US payments reform: evolution versus revolution
When the US Federal Reserve held a consultation last year about implementing a real-time payments system, the plan received a cool reception from banks.
Sensitive to cost and mindful they would end up paying for whatever change is coming, banks questioned the demand for faster payments and suggested other priorities might take precedence for their clients.
Their argument is the US offers much faster payments options than countries such as the UK, which have invested in new payments systems. Wire payments clear in real time and automated clearing house payments clear the next day, so the business case is not as clear as in the UK, which before Faster Payments contended with three-to-four day clearing.
There is always a trade-off between speed of progress and acceptability in the market. Working to build consensus through industry bodies can take time, but builds up acceptance, while a more centrally driven approach is faster, but less likely to enjoy the same level of support among market participants.
Whereas countries such as the UK and Singapore have taken the centrally driven route, successfully developing new payments systems championed by their central banks, this model might not work so well in the US.
The sheer diversity of the US market presents a unique challenge. “There are such a lot of banks, and so many small banks, you don’t have anything like the concentration you see in the UK or Sweden,” says Chris Dunne, payments services director at VocaLink. “Even the central bank isn’t central, but federal, a group of separate institutions.”
Reach is therefore the key issue for success. With thousands of banks operating under a host of different laws and across a number of time zones, it will be a tougher challenge developing a system that works in the US, and demand is likely to falter if customers cannot be confident their bank, or the bank they are attempting to make a payment to, is involved in the new system.
“It is important to learn from our experiences in other markets, but at the same time it is important to recognize that each market has its own unique nuances,” says Sayantan Chakraborty, head of North America payments at Citi treasury and trade solutions. “The lessons learned from dealing with Sepa in Europe, for example, may not be directly applicable in the US.”
The US is more likely to see evolution driven by private industry groups, says Ather Williams, head of global payments and global GTS strategy at Bank of America Merrill Lynch (BAML).
These groups are in the best position to drive a client-centric approach that takes into account market needs, which are in turn critical to the long-term success of any payment innovation. In contrast, centrally mandated system improvements can end up being costly and underutilized, as the extended remittance initiative shows.
ClearXchange, the peer-to-peer payments platform developed by BAML, JP Morgan Chase and Wells Fargo, illustrates how new payments channels can be created without government or regulatory mandate, with financial institutions responding directly to the needs of customers.
Advocates of a more urgent, centrally orchestrated approach concede it will be difficult, but have various ideas about how to mitigate these challenges. One solution would be to start small and build up the system over time, for example sticking with a single state or a small group of states, where a manageable number of banks are operating, and bring others into the system when it is up and running.
“You would need to either have a critical mass in a regional hub like the tri-state area, or else have all the major banks involved,” says VocaLink’s Dunne. “Once you have that level of participation, the other banks would follow.”
However, some view this as unlikely, given even banks with local coverage in terms of their branch networks often have customers dispersed throughout the country. Such an approach might restrict their ability to provide equal services to all their clients.
For the top-10 global banks, the work required to implement a new payments system would be manageable, but for the remainder, which account for a small proportion of the overall payments traffic, the cost of implementing new systems could be prohibitive.
However, that could provide an opportunity for the global banks and third-party processors, says Elena Whisler, director of product management at Clear2Pay, which could manage the back-office functions of payments for the smaller banks on an outsourced basis – if the regulators were happy with the additional concentration of risk this would represent.
Yet most remain convinced an evolutionary, opt-in approach makes most sense for the US market. It would allow participants to experiment with different innovative business applications, with only the most workable ones gaining momentum, says Citi’s Chakraborty, allowing institutions to do what makes most sense for their clients.
Few anticipate a heavy-handed approach from US authorities. “The Fed appears to be leaning towards getting more actively involved in the payments space and is actively driving the discussion, which is really healthy,” says Clear2Pay’s Whisler.
“It has proved itself to be good at bringing groups together and deserves credit in particular for its inclusive approach to the consultation, for involving all the interested parties.”
However, she calls for more work to be done to construct the business case for change, which sectors will be involved and what the benefits to those users will be.
Others agree. “The desire for faster payments is not necessarily specific enough,” says Isabel Schmidt, global head of product management for cash clearing, financial institutions, at Deutsche Bank. “There needs to be more clarity around what exactly is needed and what problems we are trying to solve.
“Do faster payments mean that real-time settlement is required, or is it enough to simply have confirmation of an irrevocable payment in real time?”
What is clear is, even the faster, centrally planned approach isn’t going to lead to imminent change. The Fed itself has an even longer time horizon in mind, having consulted on the basis of a 10-year goal.
“The US is such a large and fragmented market, it could take as long as five years to implement a real-time payments system there,” says Dunne. “I can’t see anything happening before 2019 at the very earliest.”