Why the Fed Needs to Offer a Real-Time Payments Alternative
The U.S. continues to be an embarrassing laggard in payments. While the rest of the developed world spent the last 25 years implementing Chip & PIN to reduce fraud, the United States continued to rely on signatures and magnetic stripes. That was the equivalent of the world migrating to personal computers, while Americans remained loyal to the typewriter. Remarkably, while we have begun to use Chip based cards we are still signing for transactions at the POS. In the payments world, we just can’t seem to give up the typewriter no matter how hard we try.
This pattern also is playing out with real-time payments. We live in a 24/7 real-time communications world, yet injecting that technological reality into our payments system is proving to be remarkably difficult. Once again other parts of the world are leaping ahead of the United States. In China, retailers and taxi cabs are using QR codes for real-time payments with consumers using their cell phones to scan the QR code. Payments are happening in real time without chip cards or terminals. Europe is also beginning to introduce real time payments that flow through 21st century POS terminals.
So how does the U.S. payment system stack up in real-time payments? Before we answer that question, it is helpful to define what we are talking about. FIS, which publishes an annual “Flavors of Fast” report on real-time payments, defines the term as “inter-bank fully electronic payment systems in which irrevocable funds are transferred from one bank account to another, and where confirmation back to the originator and receiver of the payment is available in one minute or less.” Using that definition, real-time payments are virtually non-existent in retail payments in this country.
That leads to the next question, is anything being done about this? Unfortunately, the answer is “not enough.” There is an ongoing debate about whether the Federal Reserve should offer a set of real-time payment rails to introduce this functionality to American consumers. This debate, interestingly, pits retailers, small banks, and the tech industry against the networks and the largest banks. Retailers are looking to spur alternative payment systems that bypass traditional network rails, and a Federal Reserve set of connections could help facilitate that much needed competition. The technology sector, for their part, seeks a low cost model that will enable them to capture the potentially lucrative data that is currently controlled by the banks.
By contrast, the firms that dominate the current payment system – the networks (especially Visa and Mastercard) and the large issuing banks – predictably, are opposed to a Fed real-time payment system. The other major opponent to a Fed-operated real-time payment system, The Clearing House, is owned by those same large banks, has launched its own real time payments system, and just so happens to compete with the Fed as an ACH operator. Their opposition is pretextual, pure and simple. They claim that Fed involvement is unnecessary because the innovation required to bring faster payments to the U.S. is already well under way. They also claim that a Fed system will “delay ubiquitous adoption, complicate and inhibit interoperability, and result in lower volumes but higher costs to the industry and end-users”.
Coming from firms that are doing everything in their power to preserve the interchange model, these arguments are a little hard to swallow. Interchange imposes excessive and unnecessary costs, while reducing banks’ incentives to innovate in retail payments. That model is the reason why a fraud prone system has been perpetuated in this country to the detriment of American consumers. The costs of the interchange model are not only borne by merchants and their customers, but also by smaller banks that do not control the payment system. It is telling that, while Visa and Mastercard and the big banks have developed (or acquired) real time capabilities, they do not currently intend to extend those capabilities to domestic retail payments. Visa Direct, Mastercard Send, and TCH’s Zelle products focus on use cases such as P2P, bill payments, disbursements and cross-border, but not traditional consumer-to-business payments.
The reason why is simple – they want to protect their golden goose, interchange. That is the only reason the U.S. has always lagged behind the rest of the world in payments security and efficiency. And that is the reason why the Fed needs to introduce a faster payments option in this country and do so fast.