Second of two parts.
In a little-noticed paper released in September, the nation's Federal Reserve banks signaled their intention to take a more active role in improving the U.S. payments system.
One of the Fed's new "desired outcomes": Within 10 years, the United States should have a ubiquitous electronic retail payments network that moves money much more quickly than banks do today.
In particular, the Fed said that it wants funds to be available in something close to real time, and the enhanced system should work even without the sender knowing the recipient's bank account number. Under this vision, which is already a reality in some countries, one could split the check at a restaurant by sending cash almost instantaneously, via mobile phone, to a dining companion's cell phone number.
"Today, U.S. consumers can't make a near-real-time payment in a convenient and cost effective way from any bank account to any other bank account," the 13-page paper noted.
The Fed paper came in the wake of the demise last year of a banking industry plan to marginally speed up the nation's glacially slow system of electronic payments between different banks.
The proposal had the support of a majority of the members of Nacha, the industry-owned group that sets the rules for the electronic payments network. But it fell short of the 75% margin necessary for passage.
That episode, which was examined in the first part of this series, illustrated the shortcomings of a private-sector-only approach. Different banks have diverging interests with respect to the payments system; in particular, there's a gulf between the views of many large and small banks. But any industry-led change requires an extraordinarily high level of consensus.
By law, the Fed is responsible for promoting an efficient nationwide payments system. But it has traditionally taken a back seat to the private sector.
"I think historically the Federal Reserve banks are really hesitant to step in the way of markets," says Kirstin Wells, a business economist at the Federal Reserve Bank of Chicago, emphasizing these are her own views. "That's the Fed's M.O."
Today, as the Fed paper illustrates, the central bank appears poised to take a more assertive role, with an eye toward a faster payments network that would be open to all banks and could compete against a new crop of proprietary networks, such as clearXchange, a person-to-person payments network being developed by JPMorgan Chase, Wells Fargo and Bank of America.
But key questions remain: How forcefully must the Fed act to spark the change it seeks? How aggressive are Fed officials prepared to be? How broad is the Fed's legal authority? And how will the banking industry react if the Fed does take the reins?
At the moment, the Fed is engaging in a careful tiptoe act signaling that it plans to be more proactive than it was in the past, but also trying not to come off as heavy-handed.
In a recent speech, Federal Reserve Bank of Cleveland President Sandra Pianalto praised the "entrepreneurial activity of banks, vendors, processors, and nonbank service providers," saying free-market competition has led to lower costs and a diverse range of services.
But she added: "There have been times when individual action on the part of banks, vendors, and nonbank service providers was not sufficient to move the payments system forward."
A Failed Experiment
Pianalto didn't mention it in her speech, but one recent payments initiative by the Fed illustrates the collective-action problem she was describing.
The Federal Reserve banks run one of two nationwide Automated Clearing House networks. (The Clearing House, which is owned by many of the nation's largest banks, runs the other.) These are the pipes that enable U.S. consumers to pay bills online and allow businesses to send direct deposit payments to employees.
In 2010, the Fed began offering banks the option of settling such electronic transactions on the same day they're initiated, rather than a day or two later. Individual banks could choose to opt in to the new service, but none were required to participate.
From the start, payments experts predicted that the voluntary program would flop.
Bob Meara, a senior analyst at the research firm Celent, said in 2010 that the "opt-in nature" of the service would be "its Achilles heel." That warning proved prescient.
In three years, only about 50 banks and credit unions have signed up, out of a total of around 14,000 nationwide, for an opt-in rate of well under 1%. Most of the banks and credit unions that have enrolled are tiny institutions that process few payments.
"Enrollment is still low," acknowledges Steven Cordray, project director at the Federal Reserve Bank of Atlanta's Retail Payments Office. "So we have a long way to go."
The opt-in same-day service has something of a chicken-and-egg problem, according to Cordray. Banks don't want to commit until the program gains critical mass. But that won't happen unless more banks enroll. And the Fed has elected not to force banks to participate.
In turn, the low enrollment rate has made it harder for banks that want to participate to convince their vendors to accommodate the same-day system, says Beth Robertson, a payments industry analyst. "You have to get partners to buy in," she says.
Learning from Other Countries
In 2011, researchers at the Chicago Fed examined countries that have already built fast, ubiquitous electronic payment systems and concluded that government involvement will likely be necessary if the U.S. is to follow suit.
Among the early adopters of near-real-time electronic payments were Mexico, where the system dates back to 2004, and the United Kingdom, which launched its Faster Payments system in 2008. In both countries, commercial banks were forced into action by their national government.
"The point I would make is that some kind of immediate settlement system is a benefit to society as a whole," says Dave Birch, a U.K.-based electronic payments consultant.
But in other countries, banks have been able to implement faster payments systems without a government mandate.
