Cover Story: Faster Payments

There’s clearly consumer demand to speed up settlement, and it’s been done overseas. The challenges here, though, are formidable, starting with defining just what ‘real time’ is.

By Jim Daly

Doctors often tell their harried patients to slow down, but in payments it’s just the opposite. In an effort to make transactions faster, payment processors and financial institutions today are looking for the strongest electronic steroids they can find.

This new demand is being driven by various forces, including new technologies such as mobile devices—smart phones and tablet computers—and improved Internet connections.

Plus, a rising generation of consumers has little tolerance for the more leisurely payment practices of the past. Younger people, says Nancy Atkinson, a senior analyst at Boston-based Aite Group LLC, “just don’t have the experience waiting for things.”

Recent surveys by payments-industry consultants and processors, as well as the experience of other countries, give credence to the sense of rising demand for faster electronic payments.

In March, research firm Ipos Vantis surveyed 1,508 adult Americans for Jacksonville, Fla.-based processor Fidelity National Information Services Inc. (FIS), asking them their thoughts about real-time payments and their willingness to pay for such services. Some 80% of respondents considered the ability of overseas money-transfer recipients to be able to use their funds immediately as extremely or very important.

Similarly, 58% of respondents placed high importance on account-to-account (A2A) transfer recipients being able to use their money immediately, and 41% felt the same about person-to-person (P2P) transfers.

“There is strong demand for real-time payments,” said Paul McAdam, senior vice president of strategic thought leadership at FIS, during a session at April’s annual payments conference of automated clearing house governing body NACHA.

The financial industry seems to feel similarly, according to a global poll of 89 executives from financial institutions, central banks, processors, and consultants and researchers in April by consulting firm Glenbrook Partners LLC.

Some 94% of respondents said they considered faster transactions to be either very or somewhat important for the growth of domestic P2P payments.

Answering another question about “how fast is fast enough?” some 49% of respondents preferred immediate messaging and settlement while another 36% would be happy with immediate messaging with batched settlement a few times a day.

“Certainly the respondents think faster is better and even faster is even better,” Elizabeth McQuerry, senior director at Menlo Park, Calif.-based Glenbrook Partners, says by e-mail.

Countries as varied as Mexico, Sweden, and Poland have services that deliver real-time or near-real-time payments. In the United Kingdom, transactions on the Faster Payments Service system grew 55% last year to 816 million.

Faster Payments claims its real-time service can complete transactions in a maximum of 15 seconds. P2P payments are the most common use of Faster Payments, but consumers also use the service for bill payments, and companies use it to pay temporary workers and service providers.

Expensive Hurdles

But in the U.S., meeting demand for anything approaching real-time payments won’t be easy. First, people need to agree on just what is “real time.” Operational issues could prove to be big, expensive hurdles for many banks.

And while faster clearing times can reduce settlement risk, the introduction of new processes and participants in the payments system may actually increase risk.

Some financial institutions, particularly those running highly profitable wire-transfer businesses, may have little motivation to speed up other payment forms that would jeopardize current revenues.

At the center of the U.S. debate is the ACH network, to which virtually every checking account in the country is connected.

The ACH started out four decades ago as a batch processing system for moving direct payroll deposits and government payments between trusted parties. In the early years, two- or three-day clearing times were good enough.

But now the ACH is rapidly evolving into a system that includes millions of consumers initiating transactions for Internet bill payments and even P2P payments. The ACH has also been adopted as the backbone settlement network for countless alternative-payment systems.

More strangers, so to speak, are riding the ACH rails, and many aren’t satisfied with the usual day or so that it takes for an ACH transaction to settle.

‘Facing Down Dodd-Frank’

To address the growing demand for faster transaction times, NACHA last year submitted to a membership vote a same-day settlement plan called Expedited Processing and Settlement (EPS).

Two years in the making, the plan received a majority vote in August but fell short of the 75% it needed to take effect.

The demise of EPS came up during a hot panel debate in a packed meeting room at NACHA’s Payments 2013 conference in San Diego. While NACHA doesn’t disclose how its members vote, speculation arose during the postmortem that some of the nation’s biggest banks voted against it to protect their lucrative existing payment services (wire transfers, payment cards, and even person-to-person payments) from low-cost ACH competition.

