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August 13, 2019

CQ: Fintech Beat by CQ: The real-time payments debate

The U.S. payments architecture is antiquated, and the Fed will be launching a “real-time payment” platform. However, big banks have been developing their own private platform and are resisting the measure.

Competition between a Fed-based system and the big banks may ultimately lead to the best outcome for small banks and consumers.

Ultimately, however, swifter payments might assist the underbanked — those who already have access to basic banking services, though not an optimal suite of services — but may do little to help the unbanked.

One of the biggest problems facing the working poor is living paycheck to paycheck. And it’s not just because finances are tight and they worry about having enough money to pay the bills. It’s also because even if a check is coming in and is deposited at a bank, it may not clear and become available for several days, which can matter if cash-strapped workers need the money for essentials — from rent to daycare to school loans. The only workaround is a direct deposit, which can still take a day to clear, and more on weekends. When pay gaps arise, payday lenders tend to step into the breach, charging those who are already cash strapped double-digit interest loans.

The slow speed characterizing the U.S. payments system has made it a real anomaly. Other countries have real-time payment platforms, where funds can be transferred nearly instantaneously. But the United States doesn’t, and only last week the Fed announced its intention to launch a system capable of making bill payments, transfers and paychecks instantly available — aiming for a launch date of 2023 or 2024.


Why the U.S. is behind

Brookings economist Aaron Klein has argued that the roots of the problem lay in laws based on outdated legacy infrastructures and (surprise!) politics. Decades ago, Congress gave the Fed the power to set withholding times for payments, and currently banks are subject to a multiple-day cap reflecting 1970s-era technology. But technology has changed, and, as Klein has noted, the Fed could change its regulations and mandate real-time payments; after all, real-time payment is already used by the 50 or so largest banks in the U.S. This is a mandate that is possible.

One theory as to why upgrades have been so hard to come by has to do with the Fed’s own (potentially conflicted) interests. The Fed isn’t just a regulator, but also operates the Automated Clearing House payments system. Devised in the 1970s, the ACH system does not facilitate real-time payments, nor can it be easily modified to do so.

Klein has noted that transitioning to a new payments infrastructure is also difficult, so the Fed has tried to speed up the ACH to operate on the same day at least for the East Coast — those operating out West would have to wait at least a day, or more.


A new Fed approach?

The payments problem has led to all kinds of companies seeking to provide their own solutions. For example, Facebook’s Libra cryptocurrency, which was rolled out in a white paper last month, isn’t trying to solve this domestic payments problem per se, but it is aiming to set up an infrastructure whereby international payments can be processed “instantaneously” and at low cost everywhere. (The problem, however, is that holders of the coin would earn no interest on the money they give to Facebook and its associates, making the project the equivalent of a no-interest deposit).

Sens. Chris Van Hollen of Maryland and Elizabeth Warren of Massachusetts, along with Reps. Jesus “Chuy” Garcia of Illinois and Ayanna S. Pressley of Massachusetts, have argued that the Fed itself needs to create its own real-time payments system. The four Democrats introduced legislation in late July that would mandate the Fed create an around-the-clock, real-time payments system enabling customers to access funds seconds after a check is deposited or a wire transfer finished. The Fed is not unaware of the challenge and in 2013 acknowledged that real-time payments could help people avoid late fees, overdraft penalties, and more. And in 2015, the Fed launched a task force to facilitate a real-time system, though it demurred from launching its own private system unless necessary. The work has now culminated with a 4-1 vote by the Fed to upgrade the payment system.


Big banks aren’t impressed

But there is some resistance — not only because of the government-led nature of the legislation, but also because an industry group consisting of the largest banks, called the Clearing House, which operates its own payment system, has prepared to make way for its own real-time payments platform. And even at the Fed, Randal Quarles, the lone dissenting voice, reportedly queried whether or not it was justified for the Fed to move into the space where “viable private-sector alternatives are available.”

Regional banks tend to disagree with their larger global counterparts, however, and many voiced their own concern that the Clearing House could end up penalizing smaller financial institutions. The big banks, meanwhile, are concerned that the entry of the Fed could complicate their own entry into the business.

My view on these things is that I can’t see why the two approaches can’t coexist. Indeed, competition may be quite beneficial. Historically, the Fed system has not exactly been responsive to the demand (or need) for reform.  Meanwhile, I’m not convinced that a conglomerate of big banks will be seeking the lowest-cost fares and fees for small banks or their customers. Instead, they may well be incentivized to either raise prices like any other oligopoly or grow their businesses that protect native business lines. Having healthy private-public competition play out, between two institutions that have the scale to really drive down costs for everyday people, seems like a good outcome for everyone.

Still, it’s entirely possible that there may be more than a little hyperbole on both sides as well. For all of the benefits of a payments system, the real financial services problem hampering financial inclusion is that not enough people have deposit accounts — or regular sources of income to support no-fee, deposit-account minimums. So swifter payments might assist the underbanked — those who already have access to basic banking services, though not an optimal suite of services — but it may do little to help the unbanked. Finding the right policy for this especially vulnerable subset of people, which account for about 8 percent of the U.S. population, will require not just technological innovation, but also a clear-eyed pragmatism about how a broader array of reforms will be required to open the doors of financial access more fairly.