Payments Innovation – With a New Payments Infrastructure

Much focus today by the payments industry globally seems to be to compete for significant profit, which is understandable, but providing ease of payment for businesses and consumers at a reasonable cost and price through collaboration, and to make a payment with ease and for the common good, should not be looked down upon, and is a payment industry challenge with
thoughts for resolution compiled in the Federal Reserve Bank’s “working paper” as referenced by Karen; formally titled the “Payment System Improvement - Public Consultation Paper” It should be reviewed, in-depth and with serious thought. I’ve read Karen’s critique of John’s critique of US payments systems, and found Karen’s critique a defensive one, rightly so in
some respects given the pride and scope of growth of the payments innovators
and large banks who’ve gained traction in the US market with the funding and
growth of “enhanced” payments products with innovative payments products
features within their payments products space. However, the gains of growth by payments
innovators and large banks in the US has occurred in some cases by not
deploying an efficient, ubiquitous US clearing and settlement infrastructure, proving
John Gapper’s statement correct,

the US “lags behind badly in the basic infrastructure of retail banking.”

Checks

John’s example of a check and its inefficient flow through the US payments system
shows the extremes of inefficiencies, acknowledging the decline of check usage,
as does Karen although conceding check usage for business payments still exists
at undesirable levels due to expensive alternatives. However, payments
innovators have succeeded in integrating the payables and receivables segments
of products for SMB’s by some of the vendors she’s listed such as PayPal, NvoicePay, Intuit, Ariba and Dwolla, omitting others such as MineralTree and a plethora of emerging B2B
players offering ASP and software solutions with the goal of driving price points to levels
where checks become a less desirable alternative. More promising are ASP solutions interfacing with a more streamlined US clearing and settlement system providing payments innovators and banks in this space a greater opportunity succeeding with more efficient real-time low-cost payments, or scheduled low-cost payments from directory based buyer
accounts to supplier accounts. Coupled with remittance information, transaction
detail matching purchase orders with invoices would streamline workflow for both the supplier and buyer. Regarding the larger buyers and suppliers with existing B2B solutions, no market exists for them for payments innovators since they’ve already developed payments solutions
among bank participants conducting trade among them.

One can claim the reason for the success of some payment innovators named by Karen in her article is the lack of a streamlined US clearing and settlement infrastructure. Payment innovators are able to leverage the inefficiencies of the existing payments networks with
enhanced technologies for the origination and delivery of payment instructions
with a modern high tech face, while using the existing legacy back-end retail (DDA) systems for clearing and settlement, and some middleware payments networks such as ACH and Debit packaged in a new all encompassing payments architecture design. Good for payments
innovators, bad for banks that aren’t partners in some form with the payments innovators. One can claim most banks are to blame due to their inability to innovate and inability to stay abreast
of the demands of the consumer, and let their system capabilities; technology and business models ferment to rancidity, or unknowingly “wilt” to some degree, and these claims could be true for the most part. As both a payment professional and consumer, let me convey my
experiences.

Having worked for “Large West Coast Bank” in my youth in a variety of technical and lead positions in their Wire, ACH, Swift, Bill Payment and other areas of the bank with a team of
exemplary and innovative peers, both technical and operational, we succeeded to
streamline payment transaction flows from customer origination through delivery and settlement to DDA systems, from customer origination devices to customer receiving devices where applicable, reducing unit costs significantly throughout the years. After significant reductions in unit costs due to automation, reduction in personnel, and other cost savings,
“Large West Coast Bank” proved unwilling to reduce some price points to consumers and businesses to maximize profit, enjoying increased profits per transaction, remaining reliant upon revenue streams throughout the years when new “payments innovators” outside of
the banking industry exploited new and improved technologies, with new and improved businesses models, and “innovative” payment delivery methods. The devices and streamlining within “Large West Coast Bank” advanced from paper documents with wire and ACH instructions entered in multiple systems through dumb terminals in multiple steps across multiple communications links by multiple people throughout the day with DDA
posting and settlement at the end of day. Advancements in technologies occurred
over time with intelligent PC’s, the internet, SQL databases, advanced programming languages, etc., with skilled personnel providing innovation, allowing for the removal of manual steps with streamlined processes, DDA posting and settlement remaining at the end of day,
resulting in significant unit cost reduction, but minimal price reduction to consumers and businesses based on business model choice of price retention, a long term flaw for business and consumer customer attraction and retention.