“Those votes [against] weren’t the majority of institutions,” said panelist Cary Whaley III, vice president of payments and technology policy at the Independent Community Bankers of America, a Washington, D.C.-based small-bank trade group. “It represented a handful of players … but a lot of volume.”

Another panelist, Rebecca Garrett, senior director of financial operations at mega-retailer Wal-Mart Stores Inc., added that, “I haven’t seen a lot of transparency [from banks]. The perception among the corporates is that it was revenue protection.”

Peter A. Davey, vice president and director of enterprise payments at McLean, Va.-based Capital One Financial Corp., a big credit card issuer and bank owner, had a different assessment, saying same-day ACH failed “due to a timing issue.”

Bankers last year spent considerable time dealing with more urgent issues, he suggested, particularly new regulations arising from 2010’s Dodd-Frank Act and the Consumer Financial Protection Bureau that the law authorized.

“All of us were facing down Dodd-Frank,” he said.

‘We’ve Got To Have This’

In any case, the prospect of a same-day settlement system that would require all banks to participate appears to be dead for now. The Federal Reserve, one of the nation’s two switches, or so-called operators, for the ACH, in April partially filled the void with a beefed up version of its existing same-day service that has some of the key features of EPS.

The expanded service now covers both credit and debit ACH transactions whereas the earlier one covered only debits. It includes all of NACHA’s so-called standard-entry class (SEC) transaction codes except International ACH Transactions (IAT) and two check-truncation codes. Dollar limits are largely gone, unless a particular SEC code’s rules already have them.

But the plan has limitations. It’s voluntary for receiving banks, so it is not ubiquitous among financial institutions. It also imposes tight operational deadlines on banks, deadlines some attendees at the panel session thought will make it tough for smaller banks to use the service.

The ICBA’s Whaley said that the lack of ubiquity was indeed a drawback. But he urged banks to sign on and then work for improvements.

“We’ve got to have this … there isn’t a NACHA ballot out there, so we need to vote with our feet,” he said.

Davey of Capital One also said banks need to move now on same-day ACH.

“If we don’t do it, we’re going to become obsolete,” he said. “Your customers are going to want this.”

Steven Cordray, project director at the Federal Reserve Bank of Atlanta and product manager for same-day ACH, said 31 banks had adopted the expanded service in its first three weeks, a number he admitted was “very small” but still twice the number using the limited service the Fed launched in 2010. The most prominent user is Tulsa-based Bank of Oklahoma.

But Cordray predicted the enhanced service will get a strong bank reception in the coming months.

“We’ve gotten quite a bit of interest and excitement since we announced it on April 1st,” he said. “Banks, as I said, may be interested but they’re waiting for others to participate … certainly I’m getting the feeling that we’re going to see significantly more adoption than we have in the past.”

Even though Herndon, Va.-based NACHA doesn’t have a formal same-day clearing proposal on the table, president and chief executive Janet O. Estep says by e-mail that the issue hasn’t gone away. In the meantime, she says NACHA supports the Fed’s expanded system.

“Many organizations have encouraged NACHA to continue its work on a ubiquitous rule supporting same-day settlement of ACH transactions, thereby creating a common foundation for all financial institutions on which they can then develop valuable services for their customers,” she says.

“In response,” she continues, “NACHA is continuing its outreach to its members and the industry, exploring options that can lead to the certainty of a ubiquitous same-day settlement rule.”

One recent step the ACH network took to move into P2P payments was its March approval of a credit version of its WEB SEC code, which previously facilitated only ACH debits from online-banking sites.

NACHA says WEB’s credit version will bring standardized formatting to an ACH P2P payments business that had been developing online without much guidance.

It could even spur mobile payments, according to Christopher Huppert, senior vice president at Wells Fargo & Co. and chairperson of NACHA’s Council for Electronic Billing and Payment.

“Here we’re basically opening up the network,” Huppert said at Payments 2013. “It’s being used for broader purposes to effect consumer-originated payments, yet we really haven’t had a good set of rules to support that use case or application in the network.”

