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.

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November 24, 2014

What’s Unsettled in Faster Payments?

When I started at the Federal Reserve Bank 27 years ago, the phrase "faster payments" was rarely spoken. Indeed, if people talking of payments were musing on speed (or the lack thereof), two things were a safe bet: first, the conversation was likely among bankers and, second, the talk revolved around check float and the tools for reducing it—check sort patterns, airplanes, or optimized ground routes. Those tools are not part of today's "faster payments" conversations, and the universe of discussants is much broader; it's not just bankers anymore.

Payments essentially comprise two components. The first is messaging—the instruction that delineates who is to be paid, by whom, and in what amount. The second component is settlement. Settlement is the event that finishes a payment. It is also commonly the slowest aspect within any given payment scheme. Settlement is the actual transfer of funds, the account adjustments directed by the messaging components.

For many payments, settlement takes much longer than appears to be the case, particularly from the perspective of the end user. For example, in a typical payment card transaction between a consumer and a retailer, once the card is swiped and "approved," the consumer is considered to have paid and can generally leave with the goods. But the merchant has received only the promise of payment. Settlement between card issuers and acquiring banks must occur before the merchant is paid. This can take more than a day and illustrates one issue with settlement lags: consequential strains on liquidity that merchants experience when they need to replace goods but may not have received payment to fund the resupply.

So will a faster payment solution resolve the liquidity issues currently experienced in many of the extant payment schemes? At this point, the answer is not a simple one. In town hall-style meetings and other updates, Fed speakers have noted that "real-time settlement is not required for real-time availability." This suggests that at least at the outset, a faster payments scheme here may not include immediate settlement. And if settlement does not occur simultaneously with messaging, certain parties in the transaction remain exposed to liquidity as well as other settlement risks. This doesn't mean that a new scheme will be plagued with settlement risk. The UK has successfully offered real-time clearing and availability without real-time settlement. However, other countries have built real-time settlement into their new systems because it does indeed reduce systemic risk. If a new system here is to be built from scratch, it seems important to probe fully the range of design issues and options and consider solving all of the longstanding payment risks that can be feasibly solved.

By Julius Weyman, vice president, Retail Payments Risk Forum at the Atlanta Fed

November 24, 2014 | Permalink


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From my vantage point of having being involved with the implementation of Faster Payments for a Top 5 UK Bank, I believe the non-availability problem is overstated: (1) Retailers typically enjoy 30-60-90 days credit from their suppliers, so having to wait for a few hours / couple of days for their sales proceeds via a non realtime settlement system like FPS shouldn't really affect their ability to fund resupplies (2) In fact, immediate realization of sale proceeds may ironically cause problems for some of them! A couple of days after FPS went live in May 2008, I remember a leading MNO calling us up and telling us NOT to credit their customer payments immediately. When we inquired why, they told us that their payable systems swept their collection accounts only for bills due 2 days before. So, after FPS, they started missing payments that were credited on the due date. This apparently led them to suspending service to their prompt paying customers and all kinds of customer dissatisfaction!

PS: Hi @TomH: Nice to bump into you on Portals & Rails!

Posted by: Ketharaman Swaminathan (GTM360 Marketing Solutions) | November 27, 2014 at 08:15 AM

As someone who was heavily involved with the design of settlement for UK Faster Payments I can confirm that several options were considered before choosing the Deferred Net Settlement model, with exposure limits enforced per bank. Real-time settlement imposes a huge load on RTGS systems which were designed to handle low volumes of high value transactions, not high volumes of low value. It also adds significant complexity to ensuring integrity across the sending and receiving bank systems, the message switch and the RTGS system, as well as adding a delay to message processing and introducing a potential single point of failure.

Banking is about determining acceptable risk levels, not completely eliminating risks. RIsk experts must work closely with their technical colleagues to create a system design that balances settlement risk management with system performance, integrity and cost.

Posted by: Tom Hay | November 26, 2014 at 02:55 AM

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