For example, in Sweden, it's now possible for everyday consumers to send money to one another over their mobile phones in near-real-time, though not all Swedish banks are participating. Those innovations were driven by the private sector.
Likewise, in South Africa, the banking industry took the lead in developing a near-real-time payments system for consumers and businesses, though the country's central bank did provide support.
One factor that could make it harder to achieve any private-sector consensus here is the fragmented nature of the U.S. banking system. There are nearly 7,000 banks in the United States. By contrast, Sweden has 117, including foreign banks, while South Africa has 82 banks.
The Fed's New Goals
The Fed's new paper on how to improve the U.S. payments system strikes a fairly cautious tone. The document refers repeatedly to collaboration with private industry; indeed, much of it consists of a series of questions aimed at soliciting feedback from industry participants.
The paper refers to "desired outcomes," rather than "goals," which suggests the Fed is wary of being perceived as laying down edicts. Moreover, most of the Fed's "desired outcomes" are not terribly specific, and they have a generous time horizon of 10 years.
Nonetheless, the paper marks a notable change of course for the central bank, because it states that developing a faster payments system would be a good idea.
The benefits of such a system, according to the paper, would include: The ability to make last-minute payments; improvements in how consumers and businesses manage their finances; and the inception of a faster method of making person-to-person payments.
"Moreover, a near-real-time payment platform may spur other innovations, particularly in mobile payments, and may enhance U.S. global economic competitiveness," the paper states.
The consultation paper makes clear that the central bank is interested in hearing not only from financial institutions in the past the Fed has been focused on interbank payment issues but also from consumers and companies that rely on the payments system. Individuals and businesses that make payments have less invested in the status quo than banks do, and their input could tilt the scales in favor of change.
Still, the two-month-old paper leaves the Fed plenty of wiggle room.
For example, the paper suggests several different ways of developing a faster payments network such as using the existing ACH network, enhancing debit card networks, or building a new payments system without endorsing any of them.
"It doesn't have to be necessarily a Fed solution," says Ken Isaacson, a vice president at the Federal Reserve Bank of New York.
Moreover, the Fed paper doesn't make clear how forceful a role the Fed might take if private-sector actors can't find a solution.
Is a government mandate possible? The Fed paper doesn't say, but some observers are skeptical that the Fed has the statutory authority to order banks to create a near-real-time electronic payments system undoubtedly a costly undertaking.
"I think that they've got limited powers to effect what they're talking about," says Oliver Ireland, a former associate general counsel at the Fed who is now a law partner at Morrison Foerster. "And a lot of what they're talking about seems to be outside of their realm of their jurisdiction."
The Industry Responds
The Fed is holding six town hall meetings this month on improving the U.S. payments system, including upcoming meetings in Boston, Dallas and San Francisco. But public comments on the Fed's paper are not due until Dec. 13, and few in the banking industry have formally weighed in yet.
The comments that have trickled in so far reflect a split over the appropriate role of the Fed in improving the payments system.
Jeff Plagge, president of Northwest Financial Corp., a $1.5 billion bank holding company based in Arnolds Park, Iowa, not only sees a role for the Fed, he also argues that the Fed's timeframe for change is not aggressive enough.
"I think 10 years is too long," writes Plagge, who is also the current chairman of the American Bankers Association. "I think these are innovations that should be on a 5 year track."
Robert Hullar, president of Rosetta Technologies, a vendor of technology that banks use to process checks electronically, counters that the Fed should allow free enterprise and market pressures to prod the payments system forward. "Keep big government out of it," he writes.
Last year's bank industry vote, which killed a plan to enable same-day processing of electronic payments, may have been a blessing in disguise, argues Elizabeth McQuerry, a payments consultant at Glenbrook Partners. A near-real-time system is needed, she says, noting that last year's plan would have fallen short of that standard.
"I think it may turn out to be advantageous that it didn't pass," McQuerry says. "The industry just wasn't ready for that type of transformation. The failure of the vote has seemingly brought a lot of people into awareness about this issue."
As long as the discussion surrounding faster payments remains as general as the Fed's current framing of the issue, there likely won't be many dissenters.
Even the Clearing House, the trade group owned by the nation's largest commercial banks, which was the most visible opponent of last year's faster payments proposal, is now speaking about the need to improve the system.
"I think the industry is more focused on embracing proposals that are more forward-looking," says Steve Ledford, senior vice president of product development and strategy at the Clearing House, referring to last year's vote. "I think the entire debate has moved along."
If the Fed begins proposing concrete changes to the payments system, it will likely face more opposition from those who stand to lose, including banks that fear cannibalizing existing revenue sources and vendors that support today's technology.
Still, no institution is better positioned to coordinate a modernization of the U.S. payments system than the Fed, according to industry analysts.
"I would say that the Fed is probably the only organization in the U.S. that has both the clout and the broad focus to do something like this," says Nancy Atkinson, a senior analyst at Aite Group.