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Fed’s Faster-Payment Plans Will Help, Not Hinder

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September 03, 2019

Fed’s Faster-Payment initiative another option, not a direct competitor to The Clear House's RTP.

financial system softwareThe Federal Reserve recently announced its intention to develop a faster-payment system, a decision that probably will not change how most corporates are approaching the existing private system that has gained traction this year. Nonetheless, it created some angst in the banking industry, which is backing that private system. The net result however is that the Fed’s initiative may ultimately calm some nerves as it appears it will run as a backup.

In a July 26 response to senators’ query, the Fed said that it is “seriously considering proceeding” with two actions it described in a 2018 request for industry feedback. Those actions include a 24x7x365 faster-payment service and expanding the hours of its Fedwire Funds Service and the National Settlement Service (NSS) to support liquidity management for faster payments and other payment activities.

“Through both these potential actions, the Federal Reserve System would modernize its payment and settlement services and help foster the development of safe, efficient, and broadly accessible faster payments,” the letter says.

On Aug. 5, the Fed issued a second request for comment about its proposed real-time and always open, gross settlement service to be called the FedNow Service that it plans to develop to support faster payments. Comments are due November 7.

The Clearing House (TCH), owned by a consortium of large banks, launched its Real-Time Payments (RTP) initiative in autumn 2017, and earlier this year it started gaining significant traction when 16 banks representing more than 50% of US demand deposit accounts signed on to the RTP Switch. TCH anticipates by year-end several more large banks connecting as well as smaller banks through intermediaries such as Jack Henry and BNY Mellon.

A four-year wait. Smaller banking institutions wary of a payment system run by the largest banks lobbied for a Fed faster-payment system, although RTP has promised the same low fees—published on its website—for all bank customers. Even so, the Fed doesn’t anticipate the system to be up and running until 2023 or 2024, so at least four years away, leaving TCH’s RTP the only game in town in the meantime.

Payers’ Plusses. RTP’s current transaction maximum is $25,000, although it is expected to increase soon, and the Fed proposes starting out with the same maximum. The UK’s faster-payment system, active for more than 10 years, has a maximum payment of £250,000, depending on the bank. Transactional functions such as daily positioning, whether reconciling accounts or managing cash, often require uploading entries in processes that can result today in delays of 30 minutes or more to verify all transactions were made correctly. With RTP and assuming the amounts are less than the limits, those transactions would be recognized right away and corrected, said Thomas Spataro, US treasurer at Computershare, the largest stock transfer agent that provides corporate trust, stock transfer and employee share plan services globally.

Mr. Spataro also noted that when one-off instances occur, such as covering overdrafts or when a payment under the $25,000 limit fails to reach a vendor/participant, the company can quickly correct the mistake by sending the payment via RTP, avoiding potential penalties and cost. There are also plenty of instances where making payments in real-time simply isn’t necessary. “If my company owes a vendor a regular payment of $2,000, I can just as easily send it through ACH channels and it arrives a day later,” Mr. Spataro said, adding, “Not every payment has to be made in seconds.”

Dan Blumen, a founding partner of Treasury Alliance, noted that companies typically want to make especially larger payments later rather than sooner. However, companies dealing with retail customers often want to receive payments as soon as possible for a variety of reasons, such as to avoid cutting their telephone or other services. “If someone is in the consumer space, real-time payments will matter to them. But if not, the uses cases are not as compelling,” Mr. Blumen said.

Echoing Fedwire and ACH. In the long term, the Fed system will likely run alongside TCH’s RTP, similar to what already happens today with ACH and wire payments. Critical will be the interoperability of the two systems,” said Carl Slabicki, product-group manager for strategic payment solutions at BNY Mellon, which was the first bank to connect to the RTP switch. “We don’t want bifurcated RTP solutions that make it not possible to send transactions across banks on either side,” he said.

In the meantime. Until the Fed’s system arrives, RTP solves the market need for 24x7x365 processing, Slabicki said. “The need is there, and the Fed stated it as one of the reasons it decided to move forward.” Whether the Fed’s timeline slows adoption of RTP, as some have feared, remains to be seen. “If you’re a bank or corporate who sees the need for 24x7 instant processing over the next one to three years, with all the bells and whistles this service brings, it’s already here,” Mr. Slabicki said.

The Fed’s challenge. The central bank is essentially trying to hit a moving target in terms of providing a real-time-payment service, since RTP will continue to evolve. Mr. Spataro noted that a big difference between using existing wire or ACH payment services and RTP is the latter’s enhanced messaging capability. It should greatly improve payment efficiency, assuming the systems of the organizations receiving the payment are connected to RTP and able to digest the messaging. The Fed will presumably have to build something similar.

The Fed’s advantage. Mr. Blumen said that unlike central banks in countries such as Singapore, the Fed does not supervise payment systems in the US. In its letter to the senators, the Fed notes that central banks in other jurisdictions, it “does not have plenary regulatory or supervisory authority over the US payment system.” That lack of supervision appears to be a factor in some banks wanting a Fed alternative.

TCH and the RTP banks pre-fund what is essentially a joint account at the Fed, with each bank keeping a sub-ledger to do settlement in real-time. Mr. Blumen noted that the structure allows for real-time, irrevocable payments by agreement of the banks, compared to the Fed’s proposed real-time system that will be backed by its credit and account relationships with member banks. He added that the different systems would be indistinguishable to users, but payment systems are systemically important.

“In the next financial crisis, which in my view will be caused by a payments problem, which system helps you sleep better?" Mr. Blumen said.

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