Straight Talk About Faster Payments

Faster payments is one of the liveliest narratives taking place in financial services today. Banks and businesses both want a faster way to move money, data and a variety of other financial services products across physical and digital borders, and for different reasons. Theories abound about how to do that – and why. David Kretz, Managing Director and Head of Global Payments for Global Transaction Services at  Bank of America Merrill Lynch, and Dean Henry, Director and Head of Global Low Value Payments for Global Transaction Services at Bank of America Merrill Lynch, talked with MPD CEO Karen Webster about what solutions the industry needs, starting with what problem the industry is trying to solve – and for whom.

ON WHAT FASTER PAYMENTS REALLY MEANS (AND WHAT IT DOESN’T)

KW:       I think there’s a general lack of clarity about what faster payments really means. Is faster about speed – and if so, does that mean same day or real time? Or does faster really mean more efficient? Or smarter? Or more flexible? How do you define “faster?”

DK:         You’re right that “faster” is used loosely. “Faster payments” is often used to describe the evolution of low-value or ACH payments, which are typically on a 48-hour delivery cycle, to something faster. Sometimes it means same day, and other times, it means real time. The difference between same day and real time is quite material. Same day is something as simple as adding more clearing windows during a particular time frame, but real time means the settlement of a payment near-instantaneously.  The latter is much more like how wire transfers are done today for high-value payments. The confusion lies in people calling that evolution “real time” when they really mean “same day” or vice versa.

ON THE PROBLEMS THAT FASTER PAYMENTS SOLVES

KW:       From where you sit, what problems does Faster Payments solve – and for whom?

DK:         The easiest example of problems solved is in the business to consumer or business to employee use cases. It’s still the case that payroll is best made by ACH rather than by wire, but situations do occur requiring faster than 48 hours. A company might add an employee at the last minute or inadvertently miss an employee in their file. The nice thing about real time is that a business will have the opportunity to pay that person in a cost-effective manner and still on the scheduled payroll date.

KW:       But aren’t those the exceptions and not the rule?

DK:         We don’t think so. Based on our review of other countries that have converted, same day or real time becomes an alternative to wire transfers. However, to your point, not a substitute for all payments currently delivered via high value means. There will be specific cases where same day or real time makes sense for businesses, and we don’t think it’s going to entirely replace wire transfers.

DH:         Our wholesale clients are not asking to get paid faster. They have the age-old problem of trying to figure out what they got paid for and reconciliation remains the big operational expense category.

ON THE REAL PROBLEM

KW:       Aha, so, the problem isn’t moving the money, it’s trying to figure out what the money that’s being moved is for.

DH:         Exactly. The No. 1 challenge our clients are talking to us about is the importance of payments data.  The Fed is certainly inspiring an industry dialogue about this and other industry payment challenges. And, we see The Clearing House picking up the main themes and pushing an actionable plan. I understand that part of The Clearing House’s vision addresses many of today’s data challenges and has a common format that is more robust than the traditional capabilities available today.

Lastly, the growth in cross-border payments is also compounding data challenges as transactions move between differing domestic payment systems. As this trend continues, it will be important that cohesion emerges around standards that can enable interoperability between the various global schemes that exist today.

ON THE IMPORTANCE OF (OR LACK OF) THE DISTRIBUTED LEDGER

KW:       So is solving for the data issue one of the reasons that the distributed ledger has so much appeal for banks? Is the thinking that distributed ledger solutions solves for both the movement of money and movement of data?

DK:         Distributed ledger is communication technology that is prompting banks to look at the correspondent banking model. The correspondent model can result in a payment being passed among several banks in between payer and beneficiary. What distributed ledger is doing is making banks ask the question, “Can we communicate better and more directly with fewer intermediaries?” The technology itself doesn’t solve anything. The way that banks would use it for communication and how they organize themselves in delivering payments is the discussion going on.

DH:         Generally speaking, the fact that you have a platform like distributed ledgers that isn’t burdened by 50 years of technology and standards enables the freedom for a redefinition of transaction flows and the associated data.

KW:       So you’re not saying that it’s possible to enable other kinds of innovation that leverage the other systems in place? There are the good and bad in those systems. In the “good column” they are hardened and compliant, consistent with regulatory regimes around the world that require very specific compliance for moving money. In the “not so good column” they’re 50 years old and written in COBOL. But isn’t there a way to bring those two things together?

DK:         Distributed ledger can help to deliver one component of the solution. Looking at the overall system today and what’s broken, I see that there are two things we’re all trying to fix. There’s messaging, which is the data that you can send along with the clearing instructions. Then there’s settlement. The settlement infrastructure is 50 years old. Everybody uses it and it’s the hardest to replace. A lot of the distributed ledger innovations have focused on the messaging, but leave the question, “How do I actually settle the money in real time?”

KW:       So basically, there is no good answer right now.

DK:         There is no good answer right now, but there are a lot of interesting hypotheses.

ON BANKS AS INNOVATORS IN THE FASTER PAYMENTS ARENA

KW:       Silicon Valley is flush with cash and throwing it at a lot of companies that are trying to solve for the messaging and settlement problems you just described. As you see it, where do the banks fit? Are the banks leading the innovation bandwagon? Riding alongside it? Falling behind it?

DK:         I would say that technology companies have started a conversation about new ways to send payments globally that can only be completed with banks engaging and, in many ways, taking the lead. Banks can embrace the solutions proposed by tech companies, but we also have to figure out how to reorganize the correspondent banking network to accommodate changes. Distributed ledger technologies have a lot of promise, although there are issues around transparency inherent in these technologies that have privacy impacts. You also have the need to ensure compliance with regulatory requirements. These are the things that technology companies are not able to solve because they’re not the ultimate user of the solution itself – it’s banks and their clients.

ON WHERE WE WILL BE IN THE NEXT FIVE YEARS

KW:       Let’s fast forward five years. Will we be having the same conversation or will anything have changed?

DK:         Five years from now, correspondent banking will look a lot different than it does today, which will be the result of several things happening: improvements in messaging, organization, payment transparency and traceability of payments. It’s hard to predict which of those elements will be the subject of that improvement. But things will change for the better just as banking is better today than it was 10 or 20 years ago.

DH:         We estimate that in five years the industry will utilize distributed ledger, mobile and alias-based payment networks as a standard part of its payment services and solutions. The quest for “better, faster, cheaper” will inspire the widespread use of digital payment platforms.

KW:       Wow, so you envision in five years that there will be some cryptocurrency-enabled set of rails that will move money and messages? Maybe not bitcoin but something else?

DH:         You don’t have to have a cryptocurrency to facilitate a distributed ledger payment. There are reasons why cryptocurrencies has been built into some of the models, but there are also approaches where you could factor it out. I do think in the future you will have distributed ledger solutions that provide alternatives to some of the traditional clearinghouses that we use today to clear payments both domestically and internationally.

KW:       OK, well we’ve got it all right here, recorded for posterity! Five years sounds like a long time but it’ll be here before we know it. It will be fun to watch this all play out.