What’s ‘Real Time’?

While there are different options available for financial institutions intent on offering an ACH variant of real-time payments, the operational tasks to make them happen can represent either a low hurdle or a mountain.

Part of it depends on definitions and what a bank, service provider or network wants to do, since “real-time” can mean different things. As London-based banking analyst Gareth Lodge of Celent LLC noted in a recent blog post, “real time isn’t always real time.”

“The most frequent myth is that everything end-to-end is suddenly instant,” he wrote regarding systems he’s researched around the world. “In reality, most (though not all) real-time systems are real-time in notification and authorization, not settlement.

“In fact,” he continued, “in some systems in certain situations, settlement can take place days later. The starting point should be what needs to happen, and at what speed. Indeed, for many payments, it’s the certainty, not the speed, that matters.”

Glenbrook’s McQuerry says real-time models do vary, which provides a “lot of room for flexibility.” But any system with frequent settlement will require more back-office support.

“There would be significant changes on the operational side for most financial institutions because they are not in the habit of processing retail payments on a real-time basis,” she says. “Many smaller financial institutions today shut down payment processing at 3 p.m. Many non-bank payment providers and processors have an advantage here in that they already operate in a 24-by-7 environment.

“While immediate funds transfer is generally understood as an account-to-account payment, the same pressures are present in the market for any payment that does not have instant messaging and more importantly, that has deferred settlement,” McQuerry adds.

‘A Clear Proposition’

Take the experience of the U.K.’s Faster Payments Service. It was was created at the behest of regulators as a speedier derivative of the country’s existing ACH system. British banks planned to link virtually all of their accounts—checking, savings, business, and other accounts—with the service in one fell swoop.

That proved to be a massive undertaking, and what originally was planned to be a simultaneous launch turned into phased rollouts, with 12 banks going first in 2008.

For some banks, preparing for Faster Payments “was a very small uplift,” says Jim Mortimer, head of real-time products, global transaction services, at London-based VocaLink Ltd., which operates the system. For others, “it’s fair to say it was a major re-engineering job.”

“Some [banks] were prepared well ahead of time, some were not prepared,” says Nick Senechal, VocaLink’s corporate strategy lead.

Costs ranged from less than 1 million pounds to “several tens of millions of pounds,” says Mortimer. “It’s been a painful process.”

But there has been a payoff. Faster Payments could clear the 1-billion mark in transactions this year. Some of the new volume will be coming from PayPal Inc., whose online-payment system is now integrated into Faster Payments.

No longer does a PayPal user who sells something on eBay need to wait three days to get access to the buyer’s funds, according to Mortimer.

The VocaLink executives have some advice for U.S. banks intent on implementing a Faster Payments-style ACH variant.

Rather than linking many different types of accounts, says Mortimer, “I would start with a much lighter touch and start with accounts that are addressable by debit card, a smaller starting scale.”

And Senechal says U.S. banks should be on the same page regarding transaction sizes, limits, and related matters, lest differing rules for each bank generate customer confusion, limiting the national utility of the service.

“Make sure it’s a clear proposition. It needs to be understood by consumers,” he says.

‘A Red Flag’

Another issue the British banks confronted, one not unfamiliar to Americans, was pricing. Person-to-person payments had been mostly free pre-Faster Payments, and today banks have a hard time charging for many consumer payments. Revenues come mostly from businesses, according to VocaLink.

But processor FIS says its March survey shows American consumers are willing to pay for some real-time payments, especially outbound foreign money transfers followed by P2P payments.

Yet another big issue with real-time payments is risk control. The addition of more unknown parties has resulted in an uptick in fraud on ACH debit transactions, Aite’s Atkinson claims (“Good News, Bad News About ACH Fraud,” May).

“When you talk about real-time payments, you have to show some concern for the potential for fraud,” says Atkinson.

A faster ACH system should be protected by the types of behavior-analytics systems now commonplace in credit card systems, according to Atkinson.

These systems apply a host of checks, such as how many times a card is used in a time period, where it’s used, the value of the purchases, and numerous other measures, to assess the likelihood of a fraudulent transaction.

