The US payments system is rapidly evolving in a market-driven manner, which differs from other countries’ payments systems, where the government or central bank has prescribed specific payment solutions or directions. Technology is driving innovation and expanding consumers’ choices for how they make payments. Despite innovations in how transactions are initiated, there still remain five core payment types:
- Wire transfer.
- Automated clearinghouse (ACH).
This article will focus on non-cash payments and their evolution.
Each of these payment types was created for specific applications with supporting legal structures, and every payment must provide a transfer of value in the process (such as clearing and settlement).
A wire transfer payment provides finality critical to certain types of transactions with a credit push to the beneficiary. Whether the dollar values are high or legal agreements prescribe finality, wire transfer payments enable critical wholesale settlement for financial institutions, corporations and at times consumers. For mission-critical payments, the rigid-originator risk structure and often manual, one-time nature of wires frequently work best.
Cheques provide debit-pull access to the payer’s account for the depositor of the check. The ubiquitous nature of cheques has made them a favourite payment instrument in the US. Cheques’ acceptability and convenience have fostered a vast support infrastructure, making this payment mechanism’s near-term elimination impractical. From a corporate perspective, the reconciliation and tracking of transactions through simple reference information, such as a cheque number, enable effective risk management and accounts payable (A/P) processes.
According to the 2009 Federal Reserve Payments Study, the number of cheques written continues to fall faster than past surveys indicated: the number of cheques written declined by 6.1% between 2006 and 2009. However, in 2009 cheques still made up 22% of non-cash retail payments in the US and 44% of their value. Cheques are still a primary payment method for person-to-person, person-to-community organisations (for example, school Parent-Teacher Associations (PTAs)), and person-to-property owner payments. Many businesses rely on cheques for their cash management and remittance reconciliation features.
The debit and credit capabilities of ACH allow it to be used in a variety of ways. ACH began primarily as a method for paying a large number of consumers with direct deposits from the federal government for benefit payments (such as Social Security) and corporate payroll. Because of the automated nature of the ACH and ACH participants’ agreement to follow ACH rules and standards, ACH is a low-cost payment system. These features have expanded ACH’s application to transactions with a one-time use, such as cheque-conversion applications at point-of-sale (POS), lockbox banking services, or payments initiated by internet or telephone.
ACH payment formats allow information about the payment to ride with the payment transaction, creating efficiencies for the ultimate payment receiver. ACH made up 18% of noncash retail payments (and 51% of their value), according to the 2009 Federal Reserve Payment Study. This focus on efficiency, low cost and information with the payment has made ACH a critical component for back-office settlement in many payment innovations today.
The card networks continue to dominate POS applications. Debit cards alone have grown 14.4% from 2006 to 2009, according to the Federal Reserve Payment Study, likely spurred by their ease of use and features that allow users to better manage their personal finances. The card networks’ fast authentication and transaction approval provide a high rate of payment approval with a strong balance of risk management.
Influencing Change in the Past Decade
Three primary forces are influencing change in payments today:
Technology is evolving faster than ever and touches all aspects of how we live and work, including payments and commerce. Mature technologies have also innovated to include new value-added functions. Remote deposit capture is a perfect example of this type of integration, or incorporation, of new technology. Software once used to support paper processing on reader sorters was integrated with imaging software to eliminate the need to physically move paper cheques. Other examples of integration include mobile devices or web applications over older back-office technologies that leverage one of the traditional legacy payment systems to create innovative solutions for initiating payments.
Technology has influenced the amount of information we have access to and the speed by which we can receive it. Payment standards and formats create the capabilities to allow the information about payments transactions to ride with the payments. Technology solutions now allow the automated reconciliation and exchange of this information, creating efficiencies and value-added services for businesses and consumers. While many standards exist for the exchange of information with the payment, this market still possesses great potential as a result of the growing information needs of thousands of small and medium-size enterprises (SMEs), as well as newer markets where cheques and paper statements still dominate (for example, electronic health care payments).
Technology and information reach have also promoted globalisation of commerce, which introduces additional challenges as consumers and businesses of all sizes look to make and receive payments across borders. While cross-border ACH payments is an area with great growth potential, complexities in country rules and laws and payment formats and standards have proven to be challenging. Global initiatives such as the International Payments Framework Association (IPFA) are important in helping to establish a common set of rules, payment standards, and guidelines for the exchange of cross-border ACH payments.
In fact, with the implementation of the international ACH transaction domestic rules for cross-border payments, the Federal Reserve Banks have the first US cross-border gateway built on the IPFA rules. Partnering with a European payments processor, Equens, the service allows ACH cross-border transaction access to 22 countries.
The maturation of the payments environment through the availability of more effective technologies has driven changes in payments over the past several years. The vast majority of this change has occurred by improving how a transaction is created, while back-office support infrastructures in many organisations have remained static. As the gap between these two technologies widens, the need to improve these back-office systems becomes more apparent.
Paying it Forward
Innovation in the core payments types is still occurring. Cheque infrastructures have simplified as imaging matures and the need for geographic distinctions associated with physical paper disappears. This transition has caused cheques to clear quicker than ever. Expanded wire payment formats provide a greater flow of information with the payment transactions. Card network innovations are improving risk management and consequently expediting the rate at which merchants receive funds. These improvements are expediting settlement and reducing systemic risk in the operation of the payments systems.
As a primary support function for payments innovation, the ACH network must continue to improve its processes as well. One key area where ACH can facilitate innovation is same-day ACH. NACHA is seeking input on a set of rules concerning expedited processing and settlement; these rules would allow for same-day settlement of both debit and credit ACH payments. As ACH provides accelerated options for transaction settlement, the time required to process these transactions and the associated settlement becomes more favourable.
Bringing Down Barriers
While these innovations are important, we must also look ahead to see what sort of payment alternatives consumers will demand. Payment system innovations such as PayPal and CashEdge offer a consumer or business capabilities that appear to clear payments faster than legacy systems allow (in essence simulating faster payments by taking on the settlement risk of the originating party of the transaction until the payment settles over legacy payment systems such as ACH or card networks).
These innovations raise questions the industry needs to consider: for example, should we leverage legacy systems and make investments in those systems to support demands for faster payment? This question is particularly important with respect to the existing investment in ACH technology. Many ACH systems are built on older technology that can be expensive to update. Also, while ACH is a low-cost, ubiquitous payment system, it lacks the real-time validation of account information or end-user identification required to support a faster payment application. We must identify the financial benefit associated with upgrading these systems.
Also, what does the risk profile look like for these types of payments, and how will risk be mitigated? New payment risks and their associated impact on the banking industry remain nebulous.
The rate of change in payments is not likely to slow any time soon. It is important that the payments industry continue to move through the cycle of technology innovation and technology simplification to ensure a robust payment system for the future.
Cheryl Venable is speaking in two sessions at the AFP Conference:
- 7 November 10.30-11.45am ‘Federal Reserve Payments Initiatives from A to Z: Current Facts and Future Developments’ (room 210B).
- 8 November 2-3pm ‘Same-Day ACH: What’s Next?’ (room 156).
The implementation date of Europe's revised Markets in Financial Instruments Directive, aka MiFID II, is fast approaching. Yet evidence suggests that awareness about the impact of Brexit on MiFID II is, at best, only patchy and there are some alarming misconceptions.
Despite all the automation and improvements that digital banking has the potential to achieve, customers and their needs still form the very core of the banking sector.
Banks might feel justified in victim blaming when fraud occurs, but it does little for customer confidence.
Politicians have united in urging the Reserve Bank of Australia to lend its backing to the digital currency by officially recognising it.