The New Reality in Real-Time Payments

Now that the Fed’s so-called public option is no longer a matter of speculation, the race is on to dominate a crucial payments market. But in real-time transactions, will the race go to the swift?

After 10 months of playing it coy, the Federal Reserve early last month finally jumped into real-time payments with both feet. But while the central bank is now unquestionably the 500-pound gorilla in this all-important game, it won’t really figure as a player until at least 2023.

In the meantime, the big private-sector provider, New York City’s The Clearing House Payments Co., could sew up critical swaths of market share with its own service, which has been up and running since November 2017. That is, unless the prospect of the Fed’s product freezes the market.

Confused trying to handicap this race? You’re not alone. But one thing is clear: creating a nationwide, interoperable network that connects all or most financial institutions will be a long, complex, expensive business. Already, TCH figures it has spent $1 billion developing its Real Time Payments service. RTP now reaches 51% of the country’s demand-deposit accounts, according to Steve Ledford, senior vice president of products and strategy at TCH.

Nor can planners figure on building the service on existing rails. “This is not ACH. This is not wire transfer. This is a different animal,” Ledford says.

On this point, even bankers who cheer the Fed’s real-time effort, called FedNow, take a similarly sober-minded view. “This is very complicated,” says Bob Steen, chairman and chief executive of Bridge Community Bank, Mechanicsville, Iowa. “It’s going to be hard. We just have to keep our eye on the ball.”

‘Vast Resources’

Just how hard is reflected in the Fed’s timing estimate. For some observers, 2023 is a long way off. Will banks wait that long while competitors are signing up for TCH? On the other hand, will banks that might have gone with TCH hold back, waiting for the Fed solution?

What’s clear is that banks have a lot of thinking to do. “It’s not the case that banks will be able to magically receive transactions from the Fed,” notes Sarah Grotta, an analyst at Mercator Advisory Group, Maynard, Mass. “There’s work that will have to be done. And banks that joined [TCH’s] RTP will have to build tools to connect to the Fed.”

As if the plumbing the pipes for real-time settlement weren’t challenge enough, the politics of the effort are ever-present. Small banks like Bridge, and a lot of merchants, welcome FedNow at least in part because they want a public-sector rival for TCH, which is controlled by 25 of the nation’s biggest banks.

Without the Fed’s intervention, merchants fear the way will be open to another Visa-Mastercard behemoth. Some small and mid-size financial institutions are alarmed about the pricing an unrestrained private entity controlled by big banks could ultimately extract.

Others just want a public utility and figure that only the Fed has the funds to create one. “I’m not going to spend 10 seconds fussing about the big banks,” says Steen. “They have vast resources.”

‘Numerous Concerns’

For his part, Ledford says TCH has made itself as welcoming as possible for small-fry institutions. It operates on a cost-recovery plan and levies none of the monthly fees or minimum volume requirements that could freeze out even some mid-size banks.

By late summer, 15 banks had gone live on RTP, and several community institutions, like Colorado’s First Bank ($18.6 billion in assets), Cape Cod Five Cents Savings Bank ($3 billion), and another Massachusetts bank, Avidia ($1.6 billion), had signed up.

In fact, TCH may have received an assist from the Fed. Far from freezing financial institutions in place, the regulator’s decision to build a real-time service may have spurred some to link up with RTP.

“We’re seeing more of a split,” says Ledford. “Before the Fed announcement [in August], there were a lot of banks and credit unions saying they wanted to see what the Fed would do before making a decision. That was freezing the market.”

But, he goes on, “Now that the Fed has announced, we are hearing from financial institutions saying they can’t wait, and they are moving forward with RTP. Others are still waiting, but it’s not clear how long they will wait.”

Whenever the Fed’s system finally goes live, however, it will face competition from more than TCH. The big card networks, for example, long ago perfected a push-payment service that allows clients to send funds immediately to anyone with a debit card. Now, with the advent of the so-called gig economy, Visa and Mastercard are eyeing even bigger opportunities in real-time payouts to ride-share drivers, delivery impresarios, and anyone else with a bank account.

And even Facebook Inc.’s Libra initiative (see sidebar below), should it be allowed to launch in the face of seemingly implacable hostility from politicians and regulators, could compete for the real-time market. Like other cryptocurrencies, Libra, with backing from 28 major companies, is designed to function like digital cash.

“Just the fact that a project like Libra can be conceived and companies are there to do that, that’s a dynamic here,” says Patricia Hewitt, principal at PG Research & Advisory Services.

The Fed took notice while it was fleshing out its plan for FedNow. “Facebook’s Libra project raises numerous concerns,” noted Fed Governor Lael Brainard on Aug. 5 while announcing the Fed’s decision.