A wire transfer in 1983 incurred a high unit cost within the bank, was charged a mid-level price by the Federal Reserve Bank, with “Large West Coast Bank” levying a charge to the business or consumer at a price somewhere in the $30 - $50 range; a decent profit. After streamlining processing over time with front-end and middle-ware changes, the wire transfer incurred
a unit cost between $1.50 and $3.00, was charged a price by the Federal Reserve Bank between $.17 and .67, volume dependent, with “Large West Coast Bank” levying a charge to the business or consumer at a price somewhere in the $5 to $30 range, volume and business or consumer customer dependent; a more than decent profit. Fear of revenue loss from a
change in business models was, and is, a primary incentive for payments innovation providing payments services to businesses and consumers outside of the banking payments industry. Although the model chosen is a wire transfer payment, not necessarily one used heavily by
consumers in the banking industry, the payment type is noted to indicate business
model choices made in the banking payments industry and indicative of price point definition for charges with variations on specific components of the unit cost and variations for added
profit margins.

This example highlighted shows transaction flows reliant upon the banks internal systems architectures and existing business models long term. Other examples of the streamlining of
transaction flows with success at “Large West Coast Bank” also exist with their home banking account transfer products, bill payment products, international consumer remittance products and those using ACH for account movement. Most of which are great products with varying internal systems architecture designs and money transfer pricing structures. I expanded
upon these products due to my familiarity with their relation to the comparisons made by John and Karen with regard to money movement cost and timing between accounts with products in the US, and with products in the UK. The comparison began with John’s frustration with the behavior of check timing of clearing and settlement in comparison with timing of clearing and settlement with Faster Payments, and mention of mobile and card, with further expansion with Karen passionately promoting payments innovation in the US with like products; interesting comparisons with payments innovators and product adoption to be determined
long term by consumer and merchant acceptance.

Debit and Credit Cards

John proudly touts the claimed superiority of the security of the EMV chip and pin, and the value of contactless cards which Karen denounces vociferously as an unworthy claim and proudly promotes the efforts of The Clearing House with its admittedly interesting attempts at
solving one of the most difficult problems in the payments world, authentication.

With EMV chip and pin cards, the solution appears to be economic with merchant
acceptance being the driving force, and determination by security industry experts of security a factor, Frankly EMV appears to be a solution tepidly embraced by the payments industry in the US per the article referenced1 although early in the evaluation stage, with The Clearing
House very early in determining whether their approach2 will even succeed, let alone convincing the merchants to accept the changes, whatever those changes may be.

Regarding contactless cards, I’m not sure whyJohn references this other than to tout this as a major accomplishment in the UK, and suggesting the possibility of contactless cards as a potential product for market in the US. Karen appears to question the success of the card in the UK in numbers, rather than accept the value John believes the card adds to the
economic and social construct of the market in the UK.

1EMV CHIP and Pin

www.digitaltransactions.net/news/story/EMV-Commercial-Card-Issuers-May-Herald-PIN-Dominance-With-Consumers

2The Clearing House Tokenization Pilot Info

www.mobilepaymentstoday.com/news/the-clearing-house-to-pilot-new-digital-payment-standard/

