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Take On Payments, a blog sponsored by the Retail Payments Risk Forum of the Federal Reserve Bank of Atlanta, is intended to foster dialogue on emerging risks in retail payment systems and enhance collaborative efforts to improve risk detection and mitigation. We encourage your active participation in Take on Payments and look forward to collaborating with you.

Take On Payments

August 14, 2017


Extra! Extra! Triennial Payments Data Available in Excel!

In countless old black-and-white movies, street newspaper vendors would shout out the latest sensational news from hot-off-the-press special editions. The Fed is no different in that we want to shout out that it is no longer necessary to mine the PDF-based Federal Reserve Payments Study report to extract the study's data. For the first time, we are offering our entire aggregated data set of estimated noncash payments in an Excel file. The report accompanying the data is here.

The data set is very rich and covers the following categories:

Accounts and cards
Private-label credit processors
Checks Person-to-person and money transfer
ACH Online bill pay
Non-prepaid debit Walk-in bill pay
General-purpose prepaid Private-label ACH debit
Private-label prepaid issuers & processors Online payment authentication
General-purpose credit Mobile wallet
Private-label credit merchant issuers  

Here is another table that is just one extract from the non-prepaid debit card portion of the extensive payments data available.

To get a taste of what this data can teach us, let's look closer at the cumulative volume distribution by payment dollar value threshold for non-prepaid debit cards (the data are shown above) along with general-purpose credit cards. The number and value of both types of payments grew substantially from 2012 to 2015, the last two survey periods. The chart compares these distributions, showing more vividly how this growth affected the relative proportions of payments of different dollar values.

Chart-two

For example, debit card payments below $25 accounted for 59.1 percent of all payments in 2012 versus 61.8 percent in 2015—evidence that debit card purchases are migrating to lower ticket amounts. The trend is even more dramatic over the same time span for general-purpose credit cards.

Because this is a distribution, increases in the relative number of small-value payments must be offset by decreases in the relative number of large-value payments. Unfortunately, our previous survey capped the payment threshold at $50 in 2012. Otherwise, we would see the dashed 2012 lines crossing over the solid 2015 lines at some payment value threshold above $50. In brief, the results suggest cash payments are continuing to migrate to debit cards, while credit cards may be garnering some share at the expense of both cash and debit cards.

The challenge is on for you data analysts out there. Please share your findings.

Photo of Steven Cordray  By Steven Cordray, payments risk expert in the Retail Payments Risk  Forum at the Atlanta Fed

August 14, 2017 in ACH, cards, checks, debit cards, mobile payments, payments study | Permalink

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August 7, 2017


Are Business Payments Directories Coming to the Fore?

Financial institutions (FIs), service providers, and particularly businesses have been dreaming of a ubiquitous payments directory for business-to-business (B2B) payments over the last five years or so. Payments directories give payers the ability to quickly look up accurate account and routing information to originate payments of all types to payees. Directories reduce friction and time needed to efficiently and accurately make payments and accelerate the transition away from checks.

That the dream is getting closer to reality became obvious to me in April, when I attended a NACHA Payments Conference that included the panel discussion "Can a B2B Directory Service Advance e-Payments?" Significantly, one of the panelists was the chair of the Business Payments Directory Association (BPDA), a nonprofit initiative to advance an open, nonproprietary B2B directory for small and large businesses. The independent BPDA has the support of the Business Payments Coalition comprising banks, industry associations, service providers, and businesses.

Businesses wanting to pay other businesses have a variety of payment instruments to choose from—check, ACH credit, wire, and card—with consequential differences among them such as costs, payment reconciliation, and funds availability. Though ACH has made significant inroads into B2B payments, particularly for large businesses, checks are still the fallback payment method when payers are not sure if the payee is willing to accept anything else. Checks are still widely accepted, and attaching associated remittance information with the check is straightforward. The ease of paying by check contrasts with the potential difficulty of determining whether the payee is willing to accept electronic payments and of getting accurate account and routing information.