‘Uniquely Positioned’

In 2015, the Fed convened a task force on faster payments that included representatives from a wide swath of the private payments economy. The group worked diligently for two years while the Fed religiously stuck to its facilitator role.

But last October, the regulator said it was considering an active role in building a real-time gross settlement system, and solicited comments. It got 350, of which 90% were positive, leading to the announcement in August. Only one Fed governor, vice chairman Randal Quarles, dissented. Later in the month, FedNow had a leader: Kenneth Montgomery, first vice president at the Federal Reserve Bank of Boston.

To be sure, building the system will be a momentous job for the Fed, rivaled in its history perhaps only by the automated clearing house network 40 years ago and the Check21 project of a decade ago. But some of the project’s leaders see an almost moral responsibility undergirding FedNow. For all the talk about TCH, Visa, Libra, and other existing and potential real-time providers, Brainard made one imperative crystal clear: ubiquity.

Said she on that August day: “We are not making this decision lightly. It’s our responsibility … No private-sector provider has ever achieved 100% reach. The Fed has already invested in connections with nearly every bank across the country. We are uniquely positioned.”

It’ll be a few years, but FedNow will ultimately demonstrate how solid that “uniquely positioned” advantage really is.

 

And Then There’s Libra

Facebook Inc. and its proposed Libra cryptocurrency took a beating this summer on Capitol Hill, but the outlook for the new coin—and its Calibra wallet—may be more nuanced than that reception would seem to indicate.

The skepticism toward Libra was bipartisan, with Senators and Representatives of both major parties raking Calibra chief David Marcus over the coals in separate hearings in July. But what the ordeal really meant was that Libra could be a serious player not just in cryptocurrency but, even more crucially, in real-time payments.

Politicians in both hearings pointed to Facebook’s questionable record regarding privacy and security, while House Financial Services Committee chairwoman Maxine Waters and other committee Democrats have already prepared legislation to stop Libra development until all questions are answered.

But regardless of Marcus’s defense of Libra in both forums, and the heated rhetoric it drew from Senators and Congressmen, some observers say Facebook could be playing a long game with Libra and its wallet app.

One key to this view lies with the Libra Association, the international consortium of 28 companies that is expected to take over governance of Libra after this year, basing its operations in Geneva, Switzerland. Facebook will be one of the 28, along with payments companies Mastercard Inc., PayPal Holdings Inc., PayU, and Visa Inc.

This means there aren’t likely to be any moves any time soon to establish Libra or its wallet as a commercial proposition, these observers say.

“It will take years to establish the Association’s governance documents and more years to identify the initial payment use cases the platform will support and the regulatory constraints that the platform must address specific to those use cases,” points out Tim Sloane, vice president of payments innovation at Marlborough, Mass.-based Mercator Advisory Group. Sloane has been closely following Facebook’s crypto strategy.

Furthermore, there will likely be an even longer wait for the wallet. “Calibra can’t enter the market until Libra is up and running,” Sloane says. “When it is, then Calibra needs to align with all of the [regulatory] agencies. This still leaves significant wiggle room as few of these agencies have regulations in place that recognize the unique nature of crypto.”

Other payments analysts point out that such patience could pay off. When Libra finally delivers on its promise, it could have a powerful—and immediate—impact because of its backers’ plan to tie its value to existing fiat currencies.

“Tying it to a hard asset like gold would have been bolder, but also more threatening to central banks,” notes Eric Grover, principal at Intrepid Ventures, a Minden, Nev.-based financial-services consultancy. “In contrast, Bitcoin is backed by nothing more than the hope there’s a greater fool willing to buy it for more.”

Indeed, Grover argues a heavy regulatory hand could defeat one outcome the currency’s designers may or may not intend. “Libra threatens and stresses existing systems. No bad thing,” he argues. “A credible, lightly regulated, new global currency and payment system would force existing currencies and payment systems to perform better.”

Light regulation, though, isn’t likely. Calibra has filed for state money-transmitter licenses, according to Mercator. And Marcus told the Senate Committee on Banking, Housing, and Urban Affairs that Facebook is working to comply with a wide swath of agencies, including the U.S. Treasury Department’s Financial Crimes Enforcement Network and Office of Foreign Assets Control, as well as the Federal Trade Commission.

And even if Facebook is patient, it will continue to draw skepticism about its venture into cryptocurrency and, by extension, faster payments.

Sloane, for example, points to the simple matter of the Association’s intended headquarters city. “How a Geneva-based operation squares with the statement, ‘I believe that if America does not lead innovation in the digital-currency and payments area, others will’ is beyond me,” he says, noting a sentence in Marcus’s prepared statement for the House committee he faced in July.