Banks and other traditional payment companies need to keep an open mind when assessing the market today as new entrants build systems to disrupt the old models, said Christine Cumming, first vice president of the Federal Reserve Bank of New York.
The important question is: "What makes banks so special in today's world?" she asked during a keynote at The Clearing House's Payments Risk Symposium on Nov. 19 in New York.
Cumming, who plans to retire in June, doesn't think banks have lost their relevance in today's financial services and payments landscape, but more that their area of influence is shifting from what it is today.
The financial and payments technology market has exploded over the past couple years, with investors throwing millions if not billions of dollars at startups building faster, lower-cost payment mechanisms and mobile-focused financial tools.
Banks have relied on the assumption that accessing and transferring large pools of capital is difficult, but that belief is quickly becoming inaccurate. The next generation of banking and payments may model itself on the existing wire and ACH systems but could also turn into a totally different network, Cumming said.
The Clearing House, the trade group that hosted the conference, itself announced plans in October to build a real-time payment system to be used by U.S. financial institutions.
Consumers still look to banks for payments safety and soundness, and will likely continue to do so, said Jim Aramanda, CEO of The Clearing House, in a separate interview.
"Payments are core to banks; they're the underlining enabler for virtually every product [banks] have," said Aramanda. For "the non-banks it is not core to them and that raises the risk profile for payments."
Non-bank financial services providers such as PayPal and its Venmo unit also don't have the ubiquity or reputation they need to open up real-time payments to the majority of consumers and businesses, said Russ Waterhouse, head of strategy and products at The Clearing House. "People are reasonably comfortable putting small amounts of money into these" alternative accounts, but not with transacting larger amounts over those rails, he said.
The Clearing House is embarking on a multi-year endeavor to build a real-time payments network that relies on push credits instead of the existing pull mechanisms. By using push, consumers will not need to provide payment credentials to a third party.
"Debits are a weakness in the system today" because they require money senders provide merchants with credentials that they can then use to pull payments out of accounts, Waterhouse said. Push credits "are inherently safer for the consumer and the bank."
The Clearing House also sees push transactions allowing for irrevocable payments without a mechanism for consumer chargeback.There will be a mechanism for resolving true errors or mistakes, but the goal is finality, Waterhouse said.
The U.K. recently updated its payment system after the country's government became frustrated with the three-day settlement cycle. In contrast, the U.S. move isn't as much about government dissatisfaction. "This is a different issue, based on the response we're seeing in the market because of new technology," said Waterhouse. The smartphone and other mobile devices have increased consumer's expectations of real-time gratification, he said.
Also in October, the Federal Reserve unveiled its plans for an improved U.S. payment system, suggesting a whole new infrastructure could be the best way to facilitate near real-time payments.
And the rise of Bitcoin and other cryptocurrency protocols has also increased awareness to the possibility that payments can be facilitated without the traditional intermediaries.
While Waterhouse thinks there are things to be learned from cryptocurrency protocols like Bitcoin and Ripple, he says these companies are underestimating the cost of regulation, such as know your customer, anti-money laundering and fraud mitigation. In the future, as the regulatory environment surrounding digital currencies matures, these companies may have to raise their fees more in line with what traditional players charge.
Rapid change abounds when new competitors arrive, rivalry among existing players escalates and suppliers and end users gain more bargaining power, said Cumming. In the payment system we're experiencing them all, she said.
The current surge in financial services and payments innovation is exciting because "payments has an affinity for joint products," or those that mix payments with other industries, she said.