Essentially, any B2B directory should contain all the information a payer needs to specify the payee’s payment account and route the payment electronically. Typically, directories by themselves do not clear and settle payments. The idea behind the BPDA initiative is that each payee in the directory is provided an electronic payment identity (EPI). That EPI uniquely identifies a payee and supports multiple payment accounts. It also specifies the payee’s preferred way to be paid, the type of remittance information needed, and preferred remittance delivery methods. A payee owns its EPI, which is portable across multiple subdirectory providers. As envisioned, a central node would link multiple subdirectories containing EPIs, each managed by a subdirectory provider that validates payee information so that it can be trusted. Subdirectory providers can include FIs, service providers, and payment networks. All of this is managed by the BPDA that sets rules, credentials subdirectory providers, payees and payers, and oversees the central node.

The image illustrates the process. Payers query the system to retrieve account and routing information from payees. They can then use this information to originate a payment through existing payment rails.

Chart-one

The BPDA lists several advantages of this approach, including these:

  • Payees can centrally communicate preferred payment methods and the information needed to effect payments by payers.
  • Payers can centrally retrieve accurate payee payment and remittance content and delivery preferences.
  • Friction for noncheck payments between payees and payers is reduced.
  • Minimizes misdirected payments.

One lingering concern about having a centralized directory is the risk that fraudsters could gain access to account numbers of large businesses for producing counterfeit checks or unauthorized transactions. In addition to the need for robust credentialing, one mitigant the system offers is that account information can be made private and restricted to specific payers.

It will be interesting to see how this nascent service shakes out given hurdles in governance framework, garnering industry support, developing a funding model, and, of course, getting businesses to enroll and participate. What are your views on the future of B2B directories?

Photo of Steven Cordray  By Steven Cordray, payments risk expert in the Retail Payments Risk  Forum at the Atlanta Fed

August 7, 2017 in ACH, banks and banking | Permalink

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June 26, 2017


Responsible Innovation, Part 2: Do Community Financial Institutions Need Faster Payments?

In my last post, I introduced themes from a summit that the Retail Payments Risk Forum cohosted with the United Kingdom's Department for International Trade. The summit gathered payments industry participants to discuss faster payments and their effects on community financial institutions (FIs). This post, the second of three in a series, tackles the question of whether community FIs and their customers actually have an appetite for increasing the speed of payments.

A summit attendee from WesPay, a membership-based payments association in the United States, presented the findings of a survey of 430 U.S. FIs about current payments initiatives. An important discovery was that awareness and adoption of faster payments solutions remains low, as the responses to two survey questions indicate:

  • For same-day ACH, a majority (57 percent) indicated that the first phase—faster credits—"has had no measurable impact on our customers'/members' transactions."
  • When asked about the Federal Reserve Faster Payment Task Force, 34 percent of respondents indicated they were unaware of the initiative, and 46 percent indicated they had only high-level knowledge.

Responses to another of WesPay's survey questions suggest that, although there may be low awareness of many current initiatives, many financial institutions are recognizing that faster payments are inevitable. A majority (60 percent) agreed that faster payments initiatives are "an important development in the industry. However, our institution will be watching to see which platform becomes the standard."

NACHA's representative presented statistics from phase one of same-day ACH, with reminders about the phases to come.

  • Same-day ACH reached a total of 13 million transactions in the first three months (launched September 23, 2016).
  • Phase 2 will allow for direct debits to clear on the same day (to launch September 15, 2017).
  • Phase 3 will mandate funds availability for same-day items by 5 p.m. local time (to launch March 16, 2018).
  • The current transaction limit is $25,000, and international ACH is not eligible.

Results of a study by ACI Worldwide, a global payments processor, look a little different from WesPay's survey results. The study looked at small to medium-size enterprises to gauge real-time payments demand. For the U.S. respondents, the research revealed that:

  • Fifty-one percent are frustrated by delays in receiving payments.
  • Forty-two percent are frustrated by outgoing payments-delivery timeframes.
  • Sixty-five percent would consider switching banks for real-time payments.

We don't know yet what U.S. adoption rates will be, but Faster Payments Scheme Ltd. (FPS) in the United Kingdom already has a story to tell. U.K. panelists attending the summit at the Atlanta Fed stated that FPS has had constant adoption growth due to cultural change and customer expectations.

