Most countries today settle and clear retail bank transfers within minutes if not seconds. In the US it takes days, and there are still bankers who ask, do we really need faster payments? For anybody outside the US, it’s a ridiculous question: Does the Sun rise in the east? Just look! Of course we need faster payments. The UK, Europe, Australia, India — almost everyone else on the planet has them.
The first thing to know is that the U.S. Federal Reserve’s newly announced real-time payment platform scheduled for 2024 — FedNow — did not come out of the blue. This is the culmination of work that started over four years ago with the creation of the Faster Payments Task Force, where the Fed recruited hundreds of subject-matter experts to evaluate the problem. I was part of the task force for a year in 2014, and it was a veritable who’s who of the payments industry.
The current US payments system is comprised of Fed Wire, NSS (for securities-related transactions), Checks, and the Automated Clearing House (ACH). When ACH first started in 1972, it was amazing that the US was even conducting electronic payments then: It was state-of-the-art. Forty-seven years later, ACH still manages the bulk of all US interbank transfers. However, while the Fed is the largest processor of ACH payments, it is not the only one. The other entity is the Electronics Payment Network (EPN), a non-governmental organization owned by the Clearinghouse — a consortium of large US banks.
Furthermore, the rules for ACH are not set or managed by the Fed but by a membership organization, the National ACH Association (NACHA), which is composed of banks. NACHA’s rules are set up so that the big banks have veto power over any proposed changes. Back in 2011, a group of NACHA staff members submitted a far more modest proposal than the real-time systems that now exist in many countries. The plan, called Expedited Processing and Settlement, stated that if a US bank submitted a payment before 2 p.m. on a weekday, it would be settled around 5 p.m., rather than waiting until the following business workday, or perhaps the day after that. This would have enabled what we in the industry call “same-day ACH.”
The big banks decided it was not in their best interest to speed up payments because faster transaction times would reduce all that big revenue from wire, interchange, and overdraft fees. While the majority of NACHA was in favor of same-day payments, the big banks exercised their veto power to vote it down.
This was a shock to insiders in the industry. I made a lot of noise and blogged about it, but it wasn’t picked up by the mainstream media until a year later. The Fed, however, which has a responsibility to the US public and not the banks, did notice, and realized that the country could not advance if NACHA’s private, for-profit interests continued to dictate policies.
Given that the Fed does not have plenary authority to create or alter payments infrastructure, it responded by launching the Faster Payments Task Force to push the industry as a whole to conceive and build a faster payments platform.
Due to the outcry following NACHA’s decision to vote down same-day ACH, banks revisited the proposal in 2016, but this second-time around they included an interchange fee. Before, it used to be that ACH, checks, and wire transfers were all cleared at par, which means the banks don’t get any fees for receiving or sending payments, but on cards banks can charge an interchange fee. Hence the constant barrage of advertisements from banks trying to sell you cards. The banks’ fear was that if ACH became faster, and eventually real-time, consumers would use ACH instead of cards or wires, and retail banks would lose very profitable revenue streams.
Traditionally, the payment systems run by the Fed always cleared at par, and this is going to be one of the critical issues in the coming years. The banks are going to adopt faster payments, and due to innovations in fintech, this time they can’t stop it. But they will do their best to build in interchange fees if left to their own devices. I hope the Fed holds the line here and declares that FedNow will clear at par, just like every other backend payment system used to.
After years of discussion following the NACHA scandal, in 2017, the Faster Payments Task Force wrapped up and created a report that analyzed the US payments landscape and compared it to other parts of the world. The task force followed up with a series of recommendations, one of which was that the Fed should consider building a new payments platform for the whole country. After a couple more years of deliberations and industry feedback, the Fed has now formally announced it is going to build a new payments system in the US.
It has been and will continue to be a mind-bogglingly slow process, but at least now that the Fed finally has a legitimate foundation, experts can start to research and plan out the new system. If we want to see it move faster, then Congress has to pass a law that gives the Federal Reserve authority to develop new infrastructure. No laws have been passed in this vein, but there is a bill on the Senate floor co-sponsored by Elizabeth Warren. It’s unlikely this law will pass in the next 18 months, but in January 2021 the political makeup of Congress could be different.
It will be crucial to track what technology the Fed uses to implement these new payment rails. While a cryptocurrency dollar is unlikely to be considered, I really like the architecture of blockchains as a payment platform and development system. The problem is that the Fed has massive volume requirements: ACH processes around $40 trillion a year. Any new system the Fed builds will have to be capable of handling (at launch) at least a few trillion a year. With ubiquitous, real-time payments, by 2030 we could easily see FedNow doing $100 trillion a year. It needs to be at a level of scale a few more zeros beyond any blockchain that is currently built. I hope the Fed takes the time to dive deeply into blockchain technology and specifically look at the new proof-of-stake systems because those architectures do have real volume capabilities.
The dollar has been electronic for a very long time, and the backend systems on which it runs (FedWire, NSS, ACH) are not public, they are not transparent, they are not blockchain-based, and they are not easily programmable. Now that the Fed is building a new payment system, it could fix those issues. It could make the system blockchain-based, more programmable, and more accessible. But judging from what the Fed has published in its FAQ, the only entities that will have access to FedNow are the same as those that have access to ACH: You have to be eligible for federal deposit insurance, i.e., a bank. This means it will still be a closed bank-only system, which is a shame because they could have done better. But again we need Congressional action to enable financial innovation and take the power away from the banks who are stifling it.
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Shamir Karkal is CEO of payments API company Sila.