An alliance of some of the largest U.S. technology firms is pressuring the Federal Reserve to provide a real-time payments system for consumers and businesses, one that would radically transform the way money is currently exchanged by banks.
The union of tech companies, called Financial Innovation Now (FIN), includes Apple, Amazon and Google, and payment providers such as PayPal. Noticeably absent from the list is Facebook.
However, with Facebook’s recently announced plans to launch Libra, a digital currency, the U.S. payments sector, traditionally the domain of regulated banks, is fast becoming a contentious battlefield. If anything, Libra is perhaps having the unintended consequence of concentrating minds in both the private and public sector on how to speed the transition to a real-time network. “What we need is an improvement in the payments and exchange system and not necessarily a new currency,” Richard Levich, professor of finance and international business at NYU’s Stern School of Business, told Regulatory Intelligence.
Bank responses to the idea of a Fed-developed payments network are divided, with smaller banks receptive but bigger banks wary.
2015 Faster Payments Task Force
The backdrop to the current debate has its roots in 2015, when the Fed convened a “Faster Payments Task Force” whose remit was to “identify and assess alternative approaches for implementing safe, ubiquitous, faster payments capabilities in the United States.”
As part of that effort, 300 organizations representing consumers, businesses, banks, card companies, and technology providers came together to define expectations for the future of the retail payment system and to make recommendations on how to implement those expectations. The most important message the task force had for the Fed is that it needed to develop a 24/7 settlement system. The U.S. Treasury echoed this theme in its own study late last year.
On the back of the task force recommendations, the Fed in December 2018 said it would consider developing its own real-time settlement system that would compete with private sector solutions and asked for public comment.
Current ACH system inadequate
Under the current Fed network that handles card payments and direct deposits, called Automated Clearing House (ACH), transactions are settled three times a day and only during business hours. Last week, FIN urged the Fed to extend daily operating hours for “Same Day ACH,” while continuing to advocate for a real-time settlement system run by the central bank. “FIN supports the proposed extension of daily operating hours for Same Day ACH and believes it will bring substantial benefits to consumers and small businesses that use the ACH Network,” the alliance wrote in a letter to the Fed.
“FIN strongly urges the Board to act as soon as possible in issuing a final rule, without further delays. If it is to continue adequately serving the economy and consumers, the U.S. payments system needs to evolve in many ways,” said FIN. The group stressed that a real-time payment infrastructure was particularly important for those individuals and businesses seeking to avoid higher-cost credit alternatives.
“While FIN strongly supports the Fed operating a real-time gross settlement service, FIN agrees that the expansion of Same Day ACH must continue separately on its own,” said the alliance.
Large banks develop alternative real-time system
Responding to the 2015 task force call, large banks, under the auspices of the The Clearing House, a private sector system that operates an electronic check clearing and settlement system, began work on a real-time system. According to industry participants, what has evolved is a real-time system that is run by large banks, mainly for large banks. Community banks, merchants, and fintech firms currently don’t have access to the service operated by The Clearing House.
In response to the Fed’s decision to consider building its own payment system, the Business Policy Institute (BPI), the advocacy arm for large banks, many of whom are behind the Clearing House real-time system, said it would be wrong for the Fed to get into the payments sector at this late date. “The private sector has met regulators’ demands to develop a safe, efficient and equitable real-time payment system accessible to all financial institutions. A government-run real-time payment system is unnecessary and will harm, rather than advance, regulators’ goal of faster payments by 2020,” said BPI in a policy paper. “The Federal Reserve should not develop a separate real-time payments system. Doing so would slow and potentially disrupt consumer access to real-time payments.”
One of the concerns the Fed might have in building an alternative system is the impact it would have on bank earnings. Facilitating payments has long been a core function for large U.S. banks. Should the Fed implement its own system, banks might see a good chunk of their earnings go away, and potentially lead them to make up the lost revenue through higher prices and fees for other services, say analysts.
But supporters for a Fed network say the time has come for the regulator to provide a payments system that is more akin to a utility. Moreover, with technological pressure coming from the likes of companies like Facebook, one way to diffuse such ventures would be to meet the issue head on — reduce the “friction” in consumer payments that has long been an unwelcome feature of the U.S. payments system. Some industry leaders acknowledge that the consumer space is where there is an opportunity for a massive overhaul. Last week, Michael Corbat, CEO of Citigroup, said he recognized that digital currencies could take out so-called “friction” or layers of costs in the payments world, and acknowledged that the entry of such currencies into the global financial system was only a matter of time.
“As I think of things like Libra, it’s not a question of if, it’s when the digital currency comes; it’s a question is that currency one that kind of operates as a consortium, or is it a Federal Reserve, or is it a central bank-backed type currency?” Corbat told bank analysts on an earning call.
Smaller banks advocate for Fed solution
Perhaps the most vocal advocates for a Fed solution are community banks who see themselves at a disadvantage should the Clearing House network be the sole game in town. In a new op-ed piece, Rebeca Romero Rainey, CEO of the The Independent Community Bankers of America, said: “A Fed-operated real-time settlement system is consistent with the roles it already serves in providing integrity, safety, transparency, equitable access, and ubiquity for checks, ACH payments, and wire transfers to nearly 11,000 financial institutions of all sizes and charter types. The Clearing House simply doesn’t have that kind of reach.”
“We can’t afford to leave it in the hands of a private monopoly, especially one that does not have a proven track record of reaching smaller banks,” Rainey added.
Fed decision expected soon
When asked to comment on whether the Fed was nearing a decision, a spokeswoman for the regulator declined comment. The last public remarks by a Fed official on payments was an October 2018 speech by governor Lael Brainard, who appeared to support the development of a central bank-run real-time settlement system, seeing benefits to the public and other private sector networks. “The development of a nationwide real-time interbank settlement infrastructure could also support the development of private- sector faster payment services, thereby increasing innovation and choice in the market,” said Brainard. However, in a presentation last week on cryptocurrencies, St. Louis Reserve Bank president James Bullard waded into the debate, arguing that a solution was needed to facilitate faster payments, but it was not a new digital currency.
“Cryptocurrencies may unwittingly be pushing in the wrong direction in trying to solve an important social problem, which is how best to facilitate market-based exchange,” Bullard told a New York gathering of central bankers and academics.
Industry sources familiar with the central bank’s thinking said a decision will be announced soon. “I think they are very close to a decision and the support has been overwhelming,” said a partner at a Washington D.C. law firm.
Banking sources said an analysis of the more than 400 comments submitted in the Federal Register to the Fed’s public outreach showed that over 90% supported the Fed operating a faster payment service alongside the existing private-sector service.