  • FPS reached a total of 19 million transactions in the first three months (launched May 27, 2008).
  • The FPS transaction limit increased in 2010 from £10k to £100k, and then to £250k in 2015.
  • On April 2014, Paym, a mobile payments service provider, launched, using FPS. Paym handles person-to-person and small business payments, similar to Zelle in the United States, which started up in June 2017, using ACH.
  • FPS had a total volume of 1.4 billion items in 2016.

For payment networks offering new solutions, community FIs are the critical mass that ensures adoption. Their participation will require practical benefits with a lot of support before they are willing to commit. Some community FIs might be forced to adopt new systems because everyone else has. Will new networks in the United States contest same-day ACH, which already has the advantage of ubiquity? Likely, as options develop, so will customer culture and expectations.

In the final installment of this "Responsible Innovation" series, I will look at future impacts of faster payments.

Photo of Jessica Washington  By Jessica Washington, AAP, payments risk expert in the Retail Payments Risk Forum at the Atlanta Fed

June 26, 2017 in ACH, banks and banking, financial services | Permalink

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June 19, 2017


Calculating Fraud: Part 2

Part 1 of this two-part series outlined an approach for whittling down credit card transactions to the value or number of authorized and settled payments as the denominator for calculating a fraud rate. This post reviews the elements needed to quantify the numerator.

To summarize from the previous post, when analyzing credit card fraud rates, you should consider what is being measured and compared. To calculate a fraud rate based on value or number, you need a fraud tally in the numerator and a comparison payment tally in the denominator. The formula works out as follows:

Fraud Rate = Numerator
                      Denominator

Where, for any given period of time
Numerator = Value, or number of fraudulent payments across the payments under consideration,
Denominator = Value, or number of payments under consideration.

Before calculating the numerator value, you must first decide what types of fraud to include in the measurement. One stratification method divides fraud into the following two categories:

  • First-party payments fraud results when a dishonest but seemingly legitimate consumer exploits a merchant or financial institution (FI). That is, the legitimate cardholder authorizes a credit card transaction as part of a scam. One manifestation of this is "friendly fraud," whereby a consumer purchases items online and then falsely claims not to receive the merchandise.
  • Third-party payments fraud occurs when a legitimate cardholder does not authorize goods or services purchased with his or her credit card. Besides the victimized cardholder, the other two parties to the transaction are the fraudster and the unsuspecting merchant or FI.

Sometimes no clear delineation between first-party and third-party fraud exists. For example, a valid cardholder may authorize a payment in collusion with a merchant to commit fraud.

The 2016 Federal Reserve Payments Study used only third-party unauthorized transactions that were cleared and settled in tabulating fraud. The study measured and counted fraud as having occurred regardless of whether a subsequent recovery or chargeback occurred. Survey results had to be adjusted because some card networks report gross fraud while others report net fraud, after recoveries and chargebacks. Furthermore, the study made no effort to determine which party, if any, in the payment chain may ultimately bear the loss. Finally, the study did not measure attempted fraud.

Excluding first-party payments fraud
The study excluded first-party fraud due to the greater ambiguity around identifying and measuring it along with the idea that it is difficult to eliminate, given that controls are relatively limited. One control option would be to place repeat offenders on a negative list that, unfortunately, might not be shared with other parties. As a result of excluding first-party fraud, the study focused on fraud specific to the characteristics of the payment instrument being used.

Paraphrasing from page 30 of the 2013 Federal Reserve Payments Study, first-party fraud, while important, is an account-relationship type of fraud and typically would not be included as unauthorized third-party payments fraud because the card or account holder is by definition authorized to make payments. Consequently, first-party fraud can occur no matter how secure the payment method.

As with tallying payments, you could follow a similar process for tallying fraudulent payments for other types of cards payments, with more questionnaire definitions and wording changes needed for other instruments such as ACH and checks.

