Why The Fed Will Create Its Own Real-Time Payments System

Prediction — The Federal Reserve will announce before Labor Day that it will build a real-time payment system to offer an alternative to the system that has been started by TCH and Mastercard using the Vocalink technology it acquired when it bought the company.

The UK implemented a faster payments system 10 years ago. Admittedly the country has a far simpler banking system with just a handful of major banks. It also has a regulator that takes a far more active role in promoting consumer interests vs. banks than the Fed does.

Major U.S. banks have blocked real-time payments for years, mostly obviously in 2011 when they voted against making the ACH system real-time. See Kevin Wack’s article in The American Banker

The reasons aren’t clear because the banks haven’t tried to justify their anti-consumer stance. However, among the reasons usually discussed are that they don’t want to reduce their income from wires, they make a lot of money from overdraft charges, moving to real-time is an obvious expense with no obvious increase in revenue, and they would cut into their earnings from financing payday lenders.

Why change now? Sheer embarrassment that banking systems around the world — from Australia to Mexico —have achieved real-time payments? Maybe, if you thought that bankers whose behaviors have led to billions in fines and compensation payments were truly capable of embarrassment.

More likely they are aware that the Fed, which has pursued a strategy of consultation and cajoling for years, may eventually run out of patience.

And they’re not exactly leaping to real-time. TCH says that about half the accounts in the country are already connected to real-time payments, but that is more a commentary on the degree of concentration in banking than evidence of a drive to real-time. Fewer that half the TCH members have implemented some level of real-time payments and they have no deadline.

How long will the Fed let this continue?

In response to the Fed’s request for comments, the Congressional Black Caucus wrote that “Delay is costing Americans billions of dollars they do not have and contributing to the growing income inequality that the Fed rightfully agrees is harming our nation. Specifically, research conducted by the Brookings Institution, Pew Charitable Trust, Center for Financial Services Innovation and others has illustrated the prohibitively high costs of our nation’s slow payment system and the sizable benefits for communities of color that would begin to accrue savings from adoption of real time payments. The increased prevalence of overdraft fees, high cost small dollar credit, and check cashing has cost our constituencies tens of billions of dollars that a real time payments system would help ameliorate.”

Estimates of those costs run to about $10 billion a year, or as Brookings noted, the delay has cost Americans $100 billion in fees since the UK went to faster payments more than 10 years ago.

Other than TCH, just about everyone else involved in commerce and payments, from convenience store associations to the NRF to Walmart and Amazon and community banks, wants the Fed to set up a Real Time Gross Settlement System RTGS so they won’t have to depend on a system run by the big banks. NACHA would prefer a bigger role for itself and BAFT thinks it would be fine for the Fed to wait a few years and see how the TCH solution works.

TransferWise noted that in many respects “banks are subsidized by governments and protected from competition and they enjoy exclusive access to the payments system. When firms face excessive barriers to entering a market competition stagnates, prices remain high and innovation remains low.”

And it specifically said access to an RTGS should not be limited only to banks, a position also endorsed, not surprising, by Amazon.

Consumer Reports said that “the payment options available to most Americans are dated and inefficient, due to complexities and lack of competition at a systemic level…non-bank providers like PayPal were early to build a system that met consumers’ need for a way to transact person-to-person over the internet. Only after consumers flocked to these services were traditional providers like major banks motivated to develop similar services. “

One big change over the five years the Fed has been studying (dawdling) is that the House of Representatives now has a Democratic majority and Rep. Maxine Waters is chair of the banking committee. Lower costs for banking services as a campaign platform? Socialist subsidies for big banks? Privatizing the profits, socializing the losses? Edit to see if it fits on a bumper sticker.

The three former Fed payments experts who comments made several arguments for the Fed to develop a RTGS. One is that in a crisis, the Fed is the financial resource the country depends on. If the TCH system freezes and the Fed doesn’t have an alternative, as it has with Fedwire and the Fed ACH, what could it do, and how long would it take to get authorization?

Another, as Bruce Summers noted in a detailed commentary, is that payments are moving to real-time and digital, pushed by the growing use of smartphones for banking. If the Fed doesn’t develop its own RTGS it could be left with check processing and its ACH, not exactly the cutting edge in payments.

““If the Federal Reserve banks don’t develop and take an operational role in faster payments then their competency will further deteriorate. They are at a tipping point…If the Fed doesn’t participate in this it will be really left behind, and then it will be too late for society to rely on the Fed going forward over time…if the big banks had complete control over the digital payment system and we have another crisis we will be in double jeopardy.”

And besides being trusted by community banks, which provide small business and agricultural loans and are core assets in their communities, the Fed is already connected to banks across the country, while TCH is not.

The Fed can do it — it has the technical skills and the connections and trust of banks of all sizes.

Thomas Hoenig, former president of the Federal Reserve Bank of Kansas City and a member of the Federal Reserve Banks’ Technology and Financial Service Policy Committees, said the U.S. needs to upgrade its payment system, starting now.

“We should stop talking about it and start moving forward on it…the Fed with a nearly 100 year history in payments has the infrastructure, knowledge, technical capability and is the more transparent in price, as we learned in check and in ACH.”

The links below go to the Fed comments page, and to the six articles I have written on this, which provide a fairly quick overview of the issues.

The Fed comment pages

Google And Amazon Favor Fed Role In Real Time Payments

The Benefits to consumers

What retired Fed payments experts have to say

How community banks don’t trust TCH and want the Fed to provide RTGS

Merchants of varied sizes want a Fed RTGS

The TCH argument

And take a look at “How the Other Half Banks” by Mehrsa Baradaran, a very impressive book that looks in depth at how many people are left out of banking. She proposes postal banking, which I think is a look backwards — smartphone banking would be a useful alternative. It is a great book, and as perhaps only a university press could, provides pages of detailed footnotes that will be a boon to anyone looking into these issues.

See also Mayra Rodriguez Valladares in her detailed coverage of these banking topics.

Great article about Mehrsa and her sister, Shima, who is also a law professor and leaving Iran at 6 and 8. And if this interests you at all in Iranian culture and learning, at least take a look a “Reading Lolita in Tehran” by Azar Nafisi.


About Tom Groenfeldt

I write - mostly about finance and technology, sometimes about art, occasionally about politics and the intersection of politics and economics. My work appears on Forbes.com and International Finance Magazine. The Financial Brand ranked me 20 on a list of the top 25 global influencers in financial services and Jay Palter included me in his list of 250 fintech influencers to follow in 2016 http://bit.ly/1SSRXC6
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