I began comments to Karen’s critique when her original article was published on July 14, 2014, citing personal examples where deficiencies in the US payments infrastructure exists
with payment types used by me with various products in the market; my “Large West Coast Bank” home banking product, independent utility and mobile phone website billers, PayPal money transfers, EBay, Amazon.com, Western Union, Lendup, Debit Cards, etc, but realized the comments became too detailed, but determined examples of payment types requiring improvement were best identified by organizations solicited by the Federal
Reserve Bank in the “Payment System Improvement - Public Consultation Paper” by
some respondents published. One such organization, The Clearing House, submitted a
comprehensive, well written response with specific examples of payment types as
“Business Cases,” that would benefit from faster payments and a restructuring of some
features of the US payments system. Although the recommendations will be
agreed to by some, not all features will be agreed to, specifically their position with
regard to negating recommendations to Debit POS structural changes. However, their
position is commendable among others who’ve submitted responses to the Federal
Reserve Bank, and is one to be debated in further sessions with others who may
have conflicting opinions. I suggest those who are interested, review “The Clearing House” response by accessing the Federal Reserve’s website,

http://fedpaymentsimprovement.org/wp-content/uploads/2013/12/Response-The_Clearing_House-120313.pdf

and gauge others’ responses. Some of the responses contain content lacking sufficient quality, others are of sound quality with many payment innovators prominent in the market including, PayPal, FIS-Paynet, Fundtech, ClearXchange, MCX, Wal-Mart, JP Morgan, etc;

Federal Reserve Bank Payment System Improvement - Public Consultation Paper

http://fedpaymentsimprovement.org/user-submissions/

My experience with the Federal Reserve Bank over the decades, working directly and
indirectly, at a large bank and with small and medium sized banks, and payment servicing companies was an educational experience. Having worked in technical and operational positions with their Fedwire, ACH and Check processing network and operations groups, I found them highly competent. Their current approach actively soliciting consultation from payment industry participants, Fed bank members, and Fed bank member customers, with the Fed knowing their clearing and settlement systems lacks a formidable infrastructure necessary for payments innovators to leverage all bank members for payments ubiquitously or a desire for them to do so, and knowing the tendency towards peripheral payment innovators with large bank members moving away from the formation of ubiquitous, streamlined formidable, low-cost payments systems towards fragmented, non-ubiquitous, higher priced, payments systems,
puts them in a position to assist in collaborating with payment industry participants, Fed bank members, and Fed bank member customers, and given the number of town hall sessions conducted, and the symposiums where many of the payment industry participants and customers responding to the payment industries “desired outcomes” collected by a
non-government, private enterprise consulting firm in the “Payment System Improvement - Public Consultation Paper”.

The Federal Reserve Bank’s desires not to be a payments innovator, their desires are to push forth and influence collaboration among the payments innovators in the payments industry, a role they should play to achieve the outcome of the agreed upon efforts, whether project deployment is conducted by payment industry participants, by the Federal Reserve Bank, or by
both. The decisions are to be made during subsequent sessions conducted by the
Federal Reserve Bank. Two additional papers were released to the public after the Federal Reserve Bank reviewed all of the responses and summarized into the following summary
reports. Select the “Industry Feedback Summary” and “End User Summary” url's to review the PDF report with statistics culled from payment industry participant responses. The results are of interest.

Payments Industry Feedback Summary

http://fedpaymentsimprovement.org/wp-content/uploads/industry_feedback_summary.pdf

End User Demand Summary

http://fedpaymentsimprovement.org/wp-content/uploads/enduser_demand_summary.pdf

Recent town hall meetings presenting detailed recommendations from user submissions held
across the United States in July at various Federal Reserve District offices and conducted by the Federal Reserve Bank with many payment industry participants in attendance. The detailed
recommendations were based on feedback from all responses gathered from user
submissions sent in December, which I believe will be made available for public review
in the fall, 2014.

So…John Gapper was right. The US “lags behind badly in the basic infrastructure of retail banking.”

John Gapper’s annoyance of the US banking system is understood and his critique is on point. Karen’s annoyance of some folks non-acceptance of payments innovation occurring in the US is understood and on point as well, but all should evaluate the payments innovators
objectively. Much innovation is occurring in the US. Both tout the advantages both countries have with their payments innovators’ strengths in the payments industry and rightly so, but should remain objective and region non-specific.

