The Parallel Universe in Faster Payments

All the talk about real-time transactions has focused on non-card rails. But all the action has centered on a little-known transaction type that just happens to be offered by Visa and MasterCard.

The late summer’s rash of announcements for ready-to-go, real-time payments without the need for a big new network must seem like a parallel universe for the “first generation” of network-oriented providers. The new, low-cost, card-to-card payment options now appearing set up a possible pathway for taking peer-to-peer payments to the promised land of mainstream transactions.

But the ramifications have left Payments Nation shaking and scratching its head.

After all, it was only July when MasterCard Inc. announced it would buy VocaLink Holdings Ltd., the repurposed automated clearing house/PIN-debit network that was turned into the U.K. Faster Payment system. VocaLink has become the backbone network system for other countries’ faster-payments systems—including that of U.S.-based The Clearing House (TCH), which has plans to ensure a fully-manifested option that works for the benefit of its 24 major financial-institution owners, which include 16 of the nation’s largest banks.

What Happened?

First, Visa Inc. and PayPal Holdings Inc. announced that Visa debit cards would get an exclusive one-year opportunity to vie with ACH as a user-preferred funding option for PayPal’s Venmo (and, potentially, the rest of PayPal). Wouldn’t that kill PayPal’s cost of account loading—with debit-card-to-debit-card payments costing, what, 25 to 45 cents, versus a penny or two for ACH?

Next, Early Warning Services LLC announced that Visa and MasterCard debit cards could be used to effect its real-time, guaranteed transactions coming online this year: check deposit, bill payment, and a mobile P2P Venmo-like application with extra, out-of-band authentication.

EWS, owned by 10 big banks, acquired the big-bank P2P consortium clearXchange in October 2015. Now clearXchange, which shared real-time pipes for account-to-account transfers among participating members, can make those same transactions with cards. But weren’t P2P payments on clearXchange free? How could cards compete with that?

Then EWS/clearXChange took the wraps off a new name for its Venmo-rival service. The new name, Zelle, is meant to connote swiftness, grace, and elegance (like a gazelle), with particulars on services to follow. Zelle gives issuers their own P2P platform with which to compete with PayPal. But with Visa (and MasterCard) offering up their cards seemingly everywhere people might want to pay each other digitally, what’s in a name?

Perplexing questions, to be sure. One of the answers appears to lie in Visa’s decision to leverage its venerable original credit transaction (OCT) transaction type (as MasterCard does with its equivalent Mastercard Send service) to morph account-to-account transactions made popular by banks overseas for more than a decade (“The P2P Revolution,” July 2015).

Under OCT, transfers are made by an originating issuer from a bank account or Visa card account (or even cash accounts) to a recipient issuer on an expedited, often real-time, basis.

The transaction parties are already vetted by the banks, and the banks at either end are known to the networks (especially within the same network), with the debit card credential acting like a token for the demand-deposit account. And in some cases, payment on a Visa credit card account is available for linkage for what is essentially a “push-payment.” The efficiency of this transaction mode is high, and the risk is low—so the costs are very low.

More than 10,000 Visa issuers worldwide are estimated to be able to use OCT services. When they do, they are obliged to move the funds within two days after receiving an OCT submission (plus any applicable fees), settling through the backbone VisaNet network (but not drawing a debit from the sender’s account themselves—hence the “credit-push” aspect of the transaction). If OCT issuers are signed up for the expedited Fast Funds service, they have 30 minutes to move the money following their authorization.

The intriguing aspect is what fees are assessed. The networks can charge whatever they want on these transactions because they occur entirely on their existing bank card networks connecting issuers and acquirers.

Reportedly, Visa charges some users nothing for a Visa-card-to-Visa-card transfer—but 35 cents or more for transfers to other cards. MasterCard, on the other hand, reportedly charges 7-to-10 cents per transaction, regardless of the brand associated with the account.

Visa’s pricing strategy obviously provides it with great deal-making flexibility to engage digital venues to ensure Visa debit cards don’t get disadvantaged in the emerging payments world. Once a deal is done, there’s ample motivation to get a digital venue’s Visa debit cardholders to encourage their recipients to use (or obtain) Visa cards, too—to take advantage of the low rates!

A Good Start

So, instead of investing, say, $250 million, to build or repurpose a dedicated new debit network into a VocaLink-type of dedicated real-time debit system, has Visa figured out that, simply by pricing push payments low enough, they have already become a virtual faster-payments system? More important, perhaps, is the question whether, if the OCT system is priced low enough, does it obviate the need for using the ACH for consumer payments?

Well, not quite. OCT is one mechanism Visa uses for Visa Direct connections, which are available not only to financial institutions but also eligible third parties, such as P2P payment-service providers, merchants, corporations, and other payment service providers (PSPs). If the transaction is cross-border, for example, it becomes subject to geographic limitations and regulatory requirements. And not all cards on the Visa system utilize the service.

