US consumers may be calling for real-time payments, but progress has been slow, with the industry’s payments evolution only at ‘the end of the beginning’, according to the American Banking Association. 

Apple Pay may have caught the attention of the financial technology world, but in some ways Apple’s foray into payments is not particularly innovative. Apple has not created a new payment type, but rather changed the user interface so that consumers can now use their iPhones to make payments from their debit or credit card.

Behind the scenes, the transactions still run along the existing payment card rails, which, to consumers may seem like an instant payment. But, as Gareth Lodge, a senior analyst at Celent notes, a retailer accepting Apple Pay may not receive the funds until up to three days later.

The calls to create a real-time payment system in the US are getting louder as consumers demand more. Meanwhile, other countries such as the UK, Sweden and Poland have already implemented faster systems. With real-time payments, an individual can send money from their account and the recipient can access the funds almost immediately. With transactions moving in this way – rather than the days it can take for other payment forms – the wheels of the real economy are oiled, speeding up economic activity as individuals receive and spend money faster.

Old and clunky

Mr Lodge notes that, of the three major retail payment types in the US, cheques and cards have been invested in and are some of the most modern systems in the world. The automated clearing house (ACH) for bank-to-bank payments, however, is one of the “oldest” and “clunkiest” systems.

Steve Kenneally, vice-president in payments and technology policy at the American Bankers Association (ABA), defends the current state of the ACH payments infrastructure. “It is dependable, it is true, it is tested and it works. It has great reliability – you do not hear about people’s payments getting lost or misdirected,” he says.

The system may be dependable and low cost, but it is not real time. Mr Kenneally notes that there has been a change in the industry, which is now looking at faster payments as a question of not “why or if, but how and when”.

The how and when are major challenges for the US, which has numerous payments networks – with competition between them – as well as competing payment types. Mr Kenneally notes that there are about 15,000 banks and credit unions in the US, which makes the move to a new system challenging. “The value of any network is that it is based on 100% participation. We have to make sure that all of them buy into the solution and it has to make some sort of economic sense for all of the participants,” he says.

He describes the current stage of progress for the industry as “the end of the beginning” and there have been a number of initiatives working in the direction of real-time payments.

Improving efficiency

The Federal Reserve has been pushing for the speed and efficiency of payments in the US to be improved and in September 2013 released a consultation paper, inviting the industry to respond and make suggestions of how US payments could be improved.

Under the current system, payments on the ACH are settled the day after they are initiated. Earlier this year, Nacha, a payments association representing financial institutions which establishes the rules for the ACH network, announced it would move towards settling payments on the same day as they are made. This would be achieved by introducing a number of settlement periods and increasing the number of batches that are processed throughout the day. This will not be creating a new real-time system, but rather speeding up an old one.

This was the second time for Nacha to propose same-day settlement after an initial vote in 2012 rejected the proposals. Smaller banks were reportedly in favour of the move to same-day settlement, but large banks blocked the vote. Some commentators believe the large US banks fear that accelerating ACH could cannibalise revenue from other payment networks – such as wire transfers for large-value payments – which are already faster.

However, one senior banker familiar with the rationale of the big banks’ voting says the initial Nacha proposal was rejected because it did not make sense economically. He also notes that the cannibalisation of the wire transfers does not feature in decisions about speeding up the ACH payments as the wire is a different proposition. Mr Kenneally at the ABA says the main reason the initial Nacha proposal for same-day settlement was rejected was because the business case was not developed. The latest proposal, however, includes a lot more economic research.

To real-time payments

The ACH network, which is typically used for scheduled payments, such as payroll or direct debits, is a low-cost network. As is common in the US, there are competing payments networks, with the Clearing House, a private sector company owned by some of the largest US banks, operating another interbank network that competes with the ACH.

In October this year, the Clearing House announced plans “to undertake a multi-year effort” to build a real-time payment system. Steve Ledford, senior vice-president for product and strategy at the Clearing House, explains that the planned system would be used for peer-to-peer payments, immediate bill payments, payroll, other payments from companies to individuals – especially when there is a need to do so quickly – as well as business-to-business payments, which will help speed up payments in the supply chain.

This would be a new set of payment rails for the US. “We are not going to do a simple upgrade,” says Mr Ledford. Some observers were sceptical about the Clearing House’s announcement, commenting that a 'multi-year effort' seemed too long compared with real-time projects in other countries.