Photo of Steven Cordray  By Steven Cordray, payments risk expert in the Retail Payments Risk  Forum at the Atlanta Fed

June 19, 2017 in ACH, cards, checks, debit cards, fraud | Permalink

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May 8, 2017


Calculating Fraud: Part 1

When analyzing payments fraud rates, we have to consider what is being measured and compared. Should we measure fraud attempts that might have been thwarted—fraud that penetrated the system but might not necessarily have resulted in a loss—or fraud losses? Whatever the measure, it is important that the definition of what is included in the numerator and denominator be consistent to properly represent a fraud rate.

In calculating a fraud rate based on value or number, a fraud tally is needed in the numerator and a comparison payment tally in the denominator. The formula works out as follows:

Fraud Rate = Numerator
                     Denominator

Where, for any given period of time
Numerator = Value, or number of fraudulent payments across the payments under consideration,
Denominator = Value, or number of payments under consideration.

This post offers a process for tallying payments for the denominator. Part 2 of this series will focus on tallying the numerator, basing its approach on the process that the Federal Reserve Payments Study 2016 used. That process includes fraud that initially cleared and settled, not attempts, and does not exclude losses subsequently recovered.

The Fed’s 2016 payments study offers a method for whittling down all payment transactions to a subset of transactions suitable for calculating a fraud rate. Below is an extract, with clarifying commentary, from one of the study’s questionnaires, which asked card networks for both the value and number of payments.

Chart-one2

At first blush, totals for value or number under questions 1, 2, 3, and 4 could conceivably be used to provide a comparison tally for fraud. However, we should rule out the total from question 1 since the definition includes declined authorizations, making it unnecessarily broad. Question 2, "total authorized transactions," has the disadvantage of including pre-authorization only (authorized but not settled). While some of these transactions could have been initiated as part of a fraud attempt, they were never settled and consequently posed no opportunity for the fraudster to take off with ill-gotten gains. On balance, the preferred measure for payments is the result of question 3, which measures "net, authorized, and settled transactions." Unlike "net, purchased transactions" under question 4, this measure has the benefit of not excluding some of the fraud captured by chargebacks under question 3b.1. Other types of fraud are not covered under chargebacks, including when card issuers elect to absorb losses on low-value payments to avoid the costs of submitting a chargeback.

We could follow a similar process for tallying payments for ACH and checks, with adjustments to account for potential fraud resulting from the lack of an authorization system like that for cards, which requests authorization from the paying bank.

Part 2 of this series, which covers the process for calculating the numerator, will appear in June.

Photo of Steven Cordray  By Steven Cordray, payments risk expert in the Retail Payments Risk  Forum at the Atlanta Fed

May 8, 2017 in ACH, checks, debit cards, fraud | Permalink

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February 6, 2017


ACH: No Trace Left Behind

In my payments research role, I believe that one problem with ACH is the lack of any definitive method for identifying a payment and any associated return, dishonored return, or contested-dishonored return using only the existing 15-digit trace number. Ideally, the trace number alone should facilitate the correct retrieval of payment or return details even if other payments contain duplicate payment details, such as for recurring payments.

This PDF file contains an image that outlines the complex web of relationships that can be used to trace back returns to the original payment. Without the benefit of a unique trace number, the identification of the original payment could involve using common data elements to minimize misidentifying the payment.

A unique trace number would offer the following advantages:

  • Unambiguously identify a specific payment
  • Facilitate tracking features similar to what is available from package delivery services such as transmittal, settlement and receipt date/time, and similar tracking of any associated return(s)
  • Enhance risk-monitoring capability
  • Simplify reconciliation and auditing
  • Flag or prevent a return from settling before its associated forward payment
  • Identify "orphan" returns sent across the public network when the original payment was sent privately between financial institutions (FI)
  • Link together forward and return payments for certain international payment applications that are not possible today

Under NACHA rules, the FI originating the payment assigns a unique 15-digit trace number; the trace number's uniqueness is necessary to differentiate each payment in the batch. Uniqueness is not mandated across payments in other batches in the same payments file. Consequently, a trace number could be repeated in multiple payment files on the same day or across many days—and, even more troublesome, within the same payments file. NACHA strives for uniqueness by mating the trace number with an associated batch number, transmission (file creation) date, and a file ID modifier. Unfortunately, any return of a payment only passes along the original trace number without the benefit of the mated data.