But considering all the efforts made in the 2000s by NACHA, the ACH’s governing body, to get its own version of credit-push into the market, as well as the potential autonomy TCH’s 16 retail bank owners might have with its VocaLink system and the hundreds of millions of debit cards already in the hands of both businesses and consumers, OCT seems like a good start.

OCT debuted in the U.S. a couple of years ago with the Square Cash P2P service from Square Inc., effectively a PSP, and has extended to Facebook, Snapchat, and other digital venues. Nobody outside of the principals in the Square deal (Visa is an equity investor in Square) could figure out how Square could offer this service at no charge to users. If half the debit card fees were, say, 25 cents per transaction, and the other half 45 cents, wouldn’t the average transaction cost, say, 35 cents? Not with OCT, apparently.

The fees in OCT deals are top secret, but it doesn’t take a lot of imagination to realize this service gives Visa (and potentially MasterCard) plenty of flexibility to ensure its payment products are wired into the next generation of digital transacting.

In fact, PayPal has been using OCT outside the U.S. for some time. It’s a very efficient way to load accounts and transfer funds. So while it’s unlikely that PayPal is getting Visa debit card-to-card payments on U.S.-based Venmo transactions for free, the fees that Visa is likely offering will almost certainly keep PayPal’s attention way from ACH as a primary account-loading tool.

And the one-year marketing agreement will likely provide Visa debit card holders some sort of incentive to make sure the people they transact with have or will get their own Visa debit cards.

More important, as Venmo seeks to monetize its fast-growing service by introducing it as a payment option for online and offline merchant purchases, the pricing flexibility offered by Visa for P2P and other transfers with OCT could provide ample room in the Visa Direct paradigm to negotiate a symbiotic set of economic terms at the point of sale.

MasterCard’s Opportunity

Taking OCT or variations of it beyond the controlled network might require more security and more operational complexity, but when it’s bits and bytes, many things are possible.

With more flexible pricing, MasterCard could do much the same thing—if it wanted to. In fact, because MasterCard entered the U.S. debit marketplace late, focusing on PIN-based Maestro rather than signature-debit (which Visa has dominated), it’s said the number-two bank card brand reaches 97% of all U.S. banks and credit unions—75% of which can transact in real-time. By contrast, Visa’s focus (obsession?) on signature rather than PIN has left it with real-time network access capabilities that are as little as half those of MasterCard.

Moreover, in the Federal Reserve’s Faster Payments initiative, until recently only MasterCard—not Visa—participated in the initiative’s two task forces. Visa, never an organization accused of effusive industry collaboration, remains largely on the sidelines with only modest participation in this payments-ecosystem effort so far.

Visa’s issuers are not so isolated from the growing move to faster payments, however. Besides TCH’s VocaLink-based system (now experiencing heightened influence from MasterCard), innovators like USAA and U.S. Bank are busy sorting out the options for doing real-time payments—including active roles in the Early Warning product rollouts.

U.S. Bank, for its part, is focused on trying to come up with a viable revenue model for digital payments. In the initial real-time P2P offering from clearXChange, U.S. Bank attempted to charge users $6.95. The other big banks offering the service continued to charge nothing, so U.S. Bank abandoned this initial pricing quest—for now.

But this brief pricing exercise has not fully answered the question whether users—particularly financially stressed consumers and businesses, and the financially excluded—will find real-time guaranteed payments something worth paying for.

A lot of small businesses might well find $6.95 (or some reasonable fee) quite acceptable if it means a supplier will ship product out by the end of the day because the real-time payment guarantee (and/or the real-time availability of check deposits) makes expedited shipments risk-free.

Consumers trying to keep the lights on or cable running without expensive account turn-off/turn-on already pay $2 to $5 for expedited payment services from companies like Western Union—often without consummating the payment until the next day.

The New Reality

The further our Payments Nation goes in the quest for faster payments, the more it seems like the move to real-time, efficient payments is becoming the new transactional reality.

What seemed just months ago to be a slow progression by big issuers to careful enablement of simply peripheral business cases now seems to be opening up to new ways to digitally re-purpose existing payment networks and types as well.

Issuers still have control through their choice to offer these services, but the accelerating growth of P2P on steroids will make it tough not to play the game.

Before enhanced P2P traversing OCT (or Mastercard Send, or maybe even blockchain configurations) morphs to mainstream payments, the security proposition has to be tested and established (even credit push can have its issues and problems). Before users can be vetted and transact independently of direct involvement by financial institutions at either end, some sort of digital identification and verification will need to be provided.

And even when traveling via bank networks, all transactions will soon need to be encrypted and/or otherwise protected.

The need for speed with faster payments is clear and growing. Enablers are proliferating in surprising fashion (witness Visa/MasterCard deals with PayPal). But while how the nation pays and what payments cost seem certain to change forever, what it pays with might not.