Real-time Payments

I did a little bit of research on real-time payments and want to share here. It’s a big topic so I’ll likely add more in the next few weeks. In this post, I just cover why we need real-time payments, what it means and what it does. Let’s go!

ACH

Before we talk about real-time payments (RTP), we must first talk about ACH. Automated Clearing House (ACH) is a method that moves money digitally from one bank account to another in the U.S. Before ACH was born in the 1970s, consumers and businesses sent and received money using checks that required a lot of human input. As the number of checks increased, along with the payment volume, and payment preferences evolved, the banks realized that they needed a more efficient way to automate and speed up the sending and receiving of money. That’s how ACH came about.

What does ACH do exactly? It acts as a financial postal office that handles transactions between financial institutions. Every day, there are thousands of transactions initiated in the U.S. ACH operators sort these transactions, bundle by recipient and deliver them accordingly in several batches every day. Each of the batches includes instructions telling the recipient financial institution whether it is to make a debit or credit to accounts under its purview. At no point do any two banks exchange real money to settle transactions. Settlement is processed through the Federal Reserve.

There are two ACH operators: EPN and FedACH. The Electronic Payment Network (EPC) handles the fund transfer for the private sector while FedACH serves the same function for the federal government. The National Automated Clearing House Association (NACHA), a non-profit, serves as a trustee and a rule-making body of ACH. Collaborating with the government agencies, NACHA sets up rules that dictate how EPN and FedACH deliver messages.

Even if this is the first time you have ever heard of ACH, you must have already used it. ACH is how employers deposit salary to employees’ accounts, a customer pays a service provider every month, a customer pays a credit card, a business makes a payment to a supplier or IRS deposits tax refund to a taxpayer’s account. Compared to credit cards or wire transfers, ACH has its strengths. Credit cards aren’t available to many consumers, especially those with a bad credit history. Meanwhile, it’s far easier to open a checking or saving account which one can use to initiate an ACH transaction. For businesses, credit cards can mean a few percentage points in revenue losses due to interchange fees. ACH, on the other hand, is significantly cheaper. Wire transfers can enable a big transaction safely and quickly; however, they are usually pricey at $15 per transaction. Because of its accessibility and cost-effectiveness, ACH is very popular with 27 billion payments worth about $62 trillion in the U.S in 2020.

But ACH isn’t perfect. Because it is batch-based, ACH can take several hours, if not days, to confirm and settle funds. The delay can have ramifications. For instance, small businesses can run into cash-flow problems with delay in fund availability. The pending transactions and, as a result, the uncertainty regarding balance can put some consumers at risk of overdrafts. Consumers that pay bills on the last day of the grace period may incur late fess or even face stoppage of services because their payments won’t be cleared fast enough.

Real-time Payments

According to the Payments Innovation Alliance, a real-time payment (RTP) is “an immediate, irrevocable, interbank account-to- account transfer that utilizes a real-time messaging system connected to every end-user through a financial institution, third party, or another real-time system. Funds are available for use by the receiver and real-time confirmation is provided to both the sender and receiver in seconds. While the requirement of immediate confirmation and fund availability is undebatable, there are conflicting opinions on whether settlement of RTP should be immediate. NACHA said that RTP settlement doesn’t need to take place real time. The majority of RTP systems today use a deferred net settlement method which offers a lower liquidity risk than a gross settlement method (settle transactions individually). On the contrary, The Clearing House claims that RTP network payments “clear and settle individually in real time with immediate finality”.

Essential characteristics of RTP include:

  • 24/7/365 availability
  • Authorization or rejection of payment is within seconds 
  • Fund posting and availability are within seconds
  • “Push” payments only
  • Use of ISO 20022 message standard. This will enable the transfer of richer data
  • Irrevocability. Funds are only transferred after sufficient funds are confirmed and when payments are sent, they are irrevocable
  • Availability of a proxy database that allows end users to send and receive payments without knowledge of the receiver’s bank account information 

RTP benefits consumers and businesses in several ways. The constant availability and the immediacy of funds increase consumers’ convenience and help them manage budgets better. Thanks to RTP, some consumers may no longer have to live in anxiety with last-minute bill payments not clearing fast enough. With a proxy database, RTP can allow consumers to receive and send money without offering bank account details, a practice that makes me nervous every single time. All they need is a phone number or an email.

