The process of making money transfers and payments often comes with numerous complications for consumers. For example, merchants pass credit and debit card fees onto consumers and sometimes do not accept digital means of payment at all.
Even platforms like Venmo and PayPal, which offer payment transfer services, can take a long time to process payments before funds are made available in the destination bank account. Small bank and fintech company clients may face even more constraints if their banks do not participate in any payment platform.
In response to these challenges, central banks, fintech companies, and financial intermediaries around the world have been launching instant payment systems – platforms that enable instant money transfers at zero cost for the consumer. Some of these technologies also allow retail payments at low fees for merchants, creating competition for established players like Visa and Mastercard. Notable examples include Swish in Sweden, Zelle in the US, UPI in India and PIX in Brazil.
PIX has been particularly successful. Launched in November 2020 by Brazil’s central bank, PIX is now in use by more than 700 financial institutions and is available to more than 120 million users. PIX currently dominates all retail payments, including credit and debit cards, and has been effective in mitigating financial frictions associated with payments and money transfers.
In a paper published last year, I studied the impact of PIX adoption across municipalities in Brazil. I found that PIX significantly affected the deposit and lending markets. Notably, there was an increase in the number of checking deposit accounts, because in order to use PIX, consumers must open a bank account.
Attracting clients
Since PIX is more convenient than cash and cheaper than debit or credit cards, it creates an incentive for the unbanked population to open accounts. Consequently, these new depositors begin to use their banks’ products, resulting in a significant increase in time and savings deposits.
Instant payment systems created by central banks especially benefit small banks, as large banks currently dominate deposit markets – partly because they offer payment convenience. For example, Swish in Sweden was originally offered only by six large banks, so it became more convenient to have checking accounts with these banks rather than others. Another example is the US’s Zelle, to which less than 40% of US commercial banks offer access.
Sweden’s central bank Sveriges Riksbank and the US’s Federal Reserve are now developing their own instant payment systems – RIX and FedNow, respectively – which will be available for all banks.
As PIX is offered by Brazil’s central bank, and it is very cheap to use, almost all Brazilian banks quickly chose to grant their depositors use of the system. This development means that payment convenience in Brazil is no longer limited to depositors at large banks.
As such, the study shows that the concentration of the Brazilian deposit market has significantly declined since PIX’s launch, and small banks have gained deposit market share relative to large banks. The pattern also holds for time and savings deposits, with small banks finding that these new clients are starting to use their products.
Paying it forward
The study also discovered a change in lending market patterns: small banks that experienced an inflow of new retail deposits used them to finance loans, resulting in a steady rise in loan supply and a reduction in personal loan rates offered by small banks. Since small banks are often concentrated in small municipalities far away from large cities, this is good news for local businesses in such areas.
Large banks also lent more but changed the composition of their loan and liability portfolios. For example, they reduced low-interest financing (real estate, agriculture loans, and so on) and increased high-interest (perhaps riskier) loans. They also increased rates on personal loans relative to smaller banks. On the funding side, they started relying more on alternative sources of financing, such as net foreign borrowing and cheques. Unlike traditional deposits, such funds are not insured, making large banks more prone to financial risks.
Bank lending, especially during the Covid-19 pandemic, was crucial for businesses and households around Brazil. PIX promoted growth in bank deposits, resulting in an inflow of loans primarily issued to entrepreneurs and households. As a result, even one year after the launch of PIX, there has been a significant rise in capital investments in municipalities with large PIX transactions. This finding is particularly important as it gives hope for more stable and prolonged economic growth in Brazil.
Lessons for future payment systems
These findings have important implications for the development of new payment systems, such as FedNow.
First, instant payment systems need to be cheap for participants and free for consumers. If the technologies are expensive for participants, the costs will be passed on to merchants and consumers, leading to a similar situation as that for credit cards. If there is a usage fee for consumers, most people will continue using credit cards as they at least provide benefits.
Second, instant payment systems should be available to all financial institutions. The Brazilian example proves that creating a platform with universal access can reach all layers of the population and businesses around the country. Even for large cities, bringing small banks back into the game will create healthy competition for larger banks, which will have to provide higher-quality products and increase deposit rates.
Finally, consumers should be able to pay using instant payment systems. The success of PIX suggests that consumer payments, not just transfers, are the key drivers of adoption for instant payment systems.
While FedNow is expected to be cheap and widely available to most financial institutions in the US, its current configuration does not enable direct payments for consumers. However, future developments could address this limitation and make FedNow a more attractive option for consumers and businesses alike.
Sergey Sarkisyan is a PhD candidate at the Wharton School, University of Pennsylvania.