What’s the point other than the claim of each others’ biased perceived heightened degree of intelligence from the resolution of payments systems challenges presented in different regions with their variables presented, resulting in each regions positive resolution with their payments
systems innovations? Our goal should be to integrate payments universally, not
regionally and evaluate each regions clearing and settlement systems for future consideration with a vision of payments innovation consolidation, all variables of each regions success
considered. Complex, yes; solvable with collaboration and co-operation, also, yes.

To end this congenial and fairly lengthy response to Karen’s worthy, interesting, and well written article and per her thoughts:

“But, here’s my big problem. I don’t get anyone claiming the government anywhere is who
we should be looking to for innovations in payments, including our every own Fed. The government didn’t invent a single one of the innovative payment systems that have revolutionized payments around the world. Not the payment card which has help make payments electronic and provide an essentially global method of payment; not the ATM machine; not the incredible mobile money schemes that are providing financial inclusion across
Africa; not PayPal or another of the payment methods that enable digital commerce. Nope, the government is what has foisted cash on us and in the US at least, paper checks.”

Karen emphasizes the words “anyone” and “government anywhere” clearly showing a strong reluctance with government “owning” innovation. I agree, as most others do, the government should not be looked upon to “own” innovations in payments, but the Federal Reserve Bank is
technically, not the government but an organization administered primarily on the operations side of its organization by some bank members. The Federal Reserve Bank should not be
looked upon unfavorably and can play a productive role by influencing the evolution of the payment industry and assisting innovation in payments, thus benefitting financial institutions and their business and consumer customers, and peripheral private enterprise payments
innovators, domestically and globally.

Having participated in the Federal Reserve Bank symposiums and observed and interacted with Federal Reserve Bank representatives, financial institutions, large retailers, payments software vendors, payments software processors and innovators, named players mentioned
in this article and prominent in the market with some included in the Federal Reserve Bank’s web site, www.fedpaymentsimprovments.org, makes me believe the Federal Reserve Bank’s recommendations should be reviewed when published, then debated, negotiated, and agreed to, since the recommendations will significantly change the payments networks and clearing and settlement systems for payments in the U.S. The changes will affect all financial
institutions, payments processors, providers, and payments participants in the market,
including emerging payments innovators! I don’t believe the recommendations will be a mandate, but a collaborative approach, with the opportunity for payment innovators to continue
to innovate, and innovate adhering to a new clearing and settlement infrastructure.

What’s compelling about the possibility of a new US clearing and settlement infrastructure is the potential replacement or major redesign, upgrade and replacement of thousands of DDA
systems at thousands of financial institutions throughout the United States, with potential significant reconfiguration of networks, potential device upgrades, reconfigurations and replacements, and agreement on messaging, security and other standards long overdue to ensure consistency of domestic and global payments processing, all with the
encouragement of payments participants to innovate in a collaborative private enterprise market, not as a government run, developed, and implemented product or project. A major cost to our economy, with a major opportunity for profit for those participating in the design,
development, implementation, and use of the payment infrastructure and business model
changes beyond implementation.

The challenge is funding the effort and developing a business case to move forward, whether it is privately funded through collaborative efforts, or a shared government funded effort, given the projected front-end costs anticipated before benefits are received. I’ve faith the Federal Reserve Bank and its private partners will succeed in this role.

So, to this end,

"The Reserve Banks remain committed to the continual improvement of the US payment
system and will work collaboratively with stakeholders this year and beyond to
implement innovations that meet evolving end-user needs for speed, efficiency
and security," Sandra Pianalto, President of the Federal Reserve Bank of Cleveland.

http://www.finextra.com/news/fullstory.aspx?newsitemid=25692&topic=payments

And moreover, we all should commend Karen Webster and John Gapper, both who’ve
sparked a constructive debate from others long standing conversations leading
to the reconfiguration of one of life’s simple successes, that being a payment,
a good thing!