A possible solution that could overcome the current limitations of the trace number would be a one-time-use, ACH-operator-assigned, 15-character alphanumeric trace number. When the originating network operator receives a file, the operator would replace the FI trace number with a unique trace number that he or she would forward to the receiving FI. Any return sent back to the originating FI would have the unique operator trace number converted back to the original FI trace number. For convenience, a cross-reference file associating operator trace numbers with FI trace numbers could help facilitate non-network communication between originating and receiving banks.

Operators could guarantee uniqueness by allowing an operator trace number to contain digits and upper and lowercase letters. Expanding to a 62-character set results in over 3.5 trillion distinct values using the last seven characters of the trace number (the first eight characters are the originating FI's routing and transit number). Further requiring at least one non-numeric character allows differentiation with FI numeric-only trace numbers.

What are your views on the benefits and disadvantages of non-repeatable trace numbers?

Photo of Steven Cordray  By Steven Cordray, payments risk expert in the Retail Payments Risk  Forum at the Atlanta Fed

February 6, 2017 in ACH, payments | Permalink

Comments

If the unique trace number could be assigned on the FI side, it would eliminate the extra step of forwarding of a unique number (which has its own chance of failing to forward) and some possible non-repudiation risks.

Perhaps this could be done by assigning each FI their own identifier, and pair that identifier with a unique number which is never used across batches, file IDs or dates. (A unique ID which is never reused since the FI Identifier would always make it unique across all FIs).

This would mean changes on the FI side and so some analysis would have to be done to find the cost benefits for NACHA, FI and FRS.

Posted by: B. Guhanick | February 8, 2017 at 09:40 AM

I like this idea. It would also make it extremely easy for an FI to research a transaction within their records by using the unique trace number. You are looking at around 20 billion transactions per year so the 3.5 trillion should easily cover the 6 year record retention requirement.

Posted by: David L Payne | February 7, 2017 at 06:58 AM

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January 9, 2017


The Year in Review

As we move into 2017, the Take on Payments team would like to share its perspectives of major payment-related events and issues that took place in the United States in 2016, in no particular order of importance.

Cybersecurity Moves to Forefront—While cyber protection is certainly not new, the increased frequency and sophistication of cyber threats in 2016 accelerated the need for financial services enterprises, businesses, and governmental agencies to step up their external and internal defenses with more staff and better protection and detection tools. The federal government released a Cybersecurity National Action Plan and established the Federal Chief Information Security Office position to oversee governmental agencies' management of cybersecurity and protection of critical infrastructure.

Same-Day ACH—Last September, NACHA's three-phase rules change took effect, mandating initially a credit-only same-day ACH service. It is uncertain this early whether NACHA will meet its expectations of same-day ACH garnering 1 percent of total ACH payment volume by October 2017. Anecdotally, we are hearing that some payments processors have been slow in supporting the service. Further clarity on the significance of same-day service will become evident with the addition of debit items in phase two, which takes effect this September.

Faster Payments—Maybe we're the only ones who see it this way, but in this country, "faster payments" looks like the Wild West—at least if you remember to say, "Howdy, pardner!" Word counts won't let us name or fully describe all of the various wagon trains racing for a faster payments land grab, but it seemed to start in October 2015 when The Clearing House announced it was teaming with FIS to deliver a real-time payment system for the United States. By March 2016, Jack Henry and Associates Inc. had joined the effort. Meanwhile, Early Warning completed its acquisition of clearXchange and announced a real-time offering in February. By August, this solution had been added to Fiserv's offerings. With Mastercard and Visa hovering around their own solutions and also attaching to any number of others, it seems like everybody is trying to make sure they don't get left behind.