For businesses, there are multiple benefits that RTP can bring. They can refund customers and pay off suppliers right away, rather than a few-day delay. Who doesn’t want to get their hard-earned cash faster? Hence, customers and suppliers will field fewer anxious calls and be ultimately happier. Happy customers and happy suppliers mean happy life, I guess. In some urgent circumstances, the value of RTP will be even more highlighted. For instance, sometimes businesses are required to make unexpected same-day payments to authorities. They can use ACH and hold their breath that their payment makes it to one of the earlier batches. Or RTP can solve that problem instantly and hence, reduce regulatory and compliance risks. As receivers, the finality and irrevocability of payments will be a boon to businesses. Once they receive payments through RTP, they don’t have to worry about whether the senders have enough funds or will recall transactions. Plus, payments are cleared and settled right away. These two factors will help improve their cash flow management tremendously.

Another benefit of RTP is the use of ISO 20022 payment messages. The new standard is an improve over the old ones in the amount of data it can transmit and its structure. With the old standards, businesses can’t extract insights from the messages. In some cases, that can send false positive compliance issues leading to delays and higher expenses. According to SWIFT, poor data results in 1 out of 10 international payments being held up. The ISO 20022 payment messaging standard enables parties involved to attach a richer and more structured data to a payment. Data can include details of the remittance, the purpose of the payment, the original source and other relevant information. With this new data that can be processed more easily, businesses can reduce fewer errors, avoid delays, decrease unwanted reconciliation expenses, and gain valuable insights. 

A practical example of ISO 20022
Source: SWIFT

What are the RTP or faster payment services in the U.S?

First, let’s talk about the RTP network. It is the first core infrastructure in the U.S in more than 40 years. It was built and launched in November 2017 by The Clearing House, whose owner banks include arguably the biggest in the country. The RTP network is available to all federally insured U.S depository institutions and already reaches 61% of U.S demand deposit accounts (DDA). 

Next is FedNow. It is owned by the Federal Reserve and is expected to launch in 2023. Once live, it will be available to all depository institutions in the U.S. The Federal Reserve said that FedNow will process messages and settle payments within 20 seconds. In the beginning, FedNow’s initial transaction limit will be $25,000, lower than the current limit imposed on the RTP network by The Clearing House. 

Clearing House's owner banks
Source: The Clearing House

Mastercard Send is Mastercard’s native method that enables instant payments between governments, businesses, and consumers. Mastercard Send supports disbursements – non P2P payments to consumers, domestic P2P payments and cross-border P2P transfers originating from the U.S. As of this writing, Mastercard Send is available in the U.S only and all domestic debit cards, including non-Mastercard cards. Interested issuers can tap into the Mastercard Send API to enable this capability. 

Visa Direct is Visa’s equivalent of Mastercard Send with two major differences. The first difference is that while Mastercard Send is currently available in the U.S only, Visa Direct can be used in more than 100 countries. Secondly, its requirement for fund availability varies from one financial institution to another. In the U.S, Visa Direct mandates that all participating issuers make funds available within 30 minutes, a more relaxed approach than Mastercard Send, which claims that funds are available and settled within seconds

Zelle is a mobile payment application developed by Early Warning Services, which is owned by Bank of America, Truist, Capital One, JPMorgan Chase, PNC Bank, U.S Bank and Wells Fargo. The application enables users to transfer funds from one to another without the need for account details. All it requires to initiate a transfer is an email address or phone number. Formerly confirming transactions within minutes, Early Warning Services announced in February 2021 that Zelle transactions can now be cleared and settled in real time, officially making it an RTP network. Zelle users need to note that several banks place restrictions in terms of the number of transactions and transfer volume that a user can initiate in a month. 

In December 2017, NACHA announced the launch of Same Day ACH, which enables the ACH payments to be processed faster and potentially settle in the same day, if a payment is submitted early enough. Despite this improvement, Same Day ACH isn’t an RTP method because transactions are still processed in batches and revocable. 

Wire Transfers offer instant payment confirmation and settlement. However, unlike RTP, Wire Transfers are more suited for low-volume high-ticket transactions, limiting its value and accessibility to consumers and businesses. Compared to a few cents per RTP transaction that The Clearing House charges, a wire transfer usually costs at least $15. 

Mobile payment apps such as CashApp, Venmo or PayPal allow instant transfers between users. Users can use their Venmo balance for purchases. What makes me unclear about whether these apps are RTP are 1/ they require users to use another payment rail to retrieve money. Customers who want instant transfers from these apps to their checking accounts will have to pay a small fee. 2/ will refunds go to bank accounts or Venmo accounts? If they go to bank accounts, how long will it take? 3/ Since not every merchant supports checkout with these apps, will it still be RTP?

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