency/coin, patent infringement and emerging electronic payments.