Prepaid Card Account Rules—When it comes to compliance, "prepaid card" is now a misnomer based on the release of the Consumer Financial Protection Bureau's 2016 final ruling. The rule is access-device-agnostic, so the same requirements are applied to stored funds on a card, fob, or mobile phone app, to name a few. Prepaid accounts that are transactional and ready to use at a variety of merchants or ATMS, or for person-to-person, are now covered by Reg. E-Lite, and possibly Reg. Z, when overdraft or credit features apply. In industry speak, the rule applies to payroll cards, government benefit cards, PayPal-like accounts, and general-purpose reloadable cards—but not to gift cards, health or flexible savings accounts, corporate reimbursement cards, or disaster-relief-type accounts, for example.

Mobile Payments Move at Evolutionary, Not Revolutionary, Pace—While the Apple, Google, and Samsung Pay wallets continued to move forward with increasing financial institution and merchant participation, consumer usage remained anemic. With the retailer consortium wallet venture MCX going into hibernation, a number of major retailers announced or introduced closed-loop mobile wallet programs hoping to emulate the success of retailers such as Starbucks and Dunkin' Brands. The magic formula of payments, loyalty, and couponing interwoven into a single application remains elusive.

EMV Migration—The migration to chip cards and terminals in the United States continued with chip cards now representing approximately 70 percent of credit/debit cards in the United States. Merchant adoption of chip-enabled terminals stands just below 40 percent of the market. The ATM liability shift for Mastercard payment cards took effect October 21, with only an estimated 30 percent of non-FI-owned ATMs being EMV operational. Recognizing some of the unique challenges to the gasoline retailers, the brands pushed back the liability shift timetable for automated fuel dispensers three years, to October 2020. Chip card migration has clearly reduced counterfeit card fraud, but card-not-present (CNP) fraud has ballooned. Data for 2015 from the 2016 Federal Reserve Payments Study show card fraud by channel in the United States at 54 percent for in person and 46 percent for remote (or CNP). This is in contrast to comparable fraud data in other countries further along in EMV implementation, where remote fraud accounts for the majority of card fraud.

Distributed Ledger—Although venture capital funding in blockchain and distributed ledger startups significantly decreased in 2016 from 2015, interest remains high. Rather than investing in startups, financial institutions and established technology companies, such as IBM, shifted their funding focus to developing internal solutions and their technology focus from consumer-facing use cases such as Bitcoin to back-end clearing and settlement solutions and the execution of smart contracts.

Same Song, Same Verse—Some things just don't seem to change from year to year. Notifications of data breaches of financial institutions, businesses, and governmental agencies appear to have been as numerous as in previous years. The Fed's Consumer Payment Choices study continued to show that cash remains the most frequent payment method, especially for transactions under 10 dollars.

All of us at the Retail Payments Risk Forum wish all our Take On Payments readers a prosperous 2017.

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Mary Kepler
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Julius Weyman
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Doug King
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Dave Lott
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Jessica Washington
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Steven Cordray

 

January 9, 2017 in ACH, ATM fraud, cards, chip-and-pin, cybercrime, debit cards, emerging payments, EMV, fraud, mobile banking, mobile payments, P2P, prepaid, regulations | Permalink

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October 3, 2016


Looming Questions with the Rollout of NACHA's Mandated Same-Day ACH Rules Change

On September 23, phase 1 of NACHA's three-phase rules change took effect, mandating two same-day ACH clearing/settlement windows for credits only. The subsequent two phases add debit payments in 2017 followed in 2018 by receiving banks being obligated to make credit payments available to receivers by 5 p.m. on the settlement day.

Prior to this change, using legacy ACH, one had to wait one business day for payments to clear and settle. A payment cap of $25,000 along with a mandatory interbank fee of 5.2 cents are other noteworthy differences for same-day ACH items as compared to legacy ACH. For some, these are unwelcome limits and fees, and time will tell the extent to which they stifle (or not) the service's growth. As the Federal Reserve's Financial Services website notes, a further limitation is that the federal government will neither originate nor accept same-day payments at this time, although plans are under way for their eventual participation.

I and others in the forum have commented on various aspects of this long-awaited enhancement here, here, and here. Now is probably a good time to proffer some questions for future consideration in helping to measure the success of this new venture.