“I think we need to start applying those across the board,” says Atkinson. “You have to have something that puts up a red flag.”

Proponents of faster transactions have alternatives to devising an ACH derivative. Already, some tech startups are probing potential opportunities in real-time payments. Des Moines, Iowa-based Dwolla Inc., for example, is working on a system called FiSync that would switch funds between accounts in under 10 seconds.

And electronic funds transfer networks, many of which are now owned by national payment processors, are pitching their systems as ideally suited for real-time payments.

In April, bank processor Fiserv Inc. added a feature to its Popmoney P2P service that will let users send money within seconds to intended recipients.

The new feature, called Popmoney Instant Payments, makes faster money movement possible because of Fiserv’s ownership of the Accel debit network and an agreement forged with First Data Corp.’s Star network to handle Instant Payments transactions.

Popmoney has offered both next-day and three-day settlement times, but with Instant Payments, recipients will have access to their money in less than a minute, according to Tom Roberts, senior vice president for marketing, electronic payments, at Brookfield, Wis.-based Fiserv.

FIS, owner of the NYCE debit network, rolled out its People Pay service this year. And the financial-institution-owned Shazam EFT network in January introduced its Shazam Bolts mobile application.

The app, which works on smart phones and tablets running Apple Inc.’s iOS software, initially will enable financial institutions’ customers to receive alerts and check balances on their debit card accounts. But Johnston, Iowa-based Shazam plans to introduce a P2P feature this summer.

‘We Have Had No Fraud’

Meanwhile, Co-Op Financial Services, a Rancho Cucamonga, Calif.-based processor that links 3,000 credit unions, is rolling out a digital wallet called Sprig. The new service, available for both mobile devices and PCs, allows members of Co-Op clients to consolidate checking, savings, and card accounts held at one or more institutions into the Sprig wallet.

In addition to letting credit-union members make transfers between their own accounts at different institutions in Co-Op’s shared-branch network, the service also supports payments to individuals with accounts at other Co-Op client institutions.

Some 300 of the 1,700 credit unions in Co-Op’s shared-branch network are already participating. Co-Op also plans to begin offering so-called out-of-network P2P payments this summer.

“We are seeing consistent transaction growth each month” in A2A and P2P transactions, says Amanda Smith, senior technology and innovation manager, declining to reveal numbers. “P2P has only recently been added, but we do see good early adoption and expect to see continued growth as we expand the product offering.”

In addition to using the EFT rails of its shared-branch network, Co-Op plans to enhance the fast-payments angle by leveraging its card-processing services used by 3,000-plus credit unions. It also has a letter of intent for use of Dwolla’s platform.

So far, so good with risk control. If an intended funds recipient’s account is not already enrolled in Sprig, the system sends the account holder verification questions by e-mail or text message.

“We have had no fraud,” says Smith. “We have good mitigation tools.” She adds that Co-Op sets daily and monthly volume and transaction limits.

‘Top-Down Initiatives’

While the EFT networks currently are faster, the ACH with its vast reach is in a strong position to influence the future of real-time payments if it can overcome dissension within the ranks of financial institutions as well as the technical, financial, and risk-control obstacles that lie in the way.

NACHA’s Estep notes that the NACHA-conceived Secure Vault Payments system for ACH Internet payments “is an example of an existing real-time messaging service with settlement through the ACH.” But SVP hasn’t gotten much traction so far.

“The issue with SVP, as well as many of the other solutions being deployed or discussed, is that they are closed-loop systems—not available to all financial institutions or end-users,” she says.

“Developing a ubiquitous solution, available to all financial-institution endpoints, is the goal,” Estep adds. “We are working with the industry to move to multiple daily settlements in support of a possible real-time messaging solution as well as other ACH network innovations.”

McQuerry of Glenbrook Partners says American financial institutions can do it.

“We have some promising solutions starting up in the U.S. even if they have limited reach among a closed set of participants,” she says. “But they will give us important insight into what works well here. It’s notable that the majority of implementations around the world are top-down policy initiatives. The lesson to bankers in the U.S. should be to pick up the pace and identify a model that works well here.”