However, the US has a lot more financial institutions than other countries, adding to the complexity of the project. Mr Ledford explains that the new system has to be affordable for institutions of all sizes. “When you deal with real time you want to make sure you are doing it in a way that is safe and secure,” he says.

Mr Ledford explains that a lot of work has gone into the technical specifications of the system and establishing what it needs to do. The project will take many years because the financial institutions linked to the system will also have to upgrade their systems – online, security, risk management and so on – so that they are in real time as well. “It is not just the requirement to build the system and create the infrastructure. A lot of work has to be done by financial institutions,” he says.

When asked about the Clearing House’s schedule for the project, Mr Ledford is reluctant to give a timeline until he has a better idea of what shape the project will take.

Shape of the system

One senior banker, who is close to the developments at the Clearing House’s project, says there is still a lot of discussion among bankers about the business case for real-time payments. While the demand for faster payments is growing, many bankers do not have a clear idea about the form the new system should take, he says.

While bankers in the US grapple with the business case, there is a question of whether, if left to market forces, the new system will actually be built. In the US, there is no mandate to force banks to provide real-time payments, although the Federal Reserve has pushed for it. Bankers in other countries – such as the UK – have been pushed into action by regulators, but Mr Lodge notes in a Celent report that this is not a prerequisite; Sweden and Poland have created real-time systems without the intervention of regulators.

Mr Kenneally notes that banks will be considering not just the business case of real-time payments, they will also be thinking strategically; could a non-bank leapfrog the existing system with an alternative? Despite this, he says, banks “still need to have an idea of what the return is going to be”.

With changes to the ACH and the building of the Clearing House’s new network, it is the banks that will bear the cost in both cases. With multiple networks that compete with each other in this way, it might not make sense economically for the major banks to invest in upgrading and improving two different systems. A bank could potentially put its volume through just one of the clearing houses, says one banker.

If the Clearing House goes ahead and is the only real-time network in the US, Mr Lodge raises questions about what this would mean in a market that is used to having competing payment networks. Mr Lodge points to an issue of competition in the payments systems, saying: “If no one throws their hat in the ring [to offer a real-time system to compete with the Clearing House], it would be the only monopoly of any of the US payments. Will the Fed force someone else to have an alternative system?”

Also, notes Mr Lodge, at the moment there is no industry body for the payments industry that can decide on issues of standards and interoperability. He raises the issue of it being the Clearing House – and not a trade body – that gets to decide the standards for the new payment type in the US just because it is the first to do so on this scale.

Mr Lodge points out, however, that there are already lesser known real-time networks in the US, such as Sprig, which is run by Co-op Financial Services and PayNet, which is run by Fidelity National Information Services. These, however, are not suitable for being scaled up into a wider system, says Mr Lodge.

Competitive landscape

One system that is scaling up has been designed by a technology start-up. Ben Milne, chief executive of Dwolla, believes there will definitely be more than one real-time payment system in the US in the future, including his own. “Which is the primary [system], the dominant one, the one that touches consumers [the most] remains to be seen,” he says, adding that it will take five to 10 years for the new competitive landscape to emerge.

“The old systems by design are not able to keep up with today’s needs – by default they do not operate in that way,” says Mr Milne. Dwolla does work in real time and is in the process of getting financial institutions on board. At the end of October, BBVA Compass announced that it would be using Dwolla from the first quarter of 2015 so that its customers will be able to use the Dwolla real-time network to make money transfers.

An individual can send money via Dwolla to someone who does not have a Dwolla account, but they need to sign up to Dwolla to receive the funds. For transactions of less than $10 it is free and for other payments the fee is $0.25, much cheaper than the fees associated with payment cards, for example. Unlike the Clearing House, which is building its real-time system from a base of already being connected to most financial institutions in the US, Dwolla has its work cut out to achieve the same ubiquity as the automated clearing houses in the US.

When asked how Dwolla plans to get the same kind of ubiquity as the ACH system, Mr Milne says: “The beautiful part is that [Dwolla] is built on the internet... Anyone who wants it can get it.” He draws a comparison with email, which started with a couple of people who messaged each other, but then soon developed with a network effect.

“We do not have any illusion that we will start with ubiquity,” says Mr Milne. By building users and continuing to sign up financial institutions, Mr Milne hopes that the Dwolla brand and its real-time system will spread.

This, of course, will take time, as will the Clearing House’s effort to create a new real-time payments system. Mr Lodge does not expect to see a ubiquitous real-time payments system in the next five years. For now, the US’s move towards a faster system will progress at a slow pace.

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