  • Will projections in the first 12 months of service match NACHA's expectations of same-day garnering one percent of total ACH payment volume? Furthermore, will volume trending point to NACHA achieving its projection of 1.4 billion same-day payments by 2027? Early numbers may be somewhat misleading if payment originators inadvertently send payments for same-day settlement that were intended to be settled the following business day.
  • Whatever volume is achieved, will the primary payment use cases identified by NACHA be the actual drivers of same-day volume?
    • Payroll for hourly workers, late and emergency payrolls
    • Business to-business invoice payments with remittance information between trading partners that are under the $25,000 cap
    • Expedited consumer bill payments using both ACH credits and debits for just-in-time and late payments
    • Account-to-account transfers among accounts owned by the same consumer
  • Given the 18-month full implementation, how will same-day ACH hold up against existing faster payment schemes that leverage such things as debit card networks that offer much faster payments or even new faster payment schemes that are not reliant on existing payment rails?
  • How much, if any, will payment fraud increase with the availability of faster ACH?
  • How will service usage be impeded, if at all, by originating banks passing along the cost of the interbank fee to their payment originators?
  • Will the somewhat complicated eligibility requirements of no support for federal government payments, deferred debit, service and delayed funds availability slow adoption?

Despite these questions, there is reason to be optimistic. This is a major step forward for same-day ACH. What are your views on how these questions will eventually resolve themselves?

Photo of Steven Cordray  By Steven Cordray, payments risk expert in the Retail Payments Risk  Forum at the Atlanta Fed

October 3, 2016 in ACH | Permalink

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August 22, 2016


As with Nuclear Disarmament, So with ACH: Trust, but Verify

During his remarks at the signing of a nuclear disarmament treaty with the U.S.S.R. in 1987, President Ronald Reagan drew upon the old Russian maxim, "Doveryai, no proveryai," or "Trust, but verify." As with disarmament, businesses and others that originate automated clearing house (ACH) payments should be offered some way to verify an account, something more than hope and a prayer that the payment recipient's routing/transit number and account number are correct and that the recipient is an owner of the account.

The lack of efficient account validation options is a common complaint against the ACH. Surveys that NACHA conducted in 2012 and 2015 attest that account validation, as judged by a majority of respondents, is ACH's chief improvement need. Failing to perform account validation creates different levels of risk, depending on the payment application, whether a credit is pushed or debit is pulled and whether it is a recurring or one-time payment.

On July 19, NACHA's Payments Innovation Alliance and Board Advisory Group released two papers reviewing and critiquing existing methods for verifying bank accounts by financial institutions and businesses. The papers also suggest that a remedy to the account validation problem may be in the offing.

In both papers, NACHA defined account validation as follows:

A service wherein a business or financial institution can validate the accuracy of the account information received from a consumer or business, and the ability of that account to receive electronic payments.

Following are the various methods that NACHA identifies—and that I've complemented with my own research—that are used today to validate accounts:

  • Manual validation—A consumer's check verifies the account and identification verifies the consumer's identity. Alternatively, the originator can call the recipient's bank to confirm account details, assuming the bank is willing to provide the information, though it is risky for the bank to share such information over the phone.
  • ACH validation, via a zero-dollar prenote verification payment—If the account number is incorrect, the recipient's bank responds within three business days, though this timeframe can be shortened by using same-day ACH. As the papers state, this is a "no news is good news" form of verification. NACHA is exploring opportunities to improve the prenote process beginning in late 2016.
  • Challenge deposit validation—Typically, two micro-deposits of random amounts are made to the recipient's account and subsequently verified by the accountholder to the payment originator. Even if the account is successfully verified, the originator may subsequently be unable to debit the account because that account blocks debit payments. To identify debit blocked accounts, some originators debit the bank account equal to the micro-deposits. This method is fraught with a high abandonment rate by the consumer due to the hassle of verifying the deposits. One large online originator says that about 30 percent of consumers selecting the deposit validation method fail to verify the payment amounts. This method can take from five to seven business days—though, as with prenoting, the process can be expedited by using same-day ACH.
  • Instant validation—The customer logs into his or her bank from the company's website to establish ownership of the account. The same online originator said that 25 percent of its customers selected this validation method over deposit validation. Many consumers hesitate to use this method because the use of a third party increases the chance their banking credentials will be compromised.
  • Validation services—Service providers with access to a large number of accounts, offer scoring services that simulate or predict the likelihood an account number is "good." Though improving, these service offerings are limited for non-financial institution originators.

