A plan by the Federal Reserve to build its own network to transfer funds quickly has pitted technology firms seeking a foothold in the financial sector against banks that have traditionally dominated the payments business.
Tech firms see the new payment system as an opportunity to get into the payments business, and banks, facing a new rival, are pushing for tight rules on companies moving into banking-like services, according to advocates on both sides of the issue.
The Fed in August announced a plan to develop an instant payment system, FedNow, drawing praise and opposition. Big banks, which have their own payments system, are trying to persuade Congress to block the Fed plan.
But even as big banks lobby Congress, they are taking the precaution of trying to ensure fintech firms can’t use the system if the Fed does go ahead. As the plan unfurls, the Fed will have to decide how much access non-banks get.
Brad Garlinghouse, CEO of cryptocurrency firm Ripple, for example, argues that fintech firms will bring more innovation than would be the case if banks are allowed exclusive access.
“It’s crazy to me that the fastest way to get money from Washington to London today is to drive to Dulles and fly it there,” Garlinghouse said last month at the DC Fintech Week conference, highlighting the slowness of the current system.
Banks have invested heavily in payment systems, and they alone can access the Fed’s transfer systems. The American Bankers Association wishes to keep it this way, it said in a letter to the Fed when the central bank proposed its instant-pay system. That’s because banks offer protections that many fintech companies don’t, the organization said.
One effect may be new competition between FedNow and the bank-owned payment systems, such as the Automated Clearing House, or ACH.
“The Fed’s decision to build an instant payments system should not slow down or divert resources from its other commitments to payments system improvement,” William Sullivan told CQ Roll Call in a statement. Sullivan is senior director and group manager of government and industry relations at NACHA, the organization that governs ACH.
NACHA wants the Fed to share new technology it develops — such as fraud detection and prevention, or expanded settlement during nights, weekends and holidays — with payment systems like ACH, he added.
But it’s the inability of systems like ACH to provide instantaneous payments that is driving FedNow, according to Fed board member Lael Brainard. She said on the day the Fed announced FedNow that ACH can take days to process transactions.
The dominant payment company, The Clearing House Payments Co. LLC, which conducts the majority of transfers, established its own real-time service in 2017, and thus argues there’s no need for the Fed’s efforts. Its owners are some of the nation’s biggest financial institutions: Bank of America Corp., Citigroup Inc., JPMorgan Chase & Co., and Wells Fargo & Co.
The Clearing House’s executive managing director, Robert Hunter, told Congress in September that he’s concerned about the chilling effect FedNow might have on the company’s plans to “bring the benefits of real-time payments to every American.” Those real-time payments are, however, almost exclusively used by big banks.
Worry about fees
Merchants and fintech firms, meanwhile, say they’re worried the banks could monopolize instantaneous payments and charge excessive fees. Access to the Fed’s infrastructure to use FedNow would address that worry.
Google’s parent company, Alphabet Inc., wrote the Fed last year that mobile devices, the main way many users access the internet, are driving the need for payments outside of normal bank settlement hours. The company is making further inroads into finance, announcing Thursday that it plans to set up checking accounts next year for Google Pay app users and is partnering with a credit union and Citigroup Inc. on the effort.
Google hasn’t said whether it would want Google Pay to connect directly to a system like FedNow.
Amazon.com Inc. also supports the involvement of private fintech companies. Instantaneous settlement allows more than just fast purchases, it also facilitates returns and refunds, it told the Fed last year.
Consumers now use applications on their cell phones, such as Venmo, a company owned by PayPal Holdings Inc., to make purchases and make payments.
These transfers are not instantaneous, however. It can take a few days for a payment to reach the seller, although some apps allow for quicker transfers for a higher fee. Venmo says free transfers typically take one to three business days, but faster ones are available for a fee of 1 percent, and typically take about 30 minutes.
Banks say these companies should have to conform to banking regulations. That means adding protections, such as an obligation to restore funds if a third-party improperly debits a customer’s bank account. The American Bankers Association said the Fed should open its payment system only to chartered financial institutions, such as banks and credit unions.
One big challenge to multiple systems is interoperability, or how well they work together.
The Clearing House said it doesn’t expect the Fed’s efforts to work with private systems like its own. That’s the situation in Europe, said Steve Ledford, a senior vice president for products and strategy at the Clearing House, noting that the European Central Bank’s system doesn’t connect to the private sector.
If competing systems do not work together, costs will likely go up as banks conclude they have to join multiple networks, he said to CQ Roll Call in an interview.
Even Google acknowledged in a comment to the Fed that getting the large number of organizations that will want to connect to the Fed’s system up and running will be very difficult.
The Electronic Transactions Association, which represents credit card companies, fintech startups and established players such as PayPal and Western Union Holdings Inc., is more optimistic about interoperability. The technical challenges are not the issue, according to Amy Zirkle, the group’s vice president for industry affairs. The issue is coming up with how the systems communicate with each other, she told CQ Roll Call in an interview.
Ripple’s Garlinghouse says the company aims to cross the interoperability hurdle with use of open-source software and distributed ledger technology, which offers theoretically immutable record-keeping.
The payment system is too important to be the responsibility of only the private sector, Sheila Bair, former Federal Deposit Insurance Corporation chairwoman under Presidents George W. Bush and Barack Obama, said to the Senate Banking Committee in September.
“History has shown the folly of exclusively relying on big Wall Street banks for financial infrastructure,” she said.
She described the current payments system as a complex set of IOUs that run on old technology. She noted that fintech firms providing real-time payment typically only can do so if both the sender and recipient use the same payment service, or alternatively have accounts with participating banks.
She said the Clearing House’s new instant pay system has low volume and only a limited number of bank participants, mostly the large ones who own the company.
The Clearing House could, according to Bair, charge excessive fees, and the Fed lacks authority over these fees.
The Fed has many supporters in Congress for its payment plan. The Congressional Black Caucus said low- and moderate-income communities would benefit from quicker settlement, which could reduce overdraft fees and expensive charges for smaller payments, such as those imposed by check-cashing services.
“These big banks oppose the Fed’s efforts because they want to be the only game in town. They want a monopoly,” said Sherrod Brown of Ohio, the top Democrat on the Senate Banking Committee.
The Fed aims to have FedNow running by 2023 or 2024.