Why the Fed is right to step in and finally make real-time payments happenThe Honorable Sheila C. Bair
With its recent proposal to create a new global cryptocurrency called “Libra,” Facebook (FB) saw a market opportunity to provide a faster way to process payments.
Anyone who has ever waited for a check to clear knows that process can take days. While the need for faster payments is real, Facebook’s ambition met with a firestorm of resistance primarily because few trust it to be a responsible steward of such an important financial function.
But are big banks any more trustworthy? They have also been trying to build a new, faster payments system to dominate the way we move money among one another. Amid growing concern from smaller banks and financial technology companies over how they might wield such power, the Federal Reserve has rightly decided to step in with its own system.
The Fed steps in where the private sector failed to deliver
Payments are the lifeblood of any economy. Yet the current payment system is fraught with frictions and inefficiencies. When we send money, the withdrawals from our bank accounts are usually immediate. However, it may take days for the money to go from our banks to recipients’ banks where they can access the funds. A handful of financial technology startups have tried to provide real-time payment services, but they are limited networks, typically working only if both the sender and recipient are subscribers and/or have accounts at participating banks.
In 2017, a group of large banks under the auspices of an organization called The Clearing House or TCH launched a real-time payments platform called the RTP Network. This network aspires to achieve the ubiquity lacking with fintech initiatives. It requires participating banks to pre-fund a joint account that stands behind payment transfers. Debits and credits are tracked in a centralized ledger maintained by TCH. As yet, it has failed to gain significant traction, with relatively low volumes and few banks participating beyond the big ones that own TCH.
What’s needed — but what the private sector has yet to deliver — is a trusted and universally available infrastructure that would allow banks and credit unions of all sizes to send and receive money in “real time.” Enter the Fed which, after years of study and public outreach, has decided to develop and launch such a system called FedNow. The Fed is already connected to almost all depository institutions in the U.S. and thus is well-positioned to provide the basic infrastructure to move money quickly between banks.
Not surprisingly, the Fed’s decision has been widely applauded by smaller institutions and fintechs, but roundly criticized by TCH and its advocates, who argue that FedNow will unnecessarily compete with the RTP Network and stifle innovation.
Currently, all major payments systems — including those for processing checks, facilitating direct deposits, and wire transfers — depend on both private and Fed systems. This has been the case for nearly half a century. One can hardly fault smaller depository institutions and fintechs for being wary of a system controlled by big bank competitors. For now the TCH has promised its system will be accessible to all on fair and equitable terms, but will those promises hold in the future if they achieve market dominance? The TCH website acknowledges its pricing could change if it has to “react competitively.” Surprisingly, while payments infrastructure has important public utility functions, the Federal Reserve lacks direct authority to regulate it. It cannot require TCH to make its system accessible to everyone or regulate its fees to prevent discriminatory pricing.
FedNow will promote competition, not stifle it, by protecting against potential anti-competitive behavior by TCH or any other monopoly provider. The Fed wants private sector innovation. Indeed, it worked closely with TCH to set up the joint account that underpins the RTP Network. And it is exploring making its current wire and net settlement services available on a 24x7x365 basis to support private initiatives for faster payments around the clock. But the Fed wants multiple players in this space, competing on fair terms. With FedNow, it will give all depository institutions and their fintech partners a ubiquitous infrastructure upon which they can build their own platforms and services.
Can ‘government bureaucrats’ innovate?
Critics scoff at the notion that “government bureaucrats” at the Fed could come up with an innovative new system, and point to the fact that FedNow is not expected to launch until 2023 or 2024. But private sector innovation in payments has also been sluggish. Work on the TCH system started in 2014. It did not go live until three years later, and TCH acknowledges that it will not be easily available to all depository institutions until 2020. The widely used ACH system, which facilitates direct deposits, took six years to develop during the late 1960s and early 1970s, and even longer to mature to its current, widely used form. Four to five years does not seem like an inordinate amount of time to build FedNow, particularly given the Fed’s commitment to work with all industry stakeholders and fully explore use of new technologies to construct the system.
Perhaps most importantly, FedNow will promote financial system resiliency. As we discovered in 2008, big banks can fail. The Fed cannot. Unlike Facebook’s proposal, which would have used a distributed ledger to move funds, risk in the TCH network is heavily centralized. Any failure to fund the joint account or compromise of the ledger could impact the entire system. Instead of criticizing the Fed, the big banks should be applauding FedNow as parallel system that could serve as a backup to their own.
Hopefully, post-crisis reforms will avert future big bank failures. However, big bank lobbyists, including TCH, are pushing to weaken those reforms. We cannot risk widespread disruptions to our payments system because large banks once again become unstable. They should have the right to compete, but not control, our payments infrastructure. The Fed is right to step in.