A solution to the problem may be in store through the World Wide Web Consortium and others working to develop a standardized application programming interface, or API, for account validation. This would allow payment originators or their service providers restricted access to bank data to verify accounts using a universal, standardized process while protecting banking credentials. Let's hope that key stakeholders rally around this important initiative and push for a speedy implementation so that we carry through with a new maxim of "Trust, but truly verify."

Photo of Steven Cordray  By Steven Cordray, payments risk expert in the Retail Payments Risk  Forum at the Atlanta Fed

August 22, 2016 in ACH, authentication | Permalink

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May 23, 2016


What Would Happen If the Lights Went Out for a Long, Long Time?

In 1859, a massive geomagnetic solar storm known as the Carrington Event caused extensive damage to telegraph systems and other nascent electrical devices worldwide. Telegraph lines sparked and telegraph operators could send and receive messages without the use of electric batteries. The Northern Lights lit up the sky in all of North America. Though not widely reported, on July 23, 2012 a massive cloud of solar material similar in magnitude to the Carrington storm erupted off the sun's surface, radiating out at 7.5 million miles per hour. Fortunately the impact of the solar storm missed Earth by nine days because of the Earth's orbit position.

One report estimates that a Carrington-level storm today could result in power outages affecting as many as 20–40 million Americans for a duration ranging from 16 days to two years at an economic cost of up to 2.5 trillion dollars. A research paper in Space Weather estimated the odds of a Carrington-level storm at about 12 percent over the next 10 years. Early warning of such a storm is possible since satellites can detect impending storms and have the potential to provide a minimum one-day warning before it hits Earth.

So what would happen if the lights went out in much of the United States because of such a cataclysmic event? One could anticipate serious disruption of electronic payments such as ACH, cards, and wire transfers in the affected areas and beyond. What would one do to facilitate commerce in such an emergency? Well, cash and, to a lesser degree, checks could come to the fore. Use of checks would be problematic given the electronification of checks, high risk of fraud, and overdrawn accounts if banking systems are not up and running. Cash would have fewer problems if it were on hand to distribute to the affected population. Perhaps cash accompanied by ration books could be used to mitigate hoarding.

For a low-probability extreme-impact event that results in cash becoming the only way, among existing payment instruments, for commerce to take place, what contingency plans are in place to ensure that consumers and businesses can obtain cash? Since the contingency systems we have in place to handle a future Hurricane Katrina or Hurricane Sandy are likely not sufficient for an extreme event of nationwide scale, some of the issues that need to be resolved include:

  • How does one ensure that sufficient cash is on hand during an emergency?
  • How is cash going to be distributed and accounted for along the supply chain with ATMs and bank offices and their core systems inoperable due to no electricity?

Addressing these questions and others involves a monumental effort, and I don't have a ready answer. Fortunately, cash solves the problem for small-scale, low-value payments during a long-term power outage. That is, during the immediate, in-person exchange, it is an instrument that doesn't require electricity, communication networks, or computers.

This and other major calamities have always made me concerned about the push in some quarters for a full transition to electronic payments at the expense of payments less reliant on electricity and our communication networks. As an engineer by training, it is in my nature to wonder what can go awry if failsafe systems aren't in place when the unexpected happens.

With the possibility of a catastrophic event in our lifetime, would you rather have cash in hand or a card/mobile app? As for me, I'm going to the bank to cash out my accounts and then on to the hardware store to buy a gas-powered electric generator. Just kidding, though I think serious consideration and appreciation is needed for the contingency aspects of cash when things invariably go awry.

Photo of Steven Cordray  By Steven Cordray, payments risk expert in the Retail  Payments Risk  Forum at the Atlanta Fed

May 23, 2016 in ACH, cards, checks, payments | Permalink

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